By Huw Jones
LONDON (Reuters) - Although the main banks have stepped up preparations for a potential no-deal Brexit, UK-based payment firms used by European Union customers are not ready, the bloc's banking watchdog said on Friday.
Britain's parliament is deadlocked over a divorce settlement that Prime Minister Theresa May has negotiated with the EU before the country's planned departure from the EU next March.
The impasse has increased the possibility of Britain crashing out of the bloc with no transition arrangements. The EU will ramp up contingency plans next week to avoid disruption to financial derivatives markets in particular.
But the European Banking Authority said in its annual Risk Assessment Report that it was concerned about the contingency plans of smaller and less sophisticated institutions like payment and e-money firms.
"The latter are of particular importance from an EU27 perspective, because of the large volumes of payments business being offered by UK-based institutions through their cross-border passporting activities," the EBA report said.
Being in an EU member state, payments firms in Britain can "passport" or sell their services to customers in the remaining 27 EU countries from a base in the United Kingdom.
Without the transition period included in the divorce settlement, payment firms in Britain would need to open new hubs in the EU by next March to continue serving customers there like many banks and insurers have already done.
"For such institutions, contingency planning, including relocation, where appropriate, is needed, and effective communication with customers ex-ante to prepare for any disruption is vital," the report said.
It said banks were holding more capital, but still failing to make enough money to be sustainable. Increased competition from financial technology or fintech firms could be making it harder for banks to increase profits.
Lending has begun to increase as the percentage of loans that have soured fell to 3.6 percent in June from 4.4 percent a year earlier. Non-performing loans (NPLs) are now at their lowest level since a common EU definition was introduced in 2014, when they stood at 6.5 percent.
Operational risk driven by cyberhacks and IT glitches continues to increase, fuelled by Brexit uncertainty, the EBA report said. "At the same time, conduct and legal risks, including breach of anti-money laundering regulations, have been on the rise in 2018."
The EBA also published its latest "transparency exercise" or 7,000 items of data on each of the 130 European banks the watchdog surveyed, a trove for bank analysts to crunch.
The data includes the first detailed information on government debt holdings. Exposures fell 2 percent to 3 trillion euros (£2.7 trillion), or about 10 percent of total assets over the year. Half of the banks' exposures are to the debt of their own country.
(Reporting by Huw Jones; Editing by Mark Heinrich; editing by David Stamp)