PPI Claims

Regulators need new rules to crack down on bankers when banks go bust and to block hostile takeovers, according to recommendations set out by the Financial Services Authority in its report into what went wrong at Royal Bank of Scotland.

In a 450-page report scheduled for publication on Monday, the FSA is expected to argue that banks need to be treated differently to other companies and their bosses must prove that they raised the alarm when problems arose if they want to keep working in the City.

Justifying why no regulatory action will be taken against Sir Fred Goodwin, the former chief executive of RBS, the FSA’s chairman Lord Turner is expected to build upon ideas he raised a year ago when he suggested that bankers might need to be held to different standards to those applied to traditional bosses.

The FSA report – first promised in March – looks at how it supervised RBS between 2005 and April 2008 when the bank embarked on a record-breaking £12bn cash call just months after taking over Dutch bank ABN Amro. The deal left it with wafer-thin capital ratios that were not big enough to absorb credit crunch losses. By October 2008, when the bank needed even more capital, the taxpayer stepped in, eventually putting £45bn into the bank in return for an 83% stake.

Goodwin was ousted at the time of the bailout and replaced by Stephen Hester. The FSA admitted a year ago that it had found “bad decisions” caused the bank’s demise rather than “dishonesty”. Hence, it took no action against Goodwin or other board directors. The only board director to be named in the FSA statement is Johnny Cameron, who ran the investment bank and has agreed to not hold any managerial roles in banks again. He is able to work on a consultancy basis, however.

In the report on Monday, the FSA is expected to recommend that regulators have specific powers to approve bank takeovers. This is likely to try to address the view of the FSA at the time of the ABN Amro deal that it did not need to approve the transaction because it did not breach any rules even though it was “highly risky”. Banks should also be required to take independent advice on any deals they do in the future, the FSA is expected to say.

According to Sky News, Turner is also preparing to argue that banks should not be as obsessed with maximising shareholder value as other companies and instead focus on risk management. Bankers should also be required to forfeit their pay when things go wrong.

A year ago, when Turner was trying to justify why the FSA had not published a report into the RBS debacle, he had suggested that bankers might need to be subjected to sanctions even if they were not guilty of reckless or unprofessional behaviour but “solely of poor judgements”. He had also suggested that if bankers at failed banks wanted to work elsewhere they would need to prove they had spoken out against the risks that caused the bank’s collapse.

The report appears to endorse these views and is published after a year of wrangling over the failure of the FSA to publish a detailed explanation of the events at RBS and its role in regulating the bank. The FSA is in the process of being dismantled by the coalition.

The failure of Royal Bank of Scotland (RBS) shows bank reform still has some way to go. Many factors identified in the Financial Services Authority’s 452-page report into the UK lender’s near-collapse and rescue are relics of a different era. However, when it comes to big bank takeovers, further changes are still needed.

The report should dispel any doubt that new Basel-III rules make banks safer. Using this measurement of capital, RBS’s equity Tier-I capital ratio at the end of 2007 was around two per cent — well below the seven per cent considered to be an acceptable minimum now. Under the new regime, RBS would have been prevented from paying a dividend at any time from 2005 onwards. Its heavy dependence on short-term funding would also now be deemed unacceptable.

However, RBS’ collapse was also a failure of supervision. The FSA describes in painful detail how its team of supervisors — which comprised just six people, compared to 23 on Tuesday — did little to challenge the bank’s assessment of the risks it faced. That approach reflected the reigning theory of efficient markets and political pressure to maintain a “light-touch” regulatory regime.

Both factors no longer apply.

Moreover, UK bank supervision is being transferred to the Bank of England.

What of RBS management? The public desire for someone to be held accountable won’t be appeased by the FSA’s decision not to bring charges against executives or board members. Adair Turner, the watchdog’s chairman, has called for a debate about how to hold bank directors accountable in future. But, the public humiliation suffered by former RBS executives — particularly, chief executive Fred Goodwin — should deter similar gambles for the foreseeable future. Besides, increasing the penalties for bank failure seem at odds with the regulatory drive to make it possible for even big banks to fail without triggering an economic catastrophe.

