British government throws $97B lifeline to U.K. banking system

The British government revealed plans on Wednesday to invest 50 billion pounds ($97 billion Cdn)  in a rescue package that would partially nationalize its major banks.

The government said the move is an attempt to provide stability to its troubled financial sector.

"This is not a time for conventional thinking or outdated dogma, but for the fresh and innovative intervention that gets to the heart of the problem," Prime Minister Gordon Brown told a news conference.

Shortly before markets opened on Wednesday, the British Treasury said it would invest the money in exchange for preference shares in eight of the country's largest banks and building societies:

• Abbey National PLC.
• Barclays PLC.
• HBOS PLC.
• HSBC Bank PLC.
• Lloyds TSB Bank PLC.
• Nationwide Building Society.
• Royal Bank of Scotland.
• Standard Chartered Bank.

Shares in these financial heavyweights have been falling in recent days as the U.S. economic crisis spreads to Europe.

Government help 

Alistair Darling, Britain's chancellor of the exchequer, said the government needed to take action because of extraordinary circumstances.

"The big problem is that if we don't do this, we run the risk that banks will stop lending to each other and if they don't lend to each other, then they won't lend to us," Darling said on the morning breakfast show GMTV.

"That is happening here, it is happening in America, it is happening in Europe, it is happening all over the world. I want to give a jolt to the system to move it on," he added.

Darling said the British government is "absolutely not" trying to seize control of the banks.

"We are not talking about running the banks. The banks will are going to be run as commercial operations, albeit with government help in restructuring," he said at the news conference with Brown.

Darling also said the Bank of England will offer at least 200 billion pounds ($387 billion Cdn) in short-term loans to improve liquidity. The scheme is designed to facilitate short-term borrowing and help to free up credit markets.

The Treasury also announced that it will also set up a special company to provide up to 250 billion pounds ($484 billion Cdn) in loan guarantees to banks and building societies.

The British prime minister said these new actions were necessary because a piecemeal approach would not work with such a large and growing problem.

"We decided we had to do more than provide liquidity or buy up assets as in the American program and, when we have to meet immediate and long-term challenges, no one measure alone will be sufficient. So, we have taken a comprehensive approach," Brown said.

In return, the affected financial institutions said they will raise their capital levels by a total of 25 billion pounds ($49 billion Cdn). 

Solvency issues

Banks and other similar companies in the industrialized world have run into fiscal trouble as the amount of cash they have on hand has shrunk compared to their outstanding lending. This ratio — known as a Tier 1 capital ratio — is a measure of a financial institution's solvency but was not a huge issue in past years.

Since investors realized back in March that the market for asset-backed commercial paper was moribund, however, depositors began seeking out banks and other lenders with limited exposure to these instruments.

In addition, these ailing firms had trouble finding new sources of capital investment because big lenders also had little interest in sinking their money in companies with high levels of this now-worthless debt.

With this rescue package, the U.K. government decided to step in as a lender of last resort, hoping that its appearance as a sector "white knight" will restore confidence in these firms among private sector lenders.

The U.S. Congress recently passed a legislative assistance plan for its banking and other financial players in the range of $700 billion US.  That program, however, will buy up companies' bad debt for resale later on, a different approach than the U.K. proposal.