The government is injecting a staggering £37 billion of capital into the Royal Bank of Scotland, Lloyds TSB and HBOS. In effect, the government is nationalising RBS and is taking a 40% stake in the newly proposed Lloyds TSB HBOS group, once it has emerged. The move aims to save RBS from collapse following the disclosure of huge debts. The government will take a £5 billion preference share in RBS meaning it will receive dividends before other types of shareholders. In addition, the government will purchase £15 million of ordinary shares if the bank cannot find private investors. The credit crunch has all but evaporated banking investors over the last few weeks as major institutions run for cover in Government Gilts and Government Paper. The government has been forced to step in because banks have been unwilling to lend to each other over the last year. This has eventually caused dramatic runs on company shares and capital funding difficulties where market operations have failed in raising business finance.
The intervention comes with strings, as senior banking board members have been removed at RBS and LloydsTSB, and replaced with non executive Government Directors. In addition, director bonuses have been shelved, dividends cut and preconditions laid down for the business strategy and banking practice. There will be restrictions on the policies of banking lending, managing risk, limiting shareholder return and restricting growth in the future years. Another critical condition is that banks offer small business commercial loans at 2007 interest rate levels as well as maintain mortgage lending to struggling homeowners. Gordon Brown said: “We must now put in place new structures and rules for the future. This cannot simply be a short-term rescue to paper over the cracks. Only a surgical approach that gets to the root of the problem will ensure the problems do not return.”
The Council of Mortgage Lenders commented that it "doubts whether, in the current market where house prices have been falling and demand has reduced, it would be either prudent or desirable for the volume of lending to home-owners to equate to 2007 levels". There is also no actual compulsion for HBOS or Lloyds TSB to actually lend to businesses again that need vital overdraft and loan facilities to survive, despite the promise of cheaper interest rates. Small businesses employ 60% of the UK is working population and are therefore the lifeblood of UK economic growth. Despite some negative in endorsements, the government's intervention has been broadly welcomed by the business community and credit rating agencies like Moody's, as a vital first step in restoring confidence and stability in the financial markets.
The British banking system is going back to basics and will be forced to behave more conservatively and take fewer risks with taxpayers money in order to prevent a feature boom and bust cycles. The impact on the taxpayer of the investment, coupled with the banking rescue plan announced a few days ago, will mean that government debt will explode to over 50% of GDP. Economists have expressed concern that taxes will have to be raised in order to fund the bailout plan. Raising taxes as the UK economy enters a period of recession and so close to a general election could be politically disastrous.
The stock market responded positively to the news, as bank shares rose in value and the FTSE had its largest one-day gain in history. The government has stated that the bailout is a temporary measure and that taxpayers could benefit in the long run, if banking share values increase in value (after debts have been repaid and stability has returned to the money markets).
Barclays which is another major UK high street bank, turned down the offer of government help and said it would abandon its planned dividend of £2 billion for the second half of 2008. The government now holds major positions in Northern Rock, Bradford & Bingley, as well as B. S. and Lloyds TSB/ HBOS. Consequently, political influence in the banking system through policy-making and financial regulation will become inevitable over the coming years in order to curtail the past excesses.