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Abyss Recedes, But Many Worries Remain
Nils Pratley:The abyss seems slightly further away, and there are three reasons to applaud the revised rescue package
Phew. The abyss seems slightly further away. There are three reasons to applaud the revised rescue package. First, the right people have been dismissed. Sir Fred

Goodwin failed at Royal Bank of Scotland when he was forced to crawl to shareholders for £12bn in the spring. Neither RBS's Sir Tom McKillop nor Lord Stevenson, the Mr Invisible at HBOS, held the basic qualification for bank chairmen of experience in banking. Farewell, both, you have spoiled your copybooks.

Andy Hornby, HBOS's chief executive, is young enough to rebuild his career - but he will have to do so at a supermarket, where he excelled, not a bank. He was the wrong person for the job.

The second reason to be cheerful is that the banks now look "bullet proof", as Eric Daniels, Lloyds TSB's chief executive, put it. When the dust settles, the Financial Services Authority will have to explain why it didn't stress-test the banks to destruction years ago, and not over a weekend in the middle of a crisis. The fact that an extra £43bn is required by four banks (on top of the fund-raisings already undertaken) is damning. The regulator, in effect, is admitting that it wasn't even close to the right answer in the past.

Third, yesterday's rescue package is a better deal for the taxpayer. Subscribing for ordinary shares in RBS and Lloyds/HBOS increases the chances that the government will eventually earn a profit. There are no guarantees, but investing in RBS at 65p-a-share looks a reasonable bet, even if earnings per share will be savaged once another 23bn ordinary shares are put into circulation. Current RBS shareholders should be warned, however: A "good" result for the taxpayer might be 10% appreciation a year for five years. That would make RBS's shares worth 105p in 2013 - not so good if you bought at 200p in the rights issue.

The protection for the taxpayers at RBS is the issue of £5bn of preference shares, which will earn £600m, or 12%, a year until the bank can buy them in. A similar principle applies at Lloyds/HBOS. There were two considerations here: the taxpayer needed to extract a full pound of flesh, but the banks couldn't be left so stricken that they couldn't make profits. The balance looks about right.

The worries? The UK will have a two-speed banking system, and nobody knows how it will work in practice. The free-wheeling bunch will be led by HSBC and Santander-owned Abbey, with Barclays pedaling desperately to join them. This crowd can set their own dividend policies, appoint whoever they wish to their boards and concentrate on stealing the cream in the UK lending market.

The slower-moving peloton comprises Royal Bank of Scotland and Lloyds/HBOS. This duo, or trio, can't pay ordinary dividends for the time being, and their boards will contain government-approved bankers. Most crucially, these banks must maintain "competitively priced lending to homeowners and to small businesses at 2007 levels" and support homeowners struggling with mortgage payments.

How onerous will these demands be? It's anybody's guess. It would clearly be silly to impose a blanket ban on repossessions - that would weaken the banks' security and make them weaker businesses. The hope is that a middle way will emerge whereby the banks, pumped up with new capital, can afford take an enlightened view.

It's a nice idea, but let's see if it works. If a deep recession arrives, the government will come under immense political pressure to interfere in the day-to-day business of deciding when to pull the plug on struggling businesses. No wonder Barclays is so keen to avoid the problem by raising its full quota of new capital privately.

So, yes, the UK banking system looks substantially stronger. But let's be realistic: if the FSA is even right about the need for £43bn of bullet-proofing for the banks, the real economy is in deep trouble.