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I am deputy editor at The Banker, a Financial Times publication. I joined the magazine in August 2015 as transaction banking and technology editor, which remain the beats I cover. Previously I was features editor at Profit & Loss, an FX and derivatives publication and events company. Before that I was editorial director of Treasury Today following a period as editor of gtnews.com. I also worked on Banking Technology, Computer Weekly, and IBM Computer Today. I have a BSc from the University of Victoria, Canada.

Thursday, 6 August 2009

UK Billion Pound Banking Bail Out: Will it Work?

14 Oct 2008

The UK government's bail out of the banks was welcomed across the industry as the way to unfreeze the clogged up financial system. But will that be enough?

Last week, the UK government took the plunge and agreed a £400bn three-pronged plan to bail out British banks, following closely on the heels of the Icelandic banking collapse. It has committed to injecting at least £25bn into the banking industry, but could offer as much as another £25bn in order to increase banks' capital. At the same time, the government will offer guarantees over as much of £250bn of new bank debt, effectively adding £100bn to the existing Bank of England short-term loan scheme.

The banks involved are the major high street banks: Abbey, part of the Spanish banking group Santander, Barclays, HBOS, HSBC, Lloyds TSB, The Royal Bank of Scotland (RBS) and Standard Chartered, as well as Nationwide Building Society. This week, the government has agreed to inject up to £37bn of taxpayer cash into RBS, Lloyds TSB and HBOS.

Although there is some debate over the exact amount the UK government has committed with different figures being bandied about, Andrew Gray, UK banking advisory leader at PricewaterhouseCoopers (PwC), told gtnews that it is important to draw distinctions between the two pools of numbers. "There is the amount of money that the government is looking to inject in additional capital - which stands at £37bn as of 14 October - that would effectively sit on the banks' balance sheets. Then there is the separate £400bn plus, depending on the figures, in relation to additional liquidity that could be injected through the Bank of England liquidity arrangements," he explained. "Even now neither of those two numbers are firm in terms of what the banks will actually use - it appears to be an expectation that banks have 8% Tier 1 capital."

The UK government is looking at both capital and liquidity, which marks it out from the US's bail out scheme. On the capital side, the UK government is looking to put in up to £50bn to allow the banks to raise additional capital through that route. "It is uncertain how much capital any one bank would call upon - current market expectations are ranging from £0 for HSBC with RBS requesting £20bn," said Gray. This money would be a cushion to protect them from future losses in line with other banking capital that they have in place. The Special Liquidity Scheme is about ensuring that when banks need to borrow intra-day or over short periods of time, they can fund day-to-day trading activities by accessing thescheme rather than relying on lending and borrowing to each other. "That is what had effectively become more expensive through the current Libor rates which still, despite the announcement last Wednesday [about the reduction in interest rates], remain very high compared to base rates, although these rates appear to be easing following the combined efforts of governments this week," he added.

The US government, on the other hand, is looking to make the US$700bn available to buy bank assets, so it is a different way of looking at the same underlying problem. At first sight, Gray thinks that by giving banks a mechanism to raise additional capital will provide a more comprehensive and longer-term solution to allow banks to become more robust, which is ultimately what everyone is trying to ensure. "I think that it is interesting that a number of other countries are looking at methods of providing additional capital because banks have found it difficult over the past year to raise capital. RBS and HBOS have been able to raise capital on the markets, Barclays managed to raise capital through direct access to funding from sovereign wealth funds, and Goldman Sachs has transformed itself into a bank and raised capital through billionaire investor Warren Buffet; but as a whole it would remain difficult for the banking industry to access large amounts of new capital in a reasonably cost effective way."

ACT Welcomes UK Government Action

This definitive action by the UK government has been applauded across the board from the bankers through to economic analysts, credit ratings agencies and corporate treasurers. The Association of Corporate Treasurers' (ACT) chief executive, Richard Raeburn, said in a recent press statement: "The actions in the UK and the US [new commercial paper (CP) lending facility to jump-start lending for companies] represent sound and stabilising steps to restore the financial markets on which companies depend for their funding; we hope that market participants will now work together to help restore systemic confidence. The initiatives by the authorities should play an important part in shortening the period of necessary adjustment in the wider economy."

Martin O'Donovan, assistant director, policy and technical at the ACT, told gtnews that he believes it is quite an imaginative and helpful package and, in particular, it addresses the specific problems in the financial system. "It comes at it from several angles. One element is to demand that banks top up their capital. Because many of the banks have had to make write-downs and losses, their capital has been whittled away, which limits the amount of business that they can prudently do," he said.

