RBS Report Blames Bank Managers for Collapse

By Ben Moshinsky and Gavin Finch - Dec 12, 2011 5:38 PM GMT+0700

U.K. regulators pushed for new powers to automatically sanction senior bank executives as well as increased oversight of financial mergers as part of a report on the near collapse of Royal Bank of Scotland Group Plc. (RBS)

Automatic sanctions for poor decisions that lead to a bank failure “have the advantage of not requiring expensive and contentious legal processes,” the Financial Services Authority said on its website. Takeovers should be more forcefully regulated, according to the study, which detailed how RBS’s purchase of ABN Amro Holding NV in 2007 almost brought the lender to the brink of collapse.

Bank mergers should be supervised to “reflect the fact that major acquisitions by banks pose potential social risks which are not present in the case of contested takeovers by non- banks,” according to the report.

RBS reported a 24.1 billion-pound ($37 billion) loss for 2008, the largest in U.K. corporate history, and required a 45.5 billion-pound taxpayer rescue, the world’s biggest banking bailout, after the acquisition. The FSA, which will be split up next year, came under pressure from lawmakers to publish the probe into RBS finances after it cleared former RBS Chief Executive Officer Fred Goodwin and others of wrongdoing.

“Regulation is in the throes of being handed back to the Bank of England,” said Simon Willis, an analyst at Daniel Stewart Securities Plc. “One of the biggest ironies of all is that it’s the FSA that’s done the report. Perhaps it should have been an independent report.”

The report, which has been more than a year in the making, meted out equal criticism of bank managers and FSA regulators.

Short-Term Funding

RBS relied too much on short-term wholesale funding, a weakness that was missed by the U.K. banking regulator, the bank regulators said in the report. The watchdog listed seven reasons for the bank’s failure, including uncertainties over the quality of the lender’s assets and lack of capital.

Goodwin pushed through the world’s biggest bank takeover, the 72 billion-euro ($96 billion) purchase of Amsterdam-based ABN Amro with partners Banco Santander SA (SAN) of Spain and Belgium’s Fortis even after global money markets froze in 2007. The acquisition saddled RBS with bad debt and depleted its cash reserves.

‘Perceived Dominance of’ Goodwin

The FSA “identified a risk created by the perceived dominance of” Goodwin as CEO as early as 2003, the report said, adding that the bank’s chief had developed a “challenging management culture.”

“Taxpayers should never have had to rescue RBS,” Philip Hampton, the Edinburgh-based bank’s chairman, said in an e- mailed statement. “The FSA’s views are an important contribution to the debate on how banks should be managed and regulated in the future.”

The FSA said its initial probe into the bank’s bailout found that there were no codes or standards that would allow prosecutors to show at a tribunal hearing that bank managers breached their duties of due diligence in the ABN Amro takeover.

“The crucial issue that this raises, however, is whether the rules are appropriate: whether the decisions and actions which led to failure should ideally have been sanctionable, and whether we should put in place different rules and standards for the future,” FSA Chairman Adair Turner said in the report.

The experience in the U.S. of bringing criminal cases against directors shows it’s “very, very difficult,” said Matthew Czepliewicz, a banking analyst at Collins Stewart in London.

‘Judgment Call’

“If we’re talking about Fred Goodwin paying a certain amount for this acquisition, that’s a judgment call and the market and regulators knew what he was doing,” he said.

The report blamed RBS’s collapse on a liquidity run, where lenders to the bank became increasingly unwilling to roll over their funding commitments. That, in turn, had its roots in uncertainty about whether the bank had sufficient capital to absorb losses.

“There was insufficient focus on the core prudential issues of capital and liquidity, and inadequate attention given to key business risks and asset quality issues,” according to the report.

The lack of confidence saw the bank lose a total of 19 billion pounds in deposits between August and October in 2008.

RBS’s capital ratio in 2007 would have equated to 1.97 percent, under more rigorous capital rules now in force, the study estimates. That figure is less than a quarter of the amount required now.

Deal Financing

The FSA criticized RBS’s decision to finance the ABN Amro purchase primarily though debt rather than equity. RBS paid 4.3 billion euros in stock and 22.6 billion euros in cash to ABN Amro shareholders, with the majority of the cash funded by debt, 12.3 billion euros of which matured in under a year, the FSA said.

RBS had one of the “greatest dependencies” on short-term wholesale markets, and in particular overnight funds, the FSA said. That left it more vulnerable than its peers to even short periods of market stress.

This weakness was exacerbated following the bank’s purchase of ABN Amro, as it became even more reliant on the short-term funding as a consequence, the report said.

The report said the FSA moved too late in April 2008 to force RBS to raise 12 billion pounds in capital, saying the regulator’s supervision of reserves was mainly reactive. The bank needed as much as 166 billion pounds in additional “high- quality unencumbered liquid assets,” the FSA said.

‘Too Late’

“From late 2007 onwards, the FSA was increasingly developing and applying a more rigorous capital regime, and it pushed RBS to make a large rights issue in April 2008,” the FSA report said. “In retrospect, however, the changes in the FSA’s capital regime came too late to prevent the developing crisis.”

The FSA operated a flawed supervisory approach which failed adequately to challenge the judgment and risk assessments of the management of RBS, the FSA’s Turner said.

“This approach reflected widely held, but mistaken assumptions about the stability of financial systems and existed against a backdrop of political pressures for a ‘light touch’ regulatory regime,” Turner said in the report.

The U.K. Treasury called the report an “important part of learning lessons from the financial crisis and gaining further understanding of its causes,” in an e-mailed statement.

The government said in 2010 that it would abolish the regulator, handing its bank supervision powers to the Bank of England.

Since the crisis, RBS has cut more than 27,000 jobs and shrunk RBS’s balance sheet by almost a trillion pounds since Stephen Hester replaced Goodwin in 2008.

To contact the reporters on this story: Gavin Finch in London at gfinch@bloomberg.net Ben Moshinsky in London at bmoshinsky@bloomberg.net;

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net Edward Evans at eevans3@bloomberg.net