Lloyds, Barclays: Cash ISAs swell as UK savers shift into higher-yield deposits

UK savers' April shift into higher-yield cash ISAs and time deposits, as indicated by a 3.1% increase in time deposits and a 1.6% fall in sight deposits, is squeezing bank margins by raising average deposit rates to 2.23% and pushing deposit betas higher to 48%. UBS, while maintaining 'buy' ratings on Barclays, NatWest, and Paragon Banking Group due to strong revenue growth and attractive valuations, is more cautious on Lloyds and Close Brothers, citing slower growth and margin sensitivity; the shift highlights the importance of margin management for banks amid rising funding costs.

Analysis

UK savers demonstrated a significant shift towards higher-yielding cash ISAs in April, evidenced by a 3.1% month-over-month increase in time deposits and a corresponding 1.6% decrease in sight deposits, according to Bank of England data. This migration, while typical for the start of a UK tax year, carries material implications for bank profitability by elevating funding costs, as time deposits are more expensive to service. Consequently, the average deposit rate edged up to 2.23%, and deposit betas rose to 48%, signifying a greater portion of the prevailing interest rate environment is being passed to depositors, thereby compressing bank net interest margins (NIMs). UBS highlights this margin pressure as a key concern, even as the market sentiment towards the banking sector improves. Despite these headwinds, UBS maintains 'buy' ratings on Barclays PLC, NatWest Group PLC, and Paragon Banking Group PLC, citing expectations of strong revenue growth and attractive valuations, with these stocks trading at approximately 7.6 times forecast 2026 earnings and anticipated returns on equity nearing 15%. Conversely, UBS expresses more caution towards Lloyds Banking Group PLC and Close Brothers Group PLC, assigning them 'neutral' ratings due to their comparatively slower growth profiles and heightened sensitivity to margin erosion from escalating funding costs. The core issue is that increased flows into term deposits, while reflecting prudent saving, directly increase banks' operational costs, potentially capping NIM upside even amidst improvements in loan growth and fee income. Effective management of this margin squeeze will be a critical differentiator for banks in a market prioritizing reliable income and earnings visibility.

Key Decisions for Investors

• Investors should closely monitor individual bank net interest margin trends, as the observed shift in UK savings towards higher-cost time deposits is creating sector-wide funding cost pressures.
• Consider overweighting positions in banks like Barclays, NatWest, and Paragon, which UBS views as having strong revenue growth prospects and attractive valuations, potentially offering better resilience to margin pressures compared to peers.
• Exercise caution with banks such as Lloyds and Close Brothers, rated 'neutral' by UBS, due to their slower growth outlooks and greater vulnerability to margin compression if funding costs rise more sharply than anticipated; a thorough assessment of their cost management strategies is warranted.