In the latest session of the Public Accounts Committee, Jo questioned Sir Nicholas Macpherson, Permanent Secretary to the Treasury, and Tom Scholar, Gordon Brown's chief of staff at Number 10, on Labour's bailout of the Royal Bank of Scotland in 2008, and the establishment of the Asset Protection Scheme.  Read extracts of the transcript below:

Joseph Johnson: Why did we have lending commitments at all in this agreement if you did not believe they were enforceable and had no real interest in pursuing them? Why did the Treasury bother with them at all?

Sir Nicholas Macpherson: All of us agree that we want to see greater lending. We have just had a credit crunch without precedent in our lifetime—in fact, probably without precedent in 100 years. Banks, individuals, some companies and particularly the state need to de-leverage, but we do want to get lending going. As part of these interventions, there were discussions about that, to try to look at what was in the collective interest as opposed to the individual interest. Lending agreements certainly have a role, and that informed the previous Government's intervention. I think it is a matter of record that the current Government is also considering options in that space, but I think that is very different from nationalising a bank and effectively telling it to run at a loss to subsidise lending, often to individuals and companies who may not be good credit risks.

Joseph Johnson: Before we go into the details of the Asset Protection Scheme itself, could we go back to the moment when you faced the choice of which solution to go for: the bad bank; the injection of more capital, which effectively would have meant nationalisation, particularly of RBS; or the Asset Protection Scheme? Appendix 3 of the Report seems to suggest that injecting more capital might have been better, on a simple value-for-money basis. If I read the Report correctly, the NAO suggests in paragraph 21 that you might have saved between £200 million and £4 billion had you decided to go down the route of more contingent capital to RBS. In light of that, why do you say so confidently that APS was a better route, from a value-for-money perspective?

Sir Nicholas Macpherson: There are a number of reasons for that. First, the APS gave greater protection, in terms of ensuring that RBS was not ultimately nationalised. The second quite important reason was that we were not certain at that stage whether the Asset Protection Scheme might need to be used for another bank. Indeed, even now you could envisage admittedly very extreme circumstances where you might need it. So we felt that it was in the wider interests of financial stability to get the scheme up and running. I should say that the contingent capital option was quite a late runner. Had we gone down that route, it would probably have delayed eventual agreement, which in itself might have undermined financial stability because the markets—

Joseph Johnson: But the APS was not quick to get off the ground. You announced it in January and did not sign any deals until November, so it took the best part of a year. Would it have taken less time simply to offer more contingent capital? It is not a very complicated process.

Sir Nicholas Macpherson: It is not a particularly complicated process, but my recollection is that as the year went by the contingent capital option began to look more attractive, but Tom may want to expand on that.

Tom Scholar: Yes. In January, when we first announced the intention to move ahead with the scheme, a contingent capital option would not have been possible; it would have had to have been actual capital at that stage. During the course of the year, markets gradually improved, and with them, the outlook for the two banks concerned, with the consequence that in the case of Lloyds, it was able to exit and raise capital on the markets, and in the case of RBS it became possible to imagine, in a way that was not possible a couple of months previously—

Chair: Hang on. Was it the change in confidence at that stage that changed the potential options?

Tom Scholar: Correct. For that reason, it was available only in the closing stages of the negotiation, and even at that point we felt we were not sufficiently certain about the outlook to want to give up what would have been, as Nick said, a scheme that was potentially available for the whole sector.

Joseph Johnson: Clearly, you were weighing up a lot of very difficult sets of pros and cons in every solution that you were examining. To dwell for a second on the option of injecting more capital, or contingent capital as became possible later in the year, in retrospect that would have had considerable advantages, in the sense that had you injected more capital and been forced ultimately to seek the de-listing of RBS, effectively to take control of it and take it off the public market, you would not have faced the problems that we have faced over the past year, with respect to some of the objectives set out in the intervention, particularly with respect to lending. We have had a situation where RBS has breached its lending commitments—it came nowhere near meeting them. Had you been in absolute control of it, which would have been the result of an intervention along the lines of contingent capital or capital injection, we would not have faced that at all. Do you acknowledge that?

Sir Nicholas Macpherson: No, I do not accept that. The first point I make is that this year RBS is on track to deliver its lending commitments. There was a problem in 2009, to which no doubt we will come back. I think there are real risks in the Government getting into the banking business. It is always nice to think that the state will be better at lending, but in my experience, having observed nationalised banks around the world—there were some good examples in France in the early 1980s—the state is not good at managing risk. I can see the attractions in thinking that if the state was in charge of the lending process we could just go out and hand out money willy-nilly, and no doubt the lending figures would look a lot better. But speaking as a Treasury official, the Treasury is both an economics and a finance Ministry. I certainly do not think it is in the taxpayers' interest for the state to get into the banking game and, in the long run, it is not the interests of the economy.

Joseph Johnson: What percentage of the £325 billion of RBS assets covered was being referred to in the letter of direction? How big was this pool of junk, as Austin called it?

Tom Scholar: I cannot recall the percentage figure. I think it was a small percentage about which we were directly concerned, but given what we discovered about the quality of risk management and the poor systems and controls within the business, we were concerned that there might be other problems had not come to light.

Joseph Johnson: So, it was a general blanket letter to the Chancellor at the time, saying that there was an unspecified amount of assets that might be fraudulent?

Tom Scholar: Again, we can come back to you with the answer to the specific question about how many assets there were.