2008 United Kingdom bank rescue package

Overview

During the period 2007–2009, the UK government intervened financially to support the UK banking sector, and four UK banks in particular. At peak, the cash cost of these interventions was £137 billion, paid to the banks in the form of loans and new capital. Most of this outlay has been recouped over the years. As at October 2021, the UK Office for Budget Responsibility reported the cost of these interventions as £33 billion, comprising a loss of £35.5 billion on the NatWest (formerly Royal Bank of Scotland (RBS)) rescue, offset by some net gains elsewhere. The first public indication of the crisis was in February 2007, when HSBC issued its first-ever profit warning as a result of losses incurred by its U.S. consumer finance arm. Later that year, in July 2007, two Bear Stearns hedge funds became insolvent. There followed a series of global events that led to the seizure of interbank credit markets. The UK retail bank Northern Rock, which relied heavily on short term funding, sought emergency assistance from the Bank of England. When this arrangement was publicised, the bank experienced the first run on a British bank in 150 years. In news reported around the world, customers of the bank were shown queuing outside branches to withdraw their deposits. In an effort to stop the panic, on 17 September 2007, the Chancellor of the Exchequer, Alistair Darling, announced the government would guarantee all Northern Rock deposits. From September 2007 to December 2009, the UK Government made further interventions to support the banking sector, and specifically to RBS (now NatWest), Lloyds Banking Group (LBG), Bradford & Bingley as well as Northern Rock. Northern Rock and Bradford & Bingley were both taken into full public ownership; RBS was taken into majority public ownership; and the government took a minority stake in LBG. In addition to cash support, the UK government enacted a number of other schemes involving financial guarantees with the aim of restoring confidence in the banking sector. These were contingent liabilities that did not involve cash outlays. The National Audit Office (NAO) estimated that total guarantees added up to over £1 trillion at peak support. As these guarantees were gradually withdrawn or expired, the outstanding sum under guarantee stood at £14 billion as at 31 March 2018. Subsequently, broadly similar measures were introduced by the United States and the European Union in response to the 2008 financial crisis.

July 2007 to September 2008

The first public indication of the crisis was in February 2007, when HSBC issued its first-ever profit warning as a result of losses incurred by its U.S. consumer finance arm. Later that year, in July 2007, two Bear Stearns hedge funds became insolvent, and in August 2007, French bank BNP Paribas froze three investment funds. These events initiated a seizure in the wholesale interbank credit markets. On 14 August 2007 the FSA disclosed concerns about the UK mortgage bank Northern Rock, which relied heavily on such markets in its funding model, to HM Treasury and the Bank of England. On 13 September the BBC reported that Northern Rock had been granted emergency financial support by the Bank of England in its role as lender of last resort. This triggered the first run on a UK bank in 150 years, that was ended only when HM Treasury announced, on 20 September, that the UK government would guarantee all existing Northern Rock retail deposits. The following month, the guarantee was extended to all new deposits. In February 2008, Northern Rock was taken into full public ownership. In April 2008, the Bank of England launched the Special Liquidity Scheme, allowing banks to swap mortgage-backed assets for Treasury bonds, so providing more trusted collateral for accessing market liquidity. The same month, Royal Bank of Scotland launched a £12 billion rights issue to supplement its equity capital. In September 2008, the US government launched bail-out rescues of the US mortgage lenders Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation).

September 2008 – collapse of Lehman Brothers

In 2008 Lehman Brothers was the fourth largest US investment bank, with worldwide operations. Its two principal business units were the broker dealers Lehman Brothers Inc (LBI), based in New York, and Lehman Brothers International (Europe) (LBIE), based in London. The cash resources of the Lehman Group were managed centrally in New York by the parent company, Lehman Brothers Holdings Inc. (LBHI). Following a deterioration in LBHI's financial position, on the afternoon of Sunday 14 September 2008, the directors of Lehman Brothers International (Europe) Ltd (LBIE) sought assurances from LBHI that payments due to be made on its behalf on the following business day would be made. At approximately 12.30 am on 15 September, LBHI informed LBIE that it was preparing to file for Chapter 11 Bankruptcy protection under US law and that it was therefore no longer in a position to make payments to or on behalf of LBIE. Accordingly, overnight preparations were made for a number of UK based Lehman companies to protect their interests by seeking an Administration Order under UK law. This order was granted by a UK judge at 7.56 am on Monday 15 September 2008. The immediate impact of the failure of the LBIE business in particular included 142,000 unsettled securities trades to which LBIE was a counterparty, of which approximately 83,500 were trades to be settled in Europe, 45,000 in Asia and 12,500 in the US. There were gross assets (i.e. grossed up for collateral and Client Assets)totalling $628 billion and gross liabilities of $611 billion, which after counterparty and cross product netting and eliminating amounts relating to trust property, reduced to assets of $49.5 billion and liabilities of $32.6 billion. These were frozen and would remain so for several years. The Lehman collapse initiated a period of significant market turmoil. This was caused by complex financial interrelationships between the major banks, since assets on the Lehman balance sheet were inaccessible by counterparties, creating a domino effect in financial markets.

