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Archives for December 2010

Will the chancellor regret creating the Banking Commission?

Robert Peston | 10:09 UK time, Thursday, 23 December 2010

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One of the bigger stories next year will be the recommendations of the Banking Commission set up by the chancellor on how to increase the safety of our banks and enhance competition between them.

What is increasingly clear to me is that this could cause something of a political car crash, in that there is no chance that the commission will say that the status quo is acceptable. Of the five members of the commission, not one believes that the way banking in the UK is organised today is either sensible or sustainable.

Mr Osborne leaving a cabinet meeting, 21 December

Mr Osborne leaving a cabinet meeting, 21 December

That means the chancellor is likely to be presented with proposals which will be hated by much of the City and by an influential contingent of his own party. The Commission's recommendations - due to be put forward in preliminary form in April - may well therefore precipitate something of a war both between the banks and government and within the government.

None of which is to say that I know precisely what the commission will propose. It is too early in the process to be sure of that. But the members' identification of the problems tells you that what they'll eventually say cannot be anodyne.

Their starting point is that if they were designing a banking system from scratch, it would look almost nothing like the banking system we have.

First and foremost, they believe that it is profoundly unhealthy for the UK to have banks which insist on the freedom to operate how they like (including paying whatever bonuses they like) and yet could not carry on in business without implicit or explicit financial support from taxpayers on a colossal scale.

So one challenge for the commission is to come up with a structural reform that would make banks, bankers, their shareholders and creditors completely liable for the business mistakes of banks' managements, without putting at risk either the savings of retail depositors or the integrity of the payments and credit-creation systems.

That will mean forcing banks to hold substantially more capital - tens of billions of pounds more - to absorb potential losses. This will be neither cheap nor easy for the banks to raise (and may take the form of debt that automatically converts into equity capital in certain circumstances).

And it will also mean - subject to agreement in the EU (which won't be simple to obtain) - some kind of credible separation of retail banking and the money-transmission mechanism from banks' more speculative activities (which could mean splitting banks or putting in place robust firewalls and barriers within banks so that savers' money can't be tainted by investment banking).

What I think the commission wishes to build is a new structure for the banking industry in which it is perfectly clear that the investment banking parts of Barclays and Royal Bank of Scotland, for example, won't in any circumstances be rescued by taxpayers - so that if they get into trouble, all the pain of that trouble falls on commercial investors and creditors.

The onus for Barclays and Royal Bank in those circumstances would be to prove that their investment banks are viable, profitable businesses. Which they will not find easy. Because right now those banks are able to borrow at cheaper rates, since creditors know that they'll be bailed out by taxpayers if the banks get into difficulties (see my earlier post How to curb bonuses for more on this).

Funnily enough, proposals to enhance competition between banks could also make it easier to ring-fence the bits of banks that can't be allowed to fail because of the consequential damage to the economy.

The main obstacles to effective competition are the inertia of consumers - our reluctance to switch banks - and the difficulty for new banks and smaller banks in obtaining access to essential financial infrastructure, such as the money-transmission or payments system.

If the money-transmission system were regarded as a utility, a bit like the national grid in energy, then it could be regulated both to preserve its integrity and to make sure that smaller banks were allowed to use it at a price that permitted them to generate a decent return.

This could involve forcing the big banks to de-merge the vital payments infrastructure into standalone, service utilities - which in theory could have benefits both for competition and in ensuring that when a bank got into trouble there would not be a serious risk to wider commerce.

What it will all boil down to for the Banking Commission is this: how to let bankers who want to be entrepreneurial do their stuff, without having the comfort of knowing that if it all goes wrong for them, we as taxpayers will pick up the bill. It won't be easy or uncontroversial.

Unanswered questions about Cable

Robert Peston | 10:22 UK time, Wednesday, 22 December 2010

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What I still feel bemused about is why the Telegraph, for which I used to work, did not publish the one story that would have unquestionably legitimised its under-cover exercise to elicit the private views of Lib Dem ministers.

Vince Cable

 

Pretty much everything these Lib Dems have been caught saying about their Tory colleagues is what one would expect them to say to their supporters in private. And readers of my blog, among others, say there are questions to be asked about whether democracy is best served by hounding MPs to such an extent that perhaps in future they will feel safe to speak their minds only in the matrimonial bed.

But Vince Cable's remarks that he had "declared war on Mr Murdoch" were in a different category. And that's not because there is anything special about Mr Murdoch that should protect the media billionaire from the criticism of ministers or from anyone else for that matter.

It's because there was something very special about Mr Cable's legal status as business minister, in respect of his dealings with Mr Murdoch's News Corporation and its attempt to buy the 61% of BSkyB that it doesn't already own.

The important point is that Mr Cable was the final judge - on his own, with almost absolute power - about whether this takeover should be allowed to proceed. This would have been a personal decision, not a cabinet one, under the terms of the 2002 Enterprise Act.

And Mr Cable was supposed to exercise that authority in a dispassionate way, having heard the evidence and listened to the advice of regulatory bodies and his own officials.

So in saying, even in private, that he's out to get Mr Murdoch, he undermined due process: he allowed News Corporation and its lawyers the ability to say, with considerable credibility, that the case was rigged against them (which of course they have said).

Mr Cable's remarks were like a judge telling a defendant that he is going down, weeks before prosecution and defence have presented their cases. They were straightforwardly inappropriate, as the prime minister said yesterday, which is why Mr Cable and his department were yesterday stripped of all responsibility for media policy and regulation.

So whether you like Mr Murdoch or hate Mr Murdoch, it was straightforwardly and unambiguously in the public interest for Mr Cable's remarks about Mr Murdoch to be put in the public domain.

Why didn't the Telegraph publish these remarks when it exposed much of the rest of what Mr Cable said to undercover reporters overnight on Monday? Why weren't these remarks included in what it called, on its website, a "full transcript" of the secretly recorded interview?

The whistleblower, who yesterday gave me the full recording, told me that the Telegraph's omission of these sections about Mr Murdoch was a commercial decision, motivated by the fact that the Telegraph - like Mr Cable - would rather News Corporation does not end up as 100% owner of BSkyB.

I of course put this to the Telegraph. And rather late in the day, at 19:19 last night to be precise, the Telegraph's external media adviser sent me a statement attributed to an unnamed "spokesman for the Daily Telegraph". The statement says:

"It is utter nonsense to suggest that the Daily Telegraph did not publish comments from Vince Cable on the Rupert Murdoch takeover of BSkyB for commercial reasons. It was an editorial decision to focus this morning on Cable's comments on the Coalition because they were of wider interest to our readers".

Well, some would say that was a slightly eccentric editorial decision for an editor, Tony Gallagher, widely regarded as one of the sharpest in the business. I rang Mr Gallagher to discuss this, but he directed me to the Telegraph's internal PR spokesperson.

Also, you may have noticed that the Telegraph has not yet put out any clear and unambiguous statement that it was ever planning to publish Mr Cable's remarks about Mr Murdoch (though it has now published them, after they were put out by the BBC).

Maybe I am being a bit naive and silly to think any of this matters. Maybe most of you think that what we do as reporters is so obviously and constantly subject to commercial interference that there is no particular benefit to be gained from asking the Telegraph to explain itself in this case.

But actually that's not been my experience in 27 years as a hack. And I still think the question of what news organisations put into the public domain, and how they do it, matters.

And there is one other thing. Which is that we have surely learned beyond reasonable doubt that it is quite difficult for any single individual to be dispassionate about Mr Murdoch and his expansionist ambitions.

Some love him, some hate him.

And since it surely matters to democracy who owns our major providers of news and mass culture, is it really sensible that a single politician should have the final say about whether a takeover as important as that of BSkyB by News Corporation should go ahead?

The Culture Secretary, Jeremy Hunt, will doubtless endeavour to be impartial in that adjudication, now that the power has been passed to him.

But if he allows News Corporation to own all of BSkyB, critics of Mr Murdoch - and they are not small in number - will accuse Mr Hunt and the government of repaying the support given to the Tory Party by Mr Murdoch's newspapers in the last election.

Even the perception that favours can be earned in that way is bad for the reputation of government.

Which is why there is probably a debate to be had about whether media takeovers should become subject to the same rules as almost all other takeovers - which is that ministers have no say at all, and decisions on whether to allow deals are taken by independent regulators (who are, of course, accountable to parliament, but not to the executive).

 

Mr Cable: What he thinks about the Telegraph

Robert Peston | 19:13 UK time, Tuesday, 21 December 2010

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Some would say that Mr Cable is fortunate to still be Business Secretary.

Some would argue Mr Cameron's decision to rebuke him rather than dismiss him shows that the coalition's grip on power is not as firm as it would like - in that, perhaps, Mr Cable is still in his job because of the perceived damage he could do the solidarity of the coalition from the bankbenches.

However Mr Cable and his department have paid a substantial price - in that the whole of the business department's media responsibility are being transferred to the department of culture, media and sport.