"The other side is the funding and liquidity side - from a corporate treasurer's point of view this is really where the problem has been. All the usual markets that a treasurer likes to use for bank borrowing have dried up, or if they haven't dried up, the liquidity has disappeared from the three-month period and shrunk back to the one-week level. This is all very well but it is not how you want to be managing your short-term borrowing with everything running overnight or needing re-fixing every couple of days," explained O'Donovan. "The UK government is making funding available under the Special Liquidity Scheme, which will allow the banks to fund themselves and, therefore, hopefully start lending to each other and the corporate sector." There is to be further help in the form of a Government guarantee of new or refinanced medium-term bank debt with the intention of reopening the market for medium-term funding.

An additional intention of the authorities is to manage interest rates. "What you have at the moment is that the overnight rate in the market is down near 5%, which actually should have dropped even more now that base rates have gone down. That bit is working - there is liquidity and the rates are broadly being kept at the appropriate level at that maturity. But when you want to access a three-month loan, the rates are still over 6% since there is no activity there and people that do need the money are having to bid the price up," he explained.

The third element is that the government is prepared to guarantee longer term funding up to three years. "Again this is trying to get the inter-bank market moving again. So the banks will be able to fund themselves and they will be able to get going and get back into the business of lending to corporates - it oils the wheels again and gets the liquidity back," said O'Donovan.

There is some concern that the banks may attempt to use the ‘market disruption clause' commonly found in loan agreements to push rates up even higher. This is when the banks can't fund themselves at the Libor rate, so attempt to push the costs onto their corporate clients, which usually borrow at Libor rate plus an agreed credit margin depending on the risk level of the corporate. To O'Donovan's knowledge, this has not happened in western Europe but commented that recently there has been "a lot of debate around this issue". The ACT believes that this should be a last resort and implemented only after certain other steps are taken.

Will the Bail Out be Enough?

Charlie McCreevy, European Commissioner for Internal Market and Services, when addressing the European Parliament Plenary Session on the Lamfalussy process follow-up, stated: "We are in the most serious crisis in living memory. What started as a sub-prime crisis has now moved way beyond this to embrace the whole economy. Fears about the ability to raise financing are creating even greater lack of confidence among all economic actors. Unless there is a rapid unfreezing of lending we face a continued downward spiral with obvious impact on economic activity. One thing we have seen over the past few weeks is that no economy or financial market is immune from what is taking place."

Across the globe, national governments are responding to the crisis through injecting capital into the system. But will this be enough?

The ACT's O'Donovan believes that it should. "We certainly hope these measures will work. They should provide a good deal of hope and help where it is needed, but the markets at the moment are so peculiar that it needs other countries to follow suite and provide the same quite extensive and targeted support packages. Governments have been quite supportive in protecting the retail customer with all their deposit insurance schemes, but moving on to the wider markets and getting the liquidity going will need further co-ordinated action to get everything up and running again." This weekend the G7 nations - which comprises the US, Japan, the UK, Germany, France, Italy and Canada - issued a five-point plan of ‘decisive action' to unfreeze credit markets, after a meeting in Washington. The details of this plan have not been released.

PwC's Gray was similarly cautious about the answer. "Time will tell. [The UK's government's action] is positive in the fact that action was taken when action had to be taken. Until we understand a bit more detail about how the scheme will work and the banks' ability to access and use it properly, it is going to be difficult to understand the full implications of it, although this week markets have so far responded positively," he said. "Clearly the ripple effect around the global economy is likely to become a stronger feature of the overall economic backdrop. The main UK banks with the additional capital look to be reasonably well-placed. I think there will be ongoing challenges, and it really depends on the overall economy and to what extent we do or do not go into recession and how deep it is."

Gray stands by his statement of two weeks ago (UK Financial Industry Predicts Gloomy Outlook for More Than Six Months) that the systemic risk within the UK banking system is being contained. "I think it is still true to say that no retail depositor has lost money. Clearly the government is looking to make arrangements to ensure that that continues to be the case. The government has stated that no retail depositor will lose money. In as much as the statement remains true for retail, then I stand by the statement.

"Clearly there is a risk there, but do I see it resulting in the collapse of the banking system as we know it? The answer is no," he said.

First published on www.gtnews.com 

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