House of Commons - Maintaining financial stability of UK banks: update on the support schemes

Maintaining financial stability of UK banks: update on the support schemes - Public Accounts Committee Contents

1 Removing taxpayer support to the banks

1. In 2007, following a period of instability in the financial markets, the Treasury made a series of interventions to protect depositors and stop instability spreading across the financial system. This included the nationalisation of Northern Rock and Bradford & Bingley; lending to troubled institutions and to the Financial Services Compensation Scheme to enable them to support depositors; the purchase of a large number of shares in RBS and Lloyds; and establishing sector-wide schemes to guarantee banks' debt-funding (the Credit Guarantee Scheme), protect their assets (the Asset Protection Scheme), and indemnifying the Bank of England against losses for providing temporary liquidity (the Special Liquidity Scheme).[2] We reported recently on the Asset Protection Scheme.[3]

2. The National Audit Office (NAO) reported that the level of explicit support provided to the banks had reduced from £955 billion in December 2009 to £512 billion by December 2010.[4] This figure includes the value of all the outstanding loans and guarantees, the cost of the shares in RBS and Lloyds, and the sector-wide support schemes where the taxpayer has assumed risk. This support must now be removed through the disposal of shares, repayment of the loans, replacement of publicly guaranteed funds by private finance, and by the banks exiting from the support schemes.[5]

3. The Bank of England told us that many of the banks were "too big to fail" in so far that the Government retained the risk of needing to provide further support to any bank that threatened the stability of the overall system.[6] Consequently, many of the banks' investors expect that the Government would intervene to protect banks' creditors before any loss to their investment occurred.[7] This provided an implicit subsidy to all the major UK banks, not just those owned or part-owned by the taxpayer, whereby the banks could borrow more cheaply than if the investors believed there was a real chance of losing their money. The Bank of England estimated that this subsidy was worth some £100 billion to the major UK banks in 2009 alone.[8] RBS and Lloyds did not agree with the methodology underpinning the calculation. Nevertheless, they accepted that a significant subsidy existed - RBS suggested that it might be around £10 billion - and they agreed that the implicit subsidy needed to be removed.[9]

4. The peak of the financial crisis has passed and some senior individuals within the banking sector have argued that the time for remorse needs to be over.[10] Taxpayer support for UK banks, however, remains extensive, and the risks to the public finance from the banking sector are great. Even those banks that had not received capital cash injections from the UK Government continued to benefit from the implicit support, and many used the Credit Guarantee and Special Liquidity Scheme, and may have used international support schemes, including the US Troubled Asset Relief Programme and loans from the European Central Bank.[11]

5. In principle, taxpayers should not be providing any support, explicit or implicit, to the banking industry.[12] This requires two broad changes to the global banking system. First, banks and their regulators must reduce the risk of any bank failing.[13] Secondly, it must be possible for banks to be allowed to fail without either putting the financial system at risk or leaving the Government with no choice but to extend taxpayer support. In principle, the banks' creditors should take on the burden of supporting banks that is currently borne by taxpayers.[14]

6. The banks, however, are global, and it is unlikely that the Treasury can do much to bring about these changes without working with global and European authorities.[15] Progress is being made on reducing the risk of any bank failing through the Basel III proposals on capital and liquidity, although much of the practical detail had still to be worked out.[16] Little as yet has been achieved on the second challenge of ensuring large banks can be allowed to fail without the need for taxpayers to provide support. The Bank of England told us that the options available to deal with a failing bank were still not able to pass the costs of failure to the shareholders and creditors instead of to the public purse.[17] The Bank of England believed that this could not easily be done retrospectively, and all players needed to understand the terms of investment in advance.[18]

7. The Government has yet to set out its position on how it will ensure taxpayers do not need to bail out banks in future. It is due to respond to the recommendations from the Independent Commission on Banking, expected to report in September 2011, and will then set out how it will attempt to remove the industry's reliance on taxpayers.[19] Meanwhile, the Treasury told us that it continued to engage with global and European institutions to enhance the stability of the financial system and improve banking regulation.[20]

