Eurozone Follows U.K. Lead in Bid to Stem Financial Crisis

Eurozone Following in the U.K.'s Footsteps

European leaders yesterday agreed a co-ordinated plan that would see billions of euro injected into the continent’s struggling banks in a bid to boost confidence and enable the European financial sector to regain a degree of stability. The emergency mini-summit—attended by the 15 European Union (EU) member states using the euro plus Slovakia (which is set to join the Eurozone in January 2009), European Central Bank (ECB) President Jean-Claude Trichet and European Commission President José Manuel Barroso, and the United Kingdom—followed a meeting in the U.S. capital, Washington, that saw the Group of Seven (G7) agree to a common framework calling for the recapitalisation of banks with public and private funds, the insurance of depositors, and the unblocking of credit markets. Details of the European package of measures have been scarce; however, it is clear that the co-ordinated plan will closely mirror the £500-billion (US$858-billion) banking rescue package unveiled by the United Kingdom on 8 October (see United Kingdom: 8 October 2008: U.K. Government Unveils £50-bil. Bank Rescue Package). To this end, the Eurozone nations will guarantee loans between banks throughout 2009 and allow governments to buy stock in distressed financial companies.

The four key areas on which the rescue plan focuses are:

• Recapitalisation: Governments have promised to provide funds for banks that are struggling to raise fresh capital because of the effective freeze in inter-bank lending. As witnessed in the United Kingdom (see below), the majority of Europe's struggling banks and financial institutions, such as French-Belgian lender Dexia and Dutch-Belgian conglomerate Fortis, are expected to take advantage of this offer. The governments have, however, pledged to pursue wide-reaching restructuring of the leadership of those banks turning to the state for capital.
• State Ownership: Governments have also stated that they will be buying shares in the banks seeking recapitalisation. The Eurozone governments are currently considering the best way to ensure that banks receiving state capital and becoming in part state owned do not have an unfair advantage over those banks not turning to the government for help.
• Government Debt Guarantee: The governments will also be guaranteeing any new debts issued by the banks, including inter-bank loans, at market rates. The guarantees will be available to financial institutions operating within all EU member states until 31 December 2009 and will be valid for up to five years. As previously agreed, governments will also be guaranteeing savers’ deposits to at least the value of 50,000 euro.
• Improved Regulations: The governments have also agreed to encourage regulators to permit that assets be valued based on their risk of default instead of their current market price. The Europe-wide co-ordination of regulation is a relative novelty considering that up to now market regulation in the financial industry has by and large been under the control of national administrations and regulators. The need to improve regulation and accountability has become a mantra repeated by nearly every European government in the last month.

Although all the Eurozone countries will be launching similar measures, the amounts made available will differ, as will the extent of government participation in the banks seeking aid. The exact sums are due to be revealed later today, but France is expected to create a 40-billion-euro fund to take stakes in banks. This morning, Germany revealed its 470-billion-euro Financial Market Stabilisation Fund, which will provide 70 billion euro in recapitalisation funding and 400 billion euro in bank guarantees to help overcome the illiquidity in inter-bank lending, while the government will take on the risk acquired before 13 October 2008. Furthermore, the government will receive the right to guide the banks’ policies and direction and to make financing decisions. Some European countries, such as Portugal, which has approved the creation of a 20-billion-euro credit line to support banks, have already undertaken steps to boost their financial sectors. The announcement of the co-ordinated action has already mildly improved market performance after the freefall witnessed last week, which saw U.S. markets plunge by 18%, European stocks spiral by 22%, and Tokyo's Nikkei decrease by 24%. Asian markets have recovered some of the ground lost last week, while the FTSE 100 index in London jumped by 7% this morning.

The U.K. Rescue Plan in Action

The rescue plan is already being implemented in the United Kingdom. It has been revealed that the U.K. government will take a controlling stake in the Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS). The move was prompted by the revelation that RBS is seeking £20 billion from the government, effectively giving the state a controlling 60% stake in the bank, with £5 billion being issued in preferential shares and £15 billion being underwritten by the government. The amount of capital being raised is almost twice the present market value of RBS, which had lost 61% of its stocks at the close of business on Friday (10 October), coming in at £11.8 billion. Meanwhile, speculation is rising that HBOS will ask the government for £12 billion as the future of its merger with Lloyds TSB is looking increasingly shaky. If the merger goes ahead, the government will own 40% of the merged Lloyds TSB-HBOS. Barclays, one of the country's largest lending banks, has refused to turn to the government for funding, instead announcing that it will attempt to raise more than £6.5 billion from investors. The government has been encouraging banks to ask for more money than they need immediately so as to build a buffer against any possible further shocks to the financial system and to prevent any further deterioration in confidence.

Outlook and Implications

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