Prem Sikka details the politics of banking bailouts and says that one deal in particular is bad for everyone except the bank’s fat cat bosses
IN THE coming months, the politics of bailouts are likely to receive considerable scrutiny. Without changing the nature of capitalism, financialisation of the economy or democratisation of corporate structures, governments are providing billions of pounds of taxpayers’ money to rescue the financial sector.
The British Government has guaranteed the security of the first £50,000 of each individual’s bank deposit. Northern Rock has been nationalised. Meanwhile, £100 billion has been injected into the banking system by taking a wide range of toxic assets as collateral. Another £200 billion has been provided through a special liquidity scheme. The Government is making capital investments to RBS, and upon a successful merger, HBOS and Lloyds TSB, totalling £37 billion. Altogether, the Government has probably committed around £500 billion and most banks have received some help. Without support from the state, many bank shares would be virtually worthless and their directors would be facing inquiries for reckless behaviour. The Bank of England estimates that the banking sector will produce losses of around £1,800 billion.
In an equivalent position, banks would impose a lot of covenants on borrowers. They would appoint directors, closely monitor costs and ensure that cash cannot be removed. In comparison, the conditions imposed by Gordon Brown’s Government are relatively weak. For example, the Government retains the right to appoint non-executive rather than executive directors. There are no plans to allow depositors, borrowers or employees to appoint directors and check their speculative instincts. Banks are allowed to pay dividends even before all loans from the taxpayer are repaid. The Government expects banks voluntarily to impose some constraints on executive remuneration, with vague threats of some regulatory action if they don’t.
In the financial sector, risks been transferred from markets to taxpayers. Banks can now bankrupt states. That alone should be a powerful reason to change the way banks operate. Instead, directors of some banks are giving a two-fingered salute to taxpayers.
Barclays, a major bank that is part of the world’s 25th biggest company, is an interesting case. It is facing a lawsuit in the United States claiming that it shunted hundreds of millions of dollars of toxic assets into two secretive investment vehicles. Its 2007 accounts show that the face value of its derivatives is more than £29 trillion, although analysts believe that the actual economic exposure, which is dependent on future events, may be around £2.4 trillion.
In August 2007, Barclays negotiated a £1.7 billion standby loan with the Bank of England. Earlier this year, it raised around £4.5 billion through a rights issue, but with the general collapse of the value of banking shares, shareholders only took up around 19 per cent of that. The remainder was taken up by Asian and Middle Eastern investors, including state-sponsored sovereign funds.
Now Barclays is looking for another £7.3 billion to strengthen its capital base. It has refused to join HBOS, Lloyds TSB and RBS and issue preference shares to the British Government. These would have come with a 12 per cent coupon rate. Instead it is raising money from Middle Eastern sovereign funds. The deal comes in two parts.
First, there is £3 billion through complex capital instruments from Qatar Holding and entities representing the beneficial interests of the Royal Family of Abu Dhabi. On this finance, Barclays will make annual payments of 14 per cent until June 2019.
Another £2.8 billion is being raised through convertible notes issued to Qatar Holding, Challenger Universal Limited and the Royal Family of Abu Dhabi. There is a further issue of £1.5 billion of convertible notes given to existing institutional shareholders and other institutional investors. These will carry an interest rate of 9.75 per cent.
Barclays has baulked at the coupon rate of 12 per cent for the British Government but is willing to pay 14 per cent to Middle Eastern investors. It is quite likely that the Government would have permitted Barclays to redeem any preference shares within a few years and thus limit the payment of interest. In contrast, the Middle Eastern deal locks Barclays into making payments for a decade and will continue to drain its cash flow. The deal also gives Middle Eastern investors the chance to buy shares at 22 per cent less than last week’s share price. The same is not available to ordinary shareholders. The deal will erode the wealth of Barclays’ current shareholders. Markets took a dim view of the deal and last week Barclays’ shares hit a 12-year low. The deal needs to be approved by shareholders at a meeting to be held on November 24.
Why are Barclays directors willing to pay over the odds for new finance? The official response is that directors wish to preserve their autonomy and set their own strategy – in other words, keep the Government at a distance. Such a reply presupposes that the new investors will not try to influence the bank’s policies – which is highly unlikely. It also assumes the Government is so impotent that it won’t introduce any legislation to provide strategic direction for banks.
However, a more plausible reason is that directors are keen to protect executive bonuses. Barclays’ most recent published accounts show that Bob Diamond, head of investment banking, received remuneration, made up of salary, bonuses and share options, of nearly £21 million.
Barclays will pay interest at the coupon rate of 14 per cent for the next decade. This cost is tax deductible and will reduce the bank’s taxable profits and tax bill in Britain. As Barclays’ new investors do not live in this country, they will receive interests gross – with no tax deducted at source. Since the recipients are not resident in Britain, they will not pay any British income tax on that income. The same will apply when the convertible notes are turned into shares and its holders receive dividends. The net result is that the British taxpayer will be subsidising Barclays’ financing arrangement to the tune of around £120 million a year. The Barclays directors’ choice will further erode this country’s tax base, just at the time when banks are being bailed out by its taxpayers. Barclays will still enjoy the taxpayer funded stand-by facilities from the Bank of England and the £50,000 deposit guarantee. It still expects the Government to be the lender of last resort.
Barclays’ finance deal is bad for its shareholders, pension funds and taxpayers. It will allow the company to pay fat cat bonuses. The Government should investigate the deal and refuse to provide any further funding. Regardless of how Barclays’ raises it finance, the Government should impose a statutory upper limit on executive remuneration. And while the Government is a listening mood, it should also investigate Barclays’ support for Robert Mugabe’s regime in Zimbabwe and its past support for the apartheid regime in South Africa.
Prem Sikka is professor of accounting at University of Essex
