UK Bank Recapitalisation Scheme

In late 2007, Northern Rock reached out to UK authorities—the Bank of England (BOE), Her Majesty’s Treasury (HMT), and the Financial Services Authority (FSA)—otherwise known as the Tripartite Authorities, for liquidity support (HMT 2007). This information leaked and led to a massive run on the retail deposit business, where £4.6 billion was withdrawn, and prompting HMT to extend an emergency loan to the bank. With no luck in finding a buyer, Northern Rock was nationalized by HMT in February 2008 under the Banking (Special Provisions) Act of 2008, which granted the government the temporary ability to nationalize banks (HMT 2012).

In light of Northern Rock’s nationalization, the Tripartite Authorities undertook a full examination of the UK banking system, finding in the summer of 2008 that “broader systemic problems” were on the horizon, mostly due to solvency issues in large banks and building societies. On September 15, 2008, the US investment banking arm of Lehman Brothers filed for bankruptcy, leading to a fast deterioration of the global banking system. Global credit markets tightened as banks adjusted their balance sheets and contractions in the UK economy led to a freeze in the overall lending market. According to the BOE’s October 2008 Financial Stability Report, banks felt significant “funding pressure” following the failures of Washington Mutual and Lehman Brothers, where banks sought to deleverage their balance sheets rapidly, resulting in concerns over the capitalization and solvency of UK banks (BOE 2008). Share prices of Halifax Bank of Scotland (HBOS) and the Royal Bank of Scotland (RBS) fell significantly in the following weeks, while other companies sought to disband or merge certain business units with other banks (HMT 2012).

Seeking to reignite lending and to provide a backstop against further losses in the banking sector, HMT announced an economic package on October 8, 2008, aimed at combating the systemic problems across the lending market and mortgage market (HMT 2008a). The £500 billion bailout package included a series of system-wide programs intent on recapitalizing banks, guaranteeing bank loans and other debt, and providing extra liquidity to credit institutions. At the time, the BOE’s Monetary Policy Committee (MPC) believed that while the announcement would boost confidence in the UK’s banking sector, the impacts of the Recapitalisation Scheme’s “scale and timing” were still unclear (MPC 2008).

On October 12, the UK notified the European Commission (EC) of the new government Bank Recapitalisation Scheme, which the EC promptly approved a day later under the authority of Article 87(3)(b) of the EC Treaty. The overall bank support package required the largest UK banks and credit institutions to commit themselves to boosting their total Tier 1 capital by £25 billion, either by raising funds in the private sector or by requesting assistance from the government under the Recapitalisation Scheme (EC 2008a).

The scheme’s objective was to “shield the economic capital of the banking system and to ensure that banks are sufficiently strongly capitalized to meet potential stress.” The scheme, a cash facility backed by a £50 billion fund, was split into two tranches of £25 billion, with the first tranche intended for injecting capital to the largest UK banks and the second tranche intended for systemically important smaller banks, if capital necessary (EC 2008a).

To be considered eligible to participate in the scheme, an institution had to have been deemed solvent and fundamentally sound by the FSA. The type of institution eligible to participate could have been a domestic bank, a UK-subsidiary of a foreign institution, or a building society. Capital injections under the scheme were in exchange for either ordinary or preference shares in the participating institution, with the ultimate goal of ensuring taxpayers were adequately compensated and that banks were motivated to repurchase those shares once their capital positions were strengthened. Building societies that participated issued permanent interest-bearing shares (PIBS) in return (EC 2008a). If the institution issued ordinary shares in exchange for the capital injection, the UK government sought the maximum discount rate of 10% on the share price.

All preference shares issued to the UK government paid out an annual dividend of 12% for the first five years. Thereafter, if the UK government held any preference shares, the dividend payout was 7% annually, plus the three-month London Interbank Offered Rate (Libor). As long as preference shares existed, no dividends were paid out to ordinary shares. In terms of voting power, ordinary shares allowed the UK government to vote at any annual shareholder’s meeting of the company if dividends were not declared or paid in full. Preference shares did not provide shareholder voting rights (EC 2008a).

