Just after the U.S. Congress passed a $700b bailout bill last week aimed at restoring confidence in the financial system, the UK government has also unveiled a bailout plan which may potentially inject tens of billions of pounds into some of the country’s largest financial institutions reports WSJ, quoting people familiar with the matter.
As part of the plan, the British government will offer to buy stakes in Royal Bank of Scotland Group PLC, Barclays PLC and soon-to-be-combined HBOS PLC and Lloyds TSB Group, and provide other assistance that could total as much as £50 billion ($87.9 billion). An announcement to the same is expected in some time. WSJ further reports that this plan was hastily put together and is not clear how the banks would respond to it.
The government’s measure is aimed at infusing liquidity into the system by propping up the banking sector. Central banks across the world are injecting liquidity as the global financial crisis deepens. It was only recently that India’s central bank announced a half percentage point (50 basis point) reduction in the cash reserve ratio to ease liquidity in the system.
However, there is a subtle difference between the approach taken by the U.S. with its $700 billion financial-markets bailout fund and bail out plans of the UK.
While the big part of the US government’s bailout effort is aimed at restoring confidence in the credit markets by creating a “buyer of last resort”, especially for the toxic credit derivatives that have heavily damaged the financial sector, the UK plan is aimed at boosting the banks’ capital so they can restart the lending that is crucial to economic growth.
The report adds that the UK banks are especially vulnerable to the credit crisis because they depend more on credit markets, and less on customer deposits, for the funding they need to make loans.
What led to UK’s Bailout
The credit problem in the UK intensified in recent weeks after the bankruptcy filing of US securities firm Lehman Brothers Holdings Inc. whish raised concerns about other bank failures. Signalling increasing lack of faith among banks, the overnight sterling London interbank offered rate, or Libor, the stated rate that banks charge each other to lend, sharply increased Tuesday to 5.84% from 5.08% on Monday.
It was only last week, U.K. authorities moved to nationalise mortgage-lender Bradford & Bingley PLC after its stock price fell 28%. The Bank of England tried to shore up confidence in British institutions by allowing banks to swap hard-to-sell securities for government bonds. According to the analysts, the loan-to-deposit ratio among UK domestic banks is 143%, up from 105% in 2000, according to a recent Credit Suisse report.
The news report also quotes a report published by Citigroup last month which estimated that the six largest domestic U.K. banks — including Barclays, RBS, HBOS and Lloyds — depend on lending markets for a combined £542 billion.
Further, the financial contagion continued to spread, and like the U.S., Germany and other countries, the UK was forced into a series of ever-bigger moves. Iceland looked to Russia for an emergency loan and seized control of a second big bank. Russia announced it would inject about $36 billion into its own banks, a month after it put together a $120 billion bailout of its financial markets. Australia’s central bank slashed its key lending rate, keeping in line with the dramatic rate cuts around the globe.