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MASTER OF PROFESSIONAL BANKING (MPB)

DEPARTMENT OF BANKING AND INSURANCE


FACULTY OF BUSINESS STUDIES
UNIVERSITY OF DHAKA
Presentation on
The Failure Of

Abu Taib Md. Zakaria, MPB


Objective of the Presentation

This presentation aims identifying the multiple factors which


combined to produce The Royal Bank of Scotland (RBS)s
failure. It describes the errors of judgment and execution
made by RBS executive and management, which in
combination resulted in RBS being one of the banks that
failed amid the general crisis.
Overview of RBS
The Royal Bank of Scotland (RBS) is one of the retail banking subsidiaries
of The Royal Bank of Scotland Group plc, together with NatWest and
Ulster Bank. And has around 700 branches, mainly in Scotland though
there are branches in many larger towns and cities throughout England and
Wales.

But this bank has a history of operational disaster in the year 2008. RBSs
failure in October 2008 has imposed large costs on UK citizens. To prevent
collapse the government injected 45.5bn of equity capital: that stake is
now worth about 20bn.1 But this loss is only a small part of the cost
resulting from the financial crisis. The larger costs arise from the recession
which resulted from that crisis, within which RBSs failure played a
significant role. That recession has caused unemployment for many, losses
of income and wealth for many more.
Acquisition of 2 Banks by RBS in 2000-2006
RBS Takeover of National Westminster Bank Plc in the Year 2000.
RBS lead a hostile takeover of the troubled ABN AMRO.
But it was complex and risky because the market was peaking and
maximum of the risk were about to turning into major losses,
In 2000 In 2006
Balance Sheet Position 304 Billion Pound 848 Billion Pound

0
In 2000 (Billion) In 2006 (Billion)
Position of RBS in 2000-2006
In 2000 In 2006

Profit 1.8 billion Pound 5.6 Billion Pound

3
Profit
2

In 2000 (Billion) In 2006 (Billion)


Position of RBS in the Year 2000-2006
Prior to 2007, RBS was a major player in international banking market

RBS was the Leader of leveraged finance & Property finance.

Ranked 1st in global asset backed and mortgage backed securitization

Ranked 4th in global syndicated loans

Ranked 8th is International Bond market


RBS Tier 1 Ratio
Name of Banks Tier 1 Ratio
RBS 7.5%
Barclays 7.7%
HSBC 9.4%
The ABN AMRO acquisition
The acquisition of ABN AMRO by a consortium led by RBS greatly increased
RBSs vulnerability. The decision to fund the acquisition primarily with debt, the
majority of which was short-term, rather than equity eroded RBSs capital adequacy
and increased its reliance on short-term wholesale funding. The acquisition
significantly increased RBSs exposure to structured credit and other asset classes
on which large losses were subsequently taken. In the circumstances of the crisis, its
role as the leader of the consortium affected market confidence in RBS.

RBS decided to make a bid for ABN AMRO on the basis of due diligence which
was inadequate in scope and depth, and which hence was inappropriate in light of
the nature and scale of the acquisition and the major risks involved. This was the
inevitable result of making a contested takeover, where only limited due diligence is
possible. In proceeding on that basis, however, RBSs Board does not appear to
have been sufficiently sensitive to the wholly exceptional and unique importance of
customer and counterparty confidence in a bank. As a result, in the Review Teams
view, the Boards decision-making was defective at the time. RBS believed in its
ability to integrate businesses successfully after the acquisition of NatWest; in the
case of ABN AMRO, it underestimated the challenge of managing the risks arising
from the acquisition.
Drawback of RBS while doing Business
Weakness:
Risk appetite was greater than peers
Greater reliance on prefer share than ordinary equity
RBS was heavily relied on short term wholesale market for fund
sourcing.
Year 2006 Year 2003
Net Borrowing Comparison 72 Billion Pound 3 Billion Pound

Yr-2003 bn

Net Borrowing
Comaprison Yr-2006 bn
- 20.0040.0060.0080.00
Fund Sourcing Status of RBS
RBSs position : Just before the disaster
RBS bought risky bank (ABN AMRO) for Euro 22.6 Billion.
Funding Source was short term debt rather than capital raising .
94% shareholder voted for acquisition.

Area of losses Yr-2007-2008 Yr-2008-2010

Credit Trading 14 Billion Pound


Commercial Property 10 Billion Pound
Net Credit Market Exposure of major banks
Consequences.
October 2007:
Royal Bank of Scotland's disastrous and ill-timed takeover of Dutch bank
ABN Amro set off a chain of events which led to its eventual collapse.

December 2007:
RBS eases investor fears when it reveals lower-than-expected write-downs of
1.5bn for both RBS and ABN Amro following the meltdown in the US sub-
prime mortgage market. It offsets 250m of the write-downs by using its own
cash reserves instead of turning to the increasingly expensive wholesale
credit markets.

November 2008:
The move comes as the government takes a 58% stake in the bank for 15bn
as part of a mammoth capital raising. RBS was nationalized in
2008.Government injected 45.5 Billion of Pound as Equity and currently
80% owner.
Why did RBS fail?

Initially, we found complex combination of factors which led to RBS


failure. They are

Some factors which were common to many banks and


which contributed to the overall financial crisis.

