How healthy is your bank?
Banks are supposed to be the safest place to put your money. It’s generally accepted that the stockmarket is a bit of a rollercoaster, and that the housing market is subject to corrections, but banks are the boring, reliable option.
But in 2008, that changed. The deluge of bad news, emergency bail-outs, failed take-over offers and nationalisations has been anything but boring, but does it also mean banks are no longer safe?
The year that was...
The rot in the banking sector began in the summer of 2007, as the knock-on effect of the US sub-prime crisis was first felt over here. The first sign of just how bad things had become was in September 2007 when Northern Rock was granted emergency support from the Bank of England, its share price fell by a third, and queues gathered in the streets.
Shortly afterwards the government had to guarantee deposits in order to halt a run on the bank, and after successive takeover attempts failed, the bank was nationalised in February 2008.
The rot has now spread. In July 2008, Alliance & Leicester announced it had received a takeover bid from Spain’s Banco Santander, which it urged shareholders to accept, admitting there were “significant external risks” to the company if the takeover didn’t go ahead. Then in September, it emerged that the Derbyshire Building Society and Cheshire Building Society were also mired. They were rescued and absorbed by Nationwide, but confidence was shaken still further.
Just as the world was getting to grips with the collapse of Lehman Brothers, then came even bigger news.
HBOS, the largest mortgage lender in the UK, announced it was in merger talks with Lloyds TSB after a run on its shares. The deal was encouraged by the Treasury as there was real concern HBOS could struggle to get wholesale credit, and it is now predicted to go ahead in January.
Then, 10 days later, came the demise of Bradford & Bingley, with the government nationalising the assets and selling the bank’s retail deposits to Banco Santander.
In the first week of October 2008, the crisis hit Iceland. Emergency laws gave the regulator power to force banks into receivership, and on day one it called the administrators in to Landsbanki, the country’s second-largest bank. Worryingly for UK savers, it owns Icesave in the UK as well as Heritable Bank, so Chancellor Alistair Darling was forced to announce that he will ensure all UK savers with Icesave get all their money back.
Finally, in December, Manchester-based London Scottish Bank was placed in administration. The Financial Services Compensation Scheme (FSCS) and the Treasury immediately promised its 10,000 savers 100% of their money back.
The UK government may have staved off any more immediate problems with the rescue package it announced at the beginning of October 2008 of £25 billion (and another £25 billion if necessary) in the form of preference shares. Experts welcomed the move and said it should stop the panic over banks. But savers, unsurprisingly, remain concerned.
Ashley Clark, a director with IFA Needanadviser.com, says: “I am inundated with calls from people worried about their money on deposit.”
The good news, is that so far the UK government has stepped in to stop any UK bank going under. And for the banks that have already been nationalised: Northern Rock and Bradford & Bingley, 100% of deposits have been guaranteed by the government. Likewise Icesave and London Scottish Bank savers have UK government guarantees.
However, there’s no certainty the government will continue to offer guarantees. Clark says: “The government has made verbal promises not to let a British bank go under, but there’s nothing in writing, so savers can’t rely on it.”
Fortunately, if a UK bank does goes to the wall, there will be compensation. Before the crisis this was set at £31,700 of the first £33,000, then it was boosted to all of the first £35,000, and at the beginning of October 2008, the rules were changed again to allow compensation for the first £50,000 invested with any institution.
Beyond that there are no guarantees, but there’s a chance savers will receive a share of their savings back following any distribution of assets as part of the insolvency process for a failed bank.
There are also proposals to boost this further. The Financial Services Authority intends to consult on changes to the FSCS compensation limits for all sectors and changes to other factors used in compensation calculations. The consultation will close in January, so any changes as a result are likely to come in April 2009.
But there are limits to consider. Each investor is limited to £50,000 per bank (£100,000 if it’s a joint account). However, if you hold accounts with several banks that are all part of a larger group, then your compensation will depend on how your banks are authorised. If each of the banks is separately authorised by the FSA, you will have a separate limit for every bank. However, if they are simply covered by the parent company, you may only receive just one £50,000 limit.
Overseas banks are different. Some have made a stand. The Irish government announced at the end of September that it was guaranteeing all deposits, bonds and debts in the country’s six banks and building societies for two years. This includes the Bank of Ireland. They were followed in October by Greece, Germany, Austria, Sweden and Denmark.
Countries in the European Economic Area are also covered by the EU Deposit Guarantee Schemes Directive, which means every country in the EEA must have a scheme that protects at least €20,000 in the event of a bank failure.
