In the magnificent surroundings of Mansion House – and in the convivial atmosphere you have been enjoying today – it’s nearly possible to forget the extraordinary turmoil which is affecting the international banking and financial systems around the world.
Chairman, Lord Mayor, Sheriff, Ladies and Gentlemen.
I’d like to begin by thanking Roger Gifford and the board of the Association of Foreign Banks for inviting me this afternoon.
In the magnificent surroundings of Mansion House – and in the convivial atmosphere you have been enjoying today – it’s nearly possible to forget the extraordinary turmoil which is affecting the international banking and financial systems around the world.
Related
But I hope you will forgive me for bringing us back to reality – and for asking you to turn your minds back to the events of mid-September last year when the collapse of Lehman Brothers confirmed that the world was facing the worst financial crisis in generations.
Faced with the potential collapse of our financial system, the UK Government took unprecedented action, including subscribing for new shares in three of our largest banks.
Our decision to invest £37 billion in our leading banks, combined with additional private sector capital, prevented the collapse of the banking system and avoided devastating consequences for the real economy.
It became clear in the months after the recapitalisation that banks remained unsure about the value of legacy assets on their balance sheets and so were choosing to hoard capital rather than extend lending to new borrowers.
Content from our partners
If we had not dealt with this problem, this would have had the effect of further exacerbating the downturn and compounding the financial crisis.
It was clear that we had to act to clean up banks’ balance sheets. We were not prepared to run the risk of zombie banks holding our economy back for a generation.
So we announced in January the outline of an Asset Protection Scheme (APS), whereby for a substantial fee and loss sharing arrangement, the Government would provide banks with tail risk insurance against exceptional losses on legacy assets most affected by economic conditions.
RBS and Lloyds both announced their intention to participate in the scheme.
We needed to deal with any outstanding doubts about the capital security of our banks through a recession and so took the bold decision to insure £585bn of assets, including complex assets in jurisdictions outside the UK.
As a first step we conducted detailed diligence on two banks in January and February. As part of this the Financial Services Authority conducted detailed stress tests to ensure that, with the Asset Protection Scheme, the banks could withstand a severe recessionary scenario and maintain the supply of credit to the economy. The Treasury conducted its own stress tests on the assets to be placed into the Scheme.
Each of the banks will pay a fee to enter the scheme. They will then bear a substantial first loss on the assets that go into the scheme – £42.2 billion in the case of RBS, £35.2 billion for Lloyds.
The taxpayer will only be exposed if that first loss is exceeded. Even after that, the banks will still retain 10% of any further loss so that they remain interested in the outcome.
The Asset Protection Scheme will be administered by dedicated executive agency -the Asset Protection Agency – acting at arms length from the day-to-day business of the Treasury. We are in the process of recruiting a highly qualified Chief Executive to run the agency and administer the scheme on the taxpayer’s behalf.
We have reached agreements in principle with the participating banks and continue to work towards final signed agreements on all detailed terms, which we hope will be completed during the summer.
To tackle the global crisis, countries around the world must work together to deal with uncertainty surrounding bank assets.
And governments everywhere are taking steps to clean up the banks, putting in place solutions to the financial crisis that are tailored to the particular circumstances in their countries.
The US established the Trouble Asset Relief Program with participating banks including Citibank and Bank of America. The Dutch government have set up a similar scheme to protect assets of ING.
The Asset Protection Scheme was chosen as the best approach for the UK for a number of reasons.
First it enables the banks to remain substantially in the private sector – where they belong.
Second it ensures the most distressed assets are ring-fenced, capping the banks’ losses and freeing up the banks to increase lending.
Third it ensures the banks properly share the burden of losses with the taxpayer, and is structured with incentives to minimise those losses, so reducing the taxpayers’ exposure.
Fourth it has all the ring-fencing virtues of a bad bank approach, while leaving open the option that the covered assets can be reintegrated when they are no longer distressed.
Most importantly this model allowed us to act quickly and decisively. In the current climate, speed has been shown to be essential to restore confidence. The consequences of inaction would have been unthinkable.
