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The hole in Ireland's banks is £21bn

Robert Peston | 18:28 UK time, Thursday, 31 March 2011


Could the Irish banking system, where a single nationalised bank, Anglo Irish, has just announced losses of £16bn (18bn euros), equivalent to well over a third of all revenues received by the Irish government, be any more bust (and thanks to the journalist Fintan O'Toole for that comparator)?

A man begs for money outside a branch of the EBS building society in central Dublin, Ireland


It turns out that it could.

The Central Bank of Ireland has announced that total losses of four other banks - Allied Irish, Bank of Ireland, Irish Life and Permanent, and EBS - are expected to be £18bn (20bn euros) over the coming three years, on the basis of what is expected to happen to the struggling Irish economy over that period.

And if the Irish economy performs worse than expected, then the losses on what the regulators call this "stressed" basis will be £25bn (28bn euros).

The banks are also being forced to shrink to a size that poses less risk to the Irish economy. They've been instructed to reduce the net loans on their balance sheets by £63bn (71bn euros) by the end of 2013 - or by an amount equivalent to around half the value of the Irish economy.

And this process, known as deleveraging, is expected to generate another £11bn (12bn euros) of losses for the quartet of Irish banks, as certain loans and assets are bound to be sold or unwound for less than their face value.

The painful consequence is that there is a shortage of capital - the shock-absorber to protect depositors from losses - of £21bn in these banks. This capital shortfall consists of money to cover the expected losses and further rainy funds designed to be a buffer just in case things get even worse.

That is a colossal sum for them to find. And remember that £41bn of taxpayers' money has already gone into Ireland's banks.

So in total Ireland's banks will have been required to raise capital of £62bn at the end of this process, equivalent to more than half its annual output.

When it comes to projected losses, worst hit of the four would be Allied Irish Banks with between £8bn and £11bn of losses between 2011-13.

The cause of these losses? Well it's the continued weakness of the Irish economy. So Black Rock, which assessed likely losses at banks on behalf of the Irish Central, expects substantial pain for banks on their residential mortgages and also on loans to companies, small businesses, consumers and commercial real estate developers.

When it comes to the housing market, latest figures, for the end of 2010, showed that 5.7% of all mortgage accounts were in arrears by more than 90 days, which represents a rise since 2009 of 56% in the number of borrowers finding it impossible to keep up the payments.

No surprise really. Unemployment in Ireland has been rising and stands at 14.7%. Wages have been under pressure, and the price of houses has been falling for four years.

If anything, the surprise is that regulators have not until now forced Irish banks to recognise their potential losses on lending to home-buyers.

Update 1748:

The hope for the Irish government is that in owning up to the full extent of the hole in its banks, it will begin to rebuild the confidence of those who lend to the financial sector and to the state.

There are questions about why it has taken so long for the regulators and the banks to recognise the full exent of losses faced by the banks on loans to homeowners and businesses - given that the housing market and economy have been in trouble for some time.

But there is no possibility of recovery until all the horrors have been disclosed.

And what horrors they are. By the time taxpayers have injected new capital into the banks as a shock-absorber against the problems that lie ahead, they will have invested a sum equivalent to more than half the value of the Irish economy.

Where from here?

Well it is by no means the end of Ireland's woes. Its banks, even when wholly or partly nationalised, are still on a drip of loans from the European Central Bank - which is not sustainable.

And the new Irish government fears that the interest rate it is paying on 67.5bn euros of rescue loans from the eurozone and International Monetary Fund is too high - and threatens to undermine its ability to recover.

Mending the banks is only the beginning of Ireland's economic and financial rehabilitation.

Update 1827:

The other issue raised by the elongated, episodic and - some would say - belated disclosure of the woes of Ireland’s banks, is what it says about horrors that may lurk elsewhere in the eurozone.

Those, for example, who fear that Spain’s banks haven’t yet been forced to disclose the full extent of the losses they face on their exposure to the burst residential and commercial property bubble will not be reassured by events in Ireland today.

Can banks dodge the break-up?

Robert Peston | 11:42 UK time, Thursday, 31 March 2011


There is a slightly odd lead story in the FT this morning, which says that "senior Whitehall officials are pushing for a three-way peace deal between government, big banks and the Independent Commission on Banking".

Bob Diamond, Chief Executive of Barclay's bank

That may be so. However, if it is, the commissioners don't know about it - and nor does the Treasury. And the commissioners are certainly in no mood to alter their interim report, due in 10 days, for anyone.

It is also mildly amusing that one of the commissioners is the FT's Martin Wolf. I am confident he had no role in the creation of that splash story.

What is happening is that the UK's big banks are thrashing around in a state of mild panic, because of their concerns about what the commissioners will recommend.

The penny has dropped for them that this is the big event, more important than the final report due in the autumn - because it will condition the public and political debate about how to fix the banks, which will in turn determine what the government eventually feels confident it can deliver.

So what do I expect from the commissioners?

Well, as I have said for some time, I would be staggered if they don't recommend some form of break up of the universal banks - Barclays, HSBC and Royal Bank of Scotland - which combine investment banking and retail banking.

A formal, physical separation isn't likely however. What I would expect is a proposal for investment banking and retail banking to be put into separate subsidiaries, each of which would be obliged to have their own respective pots of capital to protect against losses.

The idea would be to insulate the retail banks - the bits of banks that look after our savings, move money around and lend to individuals and to smaller businesses - from the risks taken by investment banks.

Think of the separation as the equivalent of building a super-strong steel and concrete firewall in the middle of a building - which would protect one half of the building if the other half were to catch fire.

You probably think that all sounds sensible. But the banks don't like it, for two reasons.

First, capital is expensive for banks, because of the rewards expected by the investors who provide capital. So if the bits of RBS, Barclays and HSBC that do investment banking are separately capitalised - to use the jargon - they would probably have to become much smaller organisations, focusing only on business that is particularly profitable.

But perhaps an even great worry for these mega banks is what would happen to the cost of the money they borrow. They fear it would become much more expensive for their investment banks to raise the finance which they then use for lending and investing.

How so?

Well if creditors of Barclays or RBS, for example, came to believe that the relevant investment bank was now so separate from the retail bank that the government would no longer feel under any pressure to rescue the investment bank to protect ordinary savers and the money transmission mechanism, that investment bank would be perceived to be riskier.

It would no longer be seen to be "too big to fail".

And once any institution is seen to thrive or sink according to its own management of its affairs - and is no longer benefiting from any kind of protection or insurance from taxpayers - well, at a stroke it has to pay more to borrow.

Now you might think that is the whole point of what the banking commission is trying to achieve. And you would be right.

But the banks don't like it, because if they have to pay more to borrow, then either their profits are squeezed or they have to pass those increased costs on to customers.

And, they say, they would not be able pass those costs on to customers - because they face competition from overseas banks which don't face the same strictures.

Now, for what it's worth, the banks believe that the benefits to their funding costs of being too big to fail, of being implicitly protected by taxpayers, have been overstated.

As readers of this column will know, the Bank of England estimated this implicit subsidy as being worth around £100bn per annum at the peak of anxiety about the fragility of banks in 2008-9, and perhaps half that figure subsequently.

What the banks would say is that at least some of the lower funding cost for universal banks derives from the perceived benefits of business diversity - that investors prefer lending to organisations whose eggs aren't all concentrated in one basket.

Hmmm. Some will see that as an admission that investors don't really like lending to investment banks, precisely because they are perceived to be riskier. Which brings us back to the question of why on earth taxpayers should underwrite investment banking?

Anyway, if you are with me so far, you will understand why the likes of Barclays, HSBC and Standard Chartered are all muttering about moving abroad to avoid this kind of enforced break-up.

Which brings me, in my meandering way, to my destination: are these threats to move abroad credible, and if they are, how much should we care?

A plane flies past HSBC headquarters in London

One of the most startling omissions from the debate about how to make our banks safe is any serious analysis of the costs to the UK of the relocation of the head offices of one or a number of banks to another country.

Let's be clear what we are talking about. Barclays and HSBC could not move their branches. Nor could they quickly or easily move those bits of their investment banking operations that serve UK or continental clients. We are talking about the economic impact of relocating head office functions.

How much would this damage the prosperity of the City of London and the UK? Would it damage the UK more than the benefits of reducing the UK's vulnerability to the kind of cataclysmic banking shock we experienced in 2008?

The truth is that we don't really have the numbers to make a quasi-scientific analysis of the benefits and costs. So, paradoxically for an industry that prides itself on its facility with numbers, this is a debate conducted largely in fatuous emotion and generalisations.

Which is why I am sure the Independent Commission on Banking has done some work to estimate the financial benefits to the City and the British economy of having so many mega bank HQs here - and the potential costs of their possible emigration.

It will be fascinating to see how it evaluates the scariness of the banks' threat to leave.

I suspect the commission will also shed light on the credibility of that threat to depart - especially the question of whether the single European market would make it easy for our big banks to dodge the proposed reforms merely by relocating to Luxembourg, Frankfurt or Paris.

It is possible, I think, that the commission has found that EU law makes this kind of regulatory arbitrage impossible - even if it were possible that Barclays, for example, would enjoy the idea of embracing the German or French way of doing capitalism (which seems highly implausible).

As for Luxembourg as a possible HQ, that is absurd. The idea that Luxembourg has the regulatory resources or sovereign balance sheet to play host to banks whose balance sheets are bigger than the UK economy is not credible.

What about taking flight to some other part of the world? Well I think it would be surprising if Standard Chartered didn't move its head office to Asia or thereabouts some time in the next five years whatever the commission recommends - simply because it looks more and more odd that a bank with no serious operational presence in the UK is run from here.

But what about Barclays going to New York or HSBC going to Hong Kong?

In an earlier post, I explored why HSBC will find it hard to move. As for Barclays, how easy would it be for that bank to retain its complicated and beneficial tax arrangements if it relocated?

Not very easy, according to my tax specialist chums. So would Barclays owners be pleased to see the bank move, if that generated a big tax bill? They would probably not be ecstatic.

The unbelievable truth about Ireland and its banks

Robert Peston | 00:00 UK time, Wednesday, 30 March 2011


Ireland's central bank and new government will confirm on Thursday that the hole in the country's banks is even wider, deeper and darker than seemed to be the case last November, when those bust banks forced the country to go with a begging bowl to the eurozone's rescue funds and the International Monetary Fund (IMF) for 67.5bn euros (£59bn) of rescue loans.

Regulators at the Irish central bank have conducted a review of how much extra capital - as a buffer against future losses - is required by Bank of Ireland, Allied Irish Bank, EBS and Irish Life and Permanent.

Unless something unexpected happens in the next 24 hours, the total amount of additional capital that will need to be injected into these banks will be a bit less than 35bn euros - including 8bn euros that was supposed to be injected into them at the end of February, but was postponed because of Ireland's political turmoil.

Anyway, let's assume that the total amount extra that these banks need is circa 30bn euros. That would take the total quantity of state investment in Ireland banks to a breathtaking 75bn euros (actually a tiny bit more than that).

That is an almost unbelievably large number. When I think about it, I have a small panic attack - because it represents 45% of Ireland's GDP and 55% of its GNP.

(Irish GNP is usually thought to be a better measure of Ireland's useful economic output, because the GDP figure contains a sizeable chunk of profits exported abroad by all those multinationals that settled in Ireland for the exceptionally low tax rate).

Or to put it another way, if Britain's banks had gone bust to the same extent, British taxpayers would have invested something like £700bn in them - or more than 10 times what we actually invested in Royal Bank of Scotland, Lloyds, Northern Rock and Bradford & Bingley.

Nor is that the end of the exposure of the eurozone and the Irish state to these stunningly failed banks.

No financial institution or bank will lend to them. Ireland's banks can't borrow from anyone except the Irish people (who, poor souls, have nowhere much else to put their deposits). But even if they wanted to, Irish households could not possibly put money into the banks fast enough to allow those banks to repay all the institutions - such as German banks - which lent far too much to Ireland's banks in the boom years.

So when these wholesale lenders to Ireland's banks have been demanding their money back (as they have been in a run that has been huge and inexorable), the money has come from the European Central Bank and the Central Bank of Ireland - or, indirectly, from the taxpayers of Ireland and the eurozone.

To prevent Irish banks toppling over one after another, the European Central Bank has lent 117bn euros to them and the Central Bank of Ireland has lent them a further 71bn euros. So that's 188bn euros of loans from the eurozone's taxpayers to Ireland's banks - which makes the 67.5bn euros lent directly by the eurozone and IMF to the Irish government look like peanuts.

And a further 20bn euros of bank bonds - another form of bank debt - is still guaranteed by the Irish state through the Eligible Guarantee Scheme.

So that is 208bn euros of taxpayer loans to Ireland's banks - equivalent to a remarkable 154% of GDP.

To ask the inevitable dumb question, what on earth went so spectacularly wrong?

First, in the frenzied party years before 2008, the banks borrowed too much from other institutions - especially from German banks - and lent far too much to housebuyers and property speculators.

However, to date Ireland's banks have only properly owned up to the losses on the property developments.

On Thursday for the first time they'll be forced to admit that they also face colossal losses on residential mortgages. In February, for example, official Central Bank figures showed that 5.7% of Irish mortgage accounts were more than 90 days in arrears - which means Ireland banks then were owed 8.6bn euros in unpaid interest and principal.

It is pretty extraordinary that it has taken so long for the banks to be forced to recognise their mortgage losses - since house prices have more-or-less halved over the past few years, the economy was in deep recession after the 2008 crash and has subsequently been pretty stagnant, and unemployment has been rising.

Does the phrase "better late than never" apply in this case? Possibly not.

Second, the Irish government probably chose the worst of all strategies for propping up the banks.

By guaranteeing all their liabilities in the autumn of 2008, they turned the bloated liabilities of the swollen banks into public sector debt.

And because the Irish government didn't secure a bottomless borrowing facility from the European Central Bank, it then became impossible to force losses on any of the banks' creditors, even those which lent most recklessly: Ireland did not have the financial resources to pay back all those wholesale lenders that would inevitably have demanded their money back the moment any of them were instructed to swallow a loss.

So some of the guilty parties, namely the wholesale creditors of Ireland's banks - including banks and investors in Germany, France, Spain and the UK - have got away without taking their share of losses. All those losses have fallen on Ireland's citizens, who are not blameless for the mess (they didn't have to borrow too much) but aren't the only ones at fault.

And for the Irish people, there is a second source of possible injustice. The money they've been lent by the IMF and eurozone carries an interest rate of 5.8% on average - which is significantly greater than Ireland's economy and tax revenues can grow right now, and therefore forces Ireland into a potentially never-ending vicious cycle of public spending cuts and low growth.

What's more, the banks may also be trapped in a cycle of forced asset sales and losses, because they are paying out an estimated 2.5bn euros a year for the emergency loans from the ECB and Irish central bank, to finance mortgages and other loans which are falling in value and are not yielding interest.

Perhaps worse still, the 188bn euros of central bank loans could be withdrawn more or less at the ECB's pleasure. So Ireland's banks will continue to feel under relentless pressure to dump assets at punitive fire-sale prices, unless and until the ECB can be prevailed upon to deliver what its officials say it is cooking up, which is a new, longer stable lending facility for banks - such as the Irish ones - that need to reconstructed.

What will be the end of this sorry saga?

By default, it now looks as though almost the entire Irish banking sector will be nationalised.

Allied Irish is already in state hands. Anglo Irish and Irish Nationwide have been crunched together and are being wound up by the state. It will be tough for Bank of Ireland and Irish Life and Permanent to avoid being taken over by taxpayers too.

It will therefore be fascinating to hear what the Irish premier and finance minister lay out as their vision for the future of Ireland's banks. That will be presented at 4.45pm on Thursday, 15 minutes after the Central Bank of Ireland announces the precise, hideous amount of extra capital the banks will be forced to raise.

It will be another momentous day for Ireland and for the Eurozone. But whether it will be a day that sets both on the road to financial recovery, or nudges them nearer catastrophe, cannot yet be assessed.

Germany pushes Portugal nearer to the brink?

Robert Peston | 17:43 UK time, Tuesday, 29 March 2011


The decision of Standard & Poor's to downgrade Portugal's sovereign debt to just a fraction above a junk rating will inevitably make it harder for Portugal to borrow in the coming weeks - when it will need to refinance more than €8bn of bonds that come up for repayment.

