The UK government has taken four months to work out what almost everyone knew all along. Splitting off the toxic assets of Royal Bank of Scotland into a separate bad bank is a bad idea. The 81 percent taxpayer-held bank will now pursue an eminently more sensible plan to build capital by shrinking non-core assets more quickly.
Had RBS spun off its worst assets in 2010, it might have avoided criticism of the type meted out by Andrew Large on Friday. His study found that RBS’s ongoing quest to shrink 258 billion pounds of non-core assets distracted attention from small business lending. With non-core assets now below 50 billion pounds, an independent bad bank is superfluous. Creation would crystallise big losses upfront, run into European state-aid regulations, and take 12 to 18 months.
New Chief Executive Ross McEwan’s alternative makes more sense. RBS wants to offload its U.S. Citizens bank by the end of 2016, and reshuffle non-core assets so that the worst – which consume 20 percent of group capital – are wound down. It also wants between 55 and 70 percent of this “internal bad bank” to be disposed of by 2016.
As investors seemed to realise on Nov. 1, the gain comes with pain. Shares fell 6 percent. McEwan’s plan could mean accelerating losses, requiring higher near-term provisions and lower profit. That could make it harder for RBS to pay a dividend in the short term. And that’s probably why UK Chancellor George Osborne isn’t talking up a Lloyds Banking Group-style share sale any time soon.
McEwan could have tried to square the circle by retaining Citizens and shrinking the internal bad bank more slowly. But this would have clashed with the way UK regulators are implementing new Basel III rules, which will almost certainly push up required capital ratios. RBS is now targeting a 12 percent core Tier 1 ratio by the end of 2016.
RBS still has worrying legal issues to address, like a multi-bank global probe into alleged forex manipulation, and a potentially hefty fine for issuing duff mortgage-backed securities. Still, McEwan’s plan does enable RBS to make a fresh-ish new start.