http://www.telegraph.co.uk/finance/news ... ained.html
What is the aim of today's intiatives?
The credit markets are still not working, despite an earlier £37bn injection of cash into British banks. The authorities fear that unless something is done to get credit flowing and confidence restored in the financial system, the recession will get worse.
It is hoping to break a vicious downward spiral whereby as the downturn deepens, more borrowers default. This leads banks to set aside more capital to cover the losses. leaving them wary of lending to businesses and individuals.
The knock on effect is families stop spending, more businesses fail and the economy is further damaged. The aim is to break this cycle so the economy recovers as families start to feel more secure about their savings and start spendng and banks begin providng more mortgages and working capital to businesses.
What happened to the last bank bail-out?
Last October the Government pumped £ 37bn of public money into the banks in an attempt to bolster confidence and increase lending, but it just wasn't enough. With property prices tumbling, borrowers defaulting and bad debts rising, the banks now face heavy losses.
No one can say for sure how much the losses will be, but Gordon Brown has urged the banks to come clean about the scale of their exposure.
Government sources said they were "shocked'' to discover that up to 80pc of lending by the big banks has been to companies and individuals overseas.
How can insuring bad loans help?
Banks are carrying bad loans on their books. Investors are nervous. They fear banks are not being up front about the size of their losses on these loans.
Banks also feel the same way about rivals. This lack of mutual trust has kept credit markets closed and they will remain so until the full extent of these bad loans is known. By offering to insure losses on banks' bad debts over a certain level, the government aims to put a floor under these liabilities.
It hopes that by acting now it can prevent a further loss of confidence in banks, which are expected to unveil heavy losses over the coming weeks. The argument is that by capping the losses, banks will feel happier about their prospects and start to lend more to businesses and households.
At the same big investors such as pension funds will feel confident enough to start lending to banks again, which will provide banks will all-important funding for new loans to individuals and businesses.
What about the "toxic bank''?
Ministers had been discussing a "toxic bank'' that would have bought up an estimated £200bn of the banks' bad assets, based on these loans, holding them in the hope that the economy recovered and their value rose. It would have allowed the banks to clear bad assets off their balance sheets, but the "toxic bank'' would have had to absorb any losses.
However, it would have been difficult to establish how much the Government should pay for bad assets. The insurance scheme means the Government only has to pick up the bill as and when the bad assets mature.
How much will the taxpayer be liable for?
The banks retain the bad assets on their books. All the taxpaper is liable for is the losses over a certain level. What that level is has not been spelt out but it could potentially be tens of billions. On the positive side, It could be that in a few years these assets will rise in value and even produce a profit.
Why does the government want a bigger stake in the banks?
When the government injected money into a number of banks last year, they took preference shares in banks such as Royal Bank of Scotland, Lloyds TSB and HBOS (which have since merged).
These are shares take "preference" over other creditors and committed the banks to paying off hundreds of millions of pounds to the taxpayer before they did anything else.
The government also asked to be paid a 12pc dividend on these shares. It is a heavy burden for struggling banks - they are being urged to lend more money while still having to pay the state a 12pc return on its investment at a time when interest rates are close to zero.
By converting the perference shares into ordinary shares the government will relieve banks of this burden and enable them to lend more. It does, however, move them closer to nationalisation - Royal Bank of Scotland for example will be almost 70pc state owned.
How does easing lendng restrictions at Northern Rock help?
The Government wants nationalised Northern Rock to be a "good bank" that will lend more to individuals and businesses.
When the bank was nationalised strict limits were put on new lending so the bank would not fall foul of the European Union's rules on state aid.
Capping Northern Rock's lending also meant it could make large repayments on the £27bn the Government loaned it. By reversing this this policy, ministers believe the bank will be able to increase lending at a time when other lenders have cut the amount of business they are doing.
Will it work?
This depends on the length and depth of the recession. Some economists believe that in the coming months a lot more public funding is going to be needed to limit the damage being caused across the economy by the continuing problems in the banking system.
Already it has fed through to the broader economy - a number of High Street retailers have collapsed with the loss of thousands of jobs.
The struggling car industry is laying off workers, cutting production and asking the government for help. There are reports that European banks have only reported 25pc of the bad loans they they on their books.
That means more pain to come in eurozone, our biggest tradng partner. The global economy is also slowing and even China is starting to feel the pinch. The outlook for an early recovery is not good.
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