So in that sense, S&P's downgrade pushes Portugal nearer to crisis and the moment when it asks its eurozone partner countries for a bailout.

What is embarrassing for those partner countries is the main reason cited by S&P for the bailout - namely that eurozone leaders agreed last Friday that the new eurozone bailout fund to be launched in 2013, the European Stability Mechanism, will only lend on terms that will make it the senior creditor when it comes to repayment.

European Stability Mechanism loans will rank ahead of borrowings by eurozone sovereign states. So, by definition, the credit quality of any debt issued by a fragile eurozone country like Portugal - one deemed likely to tap the European Stability Mechanism - has deteriorated.

Which is why S&P felt it had no option but to downgrade Portuguese debt (and Greek debt too - and Ireland's debt will probably be downgraded later this week).

Or to put it another way, the understandable determination of Germany in particular to minimise losses when rescue funds are actually provided, and also to punish reckless sovereign borrowers, has had the effect of making it more likely that Portugal will have to tap the eurozone and the IMF for emergency funds (as Ireland and Greece have already done).

In other words, the reward of German prudence is that German taxpayers are now even more likely to have to bail out their Portuguese neighbours.

RBS: 'Regulators are the main risk'

Robert Peston | 10:18 UK time, Tuesday, 29 March 2011


Stephen Hester this morning gave a generally upbeat presentation on the outlook for the largely nationalised Royal Bank of Scotland at an investor conference organised by Morgan Stanley.

The chief executive of RBS made three points that stood out for me.

Stephen Hester


First, that RBS has a target of next year for weaning itself off one element of the support it receives from taxpayers: by 2012, it wants to exit from the asset protection scheme, the state insurance policy that has insured RBS against losses over £60bn on £282bn of poor quality loans and investments.

That would be an important milestone in RBS's recovery and in its journey from 83% ownership by the state towards privatisation.

Second, Hester said that he expected two interest rate rises in the UK by the end of this financial year. Which he would see as a good thing - because the rate rises would help the bank rebuild its margins, or the difference between what it pays depositors and what it can charge on loans.

That of course may make many of you rather grumpy: you may not like it that Mr Hester has to put the interests of his shareholders above those of millions of British people who fear they have borrowed too much and hate the idea of interest rates going up.

But what I find striking is that RBS's financial model calculates that the benefits to its profits of a widening in its margins outweigh the risk of the UK's economic recovery being seriously set back by such interest rate rises.

Plainly it would not be good for the UK or for RBS if those rate rises led to an increase in the number of consumers and businesses finding it difficult to keep up the payments on their debts.

With household indebtedness still at record levels relative to disposable income (the ratio of household debt to disposable income is still around 170%), the financial wellbeing of consumers is particularly sensitive to the level of interest rates.

Let's hope Mr Hester is right that not too many households - and businesses - would be put on the financial critical list by a couple of rate rises. But not everyone on the Bank of England's rate-setting Monetary Policy Committee would share his optimism on this point.

Finally, what I found particularly striking is that two of the three biggest sources of what Mr Hester called "downside" risk to RBS's ability to perform better for shareholders are "regulatory".

In other words, if RBS's share price were not to rise as much as Mr Hester thinks it should in the coming year, the blame should probably attach (in his view) to the Financial Services Authority and the Bank of England.

How so?

Well one of the big items on the agenda for regulators on the Basel Committee and the Financial Stability Board - the standard setting bodies for global bank regulation - are a review of the riskiness of banks' financial trading activities and the linked question of how much capital they should hold as a protection against losses on their trading books.

Regulators tell me that investment banks and the investment banking arms of universal banks like RBS and Barclays will be forced to hold much more capital.

And the other item on the Basel and FSB agenda is how much additional capital systemically important banks should hold compared with smaller banks.

As readers of this column will know, the Financial Services Authority and the Bank of England are what the banks would describe as hawkish on these issues.

The FSA and Bank believe there is a powerful argument for big banks being forced to hold perhaps twice the new 7% minimum ratio of equity capital to assets that is gradually being imposed under the new Basel III worldwide rules.

The argument of the Bank and FSA - made particularly by the chairman of the FSA, Adair Turner, and by David Miles, who sits on the Bank's Monetary Policy Committee - is that the long-term economic costs of the kind of banking shock we saw in 2008 are so great, that it would be very foolish not to force banks to have a much bigger shock-absorbing buffer.

Now the banks make a variety of arguments in reply - not all of them consistent. But their main one is that capital is expensive for them to raise. And the more of it they have to hold relative to their loans and investments, the harder it is for them to supply the credit requirements of a recovering economy.

You will have read the claim and counter claim by regulators and bankers on all this so many times in this blog, you may like me be losing the will to live.

So for today I am simply going to make one simple point.

When a bank as big and important as RBS says that the main threat to its performance this year is what the regulators do, you can assume that the punch-up between the bankers and the authorities on how to make the banking system and the economy safer is going to get nastier.

And if you think this punch-up has nothing to do with you, that you are a bemused bystander, think again.

Remember that we as taxpayers own 83% of RBS, and therefore it is of material interest to us whether the value of RBS shares falls or rises.

However far more importantly, the banking crash of 2008 may have condemned us to years of below-par growth. Which is why it is important to us that banks hold enough capital to minimise the risk of that kind of disaster happening again, but that they are not forced to build up their capital so fast that our insipid recovery is choked off into a new slump.

BP defeated by Russian partners

Robert Peston | 20:05 UK time, Thursday, 24 March 2011


If you don't try, you can't fail - to coin the cliche.

But it is still embarrassing for BP that an independent tribunal has blocked its attempt to form a partnership - based on an exchange of shares - with the Russian energy giant Rosneft, and prohibited an associated agreement to explore the Arctic sea for oil.

The ruling of the tribunal, which upheld an injunction in the London courts, is comprehensive and clear, raising questions about why BP's new chief executive, Bob Dudley, ever thought the deal could happen.

Perhaps he calculated that because he was negotiating with a state-owned enterprise in Rosneft, the Kremlin would put sufficient pressure on the opponents of the transaction, the group of Russian billionaires - who we'll give the shorthand name of AAR, and who are the co-owners with BP of a massive Russian energy venture, TNK BP - to cease their frustrating action.

That does not appear to have happened. And a spokesman for AAR insists it won't happen.

He says that AAR is clear that the deal with Rosneft is so damaging to the intrinsic value of TNK BP, that BP will not be able to afford to buy off the billionaires.

We'll see.

In the meantime, BP will go back to the tribunal and ask it to permit the share swap - which would see BP increase its stake in Rosneft from just over 1% to just over 10%, while Rosneft would take a 5% stake in BP.

There seems to be a deadline of April 14 for some kind of way to be found through the impasse, because that's when the agreement-in-principle with Rosneft on the share exchange expires.

So what's the damage for BP?

Well an exciting opportunity to bond with the most important company in one of the world's most energy rich countries may have been lost.

And there is some reputational damage, in that the judgment of BP's senior management appears to have been flawed.

Also BP's relations with its TNK BP partners haven't exactly been improved - which is not ideal given that TNK BP is a cash spewing business with bags of potential worth tens of billions of dollars.

All that said, none of this needs to be a permanent loss. The final bill depends on how BP proceeds from here.

Portugal to muddle through - for now

Robert Peston | 14:29 UK time, Thursday, 24 March 2011


It looks to me as though Portugal will muddle through without a formal EU bailout for a while longer, for two reasons.

Portuguese parliament, Lisbon

First, and forgive the statement of the stupendously, blindingly obvious, a sovereign state can't be rescued if it has not asked to be.

And Portugal's teetering administration, now serving in caretaker capacity, has not requested the lifeboat.

Second, even if it did tell other European governments that it needs help, at this stage all it would get probably is very short term "liquidity" support from the European Central Bank (ECB) - or rather a good deal more of that.

For some time, Portugal's government has been borrowing from its banks by selling them bonds, which in turn have been swapping the bonds for cash from the ECB (see my earlier notes on this).

And the ECB has also been endeavouring to put a floor under the price of Portuguese bonds, by buying them in the secondary market.

The ECB is increasingly uncomfortable about propping up the Portuguese state in this way. It doesn't do wonders for its reputation as a monetary purist. But it can probably stand the humiliation a while longer.

The understandable consensus among European leaders is that it would be pointless negotiating a long term bail out with Portuguese ministers who may not be in office in a few weeks.

That is the lesson for EU leaders of their Irish rescue mission - where they agreed a bailout plan with the previous government only to see the new government try to unpick it.

With a Portuguese general election looming in a few weeks, far better to negotiate the rescue loans - and corresponding measures to strengthen Portugal's banks and public-sector finances - after a new government has been chosen by Portugal's people.

So, as is the way with the eurozone's fiscal and banking disease, each new shock is met with aspirin and sticking plaster, rather than substantial major treatment and rehabilitation.

There is the small matter of €4.23bn (£3.7bn) that Portugal has to repay to lenders, holders of its bonds, next month.

But, as I've said, some kind of ECB temporary fix seems highly likely, according to official sources.

As for when the proper rescue comes - and officials tell me it certainly will come - the scale of loans may be around €80bn or £70bn, provided by eurozone and IMF.

Britain's contribution will be minimal and indirect. The UK is exposed via its 12% implicit share of the EU budget.

Only in the event that the Portuguese financial crisis exhausted the available money in the eurozone's bail out fund - which it won't - would the UK become liable.

But if other bigger eurozone states run into difficulties (you know the names and flags) Britain could yet find itself exposed.

As WPP returns, will HSBC quit UK?

Robert Peston | 09:04 UK time, Thursday, 24 March 2011


In a symbolic sense, it matters that Sir Martin Sorrell has decided that the government's corporation tax reforms and cuts are enough to lure his advertising giant back from Dublin to the UK.

The chief executive and founder of WPP told me:

"We've now had a chance to read the small print. It is subject to drafting and enactment of the relevant legislation, and to board and shareowners' approval".

But he confirmed what he told the BBC's Today Programme - which overnight he made up his mind that the Chancellor has done enough to bring the home of WPP back to London (last night on the Ten O'clock News he applauded the reforms, but hadn't yet bought his ticket back from Dublin).

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The government cannot contain its delight at WPP's decision - largely because its corporate tax changes are designed to make the UK a better place for multinationals to base themselves.

Those reforms aren't cheap. By the government's own estimates - and critics say they under-estimate the cost - they will lead to around £2bn of lost revenue a year by 2015 (and see my note from yesterday for more on the detail of the reforms to the so-called Controlled Foreign Company Rules, the taxation of multinationals' branches, and cuts in the rate of corporation tax).

For the avoidance of doubt, WPP's intentions don't constitute a trend. It is too early to say whether they will lead to the kind of investment and job creation in the UK by multinationals that the government desires.

We don't yet know whether Shire, the pharmaceuticals group, or UBM, the media company, will follow WPP's lead.

And it is unclear whether Sorrell's thinking has been influenced by the economic weakness of Ireland, which may ultimately undermine the new Irish government's ability to maintain low tax arrangements for multinationals that other EU members such as Germany want the Irish to scrap.

All that said, this morning George Osborne has had the kind of advertising from an advertising giant that money can't buy.

Of course, some may say that is because Sir Martin Sorrell is just one of the usual Tory suspects. But I don't think that's quite right: he was on reasonable terms with the last government. That said, he has been a supporter of the government's public spending cuts. And he is a member of David Cameron's business advisory group.

One more thing. There is a reasonable chance that if WPP comes back, like a giant ship in the night it may well pass HSBC - the giant international bank - travelling in the opposite direction.

It is not corporation tax that particularly irks HSBC but George Osborne's new levy on the banks. Emigration from the UK is a very live option, that comes up for discussion at every board meeting, I am reliably told.

The reason for HSBC's itchy feet, as I've mentioned here before, is that it is furious that George Osborne's new bank levy is applied to the money it borrows outside the UK, as well as its domestic liabilities. And that really matters, because HSBC has far more of its assets and liabilities outside the country than inside.

HSBC estimates that it could save itself more than £250m in levy every year by the simple expedient of moving its HQ for tax purposes somewhere else. And HSBC's directors tell me that the bank's shareholders - its owners - tell them that they don't see why HSBC should needlessly pay this tax, so are urging them to move their caravan on.

Now some of you - who don't seem to be fond of banks - might well say "good riddance". But the Treasury tells me it definitely wouldn't want to see HSBC go, though doesn't seem to have a cunning plan to persuade it to stay.

Update 13:25: But to where on earth could HSBC move its home?

A source at the top of the bank told me the group now sees the centre of its world as Africa - in the sense that Asia, Africa and the Middle East are expected to deliver most of the future growth.

So in an ideal world, it might move its domicile to Qatar or Dubai.

But with most of the Gulf either in flames or looking pretty combustible right now, emigrating there at his juncture could look eccentric, to say the least.

Now in spite of rumours to the contrary, my HSBC sources say there is no possibility of the bank returning the legal HQ to Hong Kong.

One of them muttered something about it not being a brilliant idea to sit under the clenched fist of a one-party Communist state. I can't imagine what he means.

On the other hand, HSBC is so big in Hong Kong and mainland China that moving home to the US is thought to be out of the question - because to do so would not go down especially well with the Chinese authorities, for geopolitical reasons (it was that consideration which made it impossible for HSBC to appoint the former Goldman Sachs partner, John Thornton, as chairman).

Now some months ago, I was told Australia was favourite as alternative domicile.

But given the sheer size of HSBC - a balance sheet roughly equivalent to UK GDP - it's not clear that the Australian central bank would quite cut the mustard as lender of last resort for the global giant.

In the end, the magnitude of the UK economy, the potential resources deliverable by British taxpayers (or us), and the size of the Bank of England's balance sheet combine to mean that the UK looks a decent place to be based, given that the credibility of all banks depends on them having access to emergency liquidity in a disaster.

For HSBC, is it worth paying an extra £250m a year in a special levy to the Treasury for the guarantee that the Bank of England and British taxpayers would always bail the bank out, whatever the weather.

HSBC's board might grump about the cost (they do), but that fat fee might represent value for money.

A budget for big business

Robert Peston | 13:29 UK time, Wednesday, 23 March 2011


Few I think could accuse George Osborne of going for easy vote-winning options in his measures aimed at stimulating the growth of the economy.

Cuts in the burden of corporation tax, which will be worth around £2bn per annum when implemented over the coming years, are likely to be particularly beneficial for big multinational companies.

And a significant lifting of planning constraints will delight much of the corporate sector.

The Chancellor George Osborne with the red budget box

But at a time when the residents of so-called middle Britain are feeling a sharp squeeze in disposable income, and when homeowners fear that screeching high speed trains will be zooming past their back gardens and ugly superstores will be built at the front, Mr Osborne's Budget choices may not win a vast number of votes.

The chancellor will therefore perhaps be seen as having chosen - still years from a general election - a principled Budget rather than a crowd-pleasing one. That may well be the best he can hope for, in any case.

In a way, The Plan for Growth published today alongside the Budget's red book, can be seen as a response to criticisms levelled at the government by Sir Richard Lambert when he stood down as director general of the CBI, the business lobby group, earlier this year.

Sir Richard praised the chancellor's determination to cut public spending, but said that "the government has not been nearly so consistent and focussed when it comes to policies that support growth" and had "failed so far to articulate in big picture terms its vision of what the UK economy might become under its stewardship".

So what is the vision of the chancellor and of the Business Secretary, Vince Cable? In that growth document, they say:

"We have to become much more productive so that we can be a leading high-tech, highly skilled economy. We must build a new model of economic growth - where instead of borrowing from the rest of the world we invest and we save and we export. Our economy must become more balanced. Private sector growth must take the place of government deficits and prosperity must be shared across all parts of the UK."

Most of that is as shocking and contentious as a mum pictured with a steaming apple pie.

So how is this high-exporting, high-saving, high-growth economy to be created? Well here are messrs Osborne's and Cable's quartet of ambitions, which they believe will deliver the UK's economic renewal:

1) to create the most competitive tax system in the G20 (or the 20 most powerful and richest world economies);

2) to make the UK one of the best places in Europe to start, finance and grow a business;

3) to encourage investment and exports as a route to a more balanced economy; and

4) to create a more educated workforce that is the most flexible in Europe.

And this is where it starts to get controversial.

