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MS: Capital Raising by British Banks

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Mr Speaker,

With leave, I should like to make a statement on the incentive for capitalising financial institutions put forward by the Government.

Mr Speaker, I trust that everyone in this House is aware of recent turbulence in global markets. The government has diligently monitored recent developments. The rise of illiquid assets has resulted in reductions in interbank lending. It has resulted in a freezing of credit markets. And it has resulting in a global economic slowdown.

And Mr Speaker, the reasons for this are clear. Credit, and its availability, is critical for economic growth. It is critical for families seeking to purchase a home. It is critical for entrepreneurs wishing to start a business. It is critical for businesses seeking to expand their operations. Nearly every facet of our lives is impacted by credit.

And as a result of turbulence in financial markets, banks are not issuing credit. Following consultations with the United States, Germany, and France, there was consensus that efforts should be made to encourage private sector-led recapitalisation of key financial institutions. As a result of these consultations, the United Kingdom is introducing an incentive for the recapitalisation of British banks.

Mr Speaker, this is not a decision that I take lightly. However, it is my belief that, at this time, a private sector-led recapitalisation of banks is the far preferable option for ensuring the strength of the economy. Indeed, British banks are already seeking to raise capital on private markets. The alternative, simply injecting capital into banks, creates numerous risks to the public finances and the economy writ large.

First, Mr Speaker, there is the issue of shouldering risk. Under the scheme, private investors will bear a significant proportion of the risk involved. Under alternative proposals, the government would burden the entirety of the risk. This is not insignificant. The potential cost of the government's proposal is significantly lower than other proposals that were put forward. This proposal limits the exposure to the taxpayer. That is a duty of the Treasury.

Second, Mr Speaker, there is the matter of market distortion.  Banks being required to raise capital in private markets, in which investors shoulder significant risk, requires that banks perform in such a way as to be able to attract private capital. This creates accountability: investors will not invest in banks that they do not anticipate will improve their position. Direct government equity purchases, however, lack this market incentive and, rather, distort the marketplace.

Third, Mr Speaker, there is the matter of moral hazard. A government directly invested in a financial institution has an incentive to support its position, whereas a financial institution, backed by government capital, has incentive to take further risk. This runs the risk of, as a result of the government becoming an investor, financial risk exacerbating itself. It creates a risk taking incentive: if the government does not step in, the loss on its investment would be substantial. This is not true when private investors are involved. If they wished to shore up further investment, they would do so with their funds, absorbing the risk. Governments, of course, could theoretically take a loss: however, the experience of past government involvement in industry demonstrates that this is not the case.

The regulations regarding this scheme are as follows. The government will provide a guarantee for £20 billion worth of newly issued preference shares by United Kingdom-domiciled financial institutions. The exact size of the guarantee value for each institution will be negotiated between the institution and the Bank of England. Such guarantees will be limited to Tier 1 capital. In issuing these shares, institutions, in line with recent offers, are expected to offer them at a discount to the current share price. Institutions shall further be required to have an underwriter for the rights issue. Shares obtained by the underwriter shall not be guaranteed.

The guarantee will cover no more than 50% of capital losses, redeemable three years following the issuance of the shares. In negotiating the guarantee amount with the Bank of England, a financial institution may request less coverage for a greater number of shares - provided that the maximum liability remains the same (ie, a bank with £1 billion worth of guarantees could have £2 billion worth of shares guaranteed at 50% of losses or £4 billion worth of shares guaranteed at 25% of losses). The guarantee shall terminate three years following the issuance of shares. For clarity, Mr Speaker, the purchaser of shares under this guarantee shall only be able to redeem the guarantee if the shares are sold three years following their purchase. If selling their shares at a loss, the guarantor shall have first right of refusal.

