What Treasury says, and what it means

Financial stability

The Treasury says the bank bail-out plan is driven by three priorities: "To support stability in the financial system; to protect ordinary savers, depositors, businesses and borrowers; and to safeguard the interests of the taxpayer." Shareholders do not figure on the list.
Analysis: stockmarkets bounced in London, Europe and beyond in response to the Treasury's move and similar measures from other governments. The FTSE 100 index closed up more than 8%. Meanwhile, the credit derivatives market, the best barometer of bank solvency concerns, also showed investors were increasingly confident that the prospect of bank failures was receding.

At an operational level, however, bold moves by the Treasury to kickstart the interbank lending market did not have the hoped-for immediate impact on one of the biggest stress points within the banking system. The interbank cost of borrowing, Libor, reached almost unprecedented highs last week and remains disturbingly above central bank base rates throughout the western world. This means banks are still tending to hoard cash and liquid assets, unwilling to lend them to rivals.
More optimistic analysts believe the latest initiatives from governments round the world will show through in Libor rates soon. "It's enough to get these money markets up and running again," said David Keeble, head of rates strategy at French investment bank Calyon. "But it might take a few weeks to filter through."

Banks' financial strength
The Treasury is to inject up to £37bn into new shares in RBS and a merged HBOS and Lloyds TSB. It insists that after these measures - and independent capital-raising moves by banks - these institutions will each have capital cushions capable of absorbing the heaviest losses imaginable. These solvency buffers will be "well above international minimum standards and at a level that should put them on a strong footing for the future".

Analysis: IMF data shows British and European banks have about half the capital cushions of their US counterparts, so measures bolstering these positions will be widely welcomed.
Nic Clarke, an analyst at brokerage Charles Stanley, said: "The regulators have made it clear to UK banks that, whatever the cost to shareholders, they have to have a warchest of capital to see them through a serious downturn. In recent years banks have been running 'capital lite' models to maximise return on capital."

Dividends
Mindful of public unease at the level of profits made by banks in recent years, the Treasury claims to have won commitments on the distribution of future profits to shareholders. Its hand is strengthened by holding preference shares, which will absorb the bulk of surplus profits in the form of interest payments ahead of ordinary shareholders.

Analysis: among the few shares that did not rally on the London Stock Exchange yesterday were the three banks pursuing government-backed cash-calls. Lloyds TSB, RBS and HBOS closed down 14.5%, 8.3% and 27.5% respectively. These bank shares have in recent years been popular with many income-focused investors, including most pension funds, because of their dividend policies. Many of these investors will be ditching these shares now the government is attempting to curb payouts. More than two million private shareholders in HBOS will be hit. Richard Hunter of stockbroker Hargreaves Lansdown said: "Dividend payouts are going to be depressed. You could well see bank stocks being pretty dour for the foreseeable future."

Treatment of borrowers
The government imposed conditions on mortgage activities and lending to small businesses as part of the deal. For three years, the Treasury is insisting, banks in which the taxpayer is invested must keep the mortgage market open and competitively priced "at 2007 levels". The banks must also provide "support for schemes to help people struggling with mortgage payments to stay in their homes".

Analysis: these are warm words that many small businesses and homeowners will cling to. But it remains to be seen how they will be interpreted by the arm's-length body charged with overseeing the government's bank stakes on "a commercial basis". Lloyds has already revealed as part of its pact with government it will publish in its annual report details of small business loans, overdrafts and foreclosures. Others are likely to follow suit.

Curbing executive pay
Another condition wrung out of banks seeking taxpayer cash is a commitment to keep executive pay in check. The government expects no bonuses to be paid to boardroom directors in 2008. It also claims to have extracted promises that future bonus schemes will be linked to "long-term value creation" and will take account of risk. The kind of pay packages that allow highly incentivised executives to still keep hold of so-called "payments for failure" will be consigned to history, the Treasury said.

Analysis: the FSA has written to 30 banks warning them it will require them to hold more capital if it sees pay policies deemed to be encouraging excessive risk-taking. This is a strong shot over the bows, but the regulator does not have many powers to enforce its preferred pay schemes. Now the government is to hold shares in the banks, its mind may be more focused on ensuring key jobs are given to the best people money can hire. Gary Hoffman, poached from Barclays to lead nationalised mortgage bank Northern Rock, will be paid £2m over two years, making him Britain's best-paid civil servant.

What are the dangers?
1 Royal Bank of Scotland If its share price stays well below the 65p the government will pay for its 60% stake, it could signal investors believe the plan will fail. Ditto Lloyds TSB and HBOS.
2 Barclays The bank is going it alone. Failure to raise capital in the markets would send it back to be offered worse terms.
3 Libor The interbank lending rate is a barometer of confidence; any increase is bad. It fell yesterday.
4 Wall Street A repeat of wobbles last week over Morgan Stanley could start a new round of global sell-offs.
5 Recession Falling growth, employment and house prices indicate this will be the biggest hurdle.

The Guardian, Tuesday October 14 2008

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