Mr Osborne has decided to cut the mainstream rate of corporation tax rate by 2p in the pound from 1 April, double the planned cut. Which means the rate will go from 28p in the pound to 26p.

And this isn't just an acceleration of cuts announced last June. It represents an extra cut, because Mr Osborne's new commitment is to reduce the rate to 23% by 2014, rather than the 24% rate he announced last year.

That extra cut of 1p in the pound (or 1 percentage point) will cost £900m next year and thereafter. Which is a lot of money at a time when the government doesn't have a lot of money.

What's more, Mr Osborne will be seen as generous to companies in a second sense. After a lengthy review of the so-called Controlled Foreign Company rules, which are hated by most multinationals, the Treasury has opted to apply a very low rate of just 5.75% on cash held by multinationals in non-trading entities overseas.

By 2015/16, the low rate of tax on this cash - which is lower than the 8% rate which business had expected to be levied - will cost the exchequer £840m per annum compared with the current tax system. Again, that is a non-trivial sum. And critics will see it as rewarding multinationals who stash cash in tax havens and low-tax countries.

The Chancellor George Osborne

Finally, a further £80m a year of revenue will be lost by a decision not to levy tax on dividends brought into the UK from branches of multinationals - which the government would see as the logical extension of a decision by the previous chancellor, Alistair Darling, not to levy tax on dividends repatriated from overseas subsidiaries.

So in toto, big companies have arguably secured tax breaks which will eventually save them around £2bn a year - which some will see as the Tory members of the government unfairly rewarding their corporate pals, while millions of individuals are struggling to make ends meet.

Indeed critics of these changes to the global taxation of British multinationals believe the ultimate loss of revenue for the exchequer will be much greater than the Treasury's estimates.

Mr Osborne however would see the corporation tax cuts as a sprat - albeit a plump juicy sprat - to catch a lovely silver mackerel.

He would argue that the UK's long term growth and prosperity - on which the UK's ability to finance public spending depends - requires big companies to invest as much as possible in the UK. And he fears that if the tax regime for big companies isn't as competitive as anything on offer from other rich developed economies, those big companies will take their head offices and their investment to other parts of the world.

For Osborne, the reality of globalisation - where businesses can locate more-or-less wherever they like - means that the burden of taxation has to increasingly switch to income taxes on individuals and to indirect taxes like VAT.

So in that context it is significant that Mr Osborne is raising around £1bn from cracking down on what he calls disguised income, or tax loopholes exploited by the super-wealthy and those who run multinationals. The tax free status of offshore employee benefit trusts, for example, is being abolished, which will be a blow to the directors of big companies who are frequently the beneficiaries of such trusts.

There will also be a rise in the tariff imposed on non-doms, those who don't pay tax in the UK on their overseas income (which can be substantial) - though the tariff rise is coupled with incentives on non-doms to invest in the UK.

Or to put it another way, Mr Osborne hopes that if he is seen as being generous to big businesses as institutions, it will be recognised that he is simultaneously forcing the rich as individuals to make an increased contribution to closing the UK's fiscal deficit.

Mr Osborne is also acutely sensitive to the charge that the reductions to the burden of corporation tax will be perceived as too kind to the large banks, whose reckless lending and investing is widely blamed for the financial crisis that tipped the UK into the worst recession since the 1930s.

So he is marginally increasing from 0.075% to 0.078% the rate of the bank levy he has just introduced. That will boost the take from the levy by about £100m per annum.

The levy rise may dispel criticism that he is letting the banks off lightly. But the banks themselves may be miffed, because they may feel that the chancellor has gone back on his promise in their Project Merlin deal with him to bring greater stability and predictability to the tax system.

Finally there are a raft of reforms to planning and building regimes, which are bound to stir up a hornets' nest.

Business Secretary Vince Cable watches the Chancellor deliver the Budget

These include a new presumption that developments should be permitted, unless the local planning authority can advance compelling reasons why they should not - which inverts the current decision-making arrangement, where the developer has to argue the merits.

Also planning decisions must be made within a year. And local authorities can no longer favour brownfield sites over other more pristine sites (though the green belt will continue to be protected).

There'll be a lifting of all restrictions on small modifications and additions to existing developments, which will please big supermarket groups like Asda which argued for it, and it will be easier to change the use of existing buildings (from industrial to residential, for example).

Finally there will be a carrot for local authorities along with a stick, in that they may be given the ability to auction - for the benefit of council taxpayers - the planning permissions attached to parcels of land.

In the round, these planning changes could lead to a massive increase in developments, of both residential and commercial properties. They capture something the Treasury has believed for years, that the growth and competitiveness of the UK has been stifled by building restrictions.

With the corporation tax changes - and the recent pledge by Vince Cable to slash red tape - they represent a loosening of alleged shackles on the corporate sector.

They demonstrate the government's belief that the rehabilitation of the British economy can only come from the liberation of private enterprise - and perhaps also show that ministers have bought into the argument advanced by the influential consultancy firm, McKinsey, that much of the heavy lifting has to be done by the very biggest multinational companies.

All that said, at a time when millions of people are feeling a good deal poorer and are anxious about their job prospects, it is by no means certain that the allocation of precious resources to big business will be seen by all or even most voters as a manifestation of social justice.

Update 1416: One group of big companies won’t be pleased: the oil and gas companies.

They will pay an extra £1.8bn in tax this year and £2.24bn next year on their North Sea oil and gas production.

If the likes of Shell and BP don’t complain that this will undermine their efforts to squeeze the last drop of oil and gas out of the North Sea for the benefit of the UK, I will drink a litre of their finest unleaded petrol.

Also, it is not clear how the government can be sure that the oil companies won’t push up the pump price to recoup the extra tax - which would defeat the point of the exercise.

Finally, I may have given the chancellor too much of the benefit of the doubt in his determination to eschew populist pressures: abolishing the duty escalator on petrol won’t be seen as hairshirt fiscal conservatism.

Update 1725: One way in which some argue that George Osborne has failed the fiscal prudence test is in respect of the discount rate at which he has chosen to value the cost of future public-sector pension promises.

The analyst John Ralfe says that the chancellor’s decision to discount future pension payments at the rate of real or inflation-adjusted GDP growth understates the liability by a third – which translates into tens of billions of pounds of hidden liabilities.

By the way, in all the widespread confidence that we no longer face a sovereign debt crisis in the UK, it is often ignored that the UK still has to sell a colossal amount of gilts or government bonds to finance the deficit.

This year the Debt Management Office has been given a mandate to sell £169bn of gilts – which may yet turn out to be a colossal undertaking in a year when there is unlikely to be an extension of quantitative easing and the Bank of England is there unlikely to be a buyer of gilts.

Can and should the chancellor cut business taxes?

Robert Peston | 08:20 UK time, Wednesday, 23 March 2011


In the run-up to today's Budget, ministers have been banging on that their priority is to promote growth.

George Osborne

So today the Treasury and Business Department will publish a paper alongside the Budget red book that will be their prescription for rebalancing the UK away from a consumer-driven, debt fuelled, City-focussed economy to one where advanced manufacturing, the creative industries, tourism, pharmaceuticals, business services other than finance, inter alia, all have a bigger role.

The impossible-to-ignore background is that recovery from the 2008-9 great recession has been insipid, and that the record burden of household, bank and government debt is weighing heavily on the UK economy's ability to grow.

To remind you what you all know (sorry), public expenditure is being cut to shrink a deficit perceived as unsustainable. And consumer spending is under intense pressure from a squeeze in disposable income and a growing recognition in households that their indebtedness - still at unprecedented levels - needs to be reduced.

Which means that the heavy lifting in the economy has to be done by private-sector companies.

Unless they invest more, export more and employ more, the three-year squeeze in living standards suffered by the vast majority of us may continue for many more years. Without growth generated by private sector companies, unemployment may not fall to any significant extent, wages won't start to rise to offset the effects of inflation and the government won't receive incremental tax revenues that would allow future tax cuts or improvements in public services.

Without growth, the coming years look bleak for the UK.

But what on earth can the chancellor do to promote growth - to encourage more investment by companies, to stimulate exports - if he has no money to give away?

At the weekend, George Osborne said that the Budget would be fiscally neutral - which means that any tax cuts in one area would be matched by increases in other taxes or new spending reductions.

If for example he were to decide it is an imperative to reduce the financial burden on companies by cutting corporation tax faster or by more than he has already said he would do, savings would have to be found elsewhere.

Which means that some of us would feel the victims of the government's determination to help the private sector, bringing political risks for the coalition government.

For business, it is not just the rate of corporation tax that matters. Multinationals have been banging on for years that rules on how their profits outside the UK is taxed means that the advantages of having a head office or domicile in the UK are no longer what they were. Some international companies, such as the advertising group WPP and the pharmaceuticals company Shire, have already packed their bags and relocated to Dublin.

In response, the government has been carrying on with work initiated by its predecessor on possible reforms to so-called Controlled Foreign Company rules, which determine how much tax multinationals pay on cash sitting in non-trading entities abroad, and on what tax should be payable on dividends remitted to the UK from multinationals' branches.

Almost any reforms that the chancellor could announce to meet the government's aims of making the UK as attractive as possible for multinationals would be expensive - at a time, obviously, when every scrap of tax revenue is precious.

To state the obvious, reducing the tax burden on multinationals - including big banks - would not be universally popular.

Apart from tax, companies are also deeply concerned about whether Britons have the skills necessary to equip the UK for the global commercial war against India, China, Korea, Germany and so on.

Some have questioned whether at a time when it would presumably enhance the UK's growth potential for its workforce to become smarter, it was sensible to raise the personal cost of obtaining university education to a maximum of £9,000 a year. If the increased private cost of education deters younger people from investing in their skills, that would not lift the UK's productivity.

Any moves by the government to boost apprenticeships, work experience and vocational training (and it's clear from weekend media leaks that there will be a fair bit of all this) will be perceived to be important. But, again, there are limits on what government can do because of budgetary constraints.

That said, not all possible measures to stimulate growth costs money.

Last week, the Business Secretary Vince Cable announced a war on red tape: there is bound to be more detail today on individual regulations that will be abandoned and on his plan to harness popular pressure via the internet to force a loosening of regulatory shackles imposed by Whitehall departments.

There is one area of commercial activity where businesses feels particularly fettered, that of development - or the building of offices, supermarkets, factories, houses and infrastructure. Companies have been shouting loudly for years that the UK's growth prospects have been inhibited by an officially sanctioned nimbyism, by the long delays and massive restrictions placed on any ambitious development.

That said, if there is the kind of sweeping liberalisation of planning and construction that businesses would want, if the powers of local authorities to curb development are reined in, there may be elation felt by housebuilders and developers - but homeowners may feel anxious and miffed, only weeks before important local elections.

Northern Rock: Back to old habits?

Robert Peston | 13:44 UK time, Tuesday, 22 March 2011


I asked someone to pinch me this morning when I saw that Northern Rock had launched its first securitisation issue since its great crisis of 2007.

The bank is raising less than £400m from parcelling up mortgages into bonds and selling them on to investors - which is equivalent to around 2% of its balance sheet. And Northern Rock would argue that it is prudent to diversify its sources of funds - and not be wholly dependent on retail deposits.

Northern Rock advert

But as you will know, it was Northern Rock's excessive dependence on raising money from securitisations, from selling asset-backed bonds, which almost killed it three and a half years ago, when the market for those bonds closed down.

So here is the question: Is it good news that those markets have recovered enough, and Northern Rock's reputation has improved enough, for the bank to be able to raise money in that way again?

Or does it show that banks are still too dependent on what some would see as a failed financial technology?

To be fair to Northern Rock, the size of this bond sale is pretty small. It would be wrong to accuse the Rock of falling off the wagon, in the sense of getting drunk again on allegedly easy money from wholesale markets.

But it is nonetheless striking that this bank which is now tiny doesn't think that it might be more sensible to have no gap at all between what it lends to households and the money it takes in from households.

Arguably if banks got back to their position of 2000, when in aggregate there was no gap between what they lent and what they took in from customers - and therefore they had no net dependence on funds raised from bond markets and wholesale providers - the UK financial system would be more solid.

So given that Northern Rock is nationalised, there is powerful symbolism in the implied decision of the Treasury to allow the Rock to engage in securitisation again.

Northern Rock office block

That symbolism is even more powerful when for banks in general, both here and throughout the EU, there is still a substantial refinancing problem stemming from the previous boom in securitisations. Over the next couple of years, vast amounts of maturing debt, including emergency loans from taxpayers made to fill the gap created when commercial markets closed, will come up for repayment.

So for example the Financial Services Authority, the City watchdog, disclosed last week that more than £110bn of bank debt guaranteed by taxpayers under the Credit Guarantee Scheme is still outstanding and is due for repayment within two years. And something like £100bn has to be repaid to the Bank of England in 2011 as a result of the winding up of the Special Liquidity Scheme.

On top of that, there's at least a further £100bn of bonds that aren't guaranteed by taxpayers which has to be repaid by the end of 2012.

Now on the one hand, it looks like good news if banks can raise money again from asset-backed bond markets to repay these debts, because it means they are under less pressure to curtail what they lend to households and businesses - and it means that there's less of a drag on our economic recovery from constraints on banks' ability to provide credit.

However, there is another argument which says that if the borrowing habits of the years leading up to the crash of 2007-8 were so dangerous, it would be better if banks increased their loans in the longer term only in proportion to the money they take in from reliable customers like you and me.

Update 13:44: Northern Rock tell me the main reason they are selling the bonds now is that raising money in this way looks relatively good value.

They are keen for me to point out (which of course I already did in my last note about their annual results) that as of now - and following the break up by the government of the old Northern Rock into an active deposit-taker and a separate organisation managing the repayment of historic loans - they have lent less in mortgages than they have taken from individuals in the form of deposits.

So, for the avoidance of doubt, the sale of bonds should be seen as a signal of how the bank see their future financial needs.

Are energy consumers being ripped off?

Robert Peston | 09:44 UK time, Monday, 21 March 2011


Anyone who has recently tried to switch energy supplier knows how difficult it is to compare what is on offer, even though there are only six big players offering gas and electricity.

Gas bill in front of cooker

There's the rate you pay for the first chunk of power you use and then the rate for everything else. Some tariffs are quoted with VAT included, some without. There are the discounts offered for different payment methods. There are deals for managing bills online or for having certain kinds of meter. And then there's the option of fixing prices for a period.

It can be bewildering enough comparing what a single company is offering. Very few of us have the time or intellectual capacity to assess the 300 odd different packages on offer (up from 180 in 2008) from the sextet - British Gas, EDF Energy, E.ON, RWE Npower, Scottish Power and SSE - who supply more than 99% of British customers.

Although you can delegate the analysis to one of the online price-comparison websites, not everyone is comfortable doing that (and indeed there are still large numbers of people without access to the internet). That said, there has never been (to my knowledge) unambiguous evidence that these de facto brokers steer consumers in the wrong direction.

So Ofgem has concluded that pricing practices are "complex and unfair".

But what is the detriment to all of us from that complexity?

Well it could mean that the intensity of competition between energy suppliers isn't what it should be, so that prices in general are higher than would be the case if more of us shopped around.

And there is some support for that conclusion from the data. Ofgem has found that this autumn, for the first time, retail prices were probably raised by the big six faster when wholesale prices went up than they have typically been cut after falls in the wholesale market.

Or to put it another way, at a time when the economy has been pretty weak, the energy companies found it easier to widen their profit margins than is necessarily consistent with a competitive market.

Second, Ofgem produces a striking chart of what has been happening to the profit margin for suppliers since 2004. And this clearly shows a dramatic improvement in the profitability of the retail energy market over the past couple of years, during which there has been this striking increase in the number and complexity of tariffs.

So there are two sources of harm that Ofgem may have identified: first that gas and electricity prices may be higher than they should be; second that individual consumers, especially poorer ones with no online access or those with literacy and numeracy problems, are at an unfair disadvantage.

Its proposed reforms are that the power companies should be forced to auction energy to smaller suppliers, to stimulate competition. And that there should be a radical standardisation and simplification of tariffs for standard energy deals (so-called evergreen products that aren't time limited).

But here's what I find slightly odd. Why haven't any of the energy companies turned themselves into the equivalent of an Easyjet or Ryanair? Why have none of them offered a limited range of low-cost packages that massively undercut their rivals? There must be something in the intrinsic risks of trying to be the no-frills, lowest cost supplier that is a major deterrent.