Guaranteed shares purchased under this scheme shall be subject to a three year lock up order, preventing their sale or transfer of ownership during this time. Should an investor wish to sell or transfer ownership of the shares, they may request that the lock up order be waived. The waiver of the lock up order will invalidate the guarantee on the shares. This time frame is being put in place to ensure that investors are committed to the long term viability of these institutions, Mr Speaker. This is a scheme designed in such a way that there can be no shorting, no cut and running at the first sign of trouble. This is a scheme determined to bolster the health of Britain’s financial institutions.

There is, of course, the question of warrants. We have determined that banks issuing shares guaranteed under this scheme shall be required to issue warrants equal to 10% of the guaranteed share issue, to be held in trust by the Bank of England and exercised via sale of the warrants to other investors. Mr Speaker, the logic of this is simple. If investors benefit from purchasing shares in the banks, then the public will benefit as well. If banks benefit from the government’s guarantee, then the public finances will benefit as well. Financial institutions are welcome to include additional warrant agreements as part of their share issue.

Mr Speaker, the government will put into place additional safeguards in establishing this scheme. First, the government, consistent with typical practice, shall charge a fee for the guarantee, equal to 0.75% of the value of the guarantee - comparable to normal market rates. Second, the government will ringfence SDRT revenues generated from the sale of these shares for potential use if liability is accrued. Third, the government will not guarantee shares held by foreign government officials, foreign state-owned corporations - excluding pension funds, or foreign sovereign wealth funds.

Mr Speaker, I know that, in the press, the Member for City of Durham has repeatedly raised concerns about hedge funds. Mr Speaker, I trust the member is familiar with the operation of hedge funds, but, should show not be, I will remind her. Hedge funds, by design, invest in highly liquid assets. As a result of the requirement that shares be held for three years in order to qualify for a guarantee, they are, by definition, illiquid. For this reason, I must express doubt as to whether hedge fund managers would be particularly interested in investing via this scheme.

Mr Speaker, raising private capital is the right move at this time. It is the right move for our economy. It is the right move for the millions of workers who require access to credit. It is the right move for the British businesses that require access to credit. It is the right move for the communities across the country that require access to credit.

This government is taking decisive action to ensure financial markets are strong and stable.

I commend this statement to the House.

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Mr. Speaker, 

I thank the Chancellor for her statements. 

Of course, while incentivising capitalisation is important, it is becoming increasingly clear that this must also be met with institutional change – both because there is a moral need and that institutional change is likely necessary to stabilise the financial sector in the long term. What steps will the Chancellor be pursuing to implement such change?

Ruth Murphy.

Labour Member of Parliament for Liverpool Walton (1974-).

Opposition Whip (1982-).

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Mr Speaker,

I thank the Rt Hon Member for Kingston and Surbiton for her question and for her support of the government's plan.

I do, to a degree, agree with her that we need to look at our banks institutionally and as a sector. I previously outlined the need to reconsider and, to an extent, redesign the Tripartite Authorities to be more nimble and to rethink the current iteration of the Basel standards, perhaps introducing new measures such as countercyclical capital requirements. Banks, like governments, should build buffers during boom years in preparation for lean times.

We must further discuss regulation of risk taking at financial institutions. I know some have focused on the idea of banning bankers' bonuses. I am concerned that such unilateral action would damage the City as a global financial centre. To that degree, it is worth working with global partners to reform regulations. Some considerations that could be on the table include enhanced capital requirements for banks that provide bonuses that encourage risk taking. These proposals are in early stages and require consultation with global stakeholders.

Additionally, I trust the Rt Hon Member is familiar with reports issued by the Competition Commission regarding concentration in the retail banking and SME financing sectors. It is my belief, Mr Speaker, that we must do more to promote competition and diversity in the financial sector. The governments actions regarding the remutualisation of Northern Rock speak to our movement in that direction. In the future, I do believe we need stronger competition regulation in the financial sector. Additionally, we must look towards using a British Development Bank, which the government is consulting on, to support the emergence of challenger banks, both nationally and locally-focused, to increase competition in the financial sector.

