IFRS 9 | 4Q25 results update: from 'all clear' to 'hold on tight': the rollercoaster just set off again.
Looking backwards, the credit risk outlook from banks in their year-end results was very benign. The flat ECL trends we saw the first half of 2025 continued into the second half, with the 4Q25 results giving a very modest reduction in ECL coverage, reflecting the stable economic outlook. Credit quality remained high, with the percentage of loans in Stage 3 reaching a new post-2019 low. PMAs stayed small as a proportion of ECL, but increased marginally in the last quarter, primarily because of model and data limitation overlays.
Given the events since late February, this view feels outdated, and uncertainty has returned. The duration and impact of the conflict in the Middle East is highly uncertain, but it seems likely there will be both a downgrade to the economic outlook for March reporters and some real credit impact.
However, we have been through multiple significant shocks since the end of 2020, and lending portfolio performance has been resilient. The mood music we are hearing is that lenders are reacting cautiously, and not over-reacting. But events are moving fast.
ECL coverage was broadly flat in 4Q25
ECL coverage has stayed broadly flat since 4Q24 and loan quality indicators have shown an improving trend with the proportion of loans in both Stage 2 and Stage 3 falling over 2025 (Figures 1, 2, 3).
The base case outlook remained stable
The economic outlook for 2026 (as of 4Q25) remained broadly stable, with only modest shifts in key variables: GDP and bank rate improved while house prices softened, and unemployment is slightly higher. Scenario weights have shifted towards base and downside.
However, the situation changed significantly at the end of February with the start of conflict in the Middle East and subsequent volatility in the markets and, in some places, real world impacts to reduce fuel and energy consumption (e.g. Philippines and Sri Lanka). It seems likely that 1Q26 will see a deterioration in outlook but the extent of this is currently unclear.
The Bank of England has signalled its 2Q26 UK inflation forecast has been revised upwards to 3.0% from 2.1% in Feb-26, a projection made before the recent energy price surge caused by infrastructure strikes. Consequently, rates markets rapidly repriced through early to mid-Mar-26, with SONIA swap rates shifting to reflect approximately 75 basis points of tightening this year, a dramatic reversal from the 50 basis points of cuts priced in late Feb-26, alongside a broader market consensus for reduced UK GDP growth and increased unemployment.
Headline unemployment numbers suggest a weakening labour market… but the picture underneath is more nuanced
Focusing on headline unemployment figures, the headline unemployment rate reached a post-pandemic high of 5.2% in 4Q25. Concurrently, real wage growth decelerated to 0.5%, despite a slight increase in vacancies.
However, under the surface, the ONS data shows a more nuanced picture. The rise in unemployment has disproportionately affected younger age groups - the rate for 16-17 year-olds has increased to 34%, and for 18-24 year-olds, to 14%. Overall youth unemployment has risen to 16.1%, its highest level in over a decade and is now higher than the EU average for the first time since records began at the turn of the millennium.
Furthermore, economic inactivity has fallen to its lowest levels since 2020. This could also explain the recent uptick in unemployment as the overall labour force is increasing in size, the number of available vacancies is shrinking. This is reflected in the consistent increase in the number of unemployed persons per vacancy in the latest ONS data.
The rise in unemployment, primarily among younger and re-entering workers, poses a muted credit risk due to their limited borrowing as a cohort. While data from Dec 25 suggest that the peak of unemployment had passed, and the base case outlook for unemployment remains benign, there are some concerns regarding the future trajectory, given the combined challenges stemming from technological advancements, fiscal policies, and tariff changes.
Neither business nor consumer confidence indicators were showing signs of stress
Business sentiment remains mixed, having trended slightly below long-term averages since 2Q24. Survey evidence from the British Chambers of Commerce (BCC) and the Federation of Small Businesses (FSB) indicated a softening in business confidence in 4Q25. Looking ahead, sentiment is expected to deteriorate further as the energy-driven inflation shock and tighter financial conditions weigh on businesses.
The GfK consumer confidence remained around the long-term average level with no indications of stress. Further, credit card transaction data in Dec-25 (Figure 9) indicates robust transaction volumes, suggesting no immediate concerns regarding consumer confidence.
