UK banking shares surged on news of a Conservative election victory last week, with investors hoping the Tories will go easy on the industry.
But it looks like the banks may have a bigger problem than regulation and levies – pension deficits.
Citi analysed a series of European bank annual reports and it found that British and Irish lenders have some of the biggest pension shortfalls on the continent. That means they don’t currently have enough in the bank to pay employees their promised retirement funds.
The Bank of Ireland, Lloyds Banking Group and the Royal Bank of Scotland are the top three most at risk from pension deficits when shortfalls are ranked as a percentage of each bank’s book value. Barclays is also in the top five most at risk.
Bank of Ireland’s deficit is an eye-watering 101%, meaning if the entire business was liquidated it still wouldn’t have enough cash to pay all employees’ pensions.
The problem lies with ultra low interest rates. Pension liabilities are calculated using something called a ‘discount rate’ – the assumed annual return a company will make from investing its pension fund. This figure determines how much companies put aside for the future.
But low interest rates have led to tumbling discount rates and the onset of Eurozone quantitative easing means rates look unlikely to rise any time soon. This has forced companies to pour more and more into their retirement funds.
Banks aren’t the only ones suffering from this trend, with BT warning earlier this year that it’s deficit has nearly doubled to £7 billion ($US10.79 billion). But Citi’s analysis shows UK banks are the worst offenders and will have to act fast to head off the problem.