However, at least on the first day the bailout package did not restore any confidence in the market. As a matter of fact share prices of the entire banking sector kept tumbling like nine pins.
The British Prime Minister, Gordon Brown, while outlining the salient features of the programme in an open letter to the nation called the banks’ rescue package as stability and restructuring programme and said it was ‘comprehensive, specific and breaks new ground.’ He said his government has taken three steps to bring the banks back from the precipice:
First, to address the immediate issue of flows of money between banks, the Governor of the Bank of England is extending and widening the provision of short- term liquidity. Loans under the special liquidity scheme will be increased from £100 billion to at least £200 billion and the bank will also now bring forward proposals for a permanent facility.
Second, to ensure the long-term health of the British banking system, we are today offering to support banks in raising additional capital by investing directly through preference shares - or at their request by assisting them in raising ordinary shares. The largest banks have committed that they will increase their capital by £25 billion which we will make available to them if they so wish. In addition, we will provide at least another £25 billion. We, the bank and the FSA are determined that UK banking should be strong and secure.
And thirdly, for a fully commercial fee we will provide guarantees to allow banks to raise their own money in the market and so resume normal lending. We expect to provide at least £250 billion of guarantees. He said there will be strings attached and conditions to be met by the banks to qualify for help from the rescue package.
Giving a brief insight into the conditions he said his government would insist on banks’ credit lines to SMEs being maintained on a normal commercial basis and it must also be satisfied, in the terms of agreements, about executive remuneration dividend payments and about improvements in supervision.
There are three main elements to the government’s package. First, the Treasury has made up to £50 billion ($88 billion) available to banks as injections of state money to raise their “tier-one” capital, the bedrock support for banking business. Eight large lenders—Abbey (owned by Santander, a Spanish bank), Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, RBS and Standard Chartered—have said that they will together increase their tier-one capital by £25 billion by the end of the year (though HSBC said that it will not tap government funds and instead recapitalise using its own resources).
A further £25 billion is available for all institutions, which include British subsidiaries of foreign banks. In return, the Treasury will take interest-paying but non-voting preference shares (or permanent interest-bearing shares for building societies) in the institutions.
Second, the government is doubling the amount of money available to banks through the Bank of England’s “special liquidity scheme”. This facility, which started in April, allows banks to swap illiquid mortgage-backed securities for Treasury bills, which can be readily cashed, for up to three years. Alistair Darling, the chancellor of the exchequer, indicated last month that £100 billion had been made available; now he has raised that amount to £200 billion.
Third, the Treasury will provide guarantees for new short and medium-term debt issued by banks for periods of up to three years. It expects the take-up of this guarantee to be around £250 billion.
The collapsing banks had been looking for some time for capital, liquidity and funding. Since none was forthcoming from the market whose confidence was completely shattered, the government was faced with the choice of either letting the banks go down and take the entire economy of the rich world along with it, or resort to the blaspehmous act of nationalisation using the tax payers money. Naturally, it preferred the second option because no other option was available.
Mervyn King, governor of the Bank of England was quoted as saying that the package amounted to, “a significant step forward in resolving the present crisis”. However, the stock market refused to respond positively. Immediately following the announcement the benchmark FTSE 100 index was down by some four per cent, and bank shares continued to slide (although HBOS and RBS staged a recovery). And although spreads on British banks’ credit-default swaps eased, the three-month sterling Libor, remained obstinately above six per cent.
Alaister Darling, the Chancellor said he expected banks to lend more to small businesses and home buyers in return for government support. Britain’s largest banks are to be part-nationalised after the government took the momentous decision to pump tens of billions of pounds of public money into the sector to avert a banking collapse.
The move came as central banks around the world announced a co-ordinated cut in interest rates in response to mounting fears about the impact of the financial crisis on the world economy. The US Federal Reserve, the European Central Bank, the Bank of England, and the central banks of Canada, Switzerland and Sweden and the United Arab Emirates all cut their main lending rates by 0.5 percentage points.