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No early bank exit for Britain

July 13, 2009

John Kingman has finally stated the obvious. After nine months of near-silence, the civil servant responsible for managing the UK government’s bank shareholdings has piped up to say Britain must be patient in recovering the 35 billion pounds it has so far injected into Royal Bank of Scotland and Lloyds Banking Group.

But Kingman has not gone far enough in stating his objectives. If British taxpayers are to fully recover the sums they have pledged to rescue their banks, they should hold onto their shares for a very long time.

UK Financial Investments, the body Kingman runs, has played down any hopes for an early exit from its bank shareholdings. This is sensible. With an election due in the next twelve months, Gordon Brown’s government is desperate to show an early return on the funds it has injected into the industry. But selling out now would be a mistake. The paper loss on Britain’s investments in RBS and Lloyds alone is currently around 11 billion pounds.

Meanwhile, UKFI is being far from clear about its own goals. Kingman even refuses to say whether he is aiming to fully recover the sums injected into RBS and Lloyds. True, setting an explicit target would tie UKFI’s hands by allowing investors to anticipate its actions. In the absence of a clarification, however, the suspicion will be that the government will in future raid its bank shareholdings to raise some much-needed cash.

One way out of this dilemma is to issue exchangeable bonds convertible into RBS and Lloyds shares at premium to the current market price. However, the government would be forced to buy back the bonds in the future if the shares failed to rise.

Moreover, taxpayers’ exposure to RBS and Lloyds goes far beyond the equity they currently hold. The government is about to insure those banks against future losses on some 450 billion pounds of toxic assets. In return for this insurance, UKFI will receive 51 billion and 37.1 billion non-voting shares in RBS and Lloyds, respectively.

But this does not compensate for the cost: mounting losses mean Lloyds could start claiming on its insurance policy before the end of 2009. The final bill will not be available for years.

Kingman is sitting on some valuable assets. But the government that employs him is facing a potentially vast — and currently unquantifiable — liability. When weighing up the merits of an early exit from the banking sector against extracting maximum value on its investments, UKFI should opt for the latter.

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