Background to the Asset Protection Scheme
The Asset Protection Scheme (APS) was announced in January to remove uncertainty about the value of UK banks' past investments and bad debt exposure. The APS was also designed to allow banks to rebuild and restructure their operations to increase lending in the economy to both businesses and consumers.
At the time the world's financial system was facing a worsening crisis of confidence about the underlying value of bank assets not just in the UK, but globally. This was undermining financial stability and preventing the UK banking system from providing loans and mortgages as the banks continued to hoard cash to protect their balance sheets.
All major UK banks were eligible to apply for APS insurance though some banks like Barclays and HSBC didn't apply due to their stronger balance sheets, lower bad debt exposure and a reluctance to give the UK government equity, fearing increased intervention thereafter,
However, Royal Bank of Scotland and Lloyds Group agreed in principle in February and March respectively to participate in the APS and in return to pay a fee to the taxpayer. They also entered into legally binding commitments to increase lending in the economy.
At the time the APS was announced, both RBS and Lloyds had insufficient capital to withstand the downside risks to their balance sheets. They were unable to raise this capital through the private sector, and needed to call on the capital protection afforded by the APS.
These agreements have given both banks implicit protection for their balance sheets, allowing them to begin the process of rebuilding and restructuring the healthier core of their businesses and to increase lending.
Current Overview
Since the APS was initially announced, investor risk appetite and market conditions have improved significantly. The globally coordinated fiscal and monetary stimulus has contributed to the improvement in the macroeconomic situation and a degree of confidence in the banking system has now been restored. But it is clear following the week's announcements that more intervention in the UK banking sector is required.
Investors exposed to Lloyds Group and Royal Bank of Scotland in particular were forced to re-examine their strategies and expectations this week on news the UK government is to increase its stake in both banks. Equity investors also have to consider the implications of European Commission demands which require both LLOY and RBS to divest branches and business units to ensure the UK banking landscape remains competitive.
Royal Bank of Scotland
RBS has agreed to issue £25.5bn of new capital to the UK government in the form of B Shares which may be convertible, subject to conditions, into ordinary shares. The cash injection will give RBS the shameful title of the most bailed-out bank in the world, following the 2008/09 credit crunch. RBS is also to sell 318 UK branches, almost 15% of its network.
RBS has also agreed new terms for its APS participation.