Which means that Jeremy Hunt as culture secretary will now have 50 more civil servants working from him, who are being transferred from the business department..

And Mr Hunt will have responsibility for deciding in early January whether News Corporation's bid for the 61 per cent of British Sky Broadcasting it doesn't own needs to be probed further by the Competition Commission.

If Mr Cable owes his continuation in office to the generosity of Mr Cameron, the prime minister may be interested in Mr Cable's views of what the two of them have in common.

Again, these are remarks which were not in the Daily Telegraph's self-proclaimed full transcript this morning. And interestingly they are not wholly flattering about the Telegraph or about the relationship between the Tory "faithful" on the one hand and Mr Cameron and his chancellor George Osborne, on the other.

"I assume you don't read the Daily Telegraph or Daily Mail but Cameron is being attacked by his own people for being a liberal.

"You see the same thing is happening to both sides. He and Osborne are both hated by their own party faithful. And I'm not kidding, if you read the Daily Telegraph I am described as a communist. They are saying 'why have you got this anti-bank communist in your government?' And they are attacked for betrayal in the same way that we are."

What Vince Cable said about Rupert Murdoch and BSkyB

Robert Peston | 14:30 UK time, Tuesday, 21 December 2010

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The Telegraph this morning chose not to publish the most explosive part of the remarks made by Vince Cable, the Business Secretary, to undercover reporters.

Vince Cable and Rupert Murdoch

Vince Cable and Rupert Murdoch

A whistleblower has passed me the full interview. Here are the excised comments by Mr Cable.

"I am picking my fights, some of which you may have seen, some of which you may haven't seen.

"And I don't know if you have been following what has been happening with the Murdoch press, where I have declared war on Mr Murdoch and I think we are going to win".

The conversation then turns to other matters for a few minutes. And then Mr Cable talks again about Rupert Murdoch and the £7.5bn takeover bid by his media conglomerate, News Corporation, for the 61% of British Sky Broadcasting which it doesn't already own.

What is important to know is that in respect of whether the takeover bid will be allowed, Mr Cable has a quasi-judicial role. It is he who will make the final decision on whether the takeover should be blocked or subject to strict conditions, because of its effect on so-called "plurality" or choice for consumers.

"Well I did not politicise it, because it is a legal question," Mr Cable says. "But he [Mr Murdoch] is trying to take over BSkyB - you probably know that."

The reporter says: "I know vaguely."

Cable: "With considerably enhanced..."

Reporter: "I always thought that he had BSkyB with Sky anyway?"

Cable: "No, he has minority shares and he wants a majority - and a majority control would give them a massive stake."

"I have blocked it using the powers that I have got and they are legal powers that I have got. I can't politicise it but from the people that know what is happening this is a big, big thing.

"His whole empire is now under attack... So there are things like that we do in government, that we can't do... all we can do in opposition is protest."

I have been passed a full copy of the interview by a whistleblower who is upset that the Telegraph chose to omit these remarks.

They are not included in a transcript that was published on the Telegraph's site this morning under the heading "the full transcript".

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The Telegraph has been a leading opponent of News Corporation's attempt to acquire the whole of BSkyB. In October, the Telegraph's chief executive, Murdoch MacLennan, signed a letter - along with senior executives of the BBC, Channel 4, the Daily Mail and Trinity Mirror - asking Mr Cable to consider blocking the takeover.

The disclosure of Mr Cable's private views on Mr Murdoch and the proposed takeover of BSkyB makes it extremely difficult for him to fulfil his role as the ultimate arbiter of whether the deal should proceed under the 2002 Enterprise Act.

News Corporation is bound to challenge his impartiality.

He is due to receive a report from Ofcom, the media regulator, on the impact on plurality of the bid by the end of the year. After that he has to decide whether to refer the deal to the Competition Commission.

If Mr Cable does ask for an investigation by the Competition Commission, it would ultimately be his decision whether the deal should be permitted, once he has received the advice of the Competition Commission.

Today the European Commission said it saw no competition grounds to block the takeover.

Update 1606: Here is the Telegraph’s official statement:

“The Daily Telegraph published some of the comments Vince Cable made to our undercover reporters today. We have made clear both in the paper today and in interviews that we will be publishing further comments in the forthcoming days.”

Now that statement is at odds with how the Telegraph described the transcript of Mr Cable’s remarks this morning, which it described as the “full transcript”.

 

Birch pub

 

What is more, the cuts from this morning’s transcript published online by the Telegraph does not indicate any passages have been removed. The normal convention of inserting dots to show an excision is not used.

The piece reads as though it is a seamless, unedited whole.

Now the whistleblower passed me the full recording of the interview having been told that Mr Cable’s remarks about Mr Murdoch’s attempt to acquire BSkyB were not going to run, at all.

You have to draw your own conclusions about why the Telegraph would choose not to publish those remarks (although following my publication of them, the Telegraph has now published them).

Some will notice that when it comes to opposition to Mr Murdoch’s proposed takeover of Sky, there is a convergence of the Telegraph’s views and Mr Cable’s views.

Banks bonuses: slim chance of deal with ministers

Robert Peston | 10:24 UK time, Monday, 20 December 2010

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The idea that we should be reading the last rites for the City and the UK's financial services industry, because of new constraints on how and what top bankers are paid, doesn't seem quite right in the context of the announcement today by JP Morgan of substantial new investments in London.

25 Bank Street

 

This leading investment and commercial bank, one of the top two or three in the world on some measures which employs 11,000 in London, is purchasing the not-so-old former Lehman HQ at 25 Bank Street as its new European investment banking HQ. Resonant or what?

It is also purchasing another building which it already occupies, at 60 Victoria Embankment, and it will continue to work with Canary Wharf on developing Riverside South.

In symbolic terms, given that all the talk recently has been of bankers flocking to Switzerland or Singapore - to escape the UK's 50p income tax rate and constant sniping from politicians and media about bonuses - this is quite a big deal (although some will argue that the lack of a firm commitment to the ambitious Riverside South development shows there has been some scaling back in Morgan's British ambitions).

And as luck would have it, the disclosure comes on the day that the bosses of the UK's biggest banks troop in to see the Chancellor, to discuss what commitments they can make to increase their lending to small businesses and decrease their bonus payouts to bankers.

What is clear is that the plucky efforts by John Varley, chief executive of Barclays, in talks primarily with the Cabinet Office minister Oliver Letwin, to establish some kind of entente cordiale between bankers and ministers are close to collapse (see my assorted notes on all this from November 14 onwards). A source told me that "all hope of a deal is hanging by a thread".

The mood of bank bosses about all this is one of despondency, and a number of them now think a deal with the coalition is impossible.

This is how the source put it: "special advisers have fessed up that a spat with banks removes the political pressure from Clegg, which is the coalition priority".

So the Conservative members of the coalition won't rein in criticism of bonuses by Lib Dem ministers, notably Nick Clegg and Vince Cable, on the basis that the Lib Dems have to be thrown some kind of bone, given the self-harm they endured over student fees.

For what it's worth, the gossip in bank boardrooms is that Mr Varley is so miffed at the apparent implosion of his assiduous efforts to agree a deal with ministers (which went by the moniker of Project Merlin) that it contributed to his decision last week to step down as chief executive a few weeks earlier than originally announced.

Here is the fundamental obstacle to agreement: Britain's banks feel they cannot unilaterally and permanently cut bonus payments to their investment bankers, without in effect signing a death warrant for those operations (because their top people would quit).

Although investment banking in general has had a worse year in 2010 than in 2009, bonuses at Royal Bank of Scotland would still be a smidgeon over £1bn when they're announced early in the new year, if they are pro-rated on the basis of the 2010 payout.

And total remuneration for investment bankers at Barclays' investment bank, Barcap, (that's their salaries plus bonuses) would be somewhere between £5bn and £6bn, if trends for the first nine months of the year are sustained.

Now to be clear, for both RBS and Barclays these rewards to investment bankers go to thousands of people all over the world, not just in the UK. But, even so, at a time when the public sector and many parts of the private sector are still feeling the pinch, no mainstream politician is going to stand up and celebrate bonus payments running to billions of pound paid to bankers widely viewed as having made a particularly handsome contribution to the mess we're in.

However, the problem say the bankers is that in the absence of some kind of entente between the banking class and political class, the banks continue to feel discombobulated, and that makes it harder for them to join the common struggle to rebuild our economy (bankers, of course, say this more in sorrow, rather than as a threat).

So is there any scope for compromise? Well, it is interesting that Vince Cable, the Business Secretary, has been banging on about the need for banks to disclose precisely what they pay their biggest earners (to prevent what he calls the "fungus" of unwarranted pay spreading in the dark). His call for publication follows the decision of the Treasury in late November to shelve legislation that would have forced such disclosure.

It certainly wouldn't be hard for the chancellor to reinstate that legislation. And, as it happens, bankers tell me that they really wouldn't object to fiercely. As one said to me, "if we can't justify what we pay, we shouldn't be paying it".