But, when it comes to big bank takeovers, there is a case for further reform. RBS’s decision to lead a hostile break-up bid for ABN Amro in the summer of 2007 was not the only factor behind its collapse. Nevertheless, it made a precarious situation even more fragile. And, it was done on the basis of minimal due diligence: According to the FSA, the information made available by ABN Amro amounted to “two lever arch folders and a CD”.

The report’s most shocking finding is that the FSA could not have blocked the ABN Amro takeover even if it wanted to. It still does not have that power. If just one lesson emerges from the sorry tale, it is that this glaring deficiency should be addressed at once.

When the Financial Services Authority was in its “light touch” phase before the financial crisis, the answer fell as low as four and a half, according to this week’s report into the 2008 collapse of the Royal Bank of Scotland.

At one point in 2007, a single person was responsible for the investment banking arms of both RBS and Barclays.

The FSA has since scrapped its hands-off approach and hired more staff. The RBS team now has about 23 members and supervisors can draw on the FSA’s 253 specialists for help on complex issues such as capital and liquidity.

Those figures put the UK broadly in line with other jurisdictions that supervise globally active banks, although there are a wide variety of approaches. In some countries supervisors are embedded within the institutions they oversee so they can keep an eye on things, while others prefer to keep their regulators at their home offices to avoid the problem of “regulatory capture”.

France’s Autorité de Controle Prudentiel does a little of both. About half its 500 supervisors are resident at the various French banks and the other half are based at the regulator. That translates to roughly 10 resident and 10 external inspectors for each big French bank.

Low numbers do not necessarily signify a loose regime. Canada, which is known for keeping its banks on a particularly tight leash, assigns roughly 15 people to each big bank.

Richard Reid, research director at the International Centre for Financial Regulation, says: “I do feel, however, that by comparison with some other jurisdictions, that figure of 23 for RBS looks light, particularly given RBS’s systemic importance.”

In Germany, Deutschebank is supervised by about two dozen people between the BaFin and the Bundesbank, and is inspected at least quarterly. The Bundesbank regulators are in a building across the road from the bankers they oversee.

The admission of error can be cathartic. Just a year ago, Lord Turner, chairman of the Financial Services Authority, insisted there was no need to publish a report into the failure of Royal Bank of Scotland. This week the FSA chairman confessed it had, after all, been a good thing to do.

There has been a lot of soul-searching at FSA headquarters recently. The RBS report is the second, after the 2008 inquiry into Northern Rock, to document failures not just of bank management, but of the watchdog itself. The FSA has since taken steps to address its failings and should be applauded for again publishing at the risk of being damned.

The FSA report makes important points about continuing vulnerabilities. It recommends sensible new safeguards, such as an automatic ban on executives working in the financial sector if their bank goes bust, or set penalties depending on their role in any collapse. In any case, this report makes clear that UK regulation should at least impose a duty of reasonable care on banking directors. For that reason alone, Lord Turner was right to set aside his initial squeamishness and go public.

Others should follow his example. The Treasury and the Bank of England, the two other pillars of Britain’s tripartite regulatory regime, could do with a healthy dose of critical self-analysis. It was the Treasury, after all, which pushed the FSA to adopt a light-touch regulatory approach which enabled RBS management to make reckless decisions.

The need to open up is equally pressing at the Bank of England, which is soon to become the main prudential banking regulator. Sir Mervyn King, governor of the central bank, has called for broad discretion in the exercise of his new responsibilities. Yet he has to date resisted calls to publish the result of any internal review on how the Old Lady of Threadneedle Street failed to act after spotting the unsustainable levels of leverage and risk that helped to bring down RBS.

The U.K. Financial Services Authority’s report on the 2008 failure of the Royal Bank of Scotland is a strange document. On the one hand, it is a 458-page defense of the proposition that mistakes and failures of judgment can drive a company to ruin without amounting to criminal misconduct. In light of some of the scapegoat-hunts conducted against bankers since the last financial panic, it’s a conclusion that offers hope that, in the U.K. at least, business is no longer at risk of being criminalized.

Then again, the report remains stuck on the view that “banks are different,” as FSA Chairman Adair Turner puts it in his foreword. After RBS was shut out of the private markets in October 2008, the U.K. government first stepped in as lender of last resort and ultimately recapitalized the bank to the tune of £45 billion ($70 billion), an investment that at current market prices has lost about half of its value.

