UK Bank Recapitalisation Scheme

According to the governor of the BOE, Mervyn King, the Recapitalisation Scheme in conjunction with the other two programs under the bank support package—the Guarantee Scheme and the Special Liquidity Scheme—would greatly resolve many of the UK’s problems in the crisis at the time. King said, “A major recapitalisation of the UK banking system of at least £50 billion is a necessary condition for regenerating confidence in the financial system” (HMT 2008a).

During a House of Commons debate, Chancellor of the Exchequer Alistair Darling made it clear that through the Recapitalisation Scheme, it was not the government’s goal to “run Britain’s banks—[it] want[s] to rebuild them.” Moreover, he said that to stabilize and rebuild the banking sector, the government would “maintain [its] stake for as long as it takes to do that,” with the “aim to sell the public share in the participating banks as soon as feasibly possible” (Darling 2008a).

It does not appear that the UK has any specific legislation in regard to HMT’s ability to recapitalize banks and receive shareholder interest in companies.

Given that the financial crisis led to a contracted credit market, access to liquidity became difficult for many financial institutions and “eroded the confidence in the creditworthiness of counterparties”. Because of the role financial institutions played in lending to the real economy, the EC was particularly concerned that liquidity worries in the banking sector would spill over into the rest of the British economy as well (EC 2008a). Under Article 87(3)(b) of the Treaty, the EC approved the Recapitalisation Scheme since it concerned the entire UK banking industry and the EC considered it as aid “necessary to remedy a serious disturbance in the British economy” (EC 2008a).

The EC also took the scale of the measure, the timeliness of the measure, and the extent of the measure into consideration. The EC stated that the objective of the scheme and its scope to only capitalize solvent companies were adequate to revitalize the lending market. Its position was that capital invested in preference shares that paid high annual dividends incentivized institutions to redeem shares as soon as possible (EC 2008a).

Finally, the EC noted that while a Special Liquidity Scheme had already been in place in the UK and the sole implementation of a guarantee scheme had been sufficient to resolve credit market problems in other countries like Denmark, liquidity shortages and write-downs might not have been completely covered by a guarantee scheme in other situations, such as what was occurring in the UK. Thus, the implementation of the Recapitalisation Scheme as an additional measure was likely to boost confidence in the UK banking system when working in tandem with the other programs submitted under the banking package (EC 2008a).

In November 2008, the UK government created UK Financial Investments to manage all UK government interest in individual banks or credit institutions. The overarching objective of UKFI was “to protect and create value for the taxpayer as shareholder, with due regard to financial stability and acting in a way that promotes competition.” UKFI’s board comprised a mix of nonexecutive private sector members, two senior government officials from HMT, and the shareholder executive, who managed all interests with a long-term perspective and independently from government supervision (HMT 2008c).

However, in April 2016, UK Government Investments was created as another government subsidiary that aimed to bring together the investments, which included remaining shares under the Recapitalisation Scheme, and the functions of UKFI and the shareholder executive. All remaining interests were transferred to UKGI in May 2018, following UKFI’s integration into the organization (UKGI 2018).

Once HMT had announced that three banks would participate in the Recapitalisation Scheme, £37 billion was raised through sales of gilts and other Treasury bills, according to the UK Debt Management Office (DMO) (UK DMO 2008).

A bank had to be “sufficiently capitalized” and a UK-incorporated bank, which included UK subsidiaries of foreign banking institutions, that had substantial business in the UK, or a building society. “Substantial business” in the UK meant that the bank was eligible to sign up for the BOE’s standing facilities according to the framework for the BOE operations in the sterling money markets, which meant banks with liabilities in excess of £500 million (EC 2008a). These liabilities included “non-interest bearing deposits and the interest earned from the deposits [that was] used by the Bank towards funding its operations” (Winters 2012).

In a statement to the UK Parliament’s House of Commons, Chancellor Darling clarified that an institution had to meet certain requirements prior to being allowed to access capital under the Recapitalisation Scheme. The institution had to be deemed solvent by the FSA; “have a substantial business model and delivery plan”; demonstrate “clear, broad-based, and sustainable” funding and sources; and have a “senior management team [that] must be credible” to carry out any presented business plan (Darling 2008b).

According to the EC decision, if an institution chose to raise funds via ordinary shares, the institution first had to undertake a placing and open offer, whereby it offered additional shares to existing shareholders for purchase. The UK government acted as the underwriter on any of these offers. Any shares that were not purchased by those existing shareholders, were invested in by the UK government under the Recapitalisation Scheme, where the government sought the “maximum permitted discount of 10% to the share price” (EC 2008a).

The FSA was responsible for determining how much capital was to be injected into a participating institution. The FSA calculated the capital assistance by using a variety of bank-specific stress tests, aimed at substantiating that any amount built outside confidence in the bank and that the bank would have enough capital to absorb losses in the case of a recession, tightened banking conditions, or to continue normal lending practices. Moreover, the FSA aimed to ensure banks had a ratio of “capital to risk-weighted assets of total Tier 1 Capital of at least 8% or greater and Core Tier 1 capital … of at least 4% after the stressed scenario” (FSA 2008).

This term was also applied when converting preferred shares to ordinary shares (EC 2008a; EC 2009).

The preference shares paid an annual interest at the rate of 12% for the first five years and three-month Libor plus 700 basis points thereafter (EC 2009; Panetta et al. 2009). Some considered this interest rate more punitive compared to the US capital injection programs contributing to stigma for the UK scheme (Farrell and Woll 2014; Culpepper and Reinke 2014).

Other conditions participating banks must follow were:

1. no cash bonuses to directors for the current year’s performance and where it is contractually owed the bonuses were to be relinquished voluntarily;
2. compliance with an Association of British Insurers best practice code on executive pay, commitment to a new FSA code on risk based remuneration at the nonexecutive level, and remuneration structures to be reviewed to ensure that incentives reflect long-term value creation and risk;
3. if board members lose the confidence of the board, they could be dismissed at reasonable and fair cost and UK authorities worked with the board on its appointment of new independent directors;
4. commitments to maintain, over the next three years, lending to homeowners and to small businesses, at a level at least equivalent to that of 2007;
5. commitments to support schemes to help people struggling with mortgage payments to stay in their homes, and to support the expansion of financial capability initiatives; and
6. the activity of all participating banks limited to the higher of the average historical growth of the balance sheets in the UK banking sector during the period 1987 - 2007, or the annual rate of growth of UK nominal GDP in the preceding year (EC 2008a).

Participating banks instead provided a report illustrating that they remain fundamentally sound and the plan to repay injected capital (EC 2008b).

No further information was found on this.