Second, there is some bemusement that the Financial Services Authority didn't slightly toughen up the bonus restrictions agreed by European regulators when interpreting them for London. In particular, it might have made life easier for those who run our biggest banks if the FSA had imposed a ban on all cash bonuses - in that if none can pay in cash (as opposed to paying out in shares or subordinated debt) then they would not have to worry about losing people to rivals down the road.

So I wonder whether a common agreement to avoid all cash in bonus payments might not form the basis of some kind of truce with ministers.

Would that avoid all criticism of bonuses? Of course not. Bonuses paid in shares or subordinated debt will still be very valuable to the recipients, and will be seen by many as unfair and unwarranted.

But, at least, when shares are paid in paper rather than cash, there is some benefit to banks' depositors and creditors, in that the capital of the banks - and their ability to absorb shocks - is increased (although shareholders may resent the dilution of their interests).

UPDATE: 10.59: The Chancellor's plane has been delayed by the weather. So his meeting with the banks has had to be postponed, till later in the week.

 

How to curb bonuses

Robert Peston | 15:51 UK time, Friday, 17 December 2010

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The Bank of England has provided the Treasury and Business Department with both an argument and a tool for curbing bank bonuses.

It takes the form of Chart 5.9 on page 51 of the Bank of England's latest Financial Stability Review, which has the unprepossessing title "Estimated size of total implicit funding subsidy to UK banks and building societies split by size".

This shows the Bank of England's calculations of the monetary value to the big UK banks of the truth, which was revealed in the Great Crash of 2008, that the state won't allow them to fail - that taxpayers will always bail them out, for fear of the catastrophic impact on the economy that would be caused by a collapse in the payment and credit-creation systems.

What the Bank of England has done is to get from the credit rating agencies (who in this case are definitely providing a public service, in the view of the Bank) the ratings for our banks' debts on a "supported" basis and on a "standalone" basis. That is the difference between their perceived creditworthiness with and without the implicit taxpayer guarantee.

The Bank of England then looked at the interest rates that the relevant banks pay to borrow with their "supported" credit ratings, and compared this with the higher interest rate they would have to pay if there were no such taxpayer support.

The Bank then took the difference between those two interest rates and multiplied that difference by all the funds the big banks have raised on the back of their supported credit ratings.

The answer is the subsidy provided by taxpayers to the quartet of big banks, Royal Bank of Scotland, HSBC, Lloyds and Barclays, in the view of the Bank of England.

I hope you are still with me, because what comes next is pretty shocking. The Bank of England estimates that in 2009 alone, the big British banks collectively received a subsidy from taxpayers of around £100bn. And the subsidy in 2008 was around £50bn.

To put it another way, it is quite difficult to see how they could ever generate a profit without this subsidy.

And the Bank was also minded to demonstrate that the taxpayer subsidy for big banks is miles bigger than for smaller ones.

To be clear, the Bank of England acknowledges that there is an implicit taxpayer subsidy for smaller banks too. But it estimates that subsidy as equivalent to less than 1% of all the money borrowed by smaller banks, whereas it represents 2.5% of big banks' liabilities - which means that it is far more important to the big banks than to the smaller ones.

Here's what follows.

As currently constructed, our four big banks would not have much of a business without that taxpayer subsidy.

So in theory, if the chancellor and business secretary wished banks to pay zero bonuses, all they would have to say is that they are planning to legislate such that all lenders to British banks face the risk of losses ahead of any losses incurred by bank depositors.

If this sounds familiar, that's because it is similar to the formulation used by the German government a few weeks ago about a new potential risk of loss for lenders to eurozone governments such as Ireland - which immediately spooked investors and prompted a funding crisis for weaker eurozone states.

So if the chancellor and business secretary were to say, in this way, that taxpayers were no longer standing behind all the debts of banks, the price of borrowing for banks would rise very sharply, in the best case for banks. And in a worst case, the big banks would not be able to refinance all that debt maturing in the coming year (see my earlier note on this) and they would be kaput.

Of course, Mr Osborne and Mr Cable would not wish to bankrupt our banks.

But if they really want to squeeze banks' bonus payments, they might mention to the four big banks that they are keen to find a way to eliminate that £100bn subsidy - and Mr Osborne and Mr Cable might also point out that in the absence of that £100bn, the banks don't really have any spare resources with which to pay bonuses (or even, perhaps, to keep the lights on).

No deal yet on bonuses or bank lending

Robert Peston | 12:53 UK time, Friday, 17 December 2010

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Bank chief executives have been summoned to a meeting next week with the Chancellor of the Exchequer and the Business Secretary, to discuss the contentious questions of how much they lend to small businesses and the bonuses they plan to announce early in 2011 and in future years.

The date for the meeting hasn't yet been fixed. But well-placed sources tell me it may happen as late as Wednesday.

The talks may well be seen as the climax of weeks of discussion between the banks and ministers to reach some kind of repair of their uneasy relationship - although it is looking increasingly unlikely that a deal on bonuses and small business finance will be struck before Christmas.

"This is probably going to rumble on into January" said a source. "It would be wrong to expect too much from next week's chat".

That said, the Business Secretary, Vince Cable, is understood to be keeping the pressure on banks to voluntarily cut bonuses and to make new commitments to lend more to smaller companies: he is giving television and newspaper interviews this weekend in which he will say that the option of imposing further taxes on the banks will remain a live one, until the banks are perceived to be showing the kind of pay restraint and providing the amount of credit that the government wishes.

For the Lib Dems, some kind of victory in their long running campaign to force what they would see as more responsible conduct from the banks is hugely important, in the wake of the criticism they have faced for abandoning their manifesto commitment to oppose an increase in university tuition fees.

My very strong sense however is that George Osborne at the Treasury is taking a rather less aggressive approach to the negotiations with banks.

Bankers and officials tell me that no very meaningful agreement is yet in sight on either lending or bonuses, although they accept that it would be damaging for both sides if no pact is agreed.

"The economic recovery will be much weaker unless we are focussed on how to support business and households" said a senior banker. "And it's much harder for us to do that when the government see us as part of the problem rather than as part of the solution".

The total sum of bonuses announced by banks this year will be considerably less than last year, because it has been a poorer year for investment banking, which is where the bulk of bonuses are paid. But the overall bonus pool for London will still be several billion pounds, which will be viewed by many - including many Lib Dems - as too much.

Those who run banks tell me they dare not make binding commitments to pay considerably smaller bonuses now and in future years, because they have no doubt that many of their best profit-generators would defect to banks based in Asia, Switzerland or the US.

Banks also remain at loggerheads with the government and Bank of England over the cause of the long-running decline in lending to small and medium size businesses.

The banks continue to insist that the fundamental problem is a lack of demand, that small businesses don't wish to borrow. In stark contrast, the Bank of England recently reiterated that it believes the problem is that the banks are not supplying enough credit.

Another year of living dangerously for UK banks

Robert Peston | 08:28 UK time, Friday, 17 December 2010

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2011 will be a make-or-break year for our banks.

That is the implicit message of the Bank of England's latest Financial Stability Review.

By the end of the coming year, we should know whether our banks are once again capable of standing on their own feet, without exceptional support from taxpayers - although they will still be in receipt of some measure of such exceptional loans and guarantees from the state.

The biggest inescapable challenge is a very substantial bulge in the borrowings that our banks have to repay.

According to the Bank of England, up to £500bn of wholesale debt is due to mature by the end of 2012. That includes something over £200bn effectively owed to taxpayers through the Treasury's Credit Guarantee Scheme and the Bank of England's Special Liquidity Scheme.

Of that £500bn or so, between £350bn and £400bn falls due for payment this year.

Now that is a substantial amount of money to raise, in wholesale markets that are a long way from the kind of depth and liquidity of the pre-2007 boom era. It is on a par with the peak amounts raised by banks in the balmy years, so it is by no means certain they will be able to raise it all, in this chillier climate.

To put the challenge in context, the Bank of England regards it as almost miraculous that gross issuance of term debt by the UK's banks over the past year was more than £130bn - a fraction of what will be needed in the coming year.

Of course the banks could reduce what they need to borrow by simply failing to make new loans to businesses and households, as existing loans are repaid. But I don't think any of us would see that kind of return to a credit-crunch lending drought as a good idea.

How can the banks help themselves? Well, the stronger they are perceived to be, the easier and cheaper it will be for them to borrow.

That's why the Bank of England says that "banks' board should apply restraint in distribution of profits to equity holders and staff". In other words, cash should be hoarded as capital, to protect against potential future losses, rather than paid out in bonuses and dividends.

With decision time looming for banks' boards on how much to reward both shareholders and staff, it will be fascinating to see whether they are prepared to defy their new regulator.

And it isn't as though there aren't potentially substantial shocks for the banks to absorb in the coming few weeks. The big looming risk for the world's banks - not just ours - is a funding strike for weaker eurozone economies that threatened insolvency for governments, companies, households and banks (see my recent note on the refinancing challenge for Spain, for example).

