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Shares of British banking giants, Lloyds Banking Group PLC (NYSE:LYG), Barclays PLC (NYSE:BCS), HSBC Holdings (HBC), and Royal Bank of Scotland Group PLC (NYSE:RBS), as shown by the chart below, are all trading at or near new 52-week highs. These moves come as Mark Carney, who currently runs Canada's central bank, has been appointed to become the next governor of the Bank of England.

HBC ChartHBC data by YCharts

What Does Carney's Appointment Mean For British Banks?

Right now, it is too early to say what the impact will be on the British banks. However, there has already been a lot of speculation about potential changes to the U.K. banking system based on Carney's appointment. I think that, given Carney's role as head of the G20's Financial Stability Board and his role in leading the push for new banking rules, it is safe to say that there will be at least some significant new regulations. While it must be noted that Carney was only recently appointed, so far, the reaction as judged by movement in British banking stocks, has been relatively positive.

European Market Rally

While Carney's appointment is important, the most important driver of British banking shares is the situation in Europe. As shown by the chart below, the tide appears to have turned in Europe.

^GDAXI Chart^GDAXI data by YCharts

Notably, as shown by the chart above, the British stock market (represented by the FTSE in orange) has significantly underperformed both the German and French markets. This makes sense when considering that exposure to the Eurozone was stronger in Germany and France as both nations use the Euro, whereas Britain still uses its own currency, the pound sterling. Simply put, Germany and France have benefited more from the recent recovery as they were more exposed to the previous risks.

British Banks Outperform

As shown by the chart below, LYG, RBS, and BCS have done significantly better over the past year than other large European financials. Deutsche Bank (NYSE:DB), ING Group (NYSE:ING), and The Bank of Ireland (NYSE:IRE) have all risen over the past year but less than British banks. This divergence it especially noteworthy because the British stock market as a whole has, as discussed earlier, underperformed other European markets.

LYG ChartLYG data by YCharts

Why Have British Banks Outperformed?

I believe the best explanation, while not the only one, for the recent outperformance of the British banks has to do with how poorly they have performed over the past few years. As shown by the chart below, RBS and LYG, the two banks which have rallied the most over the past year have also taken significantly more pain over the past five years. Perhaps, the recent outperformance is simply these beaten down stocks playing catch-up.

Another reason for the recent outperformance is the recent move by British banks to sell assets. Notably, LYG has had a very busy 2012. In May, LYG put some of its branches up for sale. More recently, LYG announced the sale of private equity investments. Throughout 2012, RBS has also announced various divestitures.

Finally, another positive for British banks in 2012 has been the settlement with the Financial Services Authority. BCS, HBC, LYG, and RBS were all involved in the settlement.

LYG ChartLYG data by YCharts

My Take

The most important driver of the British banking stocks going forward will be, without doubt, the ongoing European debt crisis. That being said, even if the worst is over for the European financial system, I am not sure weak banks, despite being hit the hardest, will be the biggest beneficiaries. Notably, during the recovery from the financial crisis in the U.S., low quality financial stocks did not outperform. As shown by the chart below, since mid-2009, higher quality U.S. financials such as JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) did better than weaker financial names such as Citigroup (NYSE:C) and Bank of America (NYSE:BAC). I picked mid-2009 because I believe that time is most similar to where we are now. In 2009, the stock market bottomed early in the year. Immediately following the bottom, the weakest financials such as Citi and Bank of America rallied the most. However, as the recovery continued, it was the stronger banks, Wells Fargo and JPMorgan that did better.

C ChartC data by YCharts

Right now, I believe LYG and RBS in particular have benefited most from the recent bottom in Europe. Going forward, I would rather own higher quality European financials such as HBC, BCS, or DB instead of LYG or RBS.

Source: British Banks Outperforming Amid Carney's Appointment As BOE Governor