Commentary: Banks' health needs a rate cut

If there were no U-turn, one might have to be invented to keep the clearing banks from plunging dangerously into the red. Of pounds 152bn of UK corporate loans by major banks, pounds 31.8bn is to companies with the poorest Dun & Bradstreet credit rating, according to an analysis by Robert Fleming, the merchant bank. Firms in those categories, rated '4' and 'N4' in the Dun & Bradstreet system, have an unfortunate habit of folding rather regularly.

The figures are derived from 262,000 companies in the credit rating database, which has the great advantage not only of wide coverage but of listing companies by bank sorting code. This allows detailed analysis of credit quality by lending bank, region and industry.

The banks' UK corporate bad debt provisions are currently pounds 5.3bn, or 16.8 per cent of the loans to companies with poor credit ratings. But if the economy deteriorates further, the proportion will have to be sharply increased. To raise corporate loan provisions in the UK to 20 per cent would cost the banks over pounds 1bn, but to go to 30 per cent would cost pounds 4.2bn, of which pounds 1.5bn would be at Barclays and pounds 1.4bn at NatWest, according to the analysis. This would more than double the amount each bank currently sets aside from its profits.

But the impact on profits is uneven and surprising. TSB has displaced Lloyds as the bank with the largest proportion of high-risk corporate loans, although this is because the data for the TSB's Hill Samuel subsidiary was not available in the previous survey. Nevertheless, the TSB is the least vulnerable to a further economic downturn because it has been exceptionally cautious, and made far higher provisions than the rest, amounting to over 50 per cent of its poorly rated loans. This clean-up confirms TSB's potential attraction to the much-rumoured bidder.

For a different reason, Midland is also in an excellent position, because shortage of capital restrained its lending in the boom years, and it cut back sharply on riskier corporate lending from 1988 onwards. This has left Midland with a higher proportion of low-risk customers than most other banks. The very best quality loan book belongs to Clydesdale, which used to be a Midland subsidiary.

In contrast, the most vulnerable to a renewed economic decline are NatWest, Barclays, Bank of Scotland and Royal Bank. To reach provisions of 30 per cent of poorly rated loans would cost each of them around two thirds of operating profit. The Scottish banks' problems tend to arise when they stray into England.

Bank of Scotland and Barclays stand out as having a particularly high proportion of property loans in the poor-risk category and relatively few high-quality property loans, according to Flemings.

What the survey confirms is that the clearing banks need a sharp reduction in interest rates and other measures to boost confidence just as much as their customers do.