RBS and the case for a bad bank: the Government’s Review November 2013 RBS and the case for a bad bank: the Government’s Review November 2013 © Crown copyright 2013 You may re-use this information (excluding logos) free of charge in any format or medium, under the terms of the Open Government Licence. To view this licence, visit www.nationalarchives.gov.uk/doc/open-government-licence/ or email [email protected]. Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned. Any enquiries regarding this publication should be sent to us at [email protected]. You can download this publication from www.gov.uk ISBN 978-1-909790-43-8 PU1581 Contents Page Executive summary 3 Part 1: Introduction Chapter 1 The challenges facing RBS today 17 Part 2: A new direction for RBS Chapter 2 RBS’ new direction – the best bank in Britain for business 27 customers Chapter 3 RBS’s new direction – a focus on the future and a return to 31 private ownership Part 3: Assessing the case for a taxpayer-funded external bad bank Chapter 4 Review of the case for a taxpayer-funded external bad bank 37 Chapter 5 Why consider a bad bank and what assets might it include? 43 Chapter 6 Would a taxpayer-funded external bad bank accelerate 61 return to the private sector? Chapter 7 Would a taxpayer-funded external bad bank support the 73 British economy? Chapter 8 Would a taxpayer-funded external bad bank get the best 101 value for the taxpayer? Chapter 9 Designing and delivering an external bad bank 111 Part 4: Conclusions of the Government’s Review Chapter 10 RBS bad bank – separating the good from the bad 137 Chapter 11 RBS’s new direction – conclusions 145 Executive summary The Royal Bank of Scotland (RBS) has announced a new direction today that will enable the bank to focus on its core job of supporting the British economy and lending to British businesses. The new direction is supported wholeheartedly by the management and Board of RBS, the Bank of England, UK Financial Investments (UKFI) and the Government. RBS’s new direction will deliver a bank that is a boost to the British economy, with an ambitious goal to become the best bank in Britain for business customers, and from which – in time – the British taxpayer can start getting its money back. Alongside RBS’s announcement on its new direction, the Government is publishing in this document its Review into the case for an RBS bad bank, announced by the Chancellor at Mansion House in June 2013, which has assessed the case for creating a taxpayer-funded external bad bank against the Government’s three objectives for its shareholding in RBS: 1 accelerating its return to the private sector; 2 supporting the British economy; and 3 getting best value for the taxpayer. The Review was conducted by the Treasury – using external expert advisers – and sets out the challenges facing RBS today, and how RBS’s new direction tackles each of these challenges, including tackling the legacy of its ‘high-risk’ and poorly-performing assets. Through RBS’s new direction, a bad bank will be created – but instead of an ‘external’ bad bank that would require taxpayers’ money, an ‘internal’ bad bank funded by RBS will enable management to focus on new lending. In order to become a bank that is a boost to the British economy, rather than a burden, RBS has announced comprehensive measures including: accelerating exit from Citizens in the US, as part of a plan to raise capital equivalent to adding two percentage points to its capital ratio by 2015, in order to strengthen its balance sheet and focus on lending in the UK; embracing a new commitment to being the number one small business bank as judged by customers, measured by a newly-created survey to be run by the Federation of Small Businesses (FSB) and British Chambers of Commerce (BCC); continuing to shrink its investment banking arm with the results of a review of the Markets division to be published in February 2014; and aggressively tackling its cost base to improve the performance of its ‘core’ businesses. With the retirement of the Dividend Access Share (DAS) – on which the Treasury and RBS are in advanced negotiations with the European Commission – this will also over time make RBS shares more attractive to external investors and accelerate the bank’s return to the private sector. 3 As a result of RBS’s new direction, the Bank of England has also confirmed that the taxpayers’ exposure to the banking system can be further reduced by removing the £8 billion Contingent Capital Facility one year early. Following a comprehensive assessment of the case for a taxpayer-funded external bad bank, the Review demonstrates that RBS’s new direction will help deliver against the Government’s objectives to a much greater extent than would be possible through establishing an external bad bank alone. The Bank of England will play a continuing role in overseeing the implementation of RBS’s plan as part of its ongoing supervision of the firm. The shareholder value implications of the plan have been reviewed by UKFI. UKFI support the plan and will engage closely with the Board and management to oversee its development and implementation, in line with their mandate to act commercially and in the best interests of the taxpayer as shareholder. The challenges facing RBS today Nearly five years after RBS required several successive bailouts from the then Government, RBS remains weighed down by the legacy of its pre-crisis actions – not just its poorly-performing legacy assets but also by weak returns in its ‘core’ businesses and a lack of strategic coherence. While RBS has made huge progress since its rescue in the depths of the crisis, challenges remain in securing its recovery. There remains an ongoing debate about the bank’s future and role in the British economy, most recently articulated in the Parliamentary Commission on Banking Standards (PCBS) report in June 2013. The Government believes that the bank is still not in an appropriate shape for reprivatisation and that none of the three objectives for its shareholding of RBS is met under the status quo. RBS must overcome a number of challenges if this is to change and these are set out below. Balance sheet strength and strategic coherence Before the financial crisis, the RBS Group operated with relatively low levels of capital. A five year plan to de-risk the bank led to a subsequent strengthening of the Group’s capital position. As at the end of June 2013, the Group had exited the Asset Protection Scheme (APS) and its Core Tier 1 ratio had increased from 6.1 per cent as at the end of 2008 to 11.1 per cent. These improvements have been primarily achieved through the reduction of the Group’s balance sheet via a combination of whole-business disposals, run-off, asset sales and write-downs as opposed to capital raisings or earnings retention. The Group has made substantial losses over the five years since the crisis, meaning that it has been unable to generate new capital internally. Against this background, the Bank of England (in its role as RBS’s prudential regulator) – and following an assessment of capital ’headwinds’ – concluded that RBS had a shortfall of £13.6 billion. However, taking into account capital actions in RBS’s capital forecast, the Bank of England assessed the shortfall to be £3.2 billion at 31 December 2013. Furthermore, regulatory standards continue to evolve and, in addition, RBS needs to be able to accommodate any additional headwinds which may adversely affect their capital resources, for example future costs of conduct redress. 4 The significant reduction in the scope of RBS’s activities and the size of its balance sheet over recent years has also meant that the remaining business appears to some investors as having lost strategic coherence. In particular, Citizens and parts of the Markets division are perceived as lacking connectivity with the rest of the business, which is becoming increasingly focussed on UK retail and commercial banking. Lending to the British economy Since the financial crisis, overall bank lending to small and medium sized enterprises (SMEs) has declined by nearly a quarter. In part, this is because banks lent too much before the crisis, particularly in Commercial Real Estate (CRE). Nevertheless, a healthy supply of credit is essential for stimulating business investment and facilitating the entry of new businesses. RBS represents around a third of the SME market with a self-reported market share of some 25 to 30 per cent of SME customer relationships. Yet data suggests that RBS sits among the group of banks that have been reducing their lending, especially to businesses. The concern is that this is translating into weaker lending conditions for SMEs, impairing entry of new firms, and that this will continue in future. An independent review commissioned by RBS from Sir Andrew Large and published today has examined RBS’s support to SMEs and decisions on SME lending. It found that RBS has substantially underperformed the market and its previous market position in generating new lending, despite planning to increase SME lending as part of the new direction it outlined in 2008, for a range of reasons both generic to the small business lending market and specific to RBS. Performance of the ‘core’ bank Rothschild’s analysis undertaken for the Government’s Review of the case for an RBS bad bank has shown that many of the issues affecting RBS as an investment proposition relate to the ongoing ‘core’ business, rather than to its poor-performing legacy assets.