Rock carving

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: Northern Rock was rescued in September 2007, more than a year before the much-bigger Royal Bank of Scotland (RBS), Lloyds TSB and HBOS. The mortgage bank may also be the first to wriggle out of government hands. On October 28th the European Commission approved a restructuring plan, as required under the European Union’s state-aid rules, splitting it into a good bank and a bad bank.

The good bank will keep the retail deposits and some existing mortgages. The bad bank will take no deposits and look after the remaining assets. UK Financial Investments (UKFI), which manages the government’s shareholdings in RBS and Lloyds, will take over both bits after the split. The plan is to sell the good bank and gradually run down the assets of the bad one, making sure in the process that neither distorts competition.

So far, so uncontroversial, except that there is some doubt as to whether the taxpayer is getting a good deal or being stuffed with Northern Rock’s most toxic assets. The elephant in the room is what restructuring the commission will force on RBS and Lloyds Banking Group (the merged Lloyds TSB and HBOS). Neelie Kroes, the European competition commissioner, has made it clear that she regards both banks as overlarge and over-competitive.

The most likely outcome is that each bank will have to shed some of its operations in Britain. Lloyds may sell its branches in Scotland, where HBOS has a big market share. RBS could close some of its corporate branches and concentrate on the NatWest retail brand. But would such measures be enough? The commission forced ING, a Dutch bancassurance conglomerate, to break itself in two (see article). Assessing the value of the government’s offer to insure up to £585 billion ($956 billion) of the banks’ bad loans through its asset-protection scheme (APS) could be crucial. Lloyds and RBS are still haggling with the Treasury over it.

Lloyds wants to duck the APS altogether by raising private capital, possibly more than £11 billion. If it did, the government would be invited to subscribe around £5 billion because it owns 43% of the bank. A question for the European Commission is whether Lloyds would distort competition more or less as a result of this extra shot of government cash.