Much of the financial press in recent weeks has been dominated by the turmoil in the global banking sector. September saw the failure of a number of high profile global financial institutions, which lead to a potential collapse of the banking system. Consequently, world governments took unprecedented steps in early-October to prevent such a crisis.
The UK Government led the way by announcing a package of wide-ranging measures aimed at rescuing the UK banking system. The intention was to stabilise the banking sector and in particular, encourage the banks to start lending to each other again.
The key points of the plan are detailed below:
- Banks will have to increase their capital by at least £25 billion and can borrow from the Government in order to do so if necessary;
- An additional £25 billion in extra capital will be available in exchange for preference shares in the bank;
- £200 billion will be available in short-term loans from the BoE through a Special Liquidity Scheme, which is an increase from the original level of £100 billion;
- Up to £250 billion in loan guarantees will be available at commercial rates to encourage banks to lend to each other;
- To participate in this scheme, banks will have to sign up to an FSA agreement on executive pay and dividends.
Those institutions that commit to the Government plan have to increase their total tier 1 capital by £25 billion, although it should be noted that this is an aggregate increase and individual increases will vary from institution to institution. In order to facilitate this process, the Government is making available £25 billion to be drawn on by these institutions if desired through the issue of preference share capital while it is also willing to assist in the raising of ordinary equity if requested to do so. Although all the major UK banking institutions committed to the Government that they will conclude their respective increase in tier 1 capital by the end of the year, this does not mean that they will be participating in the scheme and it is down to them to make this decision. For example, both HSBC and Standard Chartered confirmed in statements that they will be able to raise the necessary capital internally.
If the Government is to provide the capital to the bank, the issue will carry terms and conditions that appropriately reflect the financial commitment being made by taxpayers. In reaching agreement on capital investment, the Government will need to take into account the dividend policies and executive compensation practices of the institution and will also require a full commitment to support lending to small businesses and home buyers.
Furthermore, it was recently announced that the Government would invest a significant sum of around £39 billion into three of the country's largest banks in order to recapitalise their balance sheets. This move could see the Government ending up with controlling stakes in the Royal Bank of Scotland and HBOS, as well as a large holding in Lloyds TSB, which effectively would part-nationalise each lender. Unlike the plans mentioned above, these investments would see the Government receiving ordinary shares which carry voting rights unlike the preference shares that would be given under the scheme previously announced. The level of the Government's holding in each bank would be dependent on the take-up of the additional shares by existing investors.
In conclusion, the above rescue measures combined with the recent global cut in interest rates should assist in resolving the problems in the banking sector as well as contribute to restoring confidence in the interbank lending market. Furthermore, it certainly represents a positive move by the Government and should also provide reassurance to savers. However, it is unlikely that these measures will provide a 'quick-fix' solution to the credit crunch and any recovery is likely to be gradual until confidence returns in both banks and in the interbank lending market.
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