Public sector finances excluding financial interventions

Public sector finances Public sector finances excluding financial interventions

Office for National Statistics

CONTACT INFORMATION If you require further help or information about this report please contact:

By telephone on: 020 7014 2180 Jim O’Donoghue By email on: jim.o’[email protected]

By post at: Office for National Statistics Cardiff Road Newport NP10 8XG


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Contents Public sector finances excluding financial interventions ............................ 1 Introduction ........................................................................................... 1 Concepts ............................................................................................... 1 Financial interventions .......................................................................... 3 Annex A: Financial interventions ............................................................... 7 Annex B: Reconciliation tables .................................................................. 9 Annex C: Composition of the categories shown tables............................ 10 Reconciliation of PSNB and PSNB ex ................................................ 10 Reconciliation of PSND and PSND ex ................................................ 10 Annex D: Boundary of PSNB ex .............................................................. 12


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Public sector finances excluding financial interventions Introduction A measure of public sector net debt excluding the temporary effects of financial interventions, known as PSND ex, was introduced in Budget 2008. A parallel measure of public sector net borrowing, known as PSNB ex, was introduced in the 2009 Pre-Budget Report. The government bases its fiscal policy on these measures. They are intended to show the underlying state of the public sector finances without temporary distortions caused by financial interventions, but including any permanent effects from these interventions. Annex A summarises the main financial interventions. Each month in the Public Sector Finances Statistical Bulletin, ONS and HM Treasury publish reconciliation tables showing how PSNB and PSND relate to their corresponding ex measures (see Annexes B and C). This article expands on the short announcement describing the calculation of PSNB ex 1 that was released on 9 December 2009, the date of the 2009 Pre-Budget Report. It sets out the concepts behind the ex measures and describes how these are applied to the various financial interventions that have taken place, with particular reference to the reconciliation tables.

Concepts PSNB ex and PSND ex are based on, and consistent with, National Accounts definitions and methodology, both in terms of the transactions that feed into their calculation and the institutions between which these transactions take place. When calculating the ex measures, the key is to identify whether transactions and balance sheet positions are temporary effects of the financial crisis that will be eventually reversed, or whether they are permanent. Temporary effects on PSNB or PSND need to be removed when moving to the ex measures; permanent effects that are not captured as a result of removing the temporary effects need to be specifically included. There are four key principles that underpin the calculation of the ex measures: 1. Public sector transactions and balance sheet positions that are not related to financial interventions contribute to the ex measures. This applies to central government, local government, non-financial public corporations and the Bank of England 2. Permanent effects from financial interventions are those that will ultimately have an effect on central government’s net debt or net borrowing. This includes transactions involving central government and central government run schemes, such as the asset protection scheme and credit guarantee schemes 3. All other effects are regarded as temporary and do not affect the ex measures

1

http://www.ons.gov.uk/about/newsroom/statements/new-measure-of-public-sector-borrowing.html


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4. Payments or receipts related to permanent effects are recorded in the month in which they occur for PSND ex. For PSNB ex, the timing of recording is in line with National Accounts accruals principles This is illustrated in Annex D. In relation to the second principle:  

a permanent effect may also arise if local authorities fail to recover their deposits with Icelandic banks; currently, it is assumed that they will be recovered Bank of England run schemes indemnified by central government, such as the special liquidity scheme (see Annex A), are only regarded as having a permanent effect when there is an impact on the central government finances

The main class of interventions regarded as temporary, in line with the third principle, are those relating to the public sector banks (Northern Rock 2 , Bradford & Bingley, Lloyds Banking Group and Royal Bank of Scotland). Their designation as temporary reflects the government’s intention to return these banks to the private sector and to divest itself of shareholdings in these banks. This means that, when calculating PSNB ex and PSND ex, these institutions are treated as though they were outside the public sector. An example of the fourth principle is the credit guarantee scheme where there will be an impact on central government’s finances but the size and direction is unknown. Consistent with this principle, fees are being recorded in the month they are received, and payouts will be recorded as they occur. The impacts of the financial interventions on PSNB may differ from those on PSND. PSND is calculated from financial balance sheets that are measured at nominal values so as to reflect the debt that will have to be repaid when gilts or other borrowings mature; assets are also recorded at nominal values. PSNB, by contrast, is a flows measure calculated at market prices. There are also differences in coverage. PSND is calculated as the difference between liabilities (excluding amounts payable) and liquid assets (deposits plus short term securities). PSNB is calculated as the balance between total transactions in financial liabilities and assets; alternatively, it can be calculated as the balance between total current and capital expenditure and total receipts. The effect of these differences can be seen when considering the government’s shareholdings in RBS. The shares were acquired at a price in excess of the market price at the time, because purchasers had to buy at a pre-arranged offer price. The market value of the shares acquired is recorded as a financial transaction in the financial accounts. The excess amounts paid are recorded in the capital account as grants from central government because nothing was received in return. This has a permanent effect on PSNB ex, which will remain if and when the shares are sold back to the market, whatever the price achieved in the sale(s). The reason for this is that the sale of the shares is a purely financial transaction (the exchange of shares for cash), so has no impact on net borrowing. In contrast, the permanent impact on PSND ex is the difference between the cost of acquiring the shares and the amounts raised on their sale.

