Can we still bank on the banks? Paul Roberts

Keen-eyed readers may have seen an Insight back in May which looked at some of the changes made to the banking system following the global financial crisis and how banks are now much safer than before 2008. As part of this, we issued an update to our clients which analysed what might happen if coronavirus caused UK banks to suffer a similar level of bad debts to that in the period after the global financial crisis.

We are currently undertaking a similar analysis on a number of non-UK banks, which clients will receive an update on in due course, but with UK bank news currently being dominated by reports of coronavirus causing plunging profits, huge provisions for bad loans and falling share prices, should depositors be any more concerned compared to a few months ago?

In recent days HSBC reported pre-tax profits had fallen by 65% in the first six-months of 2020 with provisions for bad debt expected set to reach almost £10 billion for the year. Barclays reported a similar position with profits down by two-thirds and almost £4 billion set aside so far. Lloyds Banking Group made a loss in the second quarter and expects loan impairments to be around £5 billion by the end of this year. The last of the ‘Big Four’, NatWest Group (formerly Royal Bank of Scotland Group) also reported falling into the red in the second quarter and expects loan loss charges to be in the order of £4.5 billion for 2020.

Between these four institutions, bad debt provisions for just the first half of this year have totalled over £15 billion. Bank shareholders have clearly felt the pain as the equity prices of all four have plummeted over the last six months. However, those depositing with banks care less about future dividends and more about future solvency.

Credit Default Swaps (CDS) allow bondholders to insure themselves against losses from the lender going bust at some future date. Analysing movements in CDS prices is just one element of assessing creditworthiness, however, as the prices move in real time they can provide a much quicker insight into what ‘the market’ is thinking compared to the sometimes slower-moving credit ratings.

So, if shareholders are clearly concerned about these banks’ prospects, are bondholders feeling the same way about the future? Well, the answer, is not really.

The cost of buying a CDS for each of these banks roughly doubled between the end of February and the middle of March as bondholders jumped to protect themselves against the uncertainty of potential losses and bankruptcies (or bail-ins). Since then, however, prices have been steadily falling and are now at broadly the same levels as they were 12 months ago, well before the word ‘coronavirus’ came into common parlance.

The potential impact from coronavirus has clearly been, and remains, a test for the capital positions of banks, but the structural changes made since 2008 would appear to be holding up under the current stressed market conditions. While the threat of a bail-in remains a now ever-present risk for some UK bank depositors, the strength of the capital buffers these institutions now have in place, while clearly concerning for equity holders who are first in line to lose their shirts if the worst occurs, appear to be much less of a concern to those in other parts of the capital structure.