AT THE height of the banking crisis, restoring financial stability was paramount for the British government. Worries about limiting the taxpayer’s exposure came second. Ensuring that banking customers continued to enjoy a competitive market was a distant third. Indeed, the government waived competition rules to let Lloyds TSB take over Halifax Bank of Scotland (HBOS), Britain’s biggest mortgage lender, in what proved to be a disastrous move for Lloyds, as the merged group then required a massive state bail-out.
Now that the crisis has abated, fostering a competitive banking market is becoming more significant again, though mainly because of the intervention of Neelie Kroes, the European Union’s competition commissioner. Last week she forced ING, a rescued Dutch bank, to split its banking and insurance operations. She also imposed restrictions on lending and deposit-taking at Northern Rock, a nationalised mortgage lender which the British government is splitting into a “good” bank, to be privatised, and a “bad” part, to be wound down.
Announcements on Tuesday November 3rd from Royal Bank of Scotland (RBS) and the merged Lloyds Banking Group set out divergent paths for the two biggest banks that the British government had to rescue. But at the commissioner’s insistence both must pay a price, through disposing of some of their businesses, in return for their state aid. More than 900 bank branches are to be put on the market over the next four years and some well-known insurance firms will also be sold.
The government’s aid for the two banks came in two forms. First, both received big slugs of equity capital, worth £20 billion ($32.8 billion) for RBS and £17 billion for Lloyds, as an emergency measure when the banking system was teetering on the edge a year ago. Then, early this year, as banks were rocked again by worries about the losses from a savage recession, RBS and Lloyds agreed in principle to join an Asset Protection Scheme (APS), in which the taxpayer would cap their losses by providing a form of catastrophe insurance in return for fees paid by the banks. Altogether the APS was to cover £585 billion of suspect loans and other assets, £325 billion at RBS and £260 billion at Lloyds, of which over 80% derived from HBOS’s poor lending decisions.
For some time, Lloyds has been trying to escape the clutches of the APS, because it regards its terms—an upfront insurance fee of £15.6 billion—as onerous in relation to the likely risks on the assets covered. On November 3rd it was able to announce success on this front. Instead of joining the APS, it will shore up its core capital by making a rights issue of £13.5 billion, and turning £7.5 billion of bonds into ones that convert into equity during times of stress (nicknamed “coco” for “contingent convertibles”). The government will subscribe £5.7 billion to the rights issue, in line with its 43.3% holding in Lloyds, but will receive £2.5 billion for the implicit cover offered by the APS since March.
In contrast, the more sickly RBS, which made an ill-fated takeover of ABN AMRO, another Dutch bank, on the eve of the financial crisis in 2007, must stay in the APS. However, the state insurance scheme will now cover £282 billion of loans rather than the £325 billion originally intended. The bank will have to cover the first £38.7 billion of any losses it suffers henceforth, up from £19.5 billion. As already planned (though at once rather than in stages), the Treasury will provide an additional £25.5 billion of equity capital to bolster the bank’s balance-sheet, raising the government’s economic interest in the bank to 84%, although its ordinary shareholding will remain at 70%.
Lloyds may no longer need the government’s insurance scheme, but it has clearly benefited from the state injections of equity capital, old and new. As a result it will have to dispose of at least 600 branches across Britain, reducing its share of the personal current-account market by 4.6 percentage points and its mortgage book by almost a fifth (in each case Lloyds dominates the national market with around a 30% share currently). RBS, for its part, will have to get rid of over 300 branches, mainly in England, which will reduce its share of the retail-banking market by two percentage points. It will also have to sell off its insurance business, which includes the Churchill, Direct Line and Green Flag brands. To assuage popular anger over bankers’ pay, both banks have promised not to pay discretionary cash bonuses to staff earning over £39,000 this year.
The divestments will make the banking market more competitive, but compared only with the current position, which follows the merger between Lloyds and HBOS that would never have seen the light of day in normal conditions. Even after Lloyds’ disposals it will remain a behemoth in the retail market. The government has sought to present the restructuring as a new competitive dawn rather than a response to stipulations from Brussels. But even after the changes, British banking will remain highly concentrated.
Font: The Economist