Also, it is probably worth pointing out that Ofgem's finding that between 40% and 60% of energy customers are "sticky", that these tend to stay with their suppliers rather than shopping around, may be evidence of inertia for that regulator - but it looks like a bubbling, thriving market with lots of bargain hunting and switching compared to another market that is important to us, the retail banking market.

If, for example, future proposals from the Banking Commission set up by the government were to encourage up to 50% of bank customers to switch banks, that would transform competitive conditions in retail banking.

A couple of final points.

First, you can expect the energy companies to complain that any squeeze in their margins will erode their ability to make the investments necessary to deliver security of energy supply - and low-carbon supply to boot - that is a priority for the coming decade.

Second, it is striking that no one credible seems to be arguing the caveat emptor point any longer, that if consumers are too thick to notice when energy suppliers are bamboozling them than they deserve to be ripped off. In that sense, in energy at least, there has apparently been a triumph of the nanny state.

Does transparency kill 99% of despots?

Robert Peston | 16:10 UK time, Sunday, 20 March 2011


There is an argument that is fashionable among the class of do-gooding plutocrats - the George Soroses, Mo Ibrahims and Bonos - that the developed world might not have to be bombing Libya, if only a brighter light had been shone on payments made by multinationals to despotic regimes, and if banks had been less enthusiastic to open offshore personal bank accounts for the relevant despots.

And today there is this statement from one of the campaigning groups in this area, Global Witness:

"The governments that have frozen funds controlled by Gaddafi, Mubarak, Ben Ali and their cronies should name the banks holding their assets...Those banks holding dirty money should be publicly named and then regulators need to devise a new system which stops banks from taking suspect funds in the first place."

Before assessing whether transparency and the bright sunlight of publicity would in fact kill 99% of all known despots, let's see what kind of cash flow we're talking about in the case of Tyranny Incorporated.

For Libya, I am told by a government source that Britain has frozen £12bn associated with the Gaddafi regime. Now the vast bulk of this takes the form of assets controlled by the Libyan Investment Authority and the Central Bank of Libya - or institutions which are perceived to be controlled by Muammar Gaddafi and his family.

The amount of money identified and frozen in bank accounts belonging to named individuals - accounts with titles such as "Mr M Gaddafi" - is relatively small, I am informed. Millions of pounds, rather then tens of millions of pounds.

The point about drawing this distinction between personal bank accounts and the assets of the Libyan central bank, for example, is that it would have been quite hard for a big international bank to tell almost any central bank to take its lucre elsewhere, especially when the previous British government invested a lot of time and effort cosying up to Mr Gaddafi.

But that doesn't mean to say banks should ever have felt comfortable taking substantial personal deposits from Gaddafi or those linked to him.

At a time when money laundering rules make it an administrative nightmare for the likes of you and me to open a bank account that contains even a few bob - and only investment bankers can transfer a few million into their accounts without anyone wondering whether that's a bit fishy - questions are legitimately asked about why household-name western banks should feel comfortable allowing tyrants and their associates to open accounts holding a few million squids.

And if I doubted that this was an issue about which the banks feel a bit vulnerable, those doubts were dispelled when I asked the chairman of a bank what checks were in place to prevent his organisation servicing evil dictators who expropriate their people's money and then re-invest the wonga in Hampstead and Kensington mansions.

It was the colour he turned (a bit redder) and the pause before he answered that gave some of the game away - as did his admission that the bank did what it could not to aid and abet political wrong 'uns, but it was tough

Even so, there is some evidence that British banks (though who knows about others) have been complicit in petty theft rather than grand larceny from the Libyan state.

Here's the main question. If the Libyan people knew what kind of money went into Libyan state coffers from overseas multinationals, and if they could see precisely how much left the country, would they have turfed out the Gaddafi dynasty by now and installed a proper democratic parliamentary system?

If Facebook and Twitter could shout out how much multinational oil companies such as Shell and BP were paying pay the Gaddafi regime for exploration and development rights, would every son and daughter of Libya make jolly certain those funds were being used for their benefit and were not being sequestered by an unelected, unaccountable elite?

Well we should have a real life test before too long. In the US, the Dodd Frank Act will from April force all "extractive" companies - oil, gas and mineral businesses - with a US stock-market listing to reveal precisely what they pay governments for mining and extraction rights. And here in the European Union, there is a good chance that a new directive will impose the same disclosure obligations on their European peers (it has the backing of George Osborne, the British chancellor, among others).

Some mining and oil companies don't like it. For example the chief executive of Royal Dutch Shell, Peter Voser, recently complained that the Dodd Frank provision "may even require companies to violate sovereign laws to disclose information that the laws do not allow."

Multinationals' main concern however will be the absence of a level playing field: a Russian or Kazakhstan miner not feel quite the same moral obligation to disclose its financial relationship with a smelly regime as a western company may.

There is also a point to be made about why the disclosures should apply only to extractive industries. Governments award all sorts of valuable licences. So when Vodafone or Telefonica obtain a licence to provide mobile services in country with a dodgy record on human rights (for example), why shouldn't the licence agreement in that case be a public document?

Also, if the argument runs that democracy is more likely to flourish in the Middle East and Africa if the peoples of those regions can see how their mineral wealth is being exploited, why hasn't the US Congress voted to disclose any financial agreement between a multinational - a pharmaceutical company, a bank, a computer manufacturer - and the one-party Chinese state? Why would the establishment of democracy be more important in Africa than in China?

You can even make the case that to guard against the propensity of any British government to waste taxpayers' money or reward friends, you would probably want every page of every outsourcing or PFI contract published on the internet.

Here's the thing. There is almost always a public interest in publishing commercial agreements with governments wherever they sit on the spectrum from parliamentary elective democracy to corrupt military junta. But against that public interest comes the national economic interest, which - whether we like it or not - is occasionally served by allowing businesses to operate under a dank fog of partial disclosure.

What RBS pays its top people

Robert Peston | 16:01 UK time, Thursday, 17 March 2011


It is with no real enthusiasm that I write once again about bankers' pay. If you feel you've read this story before, well I would understand.

Two men are pictured in a branch of RBS

But there is a public interest in shining a light on the remuneration practices of Royal Bank of Scotland, since we as taxpayers rescued it from extinction in the autumn of 2008 and we own 83% of the bank.

The guys (mostly men) who run that bank work for us, in that sense.

So what have we learned from the publication of its annual report and accounts today?

Well a bank that made a loss for the year of £1.67bn in 2010 (way better than the £35bn it lost in 2008 but still a loss) paid a total of £375m to 323 so-called "code" staff, or around £1.2m on average to each of them.

A couple of further things need explaining.

First "code" staff are those executives who - under rules set by the Financial Services Authority, the City watchdog - are perceived to do things that have a bearing on the risks that banks takes. They are executives with jobs that matter to the stability and health of a bank.

And second, some of those 323 earned more than £1m, and the majority earned less: £1.2m is just the average.

According to the bank, there are something over 100 RBS employees in total who made more than £1m last year. Which, on the basis of the average figure of £1.2m for code staff, implies that most of the higher paid individuals pocketed well over £1m.

What's more, there are other RBS employees, who aren't code staff - some traders for example - who earn even more than top-paid code staff (hope you're still with me).

Anyway, for what's it worth, RBS's code staff earn less than Barclays' 231 code staff, whose average pay was £2.4m per head.

So presumably the Chancellor of the Exchequer will point to this disparity as proof that taxpayer-owned RBS is showing restraint.

You will have your own views on whether RBS is showing enough restraint.

RBS makes another disclosure of some interest, which is the pay of its five highest paid senior executives below board level (a disclosure it and the other big banks promised to make under the recent Project Merlin deal with government).

These five executives earned £5.95m, £5.93m, £3.36m, £3.24m and £2.62 respectively - massively less than their equivalents at Barclays (see my post on Barclays' pay).

But, again, this does not tell the whole story of what RBS pays.

There are other RBS staff, working in high-paying bits of its investment bank, who earned more than these five.

And, just to remind you, RBS's chief executive Stephen Hester earned £7.7m last year.

UPDATE 18:17

Earlier this week, the goverment received a report (from Will Hutton) urging that public and private sector organisations publish the ratio of their top people's pay to median or typical pay within the relevant organisaton. 

Now in the case of RBS, its chief executive's pay of £7.7m is equivalent to about 233 times typical pay in finance, compared with other FTSE100 bosses who on average earn 120 times typical pay.

As for for top civil servants, well they tend to earn around £160,000 a year, around 6 times a typical public official's salary.

Or to put it another way, RBS's boss, Stephen Hester, seems to be handsomely paid for public sector or private sector.

Why? It's because he's a banker. 

Turner: Regulation must be Trotskyite

Robert Peston | 18:30 UK time, Wednesday, 16 March 2011


There is not a great deal in tonight's speech by Adair Turner at the Cass Business School that he didn't say in late February at Clare College Cambridge (click here and here for my posts on that important speech).

But I would highlight a handful of newsworthy remarks made this evening by the chairman of the soon-to-be-dismantled Financial Services Authority.

First, Britain's big banks, Barclays, Royal Bank of Scotland, HSBC and Lloyds, need to brace themselves for an ordinance forcing them to hold more equity capital - to absorb potential losses - than was prescribed by last year's Basel lll global agreement on new capital requirements for banks.

Here is the relevant, resonant (for a bank) phrase from Lord Turner:

"For the UK, with major banks which are very large relative to our GDP, a key policy objective for this year is to ensure that Financial Stability Board decisions on Systemically Important Financial Institutions (SIFIs) result in higher than Basel lll equity requirements for our most systemically important banks".

Or to translate: Turner wants our mega banks to be forced to hold more shock-absorbing equity relative to the loans and investments they make.

Now our biggest banks won't like that. And they will claim their opposition stems from the short term costs to the economy of building up their capital reserves: there would be an additional constraint on their ability to lend to households and businesses in the ordained transition period for increasing the ratio of equity capital to assets (as a matter of simple mathematics, one relatively easy way to increase the ratio is to stop lending).

However some might point out that there may be another reason why banks will resist reconstructing their businesses so that they lend less relative to the equity provided to them by shareholders. Other things being equal, it would automatically lead to a reduction in the return generated by the bank on equity capital and would therefore provide a powerful incentive for the banks' owners to insist that banks pay out less to employees in the form of salaries and bonuses.

This switch to more equity funding would also increase the taxes paid by banks, in that interest on their debt finance is tax deductible but dividends are not. Which would lead to a ratcheted squeeze in the surplus available for bonuses (don't smirk please).

For those of you who care about these things (and of course I do), it is also striking that Turner is unambiguous that equity capital is the best shock absorber. He accepts that there is a role for improved resolution procedures, bail-ins, CoCos and so on (stay behind after class if you want any of that explained, or see earlier posts) in making the banking system safer. But, for him, "more equity is the best solution".

All that said it is the wider points on the future of regulation that are probably more important. Here are a handful of his observations.

1) The task of making the financial system safe is seriously unfinished business.

2) More intense regulation must apply to all financial firms - to hedge funds, money market funds and shadow banks, along with banks - or dangerous risks will migrate from the banks to somewhere else.

3) Effective regulation must look for the interconnections between financial institutions, the risks that reside in markets and in the linkages between firms, rather than just concentrating on the elimination of dangers posed by individual banks and institutions.

4) Regulation must be dynamic. The notion that a new set of rules can be established that will permanently make the system safe is naïve and dangerous (though it was the prevailing orthodoxy prior to the crisis of 2007-8) - because any new set of rules creates incentives for financial players to find ways round those rules. Regulators therefore have to be permanently on the look out for the innovations that create new risks, they have to be the leaders of a permanent Trotskyite regulatory revolution.

Which means, as I have argued in posts before, that the Financial Policy Committee that is being created at the Bank of England - and whose fledgling version includes Lord Turner as a member - will be a hugely powerful new financial and economic institution.

Its very mission will be to significantly limit banks' and other financial firms' cherished freedoms to lend, invest and sell what they like, to whom they like, when they like - and not because of any identified harm to individual consumers or any one bank's depositors, but in response to perceived threats to economic stability.

Can HMV reinvent itself?

Robert Peston | 08:16 UK time, Wednesday, 16 March 2011


In its last full year, HMV had sales of more than £2bn. It employs 13,000 people. It has 600 stores in the UK. And it is responsible for more than a third of all music CD sales here and more than a quarter of all DVD sales.

HMV in Norwich


It owns the only remaining chain of recorded music stores in this country of any size, the eponymous HMV shops. And its Waterstone's chain is the dominant force in specialist book retailing (from real shops) by a country mile.

On the face of it, HMV is an important employer and it is pretty important to our creative industries. Smaller record companies, for example, find it hard to shift their back catalogues at a profit anywhere else (Tesco won't take stuff outside the charts; online margins are wafer thin).

Here is the jaw-dropping statistic. At last night's closing share price of 11p, HMV has a stock market value of just £47.65m - down from £650m less than two years ago.

What's going on?

Well HMV is about to breach the terms, or covenant, on a £240m borrowing facility provided by eight banks, led by those semi-nationalised giants, Royal Bank of Scotland and Lloyds.

That means the banks have the right and ability to demand all their money back. But, of course, HMV can't possibly repay in an instant the £130m it has actually borrowed out of that £240m.

So unless HMV can reach an accommodation with the banks, its directors would have no option but to call in the administrators under UK insolvency procedures. HMV - a legendary name in the history of the recorded music industry - would be bust; the shares would be worthless.

What's going to happen?

Well early next week HMV will make a presentation to its banks - which are expected to be advised by the accountancy firm Deloitte - on how it intends to regenerate its business.

Then the banks are expected to take two or three months deciding whether to pull the plug or keep the lights switched on.

As for the breached covenant, it relates to the minimum permitted ratio between HMV's earnings before interest, tax, depreciation and amortisation - a proxy for cash generated by the company - and the total rent paid by HMV for its stores.

The covenant matters to the banks because landlords rank ahead of them in the queue of creditors; landlords get their money first in a wind-up. So for any retailer, as and when aggregate rents represent too high a proportion of EBITDA (or cash flow), the banks start to fear they'll lose money on their loan.

Which is one reason why HMV has already announced that it will close 48 HMV stores and 12 Waterstone's.

But simply reducing the number of rent-paying stores does not get to grips with arguably the more fundamental problem.

What will ultimately determine whether the banks decide to keep HMV afloat is whether they are convinced HMV has a credible survival plan to cope with markets that are vanishing into cyberspace before its eyes.

To put it another way, Apple - with its iPod and iPad - is the silent white assassin of HMV, because more and more of us are choosing to download music, games and films, rather than buying those silvery discs. And Waterstone's is being squeezed as we opt to download books on to so-called tablets.

The magnitude of this shift can be seen all over the world: chains that specialise in films and music barely exist anywhere these day (there is no equivalent of HMV in the US any longer, for example); and book stores are going bust wherever you look (Borders Group in America filed for bankruptcy protection last month).

That said, HMV remains in profit, although profit is shrinking. And, unlike Woolworths - which disappeared at the end of 2008 - consumers have a pretty clear idea what the group's two brands, "HMV" and "Waterstone's", represent; they know the kind of product they will find if they enter one of the stores.

The problem is that they don't want as much of that product, in its traditional form, as they used to do.

So what is HMV's cunning plan? Well part of it is to join them rather than beat them: it is aiming to refit 100 stores this year, to give 25% of selling space over to the sale of new digital devices, those beastly tablets and handheld devices that are killing sales of "hard" software (the CDs and DVDs). Its aim is to generate a quarter of all sales from these assorted i-Thingummies.

Through its 50% ownership of a digital downloads business called 7digital, it plans to stay in the business of selling recorded music. 7digital has negotiated agreements with the likes of RIM so that the new Blackberry Playbook (a soon-to-be launched competitor to the iPad) will come with the 7digital download app already built in. Which means HMV should share in income from downloads on these devices.

HMV has other digital ideas too - such as trying to persuade publishers to provide hard copies of books that incorporate a right to download those books to a tablet.

The plan recognises that HMV can't survive by simply doing what it has been doing for the past few years: it has to acquire a meaningful share of the digital cake.

Will the banks be persuaded it can work?

It is not a plan which requires more money from them. HMV believes it can reinvent itself for the new digital world so long as the banks allow the group to continue to use the £240m already in place.

