This is a carefully constructed rehearsal of the facts and likely developments in the banking saga.
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The saga of Eurostar eavesdropping/ bugging/ leaking grows by the minute. Might be productive to get a job as a steward?
Many of the apparent dilemmas over bonuses would disappear as soon as the banking system were reformed to separate the investtment bankers from the retail bankers. The latter would be paid properly of course but massive bonuses would not be needed. The investrment banks with their highly skilled risk-taking entreptreneurs would pay what is needed to attract that talent. Then if they get it wrong they go bust and we just say ‘Bye; Have a good day!”
They won’t grasp the nettle though even though the Governor of the Bank of England is urging them to!
Christina
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SUNDAY TELEGRAPH
1.11.09
Battle for the future of British banking
When high politics meets high banking blood will be spilt. After an astonishing week of manoeuvring Jonathan Sibun and Philip Aldrick assess the casualties.
By Phil Aldrick and Jonathan Sibun
It had been a trying day in Brussels for Stephen Hester. No matter how hard he argued last Friday with the bureaucrats that his strategy to rebuild Royal Bank of Scotland was in UK taxpayers' best interests, his case fell on deaf ears.
Neelie Kroes, the EU competition commissioner, was refusing to give any significant ground on the remedies required for £20bn of taxpayer support and access to a state insurance scheme for £280bn of RBS's toxic assets. After a long day at the end of a long week, Hester, the RBS chief executive, boarded the Eurostar and headed home.
By coincidence, Gordon Brown was returning from the European Union summit on the same train. Passing him the aisle, and mindful of the 70pc stake the Government has in his bank, Hester seized the opportunity for a light joke. "Just demonstrating we're good value for money, Prime Minister," he said. With a grin, both men acknowledged the reference. After all, RBS was the bank famous for its corporate jet and scallop kitchen.
Hester had got rid of the jet on taking over from Sir Fred Goodwin as chief executive last October in a symbolic break with the past. For a year, he had poured his energy into picking over the RBS carcase and homing in on the businesses that would lead it back to growth. Now Europe was jeopardising his plans and he was feeling roughly treated.
This weekend is yet another remarkable one in Britain banking. It now appears that the Government will this week announce what both Lloyds TSB and RBS, the two banks it owns significant stakes in, will look like in the future.
They will certainly be much smaller as Alistair Darling looks to increase competition on the high street. After the EU ruling, it now appears that Lloyds will have to sell Cheltenham & Gloucestershire, Intelligent Finance and TSB across the UK. RBS will sell its English branch network, probably under the Williams and Glynn's brand, its insurance business including Churchill, Green Flag and Direct Line and Global Merchant Acquiring, a card payments processing business.
Hester has made Citizens, its foreign investment bank, a "red line" issue saying it is too important to RBS's core business to sell. The EU and the Government are still considering whether to enforce the sale.
For Hester the problems started on Monday, when Kroes set out her remedies for ING, the Dutch bank, as a condition of receiving €10bn (£8.9bn) of state aid. Her demands, that the bank sell its insurance business and pare back its balance sheet by 40pc, were far more severe than feared. ING shares collapsed 20pc and sparked a rout in RBS and Lloyds Banking Group stock as the read-across looked vastly unfavourable.
By the end of Wednesday, RBS stock had fallen 15.7pc and Lloyds 16.6pc. For Lloyds, the sudden loss of confidence threatened to undo months of careful planning. The bank was waiting for the green light from Government to proceed with a £20bn capital raising, including an £11bn rights issue – the third largest ever in the UK. The funds would be used to escape the asset protection scheme (APS) – a giant state insurance policy for £260bn of its bad debts. Confidence in the stock was vital to see the capital raising through.
On Wednesday, as Lloyds shares plunged further, the board and politicians sprang into action, calling shareholders and sub-underwriters in to see the bank the following day. Alistair Darling needed to test the market to check the support was there to proceed. His worst fear was that he would allow Lloyds to go ahead with the fund-raising, only to watch the markets buckle and the Government be forced to step in to prop up the bank. The message that would send, in terms of both political control and financial stability, would be devastating. He needed cast-iron guarantees before signing off Lloyds' plans.
However, he had decided it was a gamble worth taking. Kroes was demanding such draconian remedies for state aid that she was threatening to make the APS unworkable. In the EU's rules on the "treatment of impaired assets in the community banking sector", published on February 25, one "principle" was proving problematic. It read: "The difference between the book value and the transfer value is the loss that the banks need to bear now in order to share the cost of the asset relief measures with the taxpayers".
