It should be no surprise to hear that, since the onset of the credit crisis family members have regularly asked me whether their money is safe in a particular bank. They are not financial experts – and they figure that since I am a financial journalist I should be "in the know".
My routine answer has been: "Relax. Your money is fine in any of the major banks. But just as a precaution spread it around a little between different institutions – don't park all your money in one single account. Just to be safe…"
After all, governments in the major economies just cannot allow their population to "lose" their money in the collapse of a major banking institution – since it is the government's responsibility to make sure that such a collapse is averted.
Just recently, however, I have begun to question the simple nature of my advice. It is not the fear of a banking failure that has caused this, but a belated realisation that the issue is much more complex now than it was just a few months ago.
Common sense dictates that a bank is only as strong as the governmental authority that stands behind it – in practice a country's central bank, which acts as a so-called "lender of last resort". This institution is the bedrock of confidence in any country's financial system, since it stands ready to step in and provide temporary support in the event that confidence in an otherwise solvent bank falls for some unexpected reason. Now consider the value of my home currency, the Great British Pound Sterling, which on a trade-weighted basis has lost about a quarter of its value from its 2007 peak. The sell-off has been especially violent over recent weeks, causing many ordinary Brits to question whether they will ever again be able to afford a holiday abroad.
There are assorted reasons for the decline, not least concern over the depth and length of the recession Britain has tumbled into. But the decline also reflects rather real and very specific concerns over the ability of the British government to safeguard its own banks. Its status as lender of last resort – through the Bank of England – is being questioned.
Now, those concerns do not stem primarily from weakness in the nation's finances. Pubic sector debt, as a percentage of GDP, is below that of many of it's European peers such as Germany and France.
Instead, these central banking concerns come from the actual size of Britain's banks. Indeed, the worry is that Britain's banking sector is too big for the government to confidently stand behind.
Which brings us to a new metric now being banded about financial markets: the ratio of total banking assets to GDP.
Ordinarily banks match their assets and liabilities. But during stressful times – like right now – the assets may not be available in the event that the liabilities need to be met. They may be held in illiquid form – or be difficult to price, such as in the market for structured credit that brought the credit crisis down upon us.
That is where the lender of last resort comes in – the central bank, which would typically inject some liquid such as cash or government securities into a stricken bank to help it get over its temporary problems.
But what if the banks in question have expanded all over the world, building up a huge asset base? The situation can clearly get tricky.
In countries such as Germany and France, the total assets of each country's banks add up to less than annual GDP. In Britain, one bank alone – the Royal Bank of Scotland – is substantially bigger than British GDP. The situation is even worse in countries such as Ireland and also Switzerland.
It is this issue – a sense that some national banking systems are "too big to bail" – that, over the past two weeks in particular, has sent the British banking sector into something that looks like a death spiral. Every day seems to see fresh stomach churning drops in the banks' share prices as investors have become increasingly convinced that full-scale nationalisation of the entire British banking system is the inevitable end-game in this crisis.
The Royal Bank of Scotland – once the sixth largest bank in the world by market value – now trades like a penny stock, lurching around five or six per cent with every penny move in the price. The British government already owns 70 per cent of the bank; the market things that figure will go to 100 per cent. It is a shocking state of affairs.
Where does this lead us? Well, aside from the sheer size of the value destruction – businesses built up over many generations suddenly falling into emergency state ownership – there is also the fact that governments are not very good at running banks. In fact, it's rather at odds with the whole idea of capitalism. Such an apocalyptical event may of course be averted. Regulators in Britain continue to insist that the banks are now well enough capitalised to endure even the deepest of recessions. But those who believe in the market mechanism tend to pay more attention to prices, rather than listening to the words of officials – and the share prices are screaming "trouble"!
So should the ordinary British public – including my family – be concerned about the relatively modest amounts of cash they have on deposit at British banks? My answer remains "no". But if, say, they had money in Irish banks in the UK, the answer would be "move it – just to be on the safe side". Indeed, if a Frenchman asked me advice about funds deposited with a British bank in Paris, my advice would be to move it to a French bank.
Because at some stage the credit crisis is going to get a nasty nationalist tinge. If governments, like the British government, are going to have to step in and put taxpayers funds at risk by propping up banks they are not going to be extending that umbrella to individuals in other countries. They might not even be able to afford to.
Paul Murphy is Associate Editor of the Financial Times