Nov. 6 (Bloomberg) -- Royal Bank of Scotland Group Plc, Barclays Plc and HBOS Plc are paying as much as 121 million pounds ($192 million) a year in additional fees in exchange for government backing of their debt.

The U.K. Treasury is charging banks an annual 50 basis points for the guarantees plus a fee based on the price of the lenders' credit-default swaps, according to the U.K. Debt Management Office. The cost is on top of the fees charged by underwriters to sell debt and the interest paid to investors.

The banks are the first to take advantage of Britain's pledge to guarantee as much as 250 billion pounds of debt in an effort to unlock credit markets. They are using the Treasury facility as the extra yield investors demand to buy bank bonds instead of government debt has more than tripled in the past year to a record 5.75 percentage points, according to Merrill Lynch & Co.'s Sterling Corporate Financials Index.

``The government is exposing and exploiting the market's inefficiency,'' said Georg Grodzki, London-based head of credit research at Legal & General Group Plc, the U.K.'s third-largest insurer which manages more than 110 billion pounds of fixed- income assets. ``It is capitalizing on the market's paralysis.''

Bank Bonds

RBS sold the equivalent of 3 billion pounds of three-year guaranteed notes today, following issues by Barclays and HBOS. The sale may cost Edinburgh-based RBS about 40 million pounds a year in fees the government is charging for the guarantee, according to data compiled by Bloomberg.

Barclays will pay an annual 38.7 million euros on its sale of 3 billion euros of debt, based on Markit Group Ltd. prices for credit-default swaps. HBOS will pay 48.6 million euros for its 3 billion-euro bond sale and 9.7 million pounds for its sale of 600 million pounds of bonds. Bond sales in currencies other than pounds may incur additional fees, the DMO said.

Fiona McRae at RBS, Ross Keany at HBOS and Jon Laycock at Barclays declined to comment.

The fees are ``money left on the table by investors who would not take paper on an un-guaranteed basis, despite equity and liquidity support from the government and Bank of England,'' Grodzki said. ``Many trading opportunities are left unexploited at the moment because investors can no longer stomach the volatility and liquidity risk, need to deleverage or are scared that the economy will get a lot worse,'' he said.

Currency Fee

Apart from RBS, Barclays and HBOS, five other U.K. financial institutions may issue government-guaranteed bonds so long as they comply with certain criteria, according to the DMO. Banks have to pay an additional 4 basis points for sales in currencies other than pounds, RBS analysts led by Corinne Cunningham wrote in a research paper on Oct. 24.

The guarantee is available for the next six months and may be extended by the Treasury, the DMO said.

Barclays had to offer 1.2 percentage points in extra yield over the government rates to sell Treasury-backed bonds on Oct. 22. Bank of Scotland Plc, a unit of HBOS, offered investors a spread of 1.36 percentage points on its bonds in euros, and 1.23 percentage points on the sale of pound bonds, Bloomberg data show.

Extra Yield

Investors are demanding an average 4.35 percentage points more in yield to buy financial bonds in euros rather than government securities, close to a record high of 4.36 percentage points on Oct. 30, according to Merrill Lynch indexes. European financial bonds are poised for their worst year in a decade as they have so far handed investors a 7.25 percent loss, the biggest decline since Merrill started collating the daily data in 1999.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality; a decline, the opposite.

To contact the reporter on this story: Shelley Smith in London at ssmith118@bloomberg.net

Last Updated: November 6, 2008 10:22 EST