2

On 1 January 2010 Northern Rock was restructured into two different companies: Northern Rock plc and Northern Rock (Asset Management) plc


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PSNB ex and PSND ex may also differ because of differences in the timing of the recording of transactions. PSNB ex is an accruals-based measure whereas PSND ex is a cash measure. For instance, RBS made a lump sum payment of £1.4 billion in December 2009 to fund their participation in the asset protection scheme in 2009 and 2010. The full amount impacts on PSND ex in that month, but the payment for 2010 is spread across that year for PSNB ex.

Financial interventions As noted above, the public sector banks are regarded as being only temporarily in the public sector. Their net debt positions are therefore excluded from PSND ex (although they are included in PSND). Currently excluded are the impacts on net debt of Northern Rock and Bradford & Bingley. Also excluded will be the impact from Lloyds Banking Group and RBS when data for these banking groups are fully included in PSND. The contribution of the public sector banks to public sector net borrowing (their estimated gross operating surplus, net interest receipts and net investment) are excluded from PSNB ex but remain in PSNB. Payments by the Financial Services Compensation Scheme (FSCS) and HM Treasury (for deposits not covered by the FSCS) to compensate eligible depositors in the Icelandic banks operating in the UK, London Scottish Bank or to contribute to the costs of resolving the Dunfermline Building Society currently add to PSND. However, in time, HM Treasury and the FSCS aim to recover these payments, initially by realising the assets of the failed banks. This is therefore a temporary effect which needs to be excluded in calculating PSND ex. There is no effect on PSNB ex, as the payments by the FSCS and HM Treasury are matched by imputed capital taxes on the private sector banks. The situation involving Bradford & Bingley is slightly different. The FSCS and HM Treasury contributed £15.7 billion and £3.3 billion respectively to back the transfer of the bank’s retail deposit liabilities to Abbey National. As with the other banks, the amount owing to the FSCS will be recovered as a capital tax. However, reflecting its status as sole shareholder in Bradford & Bingley, any recoveries by HM Treasury of the amounts owing will be recorded as withdrawals of equity. This is a financial rather than capital transaction so the impact on PSNB ex is permanent at £3.3 billion. The maximum impact on PSND ex will be less, at £2.7 billion, since £0.6 billion of the amount owing to HM Treasury was recovered, by a withdrawal of equity, from Bradford & Bingley from the proceeds of the sale of their branch network and deposits to Abbey National. The timing and amounts of any further recoveries are uncertain, so a convention has been adopted that none of the £2.7 billion owing to HM Treasury will be recovered. This therefore adds to PSND ex. The Bank of England established two schemes (the asset purchase facility and the special liquidity scheme) to provide liquidity in response to the financial crisis. Both schemes are indemnified against losses by central government. The eventual losses or profits generated by the scheme will have a permanent effect on PNSB ex and PSND ex. In the meantime, given the uncertainty about the size and direction of any permanent effect, the effects from both schemes are regarded as temporary.


