United Kingdom: Credit Guarantee Scheme

In the years leading up to the global financial crisis of 2007–2009, the UK banking system became increasingly reliant on short-term wholesale funding as growth in customer loans far outpaced that in customer deposits. As shown in Figure 1, the extent of this customer funding gap increased from under £600 billion in 2005 to about £900 billion just three years later. The result was that many UK banks became extremely vulnerable to disruptions in wholesale funding.

Although stress in the UK banking system was evident as early as the September 2007 run on Northern Rock (in which the loss of wholesale funding required Northern Rock to seek assistance from the Bank of England, triggering the first British bank run in almost 150 years), it was not until a year later that the magnitude of the problem became fully apparent. Lehman Brothers’ bankruptcy filing on September 15, 2008, resulted in a substantial spike in three-month interbank rates as indicated in Figure 2. Within a short time, the resulting deterioration of wholesale funding markets had threatened the continued existence of several of the UK’s leading financial institutions. On September 17, Lloyds TSB agreed to acquire HBOS for £12 billion in a bid to rescue the country’s largest mortgage lender. On September 29, the Chancellor of the Exchequer announced that the retail deposit business and branch network of Bradford & Bingley, the ninth-largest UK bank by market capitalization, had been transferred to Abbey National and its remaining business taken into public ownership following a determination by the Financial Services Authority that the bank no longer met minimum threshold conditions for operating as a depositor. These steps did little to calm the panic, however, and on October 6^,, the FTSE 100 fell by nearly 9% as it became apparent that the financial system faced the real risk of collapse.

Source: Bank of England 2011, p. 17

To avert this collapse, the British government announced a package of measures on October 8, 2008, designed to restore funding to banks. In addition to the Credit Guarantee Scheme (the Guarantee Scheme), this package included a £50 billion Bank Recapitalisation Fund (pursuant to which the government could inject capital into eligible institutions in return for equity) and an expansion of the existing Special Liquidity Scheme (pursuant to which banks could exchange high-quality mortgage-backed and other securities for HM Treasury bills for up to three years) to £200 billion, up from an initially projected £50 billion.

Under the Guarantee Scheme, eligible institutions could have eligible debt with terms of up to three years guaranteed by HM Treasury in exchange for a fee. The government does not appear to have established minimum maturity requirements for eligible debt. Initially, HM Treasury designated eight financial institutions, consisting of the major UK banks and largest building societies,^FNAbbey National, Barclays, HBOS, HSBC Bank, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland, and Standard Chartered. as eligible to participate in the Guarantee Scheme based on their commitment to strengthen their Tier 1 capital position via participation in the Bank Recapitalisation Fund. Other financial institutions could make a written request to HM Treasury for an “Institution Certificate” granting them eligibility. Subject to HM Treasury’s discretion, to receive an Institution Certificate an institution had to be an authorized UK deposit taker (including the UK subsidiary of a foreign bank) or a UK building society. The institution further had to meet a Tier 1 capital threshold specified by HM Treasury and would have its role in the UK banking system and overall economy evaluated. Finally, the institution had to agree to submit a plan for being able to access the wholesale funding markets without benefit of the Guarantee Scheme.

Eligible institutions (whether those initially designated as such or those requesting and receiving an Institution Certificate) had the ability to apply for an “Eligibility Certificate” with respect to a given proposed issuance of debt. The application would set forth details about the proposed issuance including the type of debt, the principal amount, the currency in which denominated, an indicative interest rate or discount and the proposed issuance and maturity dates. To be eligible for the Guarantee Scheme, the debt would have to meet “Instrument Eligibility Criteria” including:

• being a senior unsecured debt instrument with standard market terms in the form of a certificate of deposit, commercial paper, a bond or a note;
• being single currency denominated in an eligible currency (originally sterling, euros, or US dollars, but later expanded to include Australian dollars, Canadian dollars, Swiss Francs, and Japanese yen);
• not containing an event of default constituted by cross-default or cross-acceleration (i.e., a default or acceleration under other outstanding debt could not automatically give rise to a default under this debt); and
• being used to refinance liabilities maturing after the commencement of the Guarantee Scheme.

