Banks have other woes as short selling returns

By Dominic Lau and Laurence Fletcher

LONDON (Reuters) - Short selling of 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 on Monday the ban on short selling of financials imposed in September would expire on January 16, 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."

Bank shares were generally weaker on Tuesday, with the FTSE 350 banks index down 0.4 percent.

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 HBOS.L.

Exaggerated share price declines unnerved other investors and depositors and ultimately forced the government to recapitalise some of the firms by taking major stakes.