We have also retained the flexibility to move to other models, such as an asset purchase scheme, in the future – if we consider that taxpayer interests would be best served by such an approach.
The APS has received some criticism. I would urge critics to hold fire until they have seen the detailed agreements that we are working on with the banks. But I’d like to take this opportunity to deal with some of the main concerns here.
Some have said that it will encourage banks to force companies into liquidation rather than helping them through the recession. We will make crystal clear in the rules of the Scheme that this is not the case.
The banks will be tasked with maximising the returns on these assets, including if necessary through supporting restructurings or renegotiations of debt agreements, in line with normal commercial practice.
We will be monitoring the performance of these assets closely – with benchmarks, regular reporting, an agreed upon asset management strategy. Where a bank fails to meet these high standards, we will reserve the right to step-in and appoint our own manager to manage assets in the Scheme.
Others have complained about the fact that international assets are included in the scheme. But the fact is that our banks are international banks; losses on assets held overseas are borne by the UK parent company. So once we have taken the decision to stand by systemically important institutions, that means protecting impaired assets wherever they may be. And of course this protection enables them boost lending.
The APS has also been criticised for not being a clean break, as the assets remain on bank balance sheets. We do not accept this argument. The APS allows us to rapidly implement support for bank balance sheets, allowing banks to maintain lending.
At the same time banks are best placed to manage a number of these complex assets in different jurisdictions and will be incentivised to do this well through the scheme rules. It is also possible that these assets might perform better than expected, mitigating the need for any payments to banks under the scheme.
Banks participating in the scheme will be required to meet the strictest international standards of public disclosure to ensure market confidence.
The Treasury, too, is setting new standards of fiscal transparency with respect to our financial sector interventions. In the Budget we made a provision of £20 to £50 billion for potential losses on these interventions and will update these figures as we complete our diligence on banks’ balance sheets.
As agreed by G20 and European Finance Ministers, an international approach to dealing with impaired assets is essential. There are major spillover benefits if countries act together, making individual schemes much more effective. Over the coming months, we look forward to working with like-minded partners to implement schemes that deal decisively with the banking sector problems that we face.
It is also vital that the EU Commission plays its role in ensuring rapid state aid clearance for schemes. These financial sector interventions are unusual. State aid is normally considered to be a disadvantage for competitors.
In this case, the scheme is open to all major UK banks and has helped to restore confidence in the banking system, which all banks benefit from. The fact that not all banks have sought to take up these schemes highlights the fair pricing that the Treasury has insisted on.
I make no apologies for saying that the Government is totally focused on defending the UK’s national interests in Europe. But we best defend our interests through active engagement with Europe. In fact European and international cooperation has never been more important to Britain’s national economic interest.
We must have greater cooperation between European regulators. We must make sure that we plug the gaps that have become very apparent over the last couple of years. What we could not live with – and we have made clear to our European colleagues that this is a point of principle – is an agreement at a European level that would have had domestic fiscal consequences for domestic governments. That is why supervision of individual institutions must remain a matter for national supervisors.
At a meeting of finance ministers this week Alistair Darling secured a commitment from his colleagues that any proposals should not impinge on this principle. We will continue to work with the EU to take these proposals forward, and ensure that we continue to lead the debate for effective and appropriate reform as with have with the G20.
I’d like to finish by reconfirming the UK government’s belief in the principle that financial markets need to be efficient, fair and stable to function properly. To achieve this the government will do what it takes to ensure the right regulatory, tax, skills and innovative environment exists.
We are already consulting on long-term issues around remuneration and corporate governance through the Walker Review, which is due to report in October.
And on 17 June – in his speech here at Mansion House – the Chancellor will set out the Government’s considerations on regulatory reform and macro-prudential issues.
We believe that an effective, commercial and privately owned banking system- that is properly supervised and regulated- remains the best system for generating and sustaining wealth, jobs and prosperity in our economy.
That will remain our focus for the future.
