Chancellor Alistair Darling today unveiled a belated but radical three-part £500 ($906.6 billion / Rs4,215,000 crore) rescue plan in a move designed to stave-off a failure of British banks hit by the US sub-prime mortgage crisis through a part-nationalisation and ensuring that the banks have enough cash to cover their daily activities as signs of recession creeps in.
Speaking at a press conference, Prime Minister Gordon Brown, said, ''This is not the American plan, our plan is to buy shares in the banks themselves and therefore we will have a stake in the banks. We are not simply giving money.''
The British plan would entail discipline and supervision and the American bailout package had not considered recapitalising banks.
Taking a dig at the Henry Paulson bailout package, Brown said that the American philosophy was ''outdated dogma,'' that the time for buying devalued mortgage related assets had passed, and added that, ''The problem that started in America has now hurt every banking system on every continent in the world.''
He said the government is expected to recoup the money in three year's time.
According to Chancellor Darling's plan:
- The government would make £50 billion of taxpayer's money available in two parts of £25 billion each. In order to increase liquidity, an immediate loan of £25 billion to eight banks and the other £25 billion in return for preference shares in these banks as these shares fetch a high fixed rate of interest. (See: UK launches 50-billion pound rescue plan for banks)
- It will also provide, for a fee, guarantees of around £250 billion on loans between banks, which it hopes will ease the pressure in frozen money markets. The government hopes that the core problem of banks refusing to lend money to each other will stop since it is guaranteeing the loan. The government may also help the banks to issue senior unsecured debt in sterling, dollars or euros, with repayment dates of up to 36 months.
- The third part entails the government to expand the size of its 'special liquidity scheme' which allow banks to swap risky assets for safer treasury bonds from £100 to £200 billion and will accept a wider range of collateral in its funding auctions.
The package took weeks to finalise but officials worked through the night for Chancellor Alistair Darling to announce the it before the opening of the markets on Wednesday since the gravity of financial crisis escalated, as signs of the economy going into recession was abundantly clear when big banks such as HBOS and the Royal Bank of Scotland lost more than half their value in a week with its shares falling by 39 per cent and 42 per cent respectively on Tuesday.
Standard & Poor for the first time in almost a decade, cut the credit rating of Edinburgh based Royal Bank of Scotland on concerns of its failing financial shape.
Share prices also fell since the beginning of the week, as the FTSE 100 registered its biggest fall in 21 years.
However, this bailout comes with riders which may not be liked by the top executives in the bank; if they do join the bailout plan, then, they have to consent to a new agreement on executive pay and ordinary share dividends as well as lower returns to bank shareholders in the future.
For the £50 billion of additional finance from the government, HSBC, Barclays, Royal Bank of Scotland, Lloyds TSB, Standard Chartered, HBOS, Abbey and Nationwide Building Society have signed up in exchange for the taxpayer taking preference shares, ordinary shares or permanent interest bearing shares.
All these banks have committed to raise their key Tier 1 capital ratios by £25 billion
HBOS and RBS, whose shares have plunged, said they would avail certain parts of the rescue package as HBOS, has £8 billion worth of debt falling due in the next three months, Royal Bank of Scotland £3 billion and Barclays £5 billion.
HSBC, Standard Chartered and Abbey ruled out accepting the public recapitalisation scheme with HSBC seeing no need of extra capital since it has more than enough cash mainly because of its strong presence in Middle East, Far East and Asia where the tradition of saving for a rainy day is very high.
It said, ''HSBC has no current plans to utilise the UK recapitalisation programme initiative announced today. We do agree to observe the tier 1 capital requirements but we will do this through our own resources.''
Commentators say that the plan, though excellent, should have been applied to banks across the board, as now banks have an option of mulling over their participation in it as their management ponders the risk of publicly admitting their financial problem. A few of them may use it as a last resort.
The British Chambers of Commerce in its report has said that the country was now in recession and could face the prospect of losing 350,000 jobs in the next year.
Analysts feel that the British government's new investment in the banks does not guarantee a turnaround as it could make or lose taxpayers money. If the imminent recession takes a longer time to recede and if it is becomes worse, then banks will be swollen with appalling debts.
The British government has to a certain extent negated this by taking preference shares in the banks as these shares grade higher than ordinary shares, so they are a safer gamble.
Financial commentators are watching to see whether the US plan or its British counterpart proves mo0re effective.
Central banks from across the world are making extraordinary efforts to provide liquidity so as to avert the collapse of the global financial system and for this the Banks need more capital to offset losses. According to data compiled by Bloomberg, banks worldwide have posted $592 billion of writedowns since the credit crisis started last year, more than the $442.5 billion of new capital they raised.
Britain now has joined the US and many European nations that have initiated bailouts while Ireland, Germany, and Greece have guaranteed depositor's money, Iceland has taken over two of its three biggest banks, and Spain has agreed to pump €50 billion ($68 billion) to buy bank assets.
The Bank of England cut interest rates by half a point from 5 per cent to 4.5 per cent following extreme pressure on it to cut rates in an effort to stimulate Britain's economy.
The rate cut in Britain followed similar cuts from six central banks around the world as the Bank of Canada, the European Central Bank, the Federal Reserve Bank in the US, Sveriges Riksbank, the Swiss National Bank and the Bank of Japan also cut their key interest rates.
China cut interest rates for the second time in less than one month to increase liquidity in the market. On Monday, India's Reserve Bank reduced the 'cash reserve ratio' by half-a-per cent to release Rs 20,000 crore into the banking system.
The US Federal Reserve took the unprecedented step yesterday of offering short-term loans even to large US corporations apart from banks.