8. One cause of the financial crisis was the banks' over reliance on wholesale funding markets. The Credit Guarantee Scheme was introduced to help restore investor confidence in bank wholesale funding by providing a government guarantee on certain unsecured debts in return for a fee.[21] This increased funding at a time when wholesale funding was in very short supply. The fees were set and announced in October 2008, at the height of the crisis when the Treasury believed that market prices for insuring debt were higher than could be justified by the risk. They were set at a rate that was higher than the minimum set internationally.[22]

9. The NAO identified a subsidy to the banks participating in the Credit Guarantee Scheme of at least £1 billion.[23] The scheme not only allowed the banks to access funding when it would not otherwise have been available, but also allowed the banks to borrow money more cheaply than they otherwise would have done. This difference had not been fully captured by the fees charged by the Treasury for the guarantees and therefore taxpayers have not been fully compensated for their risk. RBS did not recognise that the Credit Guarantee Scheme represented a subsidy from the taxpayer; arguing that taxpayers would make a profit and that the market price was theoretical.[24] Nevertheless, the Treasury acknowledged the subsidy and agreed to review the fees.[25] This is particularly important if the banks seek to use the rollover facility and extend their use of the scheme significantly beyond 2011.[26]

10. The Treasury and Bank of England told us they were winding down the Special Liquidity and Credit Guarantee Schemes in ways that they hoped encouraged the banks to move to a more sustainable funding model. To do so, the banks needed to reduce their use of wholesale funding and to replace their maturing debt as it fell due. The Treasury told us that UK banks were planning to manage the refinancing challenge by increasing their deposits and reducing their assets.[27]

11. The Treasury and Bank of England assured us that the banks were seeking to withdraw from the Credit Guarantee and Special Liquidity Schemes and that they were on course to do so.[28] The largest users of the schemes (the part-nationalised banks RBS and Lloyds) had reduced both their use of the support schemes and their use of wholesale funding as a whole, but had done so in a way that had not reduced the proportion of their funding that is dependent on the wholesale funding markets.[29]

12. This Committee was of the view that it was important that the wind down of the support schemes continued to be orderly. Winding down the Special Liquidity and Credit Guarantee Schemes too quickly could be disruptive to the banks' overall funding position, because it could require them to seek too much new wholesale funding at the same time. The Bank of England had already negotiated a smoother profile of exit from the Special Liquidity Scheme to avoid the forecast "cliff-like" withdrawal of that support.[30] The NAO report showed that the banks had successfully replaced some £150 billion of maturing funding in 2010, but there remained over £400 billion that would mature over the next two years.[31]

13. Inevitably the banking sector will have other financial crises, and the Treasury and Bank of England are highly likely to need to resolve another bank at some point.[32] In June 2010, the Chancellor announced proposals to restructure financial regulation, including conferring responsibility for prudential regulation to the Bank of England and its new subsidiary agency to be known as the Prudential Regulation Authority.[33] This makes it vital that the Treasury capture the practical and theoretical lessons learnt from managing this financial crisis. The Treasury committed to consider how it will capture the lessons from its staff and pass these on to the Bank of England and the proposed Prudential Regulation Authority.[34]

2 C&AG's Report, Key facts and background, page 4 Back

3 Committee of Public Accounts Thirtieth Report of Session 2010-12, HM Treasury: The Asset Protection Scheme, HC 785 Back

4 Q18: C&AG's Report, Figure 1 Back

5 Qq 12-13 Back

6 Qq 21-24, C&AG's Report, para 10 Back

7 Qq 18-20, 31 Back

8 Qq 11, 18 Back

9 Banking Support and Asset Protection hearing of 16 March Qq 105-109 Back

10 Qq 95-97 Back

11 Qq 11,14, 45, 72, 87, 90, 94, and 107; Banking Support and Asset Protection hearing of 16 March Q105 Back

12 Qq 11-13 Back

13 Qq 21, 31 Back