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Government to take a stake in UK banks

Created:

13 October 2008

Written by:

Jonas Crosland

■ Royal Bank of Scotland to raise £20bn, government could own 57 per cent of the company

■ Lloyds TSB to raise £5.5bn

■ HBOS to raise £11.5bn

■ Lloyds TSB cuts offer price for HBOS, government could own 43.5 per cent of combined company

■ Barclays seeks to raise £6.5bn from shareholders

UK banks are to receive a £39bn capital injection, as part of the government's plan to stop the rot in the banking system. The move could see the goverment taking a significant equity stake in some high street banks. It comes in the wake of intense pressure on banks that, left unchecked, threatened to destabilise and break down the whole fabric of the financial system. The new money will come through a recapitalisation involving the issue of additional shares, and is designed to recharge banks' reserves.

This is essential not only to restore confidence but to free up the interbank market, where banks have been reluctant to lend money to each other because of worries over financial stability. Interbank lending is the lifeblood of the financial system, and without it banks are unable to continue with the day-to-day business of lending money to the business world. Banks also need to boost their reserves to meet requirements set out by the Financial Services Authority to ensure they have sufficient funds to ride out a recession. Only banks considered to have sufficient capital will be allowed to take advantage of government plans to guarantee around £250bn of bank debt.

Under the terms of the new agreement, banks will issue new ordinary shares. Existing shareholders will have the opportunity to buy these first, but if they decline - which seems likely - the government will purchase whatever is left, leading to a significant dilution in shareholder value and leaving the taxpayer with what could be a controlling stake in some major high street banks.

Where a significant stakeholding is taken by the government, it will also be demanding a representation at board level, which would almost certainly lead to the government having a say in dividend payments, acquisitions and disposals. However, Yvette Cooper, chief secretary to the Treasury, stressed that it is not the government's intention to have a long term involvement in running the banks. But it seems that a full return to private ownership will depend on a resumption of normal trading conditions in the financial sector.

The timing of the latest capital injection caught most of the banks off guard. Only last week they were breathing a sigh of relief after the government's plan to bail out the country's largest financial institutions. But they failed to realise at the time the need to present a plan to boost their reserves. And the timetable suddenly took on a greater urgency as evaporating confidence saw banks' share prices hammered. Given the total absence of appetite from investors for fundraising, it became clear that the government would have to provide the funds to boost reserves.

For the banks there are several strings attached. Bonus payments will come under strict scrutiny, and participating banks will be asked to lend funds to small businesses and homeowners. In effect, the government is giving taxpayers' money to the banks so that they can lend it back to the taxpayers. However unpalatable this may appear, the alternatives would risk the breakdown of the financial system.

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