Profits at Lloyds Bank dropped sharply in the third quarter as the group pushed up its provisions for bad loans and predicted that house prices will fall by 8 per cent next year.

The owner of Bank of Scotland, Halifax and Scottish Widows suffered a 26% decline in profits to £1.5 billion during the three months to the end of September despite rising interest rates, which usually bolster banking margins as the gap between what they pay savers and what they charge borrowers widens. The fall in profits was much larger than the 9.5% decline that analysts had expected, and was the result of putting aside an extra £668m to cover an anticipated spike in loan and mortgage customers defaulting on their debts.

Lloyds, the UK’s largest mortgage lender, said it expects inflation to peak at 10.7% by the end of this year. It further anticipates an increase in unemployment to 5.5% by early 2024.

Combined with higher borrowing costs, the group said these factors are expected to push UK house prices down by 8% amid slower mortgage lending.

Chief financial officer Will Chalmers said the number of customers facing arrears, defaults and writes-offs remains low and below pre-pandemic levels.

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“So far at least, our customers are proving to be resilient and adapting well to the cost-of-living increases that we have seen,” he said.

“We are deliberately ensuring that we lend to customers who are best-placed to withstand potential future stresses on the macro level and in their own personal circumstances.”

Analyst Will Howlett of Quilter Cheviot said the results were a mixed bag with some “clear positives” from the strength of net interest margins offset to an extent by higher impairments.

“While interest rate increases will benefit the bank, the depth and length of any recessionary period is likely to offset this and beyond,” he added.

Analysts have argued that Lloyds could be particularly vulnerable to any increase in loan defaults because of its huge mortgage book and significant share of the credit card market.

The sector is also concerned about the possibility of additional taxes on the industry, with a surcharge on bank profits said to be under review by Chancellor Jeremy Hunt.

Shares in Lloyds closed yesterday slightly higher, up 0.16p at 42.71p.