Are Banks more Creditworthy than Local Authorities? Greg Readings

At Arlingclose one of our core services is advising on the creditworthiness and credit risk of investment counterparties. As someone who started their role here a couple of years after the global financial crisis of 2007/08, it has felt as though much of the past decade and a half has been characterised by heightened credit concerns, downgrades to credit ratings and a move away from unsecured exposure to banking counterparties. It has been noticeable, then, that recently many of the credit updates we publish to clients have had a more positive theme: credit ratings being upgraded for a range of financial institutions.

Indeed, over the past two years there have been 14 long-term credit rating upgrades from the three main agencies (Fitch, Moody’s and S&P) of banks we monitor, plus several positive revisions to rating outlooks. While there have been institution-specific factors at play, these have generally been driven by:

  • Increased capital adequacy – banks have strengthened their capital bases which has improved their ability to absorb losses and meet regulatory requirements
  • Better net interest income positions - improved profitability, increased revenues, and better asset quality, stemming from higher interest rates as well as cost-cutting measures

These are welcome developments from a creditworthiness perspective and indeed we have cautiously extended our recommended maximum duration for bank deposits, now that the turmoil from US regional bank failures and the rescue of Credit Suisse has settled down (more on that later).

On the other hand, UK local authorities (LAs) have been under well-publicised increasing financial pressures and the handful with published credit ratings have mostly seen these downgraded, with significantly less scope for fiscal flexibility due to the high inflation of recent years putting upward pressure on costs at a rate that LA funding levels can’t keep pace with. This has only exacerbated the effect of substantial cuts in local government funding from central government over the past decade, and reserve levels generally being on a downward trajectory. There have been governance and reporting issues, too, with one LA recently having its credit rating withdrawn due to a backlog of unaudited accounts. Outside of ratings, we have also seen some LAs issue Section 114 notices and/or request central government assistance.

Given that our LA clients can invest surplus cash using deposits with both banks and other LAs, do these trends suggest a swing towards banks should be considered by some? As always, the wider context is important. From a purely credit rating view, most rated LAs have similar ratings to many UK banks (although non-UK banks do tend to have higher ratings) so their relative positions are deemed, by the rating agencies at least, to be comparable.

From a bigger picture point of view, the banking market wobbles of March 2023 mentioned earlier were a reminder that financial institutions can fail, and do so quickly, particularly in an age of electronic transactions and social media. Even seemingly adequately capitalised banks such as Credit Suisse can rapidly come unstuck if investors lose confidence (it should be pointed out that Arlingclose hadn’t recommended Credit Suisse as an investment counterparty since 2018). The ‘resolution’ mechanism for many major banks is bail-in, meaning wholesale depositors such as LA investors could lose some (or all) of their investment when a bank is failing.

Local authority creditworthiness is underpinned by a framework of legislation providing creditor protections, regulation, a ‘lender of last resort’ and their positions as public sector organisations that ultimately have to continue delivering public services, meaning central government support of some kind is very likely. So the probability of loss when one LA lends to another remains relatively low, but there’s clearly divergence in financial strength and reputational issues to consider too.

Arlingclose’s advice reflects these differences, and other nuances, with a more cautious view on unsecured exposure to bank counterparties, which is unlikely to change. While we still think that deposits and accounts with large and well-capitalised banks have a part to play in cash management and liquidity strategies, we prefer options with significantly improved risk-return characteristics, such as secured deposits where investments are exempt from bail-in.

Arlingclose also provides clients with comprehensive information on the relative financial strength of UK local authorities, including through the dealing platform, and specific advice on the maximum amount and duration of loans that should be made to individual authorities.  

Please get in touch at if you would like to hear more about our services on credit analysis, local authority loans or secured bank deposits.

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