Risk management begins with common sense

By Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Andrew Bailey of the Bank of England and designated deputy of the new UK Prudential Regulation Authority, which will supervise banks, has made some scathing comments in the Herald newspaper [1] about how RBS and HBOS were managed in the years leading up to their massive government rescues that required tens of billions of pounds of taxpayer funds.

His comments are extensive but summed up by his comment:  “… people who ran those two institutions just lost sight of what I would call sound principles of banking.”

I was working in the investment banking sphere in the City of London in the early 2000’s and observed RBS in the wake of its acquisition of NatWest in early 2000.  At the time, the acquisition and integration was arguably the best executed and most successful of any large bank merger worldwide.  However, the bank then appeared to aggressively pursue a strategy of buying market share.  I saw it commit large amounts to many syndicated leveraged transactions for inadequate remuneration in terms of the risk.  Some borderline loans led by other banks only succeeded because of this.

Fred Goodwin, the aggressive head of RBS, seemed to want to make his institution the largest bank in the world and he almost succeeded before the pile of cards came crashing down.  From 2001 to 2007, RBS’s assets doubled, mainly through a string of acquisitions.  This culminated in the disastrous acquisition of ABN Amro, a complete basket case at the time.  Shortly thereafter, RBS required a government rescue.

In my time in the City, I wondered what RBS’s balance sheet would look like if there were a recession.  Many people attributed RBS’s downfall to the ABN acquisition.  This may have been the straw that broke the camel’s back, but it seems that RBS’s balance sheet had been weakening significantly beforehand.  It seems that Andrew Bailey agrees.  He said, talking about the pre-ABN era:  “I think there was very rapid expansion of the investment bank.  I think the controls around the expansion of that investment banking activity were clearly not adequate.”

At the same time, Andy Hornby was running HBOS – at least he was supposed to be.  He had been a great success at ASDA (Wal Mart’s UK subsidiary) in running the clothing retail business.  He seemed to take the large volume, low margin mentality into the property lending business at HBOS with disastrous consequences.  (HBOS was easily Britain’s largest mortgage lender and also had very large exposures to property developers.)  Many people blame Peter Cummings, the head of the corporate bank, as being the main culprit for the debacle but it is questionable whether or not his boss had any ability to exercise any sort of oversight on his activities. 

At HBOS in 2005, Paul Moore, HBOS’s Head of Regulatory Risk, warned that the bank was becoming too risky.  Shortly after that he was forced out of the bank and was replaced by someone he claims had a sales background.

In the cases of both RBS and HBOS, effective and prudent risk management seemed to go by the wayside in the interests of growth and, perhaps, feeding giant egos.  In fact, never mind sophisticated risk management set ups, simple common sense seemed to be absent.  (The applicability of the term common sense to the Financial Services Authority at this time is another topic.)

Interestingly, Andy Hornby has returned to his retail roots as Chief Executive of Alliance Boots, Britain’s largest drug store chain.

 

Note:  This blog first appeared on 16 January 2011

---

[1] See http://www.heraldscotland.com/business/corporate-sme/damning-verdict-delivered-on-former-rbs-and-hbos-chiefs-1.1079137

Casino Risk Management

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

Firstly, sorry to all you guys that like to have an occasional flutter on the horses or big game.  This blog is about banking and bit of a digression from our usual blogs that focus on corporate risk management.  However, there are lessons for everyone and every company. 

Banks have been a favourite and easy target for politician and the press.  There is a lot of misinformation around, although it is hard to view the scale of some of the remuneration packages around as anything other than obscene – almost as obscene as that of some football (soccer to you guys across the pond) players!  Investment banking is now routinely referred to as “casino banking” and derivatives as evil.  As most of the general public have no idea what investment banks do, politicians and the popular press can get away with this, whether or not it is true.  They also generally overlook the fact that the problems of the British banks arose mostly from traditional lending activities. 

The clamour against the banks has been less muted than the action taken against them in spite of a public mood that would seem ripe for lynching all bankers.  Banks are useful to politicians who are masters of finding anyone but themselves to blame for anything that goes wrong … and if nothing goes wrong, then for anything that doesn’t go wrong! 

Nevertheless, there has been some action by government trying to keep a fine balance between satisfying the public demand to do something and penalising the banks too much and threatening London’s pre-eminence as a financial centre, and with it the loss of substantial tax revenues, employment and economic activity generally.  Essentially this has resulted in piecemeal actions with lack of a coherent vision and therefore market uncertainty.  Perhaps this can be viewed as casino risk management by government. 

Now things could be becoming unbalanced. 

It is rumoured that HSBC, Britain’s largest bank, is about to move its head office to Hong Kong.  HSBC moved its head office to London in the 1990’s after acquiring one of England’s largest high street banks, Midland Bank.  At that time the regulatory and tax environment in the UK was favourable and getting more so.  Also, Hong Kong was about to be handed back to China with all the uncertainties that created.  At the time, London probably seemed a good place for executives to base themselves. 

Now regulation is about to be tightened considerably in the UK and costs and taxes have risen considerably.  We are in the second year of a “one-off” bonus tax that covers all bank bonuses wherever paid, mainly a populist political reaction to public outrage about the issue.  Regulation in Hong Kong is much friendlier and there is probably a more stable and sympathetic outlook from the perspective of banks.  Of course a 17% personal tax rate does not stand in the way. 

HSBC is very international with only about 10% of business actually in Britain.  The lion’s share of its business is in Asia.  It also weathered the crisis in good health, a reflection mainly of its Asian business.  Some institutional investors are suggesting that relocating to Hong Kong would provide an instant boost to HSBC’s share price.  HSBC denies the rumours, albeit in a fairly vague fashion, but if I were a shareholder, I would assume it to be the duty of top executives and the board to consider the matter.  Moving a head office across the world would not be expected to be cheap.  However, in HSBC’s case they have a substantial infrastructure in place.  From a brief look, their main Hong Kong premises are certainly impressive.  Of course, all this might just be an attempt to influence government policy. 

From all this certain questions arise.  Are senior bank executives looking after their own interests against those of shareholders?  Have large global banks become so powerful that they can ignore politicians?  Will anything change?  Probably at least one “no” there.