As the Bank of England points out, the direct exposure of the UK's banks to Greece and Portugal is relatively small. But what they are owed by all sectors in Ireland and Spain, for example, is typically equivalent to three quarters of their loss-absorbing capital. So any perceived worsening in the ability of Ireland and Spain to keep up the payments would do genuine harm to our financial institutions.

But perhaps the greatest immediate threat is of contagion via the banking system, because of the interconnectedness of banks - whose perniciousness was demonstrated beyond doubt in the Great Crash of 2008.

So, for example, major UK banks' claims on French and German banks are around £140bn, or not far from 70% of loss-absorbing capital. Which means that if those eurozone banks most directly exposed to the fortunes of the eurozone begin to suffer, their pain will be felt by our banks - and, by extension, by a British economy dependent on the health of the banking system.

Update 1332: LLoyds is increasing its provision for losses on Irish lending to £4.3bn, which means it has now in effect written off more than half the value of its £26.7bn of Irish loans.

Treasury figures show poor hit hardest by energy price reforms

Robert Peston | 16:49 UK time, Thursday, 16 December 2010

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If there is agreement that the UK needs to invest £100bn or so over the next 10 years in new power stations and grid connections, and if there is also a consensus that the priority should be to move rapidly towards low-carbon power generation, then the big question is about the best way of achieving that outcome.

I should point out immediately that not everyone would accept that the government's climate change commitment is necessary. But let's park that point.

Chris Huhne

 

Now the most striking characteristic of the measures announced today by the Energy Secretary, Chris Huhne, is that they are complicated - such that his department has proved itself incapable of describing them in language that is understandable to most of us.

So I will now try to translate the reforms into what may pass for English.

First, there will be a new and higher minimum price for carbon emissions from power generation.

Second, those who invest in nuclear plant, wind farms and other forms of low-carbon energy will be guaranteed a price that yields them a profit.

Third, there will be additional payments to those who create reserve capacity in the energy system, to cope with surges in demand or unexpected cuts in supply.

Finally, there will be prohibitions on the construction of dirty power stations.

As a quartet of policies, they have been welcomed by those power companies investing in low-carbon technologies, most notably by the French giant EDF, which wants to invest £20bn - with the UK's Centrica - in four new nuclear generators.

Vincent de Rivaz, who runs all of EDF's UK businesses, was in ebullient form and described the proposals as a landmark.

As for the Energy Secretary, Chris Huhne, he stressed a couple of points when talking to me.

First, he believes the guaranteed wholesale price for green energy should attract new investment consortia into the power generation business, which he hopes will increase competition to the benefit of consumers.

Second, the innovative payments for spare capacity should provide an incentive to power companies to persuade the rest of us to turn off unnecessary power-consuming devices.

But there will be a price for all this green power, at least for quite a few years - and it will be paid by anyone who consumes energy, which broadly means every household and business in the country.

How much extra will we pay?

That is still unclear, party because the new price of carbon has not been fixed.

However the Treasury has helpfully provided an assessment of the impact on businesses and consumers of the likely increases in power prices that will be sparked by different increases in the minimum carbon price.

These show that the average annual household electricity bill will be between £4 and £28 higher in 2016 (after adjusting for inflation), but should be between £20 and £48 lower by 2030 (when all the new generating plant should be on stream).

Also, the Treasury's figures show that the poorest will be hit hardest by the reforms.

For example the 20% poorest households in the country will be forced to allocate between 0.04% and 0.3% extra of total spending to electricity in 2020 - a fraction of the impact on the 10% richest in the country, for whom the squeeze in spending resources will be between 0.01% and about 0.07%.

And it probably won't surprise you that the most hurt will be single pensioners, for whom the reduction in spending power will be up to 0.37%.

Now these are obviously not massive sums - but for poor people, every little hurts, as they say.

Some will ask why the same climate-change and capacity outcomes couldn't have been achieved through tax reforms, skewed so that they don't disadvantage the poorest, rather than through market mechanisms.

Mr Huhne says that he is pushing through a package of measures to help the poorest reduce their energy consumption by better insulating their homes and that helping those with least remains a priority for him.

But given that Mr Huhne is a Liberal Democrat, some will see these changes through the prism of the recent controversy over student fees - and will say that they are another manifestation of an alleged abandonment by the Lib Dems of their progressive credentials.

Was BP grossly negligent?

Robert Peston | 08:05 UK time, Thursday, 16 December 2010

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The significance of the Obama administration's decision to sue BP and four other business over the Deepwater Horizon explosion and oil spill is that the US Justice Department may try to prove gross negligence on the part of BP.

Deepwater

Because if BP were found to be grossly negligent, the costs for BP of the debacle could rise very significantly indeed, for two reasons.

First, it could potentially add almost $16bn or more than £10bn to the civil penalties BP would have to pay under the US Clean Water Act.

Second, it would make it much harder (perhaps impossible) for BP to recover costs it is incurring in the clean up and restitution from its co-owners of the Macondo Well, Anadarko and Mitsui.

BP says it remains confident that it was not guilty of gross negligence. But if it is wrong, the $39.9bn or £25bn it has set aside to cover the costs stemming from the disaster will prove to be too little.

A further source of uneasiness for BP's shareholders is the statement by the US Attorney General Eric Holder that under the Oil Pollution Act he is intending to prove "that these defendants are responsible for government removal costs, economic losses and environmental damages without limitation."

For once, the verdict of the market in a few minutes may be instructive.

Update 0838: Investors plainly believe that the nature of the Department of Justice's case against BP hasn't increased potential liabilities for the company in a fundamental way.

BP's shares have fallen 2.5% this morning to 465p - which takes the edge off a recent strong run in BP shares.

Little British charity in Irish loan

Robert Peston | 15:44 UK time, Wednesday, 15 December 2010

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When the chancellor originally announced that the UK would be making an emergency loan to Ireland, he faced criticism that he was in some sense squandering precious resources that could be better deployed at home.

He may now face a rather different attack, that the Exchequer will be doing rather too well out of the loan - and that Ireland is paying a pretty steep price for British help.

The interest rate on the £3.25bn being made available in eight lumps over the next three years will be 2.29% above the cost for the British government of borrowing for seven and a half years.

Which means that a profit is more or less guaranteed for Britain.

George Osborne today estimated that profit at £440m in fees and interest over the 10 years until we get all our money back.

The first £400m being provided to Ireland will carry an interest rate of 5.9%, a touch lower than the 6.1% being charged by the European Union's financial stability facility.

The concern for the Irish government is that having to pay interest at that kind of level will actually set back the prospects for an economic recovery - because paying an interest rate greater than the underlying growth rate of the Irish economy will put sustained pressure on the resources available for public spending or tax cuts over many years to come.

Or to put it another way, there is probably more punishment than charity in the terms of the loans being provided by the EU and UK

What price for the RBS report?

Robert Peston | 11:53 UK time, Wednesday, 15 December 2010

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So are we or aren't we going to see a report from the Financial Services Authority about what went wrong at Royal Bank of Scotland - and why it didn't pull back from its near-suicidal takeover of the rump of ABN?

RBS logo

 

Well, in about three months or so, something additional may be published by the City watchdog on all of this, but that something may not be desperately enlightening.

Because the problem remains that all "persons" investigated by the FSA have to give permission for the information uncovered about them by the FSA to be disclosed. And those "persons" aren't just living, bonus-trousering bankers, but also corporate persons or entities, such as RBS itself.

Now, the FSA has been endeavouring for the past week to persuade RBS to allow general material about how it behaved to be published, in order that outsiders can learn the lessons of what went wrong.

But RBS's directors have a perfectly understandable objection to publication. Which is that the bank is being sued for potentially life-threatening damages in the US by investors who argue they were misled by the banks' directors back in 2007 about the wisdom of the ABN deal and again in 2008 about the banks' finances when it sold new shares.

The current directors of RBS are being given legal advice that they would be failing in their duties to today's shareholders if they were to put into the public domain information that could have a material influence on the US litigation.

To state the obvious, the serving directors of RBS would be taking quite a financial and reputational risk if they were to ignore the legal advice. Surely even those of you who don't have the highest regard for bankers can see why the board of RBS would not rush to put itself in financial harm's way to the tune of billions of dollars.

It is also not irrelevant that we as taxpayers own 83% of RBS. And although many of us may be licking our lips at the prospect of seeing what the FSA uncovered about why RBS didn't blink as it carried out arguably the worst takeover in British corporate history, we might not be quite so keen for the info if it were to materially damage the value of our shares.

There is of course one bit of the investigation that the FSA probably could publish, without too much difficulty - and that would be its investigation of why it didn't block the takeover. The FSA's failure to act is particularly shocking, since the deal did not complete until months after the credit crunch began with the closure of wholesale markets on 9 August 2007.

To be clear, contrary to widespread perception, the FSA did not have the simple right to veto the deal. But it absolutely did have the ability to in effect stymie the takeover by insisting that RBS raise colossal sums of additional capital, to protect itself in the event that ABN became a giant lossmaker (which is of course it did turn out to be).

