Historic deal to unglue stricken markets to be unveiled

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The Independent Online

The Bank of England will today reveal an initial £50bn liquidity injection into the financial system to stop the financial crisis wrecking the wider economy. The measures will involve the most radical overhaul of the Government's finances in response to a banking crisis for generations.

No maximum figure will be put on the extraordinary secured loans the central bank will provide to banks. The Bank has already said it will do whatever is necessary to boost liquidity to the panic-stricken market.

Lenders will welcome the package, which they have called for since the start of the crisis, but they will pay a price. The Chancellor made it clear yesterday that he expected Royal Bank of Scotland's £10bn to £12bn rights issue, likely to be announced tomorrow, to be the first of many capital raisings by Britain's banks.

Barclays, Bradford & Bingley and a host of other banks are thought to be reviewing their fundraising options. Barclays is said to be in talks with a number of Asian sovereign wealth funds that could take stakes. An announcement is unlikely before Barclays' annual general meeting on Thursday, but a capital injection into Britain's third-biggest bank could open the way for a mass capital raising to shore up confidence in the UK's stricken financial system.

Yesterday the Chancellor made his strongest demand yet for them to declare their maximum potential losses and raise capital from shareholders. Alistair Darling said: "We can't tell every bank what to do but if you look at what has been happening in the last few days, the pressure on banks to declare the extent of any losses they have made [and] to declare the extent of mortgage-backed securities they hold and how they are going to deal with it and how they are going to raise money from their shareholders... I think we will see much, much more of that."

Today's announcement will see the Bank of England swap banks' illiquid assets, mainly mortgage-backed securities, for government bonds, known as gilts. Lenders will then be able to sell the cast-iron government debt to raise cash, ungluing the market for inter-bank lending. The authorities hope that the availability of the funding will boost confidence and prompt banks to resume day-to-day lending to each other without having to make full use of the funds.

Lending in the mortgage market has almost ground to a halt in recent weeks as banks have hoarded cash. As well as hitting the housing sector, the lending drought has begun to starve companies of funding, causing consternation at the Bank of England and Downing Street. The realisation that the financial crisis was threatening the wider economy has spurred the authorities into action.

The Bank of England's most recent figures showed that it had only £2bn of gilts on its balance sheet – a fraction of the amount required to support the mortgage market alone. The plan announced today will therefore require a major revamp of the state's finances. To fund the shortfall, the Bank will either ask the Debt Management Office to issue extra gilts to lend on to banks or have the Government pay back certain loans borrowed from the Bank of England.

The asset swap will be for a year, but with the option to roll over for a further two years, giving lenders the long-term funding they have been craving. The Chancellor will make a statement to the House of Commons outlining the measures.

The Bank will impose a "haircut" when swapping the assets, valuing the lenders' collateral at less than its face value. Risk of default on the underlying loans will stay with the banks. The central bank will also impose a penalty interest rate on the banks.

RBS poised to sell insurance arm in massive shake-up

Royal Bank of Scotland is expected to announce the sale of its prizedinsurance division, aboard revamp and massive write-downs this week in a wholesale acknowledgement that it has mismanaged its strategy and governance.

Potential buyers such as AIG are said to be lining up to buy the insurance division for between £4bn to £5bn. Buyers will be able to drive a hard bargain, with RBS on the ropes and motor insurance prices at a low ebb.

The sale, which includes Direct Line, will be a blow to RBS's chief executive, Sir Fred Goodwin. He bought Churchill from Credit Suisse in 2003 for £1.1bn and has held the business up as a sign of RBS's diverse income.

The Churchill acquisition was one of the deals Sir Fred made after RBS bought NatWest in 2000, propelling RBS into the top 10 banks in the world. But the £10bnbuyout of ABN Amro's wholesale and overseas retail operations last year was the last straw for many RBS shareholders. Fears about RBS's capital have been realised, with a rights issue of up to £12bn expected tomorrow.

RBS is taking soundings from investors and will hold a board meeting this evening. Sir Fred's position hangs in the balance after he pushed through the ABN deal and poured scorn on doubters of RBS's capital strength.

Britain's second-biggest bank, which also owns Coutts, the Queen's bankers, will submit to shareholder pressure by seeking new heavyweight non-executive directors. Investors have long been concerned that RBS did not have enough boardroom bruisers to counter Sir Fred's mastery of numbers and deal-making zeal.

Directors are said to have rallied round Sir Fred, but with faith in the board shaken it will be down to the reaction of RBS's top 20 shareholders whether he survives, at least for now.

RBS is deciding how much to write down from its debt holdings. The tally was said to be nearing £7bn if the bank decided to take the maximum hit, putting pressure on its rivals to expose their worst-case losses.