Jeremy Warner's Outlook: A banking bail-out that sticks in the craw even if economic salvation requires it

It may look like a bail-out, and to all intents and purposes actually be a bail-out, but please don't call it one. Rather, yesterday's "special liquidity scheme" is depicted by Bank of England and Treasury spiel as a temporary piece of support for the distressed banking system designed to improve liquidity and raise confidence at no risk to the taxpayer.

If this sounds vaguely familiar, it is because much the same thing was said when the authorities moved to bail out Northern Rock. That too was initially described as temporary liquidity support for an entirely solvent bank. Within months, the situation had spiralled out of control, culminating in the Rock's enforced nationalisation.

No one is saying the Rock debacle is about to be repeated in this instance, with the entire banking system eventually having to be brought into state ownership, yet the attempt to portray yesterday's initiative as an almost routine exercise in crisis control which demonstrates the Government's prowess in economic and financial management is ridiculous. To the contrary, the package is support for the British banking system of a scale and scope quite without precedent. What's more, the Bank of England has had to be dragged kicking and screaming into something which until only a few months back it would have regarded as anathema because of its potential for creating moral hazard.

Once apparently unwilling to listen to the problems of the banking system, still less offer any succour, the Governor of the Bank of England, Mervyn King, now seems to have turned sugar daddy in chief.

Far from being a natural progression, the scheme amounts to a 180-degree U-turn on the previously held position. Instead, there is now public acknowledgement that in fact the authorities have no option but to rescue banks from the consequences of their own folly.

Whether it is a fair comparison or not, the contrast between a government willingly providing the banking system with tens of billions of pounds' worth of liquidity while at the same time taking billions of pounds from low-paid, 10 per cent taxpayers is almost unavoidable.

Vince Cable, the Lib Dem Treasury spokesman, unusually had his metaphor mixed up yesterday when he depicted the taxpayer as Little Red Riding Hood being slowly devoured by the wolf of the British banking system. In the story she in fact ends up killing the wolf. None the less, the overriding point is fair enough.

Yesterday's special liquidity scheme is more risky than the Government pretends, while its claimed benefits are in fact not at all certain. Most banks agree that the "initial" £50bn of Government securities promised is unlikely to be enough, with perhaps as much as double that eventually borrowed.

The challenge for the Government was to use a form of words that promised enough to the markets to do the trick of getting credit securitisation moving again while seeming politically not so large that it threatens to devour the taxpayer whole. On neither count were the authorities entirely convincing.

The £50bn cited is but a small part of the funding gap faced by UK banks while the average mortgage spread is still tiny compared with what it was a decade ago and certainly not big enough for profitable lending. Bankers will want to see that spread rebuilt before they are willing to contemplate cheaper mortgages again.

For the time being, the announcement has had virtually no effect on Libor, which remains stubbornly high and if anything probably understates the true cost of lending in the wholesale markets. Nor are mortgages likely to get any less costly or more plentiful as a result of yesterday's initiative. Any early return to the halcyon days of a year ago is out of the question.

All that said, it is hard to see what else the Government and the Bank of England could have done. Perhaps unfortunately, letting banks go to the wall is not an option. Banks provide the plumbing of all modern economies. If they are allowed to break down, the wider economic consequences are likely to be catastrophic.

There was no obvious immediate danger of any of the major British banks becoming insolvent as a result of the credit crunch, but they had reached a stage where inability to securitise loans in the normal way was endangering their ability to lend. In time, there could therefore have been extreme economic fallout.

There were also some worrying straws in the wind. Northern Rock was one thing, but Bear Stearns was altogether bigger and more serious. Confidence had become so fragile that nobody seemed safe. Even the mighty HBOS, the Halifax/Bank of Scotland group, became subject to bear attack in an incident of rumour-mongering that could have produced a full-scale run.

As it is, the structure of the scheme allows the Government to argue that there is minimal exposure for the taxpayer. Risk of default or deterioration in value continues to lie with the issuing banks. The Bank of England is further protected by a 10-30 per cent haircut – that is, depending on the characteristics of the assets, banks will receive Government securities equal only to between £70 and £90 for every £100 of collateral.

Rather more worrying, credit card loans, which are an unsecured form of lending, are to be allowed as collateral alongside mortgages. The scheme is said to have an absolute limit of three years, yet quite what happens if markets are still closed at that time, or the value of the assets has suffered a collapse as a result of an extreme correction in the housing market, is not answered.

The risk to the taxpayer, though not high, is still real enough, with no guarantee that the scheme delivers the required result. Nor is there any guarantee that banks will indeed recapitalise in the manner the Government and the Bank of England require. Because of its critically undercapitalised position, Royal Bank of Scotland is now fully reconciled to taking the hit, but there is no sign of others champing at the bit.

No other industry could expect to enjoy the bail-out that banks are about to receive. Bankers would be among the first to argue that the disciplines of the market should apply in any other corporate disaster. The inability to find an acceptable market-based solution to the credit crunch is a terrible indictment of the City and its power of creativity. Yesterday's scheme may be necessary, but it sticks in the craw none the less.

RBS's painful reality check to claim scalps

Whatever corporate governance concessions Royal Bank of Scotland offers to the City today to placate angry investors over the bank's record-breaking rights issue, they are unlikely to satisfy.

Sir Tom McKillop, the chairman, was plainly not up to the job of controlling a chief executive as determined and powerful as Sir Fred Goodwin. As a former pharmaceuticals boss with limited experience of banking, Sir Tom's main qualification for the job seemed to be only that he was Scottish.

The unwritten rule that excludes all but members of the Edinburgh mafia from the top two positions is inappropriate to the global bank RBS has become. The board urgently needs to be beefed up with outside talent of international stature.

As for Sir Fred, the man who built the global bank, his position is obviously in considerable danger. If there had been any adequate succession planning, he might already have gone.

As it is, it looks as if he will have to cede both Direct Line and Churchill alongside the rights issue to put RBS back on the right capital footing. Highly cash-generative with low capital intensity, these are just the sort of businesses that banks would typically want to keep.

RBS is being forced to pay a terrible penalty for running such a high-risk capital position. The whole board is culpable in this misjudgement, but none more so than Sir Fred. Edinburgh bankers are meant to be innately conservative in their approach. RBS's determination to punch above its weight on the global stage seems to have resulted in the very reverse.

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