Government defends loans paid to banks

A Royal Bank of Scotland flag flies over a building in the City of London November 2, 2009.

LONDON (Reuters) - The government defended its central bank's right to make secret loans to struggling financial institutions after the disclosure that two of them received almost 62 billion pounds last year.

"I remain of the view that the Bank of England must be allowed to provide assistance to financial institutions on a confidential basis as financial stability may require," Chancellor Alistair Darling said in a statement on Wednesday.

The Bank said on Tuesday it had provided 61.6 billion pounds of emergency loans to Royal Bank of Scotland and HBOS at the height of the credit crisis last year.

The Bank had not detailed the loans before for fear of their impact on the stability of the banking system. They have since been repaid.

Darling noted changes to the law on confidentiality had prevented a repeat of the Northern Rock crisis of September 2007 when account holders rushed to withdraw their cash after hearing that the Bank of England had stepped in to provide support.

"Twelve months ago, we faced a situation when the world banking system was on the brink of collapse. No one should underestimate the gravity of the situation we then faced," he told parliament.

Darling said the banking system was now more stable and that no savers had lost money during the credit crisis that followed the collapse of U.S. investment bank Lehman Brothers.

The government has a 43 percent stake in HBOS parent Lloyds Banking Group and controls 84 percent of RBS after bailing out the banks.

Prime Minister Gordon Brown's spokesman said Brown was aware of the loans and that HBOS and RBS had made the appropriate level of disclosure.

"He and the chancellor were obviously aware of this. It was a very big sum of money and it was a very important decision made by the Bank of England under the auspices of being the lender of last resort," the spokesman said.

HBOS TAKEOVER ROW

However, the secrecy means shareholders were unaware of details of the loans when asked to back the government-brokered takeover of HBOS by Lloyds late last year. The loan to HBOS peaked at 25.4 billion pounds in November 2008.

Darling noted that merger documentation referred to HBOS having access to liquidity offered by the central bank.

"The directors of Lloyds were told by the Bank of England of the nature of the extent of these operations so that they knew them at the time," he said.

The heads of the Financial Services Authority (FSA), the banking regulator, defended the decision to keep the size of the loans secret.

The FSA approved the banks' prospectuses but said the companies were responsible for their content, FSA Chief Executive Hector Sants told a parliamentary hearing.

But Sants and FSA Chairman Adair Turner told lawmakers that investors who read the banks' prospectuses would have been in no doubt about their dependence on emergency central bank cash.

"It was made abundantly clear that without central bank funding HBOS would not (have remained) solvent," Sants told lawmakers, adding the risks were clear in documents published at the time of the merger. "Anyone reading this understood fully that HBOS was dependent on (central bank) funding."

Turner said the prospectuses contained "pretty in your face words" about the reliance on central bank funding.

Opposition finance spokesman George Osborne said the problems faced by the banks stemmed from a failure of the tripartite regulatory system in which the central bank, finance ministry and FSA all play a role.

The Conservatives want to scrap the FSA and give the Bank the lead regulatory role if they win an election due by next June.

Darling dismissed that argument, saying that banks around the world had got into trouble regardless of the regulatory structure in individual countries.

($1=0.5979 Pound)

(Additional reporting by Adrian Croft, Huw Jones and Clara Ferreira-Marques; Editing by Mike Peacock)