Mammoth insurance plan for toxic assets

Government launches new package to rescue troubled banking sector

The Government will unveil a mammoth insurance plan today that could see the taxpayer take on "toxic" assets potentially worth hundreds of billions of pounds in a fresh attempt to kick-start the stalled banking system.

Banks will have to pay a fee or offer shares in exchange for the insurance, and will also sign a contract committing them to lend to British-based companies. The Government aims to reduce the uncertainty banks feel over the value of their assets.

The Treasury refused to put a figure on the size of liabilities it could take on, saying it would depend on the size of individual deals with banks. It is thought British banks hold toxic assets worth as much as £200bn. Officials will sit down with senior bankers over the next few weeks to negotiate which liabilities can be insured. Officials hope the scheme will provide stability to the stock market; on Friday, Barclays share price lost a quarter of its value.

Lengthy meetings between banks, the Bank of England, the Treasury and the Financial Services Authority have been taking place since Friday to hammer out the deal. The Chancellor, Alistair Darling, met senior bankers from the major banks individually yesterday.

The Treasury will also announce an extension of its £250bn credit guarantee scheme, designed to encourage inter-bank lending. The scheme was due to close in April, but will now remain open until the end of 2009.

State-owned Northern Rock is also abandoning plans to reduce its mortgage book as the Government aims to ease pressure on the mortgage market. A scheme to guarantee mortgage-backed securities will be announced.

In a report which predicted unemployment would rise to 3.4 million by 2011, the Ernst & Young Item Club noted that "all of the economic statistics are now in free-fall".

Amid the deepening sense of gloom, voters appear to be turning away from Labour. A YouGov poll published yesterday suggested the "Brown Bounce" was receding, with the Tories now 13 points ahead on 45 per cent and Labour on 32 per cent. Support for the Liberal Democrats slipped by a single point from last month to 14 per cent.

Plans for a government-run "bad bank", on to which banks could offload toxic assets, were found to be too unpopular after the £37bn bank recapitalisation programme last autumn. A plan in the US for a bad bank-style bailout foundered after banks and officials could not agree a valuation for the liabilities.

Treasury officials confirmed negotiations to take a bigger stake in some of Britain's biggest banks were continuing. The Government could take a step towards full nationalisation of Royal Bank of Scotland (RBS) as it is expected to offer to exchange its preference shares in the bank for ordinary shares. The offer comes amid suspicions that some of Britain's biggest lenders are preparing to announce some eye-watering losses for last year. RBS is rumoured to be preparing to unveil a record loss of £20bn for 2008.

The Prime Minister said the insurance plan aimed to inspire a resumption and expansion of lending: "What we want to do is see businesses get the money that they need to be able to create jobs and secure investment for the future. What I want to see is people who are mortgage-holders having access to mortgages at prices they can afford."

John McFall, the chairman of the Treasury Select Committee, backed the insurance plan. "We have got to go back again with a bigger sum because, quite frankly, the banks ... haven't been honest enough about the toxic assets on their books," he said.

The Liberal Democrat Treasury spokesman, Vince Cable, said full state control of the banks was essential to ensure lending resumed. "It's undoubtedly the case that there is an extreme crisis in the banks as revealed by the continuing panic selling of shares and the stasis that is crippling the economy. The Government must bite the bullet on the public ownership and control of the banks to ensure that lending is maintained to sound companies."

The shadow Chancellor, George Osborne, said: "The first priority is to bring stability to the banking system and get credit flowing to the economy. The time for ad hoc solutions is past. We need a comprehensive plan to restore stability and save jobs."

The rescue package

By Sean Farrell, Financial Editor

Bond guarantee scheme

What is the plan?

Instead of taking deposits and lending them out at a profit, banks became reliant for their funds on "securitisation" – packaging up their loans for sale. But buyers of the debt took fright when the markets froze in 2007. The Government plans to guarantee these bonds backed by mortgages and other assets so that banks can raise more funds to lend.

What will it cost?

The Government has about £150bn to spare from its original plan to guarantee bank debt, though that is the sum to be guaranteed, not the cost. James Crosby, below, the former boss of HBOS, who came up with the idea, has said the Government could make a profit on the plan.

Protection

What is the plan?

Banks still have billions of "illiquid" assets on their books that are near-impossible to value or trade. The Government has ditched the idea of buying them from the banks and is now prepared to guarantee them against losses, after the banks take an initial hit, in order to free banks to lend.

What will it cost?

The Government will not say how much will be guaranteed. It will charge banks a fee for the insurance, based on what the banks want to insure, and could make a profit.

Refinancing of previous bailout

What is the plan?

RBS and Lloyds say the 12 per cent interest they pay on preference shares the Government made them sell is too high. The Government could swap the "prefs" for ordinary shares, saving the banks money on interest payments. The Treasury could also cut the interest rate on any preference stock left. The banks would be freer to lend because they will be under less pressure to repay the expensive preference shares. They would also be able to pay a dividend. RBS, already 58 per cent state-owned, would welcome the idea, though it would take the state's stake to 70 per cent. Lloyds may resist because it would give the Treasury a majority interest, versus 43 per cent at present.

What will it cost?

Swapping the preference shares for ordinary stock could save the two banks a total of £1bn a year.