UK housing market: a mixed picture in London
While UK house prices grew by approximately 1% year-on-year in Jan-26 (Figure 10), this masked some interesting regional divergence. Across most regions, prices remain close to post-pandemic peaks but consistently above their 2007 levels. Year-on-year changes highlight these disparities, showing modest growth in most areas, offset by falls in London which are highly polarised at borough level. The largest annual falls are concentrated in prime/central boroughs (e.g. City of Westminster -14.9%), while several outer boroughs with better affordability have seen positive price changes (e.g., Bromley +6.8%).
The mortgage market's risk appetite strengthened in 4Q25, with a growing number of high loan-to-value (LTV) mortgage approvals. However, with the onset of the crisis in middle east mortgage lending is impacted by the recent volatility and sharp spike in short-term swap rates. This is evidenced by the withdrawal of 472 residential mortgage deals from the UK market between 9th and 11th March 2026, which pushed the average two-year fixed mortgage rate to 5.01%. Further, this directly impacts affordability for those remortgaging.
In terms of the rental market, the Dec-25 RICS report showed tenant demand slipped further into negative territory (-27%) before rebounding in early 2026. From hitting the lowest point since the pandemic in Dec-25, landlord instructions have remained negative indicating constrained supply. Zoopla reported falling renter demand and increased supply YoY in 1Q26, leading to an overall slowdown in rent inflation.
UK corporate insolvencies: beneath the headline
UK corporate insolvencies have increased from under 20,000 annually pre-Covid, to over 25,000 in 2023 and they have remained at a similar level since. This paints a negative picture of the health of UK businesses, but commercial lending portfolios have not seen a corresponding increase in defaults. This is particularly interesting given the common use of UK corporate insolvencies as a proxy for default in economic response models within low default portfolios. So, what is behind this seeming break in the relationship?
Deloitte's analysis of Companies House filings shows that the overall rise in insolvency rates since 2021 is mainly because of smaller businesses (Figure 14). These entities typically carry lower debt levels and do not typically form a significant part of banks' business lending portfolios from our experience of the UK credit market.
Insolvency rates for medium and large companies - defined as those filing "full", "group", or "medium" accounts - have been stable since 2022 and are lower than their pre-pandemic levels. These larger companies represent the majority of high-street lending business. Their share in the overall insolvency volume has also decreased from pre-Covid levels (Figure 15). Unsurprisingly, their insolvency trends align with the trends in the proportion of loans in Stage 3 and ECL cover seen in large banks' commercial portfolios.
Sectoral risk is also interesting, with ‘Finance & insurance’ and ‘Arts, entertainment, recreation & other’ sectors recording the highest corporate insolvency rates among larger UK companies in 4Q25.
Outlook
After a very benign finish to 2025, and a great start to 2026, we find ourselves in the midst of another unexpected shock with an opaque outlook at the time of writing. The initial view seems to be for increased inflation, higher energy costs, and higher borrowing rates, but the severity and longevity of these are uncertain.
While this is very concerning, the credit teams we are speaking to note that we have been here before more than once over the last few years, with a significant energy price shock in 2022, inflation and borrowing cost shocks in 2023, and friction over trade arrangements in 2025. Not forgetting Covid preceding these, in each case, and despite their cumulative effect, there was scant credit response from UK portfolios. However, the energy impact of the current conflict is being talked about as worse than the 1970s oil crisis and Ukraine invasion combined.
On the commercial lending side, like with tariffs in 2025, it seems likely that some sectors, geographies, and individual counterparties exposed to global supply chains, energy-intensive operations, or international trade with affected regions will be impacted, but that the scale of this direct impact for UK portfolios is likely to be limited. The question is whether further pressure on corporate debt service capability starts pushing more companies into difficulties… or whether there is enough resilience that loan books can absorb current turbulence. Also, the emerging signs of stress in some parts of the private credit market could worsen.
On the personal lending side, strong nominal wage growth has helped repair affordability. We’re moving into summer, more consumers are on fixed rate energy bills than previously, and there has been speculation in the media that the government may offer “targeted support” to those who need the most help with energy bills. The trajectory of the labour market will be critical.
The near-term prospects for cost of risk will depend on the extent of downgrades to the base case economic outlook and the degree to which banks resort to using PMAs to recognise some of the novel risks that are emerging for more exposed segments. We think that making any further predictions about the prospects for the credit outlook would be overly brave at this point.
