Friday, Commerzbank released a report which analyzed the current situation in the UK banking sector and also its prospects, and commented that an expansion of Bank of England asset purchases may not be such a bad idea after all. The report also touched upon the implications of support measures for the UK government finances.
The support measures implemented by governments the world over to support the banking sector since the onset of the financial crisis include recapitalization, in which public funds are directly injected into the banking sector; debt guarantees, in which the government provides a guarantee against default on bank debts, and asset guarantees, in which the state assumes the risk of a portfolio of distressed assets.
The total amount of commitments and outlays of the UK government were recently estimated at 54% of the gross domestic product or GDP, with the proportion being the highest of all the industrialized nations. However, when compared against banking sector assets, UK commitments at 10.8% of the GDP were lower than those of the U.S., at 25.5%. The main reason for this, was that unlike in the U.S., asset protection scheme is not mandatory in the UK and only two banks have opted in - Royal Bank of Scotland or RBS, and Lloyds Banking Group.
The advantage that the UK government holds is that because debt and asset guarantee schemes comprise the largest share of government commitments, no direct injections of cash are required at this stage. The upside to such a scheme, is the fee the government receives from banks that wish to participate in the scheme, with the downside being the share of any losses less in the fee.
An estimate by the Department for Business, Innovation and Skills or BIS revealed that the UK government insured a portfolio worth £585 billion, with a maximum downside potential of£465 billion. Thus, although capital is not being directly injected, the contingent liabilities incurred by the government are huge.
In terms of the actual amounts paid out so far, RBS reportedly paid 4% to 6% of the insured portfolio of £325 billion for taking part in the guarantee scheme, while Lloyds Banking Group paid 6% of the insured portfolio of £260 billion. Putting it together, the total government revenue amounted to £32 billion compared to direct injections of £37 billion in recapitalization funds.
The main consequence that resulted from the government guarantee scheme will be the rise in the level of public debt. Estimates suggested that the addition to public net debt with the government acquisitions of RBS and Lloyds Banking Group were at a range of £1 trillion to £1.5 trillion, which is roughly equivalent to anywhere between 70% and 100% of the total GDP.
But eventhough contingent liabilities were high for the government, and there was little upside to the government in terms of sharing in rewards from future banking sector profits, it was also true that those banks which received cash injections will need to repay public funds at some point in the future, and in no sense do they get off for free.
This raises the question of how quickly banks will be able to repay the public funds. One of the ways in which domestic banks could restore profitability will be to raise interest margins. But as the Bank of England pointed out in its recent Financial Stability Report, intensified competition in mortgage lending means raising interest margins was unlikely at present. Experience of past crises suggests that banks typically take at least three years to return to profitability in the wake of a financial crisis, so the recovery process was likely to be sluggish, the report said.
Also, UK banks were under the additional burden of a huge funding gap, which is the difference between customer loans and deposits, with more than half the funding gap or around £400 billion accounted for by secured products sold to end-investors. If these were to be redeemed prior to the maturity of underlying mortgages, it would place additional pressure on bank balance sheets.
The report noted that adverse changes in global financial conditions and the occurrence of an asset-liability mismatch, with investors selling their asset-backed securities, will hurt bank profits and in turn adversely affect domestic growth. Viewed in this light, it is clear why the Bank of England must continue to push for an expansion of asset purchases above the £50 billion that was decided upon.
To sum it up, there is no doubt that both the government and the central bank played a key role in supporting the domestic banking sector in a time of crisis. The report noted that taxpayers would get their money back eventually, although it could take a number of years and that on the wake of a crisis of such magnitude, a return to "normality" cannot be expected for many years to come.
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June 12, 2026 17:14 ET Major central bank action was the focus this week in economic news. The European Central Bank became the first major central bank to move in response to the rising inflationary pressures in the backdrop of the conflict in the Middle East. In North America, the U.S. inflation and trade data as well as Canada’s central bank decision gained attention. The Chinese trade data was the main news in Asia.