As part of its application, the eligible institution also had to include an executed “Counter-Indemnity” (pursuant to which the institution agreed to be responsible for any losses suffered by HM Treasury in connection with guaranteeing the institution’s debt) and an executed “Fee Letter” (pursuant to which the institution agreed to pay the fees associated with the Guarantee Scheme as described below).

The Eligibility Certificate issued upon acceptance of an application notified potential purchasers of the debt that HM Treasury would be responsible for any payments the debt-issuing institution failed to make. The terms of this obligation were set forth in a “Deed of Guarantee” made by HM Treasury in favor of all persons holding any debt guaranteed under the Guarantee Scheme. Once the Eligibility Certificate had been issued, the financial institution would have 30 days to issue the debt it covered.

Upon the earlier of the issuance of the debt or three business days after the issuance of the Eligibility Certificate, the financial institution would become responsible for paying a fee based on a per annum rate of 50 basis points (bps) plus 100% of the median five-year credit default swap (CDS) spread during the 12 months ended July 1, 2008, of the debt-issuing institution or any affiliate designated by HM Treasury. This fee would apply to the principal amount specified in the Eligibility Certificate and would last until the scheduled maturity of the debt (or for 30 days after the Eligibility Certificate was issued if no debt was ever issued). The fee was payable in the currency set forth in the Eligibility Certificate and could be increased to reflect any costs associated with payment in currencies other than sterling.

Participating institutions initially had to agree to specified limitations on balance sheet growth tied to the average growth of the UK banking sector and the growth of the UK’s economy.  UK authorities later eliminated these restrictions. The Guarantee Scheme also prohibited explicit use of the Scheme as part of an institution’s marketing.  With the prolongation of the Guarantee Scheme in April 2009, UK authorities introduced a requirement that large banks issuing guaranteed debt after April 9, 2009 agree to negotiated levels of lending to the real economy.

HM Treasury initially anticipated that £250 billion in debt would be issued under the Guarantee Scheme, and it established this amount as the size of the program subject to subsequent adjustment. HM Treasury determined the amount that individual institutions could issue pursuant to the Guarantee Scheme based on their sterling deposit liabilities. Eligible institutions had until the end of a specified issuance window (such end originally set as April 9, 2009, but later extended until December 31, 2009, and then February 28, 2010) to apply for Eligibility Certificates and make new issuances of guaranteed debt. Following the expiration of the issuance window (known in the parlance of the Guarantee Scheme as the “drawdown window”), all guaranteed debt issued pursuant to an Eligibility Certificate could be rolled over until April 13, 2012. After that date, up to £83 billion (one-third the £250 billion program size) in guaranteed debt could be rolled over until April 9, 2014.

The Guarantee Scheme originally prohibited institutions from repurchasing and retiring any debt issued. A June 2011 amendment established a Credit Guarantee Scheme Buyback Facility that enabled issuers to repurchase guaranteed debt prior to maturity subject to a break fee of 15% of the Guarantee Scheme fee that otherwise would have been payable had the guaranteed debt remained outstanding.

A small group of eligible institutions made significant use of the Guarantee Scheme in the first three months after its introduction. By the end of 2008, approximately £100 billion of debt had been issued pursuant to the program by 14 institutions (including Barclays Bank and Lloyds TSB). An additional 47 eligible institutions (including HSBC Bank and Standard Chartered Bank) did not issue any debt under the Guarantee Scheme. In March 2010, shortly after the issuance window for the Guarantee Scheme closed, outstanding issuances stood at £125 billion, down from a total of £134 billion outstanding as debt issued during the early days of the program matured (HM Treasury 2010). This was half of the £250 billion amount initially projected by HM Treasury.

As indicated in Figure 3, debt was issued under the Guarantee Scheme in several different currencies. The overwhelming majority of this debt had a maturity of between one and three years, with less than £2 billion being issued with a maturity less than 12 months.

Source: HM Treasury 2010, p. 2

As shown in Figure 4, under the Guarantee Scheme’s rollover provisions as much as £83 billion of guaranteed debt could have remained outstanding as late as the program’s April 2014 termination date. Participating institutions did not make use of this feature however, and by October 26, 2012, HM Treasury terminated the Guarantee Scheme after the final guarantee expired. Over the life of the program, HM Treasury collected fees totaling £4.3  billion and wasn’t required to make any guarantee payouts (National Audit Office 2013).

Source: National Audit Office 2010, p. 26