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There are two phases to the Bank of England’s asset purchase facility fund (BEAPFF). The first phase involves the purchase of corporate bonds, with minimum residual maturities of twelve months, and commercial paper, which typically has a maturity of three months, issued by private sector corporations. These asset purchases are financed by the issuance of Treasury bills and the UK Debt Management Office’s cash management operations. The commercial paper purchases have no effect on PSND because they are treated as liquid assets and cancel out the borrowing used to finance the purchases. By contrast, the amounts paid to acquire corporate bonds add to PSND because the bonds are treated as illiquid. The phase one impact on PSNB is currently negligible. In the second phase, the fund purchases assets (mainly gilts), financed by issuance of central bank reserves. In the calculation of PSND, the loan between the Bank of England and the BEAPFF nets out; the creation of central bank reserves is a liability of the public sector and is equal to the amount paid to acquire the assets (i.e. their market value at the time of purchase); by contrast, the assets are by convention recorded at nominal value. The difference between the valuation of the liability on the BEAPFF and the corresponding asset adds to PSND. A further addition to net debt arises from the purchases of corporate bonds. The BEAPFF also contributes to PSND (and PSNB) by way of its net interest income, the difference between its receipts of interest from the issuers of the bonds (mainly government) and the interest paid to the Bank of England on the loan used to finance the purchase of assets by the fund. The assets acquired by the BEAPFF will, in time, be sold back to the market. Any shortfall will be made up by central government while any profit on closure of the scheme will be retained in the public sector. It is at this point that the effect of the scheme will be regarded as permanent. The current effects are regarded as temporary and excluded from both PSND ex and PSNB ex. The special liquidity scheme (SLS) is similar to the BEAPFF in that net fees received by the Bank of England (which reduce PSND and PSNB) will be used to finance the scheme, with central government making up any shortfall and any profit being retained in the public sector. The current effects from the SLS are therefore temporary and excluded from the ex measures, though fees paid to central government for providing the Treasury bills do score in PSNB ex. The permanent effect will be the net profit or loss generated by the scheme. The government has acquired substantial shareholdings in RBS and Lloyds. Some of these acquisitions have been at a price in excess of the market price at the time. The excess amounts paid are treated as capital transfers from central government to the banks concerned and therefore increase PSNB ex. This is a permanent effect in National Accounts terms as any amount raised on the sale of these shares is a financial rather than a capital transaction. When calculating PSND ex, the shares acquired by central government are treated as liquid assets consistent with the approach that these holdings are temporary. A conservative approach has been taken to their valuation, which is to value them at the lesser of their purchase price and the market price on the day of purchase. This increases PSND ex by the amount by which the purchase prices exceed the market prices. The long term permanent effect on PSND will be the difference between the cost of buying and selling the shares and will only be known when the shares are eventually sold back to the market.


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Lloyds Banking Group has also raised capital from the private sector through share issues. These are financial transactions outside the ex boundary which reduce PSND relative to PSND ex but do not affect PSNB. The government made a £1.4 billion capital injection into Northern Rock plc. The long term permanent effect on PSND ex will be the difference between any money raised by sale of shares in the company and the sum of any capital injections. The timing of any such sale is uncertain as is the amount that will be raised. In the meantime, the capital injection is regarded as a permanent effect on PSND ex. The sale of shares is a financial transaction, and so will not affect PSNB. The capital injection is therefore a permanent effect that adds to PSNB ex. The impact of the financial interventions described above on PSNB ex and PSND ex are summarised in the table below, together with the impact from other financial interventions. The effects of the financial interventions described above are quantified in the tables shown in Annex B. Annex C lists the interventions included in each category shown in the tables.


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Intervention Public sector banks net debt.

Impact on PSNB ex Not applicable.

Public sector banks net borrowing.

No. The banks are tempor-arily in the public sector. No. Compensation payments are matched by imputed capital taxes on the private sector banks. Yes. Amount due to HMT is a permanent effect.

FSCS and HM Treasury compensation of depositors in private sector banks. FSCS and HM Treasury compensation: depositors in Bradford & Bingley. BEAPFF.

SLS. Equity injections into RBS and Lloyds.

Not currently. HMT will make up any shortfall as a capital grant. This will be a permanent effect. As for BEAPFF. Yes. Difference between amount paid for the shares and their market value at the time. This is a permanent effect.

Equity injection into Northern Rock (NR plc).

Yes. This is a capital grant.

Payments to central government (CG) for the asset protection scheme.

Yes. Lump sum payments for 2009 in Dec 09; accrued payments spread across 2010. CG payouts will be permanent effects. Yes.

Payments to CG for underwriting fees. Payments to CG for £8bn contingent capital commitment to RBS. Interest payments to CG.

Credit guarantee scheme fees to CG.

Impact on PSND ex No. The banks are only temporarily in the public sector. Not applicable.

No. CG will be repaid by realising the assets of the failed banks. Yes. Until recovered, assume amount due to HMT will not be realised. As for PSNB ex.

As for BEAPFF. Yes. Difference between amount paid for the shares and their market value at the time. Permanent effect will be difference between amounts paid and received when they are sold. Yes. But if and when NR plc is sold there will be no need for an adjustment Yes. Lump sum payments are scored when they are paid. CG payouts will be permanent effects. Yes. Accumulated sum.