If the FSA had insisted RBS raise billions of pounds of additional capital, the deal might well have collapsed - because RBS might have taken the view that the FSA was in effect making the takeover too expensive.

So why didn't the FSA intervene in this way? Well it was because at the time it was the prisoner of an ideology - what we might call the Greenspan dogma - that big financial institutions couldn't possibly behave irrationally, stupidly or dangerously.

There is at least some evidence that the FSA, on the eve of its dismantling, has abandoned this naive ideology, although only after the rest of us have paid quite a price. That evidence was its intervention in helping to blow up a takeover, the Pru's bid for AIG's Asian insurer, which was much less intrinsically dangerous than RBS's offer for ABN.

If you're muttering about stable doors and horses, that's a bit unfair. Better late than never would probably be a more appropriate carp.

Update 1300: Lord Turner, the chairman of the FSA, has now put on the record - in a letter to Andrew Tyrie, chairman of the Treasury select committee - that the FSA can only publish a report on the near collapse of RBS with the consent of RBS, and that RBS has not given this permission.

He adds that ideally he would like to publish such a report, on the lessons for the FSA and banks to learn from the RBS debacle, by the end of March.

Huge financial challenge for Spain

Robert Peston | 08:29 UK time, Wednesday, 15 December 2010

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Moody's highlights three substantial financial challenges for Spain, in explaining why it may downgrade the kingdom's credit rating.

First is simply that the central government has to raise and refinance a very substantial sum in 2011, some €170bn. That won't be particularly easy at a time when investors' appetite for eurozone debt isn't what it was - especially since the Spanish government has historically been dependent on overseas buyers for about 50% of all the money it raises.

On top of that €170bn is €30bn of regional debt that needs to be refinanced next year, and a further €90bn of long term borrowings by the banks which has to be replaced.

So if nothing bad were to happen to force Spain to raise even more money, it will need to borrow €290bn next year, equivalent to a non-trivial 27% of the country's GDP.

But there are reasons to believe that, when it comes to it, Spain's borrowing requirements may be even greater.

First, Moody's fears that Spanish regional government is not engaging in the kind of belt-tightening that may be necessary.

Second, there is a pretty good chance that Spain's banks will have to raise a further €75bn or so of capital, just to bring their core equity up to new international norms, such that they will stand a better chance of raising money in wholesale markets.

On the assumption that loss-absorbing equity capital will have to come from the Spanish state - which is not an alarmist assumption - Spain's overall financing needs for next year would rise to €365bn, or 34% of GDP.

And that makes no allowance either for any possible failure of central and regional governments to hit their budgets or for a possible rise in bank losses.

To put it another way, 2011 will be the year when the financial credibility of Spain - and by extension the eurozone as a whole - is likely to receive its severest test.

£100bn hole in local government pensions

Robert Peston | 04:00 UK time, Wednesday, 15 December 2010

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There is a £100bn hole in the Local Government Pension Scheme, according to an authoritative survey of accounts filed by local authorities.

Stack of pound coins

The deficit is equivalent to around 7% of UK GDP. It would fall to around £80bn on the basis of the government's recent decision to up-rate pensions in line with lower CPI inflation, rather than RPI inflation.

The deficit was much smaller, £42bn, three years ago.

The giant gap between the value of liabilities and assets in the scheme - calculated on the basis of the FRS17 accounting rule used by all private-sector companies - has been uncovered by John Ralfe, the independent pension consultant and former head of corporate finance at Boots.

According to Ralfe, the value of assets in the scheme has risen just 8% over the past three years, to £132bn, whereas liabilities have soared 41% to £232bn.

This increase in liabilities stems from a number of factors, including an increase in the value of benefits for local authority staff and a fall in interest rates. When interest rates fall - in particular when the yield on AA corporate bonds drops - there is an automatic increase in liabilities, because future streams of payments to pensioners are discounted into today's money by using the prevailing interest rate.

Mr Ralfe said that to fill the £80bn hold over 25 years "would require an increase in council contributions of £4bn a year, increased in line with inflation, a 70% increase in current contributions of £5.8bn".

There are four million members of the Local Government Pension Scheme in England, including 1.7m current employees. It is a single scheme, though it is administered through 81 regional pension funds.

Unlike many public-sector pension arrangements, the Local Government Pension Scheme is a proper defined benefit pension scheme, which pays its pensions out of income generated from its holdings of shares, bonds and so on, rather than directly out of taxation.

That said, the giant hole in the scheme can only be filled by a combination of greater contributions from taxpayers and from scheme members (unless investment performance improves dramatically or the bond yield rises very substantially).

Mr Ralfe says that the Local Government Pension Scheme will show a much smaller official deficit when it publishes an actuarial valuation in the spring, because it will not be using the FRS17 valuation method imposed on the private sector.

Under this actuarial valuation, local authorities will be discounting their future pension payments using a much higher rate than the FRS17 AA corporate bond yield, because they will argue that the value of the shares held by the scheme is likely to rise faster than is implied by that corporate bond yield.

This kind of discretion in the assessment of liabilities is not allowed to private-sector pension schemes. Mr Ralfe argues that the government is in effect taking a massive gamble with the public finances in allowing local authorities to employ a less conservative approach than the private sector.

Why are investors turning against US government debt?

Robert Peston | 10:39 UK time, Monday, 13 December 2010

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The big financial economy and markets event of the past few days has been a sharp fall in the price of US government debt, whose corollary is a rise in the implicit interest rate on that debt, or the yield on US treasuries.

Wall Street

At the beginning of last week, the price of US treasury bonds fell more than at any time since the collapse of Lehman in 2008. By the close on Friday, when prices had recovered a tiny bit, the yield at 3.3% on the bench market 10-year bond was still 39% above the low touched in October.

Now it is important to put this into perspective. The yield on US government bonds is still incredibly low by historical standards - the US government can still borrow remarkably cheaply.

Some investors, largely banks and pension funds, will be nursing a bit of pain from the fall in prices. But the uber bears can't yet claim that this is the beginning of a devastating implosion of a great bubble in US treasuries, which was pumped up by the Federal Reserve's creation of all that cheap money to ward off deep recession.

So what has been going on?

Well there is no little debate about what all this means. And what's particularly unhelpful is that the competing explanations are the difference between economic heaven and hell for most of the rest of us.

The fashionable explanation is that the rise in yields should be seen as good news, because it shows that investors are becoming more confident in the US economic recovery - which is a combination of slightly better data on trade and growth in the US, combined with optimism about the impact of President Obama's decision to extend his predecessor's middle-class tax cut.

On this view, investors are prepared to buy riskier assets - shares for example - and are therefore minded to reduce their relative exposure to those assets perceived to be free of risk, viz the sovereign obligation of the US.

The competing explanation may appear to be based on an almost diametrically opposite view of the prospects for the US. It is that the tax cut shows a US administration utterly incapable of getting to grips with public-sector deficit and debt as unsustainably large as anything the fringe of the eurozone can boast - which proves that the quality of US sovereign debt ain't what it was, so you sell.

On this interpretation, the US economic recovery won't accelerate enough to generate a sufficiently big increase in tax revenues, to make a sizeable dent in an annual deficit running at around $1.5 trillion or well over 10% of GDP.

If you click on Stephanie Flander's blog in the next day or so, you'll find a more detailed analysis of the quality of US government debt.

But the big question is whether what's happening to US treasury bonds shows that those who control the vast pools of money are becoming more or less confident about the outlook for the biggest economy in the world and for growth prospects in general.

It is certainly relevant that there has been a smaller but corresponding fall in the price of German government bonds - which probably stems in part from the fear that the German state balance sheet is being infected by insidious migration on to this balance sheet of the debts of Greece, Ireland, Portugal, Spain, Italy and so on.

On that view, there has been impairment of the quality of all the best western sovereign debt.

The other important development last week was the fairly abundant evidence that the Chinese economy is close to overheating: inflation at more than 5% is high and rising, fixed asset investment is growing at an annual rate of almost 25%, industrial production is increasing at more than 13% per annum, and nominal retails sales growth is almost 19%.

Which rather implies that, whatever their public posture, the Chinese authorities will try to choke off the dangerous part of this boom by allowing a further rise in the yuan and increasing interest rates - although they know, and fear, that to do so would suck in more so-called hot money from the rest of the world (which would tend, I suppose, to reinforce a fall in the price of US and German sovereign debt).

Anyway, when I put all this together I am left with a slight uneasy feeling.

What's clear is that investors are no longer as enamoured as they were with the public-sector debts of the US and Germany.

What is less clear is whether that's a good thing, reflecting the growing confidence of investors that it has become safer to put their money elsewhere, or whether it shows creeping fears about incipient inflation and the recognition that even the world's best credits have been tainted by the leverage virus.

Bankers' bonuses squeezed, salaries up

Robert Peston | 08:36 UK time, Friday, 10 December 2010

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Funnily enough, the banks making the biggest stink about the new European rules on bankers' remuneration, which may be announced today, are not the ones perceived to have pushed the boat out when it came to bankers' bonuses during the boom years.

