As the Treasury turns its attention to selling the taxpayers’ stake in Royal Bank of Scotland , IAN FRASER assesses what progress has been made in the battle to revive the bank’s fortunes
The 60-year-old chief executive of Royal Bank of Scotland had spent five years battling to revive the battered business and news from across the Atlantic the previous day was just the tonic he needed.
The United States Department of Justice had agreed a provisional $4.9 billion (£3.7bn) settlement over the “mis-selling” of toxic mortgage-backed securities. It was a hefty penalty, but one that the New Zealander described as a “major milestone” on the bank’s road to recovery.
Because the tentative settlement was priced significantly lower than the $12bn (£9bn) that some analysts had been predicting, the announcement lifted a fog of uncertainty over the bailed out institution, and brought sighs of relief at RBS’s 280 Bishopsgate head office, the Treasury and among investors.
In the wake of a return to modest profitability last year – the bank reported pre-tax profits of £752 million in 2017 after nine consecutive years of losses – the settlement was seen as presaging a return to the payment of dividends.
This was a move towards “normalisation” of what had for far too long been an albatross around the government’s neck and it finally made it possible for the UK government to sell at least some of its 72% stake in the bank. It was reported on Monday evening that government agency UK Government Investments (UKGI) might be ready to sell as much as £3 billion worth of RBS’s shares, or about a 10% stake in the bank, at a considerable loss.
Following the “milestone” settlement, and prospect of a share sale, the directors are expected to be in a more positive mood as they face shareholders at the bank’s annual general meeting this week. But how much progress has been made in “normalising” operations, and what issues still need to be resolved?
After chancellor Alistair Darling agreed a £45.5bn bailout in 2008 he and Prime Minister Gordon Brown believed that RBS might be returned to private ownership within two or three years. Yet initial attempts to rebuild RBS got off to a false start. Having installed Stephen Hester as the chief executive after the ousting of Fred Goodwin in October that year, the government initially gave the former Credit Suisse investment banker his head.
Hester’s ideas for salvaging the bank revolved around a shrinking of the balance sheet through the dumping of “non-core assets”, but not much drastic surgery or behavioural reform. Hester’s attachment to retaining a globally active investment bank and fighting to protect bonuses caused friction with regulators and the coalition government, and are widely considered to have cost him his job once the government mood music changed.
It was not really until McEwan took the helm in October 2013 that serious reform got under way. He set about further shrinking the investment banking division, since rebranded as NatWest Markets, reducing its total assets from £1.1 trillion in 2008 to £277bn today. RBS also exited many countries, closed divisions, “worked out” some distressed loans and sold bundles of others to vulture funds at knockdown prices. It also divested key divisions including Citizens Financial and Direct line.
Altogether, these actions enabled the bank to slash its group balance sheet from some £2.4trn at the time of the bailout to £738bn today.
Staff numbers have been decimated in the process, falling from more than 200,000 in 2008 to below 71,000, with India being the only growth country for employee numbers. The bank now has more employees in India – 12,000 – than it has in Scotland. McEwan has also taken the axe to the branch network, with the number of UK branches falling from 2,350 in March 2000 to around 864 today.
Such measures are causing barely disguised fury and pain among employees and customers, and have provoked widespread condemnation from politicians, trade unionists and others who believe a state-rescued bank should show greater loyalty to the taxpayers who saved it.
In a report published on Sunday, the Scottish Affairs Committee demanded RBS reconsider its planned closure of 62 branches in Scotland. However, McEwan, who has already reneged on the bank’s 2010 pledge not to close branches where they are the “last bank in town”, seems deaf to such entreaties.
He insists more and more customers are happy to do all their banking online or use mobile apps, that the UK is increasingly moving towards becoming a cashless society and that RBS is making alternative channels – including mobile vans and post-office counters – available to customers who insist on using cash or who struggle to use online banking.
He is determined to lower the bank’s cost-to-income ratio and does not believe this is compatible with maintaining a branch network serving small and remote communities. He is understood to have the backing of government agency UK Government Investments (formerly UK Financial Investments) which manages the bank assets for the government, and the Treasury, both of whom see the closures as a “commercial decision” for the bank.
It has certainly made impressive strides in digital banking and mobile apps, recently announcing that 5.5 million customers are now regularly using its mobile app, surpassing the number of customers who bank with it online. With his metropolitan perspective, McEwan does not see why Borders farmers and Hebridean crofters should not bank in this way too.
Under his stewardship RBS has slashed costs by £1bn in each of the past four years and he wants to maintain that trajectory. Prodded by the Prudential Regulation Authority, which supervises the banks, RBS has raised its common equity tier-one capital ratio – a measure of its ability to withstand future crises – from 8.6% in 2013 to 15.9% at the end of last year.
However, the road to recovery has been painful and controversial, commercially and politically. Ahead of one board meeting the Treasury announced that the bank’s registered head office would be moved to London in the event of a “Yes” vote in Scotland’s independence referendum. Both McEwan and his chairman at the time, Sir Philip Hampton, warned that Scotland’s financial system would not be capable of withstanding another banking meltdown.