Yes. Accrued payments spread across 2010.

Yes. Payments are scored when they are received.

Yes.

Northern Rock and Bradford & Bingley payments implicitly included in their net debt figures. RBS and Lloyds payments reduce CG net debt but do not (yet) add to PC net debt so do not need to be taken account of. As for interest payments.

Yes.


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Annex A. Financial interventions Northern Rock is classified as a public sector bank from 9 October 2007; Bradford & Bingley from 26 September 2008; and RBS and Lloyds Banking Group (LBG) from 13 October 2008. Central government has provided loans to Northern Rock and Bradford & Bingley on which interest is paid. RBS issued new ordinary shares in December 2008, April 2009 and December 2009, which were almost entirely taken up by central government. LBG issued new shares in January, June and December 2009; in the June and December issues, substantial sums were raised from the private sector, as well as from central government. Underwriting fees were paid to central government. Preference shares in the two banks were purchased by central government at the same time as the first issues of new ordinary shares. Interest was paid on these preference shares before their redemption by RBS and LBG in April and June 2009 respectively. The Financial Services Compensation Scheme compensated eligible depositors of the Icelandic banks and London Scottish Bank for the loss of their deposits when these financial institutions failed. It also contributed a sum equal to the amount of eligible deposits in the resolution of Bradford & Bingley and will contribute towards the costs to HM Treasury of resolving the Dunfermline Building Society. In each case, HM Treasury provided compensation and other resolution costs for deposits in excess of the amount covered by the FSCS. HMT and FSCS aim to recover the compensation paid through the realisation of the banks’ assets. In April 2008, the Bank of England established the Special Liquidity Scheme whereby banks and building societies could exchange illiquid assets for Treasury Bills. These exchanges had the substance of stock lending (firstly, of Treasury Bills by central government to the Bank of England; and then from the Bank to the financial institutions) and are therefore not recorded in the public sector finances, apart from the fees that are charged to participate in the scheme. There are two phases to the Bank of England’s asset purchase facility fund (BEAPFF). The first phase involves the purchase of corporate bonds or commercial paper issued by private sector corporations. These asset purchases are financed by the debt management office, a central government body. In the second phase, the fund purchases securities (mainly gilts) in the market in exchange for central bank reserves with the Bank of England (so called ‘quantitative easing’). Interest is received on the securities held, and paid out on the reserves. RBS is participating in the government’s Asset Protection Scheme. A portfolio of impaired assets or assets of uncertain value has been placed in the scheme. RBS is responsible for losses on these assets up to an agreed limit; losses above the limit are shared between central government and RBS. In National Accounts terms, central government will make a capital transfer to RBS to cover the losses agreed under the scheme, but only once such losses have materialised. RBS pays a fee to central government for participation in the scheme. The Credit Guarantee Scheme involves government granting guarantees for bank and building societies issues of new short term and medium term debt. A fee is paid to central government to participate in the scheme.


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Central government has given an £8 billion contingent capital commitment to RBS, which can be drawn by RBS should its core tier 1 capital ratio fall below an agreed level. A fee is charged for the provision of this facility. For more detail on these and other financial sector interventions see Public Sector Interventions in the Financial Crisis: Statistical Classification Decisions


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Annex B: Reconciliation tables Reconciliation of PSNB and PSNB ex 2008Q 3

2008Q 4

2009Q 1

2009Q 2

2009Q 3

2009Q 4

£ billion 200809

12.3

30.0

23.2

41.2

35.2

43.0

86.5

0.8

0.3

0.3

0.9

2.5

2.5

1.3

0.0

-0.3

-0.8

-0.6

-0.4

-3.7

-1.1

PSNB Excluded from PSNB ex: Public sector banks, Special Liquidity Scheme and Asset Purchase Facility: transactions with private sector Included in PSNB ex Public sector banks: transactions with government Equity injections into RBS and Lloyds

