How safe is your bank?

How safe is your bank? Financial Mail deputy editor Simon Watkins sparked debate with a look at Icelandic banks last week. Now, writing for This is Money, he investigates the UK's big names.

The Taking Stock column in Financial Mail and on This is Money last week looking at credit default swaps sparked a good deal of debate, in some cases anguish and from some banks, annoyance.

So it seemed appropriate to return to the subject at greater length and offer more numbers for those who want them.

Credit default swaps are contracts designed to insure creditors against a bank (or indeed any company) going bust.

A CDS is a contract issued by big City firms or fund that guarantees the holder will be covered if a particular company defaults on its debts. It is basically a type of insurance used by large investing institutions.

The CDS is priced differently for each company and as a percentage of the value of the debt to be insured. A five year contract is regarded as the benchmark. CDSs are traded like many other financial instruments and so the price is constantly moving.

So for example the price of a CDS on bonds issued by Barclays is currently priced at 134 basis points - that is 1.34 per cent.

In other words if you hold £1m worth of Barclays bonds you can insure yourself against them defaulting on this debt in the next five years by buying a CDS for £13,400 a year. This will eat into your profits from the interest Barclays pays, but it gives certainty and peace of mind.

If the market price of a CDS goes too high it will erode or may even wipe out the interest a creditor is earning. This makes the debt less attractive and it becomes harder for the debt-issuing company to raise money.

The long and short of this is that the price of the CDS is one measure of how risky the financial markets think a company is, but it is not a reliable forecasting device.