Should Investors Steer Clear Of Britain’s Banks?

With the financial crisis now around six years behind us, some investors are starting to become interested in the banking sector again.

But is this be a mistake? Is it finally time to start trusting Britain’s banks again, or should you steer clear?

A mixed bunchcity

At least two of Britain’s banks have had a successful past few years. Lloyds (LSE: LLOY) (NYSE: LGY.US) and HSBC (LSE: HSBA) both appear to have recovered from the financial crisis, and look to be stable investments.

On the other hand, Royal Bank of Scotland (LSE: RBS) and Barclays (LSE: BARC) are struggling. Barclays in particular can seem to do nothing right and new lawsuits are being filed against the bank almost every day. 

Testing times

Nevertheless, while it may seems as if Lloyds and HSBC have recovered, we will only really find out later this year. Specifically, during the autumn the European Central Bank and Bank of England are set to publish the results of their most recent set of stress tests.

These stress tests are designed to be the most vigorous ever and the ECB is digging down into the balance sheets of banks, across the continent, to uncover any skeletons hidden away.

The tests are really designed to settle the debate about bank capital adequacy once and for all. 

Serious change

Until the results of these stress tests are released, it’s hard to analyse the financial stability of Britain’s banks. Still, it’s quite easy to see which banks have changed for the better since the financial crisis.

For example, there has been a significant change in the way Lloyds does business. The bank is now smaller and simpler, operating in fewer countries and keeping more capital on hand for a rainy day. For example, Lloyds’ tier one capital ratio (financial cushion) stood at 10.7% at the end of March, up from 10.3% at the end of 2013. Management are targeting a tier one ratio of at least 11%. 

HSBC is in a similar position. HSBC has pulled out of any risky markets, sold off any high-risk assets, reduced liabilities, cut costs and bolstered its capital ratio.

HSBC was actually the first British bank to meet the tougher Basel III tier one capital requirements. Globally systemically important banks such as HSBC require a Basel III ratio of above 10%, HSBC passed this level last year.  


Meanwhile, Barclays is struggling to turn itself around as management moral has hit an all-time low. Moreover, the bank has made multiple mistakes over the past few years, including misleading its clients and helping clients to illegally avoid taxes. What’s more, the bank made the fatal mistake of paying hefty bonuses to bankers earlier this year, only a few months after a rights issue to raise capital. 

Even now, after the rights issue last year, Barclays tier one ratio was below the 10% benchmark at the end of the first quarter, coming in at 9.6%. Management is targeting a ratio of 11%. 

And lastly there’s RBS. Investors should not be misled by RBS’s surprise profit revealed today as the bank cautioned that:

“… We are actively managing down a slate of significant legacy issues. This includes significant conduct and litigation issues that will likely hit our profits going forward…”

It’s highly likely that the ECB and BoE stress tests will find a few skeletons in RBS’s closet. There’s also the bank’s capital ratio to consider. 

Following the profit warning earlier this year, RBS’s fully loaded Basel III Core Tier One capital ratio is expected to fall to between 8.1% and 8.5% by the end of 2014. RBS was targeting a capital ratio of 11% by the end of this year. 

Working it all out

So, it seems as if Lloyds and HSBC can be trusted but we won't know for sure until later this year.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool has no position in any of the shares mentioned.