Even so, this is not a risk free decision for the banks. Corporate graveyards are filled with businesses that tried and failed to adapt to the kind of industrial shifts that confront HMV.

And if the banks do back "new" HMV, the controlled dematerialisation of HMV would still have pretty painful consequences for the group and its employees: over the coming three years, it will have to close more shops; not far off half of the 600 may eventually go.

Whatever happens, there will be quite a price for high streets and staff. But the highest social and cultural price - if not necessarily the maximum financial one - would presumably come from the business going kaput.

Which may or may not weigh on the minds of the two semi-nationalised banks, RBS and Lloyds, that are HMV's most important creditors.

The price of Japanese reconstruction

Robert Peston | 08:18 UK time, Tuesday, 15 March 2011


More than £400bn has now been wiped off the stock market value of Japan's bigger companies since the quake and tsunami hit on Friday.

A man walks past a stock price board in Tokyo

On one measure, Japanese shares have fall more over two days than since the crash of October 1987.

Shares in some of the country's biggest and best known international companies - such as Toyota, Sony and Panasonic - plunged again. The price of the country's mega banks also dropped sharply.

The contagion spread to the price of Japanese government bonds, which fell - rather than benefiting, which is what often happens, from a shift by investors out of assets, such as shares, perceived to be riskier.

Because of the sheer size of the Japanese national debt (more than 200% of GDP and rising) and the magnitude of the government's deficit (see my post of yesterday for more on this), fears are increasing about the cost of any programme to rebuild the devastated areas and national infrastructure - and what impact that will have on the health of the nation's finances.

The risk that a wide area around the Fukushima nuclear plant may have been contaminated is now weighing heavily on markets.

Although Japan's central bank yesterday doubled the size of its programme to buy financial assets, including government bonds, to $121bn or £76bn, that programme remains a fraction of what the US Federal Reserve has been deploying to stimulate domestic economic activity - so some are saying the Bank of Japan is not doing enough to bolster investors' confidence.

On the basis of the cost of insuring state debt, the credit of the government of the world's third biggest economy and second biggest exporter is now perceived to be as risky as that of nations on the fringes of Europe such as Estonia and the Czech Republic, according to Bloomberg, which cites data from CMA.

So what will be the impact of all this on the rest of the world? Although the Japanese economy and markets are vast, its almost 20 years in the doldrums after 1990 did not prevent something of an economic golden age elsewhere (at least till 2007).

But this time it may be different. Growth in the developed economies of the West remains fragile. The global financial system is not fully restored to health.

There cannot be total insulation elsewhere from the sheer size of the market movements in Japan. At the very least share prices in Europe are likely to weaken and assets traditional seen as safe - gold and US government bonds - will probably rise.

As for oil, if the perception grows that Japanese manufacturing activity will remain depressed for a while, its price will weaken - although the instability in the Gulf continues to exert upward pressure on the oil price. And to state the bloomin' obvious, shares in those businesses with a huge stake in expanding nuclear generation, such as the UK's Centrica and France's Areva and EDF, will remain under pressure.

What remains shrouded in fog is whether the combination of the Japanese debacle, with the momentous and uncertain events in the Middle East, will derail a worldwide economic recovery which is neither entrenched nor particularly robust.

Hutton wants brighter spotlight on bosses pay

Robert Peston | 00:00 UK time, Tuesday, 15 March 2011


Will Hutton was asked by the prime minister and chancellor last May to make recommendations that would promote greater fairness in public sector pay, by "tackling disparities between the lowest and highest paid in public sector organisations".

The executive vice chair of the Work Foundation was recruited to look at whether limiting the pay of top public servants to a maximum multiple of typical or median public service pay would be a good idea, and if so whether a multiple of 20 would be appropriate.

Strikingly, Mr Hutton - a campaigner over many years for a more egalitarian distribution of income - has come down against the imposition of any cap on pay in public services.

Has he had some kind of Damascene conversion to the idea that an increase in public-sector productivity requires the entrenchment of a new plutocratic class of bureaucrats?

Actually it doesn't look as though he is panting to push up the remuneration of permanent secretaries, local authority chief executives, and senior health service managers.

In fact the reverse is probably true.

What his research uncovered was that public servants don't earn as much as 20 times median pay (which is just over £25,000 for the economy as a whole). A typical NHS hospital chief executive, for example, earns 12 times the "bottom of the workforce pay spine".

So there is quite a risk that if a 20 times limit were put on their earnings, the pay of the boss class in the public sector would almost certainly ratchet up to new highs, rather than falling.

To put it another way, 20 times the median would be the new inflated going-rate. And that might not please most of you at a time when something of a squeeze (ahem) is being imposed on the public sector by the government.

But can four-star generals and the men from the ministry breathe a sigh of relief that they can carry on regardless in respect of the way their pay is set?

Probably not.

Hutton wants the publication of a fair amount of salacious detail on individual public servants' pay, or what he calls "the full remuneration of all executives, alongside an explanation of each role and of how executives' pay reflects performance".

This should be made available through a standard online template so that the rest of us can "analyse this data and thus have the information to hold public service organisations to account".

To put it another way, it should become much easier to see how and why those who generally earn somewhere between £130,000 and more than £200,000 for running hospitals, local authorities, Whitehall departments and so on are paid what they're paid.

What's more, even though there wouldn't be ceilings on pay, each public service organisation would publish top-to-median multiples every year - which would then form the basis for fair pay reports by the Senior Salaries Review Bodies.

Hutton also wants the pay of those who run the public sector to rise and fall annually depending on their performance. He proposes that a proportion of senior public servants' basic pay would only be handed over if they met objectives that had been set for them.

Hutton describes this arrangement as the imposition of "basic pay at risk", rather than a further institutionalisation of a bonus system - although the concept does rather waddle and squawk a bit like a bonus.

Whether or not it is a bonus by another name, smelling more or less sweetly, critics will allege that the idea of public service - of going the extra mile for citizens and taxpayers simply because it is the right thing to do - would be further undermined.

Meanwhile there will be others who will attack Hutton for a different reason. They'll say that the brightest and the best will be deterred from working in the state sector, because a media obsessed with the pay of public-sector executives will hold them to account in a way which doesn't happen in the private sector.

Which in a way is a great paradox.

Because those who run huge companies listed on the stock market are arguably subject to less oversight of remuneration by their respective owners than those who run local authorities (for example) are by the press.

The most explosive growth in pay over the past decade has occurred in the private sector - and that growth in pay since 2000 or so has been almost completely uncorrelated with share price performance, or rewards for the owners.

Today the remuneration of the typical FTSE100 chief executive is over £3m - and much higher for bank chief executives - equivalent to more than 120 times median pay, compared with an estimated multiple of 48 times in 1998.

Which brings us to the proposal by Hutton that will induce a fair degree of queasiness in boardrooms. He recommends that PLCs should track and publish their respective top-to-median pay multiples - and he suggests that the government should commission annual fair pay reports on big private businesses.

The harrumphing that it's no business of the interfering nanny state what the boss of Tesco or Vodafone earns may be audible from the moon.

Will Mr Cameron and Mr Osborne switch on that bright new spotlight on the pay of private-sector chief executives? Their LibDem colleagues are bound to want them to do so. But Tory backbenchers will argue that it's for shareholders, not ministers, to decide whether such information should be disclosed.

Some will certainly be watching the reaction of Mr Cameron and Mr Osborne as a test of what they mean when they say that "we're all in this together".

How will Japan finance its reconstruction?

Robert Peston | 09:06 UK time, Monday, 14 March 2011


Trying to make an assessment of the economic and financial costs of a disaster such as the Japanese earthquake and tsunami always seems tawdry.

Earthquake damage (AP)

But failure to do so is also to succumb to mawkishness or despair. Life goes on, markets continue to trade, investors put a price on the damage done.

Overnight, investors have wiped 6.2% off the value of Japanese shares on average, as measured by the Nikkei 225 index. And the value of some of the best known and most powerful Japanese multinationals fell more: Sony fell 9.1%, Nissan dropped 9.5%, Toyota was 7% lower, the banking group Mizuho was 10.5% down.

Goodness only knows whether that is a rational response, whether that represents an efficient calculation of the long term damage or a manifestation of blind investors licking a finger and holding it to the wind.

Breweries are shut. Pretty much all automotive manufacturing has been suspended. Sony has closed six component plants. Power across the country is being rationed. There is enormous short and long term uncertainty about the impact of the nuclear debacle on health, the environment and the security of power supply.

Already Nomura - the largest Japanese investment bank - is forecasting that the disaster will delay a recovery in the Japanese economy by about six months (Japan's economy contracted in the last quarter of 2010, having grown strongly earlier in 2010; Nomura had been predicting the country would emerge from this dip in the second quarter of 2011, but now says a return to better conditions probably won't happen till nearer the end of the year).

Even so, Nomura does not anticipate a major slump in share prices. Here is its logic:

"Although we expect this earthquake to provide further impetus to the correction in Japanese equities that has been occurring since mid-February, we do not envision a serious correction for the following reasons.

"First, industrial production only fell in the immediate month following the Kobe earthquake (in 1995). Second, the government is likely to provide fiscal support to the regions affected. Third, we see little risk that the earthquake will trigger a sharp rise in the value of the yen."

As for another important bit of the economic infrastructure, the banking system, the Bank of Japan has done what it can to maintain its integrity and keep the cost of finance as low as possible, by making £165bn of credit available to financial institutions, almost five times the liquidity it provided after Lehman's collapse in 2008.

So the potential for a seizure of the banking system has been minimised.

Collapsed brewery, Sendai, Japan (AP)

The greater financial risk for Japan is probably in its bond market, because Japan famously has the largest national debt relative to its economic output of any of the major developed economies together with a large and unsustainable fiscal deficit.

According to IMF figures, the ratio of general government gross debt to GDP was set to reach 228% this year, and 233% in 2012, even before taking any account of the costs of reconstructing the area devastated by the quake and tsunami. The gap between government revenues and expenditure for 2011 is forecast at more than 9%.

Which is why the credit rating agency Moody's warned this morning that the natural disaster could bring forward the moment of a potential financial calamity, which would be the moment when investors lose confidence in Japan's ability to repay its debts.

The sum that Japan needs to borrow this year is the kind of number that boggles the brain: if you add together both the maturing debt that needs to be repaid and new borrowing to finance the deficit, Japan needs to borrow around a third of its $5.5 trillion GDP, excluding very short term debt, or more than half its GDP including short term debt.

These are the sort of numbers that make the British public-sector balance sheet look like a model of strength and prudence.

But although the Japanese government's credit rating has recently been downgraded, historically this is a country that has proved able to raise these sums - largely because the vast bulk of government borrowing has been financed by Japanese savers and domestic institutions who simply have a habit of lending to the state.

Japan is far less dependent on the vagaries of the sentiment of overseas investors than most big borrowers, such as the US.

In the current circumstances where Japanese people and institutions face a huge test of their resolve, they may be more determined than ever to lend to the government - as an act of solidarity, as a tangible sign of the collective will to reconstruct their country.

But even so, the Japanese government is in a hideous position, under pressure from markets to cut borrowing at just the time when the imperative of rebuilding the country will require a massive deployment of government money.

Update 09:45: In respect of the financing of Japan's big deficit and the refinancing of its massive existing debt, the Bank of Japan is doing all it can to avoid damaging disruption.

As well as pumping liquidity into the banking system, it has doubled its quantitative easing programme to purchase financial assets - including Japanese government bonds - from Y5 trillion to Y10 trillion ($121bn, £76bn)

Interestingly Nomura believes Japanese bond prices could actually rise in the short term, because of these bond purchases by the central bank and because of a switch out of assets perceived to be riskier by investors.

Nomura thinks this strength in bond prices is unlikely to last more than three months

Also, Nomura's chief economist Takahide Kiuchi said - in a conference call with investors this morning - that he expects the quake and disaster will contribute to a contraction in the Japanese economy of between 1% and 1.5% in the three months to the end of June.

He forecasts that the Japanese economy will recover from its "lull" in the fourth quarter of this year.

Update 12:57:I have just spoken to Peter Westaway of Nomura. He made three points.

  1. Nomura believes the negative impact of the natural disaster - estimated at between 1% to 1.5% of GDP in the second quarter - will mean that the GDP will be flat in the coming few months, but should not contract.
  2. There is a massive amount of uncertainty around that forecast - because the scale of government stimulus is uncertain, the impact of the nuclear accidents can't be assessed yet and consumer spending may fall by more than expected.
  3. He expects the rating agencies - Moody's, Fitch and S&P - to "cut Japan some slack" for "humanitarian reasons". Or to put it another way, as and when the Japanese government deficit grows because of the costs of reconstruction, they will not downgrade Japan's credit rating - unless (I suppose) it became clear that the Japanese government had abandoned all hope and intention of restoring the health of the public finances. Or to put it another way again, the credit rating agencies would not wish to be seen to be triggering a fiscal crisis, as the aftershock of a national tragedy.

Public-sector pensions lose platinum coat

Robert Peston | 17:58 UK time, Thursday, 10 March 2011


John Hutton's recommendations on reforming public-sector pensions may well look as appealing as a plate of cold sick to many state employees.

But those employees should perhaps count their lucky stars that they don't work in the private sector - because were his recommendations to be adopted by the government, our public servants would continue to have access to pension arrangements massively more attractive than what's on offer in most of the rest of the economy (except for those lucky enough to be running big listed companies, whose pension pots are typically worth well over £10m each).

For public-sector workers earning close to the national average, and with limited opportunities to earn higher salaries, Hutton's proposed move from final salary to career average for determining the quantum of pension should not make an enormous difference to what they actually receive in retirement.

That is clear from the estimate - made by the analyst John Ralfe - that the switch would save just £2bn a year, out of the estimated total annual cost of state pensions (much of which is hidden) of £30bn.

That £30bn is Ralfe's estimate of the annual cost. It is double the official estimate, with the disparity due to a disagreement on the appropriate discount rate for valuing future liabilities.

A reduction in the value of retirement benefits of 1/15th would of course be unpleasant. But compared with what has happened in most of the private sector, which has seen the closure to new members of access to any kind of final salary arrangement, and often the complete closure of final salary schemes, well it doesn't look draconian.

Broadly the norm in the private sector these days is for employees to bear most of the financial risks associated with retirement, such as high and rising inflation rates, low and falling investment returns, and ever increasing longevity (that we die later).

Hutton is proposing however that the taxpayer would continue to underwrite a good chunk of these risks for public-sector workers. So, for example, he explicitly says that the government should continue to provide total protection against inflation for both current pensioners who used to work in the public sector and for future pensioners who still work in the public sector.

This is much more generous than what is on offer almost anywhere in the private sector - and, for example, is significantly more generous than the recent pension reforms imposed here (in a part of the public sector off the main map) at the BBC.

What's more, Hutton suggests that for active savers, accruals should be up-rated in line with the earnings index - which normally rises at a faster rate than either the consumer price index or the retail price index (though that might not be the case in the future) - and there should be no cap on indexation.

At a time when inflation is squeezing most people's living standards, that looks attractive.

Also, unlike what has happened at the BBC (for example), the choice for current public-sector staff won't be between a degraded existing scheme and a switch into a career average scheme that places more inflation risk on the employee or into a defined contribution scheme that heaps the investment risk on the employee. Instead public-sector staff would have all their existing rights totally protected and only new savings would accrue on the career-average basis.

So are there no recommendations that would force a significant sacrifice on employees and therefore save serious money for the taxpayer?

Well the recommended increase in the normal pension age from 60 to the state pension age - so from 60 to 65 and rising - would save around £6bn a year.

But any other savings won't flow from Hutton's report but from other decisions already taken by government, such as that pensions in payment will rise by the CPI inflation index rather than by RPI (which will save £6bn a year) and that employee contributions should increase by three percentage points of salary (for a £3bn saving).

When you put all that together, the aggregate public-sector saving from Hutton and other reforms would be around £17bn a year, so real money.

Even so, public-sector workers would be left with a pension scheme worth around 15% of typical salaries. Which would still make many in the private sector feel just a bit envious.

Robert Tchenguiz: Borrower from Kaupthing and investor in Kaupthing

Robert Peston | 13:57 UK time, Wednesday, 9 March 2011


The first thing to say about the arrest of Robert and Vincent Tchenguiz by the Serious Fraud Office, in connection with its probe into the collapse of the big Icelandic bank, is that both men deny wrongdoing.

