In this report, the exponential growth and eventual collapse and government bail out of the Royal Bank of Scotland will be discussed. The report will use reputable news articles detailing different opinions, official government documents such as the Corporate Governance Code and relevant academic journals to form an analysis based on the recent changes in legislation and whether the eventual bailout of RBS could have been prevented by changing the dynamic of the culture.
RBS started as a fairly humble bank with a clientele base of mainly Scottish people and, despite its small size, RBS was a bank that was performing well. It was however possible for them to perform better. On the 11th February 2000, RBS successfully took over Natwest in a hostile takeover for the sum of £21bn (BBC, 2000). RBS grew a huge following after such a small bank managed to takeover a much larger bank so efficiently. This in turn led to more smaller, successful acquisitions. It was the takeover of ABN Amro that finally pushed RBS too far. Proper due diligence had not been conducted and their portfolio consisted of a high percentage of sub-prime letting, (BBC, 2010), which obviously had a hugely detrimental effect once the global recession of 2007 hit due to the collapse of the housing bubble (Rasmus, 2010). Despite RBS denying involvement with the sub-prime markets, this turned out not to be the case (BBC, 2010). Confidence in RBS had dropped, a giant oil group had withdrawn billions in one transaction which led to the chairman of RBS having to ask the Bank of England for help as they were about to run out of money (Wilson, 2011). The government had to save the bank from going bust. Through research conducted for this report, it can be suggested that one of the primary elements responsible for the collapse was due to the actions of those responsible for the interests of the business; Fred Goodwin in particular. The bank was struggling with an unhealthy culture that was putting the short-term growth of the firm ahead of the financial health of the business. As a result of the bail-out, there was legislative change in the UK’s corporate governance code and this report will analyse whether they would have been effective in helping RBS to stay afloat without government intervention.
As mentioned above, one of the key contributors to the eventual demise of RBS was that the acquisition of ABN Amro was one that was not conducted with due consideration, the firm was not fully aware of what they were taking on (BBC, 2010). It can be argued that due to the hostile nature of the takeover bid, RBS were solely relying on the due diligence work that rival bidders had taken on themselves. ABN Amro’s portfolio consisted of a lot of sub-prime lending which is what led to the detriment of RBS. The Financial Services Authority failed to intervene when RBS was about to undertake this reckless acquisition (reckless due to the lack of due diligence conducted), despite various members of the city being concerned about the acquisition and the share prices of RBS fluctuating (BBC, 2010) the acquisition went ahead unquestioned, could the intervention of the FSA have resolved the situation? Potentially. Following the bailout, the FSA conducted a full investigation into the failings of RBS, it was identified that although the FSA could not have done anything formally to prevent the acquisition going ahead, they should have been more watchful. It is suggested that if the FSA were to go ahead and block the acquisition going ahead, they would have been taking away accountability from the bank and putting the responsibility on themselves instead (House of Commons Treasury Committee, 2010). One of the new elements of the UK Corporate Governance Code: Accountability (2016) added after the crisis was that “The board is responsible for determining the nature and extent of the significant risks it is willing to take in achieving its strategic objectives. The board should maintain sound risk management and internal control systems.”. RBS had only received two ring binders and a CD of information regarding ABN Amro when they decided to make the acquisition, showing a complete disregard to the risk factor of this acquisition (BBC,2011). The reason they were not prosecuted at the time was because there is no code or standard determining how much due diligence is necessary (FSA, 2011). Had the updated code been in place at the time, the directors may have looked more deeply into the risk involved, as it is stated that the board is responsible to assess the risk factor of any action.
In the renewed UK Corporate Governance Code (2016) it was stated that public limited companies must now include a strategic report within their annual report, this must include: their current strategy and objectives, trends and factors currently affecting them and any uncertainties they are facing. The objective of including the strategic report is so that shareholders can assess how well the shareholders have acted in promoting the success of the corporation (in accordance with Section 172 of the Companies Act 2006). Through being obliged to present a strategic report, a culture of openness is instilled between the board and the shareholders, as even threats to the business have to be disclosed. At the time of the housing bubble crash in the US, RBS repeatedly denied any involvement with sub-prime lending (BBC, 2011) – this was a lie. The strategic report will mean that the bank will have to be transparent with shareholders thus encouraging the board to plan more carefully and act more honestly.
