UK bail out plan

Britain has unveiled a bail out plan that commentators recognise as more comprehensive and hence more likely to succeed than the US plan. Two distinctive elements:

• Recapitalisation of British banks upto 50 bn pounds.
• A 250 bn pound guarantee on wholesale funds raised by banks

The latter is important because provision of short-term liquidity by the central bank is not enough. Banks have a serious problem with getting term finance.

The first step is even more critical. Shoring up bank capital is critical to protecting them against failure and ensuring that credit flows resume. The US plan attacks this problem indirectly by putting a floor on their assets. But banks will need more capital- and it may take time for private investors to regain confidence in banks. So government recapitalisation must be a critical component of any bail-out plan in today's conditions.

This should have happened much earlier. If it had, the turmoil in the financial system would not have been as great. But, in the western economies and in the US particularly, there is a huge mental block against government ownership. There is also the issue of how much capital can be given to which private party. That's why governments have dithered.

In contrast, recapitalisation of India's banks has not posed a problem because they are predominantly government-owned. The government's readiness to recapitalise as required plus the fact of government backing of deposits are two reasons why the Indian banking system today stands out in today's crisis.