Time for Britain to close the GAPS

August 4, 2009

Britain’s asset protection scheme, invented to protect the banking system, is morphing into a bureaucratic monster. It’s time to kill it off. Though state support is still needed, there are simpler ways for the government to prop up its ailing lenders.

More than seven months after it was conceived, and five months after Royal Bank of Scotland and Lloyds Banking Group signed up to use it, details of the APS have still not been agreed. The sheer task of sifting through 585 billion pounds worth of loans to be insured by the government means any final agreement is months away.

The only winners from this mess are investment banks, accounting firms and the public sector, which has spawned another quango. The Asset Protection Agency is supposed to monitor the assets in the scheme and make sure that the banks — which are on the hook for only 10 percent of losses on insured loans above a “first-loss” portion — do not diddle taxpayers.

The APA has found an acting chief executive in Jeremy Bennett, a former Credit Suisse banker. But Bennett has let it be known he does not want the job on a permanent basis — hardly a ringing endorsement for the APA as it hunts for recruits.

The uncertainty is undermining the banking sector and delaying the economic recovery. Companies that have borrowed from RBS and Lloyds are struggling to renegotiate their debts because the banks want to know which loans will qualify for the scheme. Even once the scheme is up and running, the APA’s involvement could delay decision-making, forcing companies that might otherwise have been saved out of business.

Indeed, the entire concept of the APS as an insurance policy for banks is false, because insurance only makes sense if there is a reasonable chance it will not be claimed. Both Lloyds and RBS are rapidly burning through the 20-plus billion pounds in “first loss” buffers they negotiated in the spring and are likely to start demanding government cash some time next year. This will reveal the real function of the APS, which is for the government to recapitalise RBS and Lloyds through the back door without resorting to full nationalisation.

Enough. The government should scrap the APS and adopt a different approach. One far simpler option would be for the state to promise that it will maintain the capital ratios of RBS and Lloyds at a certain minimum level. As losses on existing loans were realised, the government could inject fresh capital in return for shares. This approach would guarantee the future viability of RBS and Lloyds, while sidestepping the complexity involved in setting up the APS. It would also have a similar effect on the public finances, because the government would only have to put up cash as it was needed.

True, accepting additional shares could lead to the creeping nationalisation of Lloyds and RBS, an outcome the government has been at pains to avoid. But it could limit its stake by, say, agreeing to buy shares at a large premium to the current market price. After all, the government is already doing something similar by accepting the “B” shares that RBS and Lloyds are issuing to pay for the APS. At least the alternative scheme would give the two banks a big incentive to minimise their losses. Who knows, they may even find a way to persuade private investors to put up some capital.

When the stability of the entire banking system was in doubt last January, the government needed to act swiftly to restore confidence. Unveiling the APS helped to calm the markets. But the scheme has outlived its usefulness and is in danger of taking on a Frankenstein-like life of its own. It is not too late to kill it off, and replace it with something much simpler.

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