Fifty pound notes

 

In the UK, HSBC and Standard Chartered are the banks most miffed about the restrictions they'll face on paying guaranteed bonuses and limitations that will be imposed on the amount of bankers' bonuses that can be paid in cash and paid upfront.

That's because the rules, set to be agreed today by the Committee of European Bank Supervisors, will be applied by the UK's Financial Services Authority on a global basis for British banks: so they will determine how and what the likes of HSBC and Standard Chartered pay their staff in China, Hong Kong, Singapore, India and so on, as well as what they pay their people in the UK.

And that puts HSBC and Standard at a tremendous disadvantage in their most important markets, or at least that's what the bosses of those banks tell me.

They say that their competitors are still handing out guaranteed bonuses to recruit and retain top wealth generators, and are still doling out great wodges of cash. Which means that HSBC and Standard Chartered are finding it increasingly difficult to retain their best people or to hire new ones.

Because Asia is so profitable for HSBC and Standard Chartered, and because it's generating most growth for them, the notion that they might one day determine to relocate their respective offices to a place where they don't feel restricted in how they run those Asian operations, well that's not a crazy notion.

Strikingly, there's less rumpus about the pay rules being kicked up by those banks with disproportionately larger UK and European businesses. To be clear, in public they'll talk the talk of how damaging the rules will be for their ability to prevent their genuine wealth creators emigrating to rivals in places like Singapore and Geneva, where there are relatively few restrictions on pay.

And that's not an invented complaint. There's already been some migration of bankers in that way (which, I know, some of you think is no bad thing).

But I have to tell you that those who run those banks acknowledge to me that around each star sit competent but not outstanding bankers, who are paid far too much relative to their genuine wealth-creating skills. So bank bosses insist they would dearly love to find a way to pay these journeymen considerably less.

However the way the banks have anticipated the new regulators' rules certainly won't be seen by many of you as giving the bankers their just deserts. To cushion the pain of the bonus straitjacket, pretty much all the banks have increased bankers' salaries, the fixed portion of their remuneration, by considerably more than almost anyone else in the economy has enjoyed.

Most of us would say that an extra pound of permanent salary is worth considerably more than a one-off pound of bonus. So if you are thinking of taking a tin of soup and a warm blanket to your banker neighbour, in a Christmas mercy visit, it may not be strictly necessary, yet.

UPDATE 17:15   The explicit point of the new rules on bonuses - confirmed by European regulators today - is not to reduce the take home pay of bankers.

It is to eliminate incentives for bankers to take dangerous risks in order to inflate their earnings.

A second aim is to discourage banks from handing out vast dollops of cash to their employees, as it is probably more sensible for this cash to be retained by the banks as capital which can absorb potential losses.

In other words the rules - which stipulate that only 40 per cent of any bonus can be paid upfront, and only half of the overall bonus can be paid in cash as opposed to shares - are designed to strengthen banks.

That said, they may have the effect of putting a ceiling on bankers' pay. 

Because they may slow down the merryground of star bankers moving from bank to bank, bidding up their pay while the music plays - in that any banker who quits from now on risks losing his or her deferred bonus, which would be a big financial sacrifice.

But as I’ve mentioned, it won't be a diet of gruel for top bankers, quite yet. Because many of them have seen their salaries rise to compensate for the expected deferral and reduction of bonuses.

Bank levy hits big banks harder

Robert Peston | 10:27 UK time, Thursday, 9 December 2010

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The new bank levy is becoming weighted more towards the bigger banks, the Treasury has announced. And the tax rate is being increased fractionally.

It is still being charged largely on banks' short-term wholesale finance, the money they borrow for short periods from other financial institutions, corporates and very wealthy individuals, and on uninsured retail deposits (so deposits greater than £50,000).

However for each bank the first £20bn of such funding will now be exempt from the tax. Which means that banks with balance sheets only a touch bigger than £20bn will be more-or-less exempt from the tax (and those with balance sheets less than £20bn will be completely exempt).

In other words, the giant banks based in the UK will pay the lion's share of the tax. And in respect of British banks, the bulk of the tax will be paid by Royal Bank of Scotland, Barclays, HSBC and Lloyds.

In 2011, the levy rate will be 0.05%, with a 50% discount applied to uninsured retail deposits. The following year the rate rises to its permanent rate of 0.075% (and again half that for uninsured retail deposits).

These rates represent increases of 0.01 of a percentage point in 2011 and 0.005 of a percentage point in 2012 and onwards compared with the earlier indicated rates.

However because of tweaks in the way the levy is applied, the Treasury expects to raise only around £100m per annum more revenue from the tax than its earlier estimate.

So over the coming four years, the Treasury expects to receive a total of £8.8bn from the tax, with the take rising from £1.3bn next year to £2.6bn in 2013 and 2014.

As for individual banks, well it is difficult to be sure how much they will end up paying, because all of them are trying to reduce their reliance on the kind of short-term wholesale funding where the full levy rate applies.

However, if the tax had been applied to Royal Bank of Scotland's balance sheet at the end of 2009, it would have paid around £500m to the Exchequer.

Which is not a trivial sum of money, but is well under half of what RBS paid out in bonuses.

And of course the £2.6bn to be paid by the banks each year is a rounding error in the context of the £1.2 trillion of support provided by British taxpayers to the banking sector (in the form of investment, loans and guarantees) to keep the banks afloat at the height of the 2008-9 crisis.

Update 1055: RBS has calculated that, based on its 2009 balance sheet, the bank levy would cost it £315m in 2011 and £473m in 2012. But remember that, like all the big banks, RBS is both shrinking its balance sheet and trying to become less reliant on short-term wholesale funding. So it may well end up paying rather less.

Brown: 'We have a major crisis in the euro area'

Robert Peston | 17:00 UK time, Wednesday, 8 December 2010

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Gordon Brown says that the eurozone will not solve its current financial crisis unless it opts for a comprehensive and substantial rescue package, that would involve putting tens of billions of pounds of new capital into the eurozone's banks.

Gordon Brown

The former British prime minister said, in an interview I've just done with him, that the enormous liabilities of the eurozone's banks are a serious and substantial accident waiting to happen.

Mr Brown said:

"I sense that in the first few months of 2011 we have a major crisis in the euro area... You've got fiscal deficits, obviously. But you've also got massive banking liabilities in the euro area, and that's not just the peripheral areas. It's the core areas of Europe where banks are really under pressure because they have lent huge amounts of money but have no guarantee they have the capital that is necessary to sustain themselves in all positions.
 
"But then you've also got this impediment to growth. The euro area is inflexible because you can't adjust your currency... The structural reforms that are necessary to make a single currency area work have not been completed and in some cases have not been agreed. And therefore you've got to have a nigh noon...You've got to deal with these problems in one fell swoop... They've got to do it in a way that seizes the initiative from the markets... It's got to happen in the first months of 2011."

His fear is that the current process of bailing out one over-stretched eurozone country at a time (Greece followed by Ireland, so far), rather than going for a once-and-for-all bailout scheme for the entire eurozone and all its banks, will elongate and maximise the economic pain for eurozone members. In those circumstances, international investors would "pick countries off (for punishment) one by one".

He added that "if the euro were to break up, the political and economic consequences for all the countries would be disastrous" and the cause of global economic co-operation would be set back for years.

Also, if there is no comprehensive and credible rescue and reform package for the eurozone, he feared that European countries would - at best - be condemned to years of low growth and high unemployment. This would damage the UK, which conducts 50% of trade with eurozone members.

Mr Brown's intervention matters, partly because he remains in contact with other European leaders - and partly because he is saying what members of the British government and senior officials at the Bank of England also believe but cannot say (for diplomatic reasons).

He is pessimistic about the short term outlook for the global economy, because of what he sees as a rise of nationalist and protectionist tendencies in many countries, similar to what happened in the Great Depression of the 1930s.

The central theme of his new book, Beyond the Crash, is that the US and Europe will be condemned to years of low growth unless and until the world's biggest economies co-ordinate their economic policies and their approaches to financial regulation, not just to tackle individual crises but on a permanent basis.

For banks in particular he calls for a new "global banking constitution", that would go further than the current Basel agreement on capital to set rules and standards for all the world's banks, over-riding national regulations.

I reminded him that years ago, when he was at the height of his reputation as chancellor, I asked him why on earth he wanted to risk his then formidable reputation by becoming prime minister. Did he now regret having moved into No 10?

If he had a regret, he said, it was that he had failed to convince the electorate of the overwhelming importance (as he see it) of a great worldwide initiative to restore momentum to the global economy.

Lord Turner wants new punishments for failed bank bosses

Robert Peston | 09:21 UK time, Wednesday, 8 December 2010

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Directors of banks responsible for catastrophically bad decisions, which put their respective banks in jeopardy, could face a new punishment of having two years' pay clawed back from them.