The second thing to say is that the relationship between Robert Tchenguiz and Kaupthing was pretty unusual, according to the formal investigation into the Icelandic banking crisis carried out by a commission set up by the Icelandic parliament.

The commission disclosed the following facts.

1) Robert Tchenguiz was given a loan facility of around €2bn (£1.7bn) from Kaupthing's parent company, a further €210m (£180m) from Kaupthing Bank Luxembourg and €95m (£82m) from Kaupthing Singer & Friedlander in the UK. So Kaupthing provided Robert Tchenguiz loan facilities of just over £2bn in total - a fair old chunk of change.

2) The commission says that "the big increase in loan facilities to (Robert) Tchenguiz from January 2007 until October 2008 is noteworthy, in light of the fact that in late 2007 many of Tchenguiz's companies started going downhill. The minutes of the loan committee of Kaupthing Bank's board state, inter alia, that fairly often the bank lent money to Tchenguiz in order for him to meet margin calls from other banks". Or to put it another way, Kaupthing lent Robert Tchenguiz money so that he could repay other banks, which wanted their money back.

3) Robert Tchenguiz "owned at least 1.5%" of Kaupthing Bank's shares in his own right. He was also an investor in and director of Exista, which was Kaupthing's biggest shareholder.

4) Robert Tchenquiz put up his shares in Kaupthing as "collateral for loans from that same bank". Which is highly unorthodox. It is not standard banking practice for a bank to lend money to someone with shares in that bank being provided as security against the borrower's inability to repay (it is a banking equivalent of one of Zeno's paradoxes).

So what do we conclude? Well it is clear that the relationship between Robert Tchenguiz and Kaupthing was deep and close.

Will taxpayers get their money back on Rock?

Robert Peston | 09:33 UK time, Wednesday, 9 March 2011


What brought Northern Rock to the brink of collapse in the boom years before September 2007 was that it lent too much too quickly, fuelled by finance that could not be relied upon to be permanently available.

Northern Rock branch

So there is something of an irony that the £232m of pre-tax losses generated by new Northern Rock - which is owned by taxpayers and was stripped of its historic loans - stem from its inability to lend enough.

The bank has been cleaned up for privatisation. But that means it is lending too little to cover the costs of its overheads and the interest paid on deposits.

It started life a year ago with £19.5bn of deposits and £10bn of mortgages. It ended the year with £16.7bn of deposits and £12.2bn of loans to customers (with some of that fall in deposits the result of the closure of the offshore savings operation in Guernsey).

So the Rock's income from interest on loans was £407m. But it paid out £448m of interest, and administrative expenses were £251m.

When fee and commission income are taken into account, and restructuring costs are deducted, the net result is a fairly thumping loss.

Which sounds serious. But it isn't a disaster, because overheads can be cut and lending can be increased.

That said, it is pretty difficult to say when the Rock will be back in profit, which means that if the government presses ahead with an early privatisation - and the Treasury shows every sign of wanting to do that - it can't expect a bumper price for the bank.

Does that mean there's a risk of taxpayers not getting back the £27bn they lent and invested in Northern Rock in the autumn and winter of 2007-8, to keep it afloat?

Well there is a risk of losses for taxpayers, but - absent a return to cripplingly recessionary conditions in the UK - I wouldn't say it is a huge risk. On the other hand, it doesn't look as though taxpayers will do much better than break even on the Rock rescue.

Certainly in the case of a sale of new Northern Rock - the bank I've been musing about above - there is a chance that taxpayers won't be repaid all of the £1.4bn they've injected into the bank to capitalise it (unless, as I said, the privatisation is delayed until the Rock is back in profit).

With the outlook for the British economy - and for the housing market - uncertain at the moment, lossmaking retail banks aren't the easiest businesses to flog right now. Even so, the likelihood is that at the end of April, UK Financial Investments - which manages taxpayers' stakes in banks on behalf of the Treasury - will initiate some kind of auction of lossmaking Rock.

But let's say the sale of the Rock generates less than the £1.4bn taxpayers have put into it. Would that be a disaster?

Well it would be wrong to see that £1.4bn in isolation. The more important asset on the public-sector balance sheet which stems from the nationalisation of the Rock is the so-called "bad bank".

That is the part of Northern Rock, called Northern Rock Asset Management (NRAM), which was hived off from the branch network and deposit-taking business, and took ownership of £50bn of the banks' older mortgages.

The irony is that this supposed bad bank was in substantial profit at the half year and probably was for the year as a whole (its results aren't being published today). The reason for the profit is that the economy has recovered a bit, so borrowers aren't finding it as difficult to repay debts. And, unlike new Northern Rock, NRAM has relatively low overheads and a stream of interest receipts on all the loans it made.

In other words, the much more important determinant of whether taxpayers get back their £27bn is whether borrowers repay the money they owe to NRAM, and as and when borrowers default, whether their seized properties can be sold for more than the value of the debt.

NRAM has net equity on its balance sheet, largely because it succeeded in buying back £1.1bn of its own debt at a very substantial discount.

So for taxpayers to end up as losers on the Rock, the deficit on any privatisation of new Northern Rock, when netted from any profits or losses from the winding up of NRAM, would have to exceed £800m.

Which probably leads to the conclusion that - in years to come - the rescue of the Rock will be seen to be have had negligible fiscal consequences, for all its massive impact on the financial and political environment of three years ago.

Motivating RBS's Hester

Robert Peston | 17:27 UK time, Tuesday, 8 March 2011


Stephen Hester and other senior RBS executives have today been awarded their allocations in a couple of incentive schemes.

Stephen Hester

Or to put it another way, they have been given an idea of how much wealthier they will become, if RBS returns to profit in a sustainable way and if RBS's share price responds positively.

In Hester's case, he could become quite a lot better off.

His maximum allocation under RBS's 2010 long term investment plan would be 10.1m shares - which would be his if he hits targets for profits, return to shareholders, risk reduction and strategy.

He will also receive 4.6m "share bank" shares in 2012 and 2013 in respect of his performance last year.

And he could receive a further 6m share bank shares next year depending on how he does this year.

So that's just under 21m shares that will be his, if he turns the bank around.

They are worth £9.1m at today's share price - and would be valued at many millions of pounds more, as and RBS's share price finally breaks above the 50p odd price which taxpayers paid for stock when rescuing the huge bank in 2008.

Which is not a bad reward for someone who arguably works for the public sector (RBS is 81% owned by taxpayers - and the Office of National Statistics includes RBS's liabilities on the public-sector balance sheet).

Should all financial innovation be curbed?

Robert Peston | 09:56 UK time, Tuesday, 8 March 2011


I was struck by a name, Shleifer, that kept popping up in Adair Turner's recent lecture on whether reform of the financial system had been radical enough (see my post, Turner's 'radical' changes at the banks) and in the response to Lord Turner made by Paul Tucker, deputy governor of the Bank of England.

Men walking past share price board

By the way, it was resonant that Turner and Tucker were sparring in the same Cambridge room, since they are the heavyweight contenders to succeed Mervyn King as Governor of the Bank of England.

But that's a proper punch up for another day, since on this occasion they were agreed on the importance of a recent academic paper by the Harvard economist Andrei Shleifer - in collaboration with Nicola Gennaioli and Robert Vishny - entitled Financial Innovation and Financial Fragility.

As much as these things ever set the pulse racing (unless you are a saddo like me). It is a gripping piece of work - because it purports to offer a mathematical proof that much financial innovation is socially and economically harmful, by definition as it were, turning on its head the prevailing orthodoxy of the previous 30 years that markets are rational and efficient.

So the significance of its equations are not to be understated. You could say that the authors employ the methodology lauded for years by Alan Greenspan, when he was the most powerful central banker the world has ever seen, the pontiff of liberal capitalism, to demonstrate that Greenspan's faith in the universal, eternal benefits of free markets and financial innovation was false.

Schleifer et all start from the premise - which no liberal ideologue would dispute - that most financial innovation is based on the desire to create investments that deliver reliable, above average cash returns to investors.

In that lost world of four years ago where there was limited issuance of the supposedly safest investments - or loans to the strongest and richest states, bonds issued by the likes of the US, UK and Germany (don't smirk) - there was a powerful motive to repackage and reconstruct other kinds of loans so that they would mimic those ostensibly low-risk government bonds.

So far, so orthodox.

As you know, in recent years, the most conspicuous and deadly example of what became known as the search for yield was the explosive growth of structured or tranched products, of AAA-rated bonds - collateralised debt obligations - manufactured out of low quality or subprime loans to US homebuyers.

These CDOs seemed to offer the safety of US Treasuries or UK gilt-edged stock - they had the same AAA rating - but with a much higher yield.

Now, this combination of putative security and superior returns can be seen in many other innovative products of recent years that subsequently went wrong, from split capital trusts in the UK to the collateralised mortgage obligations of 20 years ago in the US.

There was also an element of the same psychology at work in the creation of enormous money market funds in the US - which in reality represented a significant market risk for investors but where those investors in practice believed their savings could never fall below 100 cents in the dollar (they were convinced the buck would never be broken).

For Shleifer and his colleagues, there is no coincidence that investors in CDOs, CMOs, money market funds, split capital trusts and so on failed to appreciate the scale of the risks they were running.

One of their important insights is that all investors - professional, wholesale investors as much as retail ones - are prone to what they call "local thinking".

To put it another way, investors will tend to ignore low probability risks - even when those risks relate to potentially devastating events.

And the longer those low-probability risks fail to materialise, the more investors will behave as though those risks don't exist at all.

That local thinking or myopia is now - in hindsight - conspicuous in the way that investors bought trillions of dollars of bonds created out of US subprime loans.

If investors thought about the risks at all, they took comfort from the performance of the US housing market in their lifetimes, during which default rates among borrowers were consistently low and where there had only been regional house price slumps, never a national one.

The consequence was that investors behaved - invested their precious cash - as if a national decline in house prices could not ever happen and as if there could never be an epidemic of defaults.

What flowed from this combination of local thinking by investors and from the understandable desire of investment bankers to create and sell fee-earning new products was that vastly more money was invested in CDOs made out of subprime - and by extension vastly more money was lent to homebuyers who never stood the remotest chance of repaying their debts - than was remotely healthy, either for the investors or for the wider economy.

It is of course the damage to all of us, not to individual investors who should know better, that matters.

And an important element of that damage to the rest of us isn't just that when the supposedly safe investments go bad, losses are generated for some important institutions - banks for example - that find it difficult to absorb the losses. What also happens is that investors become gripped by blind panic when they finally recognise they've been prone to local thinking, that they failed to appreciate the real risks they were running.

When investors learn the bitter truth, they instinctively exaggerate how bad it really is. They dump the bad investments - the CDOs for example - in a herdlike way that's as irrational as the silly optimism they manifested when buying the investments in the first place.

The price of the investments collapses, to fire-sale prices. And those unable to shift the investments - including, during the real-life example of 2007-8, banks which play a vital economic role - face bankruptcy.

The powerful conclusion of Schleifer's financial modelling is that there was nothing anomalous or exceptional in the great crash of 2008 that was triggered (if not caused) by the subprime, CDO boom.

They purport to have delivered mathematical proof that the existence of local thinking will inevitably lead to credit booms that seriously undermine economic stability. Which implies that if we want to avoid those destabilising bubbles, curbs have to be imposed on bankers' freedom to create whatever financial products meet perceived market demand.

Particularly important in this conclusion is the implication that we can't expect the financial economy to be made sufficiently safe if all we do is continue down the mainstream route currently being taken by international regulators of controlling leverage, or limiting how much banks and other financial institutions can borrow and lend relative to their capital resources.

For Schleifer, the recent global drive by regulators to force banks to hold more loss-absorbing capital relative to assets - to increase their capital ratios - will lessen the magnitude of boom-bust shocks.

But those boom-bust shocks will remain severe, they imply, unless restraints are imposed on investment banks' creative tendencies.

That said, there is nothing particularly radical about this conclusion as applied to the creation of retail products. It is taken for granted by regulators and governments that the likes of you and me need protecting from our own ignorance and folly when investing.

However the conclusion that the Financial Services Authority - or rather its successor bodies under George Osborne's reconstruction of the British regulatory system - should routinely ban or limit the use of products designed by the likes of Goldman Sachs and Barclays Capital, for consumption by financial institutions, well that will be deeply troubling for the City.

However that is indeed where the thinking of Lord Turner, chairman of the FSA and the most influential regulator in the UK, is heading.

He said as much in his recent Clare College lecture and I expect him to elaborate on all this in the coming days.

The natural home for a new culture of busybody interference in the innovative activities of investment banks - as and when that innovation may have potentially serious consequences for the economy - will be the soon-to-be-created Financial Policy Committee.

If I were running Barcap, Goldman Sachs or Deutsche Bank, I might be more than a teeny bit anxious about the imminent advent of the FPC.

Barclays: Executives enriched, shareholders impoverished

Robert Peston | 15:23 UK time, Monday, 7 March 2011


Barclays remuneration report discloses that £100 invested in Barclays on 31 December 2005 would have been worth £53 - including dividends received - at the end of 2010, which most would describe as a hopeless performance.

Barclays cycle hire bikes

And, lest you labour under the illusion that this was just what happened to the stock market in general, think again: the same £100 invested in all FTSE100 companies (a tiny bit of each company) would have increased in value to £126 over the same time period.

Or to tell you what you already know, returns on almost all our banks - including Barclays - have been lamentable.

So how is it that the chaps at the top of Barclays, and those immediately below them, earn such astonishing sums of money (see my earlier post for the details)?

Can Bob Diamond be worth the £9m he received in pay and bonuses and the £15.2m in shares he also received from earlier incentive schemes that have just matured (or vested, to use the jargon)?

Barclays would say Mr Diamond is simply being paid what's required to retain the services of an acknowledged star of his industry.

But if that's the market rate, isn't there something wrong with a market which also awarded £14.3m and £14m to a couple of executives below board level (and who knows what magnificent sums to traders without executive responsibility, whose pay isn't disclosed?)?

Or to put it another way, how can executives be worth quite so much when the owners of the business, the shareholders, have lost so much money?

Here is another way of looking at the extent to which the owners have been punished: in 2007 Barclays' investors received dividends of 24p per share; in 2010, dividends were 5.5p per share.

If a 77% cut in the dividend isn't redolent of management failure, what is - and why haven't the owners instructed Barclays and the other banks to allocate less wonga for top executives and more for shareholders?

Ministers would argue that the disparate fortunes of executives and owners stems from the ignorance of the owners about what has really been going on. So the Treasury told me it deserved credit for forcing Barclays and the other banks to disclose for the very first time the remuneration of the top five executives below board level (which was a stipulation of the Project Merlin agreement with the big banks on business lending and pay).

So now that shareholders know that the top five below board level earn £14.3m, £14m, £9m, £6.5m and £5.2m - or £49m in total - will they think that's miles too much, just about right or too little?

Will they bother to probe behind the headline figures to take a view about whether they are really paying these executives for performance?

Is there any chance that when it comes to bankers' pay, there will start to be some kind of proper alignment between the rewards to senior employees and the fundamental performance of the business - or will top bankers' pay continue to look as crazy to most people as the pay of Premier League footballers?

Bonuses for Diamond and Varley

Robert Peston | 10:45 UK time, Monday, 7 March 2011


Barclays will publish its remuneration report this afternoon, ahead of the publication of its annual report - which is a slightly unusual demerger (as it were) of one bit of the annual report.

John Varley and Bob Diamond

Presumably that's because it knows that the pay of the last chief executive, John Varley, and of the new one, Bob Diamond, is of some interest.

The headlines are these.

Bob Diamond received a bonus for his 2010 performance as head of Barclays' investment banking and wealth management operations of £6.5m, which consist of £1.8m in shares and a deferred award of £4.7m in shares and contingent capital (bonds that convert into shares in certain circumstances).

This comes on top of his salary of £250,000 per annum. He also received a few million pounds worth of shares from a long term incentive plan (I will be able to calculate the precise value of that when the remuneration report is available later today).

We can assume however that he pocketed somewhere in the order of £10m or so for 2010.

As for John Varley, he received a bonus of around £2m, according to sources, on top of his annual salary of £1.1m (again I will be able to confirm the detail later).

