Q&A: What the bail-out means for you

The government on Monday launched its second bank rescue package, injecting billions of pounds more of the taxpayer’s money into saving Britain’s banks. What does this mean for mortgage borrowers, investors and savers?

What are the proposals?

* A ‘pay as you go’ insurance scheme, which will see an uncapped amount of ‘toxic’ bank debt underwritten by the public purse.

* A £100bn plan to kick-start mortgage lending.

* A £250bn credit guarantee scheme underwriting the risk of banks’ lending to each other, due to expire in April, extended to the end of this year at least.

* A project which allows banks to swap loans for government bonds extended.

* Last year’s bank bailout rules torn up so they have freedom to lend again.

How will the bail-out help mortgage borrowers?

The main problem for borrowers has been the lack of available finance. Banks have not been able to access funds, so have been limited in the amount of new lending they can provide to customers. They have only had the appetite to lend to the least risky borrowers so have restricted their best rates to those with the most equity or biggest deposits.

The steps taken by the government to offer guarantees on loans should improve confidence, mean that banks can access new funds more easily and make those funds available for borrowers. The government has also made banks promise to increase the amount of lending they are doing.

Will the measures work?

It will depend on how easily, and at what price, the banks can obtain protection from the government.

Government guarantees should help to revive investor interest in asset-backed securities, so banks will again be able to sell on their debt.

The Royal Institution of Chartered Surveyors (Rics) said that if this strategy was successful, it would offer lenders the opportunity to use wholesale funds to help supplement savers’ deposits as a source of finance for new mortgage loans.

“This is an important first step in putting in place the conditions for a return to an orderly housing market,” said Rics.

The government also announced that Northern Rock will have longer to repay its loans, which could free up more finance for new borrowing.

So will new mortgage rates get cheaper?

Lenders have already been reducing mortgage rates for new borrowers with large deposits. If banks have renewed confidence about lending then they could start to pass on rate cuts to more borrowers.

However, brokers said that as the government guarantees looked only to apply to the highest rated debt, riskier borrowers may not see any real benefit.

Any increase in liquidity should entice more lenders back into the market, and trigger some competitive new rates.

How does easing lending restrictions at Northern Rock help?

Northern Rock has been encouraging borrowers to move to other lenders in a effort to repay its £26.9bn government loan. However, now the Government wants it to slow down the rate of redemptions and lend more to individuals and businesses. The bank’s original redemption plan had put a drain on strained mortgage finance market as orphaned Northern Rock borrowers looked for new lenders.

An increased presence by Northern Rock could also lead to some attractive new deals being launched. It also means it will be able to increase lending at a time when other lenders have cut the amount of business they are doing.

I’m a long-suffering bank shareholder - I seem to have lost out again

Shares in RBS collapsed to a record low after the bank said it will report a record loss of up to £28bn for 2008 and amid fears that it faces nationalisation.

RBS was down 67 per cent on Monday to just 11.6p a share. Lloyds - which now owns HBOS - also crashed to new lows, off 34 per cent to close at 65p.

Shares in RBS have already plummeted more than 90 per cent in the credit crisis.

The agreed increase in the government’s stake in RBS to 70 per cent means that existing shareholders will own less of the bank - and any of its possible recovery potential.

But stock brokers also fear RBS could be heading for full nationalisation and many are advising investors to sell their shares now to get some value back.

“Equity holders will be eliminated,” warned Paul Kavanagh, partner at Killik & Co.

Graham Spooner, investment adviser at The Share Centre, said: “No doubt some shareholders will be tempted to hang onto their shares in the hope that things will pick up. However, RBS could be just one step away from nationalisation. As such we are advising shareholders to consider selling in order to recoup some of their losses”.

What about Lloyds/ex-HBOS shareholders?

Lloyds has not accepted a similar offer from the government to convert high-cost preference shares for ordinary equity. This means shareholders are undiluted for now, albeit that the bank is still saddled with a 12 per cent interest rate on these “prefs”.

What will the bailout mean for savings’ rates?

Savers could find the number of accounts offering attractive rates of interest cut if the second bank bailout is a success.

Although banks have mirrored the Bank of England’s interest rate cuts by reducing interest payable on savings products, competition for retail deposits has spurred providers to continue to offer a small number of relatively high paying accounts in order to attract new customers.

Savers can still earn 4.65 per cent in a 12 month bond from ICICI. Advisers say that if liquidity in the money markets improves banks may be less inclined to pay out interest rates 3 per cent higher than the base rate.

Will savings be safer following the deal?

While any scheme which strengthens the UK banking system is beneficial for customers, advisers say savers should already be feeling confident about the security of their money.

The first £50,000 held by a customer in a bank or building society is already protected by the Financial Services Compensation Scheme, including that held in Indian owned ICICI.

What about insurance policyholders with the banks?

The latest bail-out could spell more bad news for motorists already facing steep rises in their insurance premiums this year.

Some banks who have received state help, such as Royal Bank of Scotland, own the most well-known brands in motor insurance, like Direct Line, Churchill and Privilege.

In its British Insurance Premium index released last week, the AA forecast that quoted premiums will rise 10 - 12 per cent over the next year, as insurers face rising claim costs and shore up their capital bases.

But latest developments “will simply add pressure to increase premiums”, says the AA.

“The sector has not made an underwriting profit for some years and reserves and investment returns, which have allowed insurers to sustain negative underwriting profit in the past, are depleted,” says Simon Douglas, director of AA Insurance.

“We think that insurers are going to seek to improve underwriting performance over the coming year and that will also be true of the RBS brands.”