Short selling of UK bank stocks will resume next week without a return to the extreme volatility which forced the Government to intervene last year, but investors say the sector could stay under a cloud for some time yet.
Even if the worst of the 18-month-old credit crisis has passed, the resultant economic recession and its fallout will lead to more writedowns and provisions for bad loans.
The Financial Services Authority (FSA) said yesterday the ban on short selling of financials imposed in September would expire on 16 January, but it stressed it would reintroduce the measure without consultation if needed.
"The banking sector will probably stay okay, but it's going to be a while yet before it's bouncing back fully," said Stephen Pope, global market strategist at Cantor Fitzgerald in London.
"If they are still in a situation where they are not lending to one another and they are still showing there are writedowns on their books they need to take, or they need more Government assistance, then banks will be put under pressure."
Short selling - which involves selling borrowed stock in the hope of repaying the loan at a profit by buying the shares back at a lower level - was partly blamed for confidence-sapping share price declines of major financial institutions, including the country's biggest mortgage lender HBOS.
Exaggerated share price declines unnerved other investors and depositors and ultimately forced the British government to recapitalise some of the firms by taking major stakes.
The FSA said yesterday it would extend rules requiring net short positions in financial stocks to be disclosed until 30 June, although disclosure will only be required at 0.1 per cent bands.
Ever since the short selling ban, however, the jury has been out on the long-term effectiveness of the measure.
Pope at Cantor Fitzgerald said that in the 10 weeks before the ban, UK financial stocks had outperformed the blue-chip benchmark FTSE 100, but they underperformed after it.
The poor performance was mainly because the Government banned dividend payments from banks which had taken public money, forcing long-only investors to sell as well, and the enforcement on shorting had taken away the "spring back mechanism" in the market.