What to say about all this?

Well Mr Diamond appears to be pocketing a bit more than his peer at HSBC, Stuart Gulliver - who was also recently appointed as chief executive and whose recent rewards, of £6.2m in salary and bonus, was for his erstwhile role as investment banking boss.

Barclays will argue that Mr Diamond is only receiving the going rate for a job where he plainly has world class skills in a high-paying industry.

That said, the pay of both Mr Diamond and Mr Gulliver will infuriate those who argue that they are based on banks' unsustainably large profits - or excessive profits generated thanks to implicit taxpayer funding subsidies and rent extracted from the rest of us due to the opacity of their services and products (see my post on Adair Turner's recent analysis of this).

PS This is what a senior non-executive of Barclays told me about the bonus award to Mr Diamond:

"We could have been idealistic but we felt we had to be pragmatic; we had to swallow hard. What we've done won't be popular in the UK but I think it will eventually be seen as in the interest of the country."

How many of you think he's right?

Update 12:06: Barclays has also disclosed the pay of the five highest paid executives below board level for the first time (though not necessarily its five highest paid employees, since the remuneration of super-traders with little management responsibility has not been disclosed).

The top earner received £10.9m plus £3.4m in long term incentive rewards, number two got £10.6m plus £3.4m, number three pocketed £7.9m plus £1m, the fourth go £5.2m plus £1.3m and the fifth took £3.7m plus £1.5m.

So a couple of them received more than Bob Diamond.

Anyway here is what Barclays will see an insensitive way of contextualising these rewards: each of the top five senior executives earned more than the aggregate pay of the entire cabinet, and the top four earned a multiple of total cabinet pay.

Update 12:24: The total pay for 2010 of John Varley was £3.85m, including a cash bonus of £550,000 and a shares and deferred award of £2.2m.

The total remuneration of Bob Diamond was £6.75m, as analysed above.

On top of that, Mr Diamond receives a long term incentive award - contingent on future performance - which would be worth £2.25m, on the very conservative assumption that he only receives a third of his maximum entitlement.

Finally, Mr Diamond has also received shares in the past year from previous incentive schemes worth £13.8m. So his 2010 hasn't been too injurious to his net worth.

Update 13:00: I did Bob Diamond a small disservice in respect of his recent rewards from older incentive schemes. On top of this year's pay, he has just been handed £15.2m in Barclays shares (not £13.8m) from previous incentive schemes, some of which he has sold.

Should we all get a piece of RBS and Lloyds?

Robert Peston | 08:19 UK time, Monday, 7 March 2011


If you were running Royal Bank of Scotland or Lloyds, would you welcome or hate the idea of every one of the 45m adults on the UK's electoral register having a direct shareholding in your bank?

Lloyds branch

The management of those banks might see this radical form of popular capitalism as a way of bridging the yawning gulf between banks and people, which has so poisoned banks' attempts to rebuild their reputations - along with their financial strength - since the great crash of 2008 (see Mervyn King's choice words about the banks this weekend, as just one manifestation of the rift).

If everyone could profit in a tangible, personal sense from the recovery of the banks, perhaps there would be less of a general feeling around the place that banks and bankers are only in it for themselves, and never mind the rest of us.

That, at least, would be the positive opportunity for bankers that could arise from the proposal by a Lib Dem MP Stephen Williams - which has been developed by the financial adviser, Portman Capital - to distribute to all of us as individuals (or at least those of us on the electoral register) most of the nationalised shares in Royal Bank of Scotland and Lloyds.

This distribution to almost everyone of 79% of the 83% of taxpayers' stake in RBS and 41% of the holding in Lloyds would be subject to a clawback mechanism which ensured that the £66bn injected by the state into these two banks would be repaid.

Once we had the shares, the shares could not be sold by any of us unless and until the price was above the price paid for them by the Treasury in the great rescue of 2008. And as and when we sold them, the new private shareholders would only pocket the increment above that rescue price: the rest of the dosh would revert to the Treasury, to pay back that £66bn.

It looks like a neat scheme, and has been described by the Treasury as an "interesting contribution to the debate" (so perhaps damning with faint phrase, but not at least a "stupid boy, Pike" rejoinder).

RBS branch

There is no doubt that it would be ferociously complicated to organise. And ministers and officials would be acutely aware of the great opportunity here to spend a fortune on online distribution mechanisms which ended up depriving millions of their entitlement.

That said, HMRC's online interface with taxpayers seems to have worked ok. And if Facebook was able to acquire more than 500m active users from an initial outlay of £25m, it's surely not as expensive and complicated as it once was to electronically distribute shares to the UK adult population and then monitor the relationship between shareholders and banks.

For Portman, however, the biggest advantage of the scheme isn't that it would at a stroke turn the UK into a shareholding democracy or would give something back to all of us for the economic pain we've suffered in the past few years as a result of the reckless lending and investing of the banks.

Portman believes that distributing the shares in that way would improve the prospects of the state being repaid its £66bn: UK Financial Investments (UKFI) on behalf of the Treasury would not have to suffer an "overhang" discount each time it sold a tranche of shares, a painful discount necessitated by the market's knowledge that the state isn't a long term holder of the stock, and that the initial sale tranches would only be the first of many.

There may indeed be that advantage. On the other hand, it is also possible that the Lloyds and RBS stock prices would be depressed below the rescue price for years by the knowledge that there would be a flood of popular sales of the stock, each time the price approached a level that generated a return for the state and for the individual.

As for the attitude of the boards of RBS and Lloyds, they will wonder two things.

First, would the distribution of shares to millions and millions of people let them off the leash, give them free rein to do more or less what they like - because if the shares became so widely held in such small quantities, it would be immensely difficult to put together any kind of alliance of investors to pressurise the directors to behave in a particular way?

Extreme popular capitalism could release bank directors from being answerable either to the irksome government (as owner) or to governance-obsessed investment institutions.

But maybe there would be precisely the opposite effect of handing shares to every voter. If we all had the opportunity to make a few bob from the performance of RBS and Lloyds, perhaps we would all become obsessed with how the banks' directors manage things.

Perhaps we would express our views, via social networks and in opinion polls, in ways that made it very difficult for the boards of banks to ignore.

My guess is that the City establishment will view Mr Williams' proposal to democratise the banks as naive and impractical. Which, given the recent track record of that establishment, some would say is one very good reason why the government should not summarily dismiss the idea of bank shares for all.

Is entente impossible between governor and banks?

Robert Peston | 10:42 UK time, Saturday, 5 March 2011


Mervyn King's interview with the Telegraph shows that the intellectual and emotional gap between the governor of the Bank of England and the UK's big banks is now of almost unimaginable size.

His view of what they do and how they do it is a universe away from their own self-image.

It is where he compares the banks with manufacturers that he is particularly damning.

Many manufacturers, for King, " care deeply about their workforce, about their customers and, above all, are proud of their products". But what about banks? "There isn't that sense of longer-term relationships. There's a different attitude towards customers. Small and medium firms really notice this: they miss the people they know," he says.

The financial industry, he claims, is poisoned by the idea that "if it's possible to make money out of gullible or unsuspecting customers, particularly institutional customers, that is perfectly acceptable". And he contrasts that attitude with decent businesses which "keep a clear vision of who their customers are, and are run by people who don't think they should simply maximise profits next week".

He also returns to his theme of the investment banks as gamblers in a casino, complaining that over the past 25 years, banks have increasingly "taken bets with other people's money" and where the "the rules of the game are that they get bailed out if it all goes wrong".

In the frantic taxpayer-subsidised casino, all trust between the players evaporated: "Financial services don't like the word 'casino', but instruments were created and traded only within the financial community. It was a zero sum game. No one knew which ones were winners when the crisis hit. Everyone became a suspect. Hence, no one would provide liquidity to any of those institutions."

Anyway, I've written countless times about how he and his colleagues at the Bank of England believe passionately that the guarantee to big banks that they'll always be bailed out by taxpayers has to be removed - as a necessary but not sufficient condition for making the financial system stable, robust and socially useful.

King is looking to the Banking Commission to come up with the requisite reforms (see earlier posts for what he and the Commission have in mind) and then to the Chancellor of the Exchequer to show the resolve to implement such reforms, in the teeth of an inevitable response from the banks that a great British industry would be imperilled.

But for me the significance of his remarks on this occasion are rather different.

Sustainable economic recovery in the UK requires the banks to regain some sense of confidence in who they are and what they do. They would argue that this project isn't helped when they are vilified by arguably the most important figure in their lives.

Not only is Mr King the individual who - more than any other, through the power of the Monetary Policy Committee to set interest rates - will determine whether their over-borrowed customers will be able pay their debts in the coming uncertain months.

He is also shortly to become the most important influence over whether new dangerous bubbles are pumped up and over the monitoring of risks taken by individual banks - because the government has decided to transfer to the Bank of England what is known as macro-prudential regulation and micro-prudential regulation.

According to the recent Treasury paper on regulatory reform, the governor will chair the new Financial Policy Committee, which will assess whether banks in general are behaving in dangerous ways, and the new Prudential Regulation Authority, which will monitor whether individual banks are taking excessive risks.

He will be, without any near challenger, the most important person in the lives our banks. So it matters that he appears to have so little respect for them.

Those who run the banks go further, and allege that he doesn't understand what they do. Some of the things that board members of banks have said to me about Mr King are unprintable.

Plainly it would be unhealthy for there to be a chummy relationship between the individual charged with keeping the banks in order and the banks themselves, between the headmaster and students, between the governor and governed.

There are many who believe that one of the greatest flaws in the regulatory system that's being swept away is that the Financial Services Authority in the few years before the Great Crash of 2008 was simply too respectful of the big banks and their boards.

But whether it is optimal for there to be this degree of froideur and mistrust between Mr King and the banks, well that is by no means obvious.

Sorrell: 'The UK is a league one team'

Robert Peston | 08:44 UK time, Friday, 4 March 2011


There is an interesting analysis of the plight of the mature economies of the West, especially the US, in this morning's results statement from WPP, the advertising, PR and consumer research conglomerate - whose profits before tax rose 28.5% in 2010, to £851m.

Sir Martin Sorrell

This year's motor of growth has been the US, where advertising revenues bounced back much more sharply than WPP's founder and chief executive, Sir Martin Sorrell, had expected.

On a sequential quarter-by-quarter basis, US revenues increased 9.8% in the last three months of the year and by 9.9% in the penultimate quarter. Which is a multiple of the underlying growth in the US (where there are signs of recovery, but not at a rate that is yet making meaningful dents in the high unemployment rate).

So what's going on. Well part of it is simply what Sorrell calls the "dead-cat bounce" from recession-induced levels of advertising in 2009 that were lower as a proportion of GDP than at any time since the mid-1970s.

And for those who worry about the undue influence of big business, especially the banks, over US legislators, it is striking that Sorrell identifies a particular positive factor as "heavy political spending around the mid-term congressional elections, especially following the United States Supreme Court decision permitting freer lobbying".

But what I think is most significant is what Sorrell has to say about the advertising behaviour of the biggest companies. It is worth quoting his remarks:

"Most importantly, post-Lehman and the several corporate crises, we have seen a concern, or even fear, amongst Chairmen and CEOs and in the Boardroom about making mistakes and a consequent emphasis on cost containment and unwillingness to add to fixed expenses or capacity.
"Western-based multi-nationals are said to have over $2 trillion in cash on their balance sheets, but unemployment remains at stubbornly high levels, with only increases in temporary employment and limited expansion of fixed capacity in Western markets. Hence, a willingness to invest in the brand and maintaining or increasing market share, rather than increasing capacity and fixed expenses."

In other words, the recovery in advertising reflects nervousness, caution among corporate bosses about what the future has in store. They would rather advertise to sustain the position of their existing brands, than make big investments in new productive capacity or new products.

Unless and until they are prepared to increase investment, the growth prospects for the US - and by extension for the UK too - will remain relatively subdued.

It is worth pointing out that there was also a significant recovery for WPP in revenue generated in the UK. In fact, by region, the UK produced the second fastest revenue growth for WPP (after the US), of 5.9% in so-called like-for-like or underlying terms. This British recovery was also evident in yesterday's results from ITV.

That doesn't however mean that Sir Martin Sorrell has changed his mind about the UK and US becoming less and less important to WPP over time. In fact, with the contribution to WPP's revenues from new markets (ie the likes of China, India and so on) and new media (advertising and marketing on the net, mobiles, social networks et al) each approaching a third of the total, WPP is raising its target for income from these sources to between 35% and 40%.

Again it is worth quoting him at some length:

"The world continues to move at very different speeds, both geographically and functionally. By means of explanation, perhaps an English football analogy is helpful.
"First, The Premier League consists of the BRICs (Brazil, Russia, India and China) and the Next 11 (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, South Korea, Turkey, Vietnam) or CIVETS (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa), along with new media (personal computer driven, mobile, video content, social networks).
"Second, The Championship, the United States, because of its size, immigrant, entrepreneurial culture and human and natural resources, along with an economically well-run and high value-added manufacturing export-led Germany and free-to-air television; third, League One, Western Europe, primarily the United Kingdom, France, Italy and Spain, along with newspapers and magazines; last, League Two, Japan, which has been stagnant for almost twenty years. Perhaps the United Kingdom, with its Coalition Government's emphasis on deficit reduction and long-term growth will gain promotion to The Championship?"

So to extend the metaphor, Brazil, Russia, India and China are - for Sorrell - the equivalent of Chelsea, Man Utd, Arsenal and Man City. Iran is Bolton.

And as for the poor UK, well for Sorrell it's Colchester or perhaps MK Dons, on the cusp of possible promotion, if George Osborne, David Cameron and Vince Cable manage the team properly (as per Sorrell's analysis of what's needed - which, of course, isn't every fan's prescription).


Why Jeremy Hunt is allowing BSkyB takeover

Robert Peston | 07:52 UK time, Thursday, 3 March 2011


Huge changes to the landscape of the British media industry are being heralded today.

Jeremy Hunt


Jeremy Hunt, the culture secretary, has given the green light to News Corporation's £7.5bn takeover bid for British Sky Broadcasting - which would create a media giant whose revenues would dwarf all rivals, even the BBC.

But as a condition of allowing the deal, he is forcing Rupert Murdoch's News Corporation to spin off Sky News into a new company listed on the stock market, with its own board and whose chairman could not be a News Corporation employee, so not a member of the Murdoch clan.

Sky News would be 61% owned by outside investors, and 39% owned by News Corp - reflecting the current ownership structure of BSkyB. And News Corp could only increase that shareholding with the explicit agreement of the culture secretary.

And to protect its editorial independences, its board and an editorial board would have a majority of independent directors.

What is more, News Corp would sign a contract to buy Sky News's services for 10 years, and to licence it the "Sky News" brand for seven years - an arrangement which is supposed to provide incentives to both sides to ensure that Sky News has a viable future longer than 10 years.

Correspondence published today between Mr Hunt and News Corp indicates that News Corp has - under pressure - made greater concessions than it wanted to do guarantee Sky News' independence.

And as a result of these concessions, Ofcom - the media regulator - has said that the harm its perceives as flowing from the deal, that it would restrict choice or plurality of news providers, would be purged.

Even so there will be a storm of protest that Mr Hunt is allowing the deal.

There will be criticism both from media rivals, such as the Telegraph, Mail and Guardian, and from grassroots campaigns.

One important caveat however about the significance of all this.

None of this will happen unless News Corp offers enough to persuade BSkyB's shareholders to sell. And what is completely clear is that those shareholders view the current offer of 700p per share as far too low.

Update 09:56: The hiving off of Sky News into a new listed company, 39% owned by News Corp and 61% by outside investors, would create a potentially interesting new player in the news market.

It could not be a pawn of the Murdochs and a News Corporation massively enlarged by the takeover of BSkyB (if that deal does go through - which, to repeat, is not guaranteed), for a number of reasons.

Of course it would be massively reliant on the so-called carriage agreement with News Corp that would be put in place, which would be a 10 year contract for Sky News to supply news services to Sky television.

Which means that initially at least, Sky News would be dependent on News Corp for 85% of its revenues. In other words, News Corp would be a pretty powerful customer.

But that is why Ofcom, the media regulator, insisted that Sky News should put in place a raft of governance arrangements to protect its independence (see above for more on this) - which would be a layer on top of the guarantees of independence that company law and stock exchange listing agreements force on companies traded on the stock market.

