Is Saving With Icelandic Banks Safe?

We've already had a home-grown banking crisis in the shape of Northern Rock, but are Icelandic banks operating in the UK safe?

It's not surprising savers are feeling more nervous than usual over the safety of their cash. The crisis at Northern Rock is still pretty fresh and it's going to take some time before we start to feel comfortable again.

That's why alarms bells ringing in the Icelandic banking sector as a whole may be picked up by savers over here. Especially since there has been a recent press article highlighting this issue.

So what is really happening?

Leading banks in Iceland have had their credit ratings placed 'under review' by ratings agency, Moody's. That's because the banks' profits may fall in the near future. Credit ratings measure whether a bank is able to meet its financial obligations and reflects the risk of default. The review includes Icelandic banks Landsbanki and Kaupthing Bank which operate in the UK.

Both banks currently have an Aa3 rating for bank deposits which means their obligations are judged to be of high quality and subject to very low credit risk. Even though these ratings are on Moody's watchlist for a possible downgrade, Kaupthing has been under review since August 2007 but continues to hang on to its Aa3 rating.

To put this in perspective for you: both banks have a credit rating which is equivalent to, if not higher than, a number of other financial businesses in the UK including Abbey, Alliance & Leicester (who incidentally are also on Moody's watchlist), Bradford & Bingley, ICICI and Standard Life Bank.

Should We Be Nervous?

Icelandic savings accounts have offered eye-watering interest rates in recent times, attracting thousands of UK savers. Indeed, Icesave - owned by Landsbanki - has had a presence in the UK since October 2006 and has already pulled in more than 150,000 savers with its competitive online accounts.

More recently, Kaupthing Edge, the UK arm of Kaupthing Bank, has made an impressive UK debut with the launch of a 12 month fixed rate bond paying a market-leading 6.86% and a highly competitive easy access account paying 6.50%. These accounts are bound to garner popularity with many savers over here.

If you have already put your savings with Icesave or Kaupthing Edge I don't think you should panic. To repeat, both banks have a top-end Aa3 rating. And anyway, just as savings in UK banks are covered by the Financial Services Compensation Scheme (FSCS), deposits held in the two Icelandic banks have equivalent protection.

Icesave savings accounts are covered by the Icelandic Deposit Guarantees and Investor-Compensation scheme. Under Iceland's scheme the first €20,887 (approximately £15,000) is protected in full. But savers also have a further guarantee under the FSCS which is limited to 100% of the first £35,000 less any payments made under the Icelandic scheme.

Meanwhile Kaupthing Edge deposits are currently held by UK company Kaupthing Singer and Friedlander Ltd and as such are protected entirely by the FSCS, which means they qualify for the same maximum protection of £35,000. 

So, in other words, these accounts have exactly the same protection as UK deposits.

You might think that a claim made through a two-tier compensation scheme is bound to be more onerous. But Mark Sismey-Durrant, Managing Director of Icesave, suggests this isn't the case since the structure of the Icelandic scheme has the potential to settle claims more quickly than even the UK's FSCS. Indeed, the UK scheme has a full six months to deal with compensation claims (although this process is being reviewed).

That said, the risk of either bank defaulting is exceptionally low. Landsbanki and Kaupthing are the equivalent of the big four banks in the UK. So it would follow that as the Bank of England would come to the rescue of a beleaguered Barclays or Lloyds TSB as the lender of last resort, the Icelandic government would provide similar support for its largest banks.

What's more, Landsbanki has no exposure to sub-prime debt unlike many banks in the UK, and it isn't heavily reliant on wholesale money markets, which means it may be more resistant to the repercussions of the credit crunch than some.

On a final note, I think it's sensible - given credit conditions in general - that you should limit your savings to £35,000 per institution whether you choose to save with an Icelandic bank or, indeed with a UK bank. In other words, don't keep all your eggs in one basket.  

More: Five More Places To Put Your Savings | Check out the market leading savings accounts at lovemoney.com's Savings Centre.