How safe is your bank? Szu Ping Chan explores the complex world of credit default swaps.
This article was first sent to Fools as part of our Good, Bad and Ugly email campaign.
With so much happening in the savings market, it's easy to lose track of recent events. The British bailouts may have stopped for now - but the fall-out is still a lot going on both here and across the globe.
Late last week, ING revealed that the Dutch government was injecting _10bn (£7.7bn) into the bank to shore up its capital. The French government quickly followed suit, announcing this week it was investing _10.5 bn in the nation's six largest banks to spur them to lend.
But, with governments injecting cash into banks left right and centre, what does this all mean for the safety of banks as a whole?
Weighing up the odds
In Spot Banks Before They Go Bust, I explained the usefulness of credit default swaps (CDSs) in terms of measuring risk. CDSs provide insurance on debt, guaranteeing a holder's money will be covered if a company goes under. The riskier a bank, the more expensive it is to insure its debts.
CDSs are measured in basis points (one hundredth of a percentage point). If a bank has a CDS of 100, insuring a £1 million investment would cost £10,000. To put things into perspective, CDSs in Icelandic banks were trading near 3,000 basis points before they went bust.
Bearing this in mind, it's also important to be aware of which banks belong to which institutions, so you know exactly where you stand in terms of the Financial Services Compensation Scheme.
So, in an attempt to kill two birds with one stone, here's a table listing some of the biggest names on the high street, and how risky the market thinks these banks are in terms of five year senior debt CDSs:
Provider | Parent Company | Maximum Level of protection | CDS of Parent Company |
|---|---|---|---|
HSBC, First Direct | HSBC Bank PLC | £50,000 | 64.3 |
Lloyds TSB, Cheltenham and Gloucester | Lloyds TSB Group PLC | £50,000 (in total) | 77.7 |
Alliance and Leicester | Banco Santander | £50,000 | 83.0 |
Abbey, Asda, Bradford and Bingley, Cahoot | Banco Santander | £50,000 (in total) | 83.0 |
Barclays, Woolwich | Barclays Bank PLC | £50,000 (in total) | 100.7 |
Nationwide | Nationwide Building Society | £50,000 | 102.6 |
ING Direct, Kaupthing Edge, Heritable Bank | ING Direct N.V. | _100,000 (approx. £77,000) is covered under the Dutch Depositors' Compensation Scheme. | 107.3 |
Bank of Ireland, Post Office, Bristol and West | Bank of Ireland | Fully protected by the Irish government until Sept. 2010. | 112.5 |
Bank of Scotland, The AA, Birmingham Midshires, Halifax, Intelligent Finance, Saga | HBOS | £50,000 (in total) | 118.5 |
Egg | Citigroup | £50,000 | 166.4 |
Yorkshire Building Society | Yorkshire Building Society | £50,000 (in total) | 204.8 |
Anglo Irish Bank | Anglo Irish Bank PLC | Fully protected by the Irish government until Sept. 2010. | 272.7 |
ICICI Bank | ICICI Bank Limited | £50,000 | 1038.9 |
Data correct as at 11am on 21st October
According to the markets, HSBC is the safest high street bank that has not been nationalised. You'll probably also notice a particularly large CDS lurking at the bottom of the table. This belongs to Indian bank ICICI.
CDSs in ICICI have sky-rocketed recently, as investors get jitters over the bank's ability to repay its debts. However, ICICI has repeatedly assured its savers that it is safe. You can read more about this, and what fellow Fools think here.
So how competitive are the safest banks?
Well, it varies.
You'll often find that the safest banks offer slightly less attractive interest rates.
For example, banking giant HSBC has the lowest amount of CDSs in our table, at 64.3. Egg has more than twice as many, at 166.4. So it should come as no surprise that Egg offers 6.55% AER on its Internet Only saver, while HSBC offers just 4.75% AER on its Online Bonus Saver.
Why do banks with higher CDSs offer better rates? Because banks normally get the bulk of their funding from the money markets. Banks deemed `safe' will have no problems getting cheap funding. However, if investors think a bank is more risky, they will either refuse to lend to them altogether, or charge them a higher rate of interest than usual.
But, banks have another option. They can also borrow from you and I through our savings deposits. To hook us in, they'll offer a juicy interest rate that's tempting for us, yet still cheaper than borrowing through the money markets.
However, a high interest rate doesn't necessarily indicate a risky bank. ING Direct's savings account pays 6%, which includes a 1.67% bonus for 12 months. ING's CDS is just 107.3.
Similarly, the current market leader is Alliance and Leicester's eSaver Issue 2, which pays 6.6 % on balances up to £500,000 (although no interest is earned in any month where a withdrawal is made, except July). Its parent bank Santander has one of the lowest CDSs on the table, at 83.
The future
Recent events may have forced banks to rethink the way they conduct their business, and lower interest rates means even more of us will find it harder to beat inflation. However, save smart, and there's no reason why you can't get some decent returns.
More: Where's My Kaupthing Cash? | ING Still Looks Fine | Big Banks For Safe Savings