During the period 2007–2009, the UK government intervened financially to support the UK banking sector, and four UK banks in particular.

At peak, the cash cost of these interventions was £137billion, paid to the banks in the form of loans and new capital. Most of this outlay has been recouped over the years. As at October 2021, the UK Office for Budget Responsibility reported the cost of these interventions as £33billion, comprising a loss of £35.5billion on the NatWest (formerly Royal Bank of Scotland (RBS)) rescue, offset by some net gains elsewhere.

The first public indication of the crisis was in February 2007, when HSBC issued its first-ever profit warning as a result of losses incurred by its U.S. consumer finance arm. Later that year, in July 2007, two Bear Stearns hedge funds became insolvent. There followed a series of global events that led to the seizure of interbank credit markets. The UK retail bank Northern Rock, which relied heavily on short term funding, sought emergency assistance from the Bank of England. When this arrangement was publicised, the bank experienced the first run on a British bank in 150 years. In news reported around the world, customers of the bank were shown queuing outside branches to withdraw their deposits. In an effort to stop the panic, on 17 September 2007, the Chancellor of the Exchequer, Alistair Darling, announced the government would guarantee all Northern Rock deposits.

From September 2007 to December 2009, the UK Government made further interventions to support the banking sector, and specifically to RBS (now NatWest), Lloyds Banking Group (LBG), Bradford & Bingley as well as Northern Rock. Northern Rock and Bradford & Bingley were both taken into full public ownership; RBS was taken into majority public ownership; and the government took a minority stake in LBG.

In addition to cash support, the UK government enacted a number of other schemes involving financial guarantees with the aim of restoring confidence in the banking sector. These were contingent liabilities that did not involve cash outlays. The National Audit Office (NAO) estimated that total guarantees added up to over £1 trillion at peak support. As these guarantees were gradually withdrawn or expired, the outstanding sum under guarantee stood at £14 billion as at 31 March 2018.

Subsequently, broadly similar measures were introduced by the United States and the European Union in response to the 2008 financial crisis.

Background

July 2007 to September 2008 The first public indication of the crisis was in February 2007, when HSBC issued its first-ever profit warning as a result of losses incurred by its U.S. consumer finance arm. Later that year, in July 2007, two Bear Stearns hedge funds became insolvent, and in August 2007, French bank BNP Paribas froze three investment funds.

These events initiated a seizure in the wholesale interbank credit markets. On 14 August 2007 the FSA disclosed concerns about the UK mortgage bank Northern Rock, which relied heavily on such markets in its funding model, to HM Treasury and the Bank of England. On 13 September the BBC reported that Northern Rock had been granted emergency financial support by the Bank of England in its role as lender of last resort. This triggered the first run on a UK bank in 150 years, that was ended only when HM Treasury announced, on 20 September, that the UK government would guarantee all existing Northern Rock retail deposits. The following month, the guarantee was extended to all new deposits. In February 2008, Northern Rock was taken into full public ownership.

In April 2008, the Bank of England launched the Special Liquidity Scheme, allowing banks to swap mortgage-backed assets for Treasury bonds, so providing more trusted collateral for accessing market liquidity. The same month, Royal Bank of Scotland launched a £12 billion rights issue to supplement its equity capital.

In September 2008, the US government launched bail-out rescues of the US mortgage lenders Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation).

September 2008 – collapse of Lehman Brothers

In 2008 Lehman Brothers was the fourth largest US investment bank, with worldwide operations. Its two principal business units were the broker dealers Lehman Brothers Inc (LBI), based in New York, and Lehman Brothers International (Europe) (LBIE), based in London.

The cash resources of the Lehman Group were managed centrally in New York by the parent company, Lehman Brothers Holdings Inc. (LBHI). Following a deterioration in LBHI's financial position, on the afternoon of Sunday 14 September 2008, the directors of Lehman Brothers International (Europe) Ltd (LBIE) sought assurances from LBHI that payments due to be made on its behalf on the following business day would be made. At approximately 12.30 am on 15 September, LBHI informed LBIE that it was preparing to file for Chapter 11 Bankruptcy protection under US law and that it was therefore no longer in a position to make payments to or on behalf of LBIE. Accordingly, overnight preparations were made for a number of UK based Lehman companies to protect their interests by seeking an Administration Order under UK law. This order was granted by a UK judge at 7.56 am on Monday 15 September 2008.Lehman Brothers International (Europe) Ltd – Joint Administrators' Proposals for Achieving the Purpose of Administration 28 October 2008 at http://www.pwc.co.uk/eng/issues/lehmans_administrators_proposal.html

The immediate impact of the failure of the LBIE business in particular included 142,000 unsettled securities trades to which LBIE was a counterparty, of which approximately 83,500 were trades to be settled in Europe, 45,000 in Asia and 12,500 in the US. There were gross assets (i.e. grossed up for collateral and Client Assets)totalling $628 billion and gross liabilities of $611 billion, which after counterparty and cross product netting and eliminating amounts relating to trust property, reduced to assets of $49.5 billion and liabilities of $32.6 billion. These were frozen and would remain so for several years.

