Britain's safest banks

The financial crash proved that not all banks are equally strong. Where are your savings secure?

In mid-September 2007, panic erupted when news broke that building-society-turned-bank Northern Rock had approached the Bank of England for emergency funding. What followed was a run on the Rock, as countless savers queued around the block to withdraw their cash.

When the government agreed to provide a state guarantee for 100% of savings in Northern Rock, calm was restored. However, Northern Rock's lunatic lending had left it in a mess, so it was fully nationalised in February 2008.

Bradford & Bungling

Sadly, Northern Rock wasn't the only British bank to go under during the financial meltdown of 2007/09. Its rival Bradford & Bingley (another building society turned bank) was another lax lender, both to risky homebuyers and buy-to-let landlords.

After the collapse of US investment bank Lehman Brothers on 14 September 2008, Bradford & Bingley headed for the rocks. On 29 September 2008, B&B sold its branches and savings arm to Spanish bank Santander, but taxpayers inherited over £42 billion of manky mortgages.

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As a financial tsunami washed over the western world, more banks failed, including Icelandic banks Kaupthing and Landsbanki. With billions of pounds of British savings at risk, the government stepped in, paying out 100% of the cash deposits held by British taxpayers in UK-registered banks.

In the eye of the storm

To stabilise Britain's banking system, the government provided hundreds of billions of pounds to banks in capital injections, loans and liquidity support. In addition, the Bank of England reduced its base rate from 5% in October 2008 to 0.5% by March 2009, thus boosting banks' margins and profits.

As a result of these actions (plus regulatory reform to come), the UK's banks are completely safe today. Or are they? You can't say this for sure.

Indeed, I would argue that, in terms of house prices and bad loans, Britain's banks are 'in the eye of a hurricane'. In other words, having survived one meltdown, our banks are enjoying the calm before the next storm.

In my view, this setback will be caused by falling house prices, rising bad debts and a leap in arrears and repossessions as mortgages turn sour. For proof, just look at what is happening on Britain's high streets. Hardly a day goes by without another retail group collapsing, brought down in this new age of austerity.

Are your savings safe?

Those worried about more financial crises to come should ask whether their savings are safe in whichever bank or building society they are stored.

Of course, British savers can rely on the saving safety-net provided by the Financial Services Compensation Scheme (FSCS). The FSCS guarantees 100% of the first £85,000 of cash savings per individual per institution. Thus, a couple with up to £170,000 in a joint account enjoys the full protection of the FSCS. Here's more info on this government guarantee.

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What if you have more than £85,000 on deposit with one bank or building society? My advice would be to spread your money around between different providers, so as to maximise your protection under the FSCS. In addition, before you put your life savings with any bank, building society or other institution, please check it out first.

Here are four financial figures to find:

1. Credit ratings

Just as almost every individual in the UK has a personal credit rating, almost all companies, organisations and governments are given corporate credit ratings. Generally, these are assigned and published by three leading ratings agencies: Standard & Poor's, Moody's and Fitch.

Just like exam grades, company credit ratings are letters, usually on a sliding scale from AAA to D (for default). These are a guide to the likelihood of future default, so the UK and US governments are AAA-rated. At the other end of scale, struggling Greece is CCC-rated by Standard & Poor's -- the worst government rating in the world.

Here are the long-term credit ratings of the UK's 'Big Four' banks, plus those for Santander (buyer of Abbey, Alliance & Leicester and Bradford & Bingley) and Nationwide BS (the UK's biggest building society by far):

Source: Company websites

As you can see, all six firms have high credit ratings, with none below A+. However, the two strongest are Santander (AA) and HSBC (AA-). Hence, according to S&P, your money is a little safer in these two global banks than in their four UK-based rivals.

2. Capital ratios

Under banking guidelines known as the Basel Accords, banks around the world are being forced to increase their capital ratios. These measure what proportion of their total assets is held in quality assets. The higher a bank's 'core Tier One capital ratio', the easier it can find cash in a crisis.

Under new rules known as Basel III, the minimum core Tier One capital should rise over time to reach 7% of risky assets. Here are core Tier One capital ratios for my big six:

Source: Latest company results

On this measure, the strongest in this list is Nationwide BS, with a ratio of 12.5%. Weakest in the list is Lloyds, with a ratio of 10%.

Looking ahead, banks considered to be 'too big to fail' may have to hold core Tier One capital of 9.5% to 10.5%. Several of the above banks are sure to fall into this category and, therefore, may need to raise more capital if their current ratios slide.

3. Credit Default Swap rates

In effect, a Credit Default Swap (CDS) is an insurance policy which pays out when an organisation or country defaults on its debts. Thus, CDS premiums are an indication of how likely a business is to go bad: the higher the CDS premium, the higher the potential risk of default.

Here are the yearly premiums for a five-year CDS from the big six:

Source: Markit.

Based on their latest CDS premiums, all six firms are considered to be at low risk of default. The lowest of the six is HSBC, with a yearly CDS cost of a mere 0.84%. The bank with the highest CDS premium is Santander, with protection against its default costing 2.68% a year. Lloyds and RBS are considered equally risky, with five-year CDS rates of 2.4%

4. Loan-to-deposit ratios

My fourth and final measure of financial strength is a firm's loan-to-deposit ratio. Here's an example of how this is calculated:

• Total loans: £1.5 billion
• Total deposits: £1 billion
• Loan-to-deposit ratio: 150%, or 1.5

The lower the loan-to-deposit ratio, the less a bank lends out against each £1 of savers' money. Here are the ratios for the big six:

Source: Latest company results

On this measure, HSBC is the only bank to lend less than its total deposits, with a ratio of just 78%. The weakest banks in this category are Santander (132%) and Lloyds (148%).

Britain's safest bank

At present, British taxpayers own 100% of Northern Rock, 83% of RBS and 41% of Lloyds. Given these public shareholdings, the coalition government would not allow depositors in these banks to lose any of their savings. Thus, these three banks carry implied government guarantees and, in effect, enjoy the UK's AAA rating.

Still, it's not clear how long this government support will last, as it surely will be withdrawn some day. Hence, the only institution with 100%, rock-solid government backing is National Savings & Investments. NS&I provides a range of savings products, as well as the ever-popular Premium Bonds.

Putting aside this government support and the FSCS safety-net, if I had to keep all my cash with a single bank for safe-keeping, I would choose global mega-bank HSBC. As it happens, HSBC is where I keep the bulk of my cash, so I rest easy at night!

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