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HBOS has reported a four per cent fall in profit as higher costs of lending in the second half of the year hit the bank's margins.

The group, the UK's biggest mortgage lender, which operates Halifax and Bank of Scotland, said profit before tax was £5.47 billion for 2007.

The net interest margin fell by nine basis points to 1.63 per cent, compared to 1.72 per cent in 2006.

HBOS said the main driver of this reduction was in retail where margins fell 12 basis points, reflecting the competitive pressure on mortgages in the first half and the increased costs of wholesale funding in the second half.

The overall increase in one month Libor (London interbank offered rate, the rate at which banks lend to each other) funding cost in the second half of 2007 compared to the first half of 2007 amounted to £72 million.

The recent slowdown in the housing market has led to a reduction in new business in mortgages, the bank added.

HBOS said it was cautious in its outlook, but optimistic. In a statement, the bank added: "Employment is very high and the Bank of England may well announce further rate cuts during the year.

"We expect the UK economy to move over time from being consumption led to a better balance between consumer demand and a higher level of savings by UK householders.

"We expect house price growth to be flat in 2008. Sound fundamentals underpin the housing market, in particular, record levels of employment and a continuing shortage of new properties."

Banks reporting results for 2007 have been recording declines in profits, as turbulence in the financial market during the second half hit earnings.