FTSE 350 banks: Bank on a bad year

In particular, the mounting toll from fines and compensation charges – largely for mis-selling payment protection insurance (PPI) – could harm sentiment. Lloyds (LLOY) is the sector's worst hit, with a painful £5.3bn PPI-related charge. Next comes Barclays (BARC), with a £2bn charge, followed by Royal Bank of Scotland (RBS) with a £1.7bn charge. More is thought to be on the way in 2013 with analysts at JPMorgan having estimated that the final cost could reach £15bn in total.

Other misdemeanours are also costing the banks dearly, with Standard Chartered (STAN) having been forced to cough up a total of $667m (£416m) in fines for allegedly avoiding US Iran sanctions, while HSBC (HSBA) was hit by a $1.92bn money laundering fine last month. Meanwhile, Barclays' £290m fine for Libor rigging last year could prove the tip of the iceberg, with RBS potentially facing a heavy Libor-related fine.

Then there's the problem of increasingly zealous regulation. Admittedly, extra regulatory costs are unlikely to materialise significantly during 2013, but they will eventually hurt. For example, a key proposal by the Independent Commission on Banking (ICB) to ringfence investment banking from retail banking won't become effective until 2019, but it's still estimated to come with at least a £4bn-7bn implementation cost. Moreover, politicians appear determined to attack the sector at every opportunity and the Parliamentary Commission on Banking Standards' first report this month has called for an even tougher approach than that proposed by the ICB. "The [the report's] proposals would give draconian, arbitrary powers to future generations of regulators and politicians," believes analyst Ian Gordon at broker Investec Securities.

The extra cost from holding more capital, and bolstering liquidity, as the Basel III rules begin to take effect is another factor. For instance, banks must – by 2019 – hold tier one capital (largely equity) that's equivalent to a minimum of 7 per cent of their assets, weighted for risk. But setting aside more capital to cover lending will constrain banks' ability to lend – bad news for earnings growth. It doesn't bode well for longer-term dividend prospects, either, as banks will be under pressure to hoard capital rather than reward shareholders.

But, perhaps the biggest near-term drag is the economic backdrop. The IMF is forecasting UK economic growth of just 1.1 per cent during 2013 – bad news for those UK-focused lenders such as Lloyds, RBS and Barclays. Weak economic conditions means poor loan demand and, while bank's impairment charges have continued to fall overall since 2009's sharp recession, credit quality remains a concern. That's especially so for the Irish operations of Lloyds and RBS, which have been hit hard by that country's property market collapse – despite a relatively small Irish book, for example, RBS' Irish bad debt charge represents 27 per cent of the group charge. Barclays, meanwhile, boasts a significant exposure to eurozone laggards such as Spain. On that basis, only those lenders with significant exposure to fast-growth developing markets – Standard and HSBC – can boast half-decent trading prospects in 2013, although their shares are hardly a bargain.

Mr Gordon believes that "it is the extended outlook of weak earnings and returns which primarily constrains our enthusiasm for the sector at current levels" – we tend to agree.