0.0

2.5

3.6

0.2

0.0

6.2

6.1

Capital injection into Northern Rock

0.0

0.0

0.0

0.0

0.0

1.4

0.0

Depositor compensation: Bradford & Bingley

3.3

0.0

0.0

0.0

-0.4

0.0

3.3

16.4

32.4

26.3

41.6

36.9

49.4

96.1

4.1

2.4

3.1

0.4

1.7

6.4

9.6

PSNB ex Difference between PSNB and PSNB ex Of which: Current receipts

0.2

0.2

0.0

0.8

2.1

2.5

0.4

Current expenditure

0.0

-0.3

-0.6

-0.5

-0.4

-0.5

-0.8

Net investment

3.9

2.5

3.6

0.2

0.0

4.3

10.0

Reconciliation of PSND and PSND ex £ billion 2008 Q4

2009 Q1

2009 Q2

2009 Q3

2009 Q4

733.5

742.3

797.9

822.2

865.8

-134.8

-122.3

-119.1

-119.9

-109.3

-7.1

-9.0

-9.4

-8.5

-8.1

0.5

-2.2

-13.3

-16.0

-16.9

-0.3

-0.7

-1.0

-1.3

-6.4

Equity injections into RBS and Lloyds

2.5

6.1

6.3

6.3

12.4

Capital injection into Northern Rock

0.0

0.0

0.0

0.0

1.4

Depositor compensation: Bradford & Bingley

2.7

2.7

2.7

2.7

2.7

596.9

617.0

664.0

685.4

741.6

PSND Temporary effects excluded from PSND ex Public sector banks balance sheets

1

Depositor compensation: Icelandic banks & Dunfermline Building Society Special Liquidity Scheme and Asset Purchase Facility Included in PSND ex Public sector banks: transactions with government

PSND ex 1

Includes receipts from private sector of share issues


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Annex C Composition of the categories shown in the reconciliation tables The composition of the categories shown in the reconciliation tables are listed below. For PSNB, each component is classified as either a current or capital transaction. Reconciliation of PSNB and PSNB ex Public sector banks, Special Liquidity Scheme and Asset Purchase Facility: transactions with private sector: 1. Northern Rock and Bradford & Bingley contribution to net borrowing (mainly current) 2. Net fee receipts of the Bank of England in respect of the SLS (current). 3. Net interest receipts of the BEAPFF (current) Public sector banks: transactions with government 3 : 1. 2. 3. 4. 5. 6. 7.

Underwriting fees from RBS and Lloyds (current). Preference shares; interest receipts from RBS and LBG (current). Credit guarantee scheme fees from RBS and LBG (current). Asset protection scheme fees (mixture of current and capital- 2009 q4 only). Contingent capital fees from RBS (all current). SLS and BEAPFF indemnity payments (no payments yet) APS guarantee payments (no payments yet)

Equity injections into RBS and Lloyds: 1. Cost of acquiring shares at a price above the market price (all capital) Capital injection into Northern Rock (in December 2009). Depositor compensation: Bradford & Bingley: 1. Compensation paid out by HM Treasury in excess of FSCS limit (all capital)

Reconciliation of PSND and PSND ex Public sector banks balance sheets: 1. Northern Rock and Bradford & Bingley contributions to net debt 2. Central government loans advanced to Northern Rock and Bradford & Bingley 3. Bradford & Bingley’s amount owing to FSCS and HM Treasury

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The transactions with government of RBS and Lloyds are removed because unlike Northern Rock and Bradford and Bingley their contributions to net borrowing are not yet included in the PSNB in the Public Sector Finances Statistical Bulletin.

Office for National Statistics 10

4. New issues of Lloyds ordinary shares purchased by the private sector Depositor compensation: Icelandic banks and Dunfermline Building Society 5. Compensation paid out by FSCS and HM Treasury that has yet to be recovered Special Liquidity Scheme and Asset Purchase Facility: 1. Cumulative sum of net fees paid to participate in the SLS 2. BEAPFF contribution to net debt, including net interest receipts The other four categories in the table cover the same financial interventions as in the PSNB – PSNB ex reconciliation.


Annex D: Boundary of PSNB ex PSNB ex boundary

B&B deposits above FSCS limit

Public banks

Capital injections

Non-FI PCs

CG APS fees/payouts Dividends & interest

LG

CGS fees SLS fees

BoE Underwriting fees etc SLS fees/ grants to cover losses

SLS

Interest on gilts Capital grants to cover BEAPFF losses

Interest on deposits – routed via BoE SLS fees

CGS fees

BEAPFF

Interest on deposits – private banks

Public sector boundary Private banks

Abbreviations: APS B&B BEAPFF BoE CG CGS FI FSCS LG PCs SLS

Asset Protection Scheme Bradford & Bingley Bank of England Asset Purchase Facility Fund Bank of England Central Government Credit Guarantee Scheme Financial Institutions Financial Services Compensation Scheme Local Government Public Corporations Special Liquidity Scheme
