Specific issues and case studies of recent bank resolutions

DICJ Round Table Tokyo, 25-26 February 2009

Peter Smith Head of Department Banking & Compensation Reform Outline

• Where we were in February 2008 • Bradford and Bingley • Iceland • Bank recapitalisation, credit guarantee scheme and SLS • Guarantee scheme for ABS • Asset Protection Scheme • Legislative position in the UK • Where next globally • Where next in the UK Feb „08 – the last DICJ Roundtable

• Northern Rock: options for the UK authorities – What could we do? – What couldn‟t we do? • February 21 2008 - the Banking (Special Provisions) Act 2008 came into force • In January 2008, we produced a joint consultation paper on reform and strengthening the existing framework with colleagues at the Bank of England (BoE) and HM Treasury (HMT) Feb `08 - reform objectives

• Strengthen the stability and resilience of the financial system • Reduce the likelihood of individual banks facing difficulties • Reduce the impact if, nevertheless, a bank gets into difficulties • Provide effective compensation arrangements in which consumers have confidence • Ensure effective coordinated actions by authorities, both in the UK and internationally Strengthening the framework

• Authorities need a broader range of tools to control the process more effectively

• Need to support our “non-zero failure” stance – Reduce likelihood of failure – Ensure that failures can be managed, and minimise disruption and cost to the economy and individuals What happened?

• Increasing leverage in the banking and shadow banking system • Rapid extension of credit and falling credit standards • Increasing complexity of the securitised credit model • Property price booms • Underestimation of bank and market liquidity risk • A self-reinforcing cycle of irrational exuberance (FSA, Financial Risk Outlook, 9 February 2009) B&B

• Private sector solutions explored prior to intervention • On 27 September, it was determined that action was necessary • Auction process for various packages of assets and liabilities • Retail deposits in the UK & the Isle of Man and branch network was transferred to Abbey (Santander) • Transfer of the retail deposit book was backed by cash from HMT and the Financial Services Compensation Scheme (FSCS) • Split of about £14bn FSCS and £6bn HMT B&B

• FSCS involvement financed by a short term loan from the BoE, now replaced with a loan from the government • Residue of B&B in solvent wind-down in public ownership • HMT and FSCS will make recoveries from the wind-down B&B

• The government put in place arrangements for 6 months to guarantee wholesale borrowings and deposits • B&B pay an appropriate fee for this • The listing of B&B has been cancelled • An independent valuer will determine the value of the B&B shares had the authorities not stepped in to provide public support Iceland - Landsbanki (“Icesave”)

• An EEA branch allowed to operate in the UK under EU legislation • Icesave is an internet deposit brand • Declared in default on 7 October • All retail depositors will receive full compensation as HMT has guaranteed deposits beyond the FSCS limit • HMT made an order to freeze the UK assets of Landsbanki to help ensure UK wholesale creditors are treated fairly Iceland - Landsbanki (“Icesave”)

• FSCS put an online claims system into effect in November and around 190,000 people claimed compensation • Funds were transferred to them within five working days of them confirming their claim • Remaining customers made manual claims – approx 17,000 payments so far • Most outstanding claims relate to fixed term deposits which have not yet matured • About £3bn paid in compensation so far Iceland - Heritable

• Heritable is a UK subsidiary of Landsbanki • Put into administration in the UK • Retail deposit book transferred to ING nv (ING Direct) • The transfer was backed by cash from HMT and FSCS • FSCS contributed £0.5bn and 22,000 accounts were transferred to ING Iceland – KS&F

• Kaupthing, Singer & Friedlander is the UK subsidiary of Kaupthing • Put into administration in the UK • Retail deposits under the Edge (internet) brand transferred to ING Direct • The transfer was backed by cash from HMT and FSCS • FSCS contributed £2.5bn and 157,000 online accounts were transferred to ING Iceland – KS&F

• Small number of direct retail depositors to be paid compensation • FSCS will pay compensation up to the £50,000 limit and the government covering the amount in excess of this • FSCS payout is financed through a loan from the BoE Credit guarantee scheme