Any participating institution had to abide by special requirements under the Recapitalisation Scheme (EC 2008a):

1. Institutions could not pay out 2008 bonus compensation for executives and directors.
2. The UK government could dismiss a board member if there was a loss of confidence by the rest of the board of directors.
3. The UK government worked with the institution to appoint new independent nonexecutive directors; the number of directors was based on the extent of the financial assistance.
4. Banks had to commit themselves to support lending to small businesses and homeowners via competitively priced loans for three years.
5. The UK government could review and determine the dividend policy and bonus or additional compensation packages of employees.

Last, if an institution continued to benefit from the support under the Recapitalisation Scheme six months after the initial capital injection, it had to provide a liquidation or restructuring plan to the EC. However, an institution could redeem any shares issued to the UK government five years after the issuance of the shares or on a quarterly dividend payment date, with at least one-month prior notice to the FSA for redemptions on preference shares (EC 2008a). The Recapitalisation Scheme was to expire in six months, on April 13, 2009 but was extended till October 15, 2009 (EC 2009).

Eight major banks—Abbey National, Barclays, HBOS, HSBC Bank, Lloyds TSB, Nationwide Building Society, RBS, and Standard Chartered—committed themselves to increasing their total Tier 1 capital by £25 billion (EC 2008b). Following approval from the EC on October 13, the UK government announced capital injections in RBS, Lloyds TSB, and HBOS; Lloyds and HBOS were in the process of merging at the time (Darling 2008a). In November 2008, the UK government created UK Financial Investments (UKFI), a subsidiary of the UK government, to manage the UK government’s interests in any invested institutions, for the benefit of HMT and taxpayers, including the interest received under the Recapitalisation Scheme (HMT 2008c).

RBS received £20.5 billion under the scheme, issuing £15 billion in ordinary shares and £5.5 billion in preference shares, resulting in a 58% stake in RBS by the UK government. That stake increased to 68% once the UK government converted the preference shares to ordinary shares in January 2009 to remove the high dividend rate that RBS had to pay annually. In November, due to further losses incurred and write-downs by RBS, the government had to once again step in to inject an additional £25.5 billion, in the form of B shares, which increased its stake in RBS to about 83%. The government also set aside £8 billion under a Contingent Capital Commitment if RBS’ Tier 1 capital ratio further worsened (HMT 2011a).

While the UK government invested in Lloyds and HBOS individually in October 2008, by January, the government held £13 billion in ordinary shares and £4 billion in preference shares, equal to a 43.4% stake in Lloyds Banking Group (LBG), once the merger was complete. The preference shares were converted to ordinary shares in March, with no change in the government’s stake (HMT 2011a).

In December 2008, the UK altered the requirement that banks had to file a restructuring or liquidation plan, and instead required that they submit a report that showed “that they remain fundamentally sound and how they plan to repay state capital (EC 2008b). The UK government sought multiple six-month extensions of the Recapitalisation Scheme, as well as the Guarantee Scheme, from the EC, until it the Recapitalisation Scheme was finally allowed to expire on February 20, 2010.

By the end of 2010, the price of holding stakes in both RBS and LBG became £2.8 billion annually for UKFI because the share price of each company had not recovered since the original recapitalizations. It was not until September 2013 that UKFI began to gradually sell off the government’s stake in LBG. Following two accelerated book builds and two separate trading plans, UKFI sold off the entire government stake in LBG by May 2017. Although the UK government has received net proceeds of £4.6 billion thus far from sales of its stake in RBS, which started in June 2015, it still remained a majority shareholder (~62.4%) in RBS, as of June 30, 2018 (HMT 2018). Overall, the share prices in both RBS and LBG never rebounded from the crisis, resulting in a permanent reduction in the share value for the government.

On March 29, 2018, UKFI transferred any remaining interests it held to UK Government Investments (UKGI), a limited wholly owned company of HMT, which for the purposes of the Recapitalisation Scheme only included what remained of the UK government’s stake in RBS^FNOther investments included UK Asset Resolution, the holding company that held the remainder of Bradford & Bingley’s mortgage business and Northern Rock Asset Management’s business. The two businesses were runoffs from the two nationalized banks. (UKGI 2018).