While shares in Royal Bank of Scotland were being hammered on Tuesday by concerns about alleged LIBOR manipulation in the US, the stock was being weighed down further by a downgrade by Espirito Santo.

Lloyds was also taken down a peg by the broker in its review of the UK banking sector.

Espirito highlighted that UK domestic lenders have been some of the best performing banks in Europe since the European Central Bank (ECB) unveiled its Outright Monetary Transactions programme.

However, the broker said: "While systemic and regulatory risks have receded, the operating environment remains difficult in the face of a weak economic outlook. 2013E consensus earnings have fallen steadily and only now appear to be stabilising."

RBS and Lloyds are now two of the most expensive stocks under Espirito's coverage and the broker foresees "limited upside" from current levels. Meanwhile, the broker said that short-term regulatory risks still remain.

"With Lloyds most impacted if regulators moved to standardised credit risks, and RBS the weakest capitalised UK bank, dilutive equity raisings cannot be ruledout. Hence we downgrade Lloyds and RBS to 'sells' reflecting full valuations and regulatory risks."

In contrast, Espirito reiterated its 'buy' ratings for sector peers HSBC and Standard Chartered for their international growth and for Barclays ahead of its strategic review announcement next month.

RBS was down 6.3% at 344.5p before the close on Tuesday. The business was making headlines on rumours that suggested it could be charged as much as £500m by regulators to settle claims over a probe into rigged LIBOR.

Lloyds was 2.5% lower at 51.83p.

BC

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