Further progress on a “bail in” regime to prevent future bank bailouts by taxpayers prompted Moody’s Investors Service to drop its outlook for the UK banking system to negative from stable on Tuesday.

The outlook change comes amid an improved operating environment for the banks themselves as the UK recovery gathers steam; but Moody’s notes that stronger results, and the banks’ stable financial fundamentals, will not be enough to fully offset the negative credit implications of the new resolution and bail-in regime.

“The key driver of the change in outlook to negative for the UK banking system is that the UK government is now able to finalise the secondary legislation to implement the structural reforms relating to the UK resolution and bail-in regime and the related ring-fencing framework” says Carlos Suarez Duarte, vice president and senior analyst at Moody’s.

This new regime for dealing with banks that run into financial trouble, and the ring-fencing of systemically important retail banks, “are designed to prevent the use of taxpayer funds to support failed institutions and to facilitate the going-concern loss-absorption of creditors, including senior unsecured bondholders,” it notes. Additionally, Moody’s says that banks in the UK also face continued exposure to conduct and litigation charges as well as other costs that might constrain profitability and erode capital for some banks.

That said, Suarez Duarte also says that the standalone baseline credit assessments (BCAs) of most UK banks are expected to remain stable “because of the country’s stronger economic growth prospects, improving asset quality and capital ratios, stable funding and liquidity metrics and strengthening profitability and efficiency ratios.”

The improved credit fundamentals put the banks in a stronger position to withstand unexpected shocks, such as a house price correction, Moody’s says. “In addition, a gradual increase in interest rates over the next two to three years, in line with our central forecast, will also help reduce the risk of a correction by dampening mortgage loan growth while also improving some banks’ profitability metrics” adds Suarez Duarte.

Moody’s also says that it expects the ratings of smaller banks and building societies to remain stable, as they don’t benefit from systemic support.