July 1, 2011 6:16 pm

UK banks can bear Greek default

Mortgage borrowers unlikely to be affected by second credit squeeze

UK high street banks have more than £2bn invested in Greek government bonds and other forms of debt – but, while bank shareholders can expect further price volatility ahead of a near “certain” default, mortgage borrowers are unlikely to be affected by a second credit squeeze.

This week, the Greek parliament voted in favour of two austerity bills that will enable it to receive financial aid and avoid defaulting on its bonds in the short term.

But according to many economists, the new measures have simply delayed the inevitable, as the Greek government’s debts appear unsustainable. “We don’t believe that it will default in the near term, but over the medium term it is a virtual certainty,” said Stuart Thomson, chief economist at Ignis Asset Management, on Wednesday.

If Greece can no longer service its debt, international banks will be faced with large losses on Greek bonds and loans made to Greek banks – as will insurers who will have to pay out on loan insurance.

Across Europe, governments, companies and analysts have been trying to untangle what impact, if any, a Greek default will have in their own countries.

The UK government’s only direct liability is £1.2bn that it must provide as part of the loan paid by the International Monetary Fund. But UK banks are more enmeshed. In total, UK banks are estimated to have about £2.1bn invested in Greek government bonds and other forms of debt, according to the Bank for International Settlements.

A recent analysis by UBS showed that the UK bank with the largest exposure to Greek government debt is Royal Bank of Scotland, the part-nationalised bank, which as of May held more than £1bn worth of Greek bonds. HSBC has the next highest exposure, with £800m, while Barclays holds £388m of Greek debt issues, and Santander has £300m.

But this, say economists, is not where the real problems lie. UK banks could absorb losses of these magnitudes and are likely to have already made provisions for the possibility.

A more serious problem would come if a Greek default caused shockwaves to spread across Europe, particularly to other highly indebted governments. UK banks’ exposure to Ireland and Portugal far exceeds their exposure to Greece, analysts warn.

For bank shareholders and customers, the question is whether UK banks have strengthened their reserves sufficiently since 2008 to weather a second credit
crisis. European Banking Authority stress tests of bank balance sheets, to be published next month, are expected to provide some answers.

The Bank of England governor, Sir Mervyn King, has already expressed his concern at the scale of exposure that the UK’s largest banks have to Greece, Portugal, Ireland and Spain.

The interconnection of the global banking system also means that, even if a UK bank has not lent money to a country in trouble, it may still be exposed to a European bank that has. This threat of contagion – and the opaque nature of the interbank lending system – might mean that banks simply stop lending to one another, creating a second credit crisis that would impact UK borrowers.

However, analysts and financial advisers said there is reason to believe that only UK shareholders will be directly affected, as long as any default is managed in a controlled way.

“It wouldn’t be good for UK bank share prices, particularly those with direct exposure to Greek government debt,” said Adrian Lowcock at independent advice firm Bestinvest. “But beyond this, I would not expect a Greek default to have a direct impact on the day-to-day business that UK customers have with their banks. If there were problems in Spain, then Santander could suffer, but it’s a relatively robust company and its UK arm is well financed.”

Analysts suggested that only in a worst-case scenario, in which other European banks got into difficulty, would UK high-street banks need to increase their margins on mortgages, and tighten lending criteria.

They also pointed out that most UK banks have already raised sufficient wholesale funding in the first quarter of the year – so that, even if contagion spread across Europe and made it difficult for banks in the UK to access new funds, it still wouldn’t have an immediate impact on mortgage availability.

Private investors are unlikely to be directly exposed to Greek government bonds unless they have holdings in a high-yield bond fund or sovereign bond fund – but, even then, this exposure is estimated to be minimal.

If investors are worried about falling equity and bond prices, Bestinvest suggested investing in funds that aim to offer a degree of downside protection. It recommends absolute return funds, such as the Standard Life Global Absolute Return Strategies fund.

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