In terms of remuneration it is suggested that “Performance related elements of remuneration should be stretching and about long term success of company” in the updated Corporate Governance Code (UKCGC, 2016). It could be suggested that the lucrative rewards given to RBS directors for successfully performing acquisitions was one of the encouraging factors that persuaded directors to perform so many, showing the traditional principal-agent theory in action. Fred Goodwin was ruthless in his approach to management staff and pushed them to grow the business excessively, he rewarded those that did successfully with large bonuses (BBC, 2011). In recent years, it has been found that as RBS is still making huge financial losses, the amount of bonuses paid to employees and board members is starting to decrease, the bonus pool in 2016 was £340m compared to £1.4bn in 2008, the year the bank was bailed out (Treanor, 2017). Ross Mckewan has been trying to improve the publics perception of RBS’ remuneration policies by seeking to scrap annual bonuses and waiving many payments made to himself (Kleinman, 2017). As RBS’ financial health is improving, it would appear that their remuneration policies seem reasonable – although they are still making a loss, the losses are shrinking and staff still need to be rewarded to keep them on board.
Another regulation that changed as a result of the RBS collapse was the Basel liquidity framework. At the end of the working day, it is important that a bank is able to cover their balance sheet. Whether this be through their own capital or through borrowing from another bank (BBC, 2011). The introduction of Basel III meant that banks had to become more liquid. Basel III would mean that RBS would have had to hold a common tier-1 capital to risk-weighted asset ratio of 9.5% (tier-1 capital being cash reserves and common stocks, risk-weighted assets being factors such as loans to consumers). Before their takeover of ABN Amro, their ratio was 2% meaning that they were extremely illiquid. Had Basel III been implemented at the time, they would have been unable to pay any dividends and they would have been unable to launch their takeover bid due to holding so many unsecured assets (FSA, 2011). However, from a more economic perspective Basel III has been criticised and has been presented as in fact being detrimental to the economy (Braithwaite, 2012). Due to banks having to hold more secured assets against their risk capital, they could have in fact been hindering the general economy’s recovery from the financial crash. By requiring banks to hold a higher capital:debt ratio, there will be a smaller pot for consumers to borrow from, thus resulting in a downturn in spending which would in turn worsen the economy. Banks were already struggling to prosper due to the crisis and it could be suggested the new liquidity framework would not help matters. Many economists argue that Basel III should have been implemented after the financial industry had recovered from the crisis (Haldane, 2011). On the other hand, the greedy culture within RBS would have been inhibited had they been held to this. Acquisitions would have to be better planned and people would be more trusting of the bank. Consumers lost faith in the banking industry after the financial crisis. The FSA implementing measures such as Basel III should contribute towards changing culture within organisations and their consumers perceptions positively.
A further regulation that came into place was the concept of ring-fencing. Ring-fencing can be defined as the bank not being able to use money from their retail banking division to fund riskier projects in their investment banking divisions (Cerutti & Schmeider, 2014). Prior to the financial crisis banks were able to fund investments with money borrowed from consumer’s current accounts – which is what led to a lack of confidence in banks. In 2007, Northern Rock suffered a bank run – with thousands of customers all rushing to take their money out of their accounts (Cecil, 2007). This is of course catastrophic for a banks balance sheets. As of 1st January 2019 it will be a legal requirement for banks to have ring-fencing procedures in place, RBS is changing their legal structure to reflect this change in legislation. Their investment operations Natwest Markets & RBS International will be out of the ring-fence (RBS, 2016). Consequently, this will limit the banks access to consumers money – which in turn will contribute to a positive change within the culture of the bank, consumers will be more trustworthy of leaving their money in the bank and a repeat of what happened to Northern Rock will be avoided. After the financial crisis it could be suggested that consumers main point of contention was that the bankers were being reckless with people’s money, through ring fencing – consumers will rest more assured that their avings are safe, again giving the impression that the bank are putting their customers first (Hardie & Macartney, 2016).
Through the research conducted in this report it can be concluded that had the current regulations been in place at the time the RBS collapsed, between 2000 and 2008, it could have been prevented, the updated regulations have addressed some of the key contributors to the demise of RBS. Throughout the period of Fred Goodwin’s reign, there was an unhealthy culture that focussed solely on expansion (BBC, 2011). The culture within RBS caused executives to engage in risk-seeking behaviour, risky investments that were unaffordable were taken on under the premise that they would be very lucrative. If Basel III had been enforced in the years of the collapse of RBS then they would have been stopped from making the takeover bid for ABN Amro – as it would be unaffordable in relation to the secured assets that they held (FSA, 2016) large investments undertaken by the bank would have to be appraised more thoroughly and the directors of the organisation would be held more accountable for their actions (UKCGC2016: Accountability), thus making them less likely to take such large risks. There are ongoing developments within the financial industry, for example the FSA’s ring fencing proposal is to be implemented in 2019, the effects of this are therefore yet to be seen but it can be predicted that this will help the culture of RBS begin to cater more effectively to their customers and put their interests at the heart of the business.