The Treasury is concerned that a further bailout of part-owned government bank The Royal Bank of Scotland (RBS) may be required.
The measure may be required as part of Europe’s requirement to recapitalise its banks. RBS received the largest bailout of a UK bank in 2008 and it is one of five major European banks that have a core tier one capital ratio that could fall below the required level once RBS’s exposure to toxic debt in the eurozone is calculated.
These levels were already calculated in July as part of the stress-tests demanded by European authorities to try and understand Europe’s banks exposure to euro debt.
However, in July although all of the banks were above the target level of capital ratio’s above five per cent, writedowns on eurozone sovereign debt was not taken into account.
RBS scored a capital ratio of 6.3 per cent in July’s stress test. The stress tests did very little to placate the markets, despite all major European banks passing them.
If the policy that emerges from European leaders incorporates a stronger effort to recapitalise the banks, it is possible that RBS will require more government money.
RBS will argue that in the past three months since the stress test it has reduced its level of exposure to toxic European debt. It’s exposure to Italian debt has fallen to €4 billion from €4.7 billion. It has also written down half of its €1.2 billion exposure to Greek debt.
The requirement of RBS for UK government funds will depend on what level European leaders set the core tier one capital ratio at. If it were set as high as eight per cent, RBS, Lloyds and Barclays would all need to raise more funds. Even if it were seven per cent, RBS would have to raise some funds, in the low tens of billions.
RBS, at 6.3 per cent, had a lower ratio than Lloyds, 7.7 per cent, and Barclays, at 7.3 per cent. Moody's, the credit ratings agency yesterday downgraded 12 UK finacial firms inclusing both RBS and Lloyds.
RBS would argue that the 6.3 per cent level is incorrect. This is because this ratio was calculated taking into account the huge losses the bank suffered as a result of the financial crisis and that its exposure to risk is less now.
If RBS did need to borrow more from the government it would be bad news for the UK taxpayer because under the terms of the government bailout, RBS can sell new shares to the government at 50p, around double the current market value.
This would cause a large loss to taxpayer funds and the action would happen when it is not necessarily required because RBS has reasonable levels of capital.
It is expected that if European leaders did insist that RBS required more funds, George Osborne would argue strongly that this is not the case because the 6.3 ratio was calculated using out-of-date data. Mr Osborne may even decide to fully nationalise RBS.
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