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Not an island

7 October 2011 By Hugo Dixon

Britain shouldn’t distance itself from the European Union’s bank rescue plan. The UK may wish to wriggle out of recapitalising its lenders on the grounds that the euro crisis is across the English Channel. But there are good reasons to play ball.

For Prime Minister David Cameron, stuffing more money into the country’s lenders is unappealing. The bailouts of 2008 and 2009 were one reason the Labour government lost the last election. And the UK hardly wants to spend more on banks when it is trying to shrink the deficit and maintain the country’s triple-A credit rating.

But there are three reasons to take part in the EU exercise. First, UK banks are currently seeking to raise their capital ratios by rapidly deleveraging. This is having a negative impact on the real economy. If banks had more capital, there would be a lower risk of a renewed credit crunch.

Second, the country’s banks are exposed to the euro zone. True, they have taken writedowns earlier than most of their continental peers; and they are not having as much difficulty raising funding as, say, French lenders. But an extra capital cushion would help secure funding lines and protect against a euro shock.

Third, Britain has a strong interest in the rest of the EU recapitalising its banks as part of solving the broader crisis. If Cameron opts out, he will not be able to press Germany’s Angela Merkel and France’s Nicolas Sarkozy to take action.

RBS would need the most capital, according to a Breakingviews analysis based on a more rigorous version of July’s discredited stress tests. If sovereign bonds were marked to market and banks were required to have a core tier 1 capital ratio of 8 percent in an adverse scenario, it would need 12.5 billion euros.

The government, which already owns 83 percent of RBS, would be on the hook. But the state has already promised a further 8 billion pounds in contingent capital. That could be turned into an instrument – such as a mandatory convertible bond – that counts as core tier 1 capital today.

Under the same scenario, Barclays would need 4.9 billion euros. But it might just be able to get away without a state shareholder, as it did in 2008 when it raised capital from the Gulf.

Either way, this is not a time for dilly-dallying. Cameron should hold his nose and drink this unpleasant medicine in the public interest.


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