Page last updated at 15:04 GMT, Monday, 19 January 2009

Q&A: How the banking plan works

The government has announced its latest package of measures to encourage banks to increase the amount of money they lend to businesses and individuals.

Gordon Brown and Alistair Darling
The government hopes the measures will boost lending

The plan includes an insurance scheme to cover bad debts held by banks and a 50bn fund to allow the Bank of England to lend money directly to businesses.

There have also been changes to some of the bank rescue measures announced last year.

How much will this rescue plan cost?

Billions of pounds, possibly. But exactly how many, no-one knows. Or at least, the Treasury is not saying.

There are some big figures knocking about, such as the initial 50bn being made available to big corporate borrowers.

However, that money will only be available in exchange for collateral.

So if a borrower defaults the government should get some money back, and if the borrower does not default and repays the loan, the government may make a commercial profit on the deal.

The same goes for the potentially huge asset protection scheme, under which the government is offering to insure, for a price, some of the expected future losses on past investments made by our banks.

If those losses crystallise, then some of them will effectively be transferred to the taxpayer.

If they do not, then again the taxpayer might make a profit on the premiums that the government will have charged.

It is worth noting that both Gordon Brown and Alistair Darling at their news conference skirted around questions about the eventual cost of all this.

However, they stressed that the money being put in would be mainly in the form of loans and not grants, so that there was every chance the government would get its money back.

So what is there in it for us?

If the plan works there will be greater stability for the banking system and greater access to loans, whether they be mortgages, overdrafts or business loans.

Anybody who has a mortgage or is considering taking one out will have spotted that banks are less keen to offer you a mortgage than they used to be.

And there have also been many examples of companies, that appear to be perfectly viable, having trouble borrowing the money they need to function normally.

So part of the government's big idea is that if the banks are protected against too many more big losses, then they will have to set aside less to cover them, and thus will have more to lend.

In fact, banks that buy the government's insurance policies are going to have to agree to lend more money to individuals and businesses as part of the deal.

If the government is so keen to encourage lending, why does it not just lend the money itself?

Actually, that's one of the key points of these measures.

Northern Rock, the nationalised bank, has been trying to cut back drastically on its lending so that it can pay back the money that it was lent by the government to stay in business.

But now the government has decided that this policy is counter-productive and so it has decided it does not need the money back quite so quickly.

So the state-owned bank may soon be in a position to start expanding its lending again.

And the really dramatic new idea is that the Bank of England will be lending directly to companies.

So instead of relying on banks doing so, the central bank will be able to lend 50bn of taxpayers' money to firms.

What if the government's plan does not work?

Then we really will be in a tricky spot.

The government's plan is not just aimed at restoring some of the flow of hard cash in the economy.

It also hopes to boost that very useful by-product known as confidence.

If that is restored then the government hopes the banks will be more inclined to indulge in normal lending, rather than being in a state of permanent paranoia in which they fear that almost everyone they might lend to is likely to go bust.

But if this latest plan does not work two things are likely.

Firstly, the economic downturn will be severe.

Secondly, some of our biggest banks may simply have to be nationalised outright to keep them functioning under the burden of even bigger losses than the ones they have already announced.

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