Moody's on Friday downgraded its credit ratings for a dozen British lenders, including state-rescued Royal Bank of Scotland and Lloyds TSB, due to the removal and curtailment of government financial support.
Moody's said it chose to downgrade five large banks and seven small ones as government action had "significantly reduced the predictability of support over the medium- to long-term."
The downgrades did not concern major lenders HSBC, Barclays or Standard Chartered, the agency said in a statement. But it added that it believed Britain's government was now more likely to allow small lenders to fail if necessary.
The announcement comes as the European Union seeks swift recapitalisation of the region's banks to prevent the eurozone debt crisis spreading and a day after the Bank of England injected £75 billion (86 billion euros, $115 billion) of new money into Britain's stalled economy.Moody's had warned in May that it could downgrade the British banking sector.
Its decision to follow up that warning could now result in banks facing higher rates of interest when looking to borrow on the money markets, further hindering their attempts to strengthen their balance sheets.
Affected lenders' share prices slumped in London trade, with Royal Bank of Scotland (RBS) closing down 3.04 percent at 23.62 pence and Lloyds Banking Group, the parent of Lloyds TSB, losing 3.36 percent to 34.66 pence.
At the same time, London's benchmark FTSE 100 index finished 0.23 percent higher at 5,303.4 points, helped by positive US jobs data.
RBS said it was "disappointed" that Moody's had "not acknowledged the (bank's) progress ... in strengthening" its credit profile.
"We do, however, see the removal of implicit government support for the UK banking sector as being a necessary and important step forward as the sector returns to standalone strength," it added.
Lloyds, which is 40.2-percent state-owned, said the move would have little impact on funding costs.
"It is important to note that both the stand-alone rating and short-term ratings remain unchanged. We believe this change will have minimal impact on our funding costs," a Lloyds spokesman said.
The Financial Times newspaper reported meanwhile on Friday that the British government feared the prospect of injecting RBS with fresh capital under Europe-wide recapitalisation plans.
RBS received billions of pounds (dollars) of taxpayers money in one of the world's biggest-ever bank bailouts in the wake of the 2008 financial crisis, leaving it 83-percent owned by the British government.
Moody's stressed on Friday that its financial sector downgrades did "not reflect a deterioration in the financial strength of the banking system or that of the government."
Britain's finance minister George Osborne said that despite the downgrades, he was confident British banks were not facing the same problems as their eurozone peers.
"I am confident that British banks are well capitalised, they are liquid, they are not experiencing the kinds of problems that some of the banks in the eurozone are experiencing at the moment," he told BBC radio.
Chancellor of the Exchequer Osborne said the downgrades were in fact evidence that Britain's coalition government was taking the correct action in removing support from the banks.
"As I understand it, one of the reasons they (Moody's) are doing this is because they think the British government is actually moving in the direction of trying to get away from guaranteeing all the largest banks in Britain," he added.
Moody's said it downgraded RBS and Nationwide Building Society each by two notches to A2 from Aa3; Lloyds TSB Bank and Santander UK were cut by one notch to A1 from Aa3; the Co-Operative Bank was downgraded one level to A3 from A2.
"Moody's Investors Service has today downgraded the senior debt and deposit ratings of 12 UK financial institutions and confirmed the ratings of one institution," the agency said in a statement.
"The downgrades have been caused by Moody's reassessment of the support environment in the UK which has resulted in the removal of systemic support for seven smaller institutions and the reduction of systemic support ... for five larger, more systemically important financial institutions."
Moody's said it "believes that the government is likely to continue to provide some level of support to systemically important financial institutions ... However, it is more likely now to allow smaller institutions to fail if they become financially troubled."
It downgraded the seven smaller lenders by between one and five notches.