HSBC Holdings, Europe's biggest bank by market value, said yesterday that it has set aside a smaller-than-estimated $3.2bn (£1.6bn) for bad loans related to its US consumer finance business and said first-quarter profit increased.

The news cheered investors and HSBC shares closed 16p, or some 2%, higher at 882p on the London Stock Exchange. The bank did not release the figures for its first quarter, but is scheduled to report first-half earnings in August.

The report of higher first-quarter profit "is a claim few banks in Europe will be able to make, we believe," said Alex Potter, an analyst at broker Collins Stewart.

"The outlook statement is very muted but this is hardly a surprise, whereas the US performance was well above worst fears," Potter added. "HSBC remains a safe haven and core holding for us."

Chief executive Michael Geoghegan said there has been a "lull" in delinquencies stemming from the US sub-prime mortgage debacle. The outlook for the rest of the year "remains unusually difficult to foresee in the current environment," the company said in a statement to the stock exchange.

The London-based bank expects the US economy to tumble into a recession as the slump in the housing market extends into 2009. While first-quarter earnings fell in the United States, HSBC reported higher pre-tax profit in Asia, the Middle East, Latin America and in Britain, where mortgage lending climbed.

HSBC's sub-prime losses started after the 142-year-old bank paid $15.5bn for Household International in 2003, becoming one of the largest US sub-prime lenders. Sub-prime mortgages are loans given to borrowers with poor credit ratings.

Financial companies worldwide have posted losses of more than $320bn related to the collapse of the US sub-prime mortgage market.

Royal Bank of Scotland Group, the UK's second-biggest bank, wrote down £5.9bn of credit-related assets this year, including collateralised debt obligations tied to the US sub-prime housing market and leveraged buy-out loans.

Elsewhere in the financial sector, Northern Rock, the mortgage lender that was nationalised after falling victim to the global credit squeeze, reported an increase in arrears but said it was making "solid progress" with its plan to repay its multi-billion-pound bail-out.

Executive chairman Ron Sandler said the bank still intended to repay loans to the Bank of England by the end of 2010.

Sandler said economic conditions combined with a shrinking loan book meant mortgages three months and more in arrears rose to 0.95% at the end of April, compared with 0.57% at the end of December.

The Newcastle-based lender added that arrears will rise in the coming months as it strengthens its risk controls on late payments.

However, Sandler added that the overall credit quality of the loan book remained satisfactory and at a level assumed in the bank's strategic plan.

"While arrears have increased, the credit quality of the loan book remains satisfactory," he said.

"We remain firmly focused on our business priorities of repaying the government debt, releasing the guarantee arrangements and, in due course, returning Northern Rock to private ownership."