House of Commons - Maintaining financial stability across the United Kingdom's banking system

Maintaining financial stability across the United Kingdom's banking system - Public Accounts Committee Contents

1 Ensuring that the taxpayer and wider economy are protected

1. The support measures were designed to improve confidence in the United Kingdom's banking system, and thereby maintain financial stability. The maintenance of financial stability involves:

maintaining liquidity to allow banks to meet customer withdrawals of cash, and to repay outstanding borrowings in the wholesale markets when they fall due;
ensuring that the major banks were solvent, that is, that they had capital to cushion themselves from losses caused by a further deterioration in the financial markets, and
encouraging banks in receipt of support to continue to lend on a commercial basis to creditworthy borrowers, thereby reducing further deterioration in the economy, which could in turn lead to further liquidity and solvency issues across the banking sector.[2]

2. There is no single measure of success in maintaining financial stability but a range of indicators have since stabilised and improved. Success is linked closely with sentiments and events in both domestic and world markets and drawing a direct link between individual measures and changes in market indicators would not be valid. By November 2009, a range of indicators such as the benchmark interest rates for wholesale funding, bank share prices and the perceived risk of bank defaults had eased. In his report, the Comptroller and Auditor General concluded that the Treasury had met two of the Government's objectives, namely maintaining financial stability and protecting retail depositors. The Treasury's performance in meeting the Government's other objectives of protecting taxpayer' interests and ensuring continuing lending to creditworthy borrowers are considered further in this report.[3]

3. In the March 2009 Budget, the Treasury estimated that the final net cost to the taxpayer of supporting the banks might range from £20 billion to £50 billion, depending on the strength of any recovery in the economy.[4] The most recent estimated net cost, included in the December 2009 Pre-Budget Report, was significantly lower, at some £8 billion.[5]

4. The estimated losses continue to be highly uncertain, although the risks associated with most of the interventions declined significantly during 2009. For example, in its Annual Report for 2008-09, published in July, the Treasury made a provision for expected losses from the Asset Protection Scheme of £25 billion.[6] However, following Lloyds Banking Group's decision not to enter the Scheme in November 2009 and changes to the terms under which RBS would participate, the Treasury's base case now suggests there may not be any cost to the taxpayer arising under the Scheme.[7] Overall, the Treasury has received sizeable fees for providing guarantees and other forms of support. As the economy recovers, the Treasury expects that a net profit may eventually be made.[8]

5. The main risk for the taxpayer is now the prices obtained when the shareholdings in RBS and Lloyds Banking Group are eventually sold off. For every ten pence increase in the prices obtained for the shares, taxpayers will secure an additional £9 billion from the sale of shares in RBS, and an additional £3 billion from Lloyds Banking Group shares (Figure 1).[9]

Figure 1: Potential profit or loss for the taxpayer at different share prices

Source: C&AG's Report, Figure 19

6. It will be some years yet before the taxpayer can disengage from the various support measures and shareholdings. In the Treasury's view, if the assets insured under the Asset Protection Scheme performed well and RBS gained access to alternative sources of capital, it might exit the Scheme early after two to three years. All of the support schemes will eventually be wound down but it is likely that the shareholdings, particularly in RBS, will be the last to end. Timing will depend on the performance of the financial markets, which is difficult to predict, although the Treasury considered that the process could be completed in three to five years.[10]

7. The Treasury accepted that measurement of its ultimate success should extend beyond the return obtained for the shares, with regard paid to future competition in the banking sector. The crisis in the sector had led to further consolidation in the UK market, including the merger of Lloyds and HBOS. The Treasury would have to balance its interest as shareholder against its interest in promoting a competitive banking system. The creation of UK Financial Investments as an arms-length body to manage the shareholder interest was partly a means of managing this tension. Under current proposals RBS and Lloyds Banking Group would divest themselves of some of their constituent businesses. There were also proposals to reduce Northern Rock's balance sheet, all of which should result in new entrants to the market.[11]

8. In negotiating the Asset Protection Scheme, the Government agreed lending commitments under which Lloyds Banking Group would lend an additional £14 billion and RBS an additional £25 billion in the year to February 2010. The commitments were legally binding.[12]

9. At the end of September 2009, both RBS and Lloyds Banking Group were on track to meet their mortgage lending targets but lending to businesses, particularly small and medium-sized businesses, is likely to fall short.[13] The Chancellor of the Exchequer had established a lending panel which meets once a month to hold the banks to account. The banks had argued that they were trying to lend, but demand for loans to businesses had fallen away. Larger businesses had raised £25 billion in the bond and equity markets in the previous six months with a lot of this being used to pay off debt (Figure 2).[14] But small businesses still reported difficulty getting access to credit from banks.[15] In October, the Bank of England reported that fees charged by the banks on new business or renewed lending remained at high levels compared to before the crisis. Some small businesses suggested the banks were making changes to the conditions governing existing loans and previously agreed overdraft limits.[16]

10. The Treasury could not say why the lending commitments to businesses were not being met. It did not expect the banks to enter into arrangements that were not commercially viable. Higher charges for lending could reflect the fact that lending to small business is more risky during a downturn. Interpreting the lending data was therefore difficult. The Treasury drew upon a range of evidence sources to try to identify the real position, including monthly reports on lending published by the Bank of England and credit condition surveys which sought the views of business. It accepted, however, that it needed to redouble its efforts to understand why the lending targets were not being met.[17]

11. Ultimately, the Treasury has few formal sanctions available if the commitments are not met. It could refuse to extend guarantees for wholesale borrowing under the Credit Guarantee Scheme.[18] The Credit Guarantee Scheme is due to close at the end of February 2010. On closure, a proportion of the existing loans could be rolled forward for up to three years but this was subject to a cap and the Treasury had the power to decide which loans could be rolled forward. In addition, in the case of RBS, the Chief Executive's remuneration is, in part, linked to the achievement of lending commitments. The Treasury expects to put in place further lending commitments from March 2010 but no targets had yet been set.[19] Alongside considering new targets, the Treasury would think about methods of enforcement.

Figure 2: Net funds raised by UK businesses



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