Government stakes in banks raise counterparty conundrum
The collapse of Lehman Brothers in September has put greater focus on the issue of counterparty credit risk. But dealers admit to being stumped as to how the taking of equity stakes in major banks by governments across the globe will play out.
“We do not know yet how the government guarantees will work. We don’t know what it means to deal with one of these banks. Will the fact the government has taken an equity stake in a financial institution be a competitive advantage or disadvantage for us?” asks one head of structuring at a European bank, which was not part of any government rescue scheme.
On October 8, the UK government declared it would recapitalise the ailing banking sector by injecting up to $50 billion into eligible institutions. A week later, on October 13, it revealed it would pour a total of up to £37 billion into Royal Bank of Scotland, HBOS and Lloyds TSB in return for equity stakes in those firms. Once the capital injections have been made, the tier-one ratio of the banks should rise above 9%, the government said.
It also stated it would offer around £250 billion in government guarantees on short- and medium-term debt issued by those institutions that have raised tier-one capital to “appropriate” levels.
Other countries quickly followed suit. On the same day, a number of European governments, including Germany, France and Spain, announced similar measures to guarantee medium-term bank senior debt and invest in financial institutions, either through the purchase of preferred or ordinary shares, in order to boost tier-one capital levels.
And on October 14, US Treasury secretary Henry Paulson unveiled a plan to invest up to $250 billion in banks and thrifts, as part of the $700 billion rescue package approved by the US Congress earlier that month. Banks will receive capital in return for preferred shares, as well as warrants for common shares.
The capital injections also came with other conditions. In most cases, this included curbs on executive pay and bonuses, and commitments to help struggling borrowers stay in their homes. In the UK, for instance, the three banks had to commit to continue lending to homeowners and small businesses and support schemes to help people struggling with mortgage repayments to stay in their homes.
The three UK institutions also made commitments on the remuneration of senior executives. As part of this, the government said it expects no cash bonuses to be paid to board members this year. In the future, bonuses will be linked to “long-term value creation, taking account of risk”.
In addition, the government will have the right to agree with boards the appointment of new independent non-executive directors, and will have a say in dividend policy. Other countries’ rescue packages went further, insisting on government representatives on the board of directors.
Some dealers suggest these conditions could mean recapitalised banks are restricted in the derivatives business they can do in future. Caps on remuneration may also drive derivatives traders at those institutions to other banks.
“The recapitalised banks may well be seen as rock solid derivatives counterparties in future due to the government guarantees,” says one head of trading at a European firm, also untouched by government intervention. “But these firms aren’t likely to have the same appetite to structure derivatives. Can you imagine the headlines that would appear if a bank in which the government had a partial stake were to sell a derivative, and the client that bought it subsequently blew up? I just can’t see them letting that happen.”
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (point 2.4), printing is limited to a single copy.
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. As outlined in our terms and conditions, https://www.infopro-digital.com/terms-and-conditions/subscriptions/ (clause 2.4), an Authorised User may only make one copy of the materials for their own personal use. You must also comply with the restrictions in clause 2.5.
If you would like to purchase additional rights please email info@risk.net
More on Regulation
Critics warn against softening risk transfer rules for insurers
Proposal to cut capital for unfunded protection of loan books would create systemic risk, investors say
Barr defends easing of Basel III endgame proposal
Fed’s top regulator says he will stay and finish the package, is comfortable with capital impact
Bank of England to review UK clearing rules
Broader collateral set and greater margin transparency could be adopted from Emir 3.0, but not active accounts requirement
The wisdom of Oz? Why Australia is phasing out AT1s
Analysts think Australian banks will transition smoothly, but other countries unlikely to follow
EU trade repository matching disrupted by Emir overhaul
Some say problem affecting derivatives reporting has been resolved, but others find it persists
Barclays and HSBC opt for FRTB internal models
However, UK pair unlikely to chase approval in time for Basel III go-live in January 2026
Foreign banks want level playing field in US Basel III redraft
IHCs say capital charges for op risk and inter-affiliate trades out of line with US-based peers
CFTC’s Mersinger wants new rules for vertical silos
Republican commissioner shares Democrats’ concerns about combined FCMs and clearing houses