Banking tax raid fears hit London lenders' shares ahead of crucial budget

Shares in some of Britain's biggest banks sold off Friday amid reports that the U.K. government will hike taxes on London-listed lenders' profits later this month.

Lloyds Banking Group led losses, sliding 1.8%, while NatWest was 1.51% lower by 11:30 a.m. in London (6:30 a.m. ET).

Barclays moved 0.13% higher, reversing earlier losses. London-listed shares of HSBC and Standard Chartered — which both derive much of their profits overseas — added 1.2% and 0.71%, respectively.

Finance Minister John Healey is expected to raise the sector-specific surcharge on banks' profits to 8%, up from 3%, when he delivers his first budget as Chancellor, scheduled for Oct. 28.

The levy, which sits on top of corporation tax, was earlier cut to 3% from 8% under Rishi Sunak's Conservative government in 2023. While the hike could raise £2 billion ($2.67 billion) per year for the U.K. Treasury, it could also slice 6% off lenders' earnings, KBW analysts said in a note Oct. 12.

Healey on Thursday described banks as the "jewel" in the U.K.'s economic crown in an interview with Bloomberg.

However, the proposed levy has revived wider concerns about the Labour government's approach to financial services, and how the sector may be treated as ministers seek to fund public services and meet fiscal targets.

Amanda Blanc, CEO of Aviva, said the financial services sector is one of the U.K.'s "core industries".

"What you need to do is to encourage financial services to be successful," Blanc told CNBC's "Squawk Box Europe" on Friday. "My urge would be if you really believe that financial services is important, don't make it difficult for people to invest in the U.K., and for those businesses in the U.K. to invest in the U.K."

U.K. banks operate with a total tax rate of more than 46%, according to PwC data. That compares to 38.9% for banks in Frankfurt and about 27% in New York.

While the tax hike could overshadow lenders' upcoming third-quarter earnings and weigh on shares, analysts at Citi said the budget could act as a "clearing event," resolving uncertainty among lenders.

"Fears of a tax & spend (anti-growth) budget, combined with broader geopolitical events, have driven gilt yields higher," Citi said in a note Oct. 14. "This is beneficial for the banks' structural hedge roll benefit to NII, but also serves to increase CoE, which has driven a multiple de-rating and explains why U.K. banks trade at a discount."

Analysts led by Andrew Coombs, Citi's head of European financials equity, said U.K. bank fundamentals remain healthy, pointing to corporate releveraging, with lenders' net interest income growth among the highest in Europe.

Citi expects mixed third-quarter results, with adjusted pretax profit above consensus at Barclays and NatWest, but below at HSBC, Lloyds and StanChart.