The Lehman collapse initiated a period of significant market turmoil. This was caused by complex financial interrelationships between the major banks, since assets on the Lehman balance sheet were inaccessible by counterparties, creating a domino effect in financial markets.

Failure of HBOS and Lloyds takeover Following the market disruption caused by the Lehman collapse, attention turned to HBOS, then the UK's largest mortgage lender.

The bank had first appeared on the HM Treasury watch list after the Northern Rock problems surfaced, when it became clear that the HBOS funding model closely resembled that of Northern Rock. The bank was offering highly competitive and unprofitable housing market loans, combined with aggressive and high risk commercial lending. By July 2008, profits had halved and bad debts were up by a third.Back from the brink, Alistair Darling, 2011, ISBN 9 780 85789 279 9 P.114-5

On 16 September HBOS saw 33 per cent of its value wiped out in a single day. The Financial Services Authority (FSA), the UK financial services regulator, responded by imposing a temporary ban on short selling of shares. At the same time, the UK government brokered an agreement with Lloyds Bank to acquire HBOS in a private sector deal. This was announced three days after the Lehman Brothers collapse, on 18 September.

Preparation of the recapitalisation plan By the end of September 2008, Mervyn King, Governor of the Bank of England, Adair Turner, Chairman of the FSA, and Alistair Darling agreed that plans needed to be prepared for the recapitalisation of the banking system. Until that point, the crisis had primarily been one of liquidity, but the problem had now shifted to one of lack of capital. The only realistic source of new capital was the UK government.Back from the brink, Alistair Darling, 2011, ISBN 9 780 85789 279 9 P.140-141 Darling instructed the Treasury to prepare a recapitalisation plan that envisaged the injection of billions of pounds into UK banks in return for equity. This would be financed by UK government bond sales.

Royal Bank of Scotland imminent collapse On 7 October 2008, following a 35% plunge in the bank's share price, dealing in the bank's shares was suspended. The bank Chairman, Tom McKillop, contacted the Chancellor of the Exchequer, Alistair Darling, to advise that the bank was within hours of running out of money. Darling later observed that

When dealings in bank shares are suspended it is all over. I knew the bank was finished, in the most spectacular way possible. The game was up. If the markets could give up on RBS, one of the largest banks in the world, all bets on Britain's and the world's financial system were off.

This was the decisive event that triggered the implementation of the recapitalisation plan.

Detailed support measures The intervention plan provided for several sources of funding to be made available to an aggregate total of £137 billion in cash injections and loans at peak, and a further £1,029 billion in guarantees at peak. As at October 2021, the OBR reported the current cost of these interventions as £33 billion, comprising a loss of £35.5 billion on the NatWest (formerly Royal Bank of Scotland) rescue, offset by some net gains elsewhere.

Cash support

Through the Bank Recapitalisation Fund, the government bought a combination of ordinary shares and preference shares in the affected banks. The amount and proportion of the stake taken in any one bank was negotiated with the individual bank. Banks that accepted rescue packages had restrictions on executive pay and dividends to existing shareholders, as well as a mandate to offer reasonable credit to homeowners and small businesses. The long-term government plan was to offset the cost of this program by receiving dividends from these shares, and in the long run, to sell the shares after a market recovery. This plan covered the possibility of underwriting new issues of shares by any participating bank. The plan was characterised as, in effect, full or partial nationalisation.

As at October 2021, the overall breakdown of cash support to banks and other entities was reported by the OBR to comprise the following:

+£ billions Lloyds NatWest UKAR FSCS CGS SLS Other Total Cash outlays at peak -20.5 - 45.8- 44.1- 20.90.00.0- 5.3- 136.6 Principal repayments 21.1 8.943.720.90.00.05.399.9 Other fees received 3.2 6.411.93.54.32.30.331.8 Net cash position 3.8- 30.5 11.53.54.32.30.25.0 Outstanding payments0.00.00.00.00.00.00.10.1 Market value 0.013.05.40.00.00.00.018.4 Implied balance 3.8-17.516.93.54.32.30.313.5 Exchequer financing- 4.5- 18.0- 14.5- 9.30.00.40.6- 46.5 Overall balance- 0.8- 35.52.4- 5.84.32.7 - 0.3- 33.0 source: OBR Economic and fiscal outlook October 2021

Notes UKAR: UK Asset Resolution – managed UK government holdings in Bradford & Bingley and Northern Rock Asset Management plc prior to their sale. FSCS: Financial Services Compensation Scheme – the UK's statutory deposit insurance and investors' compensation scheme for customers of authorised financial services firms. CGS: Credit Guarantee Scheme – a scheme introduced in 2008 allowing banks to issue debt guaranteed by the government. The scheme closed in October 2012. SLS: Special Liquidity Scheme – designed to allow easier access to market liquidity by using UK Treasury securities as collateral. The scheme closed in January 2012.

Other support schemes Credit Guarantee Scheme

The Credit Guarantee Scheme formed part of the UK government's banking intervention measures announced on 8 October 2008, becoming operational on 13 October 2008.

The scheme was designed to allow banks to issue debt guaranteed by the government, with the intention of enabling them to borrow more, and more cheaply, and hence lend more.