The report reiterates the long-held view that RBS had to be rescued because the consequences of bank failure—on depositors, on the economy, on the financial system as a whole—were unthinkable or unbearable.

Thus the FSA’s post-mortem focuses almost exclusively on how regulators might prevent a failure in the future, rather than asking how to make bank failure both easier and less expensive for taxpayers.

The report goes on at length about the mistakes that both RBS and its regulators made. Its leverage was too high, its regulators were too sanguine about the stability of the financial sector as a whole, and so on. Some of these mistakes are being corrected with the benefit of hindsight: RBS’s tier 1 core equity capital was just 2% of its assets in 2007; new international banking rules will require a bank like RBS to hold 9.5% capital and make provision for emergency liquidity. The FSA also examines the possibility of introducing strict liability for bankers whose firms go bust

Some of these new rules will create greater margin for error. But none of them will eliminate error, either by regulators or by bankers, and having capital on paper is not, by itself, a guarantee against collapse. Regulators can never create a perfectly safe and stable financial system. Nor should they aspire to do so.

Four years before Royal Bank of Scotland Group Plc collapsed, Britain’s Financial Services Authority identified then-Chief Executive Officer Fred Goodwin’s “dominant” management style as a risk.

A report into the near collapse of Edinburgh-based RBS released by the FSA yesterday said that rather than challenge Goodwin, regulators were too lenient dealing with him.

In 2005, Goodwin asked that FSA staff water down written concerns about RBS risk management after he was shown drafts of correspondence the regulator was preparing to send to the bank’s board. Acceding to Goodwin’s demands for a rewrite was “common practice” by FSA staff at the time, the report said.

“More should have been done to address concerns that the CEO was dominant and that he received insufficient challenge from the RBS board,” the report said. “Greater consideration should have been given to escalating the concern.”

When the regulator sought one-on-one meetings with the bank’s non-executive directors to seek reassurance that proper governance procedures were in place, RBS refused and complained that its employees “should not be picked off.” The FSA is being split up by the government next year as part of the May 2010 coalition accord between the Conservative and Liberal Democrat parties, which said the existing regulatory system is “fundamentally flawed and needs to be replaced.”

The head of Britain’s financial regulator was handed a £144,00  bonus in the same year he failed to block the Royal Bank of Scotland from taking over a Dutch bank which brought it to near bankruptcy.

Hector Sants, chief executive of the Financial Services Authority, (FSA) took home the money as part of a pay package which also rose 37 per cent to £662,000 in the year 2007-2008 – the same year Northern Rock collapsed.

RBS pursued a series of acquisitions, including NatWest in 1999 and U.S. bank Charter One in 2004, but in October 2007 Sir Fred Goodwin spent £50billion buying Dutch lender ABN Amro  – the biggest bank takeover in history.

Former banker Mr Sants considered stopping the move at the last minute but allowed it to go ahead after being advised it was ‘highly unlikely’ liquidity conditions would deteriorate so far as to cause problems for the bank, the Daily Telegraph said.

He made the decision alongside FSA chairman Sir Callum McCarthy. He had a pay increase to £481,000 from £434,000 in the same year.

The move proved a buy too far for RBS which was forced to borrow billions and it was exposed to more credit losses.

Taxpayers were forced to step in to bail it out to the tune of £45.5bn becoming owners of more than 80 per cent of it in October 2008.

This week, the London-based watchdog admitted it had not kept a close enough eye on the bank and the ABN deal. It said it should have challenged the bank on the takeover earlier – prior to Mr Sants’ appointment.

A 450-page FSA report into the bank’s downfall said in terms of the ABN Amro acquisition, RBS proceeded without appropriate heed to the risks involved and with due diligence from the Dutch bank that in April 2007 amounted to ‘two lever-arch folders and a CD’.

It identified six key factors in the failure of RBS, most significantly its weak capital position and over-reliance on risky short-term funding in wholesale markets.

The FSA said the seventh key factor in explaining the bank’s demise was the management, led by Sir Fred, nicknamed ‘Fred the Shred’, who now has a pension worth £342,500 a year.

Also this week, the watchdog said RBS’s failure helped to shift Britain from an ‘outlier’ light-touch regime of financial supervision into the mainstream.