Weak banks could be forced to accept government equity stakes under a financial rescue plan fleshed out on Monday by the US authorities.
The plan envisages stress testing the big banks to see how much extra capital they might need to remain solvent in the event that the recession turns out to be even worse than expected.
If regulators deem that a bank could need additional capital, but is in sufficiently good shape to merit further support, the government would then provide a capital buffer in the form of “mandatory convertible preferred” shares.
These shares will be convertible into equity at the discretion of bank management.
However, a senior Treasury official told the Financial Times that regulators would have a large say in this decision.
He said it was safe to assume that if a bank suffered large losses that eroded its equity, its regulators would say “it is time to get capital” either from the private sector or from the conversion of the government stake into common equity. The framework laid out could ultimately lead to the government taking sizeable equity stakes in big banks.
However, a policy statement they released also underscored the authorities’ lack of enthusiasm for nationalising US banks to overcome the financial crisis. In most cases, the process will work in slow motion, with government control growing as losses at the banks mount.
The most notable exception involves Citigroup, in which the government could take a large equity stake in the coming days.
There are three main elements to the statement. First, the Treasury, the Federal Reserve and the three bank regulators reiterated their commitment to avoiding the disorderly Lehman Brothers-style collapse of a big bank.
“We reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments,” they said.
This is designed to reassure clients of the weak banks and their bondholders. Standing behind these obligations does not necessarily imply that the authorities will support all banks in private markets.
But the statement does imply that at least the senior debtholders, and probably junior debtholders as well, will not be required to take a loss whatever happens.
Second, the authorities said all the big US banks were solvent. “The major US banking institutions have capital in excess of the amount required to be considered well capitalised.”
The authorities are emphasising that the stress test is intended to determine how much additional capital each bank might need if the economy turns out to be even worse than expected.
Privately, though, some senior policymakers think the stress test could reveal that some banks are vulnerable even in a base case scenario.
Third, the authorities said the “strong presumption of the Capital Assistance Programme is that banks should remain in private hands”. This indicates a preference wherever practicable for supporting banks in the private markets. But the statement stops short of ruling out full nationalisation in all cases.
The senior Treasury official said the expectation was that the government would make capital buffers available to support banks that were deemed sound by their regulators but the final decision would rest with the Treasury Secretary.
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