• October 2008 - HMT outlined plans to provide guarantees in relation to eligible instruments of relevant institutions • Aim is to ensure that the banking system has the funds necessary to maintain lending in the medium term • To be eligible institutions need to have tier 1 capital at a given level • About £100bn of guaranteed debt issued by end „08 Credit guarantee scheme

• Any UK incorporated bank (including UK subsidiaries of foreign institutions) may apply • Government decides if accepted on advice of FSA • Fee paid for guarantee • Term of instruments should be < 5 years, some flexibility to roll over • 0% risk weighting for capital adequacy • May be used as collateral with central bank Bank Recapitalisation Fund

• Introduced in October 2008

• Government will act as an underwriter or capital provider of last resort to enable banks to meet the capital standard required for participation in the Credit Guarantee Scheme

• Made available new tier 1 capital to UK banks and building societies Bank Recapitalisation Fund

• Government made capital investments in RBS and the now merged HBOS and Lloyds TSB totalling £37bn • FSA determine the appropriate level of capital in relation to the institutions specific risks and circumstances • Common framework to determine this – Total tier 1 ≥ 8% – Stressed core tier 1 ≥ 4% • Institutions using the recapitalisation scheme agreed to a range of commitments Bank Recapitalisation Fund

• UK Financial Investments Ltd (UKFI) set up in November `08 to manage the government holdings in these institutions on a commercial basis • UKFI wholly owned by the government • In due course, the government intends that UKFI will manage its investments in Northern Rock and B&B Special Liquidity Scheme

• Introduced on 21 April 2008 and drawdown period closed 30 January 2009 • Use of the scheme was around £185bn • A swap of high quality mortgage backed and other securities for UK Treasury Bills • Only for assets created prior to end of 2007 • Swap period of 1 year and may be renewed for up to 3 years • Any losses remain the banks‟ responsibility • A fee is charged Other liquidity support

• Discount Window Facility (DWF) introduced in October 2008 • Permanent facility to provide liquidity insurance to the banking system • Eligible institutions can borrow gilts against a wide range of collateral • On 19 Jan `09, BoE announced access to the DWF extended to 364 days in addition to the normal 30-day window • BoE continues to conduct auctions to lend sterling for three months and US dollar for one week against extended collateral Guarantee scheme for ABS

• On 19 January `09, the government announced a new guarantee scheme for asset backed securities • Provides full or partial guarantees to eligible triple-A rated ABS • Only transparent structures and high quality assets are eligible • The scheme will commence in April 2009 subject to state aid approval Asset Protection Scheme

• Announced on 19 January 2009 • Designed to protect financial institutions against exposure to exceptional future credit losses on certain portfolios • “First loss” amount still borne by the institution • Also required to retain a residual exposure • Charged a fee usually via the issue of a capital instruments (not ordinary shares) Asset Protection Scheme

• Need to meet certain eligibility criteria • Subject to conditions including a commitment to support lending to creditworthy borrowers in a commercial manner • Assets must be eligible • Required to give HMT and their advisors open access to all info required • Assets subject to HMT controls and regular reporting • Further details will be available in the last week of February 2008 The Banking Act 2009 Legislative position in the UK

• Banking Act 2009 received Royal Assent on 12 February • Numerous pieces of secondary legislation still to be agreed: – Rules around bank insolvency – Rules around bank administration – Enabling the FSCS to borrow from the National Loans Fund – Use of the FSCS to fund resolution tools – Potential pre-funding of the FSCS Where next globally

• There is work to develop more effective cross border co- operation through: – supervisory colleges – Cross Border Stability Groups • International policy developments to consider: – G20 in April – FSF work on resilience of the system and on financial crisis management – Basel Committee: • Work with IADI on Core Principles for Deposit Insurance • Cross-border Banking Resolution Group (CBRG) – EU work on: • early intervention • Deposit Guarantee Scheme Directive • Crisis management MoU • De Larosiere Group Where next in the UK

Some of the key issues for the FSA are: • Turner review • Remuneration • Follow up on short selling • Consulting on changes to liquidity policy • 2 further consultation papers on Banking Reform • Embedding changes made through the Supervisory Enhancement Programme • Finalising the Protocol between FSA and Bank of England on how we will work together in practice Further information

Contact: Peter Smith [email protected] +44 20 7066 7182