INSTANT VIEW - UK banks in govt funding talks and shares plunge

Source: Reuters

Date :08/10/2008 14:50:01

The government pumped 50 billion pounds of taxpayers' money into its banks on Wednesday, seeking to revive Europe's top financial centre and help allay an economic storm threatening industry and jobs around the world.

By Sumeet Desai and Jodie Ginsberg

"We have led the world today with a proposal to restructure our banking system," Prime Minister Gordon Brown said after emergency overnight talks with banking chiefs. "We are taking the steps that I believe that other countries will take in the future."

The talks followed a day of dramatic falls on Tuesday in the shares of British banks, threatened by a global collapse in confidence between banks that has led to a freezing up of lending, the lifeblood of the economy at large.

Just days after the U.S. approved a $700 billion (399 billion pound) package to rescue its crisis-hit financial system, Britain said it would buy new preference shares or similar instruments, guarantee up to 250 billion pounds to help banks refinance debt, and make at least 200 billion pounds of liquidity available to the market.

The bank support plan was announced just hours ahead of a co-ordinated 0.5 percentage point cut in key interest rates around the world led by the U.S. Federal Reserve.

German deputy Finance Minister Joerg Asmussen said the move would help financial stability in Europe. "It contributes to the stability of the British financial system and we know what importance that has for the European financial system," he said.

Some British banks have lost nearly half their value on the stock market amid investor fears they could collapse if they were not handed a massive liquidity lifeline.

STOCKS FALL

Banks welcomed the plan, and the stock of one of the more beleaguered players, HBOS, soared by 50 percent on Wednesday. Royal Bank of Scotland, which fell heavily on Tuesday, was up 26 percent, although other banks were lower.

Investors said the importance of the deal went well beyond the interests of shareholders. Banks might, it was hoped, be able to resume doing what banks were intended to do -- loan money to feed the economy.

"This package is operating at two levels -- immediate capital strengthing, takes out all the future issues in terms of future (capital) raising, and allow banks to operate with some degree of higher certainty, which allows them to operate as the financial entities they are supposed to be," said Emanuelle Ravano, Managing Director, Pimco Europe. Pimco is the world's biggest fixed income asset investor.

"Moral hazard is a concept that nobody can afford when markets are going down at this rate."

"Moral hazard" has become a central concern in the current crisis, referring as it does to the danger that people or institutions will behave recklessly if they know they will be rescued when things go wrong.

In all, seven British banks, Abbey, HSBC RBS, HBOS, Barclays, Lloyds TSB and Standard Chartered and the country's largest building society, Nationwide, have committed to increase their total Tier 1 capital by 25 billion pounds in total as part of the government's scheme.

Tier 1 capital is the main measure of a bank's financial strength.

The government said it would make 25 billion pounds available to these institutions as preference share capital or permanent interest-bearing shares, which offer a more guaranteed form of income for the holder, and was also willing to help raise ordinary equity if requested to do so.

"In addition to this, the Government stands ready to provide an incremental minimum of 25 billion of further support for all eligible institutions," it said.

In return the government will require banks to meet certain terms and conditions that will include banks making commitments to support small businesses and home buyers and to deal with what many see as unfair pay deals for bank executives.

OIL WHEELS

In an effort to get banks lending to one another again, the Bank of England will make at least 200 billion pounds available under its Special Liquidity Scheme and conduct three-month sterling and one-week dollar auctions for three months against a wider range of collateral until markets stabilise.

The international financial crisis began with a collapse in the housing market in the United States, which left banks and finance houses through the world with a burden of bad debt.

The Bank's Special Liquidity Scheme, set up in April in what was then the British authorities' biggest response to the credit crisis, allows banks to exchange illiquid assets, including mortgages, for government bills, helping free up their balance sheet.

As part of the latest plan, the government will also issue guarantees of short and medium-term debt to banks who commit to raising their Tier 1 capital.

"The proposal envisages the issue of senior unsecured debt instruments of varying terms of up to 36 months, in any of sterling, U.S. dollars or Euros," it said.

Governments around the globe, from Iceland to South Korea, are fighting to unfreeze lending and borrowing brought to a halt by fears of hidden losses in financial institutions.

(Writing by Andrew Callus; editing by Ralph Boulton; additional reporting by Raji Menon)

LONDON (Reuters)