The failure of Royal Bank of Scotland shows bank reform still has some way to go. Many of the 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 doubts that new Basel III rules make banks safer. Using this measurement of capital, RBS’s equity Tier 1 capital ratio at the end of 2007 was around 2 percent – well below the 7 percent now considered to be an acceptable minimum. 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’s 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 today – 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 those factors no longer apply. Moreover, UK bank supervision is being transferred to the Bank of England.
What of RBS’s 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 seems 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 – and still does not have that power today. If just one lesson emerges from the sorry tale, it is that this glaring deficiency should be addressed at once.