European Commission Forces UK Banking Shakeup

Posted by: Kerry Capell on November 03

British Chancellor Alistair Darling is proving to be a master in spin. On Nov. 3, Darling proclaimed the decision to inject an additional £25.5 billion ($41.6 billion) and £5.7 billion ($9.3 billion) of public money into Royal Bank of Scotland (RBS) and Lloyds Banking Group (LYG), respectively, as “a better deal for the taxpayer.”

Moreover, Darling says, the decision to force RBS and Lloyds to sell branches equating up to 10% of the UK retail banking market will dramatically increase competition, another big win for the British taxpayer.

If anyone deserves credit for what promises to be a massive shakeup of British banking, it’s outgoing European Union Competition Commissioner Neelie Kroes. Kroes is determined that Europe’s state-funded banks have no advantage over their private sector rivals. Determined to promote competition, the EC has demanded the sale of 318 RBS branches and more than 600 Lloyds outlets over the next four years.

RBS will also sell its NatWest brand in Scotland, RBS Insurance and its card payment business, Global Merchant Services. And Lloyds will also part with its TSB brand in England, Wales and Scotland and mortgage broker Cheltenham & Gloucester, as well as the Intelligent Finance online business.

Lloyds, which is 43.5% government-owned, says it has no plans to join the Government Asset Protection Scheme (GAPS), which provides state insurance for past toxic loans. It will pay the government £2.5 billion ($4.1 billion) to cover the cost of the insurance it has received from the government since February. Instead, Lloyds plans to raise £21 billion ($34 billion), including a £13.5 billon ($22 billion) rights issue and a £7.5 billion ($12 billion) debt swap.

It's a different story at RBS. The latest capital infusion takes the taxpayers' stake in the bank to 84.4% although voting rights are capped at 75%. Of this £25.5 billion ($42 billion), £13 billion ($21.2 billion) is upfront capital, £6 billion ($9.8 billion) is capital RBS can draw on if needed, and £6.5 billion ($10.6 billion) will be a fee taken as capital. And the British government has pledged to invest another £8 billion ($13 billion) of capital if the bank's finances deteriorated dramatically.

Unlike Lloyds, RBS will join GAPS and have £282 billion ($460 billion) of its assets insured by the taxpayer. That is less than £325 billion ($530 billion) of toxic assets first proposed in February, according to the Treasury.

So although the government is injecting more money, it is also reducing the size of the assets it is insuring. Moreover, the decision to force troubled banks to go back to basics, i.e. focus on lending and deposit taking as opposed to getting into a wide array of other higher risk businesses, is seen by many as necessary. Others such as the chairman of Britain's Financial Services Authority, Lord Turner, predicts that creating such "narrow" banks could endanger Britain's financial stability.

At a recent FSA conference Turner said: "The extreme narrow banking proposal is clearly doable in practical terms, but I believe could produce a financial system even more vulnerable to instability than the one we have today. In contrast the 'new Glass Steagall' divide is in principle attractive, but arguably best pursued through the capital requirements we place on trading activities rather than through an attempt to write a law prohibiting some activities and allowing others." What do you think?