UK Banking Stabilisation Measures 2008
By: Claudia Harrison, Katie Hillier
1. Introduction
At the start of 2008, few people predicted the dramatic financial events of the past year. Governments have rallied to stabilise financial systems which have been severely shaken and remain wary of further possible aftershocks. This article considers the stabilisation measures already implemented by the British government and the draft legislation for a permanent statutory regime to deal with failing banks.
2. Measures already implemented
2.1 Special Liquidity Scheme ("SLS")
The Bank of England (the "BoE") summarises the SLS as a scheme enabling banks "to swap temporarily assets that are currently illiquid in exchange for UK treasury bills". In fact, the BoE lends treasury bills in return for security over 'swapped' assets. It is limited by eligibility restrictions for both institutions (only those eligible to subscribe to BoE standing facilities) and assets (only those backed by residential mortgages or credit card debt). Despite these limitations, it has proved so popular that both its availability period and its value have been extended.
A key feature of the SLS is that the risk associated with the 'swapped' assets remains with participants. The public sector would only be exposed if a bank failed to return its treasury bills at maturity and the value of the assets it had pledged as security fell short of the value of the bills borrowed. The use of a margin or 'haircut', intended to ensure that the value of security assets is always greater than the value of the bills, reduces this risk.
2.2 Bank Recapitalisation Fund ("BRF")
The government has made available up to £50bn for equity share capital investments in certain UK banks. The overriding objective of the BRF is to ensure that banks maintain capital positions which support market confidence in them. The foundations of such confidence include banks having sufficient capital to absorb losses and to continue normal commercial lending. So far, Lloyds TSB, Halifax Bank of Scotland and Royal Bank of Scotland are participating in the BRF. Others intend to increase capital through normal commercial measures. Naturally, banks wish to minimise any government shareholding to ensure independence and avoid the stigma of public ownership. However, if the poor uptake of RBS's recent share placing is any indication, the amount needed from the government may be higher than anticipated. Predictions suggest that the banking system may need capital investment of at least £100bn before confidence in it recovers.
2.3 Credit Guarantee Scheme
This scheme aims to encourage wholesale lending by issuing government guarantees in respect of certain debt instruments issued by eligible institutions. In theory, if a bank is backed by a government guarantee, other banks will be less reluctant to lend to it. Wholesale funds will start to move more readily and LIBOR will fall as confidence between banks is restored. However, the scheme's eligibility conditions, both for participants and instruments, limit its scope so that it may only boost confidence in institutions least in need of such support.
3. Permanent Statutory Regime
3.1 Banking Bill 2008 (the "Bill")
The Bill, published in October, is the government's proposal introducing for the first time a permanent statutory regime for dealing with troubled banks. This replaces emergency legislation passed earlier this year, which expires in February 2009. It proposes a 'Special Resolution Regime', conferring various powers upon the tripartite authorities - the UK government, Financial Services Authority (the "FSA") and BoE. These powers include three 'stabilisation options' (to be used to rescue a failing bank), a bank insolvency procedure ("BIP") and a bank administration procedure ("BAP").
(a) Stabilisation options
These options restate and reinforce the authorities' powers under the emergency legislation. They are triggered if a bank fails to meet the conditions of its FSA authorisation (normally because of a failure to maintain adequate resources to conduct its business, in the FSA's opinion). The options are to transfer all or part of the shares or business of a failing bank to either (i) a private sector purchaser, (ii) a 'bridge bank' (a BoE subsidiary), or (iii) temporary public ownership.(b) BIP and BAP
The FSA already has statutory authority to apply for an administration order or petition for the winding up of a bank. The Bill extends this power so that, where certain conditions are met, any of the authorities can apply for a failing bank to be placed in BIP and the BoE can apply for a failing bank to be placed in BAP. These procedures follow the same structure as existing insolvency and administration regimes, with different 'officeholders' objectives. Ordinarily, a liquidator's objective is to realise an insolvent company's assets for distribution to creditors. A bank liquidator's primary objective is to ensure that eligible depositors receive compensation speedily or have accounts transferred to an alternative institution. Similarly, an administrator has three objectives, in order of priority: first to rescue the company as a going concern, secondly to achieve a better result for the company's creditors as a whole than would be likely if the company were wound up, or, if neither of the first two are possible, to realise assets to make distributions to secured creditors. In contrast, BAP will be used to oversee the operation of the 'residue' of any bank, following a partial property transfer under the stabilisation options referred to above. Consequently, a bank administrator's primary objective is to facilitate such transfer to the bridge bank or private purchaser.
3.2 Comment
In general the Bill has been welcomed, but there is widespread concern about certain of its provisions. This has led to calls for more consultation time to ensure that haste does not lead to measures which, instead of improving stability in financial markets, actually undermine it further.
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The Bill is primarily designed to limit the instability caused by failing banks by establishing an orderly regime for dealing with them. However, some consider that instability is an inevitable consequence of the failure of large financial institutions, and that stability will only be protected by tighter regulation which reduces the inherent risk of such failure. A consultation document on regulation regarding liquidity risk management and supervision is expected from the FSA in 2009. Critics suggest that the FSA's measures and the Bill should be developed concurrently.
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The Bill's stabilising effect is limited because it does not apply to foreign or investment banks, two categories with a significant impact on market conditions.
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In the context of a partial property transfer, the transferee may be able to 'cherry pick' the highest quality assets, disproportionately reducing assets available for residual creditors and undermining rights of set-off against other transactions with the same counterparty. Any such interference in creditors' rights or the ability to override contractual provisions could seriously damage confidence in UK financial markets and in particular London's competitiveness as an international financial centre. The government is consulting on secondary legislation to address this issue.
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There could be problems regarding transparency in how the authorities' powers are used. For example, it is proposed that the BoE should no longer have to disclose details of its emergency lending operations. The aim is to prevent the media-fuelled panic which occurs when news of a bank's financial difficulties breaks. However, it could lead to a more general sense of uncertainty as opposed to instability concentrated around the institutions which are the source of it.
