RBS Good money after bad

Discussion in 'Current Affairs, News and Analysis' started by Hippohunter, Feb 24, 2017.

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  1. Unfortunately, for RBS, the horse has well and truly bolted.

    The major problem at RBS was one of "culture", as set by the CEO and board...and as encouraged by Gordon Brown. There was a liberal dose of Scottish nationalism underpinning their behavior which, rather like the SNP today, blinded them to the sheer folly of their ways.

    When Goodwin joined RBS as deputy CEO in 1998, he had very, very little general banking experience, having only run a small (loss making) UK satellite business of NAB (true of his predecessor too). Three short years later, he was CEO of RBS, having acquired NatWest, a much larger bank. Moreover, Goodwin had almost zero experience of investment banking, a business that is complex and requires deep and detailed knowledge of markets and their risk management. He was a trumped-up accountant with an incredibly big ego and deep Scottish political connections which, at the time, meant deep connections into the heart of Westminster.

    Despite never having run an investment bank, under Goodwin RBS expanded its investment banking business at an unprecedented rate, almost entirely by acquisition. It paid far, far too much for low margin, high risk businesses. At the time, the overall market was their ally.....they were half way into the pre-crash bubble. Any fool can make money in a rising market. The measure of a good CEO is whether they can continue to make money during hard times. Inevitably, Goodwin failed. He simply didn't know what he was doing, but the internal culture prevented any dissent.

    To give you an idea of the level of expansion, prior to the NatWest acquisition, RBS went from being a sleepy, provincial high street bank to having a balance sheet in excess of £2.2 trillion, which was more than the entire GDP of the UK.

    The rest of the story you know.

    As of today, RBS is retreating from those same markets that it so feverishly entered. It's probably doing it too fast, shedding good assets along with bad. Dogma has again taken over, but in the other direction.

    We should be clear that the sole reason that RBS was "saved" is that the government of the time wanted to protect depositors, i.e. "mums and dads" with ordinary bank accounts. While I have some sympathy for that social position, it was adopted for political rather than economic reasons. The same is true for Northern Rock, whose depositors had the ingenuity to seek out the highest paying deposit accounts, but completely ignored the creditworthiness of the institution offering those same high interest rates.

    The "privatise the profits, socialise the losses" approach applied to both bank employees and to ordinary depositors. Indeed, the bias was towards the latter.
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  2. It's a non sequitur.

    Take Rabobank as an example. A formerly AAA rated Dutch farmers cooperative, often held up as the poster-child for good governance and prudent management. They still managed to lose some EUR 7bn in structured credit trading.

    The corporate structure of an institution does not protect it from poor management decisions. Endex.
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  3. I think that it has become rather painfully obvious, also, how little influence the shareholders (the owners) have. Somehow bank management seem to have cocooned themselves from normal business practises.

    It cannot even be said that dividends are keeping shareholders compliant. Clearing bank shareholder dividends have been risible for years.
  4. Shareholders, generally, choose not to exercise their rights.

    The largest shareholders are pensions funds (yes, your pension fund). In an effort to seek higher returns in a low interest rate environment, it was these same pension funds that harried the banks to create the structured products that "blew up". They were, after all, "customer products", sold to institutional investors.

    I'm not sure that's entirely true, although it fits your narrative.

    That's because, in isolation, "high street banking" is an expensive business with very, very low returns. Couple that with a low interest rate environment and dividends will be low to non-existent.

    Today, banks simply don't need depositor's cash to do business......until the next "oops" moment.
  5. So it is oft repeated by the banks themselves. However, the clearing bank dividends reflect the performance of the bank's entire business, not merely the retail portion. Dividends have still been derisory, whereas the exec salaries and bonuses do not appear to follow the same pattern.

    Well, it can't just be goodwill. Banks don't do goodwill. They will use their customer base to shift other highly lucrative products. These may not feature on the same balance sheet, but one generates t'other.

    One of the reasons retail banks do not need depositors' cash is that the government/BofE printed £Bs for the banks to lend in order to stimulate the economy. My understanding is that the banks were still reluctant to lend and found other uses for this cash bonanza, not least to capitalise themselves as was now required of them. That is probably the main reasons they're not interested in savers' cash. They're awash with something far cheaper to them.
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  6. Perhaps I didn't explain myself adequately.

