Prime Minister Gordon Brown has given a revealing interview to the BBC this morning that shows something of the way the UK Government is thinking and Robert Peston’s Blog (as always the source of a great deal of insight into the minds of the civil service mandarins) throws even more light.

The news appears encouraging. Certainly there is no lack of confidence in the UK banks on the part of the Government.

The Government’s analysis of the UK economy in a nutshell appears to be
1. That the contraction of lending in the UK is caused in part by overseas banks stopping their lending.
2. The pre-crunch credit bubble was caused in part by those overseas banks
3. The UK banks can safely be encouraged to lend at high levels without risking a return to a credit bubble because of (2)
4. The UK banks can restore their balance sheets by contracting overseas lending

The plan is therefore to offer UK banks an insurance policy on UK corporate (and possibly consumer lending) whereby the first 5% of losses are taken by the bank and the next say 10% is taken by the tax payer.

The benefits are that UK banks will start taking up the slack from the rapidly dwindling overseas banks and the UK banks can do this partly because the amount of capital required to follow this strategy is reduced as the assets will be reclassified under capital adequacy requirements so that effectively uk loans will no longer have a weighting of 1 but (I guess) 0.9 (assuming the UK government is guaranteeing 10%).

The implications for the world of banking are
a) We will see (at least a temporary) cessation to the global trend towards the globalisation of banks. Whether that means recent purchases like RBS/ABN might be disposed of is another matter.
b) The outlook for a bank based in a G8 economy is looking better…. up to a point.
c) The long term returns from the UK banking sector just contracted, but the risk profiles have also changed. UK banks look to me more like a buy on Monday than they did on Friday.

My concern is that we don’t have access to the figures on which this analysis is based, but if it is right then ok it sounds like a plan that can achieve a turn round without absurd levels of tax bail out. We’ll now have to wait for the unforeseen consequences. 🙂

The most interesting question is does this set any precedent for Mr Obama’s team?