Britain's strongest banks

According to this report, the UK's four biggest banks are healthy and savers are safe.

A fortnight ago, the Committee of European Banking Supervisors (CEBS) released the results of its stress tests into European banks.

Crash test dummies

The CEBS health checks were designed to measure the impact on banks’ core capital under a range of different economic stresses and strains. In total, 91 European banks were put through the wringer by the CEBS in order to see how well they would survive future economic shocks.

Some experts argued that these tests were not strict enough, partly because national banking regulators had a hand in designing each country’s tests. Nevertheless, a total of seven banks failed: five in Spain, one in Germany and one in Greece.

In total, the seven banks need to raise £3 billion of new capital in order to meet the stress-test standard, which is a Tier One capital ratio of at least 6%.

Frankly, it’s no surprise that five of the seven test failures came from Spain. A massive property crash and unemployment at nearly a quarter (24%) of the workforce has left the Spanish economy and its regional savings banks reeling. The UK looks solid in comparison!

Good news for British banks

Banks in the EU must maintain a regulatory minimum of 4% Tier One capital, so the stress-test threshold (6%) was half as much again as this requirement.

The UK tests were carried out by City watchdog the Financial Services Authority (FSA). The good news is that our four biggest high-street banks -- Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland (RBS) -- all passed the CEBS stress tests with flying colours.

Indeed, British banks were among the strongest in Europe, as my table shows (based on the CEBS ‘adverse scenario’ outcome; sorted from highest to lowest Tier One ratio):

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As you can see, the UK’s Big Four banks all passed with flying colours. Their excess Tier One capital over the stress-test 6% threshold ranged from 3.2% at Lloyds to a very strong 7.7% at Barclays. Therefore, on this measure, savers in these banks have nothing to fear from a possible ‘double dip’ recession.

A second health check

There is another way to compare the relative health of banks: by comparing credit default swap (CDS) rates. These show the cost of ‘insuring’ a company’s debt against default, typically over a five-year period. For example, a CDS rate of ‘100 basis points’ means that default insurance costs 1% a year.

For the record, here are the five-year CDS rates for the Big Four banks (in basis points):

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As you can see, global giant HSBC tops my table and is therefore considered to have the lowest default risk of these four banks. Its yearly CDS insurance costs a mere 1.16%. Buying default insurance for Barclays and Lloyds costs the same (1.65% a year). RBS is at the bottom of my table on 2.68% a year.

While these CDS rates remain elevated when compared to the ultra-low levels seen during the boom years, they are a fraction of the rates seen at the height of the financial crisis. For instance, just before Icelandic bank Landsbanki collapsed in October 2008, its CDS rate was 3,006. In other words, it cost over 30% a year to buy default insurance against Landsbanki’s debt. Yikes!

Again, based on current CDS rates, the Big Four banks look to be in pretty good shape.

Savers can sleep easy

With the support of taxpayer bailouts and central-bank liquidity measures, British banks have been reducing their risk. They have lowered their lending, shrunk their balance sheets, and improved their liquidity (easy cash at hand) through the Bank of England’s Credit Guarantee Scheme (CGS) and Special Liquidity Scheme (SLS).

Then again, the £300 billion of emergency funding provided by the CGS and SLS will start to be withdrawn from April 2011. Thus, the strain on British banks will increase next year.

Nevertheless, there’s one simply way for savers to guarantee a good night’s sleep: keep no more than £50,000 in each savings institution. The first £50,000 per person (£100,000 per couple) is covered by the Financial Services Compensation Scheme (FSCS). This safety-net is backed by HM Treasury and should be able to cope with most scenarios short of financial Armageddon.

Finally, following a European Commission ruling last month, the FSCS limit is likely to rise to €100,000 at the end of this year. At the current exchange rate of 83.2p to the euro, this safety net comes to £83,200 per account, which is enough for all but the richest savers.

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