In other words, RBS and Lloyds would have to bear a "first loss" on the assets being insured much greater that the original agreement. Bankers said that in Lloyds' case, it would have been made to absorb another £25bn on top of the £25bn agreed in March. In RBS's case, the remedy was far worse. The £19.5bn "first loss" would move to £50bn-£60bn.
In effect, the rule rendered the APS, which had rescued the entire UK banking system from collapse when it was unveiled in February by underpinning RBS and Lloyds, unworkable. Both banks would have to raise billions more in capital to offset these extra losses they would have to take. The alternative would be to proceed with the APS as it stood but face such extreme state-aid demands for what would be classified a taxpayer "subsidy" that both RBS and Lloyds would have to be virtually dismantled.
Facing such intrusion from Europe, the Government let Lloyds press ahead with its plans to raise £11bn in a rights issue, £2bn in mandatory convertible notes and £7bn by swapping bondholders into "contingent capital".
As a "simple play on the UK economy", as one shareholder put it, its story was far easier to digest than the sprawling RBS, which also gauged investor appetite for a £4bn-£6bn capital raising. RBS, which never had a chance of withdrawing from the APS completely, lost the battle for investor money.
With UK banks' shares in freefall after Kroes' decision on ING, it briefly looked like Lloyds would be unable to escape from the APS either. Hopes recovered by the end of Friday as institutions rallied to Lloyds and an announcement is expected tomorrow. [Monday]
For RBS, the timetable had just been accelerated. Hester had planned to announce the APS deal alongside the banks latest numbers on November 11, giving him almost two weeks to negotiate a better deal with Brussels.
Lloyds has changed everything, though. In its statement on Thursday, it said: "Based on the discussions to date it is confident that the final terms of its restructuring plan, including any required divestments of assets, will not have a material impact on the group."
The comment threw the spotlight on RBS and conspiracy theorists started speculating that RBS had been thrown to Brussels' wolves in return for letting Lloyds off the hook.
It's not a hard case to make. Lloyds has 30pc of the UK mortgage and current account markets. The only comparison at RBS is small business banking. Where Kroes will allow Lloyds reductions of just 5pc, RBS faces a 10pc cut. While Lloyds can keep its insurance business, Scottish Widows, RBS must dispose of Churchill, Direct Line and Green Flag.
The UK banking behemoth that the Prime Minister had midwifed by allowing Lloyds to merge with HBOS without a UK Competition Commission hearing appeared to have survived.
On his way back from Brussels, Hester grew increasingly agitated. The Treasury, he was sure, was briefing against RBS. Competition remedies that were still under discussion were being leaked to the media as a fait accompli. The sale of the £5bn insurance business, the paring back of the profitable investment bank, a possible disposal of Citizens, its giant US lender, the sale of its English branches, were all being mentioned in dispatches. "We had hoped this would be an orderly process," one RBS source said.
The problem for RBS was the sheer scale of taxpayer support. Lloyds had received £15bn of state money for a 43pc stake. Should it escape from the APS, that will rise to £20bn as the Government takes up its £5bn entitlement in the rights issue, though the taxpayer's stake will remain at 43pc. RBS has had £20bn already, giving the taxpayer 70pc of the bank, and will use the APS for £280bn of insurance. No more private money will be coming in, so the state's stake could rise as high as 90pc.
For Kroes, it was clear where the focus of her efforts should be. Seeing the writing on the wall, the Government belatedly jumped on the pro-competition bandwagon and started looking for opportunities to present itself, too, as a champion of the public interest.
In the glare of controversy over bankers bonuses, there was one easy win – backing Kroes' crackdown on RBS's investment bank.
A Treasury spokesman on Friday said: "The taxpayer cannot be expected to be on the hook for exotic instruments and overseas deals that did much to bring the bank down." Investment banking activities that are classified as riskier, such as debt syndication, may be shut down. Other parts may be sold.
The position is a reversal of the Government's previous support for Hester's plan to rebuild the bank as quickly as possible by generating huge profits out of trading and other investment banking activities. Politically, though, it may help ameliorate some of the anger over a state-backed bank paying huge bonuses.
What the past 48 hours have shown is that high politics and high banking are a toxic mix. Earlier in the week, announcements on the split of Northern Rock into a "good" and "bad" bank and George Osborne's attack on bonuses revealed the other central part of this banking crisis – public anger over how people who run banks are paid. Bankers want to ensure they support a business model that creates as much revenue and profits as possible. Politicians want to show the public they are being taught a lesson.
