The UK Government has now unveiled the plans for a £37bn bailout for key British banks, as the BBC reports today.

Terms of the UK Bailout: The key features is that the Royal Bank of Scotland (RBS), Lloyds and HBOS will get cash injections of £20bn for RBS and £17bn between the two latter banks. This money will be used to recapitalise these banks, ie strengthen their reserves in order to withstand financial turmoil and market volatility we are facing at present. However in return the Government is effectively part-nationalising these three banks by taking a large or controlling share in them as these banks sell its shares to the Government in exchange for money.

The objective of part-nationalisation, apart from taking more control in the banks’s affairs now, is to also get income back to the Government and the UK taxpayer once the banking system does recover and shares go up in value.

Banks management changing: On the strength of this effective humiliation, the heads of RBS (Fred Goodwin and Tom McKillop) and HBOS (Andy Hornby and Lord Dennis Stevenson) are resigning, stepping down, or retiring. The UK Government is keen to see proven people with strong and relevant industry experience step into their shoes.

Banking bonuses curbed: One of the conditions of the UK Bailout is that there will be no bonuses to senior executives this year, and a move towards paying bonuses in shares not in cash in future years. However these restrictions do not impact those banks that are not part of today’s headline £37bn bailout proposal.

Barclays route: Barclays has opted to raise the money it needs without Government’s help. It needs £6.5bn. It seems that one of the reasons Barclays is trying to make it on its own, apart from avoiding the humiliation of the bailout, is that it will remain free to set banking bonuses as it sees fit.

US v UK Bailout compared: There are some distinctions between the US and the UK Bailout proposals. Some are driven by the fact the two banking systems have different features – for instance, in the US there are many more banks in existence making individual targeted action possibly more difficult to achieve.

US:

  • The US package has been aimed primarily at buying up the bad debts of failing banks on Wall Street as opposed to just recapitalising banks. However recapitalisation can also be used where appropriate and there has been more support of this option in the US Government in the last few days
  • The US Government and hence US taxpayers will in return get a non-voting stake in the banks they rescue.

UK:

  • The objective is to recapitalise banks as the key objective, and not take the bad debts off them
  • The UK Government will get some shares with voting rights enabling them to take more control of banks. The UK taxpayer hence also effectively has a stake in banks.

It seems that there is now a greater interest in the US towards UK’s bailout terms. The US bailout has been received by the market in a fairly lukewarm way, probably since it was rushed and was not perceived to be addressing the core issues. The UK bailout is being received better by the market. There is now talk in the US government about turning to recapitalising banks to a greater degree, much like what UK proposes to do.

Unprecedented – but not effectively new: Yes, all these bailouts are pretty unprecedented in the West. We are seeing a shift towards “socialist” tendencies in the State controlling key financial sector players. Although these are envisaged as medium term measures, do we know for certain if the Government will elect to let go of this control in future? It remains to be seen.

Moreover, although these are groundbreaking changes to the way the banking sector will operate, none of these measures are totally new. To some extent they have been performed before although not on this scale. The remaking of the financial world’s order is thus being accomplished with fairly old tools. Maybe it’s just as well – these have been used to some extent before and are seen to have worked. There will be no debt write-offs across the whole system, for instance, as some blog writers wanted to see happen. I am relieved we’ve not come to this yet.

End of an era: But make no mistake – this is an end of an era. The world of finance will get regulated very tightly after we achieve some stabilisation. This might mean any or all of the following:

  • New regulatory bodies. We are already seeing that US regulatory bodies are being considered for remodelling, possibly using UK regulator the FSA as an example
  • New powers. The Government and the regulators will have a greater say in what banks can and cannot do
  • New legislation. Deregulation that has caused much of current day’s evil aftermath is dead. Regulation is the new flavour of the day.
  • New accounting measures. I would hope that we will finally achieve a resolution of long running inconsistencies in accounting rules across the world which has allowed banks to manipulate their statements and hide the truth, for instance improvements in off-balance-sheet disclosure and moving to bringing this on-balance sheet early.

 And like any new era, it will bring with itself new opportunities to get involved and make one’s mark.

 

Copyright 2008 by CuriouslyInspired

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