Investors worry where to put cash as banks wobble

Investors are holding more cash than at any time since the Lehman Brothers collapse to protect themselves against volatile financial markets, presenting them with a dilemma - where to hold that money when banks are looking shaky.

When the European Central Bank stepped up efforts to provide liquidity to banks in late 2011, financial markets settled down and the chances of a catastrophe scenario, in which banks fail and depositors lose their money, became more remote.

But investors are still mindful that the unthinkable, while highly unlikely, is not impossible, giving pause for thought to institutions and wealthy individuals with sums too large to be covered by existing compensation schemes.

A monthly survey of British investment managers showed in December cash holdings were at their highest for more than two years, prompted by worries over the euro crisis.

The panic about bank solvency has not yet reached the levels seen in the wake of the collapse of Lehman Brothers four years ago, investors said. One senior private banker said at the height of the post Lehman turmoil in 2009, a "particularly eccentric" rich client had enquired about putting large amounts of their wealth in gold and then burying it on their land.

But closer scrutiny of counterparty risks by investors is currently leading to more use of alternatives to bank deposits like short-dated debt issued by AAA-rated governments or cash-like instruments such as money market funds.

"It's a small chance it'll happen but it's big enough that we think there's no point in looking for a few extra basis points (of investment performance) for taking the risk," said William Drake, co-founder of London-based investment manager Lord North Street.

Drake said the firm favours putting more money in short- dated UK government bonds as an alternative to deposits in a bank, while the crisis continues.

"We think you should be absolutely sure you are going to get 100 pence back out of every pound you put in." he said.

Britain's Financial Services Compensation Scheme guarantees recovery of up to 85,000 pounds per person if a bank fails, protecting the savings of most people but falling short of the amounts deposited by rich investors or institutions.

David Scott, chief executive of London-based upmarket investment manager Vestra Wealth, favours parking clients' cash in UK banks that were bailed out by the government during the earlier crisis of 2008 to 2009.

Royal Bank of Scotland is 83 percent owned by the British government following a state bailout during the 2008 credit crisis, while Lloyds Banking Group is 40 percent state owned.

Having stopped people losing their savings once, the British government is likely to do it again should the need arise, Scott argues.

"There's no way the UK government will let a high street bank go," he said.

Xenfin Capital, a London-based hedge fund trades using a small amount of the capital it holds for its clients, mostly very rich private investors, placing the rest on deposit at cooperatively-owned Dutch lender Rabobank .

Unlike its main Dutch rivals ABN AMRO