    Retail banking is, effectively, break-even at best (vanilla accounts, payments and vanilla mortgage lending). The bulk of "retail bank" dividend is derived from investment and corporate banking (including corporate finance (M&A and advisory work)), which makes up a disproportionate share of total profitability. If those profits were not present, there would be no dividend. If you want to maintain a dividend, then you need to staff who generate those profits. You can't have it both ways.

    "Retail product", as it's called, is relatively low margin in this interest rate environment. If the "product" gets too "funky", so as to generate a profit, it's susceptible to being deemed "mis-sold" ex post.....so has become unfashionable. The days of banks utilising their retail franchise as a "distribution platform" for structured products on an industrial scale are long gone.

    To an extent that's true, but not entirely.

    The primary issue with the crash was one of liquidity. All financial institutions "borrow short, invest long", i.e. they fund their balance sheet with a bias towards short-term money (depending on the term-structure of the yield curve), and roll over that funding as it matures. In 08, wholesale markets stopped working. It wasn't a question of cost, the inter-bank market just ceased operation because the market was uncertain as to which bank would go bust next.....so better not buy their debt (i.e. lend to them).

    Retail money (i.e. deposits in vanilla bank accounts) is termed "sticky money", as it doesn't move as quickly between banks as institutional money does when trouble is on the horizon. Having access to "sticky money" is very useful to a bank, as it effectively underwrites any funding shortfall in the wholesale markets. Banks are willing to pay a price, albeit a low price, to access that type of funding. It helps with regulatory capital (where stress testing is a function of both the quantum and type of capital available) and their credit rating (which impacts funding costs).
    Last edited: Feb 28, 2017
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  7. Seriously, 26-sigma? When I saw your first reference to it I assumed it was a mistype of 2-sigma, when I re-read the whole post, that fact horrified me. I'd known that the situation was bad, but coupled with that level of variability it is just a car-crash waiting to happen.
  8. TheIronDuke

    TheIronDuke LE Book Reviewer

    Whoo. A cracking thread. As one who lost a bit on the Northern Rock debacle and has generally been stuffed when I put my money into City suits can I make a suggestion?

    Banker and Provost be made Guru of ARRSE Finance Stuff? And have a little thing on their avatar to indicate this?

    Thanks. I shall now vanish like snow on the water and continue to read with interest.
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  9. Give me a go, and we will see.
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  10. Cynical

    Cynical LE Book Reviewer

    Sorry for delay in picking this up - events and relocation have been occupying me.

    The source is John Lancaster's book "Whoops" he is quoting a Goldman Sachs director. Inevitably as part of my relocation the bloody book has also gone walkabout. But the figure stuck in my mind. Lanchester is usually pretty reliable on what he quotes, but of course that does not discount the possibility that the Goldmans chap was talking rot.

    That said, much modelling had gone into demonstrating that the various CDOs etc would perform predicatably so when they didn't the models would ascribe a very low probability to that occurrence. The stark, unavoidable fact is that the financial services industry is:
    1) (Rightly) highly numeric and thus attractive to mathematical modelling. Unfortunately this brings in probability theories.
    2) Fast. Latency is a big issue for liquid markets, particularly if stuff starts happening and prices start to move.
    3) Computerised, because machines do numbers faster than humans and can all be connected more reliably
    4) Vulnerable to poor models, and yet perfect models are impossible.​

    I remain persuaded that the assumption set (which is effectively the error budget) behind many models is obscure and thus not easily proven reasonable or reliable.

    The related problem is that when the price of one financial instrument (e.g CDO, CDS or whatever) starts to move outside of the alleged "probable" limits the markets inevitably question the strength of those who hold them (i.e. those who were training on the "bigger idiot" theory who have suddenly run out of bigger idiots). This then triggers movements in other instruments involving afflicted parties, dragging them further into the mire and sucking in others. But in the physical world, Main Street rather than Wall Street nothing has changed.

    IM(V)HO what should (and could) have happened was for the markets to be declared disorderly and closed. They would remain closed until someone could unpick the values and work out where, if anywhere, the defaults were. This concept is already in existence in some markets, which have breaks precisely to prevent these runs developing and to enable slow witted humans to catch up with the trades.

    Yes, the system had to be bailed out to avoid global financial Armageddon. but what has singularly failed to happen is that anyone has addressed the systemic errors in the banking and related industries. It could be done, but many vested interests will be upset.
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  11. Cynical

    Cynical LE Book Reviewer

    Which is fine until something goes wrong and liquidity dries up. It is this single practice that created the size of the problem. That the regulatory system accepts (and arguably encourages this) almost a decade later is, to me, profoundly depressing.