Lord Turner

 

Lord Turner, chairman of the FSA, told me that he was attracted to imposing such a sanction - which is part of the so-called Dodd-Frank financial reforms in the US - as a way of discouraging banks from taking excessive risks.

The clawback of bank bosses' pay would be punishment for misguided or stupid behaviour, rather than for illegal behaviour.

He was elaborating on an article he has written in today's Financial Times [registration required], which looks at the lessons of the FSA's investigation of how the Royal Bank of Scotland took itself to the brink of bankruptcy in the couple of years before it was rescued by taxpayers in October 2008.

The FSA has been widely criticised for saying that its review finds no grounds for punishing the senior directors of RBS at the time or the bank itself. Its decision not to publish the investigation has also been attacked - and yesterday the Business Secretary, Vince Cable, said he was disappointed that no report on the affair has been published by the FSA.

Lord Turner is open to the idea of publishing such reports in the future. However he says that this investigation was carried out according to normal FSA procedures, which makes it difficult to publish because the probe was broken down into separate parts.

Documents were prepared by the FSA's enforcement department on the events leading up to the disastrous purchase by Royal Bank of Scotland of the rump of the Dutch bank, ABN, in 2007, on the control mechanisms in RBS's global banking and markets division, and on whether RBS disclosed accurate information to investors in this period, especially when launching a jumbo rights issue in the spring of 2007.

In other words, a single seamless narrative of what happened at RBS wasn't prepared.

That said, Lord Turner sees the argument that publishing such a narrative could have been useful, in that it would allow future bank directors to learn the lessons of RBS's mistakes. So in future the FSA may organise its investigations in such a way that a report can be published at the close.

However, the big lesson for Lord Turner of the RBS debacle, and other banking disasters, is that there has to be a cultural revolution in banks, such that bank directors never think about taking the risks that may be appropriate to other kinds of business - not least because the economic damage from bank failures is so great, and because taxpayers are forced by governments to inject colossal sums into the likes of RBS, to prevent them going bankrupt, in a way that almost never happens in any other industry.

Although the kind of entrepreneurialism that leads to bankruptcy may be essential to wealth creation in the hi-tech industry or retailing, it is wholly inappropriate in banking, Lord Turner believes.

For him, RBS's directors should never have contemplated taking on the financial risks that were forced on RBS through the purchase of ABN - and the FSA should have prevented the deal going through.

It should have been palpably obvious to RBS's directors and to the regulators that the deal was leaving RBS with far too little capital for absorbing potential losses, relative to the combined assets of RBS and ABN - and that the deal made the bank far too dependent on unreliable wholesale funding.

That said, these were mistaken business decisions, albeit of catastrophic consequence, not illegal business decisions.

That is why Lord Turner believes there has to be a new, special regime of potential sanctions for directors of banks.

Apart from the US idea of demanding substantial refunds of top bankers' pay, if they make devastatingly bad business decision, Lord Turner also argues that senior bank directors should perhaps be automatically disqualified in those circumstances.

The burden would no longer be on the FSA to prove that the directors had broken laws or rules. Instead, the directors would have to demonstrate that they had taken steps to try to prevent the misguided takeovers, dodgy lending or ill-judged investments that sank their respective banks.

If the directors could prove neither that they had argued against those bad deals nor blown the whistle to the FSA, there would be no uncertainty about their fate, no long review of their behaviour by the FSA: they would face automatic eviction from the bank boardroom.

UPDATE 14:03: Just on this question of how and whether the FSA could publish a report on RBS, I am told - by a thoroughly reliable source - that the RBS file could only be turned into a publishable document if a team of four or five officials were put to work full time on the project for six months.

“It is the equivalent of a police file”, said a source. “It contains lots of different documents and simply isn’t a single coherent whole”.

Also, even if the FSA did set to work to produce a report out of the file, there might be serious impediments to its publication. It could be seen as prejudicing the civil proceedings for damages against the bank initiated by shareholders, who claim that the bank and its directors were negligent in their responsibilities.

That said, the FSA recognises there is a genuine need to learn the lessons of the RBS and other bank debacles. And it certainly understands the argument for a narrative of what happened and why it should be published.

The chief executive of the FSA, Hector Sants, has therefore told ministers that he thinks there is a case for writing into the forthcoming law, that will transfer prudential regulation to the Bank of England, a new formal requirement for reports to be written in this kind of circumstance.

Britain 'powerless' to break up banks

Robert Peston | 09:28 UK time, Tuesday, 7 December 2010

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The Banking Commission and the Treasury are in effect powerless to force through radical structural changes to the UK's banks, to break up the giant universal banks such as Royal Bank of Scotland, HSBC and Barclays, without agreement from the European Union.

Which may well turn into a great frustration for the Banking Commission's members, because my strong impression is that they are in favour of some kind of break-up of the largest universal banks - which would involve separating their retail banking and money transmission operations from supposedly riskier investment and wholesale banking.

To be clear, this break-up might not involve formal forced removal of investment and wholesale banking out of the likes of Barclays into wholly independent new organisations - which is broadly what the governor of the Bank of England, Mervyn King, seems to favour.

The preferred reform might consist of putting an impermeable legal wall between wholesale/investment banking and retail banking, so that if a bank ran into difficulties, the so-called resolution procedure would allow the regulator to hive off the precious retailing banking operation to protect savings and the money transmission network. This kind of internal resolution break-up is preferred option of Lord Turner and Hector Sants of the Financial Services Authority.

That said, right now the commission - which consists of former regulators and erstwhile bankers - seems to me to be leaning towards a definitive, physical break-up of the mega-banks.

However it turns out that neither of these major structural changes to our banks would be easy to do - in fact they might be impossible - without a decision by the European Union to force such reforms on all European banks.

"The UK's ability to force major structural changes on its banks is very very limited," said a source close to government.

The reason is that under EU law, any EU authorised bank has the right to set up a branch anywhere in the EU.

Which means, for example, that if Barclays did not wish to be broken up, it could move its head office to Luxembourg (for example) and then operate the whole of its retail banking and investment banking operations in the UK, as normal, in the form of a "branch" of the Luxembourg-based bank.

Also, any continental bank, such as Deutsche Bank or Santander, could operate both retail and investment/banking operations in the UK, even if Barclays, HSBC and Royal Bank of Scotland were somehow persuaded to comply with a British decision to break them up.

What does it all mean? "My own view is that the Commission may well recommend that the big universal banks should be broken up," said a well-placed British official. "But in practice, even if the chancellor accepts that recommendation, the Treasury would not be able implement it. Instead the chancellor would probably then have to persuade every other EU country to break up their giant banks".

So how likely is it that Germany would wish to break up Deutsche Bank, France would choose to dismantle BNP Paribas and SocGen, and so on?

Right now, that seems about as probable as France and Germany forcing all cars to drive on the British left-hand side of the road or to adopt British-gauge railway track: giant universal banks are part of the continental financial tradition: ingrained in European business culture, part of the structure of the state.

But that doesn't mean the European love affair with the mega universal bank is necessarily forever. As I have pointed out here on a number of occasions, the threat of a fracture of the eurozone stems as much from the potential liabilities of European taxpayers to the enormous risks that have been taken by some European banks relative to their smallish capital resources as from the unsustainable deficits of certain eurozone member states.

To put it another way, if the eurozone were to become the centre of another great banking crisis - not a completely absurd idea, given recent events in Ireland and Portugal - it is possible that the EU would decide that some form of break-up of the biggest banks was not some insane British obsession but was worthy of consideration.

Varley and Letwin negotiate truce between ministers and banks

Robert Peston | 08:24 UK time, Monday, 6 December 2010

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The banker trying to negotiate some kind of lasting truce between the government and the banks is John Varley, the soon-to-depart chief executive of Barclays - who (by the way) is the front-runner (so I am told) to be the next chairman of Vodafone, the mobile phone giant.

 

Mr Varley's main interlocutor in this dialogue is Oliver Letwin, the cabinet office minister. And, according to their colleagues, the talks are about the wider questions of how the reputation of banks can be rehabilitated and how banks can make a greater contribution to the UK's economic recovery, and not just what can be done to improve the perception of the quantum of bankers' bonuses.

Now you might think that the boot is only on the foot of the cerebral Mr Letwin, rather than Mr Varley's. But that wouldn't be correct, because so much of what the government wants to achieve isn't possible without co-operation from the banks.

Economic recovery? Well that will be more insipid if banks aren't enthusiastic providers of finance to businesses, especially small businesses.

Shrinkage of an unsustainable deficit? Harder if banks don't recover and don't start making their disproportionately significant payments of corporation tax once again - and harder still if they relocate head offices to overseas financial centres.

Reduction in unemployment? As per the first two points.

Creation of a so-called "big society"? Again, that'll be easier if the banks are keen supporters of the Big Society Bank, which is to distribute the estimated £500m contents of dormant bank accounts to community groups and social enterprises - and which could have disproportionate oomph if banks put a bit more money into it and if it were staffed and managed by secondees from banks.

What does all of that mean? Well that the government - and to an extent the rest of us - needs the good will of the banks perhaps as much as the banks need the good will of government.

