UK Mulls Dramatic Banking Rescue Plan

UK Chancellor of the Exchequer Alistair Darling is considering a dramatic taxpayer-funded recapitalization of Britain's banks, the Financial Times reported on Monday on its Web site.

On Sunday, Darling said he was "looking at some pretty big steps which we would not take in ordinary times".

Although the Treasury said no decision had been taken to activate any contingency plan, it would not rule out a voluntary bank recapitalization scheme, the FT reported. "It is a pretty fast-moving situation," one official told the paper.

The scheme, which reminds of a similar operation by the Swedish government in the early 1990s, would be available to all banks.

Taxpayers might be protected through preferred shares or warrants, giving them generous dividends in future.

Bank of England Governor Mervyn King is also thought to favor a recapitalization plan to supplement the central bank's own operations to boost liquidity to the financial system.

The British government will not put pressure on the Bank of England to cut interest rates, but is prepared to take big steps with economic policy to stem the credit crisis, Darling also said on Sunday.

Darling said he needed to be flexible with the public finances and would outline on Wednesday how governments ought to react to the "global shock".

Speculation has grown in recent months that the government will change its fiscal rules, which put limits on public debt, to give it more room to act to help families and businesses cope as Britain edges near its first recession since the early 1990s.

"I'm not going to be writing to the Bank of England to change its remit," Darling told BBC television, responding to a demand from an opposition politician that the government should tell the independent central bank to slash borrowing costs.

The BoE, given the power to set interest rates shortly after the Labour Party was elected to government in 1997, is required to target inflation at 2 percent and, subject to that, support the government's wider economic policies.

Most analysts expect the BoE's Monetary Policy Committee to cut interest rates to 4.75 percent from 5 percent at its monthly meeting on Thursday, despite inflation running at more than twice the official target, because of fears over the economy.

Some say borrowing costs will eventually need to fall below 3.5 percent to their lowest level in more than 50 years to prevent a deep and prolonged recession.

"We're on the cusp of a major economic disaster coming out of the financial disaster," Liberal Democrat economic spokesman Vincent Cable said.

"A big cut (in interest rates) is going to have to happen and the Chancellor of the Exchequer (Darling) is going to have to clear the way in order for them to do it." From Iceland to Italy, officials scrambled at the weekend to contain the fallout from the deepest financial crisis since the 1930s amid a continued debate about whether a fragmented European response could keep pace with a fear-driven market.

Germany offered a blanket bank deposit guarantee on Sunday in a bid to contain the spreading credit crisis as officials clinched deals to rescue Germany's Hypo Real Estate and recapitalize two other European banks.

That was followed by similar moves by Austria and Denmark, after Ireland issued the first such guarantee last week. Austria said it would raise the limit of guarantees from the current 20,000 euros, but the new level is to be decided, while Denmark guaranteed all deposits.

Bend the Rules

In a speech in London on Wednesday, Darling is expected to focus on the framework governing economic policy as pressure grows on Labour to do more to battle the economic downturn.

"We're now in a better position to allow borrowing to rise as the economy slows down," Darling said. That's the right thing to do. You support it, you don't start taking money out."

Economists argue Darling will need to relax Labour's fiscal rules that limit public debt to 40 percent of gross domestic product because the public finances are already stretched. Leading European policymakers, including Prime Minister Gordon Brown, said after an emergency summit in Paris on Saturday that European rules on fiscal policy should also "reflect the current exceptional circumstances".

"This is a profound shock to the system," Darling said. "We need to deal with it. Later this week, I will be setting out my thoughts on how we ought to be dealing with it -- maintaining discipline but also having the flexibility people would expect."

European authorities are under pressure to act in a similar way to bolster the banking system after the adoption of a $700 billion bank bailout plan in the United States, but there appears to be little appetite for a Europe-wide fund