Failure of HBOS and Lloyds takeover

Following the market disruption caused by the Lehman collapse, attention turned to HBOS, then the UK's largest mortgage lender. The bank had first appeared on the HM Treasury watch list after the Northern Rock problems surfaced, when it became clear that the HBOS funding model closely resembled that of Northern Rock. The bank was offering highly competitive and unprofitable housing market loans, combined with aggressive and high risk commercial lending. By July 2008, profits had halved and bad debts were up by a third. On 16 September HBOS saw 33 per cent of its value wiped out in a single day. The Financial Services Authority (FSA), the UK financial services regulator, responded by imposing a temporary ban on short selling of shares. At the same time, the UK government brokered an agreement with Lloyds Bank to acquire HBOS in a private sector deal. This was announced three days after the Lehman Brothers collapse, on 18 September.

Preparation of the recapitalisation plan

By the end of September 2008, Mervyn King, Governor of the Bank of England, Adair Turner, Chairman of the FSA, and Alistair Darling agreed that plans needed to be prepared for the recapitalisation of the banking system. Until that point, the crisis had primarily been one of liquidity, but the problem had now shifted to one of lack of capital. The only realistic source of new capital was the UK government. Darling instructed the Treasury to prepare a recapitalisation plan that envisaged the injection of billions of pounds into UK banks in return for equity. This would be financed by UK government bond sales.

Royal Bank of Scotland imminent collapse

On 7 October 2008, following a 35% plunge in the bank's share price, dealing in the bank's shares was suspended. The bank Chairman, Tom McKillop, contacted the Chancellor of the Exchequer, Alistair Darling, to advise that the bank was within hours of running out of money. Darling later observed that

When dealings in bank shares are suspended it is all over. I knew the bank was finished, in the most spectacular way possible. The game was up. If the markets could give up on RBS, one of the largest banks in the world, all bets on Britain's and the world's financial system were off. This was the decisive event that triggered the implementation of the recapitalisation plan.

Detailed support measures

The intervention plan provided for several sources of funding to be made available to an aggregate total of £137 billion in cash injections and loans at peak, and a further £1,029 billion in guarantees at peak. As at October 2021, the OBR reported the current cost of these interventions as £33 billion, comprising a loss of £35.5 billion on the NatWest (formerly Royal Bank of Scotland) rescue, offset by some net gains elsewhere.

Cash support

Through the Bank Recapitalisation Fund, the government bought a combination of ordinary shares and preference shares in the affected banks. The amount and proportion of the stake taken in any one bank was negotiated with the individual bank. Banks that accepted rescue packages had restrictions on executive pay and dividends to existing shareholders, as well as a mandate to offer reasonable credit to homeowners and small businesses. The long-term government plan was to offset the cost of this program by receiving dividends from these shares, and in the long run, to sell the shares after a market recovery. This plan covered the possibility of underwriting new issues of shares by any participating bank. The plan was characterised as, in effect, full or partial nationalisation. As at October 2021, the overall breakdown of cash support to banks and other entities was reported by the OBR to comprise the following:

source: OBR Economic and fiscal outlook October 2021 Notes

UKAR: UK Asset Resolution – managed UK government holdings in Bradford & Bingley and Northern Rock Asset Management plc prior to their sale. FSCS: Financial Services Compensation Scheme – the UK's statutory deposit insurance and investors' compensation scheme for customers of authorised financial services firms. CGS: Credit Guarantee Scheme – a scheme introduced in 2008 allowing banks to issue debt guaranteed by the government. The scheme closed in October 2012. SLS: Special Liquidity Scheme – designed to allow easier access to market liquidity by using UK Treasury securities as collateral. The scheme closed in January 2012.