In that sense, the guarantees of Sky News's independence would be significantly more robust than the arrangements put in place 30 years ago to preserve the editorial independence of the Times newspaper.

What is particularly striking about the correspondence published this morning by the Culture Department about negotiations to maintain Sky News as an autonomous force in news is that it shows there was a bust-up in mid February between Ofcom, the media regulator, and News Corporation over all this.

Ofcom insisted that the chairman of Sky News had to be independent, not an employee of News Corp, and not therefore a member of the Murdoch clan.

News Corp initially said no to this demand. Which is not a great surprise, because in a way it was a humiliating request to put to the Murdochs.

Remember they regard themselves as having created not only all of BSkyB, but also Sky News. So to be told that no member of their family could chair something they see as their baby, well this would not have been an easy thing for Rupert Murdoch to swallow.

But the Murdochs did make the concession. Which I think tells you something about Rupert Murdoch's desire - in the words of one of his colleagues - to get "all his ducks in a row" as he approaches the milestone of his 80th birthday (he is 80 on 11 March).

Rupert Murdoch sees the takeover of BSkyB as an important element in the tidying up of his disparate assets, and in the end was prepared to allow Sky News the freedom demanded by Ofcom to achieve that end (the return of his daughter Liz Murdoch to the News Corp fold also has to be seen in the context of tying up these loose ends, according to Mr Murdoch's friends).

The other very interesting question is about the extent to which Sky News as an independent company would move rapidly to expand and diversify. For example, there is a logic to Sky News trying to take control of ITN.

But once again it is important to stress that none of this will happen unless News Corp succeeds in acquiring all of BSkyB - and that is not a done deal.

BSkyB's share price has risen sharply this morning. Its price now well above 800p is saying that News Corp will probably have to offer 850p (or more) to secure its prize - which would push up what News Corp would have to pay in total from £7.5bn to £9.1bn.

The negotiations on price are being led by James Murdoch, Rupert Murdoch's son, who runs News Corp's European and Asian operations.

Up to now he has offered considerably less than BSkyB's independent directors and shareholders want. It is utterly unclear whether James Murdoch will offer enough to achieve his father's wish of bringing BSkyB firmly into the News Corp fold cleanly and quickly.

PS. The importance of the Sky News brand licence coming up for renewal after seven years rather than the 10 years of the carriage agreement is that the phasing prevents a huge crisis at a fixed date of all agreements unwinding at the same time.

As for that brand licence, it is seven years with an option to renew for a further seven years - so it can probably be seen as guaranteed for 14 years.

Murdoch's offer to sell Sky News

Robert Peston | 17:14 UK time, Wednesday, 2 March 2011


News Corporation has offered to sell Sky News and also subsidise the channel for years, to allay concerns about News Corp's planned takeover of all of British Sky Broadcasting.

Sky TV remote

As a result News Corp is likely to get the green light for the takeover from Jeremy Hunt, the Culture Secretary, possibly as soon as tomorrow.

One of Jeremy Hunt's close colleagues insisted he has not yet made the formal decision to approve News Corp's £7.5bn bid to buy the 61% of BSkyB it doesn't already own, but didn't rule out that Mr Hunt could do so within hours.

If Mr Hunt allows the bid to proceed, which is what I expect, some will see that as a u-turn, because on 25 January he said he was intending to follow the advice of the media regulator, Ofcom, and refer the planned takeover to the Competition Commission for further scrutiny.

Since then, however, Rupert Murdoch's News Corp has made a proposal designed to remedy the harm identified by Ofcom from the deal.

Ofcom was concerned that the combination of News Corp's market-leading newspapers with BSkyB's 24-hour rolling news channel, Sky News, would reduce plurality or choice of news for citizens.

So in what News Corp sees as a significant concession and sacrifice, it has offered to sell Sky News. And because Sky News is lossmaking - to the tune of more than £20m a year according to sources - it has also offered to in effect cover the costs of Sky News for many years through a long-term contract.

Bankers tell me that with such a long term contract in place from BSkyB, Sky News is capable of being sold.

In making his announcement, Mr Hunt would initiate a 15 day period of public consultation.

Critics of the takeover, which include news organisations such as the Telegraph Group and DMGT, owner of the Daily Mail, would complain that News Corporation will become far too powerful a player in the UK media market, if it is able to combine its newspapers (which include the Sun, Times and Sunday Times) with BSkyB's huge, cash-generating broadcasting business.

These opponents of the deal have a problem however, in that their arguments are largely about the impact on competition, not plurality or choice, and the European Commission has already ruled that the combination of Sky and News Corp would not have an adverse impact on competition.

That said, the decision by Mr Hunt to allow the takeover to proceed does not mean the deal will definitely go through - because it is not certain that News Corporation will offer a high enough price to persuade the independent directors of BSkyB to recommend the offer or to persuade shareholders in BSkyB to sell.

Last June, News Corp said it would pay 700p for each BSkyB share, valuing the 61% of the business it doesn't own at £7.5bn.

That was rejected by BSkyB's directors, who said that they wanted more than 800p per share, or around £1bn more in total.

BSkyB's operations have performed well since then, so it is widely thought in the City that BSkyB's independent directors will now be demanding nearer 850p per share.

It is by no means certain that News Corp - whose BSkyB ambitions are being run by James Murdoch, who runs News Corp's European and Asian operations - will offer as much as that.

UPDATE 21:40

If, as the FT reports, what has been proposed by News Corp is a demerger of Sky News to BSkyB's existing shareholders, which include News Corp with 39 per cent, that represents the sale by News Corp of 61 per cent (a majority) of Sky News (on the assumption that News Corp ends up owning all of BSkyB, which is by no means certain).

UPDATE 22:00

The idea of demerging Sky News to BSkyB's existing shareholders is a neat regulatory fix, because in theory that can be seen as representing no change in the relationship between News Corp and Sky News. 

Is Cameron giving companies the mother of all tax breaks?

Robert Peston | 12:33 UK time, Wednesday, 2 March 2011


There was something of a tweeting storm when George Monbiot accused David Cameron of "plotting with banks and businesses to engineer the greatest transfer of wealth from the poor and middle to the ultra-rich that this country has seen in a century".

Canary Wharf

This was quite a claim. What is he talking about?

Well, Mr Monbiot's concern appears to be a plan to bring the tax treatment of overseas branches of multinational companies in line with the tax treatment of subsidiaries of multinationals.

Which probably sounds a bit dry and technical. But the government would explain what's happening as broadly completing reforms initiated by the last Labour government, which was to tax multinationals on a territorial rather than a global basis.

Or to express that in something that is a bit nearer to English, the thrust is to tax multinationals on the profits they make in the UK, rather than on the profits they generate outside the UK. In practice what it means is that income repatriated to the UK from overseas in the form of dividends will no longer be liable to corporation tax.

The reason for moving in that direction is that multinationals are pretty mobile businesses. If they feel that being headquartered in the UK means that they will pay more tax on their global earnings than would be the case if they were headquartered in Dublin or Zurich or Singapore, then chances are that they will move to Dublin or Zurich or Singapore.

Many may not like it that big companies can hold countries to ransom over tax policy in this way, that they put fiscal advantage over patriotic fervour. But given that company law obliges company directors to give greatest weight to the interests of their shareholders, criticising company boards for striving to minimise tax is a bit like attacking gravity for making the rain fall down rather than rise up.

So with most important economies - with the exception of the US - moving in the direction of taxing corporate earnings on a national rather than global basis, it is hard for UK to go in a different direction.

It's the price of globalisation, innit?

This is how the government justifies the reform in its own policy document:

"Globalisation has meant that the world's markets have become more open and competitive. As a result companies increasingly operate across national borders and the ownership of UK businesses has become more internationally diverse. A competitive tax system should recognise this. In particular, the Government needs to ensure that the way the tax system operates for UK headquartered multinationals does not inhibit commercial business practices or make them unattractive to international investment."

As it happens, big banks like Barclays often operate abroad through branches rather than subsidiaries, and any reform which appears to deliver tax advantages to banks tends to generate controversy.

But what are we talking about in terms of the scale of advantage to multinationals?

Well, before we get on to that, it is probably worth putting the receipts from corporation tax into some kind of context.

The first thing to point out is that although corporation tax is an important source of revenue for the Exchequer, it is a long way from being the most important.

The last Budget estimated that corporation tax would raise £43bn in the current fiscal year, compared with £150bn from income tax, £99bn from national insurance, and £81bn from VAT. Personal taxation is so much more substantial than corporate taxation.

Corporation tax would not even cover half the costs of the National Health Service.

It's the tax paid by the millions of us who work for companies and institutions which largely pays for the state, not the direct taxation of the companies themselves.

Which is one reason why it matters that big companies think that the UK is a reasonable place to have an HQ and employ people - like you and me - who provide most of the government's funds.

Second, and according to new research by Oxford University's Centre for Business Taxation, multinationals have contributed 85% of all UK corporation tax revenue over the past 10 years.

So, for example, in 2007 - the year before the crash and Great Recession - UK owned multinationals paid £16.5bn of corporation tax, foreign-owned multinationals paid £17.7bn, and "domestic groups" paid only £1.1bn.

In other words, without corporation tax paid by multinationals, British multinationals and foreign ones, there would be precious little revenue at all from this source. So it seems to make sense to encourage them to stay here.

That said, the Oxford research also indicates that as a proportion of trading profit, the tax liabilities of the UK's 100 biggest companies are lower than for other businesses: unsurprisingly, big companies have the wherewithal to engage in sophisticated tax planning that reduces their tax bills.

Even so the biggest 1% of companies pay 81% of all corporation tax. So although in an ideal world, some may want the corporation tax system to be more progressive, in this less-than-ideal world big businesses are making a non-trivial contribution.

For me perhaps the most striking finding, according to the Centre for Business Taxation, is that although the UK's corporation tax rate has been well below the average for the G7 biggest economies for more than 25 years, UK corporation tax revenues as a proportion of GDP have generally been well above the G7 average.

There is some evidence, therefore, that lower headline rates which reduce the incentives for avoidance or for relocation abroad increase the overall take from companies.

But back to where we started. What about the direct impact of the government's plan to tax the overseas branches of multinationals on the same basis as their overseas subsidiaries?

George Monbiot warns that if dividends from overseas branches of multinationals become exempt from tax, that will create an incentive for multinationals to relocate more of their operations to these overseas branches situated in low-tax countries, such as Switzerland, Ireland or Singapore.

But that is to ignore the enormous current incentive for multinationals right now to relocate every single bit of their operations to low-tax countries, irrespective of what happens to the taxation of dividends from branches.

In other words, the government seems to be trying to do precisely the opposite of what Mr Monbiot accuses it of doing: it is trying to stem the exodus of companies and their assets abroad.

Which is not to say there is no cost to exempting branch dividends from UK corporation tax. The Treasury estimates it at £100m per annum by 2014/15, subject to confirmation by the Office of Budget Responsibility

That's equivalent to 0.2% of all revenue raised through corporation tax, and 0.3% of UK corporation tax paid by multinationals, which will be the beneficiaries.

This is precious money given away at a time when the government is looking for brass farthings wherever they may lurk.

But unless you believe that a fiendish conspiracy of multinationals has somehow succeeded in gulling the Treasury and HMRC about the true cost of all this, it isn't - to quote Mr Monbiot - one of "the biggest and crudest corporate tax cuts in living memory".

Turner's 'radical' changes at the banks

Robert Peston | 10:53 UK time, Tuesday, 1 March 2011


While I was away for a few days, Lord Turner gave a remarkable speech, which seems - curiously - to have been almost universally ignored.

Lord Turner


The address given by the influential chairman of the City watchdog, the Financial Services Authority, was called "Reforming Finance: are we being radical enough?"

His answer seems to be "probably not".

I am going to focus on two aspects of what he said, that the new capital ratios imposed on banks, especially on big banks, remain too low, and that reforms to the way that bankers are paid may have the effect of actually increasing their total remuneration.

Actually he made a third striking related point: that the underlying problem may be that banks are excessively profitable, that much of their frenetic activity adds little to general economic growth and is designed to extract "rent" or income from the rest of us in a way that increases social inequality. One of his conclusions: that the optimum way to address this problem of rent extraction may be through new taxes on financial activities or direct state intervention.

First, here is what he says on the recent agreement by international regulators to increase the ratio of loss absorbing equity or core capital to assets from 2% to (in effect) 7% - an agreement that goes by the moniker (as if you didn't know) of Basel lll:

"Basel lll is a major step forward, but in an ideal world equity ratios would be set much higher".

How much higher? Well at least double, or even perhaps treble that 7%.

But for regulators like Turner, all is not lost. Top of this year's agenda for the global rule-setting bodies for banks, the Basel Committee and the Financial Stability Board, is what extra capital requirements may need to be imposed on mega banks, or Systemically Important Financial Institutions (SIFIs) - banks like Barclays, HSBC, RBS, Deutsche Bank, JP Morgan, Citigroup, UBS and so on.

Now Turner makes clear that he believes they need to hold a good deal more equity, because he sees that as by far the most efficient form of capital for absorbing losses, and thus protecting taxpayers from future crises.

Interestingly, he is sceptical that forcing banks to hold new-fangled instruments, bonds that convert into equity when capital ratios slip below comfortable levels, or Cocos, will be of much use in the long term - because he is persuaded that investors as a breed will systematically ignore the risk of conversion, and the bonds will therefore end up being owned by institutions unable to tolerate the equity losses as and when they materialise.

So, as I have pointed out before, our biggest banks - and their shareholders - probably need to brace themselves in the coming months for new rules forcing them to significantly increase the amount of capital they will have to hold relative to the loans and investments they make (so the arguments made yesterday by HSBC have already fallen on deaf ears).

Oh, and by the way, he and Paul Tucker - the deputy governor of the Bank of England who responded to Turner's address - pointed to a second priority for the Basel committee this year: a fundamental review of the capital requirements for banks' trading books; and if that doesn't lead to increased capital requirements for the likes of Barclays Capital, the investment banking arms of universal banks, I will eat any number of hats.

And what about bankers' pay? Well Turner makes the compelling point that the trend to defer bonuses and award them in shares will almost certainly lead to an increase in bankers' pay in the long term, unless the profitability of banks were to fall dramatically.

How so? Well with bonuses paid in shares and subject to clawback, the risk of non-payment increases - which is precisely why heads of G20 governments demanded those pay reforms (to better align bankers' pay with banks' long term performance).

But if the risks of non-payment rise, bankers will demand extra potential rewards by way of compensation. And they will get that extra reward, says Turner, unless there is a significant reduction in the long-term profitability of banks.

Which links to perhaps the heart of Turner's argument, which is that a significant proportion of the explosive growth of financial activity over the past 15 years is in a sense fatuous: it has generated no increase in the size of the economic cake for the rest of us.

He gives four examples of how banks simply extract rent from the rest of us, with no net economic gain - and arguably some social loss.

First he points to the banks' "tax management activities, which benefit the financial service sector's clients, but also, through fees earned, the industry itself" (some of you, I am sure, will at this point be saying a big hello to Barclays).

Turner adds: "a depressingly large proportion of what is labelled 'innovative product structuring' is based on tax management activities".

Then there is rent extraction via ferociously complicated products that obscure the risks for investors - both retail investors and astonishingly gullible financial institutions (such as UBS, which loaded up its balance sheet with AAA rate CDOs that turned out to be poison).

Third, there is all that financial innovation that claims to offer protection but actually increases market volatility, thus creating the demand for yet further financial protection (much of the growth in the OTC and exchange-based derivatives markets may have been otiose in that sense).

Finally there are the super-normal returns which accrue to those "dominant" market makers that are perceived by investors to be the loci of liquidity.

Where does all this lead?

Well to the conclusion that bankers' bonuses will only fall if the potential for banks to extract rent from the rest of us is tackled.

Has that happened?


How could it happen? Turner says: neither taxation nor state provision should be excluded from the policies considered".

He repeats that financial activity taxes, Tobin taxes, may be justifiable.

And he adds: "in retail financial services we should be open to the possibility that the state could sometimes be a more efficient provider of some services, removing the churn and excess cost which pure private competition can create".

Or to put it another way, if the UK's banks think that the anything-goes world of the years before the crash will return any time soon, the senior City regulator would beg to differ.

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