8th March 2013
Outgoing Bank of England governor Sir Mervyn King has called for the break-up of Royal Bank of Scotland.Financial journalist Tony Levene considers the issues.
Just hours ahead of yet another RBS computer problem locking retail and small business customers out of their accounts – the second such failure in under a year – he told the final session of the parliamentary commission on banking standards, a body of MPs and peers, that 82 per cent state owned RBS should be split into a good bank and a bad bank.
The concept is partly analogous with administrators moving into a bust high street store chain or into a manufacturer which cannot pay its bills. Insolvency practitioners sell off whatever is viable, the good bits, sometimes to the existing management or owners. The restructured firm then has a good chance of success as it is no longer held down, either financially or reputationally, by non-performing assets. The bad bits disappear, leaving creditors, bondholders and shareholders to divide up the losses. These may eventually be sold to firms, specialising in bust assets.
But this analogy can only go so far. While the financial system itself can absorb the loss of a Jessops or an HMV, no matter how hard the process on some individual stakeholders such as landlords or voucher holders, it is a different question with a “too big to fail” bank such as RBS. It is not just because the state has poured countless billions into the bank, although that is a vital
consideration. Its very size means the knock-on effects of an administration would be enormous. All this is further complicated by the split ownership of the bank – the state owns 82 per cent with other investors owning the balance – and by the control of the organisation which, despite state majority ownership, is still run as a private enterprise, not a nationalised entity.
Any move to break the banking mould has a popular and populist appeal. But before succumbing to bank-bashing, investors need several questions answered.
1. What would be in the good and the bad banks?
2. Is there a history of breaking up banks in this way?
3. What would a “good” RBS look like?
4. How feasible is this?
5. What would happen to RBS’s minority shareholders?
6. How would this impact on other banks?
7. What would be the effect on the wider economy?
8. Why has this idea been floated now?
What would be in the good and the bad banks?
The most likely split would be between performing and non-performing (or toxic) assets. This has nothing to do with the long-running attempts to sell off Royal Bank of Scotland retail branch network in England and Wales, ordered by the European Union due to its receipt of state aid. Santander was in the frame but pulled out last year, while the latest idea is reviving the Williams & Glyn label from thirty years ago as part of a flotation.
Nor is it the long-argued split between retail and investment banking. However, because the division would be between assets that are performing and those that are toxic, most of the retail would go into the good bank with a large slice of the investment portfolio parked in the bad.
Is there a history of breaking up banks in this way?
Yes, including here in the UK, and in Ireland. It started in 1991 in Sweden when new “bad” banks , Securum and Retriva, were set up to incorporate the non-performing assets of a number of then crisis-hit banks in that country. The idea is that freed of the capital requirements and management time in dealing with loans that are unlikely ever to be repaid, the “good” banks with their clean slates can get on with lending again. Running a bad bank requires a different skill set but that can be acquired, leaving more normal banking work in the good bank to those who understand it. It worked in Sweden.
Ireland’s most toxic banking assets were put into a “bad” bank, the National Asset Management Agency. This seems to be working with the bad bank collecting 87 per cent of the cash due so far. In the UK, the nationalised Northern Rock has been split up into Northern Rock Asset Management, which contains the toxic loans, and the retail bank which was subsequently sold to and rebranded as Virgin Money. Virgin Money inherited the savings accounts and the “normal” mortgages.
What would a “good” RBS look like?
Freed of the bad part, it would need a less demanding balance sheet to deal with regulatory capital requirements. It could use more of its capital to concentrate again on putting money into the accounts of small businesses and consumers via loans. It could be argued that this re-energisation would put fresh spending power into the economy, enabling SMEs to expand and consumers to buy larger items. A good RBS might look like RBS was before it flew too close to the sun.
How feasible is this?
It can be done, otherwise Sir Mervyn would be calling for the impossible. But there is a lack of political will as the Chancellor would very much like to sell off some or all of the state stake in RBS
before the next election. A split-up timetable would be lengthy and derail this ambition. It would also mean flexing the state’s majority control rather than the present “arms-length” arrangement where the state has poured money into rescuing the bank – about £350bn according
to some – but maintains it is simply a passive investor.
What would happen to RBS’s minority shareholders?
They would kick up a fuss as they will say they maintain their presence on the shareholder register because the state stake is passive. They could be bought out, but that would cost the government.
RBS is currently worth about £19bn so the minority stakes are valued at nearly £4bn. But they contend they are holding on for eventual recovery so they would probably demand at least £6bn for their holdings. An alternative would be to give every present shareholder a stake in both good and bad banks. They have already seen the bank sell off its Direct Line insurance arm and prepare its US banking interests for sale. These comparatively simple operations have been time-consuming.
How would this impact on other banks?
They would not be happy as they currently have to bear the capital and management costs of both good and bad business. It would impact in particular on Lloyds Banking Group where the state has a 43.4% stake which it would also like to unload. Lloyds and its vociferous shareholder groups would argue that freeing just one bank of toxic assets would put it in a more difficult position commercially as it would continue to carry the regulatory capital and management costs of its non-performing loans. It would also, they claim, create a diversion from the ring-fencing of investment banking.
What would be the effect on the wider economy?
Beneficial if it encouraged economic growth. This could, if the government was bold enough, be combined with another plan – to give RBS shares to the entire population rather like the Thatcher sale of state assets in the 1980s. This so-called helicopter money could help the economy by creating demand. Privatisation has been much looked at from the point of view of the company’s direct stakeholders but less so in its effect in getting money out into the wider consumer economy
through the sale of shares.
Why has this idea been floated now?
This is not the first time – Sir Mervyn suggested the concept back in 2008 when RBS was on the point of failure. It may be that, with just a few months to go, the outgoing Bank of England boss wants to show he is independent of government and to set a few cats among the passive pigeons. A week earlier, chancellor George Obsorne had ruled out the idea saying there were “considerable obstacles”. But whatever comes of the concept, it is the Bank of England’s tacit recognition that so far, everything has failed. The best it can come up with is the “it would have been worse” line.