2. Use an objective and credible third party to analyse the ability of banks to withstand losses, and to go through their balance sheet with a fine tooth comb. This should be done with maximum transparency: the more clear, open and transparent the process, the greater the market and investor confidence which is likely. If this were Gordon Brown, he’d get one of his tame bankers to chair a commission that would give the banks a clean bill of health.
The way Sweden dealt last year with fears about losses to their banks from the Baltics presents a good role model. The full document is here and it was a multi-layered test. There was a breakdown of what each bank is exposed to (p3). A detailed outline of exactly what loss assumptions are being used - allows the investor to test them against own assumptions (p4). A ‘bad’ scenario - losing a third of all loans assumes 70percent default with only 50percent recovery. There was no sugar coating or wishful thinking about potential negative outcomes (p6). And then to show what losses of that magnitude mean for each bank, Sweden priced in every scenario short of Russia invading the Baltics and then said that nonetheless the banks had sufficient capital to withstand the hit. The regulators made Swebank raise some more capital to cover the potential for further hits just in case (fully covered by existing shareholders happy to cough up. Why? Because fear of the unknown had been removed.) Banks which are genuinely healthy should have nothing to fear from a process like this.
3. Judge success by a very simple metric: if loss disclosures and stress tests are credible, the private sector will provide new money. Banks with healthy margins and cleaned up balance sheets are normally great investments. Those who invested in Sweden’s banks after they had been cleaned up in both the early 1990s, and after the stress test process in 2009, made a killing. The same potential exists in Britain - this country having a long history of proving to be a good bet for lenders and investors.
Remember: when the state has to feed taxpayers’ money to the banks, this is always a sign of deep sickness. In most other countries with a debt crisis, banks in need of capital were able to get it from the private sector. Even where Swedish banks had been exposed to large losses in Latvia (mortgage NPLs of around 9percent) - the private sector fully provided the capital needs of Swedbank and others Scandinavian banks to cover Baltic losses. The credibility of the Government and regulator is also highly important to implementing this.
The sure fire sign of a failed bank rescue is the continual need for the taxpayer to provide capital - the third big bailout late last year was the largest thus far. Under Labour, the UK is now alone in its need to continually pump vast sums of money into the system. As the UK taxpayer was coughing up another £50 billion (along with taking £280 billion of dodgy RBS assets) through the final quarter of 2009, most other countries where quickly exiting their support at a profit. As far as I know Britain is the first country to have tried a bad bank structure (ie, the so-called ‘asset protection scheme’) and also have the taxpayer providing new bank equity at the same time. The whole point of ring-fencing losses via transferring liability to the taxpayer is to ensure private sector investment in the "cleaned up" bank.