The scandal involving the rigging of the London interbank offered rate (Libor) and foreign exchange benchmarks took place before McEwan became chief executive but he has had to manage the consequences, not least the damage to the bank’s image and reputation. The behaviour of RBS’s restructuring division, Global Restructuring Group (GRG) towards SME customers have been a further reputational quagmire. McEwan was considered to have been found wanting in his handling of the scandal.
In what Labour MP Clive Lewis has described as “the largest theft, anywhere, ever”, GRG allegedly became a gigantic threshing machine, accused of plundering and asset-stripping SME customers as part of the bank’s attempt to bolster capital ratios and return to profitability.
Allegations over GRG’s activities came to light in the Lawrence Tomlinson report in November 2013. RBS denied wrongdoing and commissioned what critics described as a “whitewash” report from the law firm Clifford Chance.
Despite McEwan’s regular public pledges to be cleaning up the bank, the smell of toxicity has lingered including allegations that it forged signatures, which it has also been forced to deny. RBS’s former head of strategy George Graham, told the St Paul’s Institute in June 2015 that Fred Goodwin’s ethos lived on.
He said: “Shifting the culture of a bank doesn’t lend itself well to 90-day plans and progress charts. Banks are trying, but it’s not easy, and success is more likely to be visible by the absence of negatives than by any observable and tangible achievement of positives.”
At Wednesday’s AGM, McEwan is also expected to be quizzed about the appointment of ex Merrill Lynch investment banker Oliver Holbourn as RBS’s director of strategy, given the scope for conflicts of interest with Holbourn’s immediate past role as head of the financial institutions part of UKGI.
Aside from the ethical issues, the bank has struggled to deal with commercial challenges such as its handling of the EU-mandated disposal of 314 branches as a condition of its bail out.
These were meant to be repackaged as a new bank under the revived “Williams & Glyn” brand, but the project was terminated as the team tasked with undertaking it struggled to disentangle the IT systems. The bank failed to find a buyer, or float it, and after hiring hundreds of expensive IT consultants, and even investing in uniforms that were never used, the bank ended up with a £2.2bn bill.
In February 2017, the UK Treasury acknowledged the game was up, and brokered a deal enabling RBS to scrap the plan on condition that it handed £833m in “remedies” to smaller rivals. Most of the RBS branded branches in England and Wales are now also to be closed.
The failure to spin-off Williams & Glyn contrasted with Lloyds Banking Group’s similar spin out of 631 former TSB and Cheltenham & Gloucester branches, a move that was also demanded by EU state-aid rules. Under chief executive Antonio Horta-Osorio, Lloyds managed to offload the branches as a standalone bank in October 2013 before completing a sale to Spain-based Banco Sabadell in July 2015 for £1.7bn.
The biggest challenge now facing RBS is to demonstrate its pared down business model – essentially to be a UK and Ireland-focused retail and commercial bank – will appeal to investors in a low interest rate, post-Brexit environment.
Amid on-going calls for it to be broken up it must continue to hack away at costs, implement the final stages of the Vickers “ring fence” forcing a separation of its retail and investment banking arms, and prove that it is sufficiently agile with IT to survive in the new “Open Banking” environment which aims to create greater transparency for customers.
The bank must bolster its net interest margin which, at 2.13%, is significantly below that of Lloyds Banking Group, and do so without driving away savers or borrowers. It must also find a successor for McEwan who is said to consider his work almost done.
Bumps in the road ahead are likely to include the GRG scandal which recently gained an international dimension and is expected to end up costing the bank far more than the £400m it has already set aside. Restructuring costs are likely to remain elevated, as fewer staff mean fewer offices, and extricating itself from some will come at a price. The bank recently revealed it must pay £200m to break the lease on its Bishopsgate London head office – because the Fred Goodwin regime entered a lease that does not expire until 2037. That’s almost as much as “Fred’s Folly” at Gogarburn cost to build.
Notwithstanding these issues, RBS is moving in the right direction. The chancellor Philip Hammond anticipates being able to sell some £15bn of its shares, or about two-thirds of the government’s stake, in £3bn-a-year tranches between now and 2022/23.
Given the vicissitudes of markets, the evolution of the banking market (which does not help incumbents with legacy systems and high cost bases), the possibility that further scandals will be unearthed, and the risk of a no-deal Brexit, this might prove a stretch.
And even if Hammond does pull it off, he is likely to do so at a loss of between £20bn and £26bn to taxpayers. That’s in marked contrast to the modest victory that was notched up by Horta-Osorio at Lloyds. It has not been without pain either, notably the huge compensation paid out for mis-selling PPI, but despite this and the extraordinary losses endured by HBOS taxpayers have emerged with an £800m profit after the government sold the last of its shares in the bank just over a year ago.
Ian Fraser is author of the Shredded: Inside RBS, The Bank That Broke Britain