Banks set to agree £50bn package

UK banks are set to agree a £50bn injection of taypayers' money under a bold plan to resolve the crisis in credit markets. Banking chiefs were this evening due to meet the Prime Minister to discuss the proposals, scheduled to be announced tomorrow morning, but subject to seeing the detail, are understood to have already agreed to be supportive. The plan could mean substantial dilution for some shareholders.

Sir Fred Goodwin's top bullet point in his slide presentation to the Merrill Lynch banking conference in London this morning was: "The outlook is subdued". Even by the notoriously phlegmatic standards of the Royal Bank of Scotland chief executive, this was something of an understatement. In fact the outlook is truly dire, as one glance at Sir Fred's plummeting share price reveals - at the close it was down by nearly 40 per cent to a fifteen year low of less than a pound. RBS was not alone. Halifax Bank of Scotland shares were down by a similar order of magnitude.

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If there wasn't already a retail and wholesale run on these banks, there would have been by the time everyone had clocked the meltdown in share prices. Quite who was responsible for this latest, calamitous collapse in confidence scarcely seems to matter any more. Was it cack-handed briefing by the Treasury, or merely confidence sapping guesswork and speculation? Certainly it conforms to the Treasury's inept handling of this crisis from the start, where kite-flying and leaks over the Government's response have only succeeded in making a bad situation infinitely worse.

Who knows? What's important is that the Government is now seen to act, and despite the denials and hand-wringing, a substantial injection of taxpayers' money into the banking system now seems an inevitable part of the policy response and may even be announced in the morning. Again, if the recapitalisation hadn't been decided on before, it will have been by now. These stories have a habit of becoming self-fulfilling. Expect a stock exchange announcement first thing tomorrow.

I think we can be reasonably clear about how it's all going to work. One way or another, the weaker banks are going to be forced to sign up to recapitalisation whether they like it or not. Policymakers have taken the view that it has to be all for one and one for all. There's no point in a piecemeal approach as this will only switch the confidence issue from one bank to another.

Even Barclays, hitherto fiercely resistant to the idea that it needs more capital having only recently committed itself to a dividend increase, seems to have dropped its objections and is prepared to be supportive. A one size fits all approach would be acceptable to Barclays if it helps restore confidence in the banking system. As things stand, there is a high chance of a domino effect of failing banks. Once the markets have finished with one bank, they merely move on to another. If a bank as big as Royal Bank of Scotland were to start failing, all banks would eventually get sucked into the hole. An industry wide solution is therefore called for.

One reasonably eloquent way in which this might be achieved, which would address the problem apparent from the reaction of individual banks yesterday - that some of them still regard it as unnecessary and don't want to do it - would be to make in mandatory on UK banks to raise their so-called tier one equity capital ratios to 7 per cent or more.

The Treasury would stand ready to provide the money that would enable this to happen. In return, the taxpayer would get convertible preference shares on favourable terms.

Such an approach would leave the better capitalised banks - HSBC and Santander, where there is no perceived problem - free of interference. Only RBS, Barclays, HBOS and Lloyds would be caught by the edict. Can the UK Government do this unilaterally? The time for international convention on these matters seems to have passed. Each country must do what it can to bolster confidence in its banking system.

Exaggerated media reports that Sir Fred had begged the Government on bended knee for a massive capital injection certainly played their part in today's further, catastrophic collapse in bank share prices. Anything now seems to go in reporting on the affairs of banks, with even the most ill informed of briefings and rumours - many of which would in more normal times have been regarded as virtually actionable - now seen as fair game for publishing and spun as gospel truth.

Since the damage is now done, here's my penny's worth to add to the growing weight of negative speculation. According to one of the stories circulating in the market yesterday, so challenging did RBS's funding difficulties become late last week in its US retail banking division that it was forced to seek emergency assistance from the Bank of England on top of the liquidity available through generally available channels. Believe it if you will.

Whatever its validity, stories such as these have been piling the pressure on the Government to come up with an urgent, bold and immediate response. Recapitalisation on its own won't work. Indeed there is some danger than taxpayers' will only be throwing good money after the bad which has already been squandered. Yet in conjunction with a state guarantee of deposits, as announced by Ireland and others, deep cuts in interest rates, and further injections of liquidity, it might just succeed in putting a floor under the British banking system and halt the process of "deleveraging" which is threatening to undermine economic activity.