Wednesday, October 8, 2008

UK Bank Bailout Plan Explained

In a recent post, I looked at the difficulties facing the government as they seek to avoid a serious economic recession - problems of avoiding recession
Today the government and bank of England have tried to act decisively to deal with growing uncertainty. Firstly, interest rates have been cut by 0.5%. Secondly, the government has offered help for the beleagured banking system.

The UK bailout Plan involves

1. Banks Selling Shares to Government. - £50 billion (or £2,000 for every taxpayer)
  • The Government is injecting money into the banking system in return for taxpayers gaining shares in the banks. (These shares could be preference shares, ordinary shares or PIBS Permanent Interest Bearing Shares)
  • In effect it is part nationalisation of the banking system.
  • Seven Banks - Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland and Standard Chartered have already taken part in the scheme. As these banks and one building society need to raise their cash ratios.
  • £50bn is a huge sum for the treasury to absorb. The annual NHS budget is about £75bn.
2. Government Guarantee for Debt. - £250bn

The government is offering upto £250 billion to guarantee banks debts. This makes it easier for banks to sell short and medium term debts to raise finance and improve their liquidity. Note: this does not mean it will necessarily cost the taxpayer £250bn. It means the government is acting as guarantor, which helps give banks confidence.

3. Extra Liquidity to Help Money Markets - £200bn

The Bank of England will be injecting a further £200bn into the short term money markets to help unfreeze interbank lending, which is important for banking system.

What Does Bailout Mean for The Taxpayer?

In the short term, it means an increase in government borrowing and national debt. In the long term, it depends how banking shares fare. If shares in banks recover, the government could profit. If bank shares continue to slide, the government will lose out.

It is hoped that decisive government intervention will help solve the paralysis facing the banks. However, A report by the IMF suggests that the scope of bad debts in the banking system are higher than previously thought, meaning more write offs and problems for banks could be occuring soon.

Benefits of Scheme
  • It is important that banks are able to lend to consumers and firms. Without lending investment will fall dramatically causing a bigger downturn and longer recession.
  • Decisive government intervention may help restore confidence in financial markets. With more confidence the banking system may need less intervention and be able to solve its own problems.

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