It noted concerns about how these banks had grown quickly in the mortgage market raised questions about possible loosening of underwriting standards.
And added that a cyclical downturn or a disruptive no-deal Brexit leading to higher unemployment or falling property prices could expose weaknesses in their risk management and financial position.
It echoed concerns raised by the Bank of England earlier this month and predicted that some challenger banks may be required to set aside more capital.
The agency highlighted that these lenders have “grown fast in retail mortgage lending, often to niche borrowers, or in asset classes that perform less well in a stress, to gain a foothold in the market,” it said.
“We view sustained above-market-average growth as a potential risk to a bank’s credit profile because it may indicate under-pricing of risk or a loosening of underwriting standards to generate volume.”
Funding issues looming
Fitch noted that funding issues may become more pressing for smaller, newer banks given their source of deposits and the need to repay cash borrowed through the Term Funding Scheme.
“Challenger banks may also be more exposed to funding pressure in a downturn given their reliance on online retail deposits with short-term fixed rates, and deposits from SMEs and corporate clients,” it said.
“These sources of funding are more price-sensitive and less stable than current accounts, and could become more costly to attract and retain in the event of rising interest rates and financial pressure on consumers.
“UK banks, including some challenger banks, will need to refinance funding from the Bank of England’s low-cost Term Funding Scheme in 2020-2022, which could also push up funding costs.”