How Safe Is Your Money In Royal Bank of Scotland Group plc?

rbsRoyal Bank of Scotland Group (LSE: RBS) (NYSE: RBS.US) recently surprised investors with an annual loss of £8bn but, beneath the continual impairments and restructuring costs, how sound are the bank’s finances?

To find out more, I’ve taken a look at three key financial ratios that might be used by credit rating agencies when rating financial institutions.

1. Net interest margin

Net interest margin is a core measure of banking profitability, and captures the difference between the interest a bank pays on its deposits, and the interest it earns on its loans.

RBS reported a net interest margin of 2.23% for 2013, up from 2.15% in 2012. These margins are among the highest in the UK banking sector, suggesting that RBS has a firm grip on its current business and enjoys decent pricing power on its loans.

2. Core tier 1 capital ratio

Tier 1 capital is essentially a measure of a bank’s retained profits and its equity (book value). The core tier 1 ratio compares a bank’s tier 1 capital with the value of its loan book.

One of the requirements of the new Basel III banking rules, which come into force in 2015, is that banks will have to meet new, tougher, tier 1 capital standards.

RBS reported a core tier 1 capital ratio of 8.6% for 2013, up from 7.7% a year earlier, but only just above the 8.5% minimum required by the Basel III rules.

3. Liquidity coverage ratio

One of the problems exposed by the bank run on Northern Rock was that a number of UK banks didn’t have enough high-quality liquid assets — such as cash and short-term government bonds — to meet a sudden surge in withdrawals.

The liquidity coverage ratio has been introduced as part of Basel III and requires that banks hold enough liquid assets to cover 30 days’ of net outflows.

RBS reported a liquidity coverage ratio of 102% at the end of 2013, suggesting it can meet the new requirements, which are not due to come into effect until January 2015.

How safe is RBS?

Under the new rules, RBS’ core tier 1 ratio is lower than that of Lloyds Banking Group (10.3%) and Barclays (9.3%). The bank’s recent results surprised the markets, as they made it clear that RBS’ restructuring has not advanced as far as investors had expected.

In my view, RBS has potential but remains a speculative buy. However, if you'd like a more detailed analysis of RBS's strengths and weaknesses, compared to other UK banks, I'd strongly recommend "The Motley Fool's Guide To Banking".

This FREE report contains details of six key valuation metrics for each of the five main UK banks. The differences are surprising and the report shows that RBS does have some specific strengths, especially in terms of potential cost cutting, which would boost profits.

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> Roland owns shares in Barclays buy does not own shares in any of the other companies mentioned in this article.