On Monday, the Conservatives had their own attempt at gaining a little political capital. Osborne chose the hostile surroundings of Canary Wharf to light the touchpaper. Banks should be lending to businesses rather than using profits to pay bonuses was his controversial message. In the shadow of financial giants from HSBC to Citigroup, it was a message that did not go down well.
The shadow chancellor made the issue sound startlingly simple. Bankers were being greedy and both their employers and the Government were letting them get away with it. State-backed banks, Lloyds Banking Group and Royal Bank of Scotland, should be banned from paying cash bonuses and forced to use their profits to support lending.
"There can be no justification for using taxpayer support and guarantees to pay cash into the bank accounts of bankers when the rest of the economy is in such desperate need of that cash," Osborne said.
The financial sector's response to the comments was predictably apoplectic. Osborne was criticised for failing to understand the industry and for suggesting rules that could provoke an exodus from the City. His comments, they said, were simply misleading.
"If you don't pay the international rate, you've got people who will walk and slow the process down [in the case of the state-backed banks] of repaying the taxpayer," said Angela Knight, chief executive of the British Bankers'
Association.
"But we're well aware that it looks awful. Bonuses are very difficult. We need to keep the talent in this country when we know that it is leaving because the environment here is more hostile than overseas. We have to make a decision – do we pay the international rate and get the taxpayer paid back or not. That's the discussion."
For those in the City, rather than presenting a real solution to the bonus issue, Osborne had simply highlighted how complex the Government's ownership of large swathes of the banking sector really is. For the politicians, the sooner the taxpayer's £15bn stake in Lloyds and £20bn holding in RBS are sold and the earlier a buyer can be found for Northern Rock, the better.
Europe approved Northern Rock's plan to split into a "good bank" and "bad bank", paving the way for a sale early next year of the "good" assets to recover some of the taxpayer's £23bn loan. Progress, though, has not removed the politicians' dilemma. Government ownership and successful investment banks, which pay large bonuses for top talent, are not happy bedfellows and nowhere is that more true than at RBS.
In February of this year, in a speech hosted by US think-tank the Brookings Institute, Gordon Brown promised to sweep aside "the old short-term bonus culture of the past". Nearly seven months later at the Labour Party conference, he made a different pledge. The taxpayer would, he guaranteed, make a profit on its bail-out of the banking sector.
For Hester, a former investment banker himself, the two comments were incompatible. At the interim results in August, he published profits for what he termed "core RBS" – the bank that would emerge from the ashes once its problems are solved. Global Banking & Markets, RBS's investment banking business, posted £4.87bn of operating profits – 77pc of the "core" bank's total earnings.
At the same time, he defended the payment of "selective" guaranteed bonuses. "In the past six months, the loss rate of our best-performing people has doubled. It is damaging," he said. "We need to make sure it does not get destructive. People don't always feel secure if we want them to come here. There are people who might be leaving who we need to retain.
For the taxpayer to make a profit we need to hire the best people."
Last year, UK Financial Investments, the body responsible for overseeing the Government's stakes in the banks, forced RBS to overhaul compensation for its staff.
The bonus pool was scaled back by up to 90pc, cash bonuses were scrapped in preference for stock pay outs, pay for directors was frozen and claw backs were introduced to allow the bank to call in any bonus paid on deals later shown to have turned sour. RBS had previously been the bank that paid top-tier bonuses. Now bankers were lucky if they got more than a doughnut – the City slang for zero.
Hester set out to reverse the trend, laying out aggressive plans to expand the investment bank's presence in the equities and commodities markets and get back to strength in fixed income.
The difficulty, though, was that RBS had walked back into a recruitment market in the City that was on fire. Investment banks had misjudged the market, laid off too many staff and missed out on a profit bonanza. To catch up, they were rehiring aggressively.
In such a hot market, RBS had to raise the temperature still further. "Why would anyone join RBS from a decent bank if they were not being bid up to do it? There is too much uncertainty and political interference to deal with," says one recruitment specialist.
"If you're hiring someone into a government-owned entity, you're going to be hiring them on a guarantee."
And there, in very simple form, is the problem. Politics is run by politicians and banks are run by bankers. In the public's mind it might be difficult to fathom whom they dislike most.
What is known, though, is that the tension between the two points of view will create a running story of conflict and controversy for months and possibly years to come. And many more trips on the Eurostar to Brussels.
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