Second banking bailout confirmed

19 January 2009

The Treasury has confirmed a second banking bailout with a host of measures that it hopes will enable banks to increase their lending to consumers and businesses.

The latest bailout include insuring banks against any losses they have to “bad” debt. Banks will not have to pay for this insurance, but will have to declare losses they expect to make from particular debts. In return, the government will offer insurance against these losses up to 90%.

The logic behind this scheme is that such debt is hard to value, as banks are not currently able to sell it through the normal avenues, making it hard for them to know how much money they have on their balance sheets to lend. As a result, banks have been storing up their finances and restricted new lending.

The insurance scheme should encourage banks to increase their lending levels, as they have a government assurance of how much money they can expect to reclaim from the debts.

A second measure announced by the government is the launch of a guarantee scheme for asset backed securities, a move recommended by Sir James Crosby in his investigation into how best to support bank lending to individuals and businesses.

This scheme aims to help banks access funding from the wholesale funding markets, thus supporting new lending, by offering Treasury guarantees to high quality asset-backed securities, including mortgages as well as corporate and consumer debt. The aim behind this move, which will not commence until April 2009, is to re-open the wholesale money markets this enabling banks to increase their funding.

Vicky Redwood, UK economist at Capital Economics, says the measures mark a “significant step” but, on their own, may not be sufficient to get banks lending again.

“These are not magic solutions. They will take time to get off the ground, with the asset-backed securities scheme unlikely to commence until April,” she warns. “Meanwhile, banks will still face significant recession-related losses as unemployment and business failures rise.

"And as the recession deepens, banks may still want to simply sit on any cash freed up by these measures rather than lending it on to potentially risky borrowers.”

Redwood predicts that the government will have to eventually give banks lending targets to force them to lend - perhaps via further nationalisation.

Northern Rock

Northern Rock is to stop actively shrinking its mortgage book in a move unveiled as part of the government’s second banking bailout.

Following its nationalisation early last year, Northern Rock announced plans to reduce its mortgage book by a whopping 60%. This meant that mortgage borrowers coming to the end of their introductory deals were offered unattractive remortgage rates or encouraged to move to other lenders such as Lloyds TSB. Read more here.

While this strategy has enabled Northern Rock to reduce its government loan ahead of its original timetable, the bank has now agreed to slow down its mortgage redemption strategy as part of the Treasury’s second banking bailout.

In a statement, Northern Rock says: “In order to support government policy to increase mortgage lending capacity in the market, the company confirms that it is slowing down the rate of mortgage redemptions.

“This means that more mortgage customers will be able to stay with Northern Rock. A reduced level of redemptions will lead to Northern Rock repaying its loan to government at a slower rate.”

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