Taxpayers to insure £500bn of bank assets
Taxpayers may become liable for £500bn of poor loans and investments made by Royal Bank of Scotland and Lloyds TSB.
Negotiations are at an advanced stage on what the Treasury has called its Asset Protection Scheme, which would involve taxpayers insuring banks against future losses on their less prudent lending and investment.
It is understood that each of Lloyds and Royal Bank hopes to insure £250bn of their loans and investments.
They are working towards a deadline of Thursday for Royal Bank and Friday for Lloyds to agree the outline of the deal with the Treasury.
If £500bn of their assets are insured, this would be a bold attempt by the Treasury to achieve two outcomes: first, to strengthen their balance sheets to avoid having to nationalise the banks fully if their losses increase; second, to release resources within the banks to generate perhaps £30bn or £40bn of new lending to companies and home buyers.
It would also, however, lift the total of British taxpayer support for our banks since the start of the credit crunch - in the form of loans, guarantees, insurance and investment - to a remarkable £1.3 trillion, more or less equivalent to the entire annual output of the British economy or GDP.
Sources close to the negotiations said that there are still important disagreements between the Treasury and the banks on the terms of the deal.
One contentious area is the size of the loss - known as the first loss - that the banks must incur before taxpayers pick up the tab.
The Treasury wanted the banks' owners, their shareholders, to be liable for the first 10% of the loss.
But on £500bn of assets, that 10% loss would potentially destroy their balance sheets - and thus end up weakening the banks, rather than strengthening them.
Second, is the size of the fee payable by the banks.
This would be in the form of participating preference shares to be issued to the Treasury and would probably be classed under banking regulations as core tier one capital - which means they would reinforce the financial robustness of the banks.
These shares would carry no votes. So the government's voting control of Royal Bank would remain at 70% and 43% for Lloyds TSB.
But if the fee were set high, the government's economic interest in these banks - it claims over the banks' assets - could approach 100%.
In the sense of rights over the banks' profits and assets, there would be little or nothing left for Royal Bank's and Lloyds' private sector shareholders. This would represent "economic" nationalisation of the banks, if not formal nationalisation.
The banks and Treasury officials, together with teams of City advisers, are struggling to construct a formula that avoids this economic nationalisation.
Update 2009-03-03: In the first paragraph of this note, I referred to "Lloyds TSB". Following the acquisition of HBOS, the bank is of course now called "Lloyds Banking Group". For Lloyds, most (but not all) of the assets to be insured by the new Asset Protection Scheme are expected to be loans and investments that were originally made by HBOS.