Some which resulted in RBS being one of the specific


firms which failed during the crisiss failure.
Reasons behind RBS failure

The 1st reason: The Regulatory framework and


supervision, and for the management of firms.
Because the poor decisions made by RBS management and Board
which made RBS highly vulnerable to failure, and the underlying
aspects of RBSs management style, governance and culture which
may have contributed to those poor decisions;
Reasons behind RBS failure (Cont..)

The 2nd Reason : RBSs capital position and the underlying


regulatory framework.
liquidity run the firms capital adequacy (as well as about capital adequacy
across the banking system)
RBS chose to be lightly capitalized relative to its peers and made considerable
use of lower-quality forms of capital. The acquisition of ABN AMRO further
weakened its capital position.
Reasons behind RBS failure (Cont..)
The 3rd Reason : RBSs liquidity position
RBS entered the crisis with extensive reliance on wholesale funding. Its
short-term wholesale funding gap was one of the largest in its peer group,
and it was more reliant on overnight funding and unsecured funding than
most of its peers. The acquisition of ABN AMRO increased its reliance
on short-term wholesale funding. liquidity were not adequate to identify
and limit this dependence, in particular RBSs significant use of non-
sterling short-term wholesale funding. Once the crisis had started, it was
difficult for RBS to improve its liquidity position significantly.
RBSs liquidity position,
Reasons behind RBS failure (Cont..)
The 4th Reason : Asset quality: concerns and
uncertainties
RBSs balance sheet and leverage increased rapidly in the years leading up
to the financial crisis, in a period of fast growth in credit extension and
leverage across the banking sector. While RBSs investment banking
division, Global Banking and Markets (GBM), was the most rapidly
growing area, RBSs loan portfolio in its other divisions also expanded.
Significant loan losses were subsequently suffered in many areas of
business, with a particular concentration in commercial property. Indeed,
impairments incurred on loans and advances eventually amounted to
32.5bn over the period 2007-10, significantly exceeding the 17.7bn of
losses on credit trading activities. The full extent of those losses would not
have been clear to the market in autumn 2008. However, uncertainties about
the scale of future losses and concerns about asset classes held by RBS
contributed to the loss of confidence in the firm at that time.
Reasons behind RBS failure (Cont..)
The 5th Reason : Losses in credit trading activities
By early 2007, RBS had accumulated significant exposures containing
credit risk in its trading portfolio, following its strategic decision in mid-
2006 to expand its structured credit business aggressively. The
acquisition of ABN AMRO increased RBSs exposure to such assets just
as credit trading activities were becoming less attractive. This increased
the firms vulnerability to market concerns.

Structured credit markets deteriorated from spring 2007 onwards. RBS,


like any others, was by then holding positions which were bound to
suffer some loss. The crucial determinant of how much loss was the
extent to which a firm could distribute its existing positions, or was
willing to take losses earlier by hedging or closing those positions out.
RBS was among the less effective banks in managing its positions
through the period of decline.
Reasons behind RBS failure (Cont..)

The 6th Reason : Systemic vulnerabilities and


confidence collapse.

The intensification of market uncertainties during the summer of 2008,


culminating in the acute loss of confidence following the collapse of
Lehman Brothers in September, affected all banks in some way. But those
most affected were those that were, or were perceived as being, in a worse
position, in terms of capital, liquidity or asset quality. They included RBS.
Key factors :The failure of RBS

Poor Supervision of RBS.


Significant weaknesses in RBSs capital position during the Review
Period, as a result of management decisions and permitted by an
inadequate regulatory capital framework;

Over-reliance on risky short-term wholesale funding;

Concerns and uncertainties about RBSs underlying asset quality,


which in turn was subject to little fundamental analysis by the FSA
Key factors :The failure of RBS
Substantial losses in credit trading activities, which eroded market
confidence. Both RBSs strategy and the Financial Services
Authority (FSA)s supervisory approach underestimated how bad
losses associated with structured credit might be;

The ABN AMRO acquisition, on which RBS proceeded without


appropriate heed to the risks involved and with inadequate due
diligence; and

An overall systemic crisis in which the banks in worse relative


positions were extremely vulnerable to failure. RBS was one such bank
Recommendation
Capital Adequacy: Higher quantity and quality of capital. The Bank
companies must hold quality sufficient quantity of capital. It should
increase the core capital while expanding its business operation.
Use of information and intelligence in banking supervision since
Weaknesses in the processing and analysis
To increase its focus on prudential supervision, including liquidity
and stress-testing since the liquidity regime was inadequate and needed to
be improved.
Analysis of firms underlying assets and off balance sheet exposures
In order to avoid a situation in future where a firms capital resources
are over-dependent on minority interests, the Authority should consider
quantitative monitoring of firms dependence on minority interests as part
of ongoing supervision.
Recommendation
At the time of Acquisition the company should
Set up a multi-disciplinary team, including internal specialists, to assess
the key risks (including, in particular, capital and liquidity risks) associated
with the transaction at an early stage.
Consider the requirements and information flows imposed by the
European legislation.
Coordinate with overseas regulators in cases of cross-border transactions
where expectations, roles and responsibilities of each regulator are
mutually agreed and understood, for example through the establishment of
a Joint Liaison Committee.
The assessment of comprehensive (in particular, key prudential)
information from the firm that sets out the impact of the proposed
transaction; the adequacy of the combined group capital position at deal
closure, taking into account financing, atforward projections, and under
stressed conditions.
MASTER OF PROFESSIONAL BANKING (MPB)
DEPARTMENT OF BANKING AND INSURANCE
FACULTY OF BUSINESS STUDIES
UNIVERSITY OF DHAKA