Lloyds TSB reported higher profits today but said the cost of protecting its high street banking operations against bad debts had risen by a third.
The group said impairment losses at its UK retail banking arm totalled £905 million last year after more customers struggled to repay money on time.
That represented an increase of £229 million on the previous year and Lloyds warned that the retail credit environment was likely to worsen over the next six months.
But the damage to its overall results was limited by healthier loans to corporate clients and the group said the situation at its high street banks should stabilise after June.
Its comments were delivered alongside a 10 per cent increase in pre-tax profits to £3.82 billion and news that it would pre-empt an assessment of its pensions liabilities by setting aside £155 million to cover the trend of staff living longer.
Lloyds is currently in the midst of a cost-cutting drive that includes simplifying its back office operations, with more than 2,700 posts removed over the past year.
Savings of £275 million a year are being targeted on an initial investment of less than £200 million.
The shake-up is expected to boost pre-tax profits by between £100 million and £150 million from the start of next year.
Chief executive Eric Daniels said 2005 was a good year for Lloyds in terms of its financial performance and delivering on its strategy of growing without having to resort to acquisitions.
He said: "Our market shares are either stable, or growing, in most of our key product lines.
"Most importantly, our customer relationship programmes are being effectively implemented and we are delivering higher revenues per customer in our retail and corporate banking businesses."
At its high street banks, Mr Daniels said income grew four times as fast as costs, but the need to set aside more money to cover bad debts meant pre-tax profits fell by 3 per cent.
Positive results for its retail banking business were achieved in attracting new customers - up 28 per cent on the previous year - and Mr Daniels said overall credit quality remained satisfactory.
Shares in Lloyds have risen by a quarter since the middle of October on persistent bid rumours, with US rival Wells Fargo and Spanish bank Banco Bilbao Vizcaya Argentaria mentioned as possible suitors.Reuse content