Turning the Corner on Capital?

On Thursday, at a meeting of the Keynes Society, I asked the head of Global Research at Deutsche Bank which bank would blink first and go to the government for an injection of fresh capital to bolster its balance sheet. The answer given was equivocal because, at the end of last week, we had a game theoretic situation in which no one bank wanted to be the first.

Now it seems that a quartet of some of the biggest and proudest names in UK banking history have been in constant negotiations throughout the weekend with the Treasury, Bank of England and Financial Services Authority.

Robert Peston blogs that an announcement will be made before the financial markets open tomorrow (Monday) which will make clear the staggering level of support that the banks will receive from the state. It will reveal just how fragile and exposed our banking sector has become - on a scale much greater than the risks facing the building society community. (Note that Britannia is in talks with the Co-Operative Bank to agree a merger).

RBS stands head and shoulders above the others and their CEO is resigning. They will be spitting blood in Edinburgh tonight - I was there in August to listen to Robert Peston speak at the Book Festival and there was palpable, almost seeting anger at the failure of Fred Goodwin and his senior management. Matters have deteriorated since then and his name will be reviled in Scotland for many years to come.

More capital - less leverage

There are two key strands to resolving the banking crisis - first to inject new sources of capital into the banking system and second for lenders to de-leverage - that in itself is not easy and may well involve a higher level of loan fore-closure than we have seen before. The supply of credit will be severely curtailed for several years to come as banks opt to operate with much lower ratios of loans to deposits. Welcome back to a decade or more of credit rationing.

It sounds as if the FSA and the Treasury are forcing the banks to recapitalise on a grander scale than they would ordinarily want - but these are unprecedented times and it makes sense for the capital base to be strengthened as much as possible given the depth of the recession that looks likely to engulf us during 2009.

Will the government’s implicit guarantee that no UK retail bank will be allowed to fail provide sufficient insurance for the banks to go back to their shareholders for extra capital? If so this might temper the truly enormous scale of public sector financial backing that we are likely to hear about tomorrow.

A fresh round of rights issues?

I opted out of the HBoS rights issue during the summer and for many thousands of us, shareholder value in HBoS has been all but destroyed - that is the price we pay for taking an equity stake in a failing business. But if share prices overall fall another ten to twenty per cent - this takes us to a decline of more than half the value of the FTSE-100 since the last peak .... and that is usually the time to start buying back into the market, there must be some real value out there somewhere. But where?

One last point:

The Observer today asked a highly pertinent question. The attention of politicians has naturally been focused on the banking sector - but will the bail out extend to the utility companies if the recession becomes extremely damaging?

Independent:
Stephen King: Lessons from the Great Depression of the 1930s have not been learnt