It shows that - for all the financial support given to banks in 2008 and 2009 to keep them afloat (equivalent to 90% of GDP at its peak) - the banks don't feel like pathetic debtors in their relationship with government.

I am not sure what that means in respect of how meaningful will be the pact that emerges from these talks.

It is likely that there will be a joint statement from the banks on how they'll make sure bonuses and big rewards only go to those bankers who genuinely make a superlative contribution to their profits - and that (as per new EU stipulations) only a fraction of these rewards will be upfront cash payments (as opposed to deferred payment in shares).

So there will be an implication that there will be a crackdown on the widespread practice of paying substantial sums to replaceable, so-so bankers - though it is very unclear how a return to what most would see as sanity in bankers' remuneration would be policed.

Also, and not for the first time since the great banking crisis of two years ago, there are bound to be pledges that adequate credit will be provided to the private sector - together with commitments on supporting the Big Society Bank, and on training and employment creation (which may look a bit odd coming on the heels of more than 40,000 job cuts by RBS and Lloyds since 2008).

In return, the banks say they want an end to ministers sniping at them and criticising them in public. Would that be a fair exchange? Over to you.

We're all gulled by special offers

Robert Peston | 09:51 UK time, Thursday, 2 December 2010

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I asked the boss of one of our largest fashion retailers whether he was concerned about the substantial size of price increases he would have to force on consumers in the new year, as a consequence of the looming VAT rise, the increment in the cotton price (which has softened a bit) and the substantial inflation which China is now exporting (in contrast to the deflation that it used to export).

Shop with closing down sale

 

He more-or-less called me a blithering idiot. Visible price increases? Don't be so naive, he said. Most of these problems could be dealt with by "changing the product mix".

What does that mean? It means there'll be more clothing on the shelves that's ostensibly better quality, priced at - say - £20 an item, and very few £2 t-shirts. Or to put it another way, it's not so much that the price of the really cheap stuff will go up very sharply, but that there will be very little of it around.

Of course there will be considerable consumer detriment, a squeeze on spending power - especially for those on lowest incomes. But the impact will be hidden to an extent: it won't manifest itself in a conspicuous across-the-board price increase.

I suppose two questions follow. First, whether this change in the product mix will be adequately picked up by the statisticians who calculate the official British inflation rate (history would suggest probably not). Second, whether shoppers will be fooled into thinking prices haven't gone up that much - and will simply be puzzled about the absence of the very cheapest clothing.

Which of course brings me very neatly on to today's fascinating report, The Advertising of Prices, by the Office of Fair Trading, the competition watchdog - because it is all about how most of us as consumers are supposedly easy to fool into making the wrong or superfluous purchases, by fiendish pricing strategies employed by consumer businesses.

You know the sort of thing I'm talking about: big adverts in shop windows trumpeting a "closing down sale", for a store that never closes; discounts offered on an "original" price, where that original higher price was charged for not much longer than a nano second; websites that advertise an incredibly low price for a service - such as travel - on the homepage, but keep adding extra charges in a "drip drip" way as you navigate towards the checkout; special offers of that gadget you always wanted for the first customers to turn up at the shop, when there are almost none of the gadgets in stock at that low price.

Now you may think that you are resistant to such ruses. But the OFT says you are fooling yourself. On the basis of extensive research - both its own and external - it is persuaded that almost all of us will end up buying something that we didn't intend to buy, having been lured into a shop or website by a spurious special offer that doesn't really exist.

What's less clear is whether we make the superfluous purchase because we are embarrassed to admit - even to ourselves - that we've been gulled, or whether it's because we don't want to go away empty handed having invested precious time in the trip to shop or website. Either way, oh-so modish nudge or behavioural economics really does seem to apply when it comes to retail purchases.

Now I hear the free-market adherents and entrepreneurs among you screaming "so what!!!!!". If consumers are there for the taking, take 'em, you'll say. If someone who really believes they can fly to Barcelona for 20p, they deserve to be charged £150, as a lesson, you might argue.

Well that may be so for those households with more money than they need. But surely not for those on a tight budget.

And although the OFT is saying it doesn't like any of these putative misleading pricing practices, and is clear that many of them are illegal, the watchdog says it will crack down only on those where the consumer detriment is considerable: it won't punish retailers who only occasionally stray into falsely claiming to offer the deal of the millennium, so long as the provable harm to consumers was minimal.

That said, there is a more fundamental point for the industry to consider, I've long thought. Which is why they employ so many people whose job is to persuade us that their prices are cheaper than they really are. Surely, if those consumer-facing firms deployed the same resources into finding ways to improve productivity and actually cutting prices, wouldn't they - and consumers too - be much better off.

Maybe price comparison websites are beginning to force some firms - especially those in the insurance, banking and energy businesses - to sweep away some of the baffling complexity of their pricing structures. Although it seems to me that progress remains slow in that respect. And some of the pricing websites themselves don't seem to me to be as transparent as they might be about their relationships with the companies whose prices they monitor.

The basic point remains. We'd all be much better off as consumers if "what you see is what you get" applied to the advertised prices of all business. And, arguably, consumer-facing businesses themselves would all be forced to become much more efficient. Oh dear, there I go again, speaking like a blithering idiot, as the boss of that retailing conglomerate would probably say.

The end of EMI is nigh?

Robert Peston | 21:01 UK time, Wednesday, 1 December 2010

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Sooner or later - and it may be sooner - we are likely to see the end of a once great British corporate name, and a still resonant name in the music business, EMI.

Because those close to EMI tell me they expect Citigroup, the giant US bank, to seize control of the business and then quickly sell it off in pieces.

For reasons that aren't entirely clear to me, there is a belief at EMI's current owner, Terra Firma, that Citi may attempt to take control of EMI fairly imminently - although I am not sure how that can happen earlier than March (see below).

The expectation is Citi would then sell EMI's music publishing arm to the private-equity house KKR for about £1.2bn.

And EMI's recorded music business would be expected go for just £400m, probably to Warner Music - though such a takeover would face tough scrutiny by the European competition authority.

In theory, Citi won't have the formal right to take ownership of EMI until at least March, because that's when Terra Firma expects to be in formal breach of the terms of its borrowing agreement with Citi (Terra Firm will probably pass this month's covenant test).

Citi is owed £3bn in respect of Terra Firma's takeover of EMI, which is considerably more than EMI is worth today. So it looks as though Citi will ultimately lose about half its money.

As for Terra Firma, the equity it put into the deal of £1.7bn is currently worthless.

If EMI is worth around £1.6bn today, which - I am told - is what Terra Firma's founder Guy Hands believes, then Terra Firma will end up losing the lot.

Bankers seek deal with ministers on bonuses

Robert Peston | 08:14 UK time, Wednesday, 1 December 2010

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The talks involving those who run our biggest banks, on how to take the sting out of criticisms of the bonuses they're to pay their top people in the new year, have moved to a new phase.

People walking in front of the Canary Wharf skyline

 

You'll recall that a fortnight ago I disclosed that bank bosses are talking to each other to examine whether it might be possible to end the arms race of paying higher and higher bonuses - an arms race which has infuriated politicians and regulators, while prompting stinging attacks in the media.

Well the banks have now put the ball in the court of the government.

"We've told the government that there's no point in our reaching some kind of collective agreement on pay, if ministers are still going to use the kind of rhetoric against us that damages our reputations and demoralises our staff," said one bank leader. "We're looking for a response from ministers, which makes it clear they recognise we're doing our bit on pay and also recognises that we have an important role to play in the recovery - which would be set back if we're attacked all the time by ministers".

So what does the Treasury and the Business Department think about all this? Well, one member of the government said there was no possibility of a statement by the chancellor, or the prime minister or the business secretary which implied that any kind of deal had been with the banks. "There'll be no kind of contract with us, or formal public agreement," he said.

But he added: "If banks show they get it, then inevitably you'll see less criticism of them by us".

So what might the banks "getting it" involve, in the government's view? Well simply paying a smaller amount of bonuses in total than last year would not do the trick.

"It's not been a great year for investment banking, so we all know the bonus pool is going to shrink whatever happens," said a government source. "So if they think that we'll be impressed by a single year of lower bonuses, well they'd be wrong about that. What we want to see is that they're tackling the pay issue in a long term sense, not just for one year but in a permanent sense."

What would that mean in practice for how banks set bonuses? That's not at all clear - though the source said it would certainly mean in part that the biggest rewards should go to smaller numbers of bankers, those who could genuinely demonstrate outstanding performance.

So will a deal actually be done? This is what a bank boss said to me: "I haven't a clue. We're waiting to hear from the government".

Hmmm.

The chances of a meaningful deal between bank bosses on the remuneration of their top bankers don't look great, not least because - in their hearts - some of the bank bosses (not all) think that the attacks on their pay are bonkers.

"This is a British obsession, a British thing," one of them told me. "In the rest of the world we pay the going rate and we don't get pilloried. It's only here that we get smashed to bits".

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