Are British banks at risk of going bust?

The news that the fourth-largest investment bank on Wall Street, Lehman Brothers, has filed for bankruptcy has sent stockmarkets around the globe into chaos. But it also puts a question mark over the future of British banks, especially as the share prices of some of the high street’s biggest names were sent plummeting following news of the bankruptcy.

Two days after Lehman’s collapse, stockmarkets in Japan, South Korea and Hong Kong - which were closed on the day after the news broke for public holidays - fell more than 5%.

Meanwhile, European markets opened sharply lower, with the FTSE 100 and Germany's Dax both down 1.7%. The FTSE 100 opened 2.5% lower on Monday immediately after the bankruptcy was declared.

British banks took a particular battering on Monday; the HBOS group, which includes Halifax and Bank of Scotland, took the biggest hit closing 50 points down, with around 40% of its value effectively wiped out. Barclays closed 34 points down, while Alliance & Leicester ended the day 30 points down and HSBC nearly 29 points down.

HBOS' falling share price sparked fears at the Financial Services Authority and Treasury that the bank's financers could pull lines of credit. On Wedneday morning, the BBC broke the news that Lloyds TSB is in talks regarding the takeover of HBOS, in a deal that will create a super-retail bank.

Now the deal has now been confirmed - find out what it could mean for your finances here.  

So, why did the collapse of Lehman Brothers - a US firm - have such a big impact on the share prices of British banks, and what does the latest victim of the credit crunch mean for their future?

Investor confidence is key. Following Lehman’s flop, speculation mounted (not for the first time) about the financial stability of other institutions. There is also real concern that, should a British bank fail, the impact on the economy would be devastating.

Paul Niven, head of asset allocation at F&C, explains: “The effects of the fall out from Lehman Brothers, and reliable estimates for the likelihood of another major bank collapse, are largely unquantifiable. What is clear, however, is that markets are increasingly concerned about the stability of the financial system, and that the lack of a centralised bail out this time has had - and will have - a material effect on confidence, and mean that volatility in risk assets is likely to remain high for the foreseeable future.”

HBOS’ share price took a particular battering during Monday’s trading, mainly because of its exposure to the British housing market and its reliance on other banks for funding.

Graham Spooner, investment adviser at The Share Centre, says there have been rumours and speculation surrounding the security of many British banks for months, and Lehman’s collapse only heightened these.

“Lehman Brothers was a big player in equity markets and derivatives, and has got a lot of contracts out there with other banks and trading houses,” Spooner adds. “No one knows how much exposure to Lehmans the banks have, or whether the contracts will be honoured.

“This uncertainty has made investors even more cautious about the banking sector, and they are shying away from banks as a result.”

But is this uncertainty justified? Are there banks out there that are at risk of collapsing?

The British Bankers’ Association says no, insisting that UK banks remain stable and far from the brink of collapse. And the FSA says it is confident that all British banks are solvent.

Spooner adds the UK banking sector has already experienced fundamental changes: “We’ve lost Northern Rock, as a private bank anyhow, Bradford & Bingley is on its knees and Alliance & Leicester is being sold to Santander.

“The majority of banks will emerge out of the tunnel in a few years' time, but whether the same names will be around or not remains to be seen.”

If a British bank were to get into difficulty, it is hard to say whether the government would step in and, in a repeat of the Northern Rock nationalisation, make public funds available to help it. However, in the past there have been hints that Gordon Brown would not let a British bank fail.

While the Lehman Brother-inflicted choas has been raging across stockmarkets, an all-party Treasury Committee has reported back on Parliament's suggestions about what customer protection should be in place should a bank fail.

Measures proposed include seven-day compensation payments, clearer consumer information and payouts per brand rather than per bank.

However, Mark Sismey-Durrant, managing director of Icelandic-owned savings bank Icesave and private bank Heritable, suggests there should be more focus on putting measures in place to stop banks from collapsing in the first place.

"If a retail bank in the UK failed, not only would compensation payments be extremely complicated, but the impact on consumer confidence and the economy would be severe. We can't afford to let a bank in the UK fail."

To read more about the Treasury Committee's report, click here.

The mortgage market

Even before it made the petition for bankruptcy, Lehman’s faltering share price was playing havoc with mortgage rates.

Michelle Slade, analyst at data provider Moneyfacts, explains: “In the last two months, mortgage rates had finally dropped to pre-credit crunch levels. As liquidity in the money markets eased, lenders passed on the cuts in borrowing to consumers.

"At the end of last week, rumours over Lehman Brothers caused the cost of borrowing on the money markets to increase. Now that it has been confirmed, the cost will likely increase further as once again the banks may become wary about lending to each other. The increase in borrowing for the banks will likely be passed on to the consumer through higher mortgage rates.”

She adds: “The longer the banks face an increased cost of borrowing, the more likely it is that UK mortgage customers will be hit. It usually takes around two weeks for any increase to filter through to mortgage rates and only then will we be able to for certain see what impact Lehman Brothers has had on the UK mortgage market.”

However, experts point out that swap rates – the interest rates used by most banks to price fixed-rate mortgages – are normally based on Bank of England interest rate expectations.

Bob Sturges, a director of Money Partners, a specialist lender owned by Goldman Sachs, doesn’t expect Lehman Brother’s collapse to have a huge impact on interest rate expectations over the long term.

“Most analysts still expect inflation to peak at 5% before the end of the year, and once the Bank of England starts to see signals that inflationary pressures are easing it will reduce rates,” he explains. ”This could be as early as November or early next year.”