The government looks forward to reporting on proposals to strengthen the financial sector in due course. However, for now I will say that I share the Rt Hon Member's concern that we need to facilitate broader change in the sector to improve resilience and provide better services for the British people.

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Mr. Speaker - 

There are many things that I object to about this scheme. I have made myself clear that this is just a terrible way to gamble the public's money. And this is a gamble that, three years from now, the shares of bank prices will not have lost any money. This government is gambling £20 billion of taxpayer money right now. And, if it loses, the wealthiest people in this country and world will benefit as this is literally an insurance policy for people with this level of access.

Second, there are several things the Chancellor has said that are fully contradictory.

I asked if sovereign wealth funds would be able to participate in this scheme. She responded by stating that no foreign sovereign wealth funds or state-owned enterprises will not be able to embark in this scheme. When I asked if this would be true for foreign-based pension funds like those found in the United States -- which are, indeed, enterprises owned by governments - I was told that these shares will be available to institutional investors. These remarks are obviously fully contradictory. Are these available to all institutional investors? Or are they available to just hand-picked institutional investors? The lack of clarity about this is very alarming.

As far as my concerns about hedge funds: There are no rules as to how hedge funds can invest their money. There are a wide variety of strategies across a very opaque investing field. But as this government has guaranteed protection against falling prices, I think it's very certain that hedge funds and billionaires with access to such shares and the like will clearly be interested in using taxpayer money for free insurance if they lose money.

But now the most alarming part of this is that the Chancellor is, on record, against limiting the bonuses of bankers. Under this government, a billionaire can buy shares of a bank, get paid by the government in case the bank shares fall in prices... and the executives of the bank in question can receive a bonus. 

This Chancellor mentioned moral hazards in her speech. 

Her party IS the moral hazard.

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Mr. Speaker,

For shame, for shame, for shame! The Chancellor has made crystal clear in her statement that the Conservative party stands for the richest in our society and bankers who make 6 figure salaries, and not for the average British citizen. I must say that I do not hold the Conservative party in high moral regard for being stewards of taxpayer money and taking care of all citizens, not just the wealthy elite--but I must say, even by my low estimation of the Tory party, this Government has gone below even my low expectations for them. As my Honourable Friend stated so eloquently, we face a farce where the wealthy can buy shares of a bank that the Government has guaranteed with public funds--and also receive a bonus for a clear track record of poor decisions. Mr. Speaker, this flies in the face of basic reason and basic decency. The British people deserve a Government that delivers on the needs of average British families, not the most wealthy in our society. It's clear who the Chancellor and the Government are focusing on--and it's not average British families.

Arnold Brown

Conservative MP for Solihull

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Mr Speaker,

I thank the Shadow Chancellor for finally showing up - well after the debate was scheduled to end.

Mr Speaker, we have allowed an exemption for pension funds as institutional investors given the scale of their investment. Of course, many pension funds do not directly invest, but rather contract through other funds. Therefore, their investment would still be protected to a degree. Such is the intermediary nature of the financial system.

Second, Mr Speaker, hedge funds are not fully protected against investments that perform poorly. Investors who lose money must still bear a loss, a sizable one at that. Likewise, nobody is getting paid by the government for bank investments going poorly. They will still lose money. Of course, I trust that the Shadow Chancellor does not understand financial loss. She wants workers to lose their savings, lose the value of the pound in their pocket, and she doesn't bat an eye at her shoddy economics.

Third, Mr Speaker, the government has taken decisive action against banker's bonuses in the event that further intervention is required. To say that I am opposed to limiting banker's bonuses, as writ, is wrong. As I clearly stated, banks that pay bonuses in such a way that bankers are encouraged to take greater risk should be subject to greater scrutiny. One mechanism which I discussed was requiring banks that use such performance metrics to hold greater capital reserves. This, of course, reduces their ability to make risky investments - limiting market exposure.

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