Where the bank’s home state scheme provides less than £50,000, the bank may choose to join FSCS to ‘top up’ the level of protection. Those banks that have topped up include Bank of Ireland, Anglo Irish Bank Corporation, Merrill Lynch International Bank Limited, TD Waterhouse Bank, ING Direct, Triodos Bank and Fortis Bank.
How safe is my bank?
Of course, nobody wants to claim through the FSCS. So the real question on many savers’ lips is: how safe is my bank? There are four useful measures. The first is the share price. If there’s a run on the shares, then the market is aware of some kind of problem with the institution.
The second is a trading announcement. Keep your eyes peeled for bad news from the banks. Northern Rock, for example, was issuing very worrying news a full year before it was nationalised.
The third is ratings. These are designed for professionals, but can give clues to savers too. Matthew Taylor, a banking analyst with rating service Fitch, says: “We have access to bank management, and tend to get more detailed information than is publicly available, so we can make an accurate assessment.”
The highest rating is AAA, which is reserved for exceptionally strong companies. After that comes AA, which is the rating most of the banks have. This is defined as “very high credit quality with expectations of very low credit risk.
They indicate very strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events”. A small number of the banks are rated one grade lower, at A. However, even this isn’t considered a major risk, and is defined as: “high credit quality”.
It’s worth looking out for downgrades in ratings. Many have been downgraded in the recent past, such as Lloyds TSB in the aftermath of its bid for HBOS, and Barclays after it bought Lehman Brothers’ assets. A one-off downgrade from a very high rating to a slightly less high rating may not be cause for concern. However, repeated downgrades should ring alarm bells.
Taylor says: “Bradford & Bingley saw a steady decline in its rating in recent months.”
Nevertheless, ratings cannot always be right. Taylor explains: “A rating is just an opinion based on the information we have. Sometimes we will know well before an announcement, sometimes it is hours. With Northern Rock we learned the full extent of its problems on BBC News like everyone else.”
Credit default swaps
The fourth measurement is the price of credit default swaps (CDS), which is essentially insurance on debt, which you would buy if you were worried about a company you held bonds with, and it would pay out if the company went bust. The cost is priced as a percentage of the debt, and the higher the price, the higher the risk (in the view of the market). The day before Icelandic banks hit trouble, for example, they were the highest-priced CDS in Europe.
That same week the riskiest bank in the UK in CDS terms was HBOS, followed by RBS, Barclays, Lloyds TSB, ING, Santander (which now owns Alliance & Leicester, Abbey and Bradford & Bingley), and HSBC. They were, however, all considered far less risky than the Icelandic banks, so the market at least doesn’t think they will go bust at the moment.
Unfortunately, CDS data is only available through a Bloomberg terminal, which is priced so that only professionals can afford it, so customers may have to rely on CDS prices quoted in the press.
However, none of these measures are watertight, as the markets don’t necessarily know everything material about a bank. It’s worth, therefore, taking precautions. The most important advice is to divide your money between banks.
In splitting your money you can favour those with the most secure ratings and lower price CDS. Alternatively you can go to a bank where all deposits are guaranteed. At the moment this includes Irish banks, Northern Rock and NS&I.
Unfortunately as a result some of these institutions have cut rates for savers, so you pay the price of very low interest. And as Clark points out: “Where the government has offered 100% protection you have to look at why they felt compelled to give such an astounding guarantee. I wouldn’t want to risk my financial future by putting all my savings with them.”
However, this is not a time to spurn banks altogether. For a start, the experts don’t think the big UK high street names are in big trouble.
Most still retain AA ratings. And if you don’t keep your money in the bank, the alternatives are even more risky. While keeping it all under the mattress may sound tempting, if a burglar doesn’t steal it the inflation monster will.
So while it pays to take careful precautions and check out the banks and groups you put your money in, it doesn’t pay to panic.
Generally speaking, insolvency is to businesses what bankruptcy is to individuals. A company is insolvent if the value of its assets is less than the amount of its liabilities, or it is unable to pay its liabilities (loan payments) as they fall due. It’s an offence for an insolvent company to keep trading, so the main options available to an insolvent company are: voluntary liquidation, compulsory liquidation, administration or a company voluntary arrangement.
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
The Financial Services Compensation Scheme is the compensation fund of last resort for customers of authorised financial services firms. If a firm becomes insolvent or ceases trading, the FSCS may be able to pay compensation to its customers. Limits apply to how much compensation the FSCS is able to pay, and those limits vary between different types of financial products. However, to qualify for compensation, the firm you were dealing with must be authorised by the Financial Services Authority (FSA).
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).