Thursday, October 09, 2008

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.

1 comment:

Gaurav Joshi said...

Hi Sir,
I am a 1st year MBA student at IIT Delhi. I have been a regular reader of the blog. It is really informative and easy to grasp because of the lucid style.
I wanted to ask about the robustness of the Indian banking system and the Indian banks in these financial crisis. I understand that with CRR and SLR requirements, Indian banks are very well capitalised. Also, as mentioned in the post, the government has promised to infuse capital as and when required.
However, my question comes in the wake of the recent sentiments against the ICICI bank and its exposure to the sub-prime losses. Inspite of repeated comments from RBI, Fin Min and the CMD of ICICI, the public sentiments remain shaky towards the banks' future. So much so that inspite of my repeated explanations, my Dad is adamant on withdrawing all the amount from the account and put up in a public sector bank.
If such is the case, what can the bank do to regain confidence among the depositors as frequent comments about the bank's sufficient liquidity dont seem to work.

Regards,
Gaurav