Credit Guarantee Scheme

The Credit Guarantee Scheme formed part of the UK government's banking intervention measures announced on 8 October 2008, becoming operational on 13 October 2008. The scheme was designed to allow banks to issue debt guaranteed by the government, with the intention of enabling them to borrow more, and more cheaply, and hence lend more. The banks that participated in the scheme included RBS, Lloyds, Barclays, Bank of Scotland, Nationwide Building Society, Clydesdale Bank, Tesco Personal Finance, Yorkshire Building Society, and Skipton Building Society. The Scheme was closed to new issuance on 28 February 2010 and was finally closed when the final guarantee expired on 26 October 2012.

Special Liquidity Scheme

The Special Liquidity Scheme (SLS) was launched by the Bank of England on 21 April 2008. The SLS allowed banks to swap mortgage-backed and other securities for UK Treasury Bills. This was designed to allow easier access to market liquidity by using UK Treasury securities as collateral. The background to the scheme was the market closure for many securities, leaving assets on bank balance sheets which were unable to be sold or to be pledged as security to raise funds. This contributed to a market seizure where banks became reluctant to make new loans, even to each other. Under the SLS banks were provided with the means to swap illiquid assets, such as mortgage-backed securities, of designated quality for Treasury Bills. The SLS had three key features:

The asset swaps were long term, with each swap for a period of 1 year and a renewal option for up to 3 years. Banks retained responsibility for losses on their loans The SLS was only available for existing assets as at the end of 2007; the scheme could not be used to finance new lending. The SLS was closed in January 2012 when the last of the SLS transactions expired.

Asset Purchase Facility (Quantitative Easing)

The Bank of England Asset Purchase Facility, more commonly known as quantitative easing (QE), was introduced in 2009. This was primarily designed as an instrument of monetary policy. The mechanism required the Bank of England to purchase government bonds on the secondary market, financed by the creation of new central bank money. This would have the effect of increasing the asset prices of the bonds purchased, thereby lowering yields and dampening longer term interest rates. The aim of the policy was initially to ease liquidity constraints in the sterling reserves system, but evolved into a wider policy to provide economic stimulus. QE was enacted in six tranches between 2009 and 2020. At its peak in 2020, the portfolio totalled £895 billion, comprising £875 billion of UK government bonds and £20 billion of high grade commercial bonds. In February 2022 the Bank of England announced its intention to commence winding down the QE portfolio. Initially this would be achieved by not replacing tranches of maturing bonds, and would later be accelerated through active bond sales. In August 2022 the Bank of England reiterated its intention to accelerate the QE wind down through active bond sales. This policy was affirmed in an exchange of letters between the Bank of England and the UK Chancellor of the Exchequer in September 2022. Between February 2022 and September 2022, a total of £37.1bn of government bonds matured, reducing the outstanding stock from £875.0bn at the end of 2021 to £837.9bn. In addition, a total of £1.1bn of corporate bonds matured, reducing the stock from £20.0bn to £18.9bn, with sales of the remaining stock planned to begin on 27 September. On 28 September 2022 the Bank of England issued a Market Notice announcing its intention to "carry out purchases of long dated gilts in a temporary and targeted way". This was in response to market conditions in which the sterling exchange rate and bond asset pricing were significantly disrupted following a UK government fiscal statement. The Bank stated its announcement would apply to conventional gilts of residual maturity greater than 20 years in the secondary market. The existing constraints applicable to QE bond purchases would continue to apply. The funding of the purchases would be met from central bank reserves, but would be segregated in a different portfolio from existing asset purchases. The Bank also announced that its annual £80bn target to reduce the existing QE portfolio remained unchanged but, in the light of current market conditions, the beginning of gilt sale operations would be postponed to 31 October 2022.

Participating banks

The plan was open to all UK incorporated banks and all building societies, including the following: Abbey, Barclays, Clydesdale Bank, HBOS, HSBC, Lloyds, Nationwide Building Society, Royal Bank of Scotland, and Standard Chartered. The extent to which different banks participated varied according to their needs. HSBC Group issued a statement announcing it was injecting £750 m of capital into the UK bank and therefore has "no plans to utilise the UK government's recapitalisation initiative ... [as] the Group remains one of the most strongly capitalised and liquid banks in the world". Standard Chartered also declared its support for the scheme but its intention not to participate in the capital injection element. Barclays raised its own new capital from private investors.