why did RBS fail? my notes from the FSA report.

After a tiring day I thought there would be nothing better to do than read and take some notes on the FSA's report into RBS's failure. They are not comprehensive, the full 452 pages are here; FSA report into why RBS failed

7/10/08 RBS funded by Emergency Liquidity Assistance from the BoE.
13/10/08 RBS £20bn rights issue, only 0.24% taken up by private holders, government the balance.

public commentary was that £40.7bn operating loss being the problem is inccorrect. Of that £32bn was intangible writedowns, which don't have an effect on regulatory capital.

"Only" £8.1bn of capital was written down.

end of 2007 had £68bn of reg cap + £12bn of rights issued raised capital, => £8bn would have been absorbed.

1) less capital than peers, therefore first in firing line (although later charts show HBOS was in worse position but Eric Daniels had a brain fart).

2) "excessively" dependent on short term funding (I use the inverted commas because, well the FSA didn't seem that bothered at the time and its NR report shows an even worse example they didn't care about).

3) asset quality concerns

4) large losses from credit trading

5) ABN amro "wrong deal, wrong price, wrong way of paying and at the wrong time"...

6) Systemic crisis.


under Basell III RBS would have had 1.97% capital ratio rather than the required 8%.

in sep07 when NR failed, RBS was still able to raise debt. thought they were experiencing a "flight to quality", really?!

customer funding gap for the whole of the UK system rose from being zero in 2000 to ~£750bn by 2008 in pretty much a straight line.

rbs had a big reliance on short term wholesale funding, even when it was levering up to buy ABN it paid in borrowed cash of less than 1yr term.

ABN effectively doubled their trading book; that only required £2.3bn of capital for £470bn of balance sheet assets. from which they took £12.2bn of losses.

FSA make a big deal about losses on credit trading, because they believe that this causes a loss of confidence, in both the institution and the system which leads to recession, which leads to defaults. Sure tighter credit hurts the economy, but part of that is signalling. trading p&l for 2007,8,9,10 were; +1.3,-8.4,+3.1,+4.5. So over the four years they made £1.3bn.

Whereas losses from loans are £32.4bn.

credit losses were £14bn over 07/08. FSA make valid point that there was a lot of uncertainty around it though, which inevitably leads to funding issues.
credit trading pnl for 2008;
they lost 2.3bn on counterparty defaults; 0.7 Lehmans, 0.6 Madoff, 0.6 Icelandic banks
-0.6 CDPC
-0.6 principal finance
-2.4 structured credit
-7.8 "strategic assets unit" ?? is that a prop desk name?
-3.2 impairments
+2.1 commission
+4.0 interest
-4.4 staff costs - is that payouts from tinning people??

organic growth of the balance sheet was 24% p.a from 2004 onwards!

losses on loans over 08-10
Residential mortgages; £2.5
personal lending 4.6
corp property 10.4
corp other 9.7
other 3.2

IMHO their enormous quickly grown loan book is the issue, and the market knew that at the time and yanked their funding. They were too reliant on short term wholesale funding so they got stopped out.

ABN deal;
paid in cash, which they borrowed rather than funding with equity.

effectively doubled their trading book.

took the risk of being consortium lead, meant they had to consolidate the purchase and then split it up, and I think is the reason they got so much of conduit losses of abn assigned to them, because that was still being discussed in early 08.

thought that because they had integrated a same country retail deal that was bigger and had good reputation on cost control and synergies they would make a lot of money on the deal. described as a "vanity purchase", "didn't know what they were buying".

because deal was competitive and of a public company, due diligence was minimal, although that wouldn't have made much difference IMHO, they had similar risks on already.

rbs board unanimous and shareholders over 90% voted in favour of the deal.

no regulatory oversight of the deal on the UK end of it - Dutch were surprised by that.


there is a lot of discussion of management styles and processes, a lot of it is waffle looking for scape goats, and a lot more of it is hindsight trading. however there are some interesting issues;

RBS were slow to take their marks. Goldmans were really quick and good at this.

RBS used the 96% for their VaR, everyone else used 99.9%, how and why were they allowed to do this. Everyone else is planning for a 1 in 1000 even, whereas RBS are planning for a 1 in 24??

losses were 8x what their VaR models were predicting. The fact they are surprised by this was worrying. Little real stress testing.

saying No to Europe.

"interesting" comments from some European politicians.

Let us be absolutely crystal clear on a few things;
1) France and Germany have shown that they wish to implement a tax on the City of London that would be paid into EU coffers. As far as I am aware there is no other example of such a tax.
2) The treaty changes that were on the table will do nothing to change the course of the crisis, the idea that implementing a slightly stronger wording of deficit controls is going to change the solvency, competitiveness issues and lack of fiscal union is naive at best.
3) Even if this would work, there is no "bluff calling", if they are going to build a new version of the EU institutions that they are not legally allowed to use, it will take years not months.
4) Making a big fuss that the British are being obstructive is helpful, because it distracts both the markets and the electorates from the really big issue; the currency union doesn't work, the solution to fix it; fiscal union has no democratic support or legitimacy.

Parachuting in an army of Monti-style technocrats to run nations in the periphery, imposing German austerity, brings no guarantee of producing the reforms that will yield the vast improvements in competitiveness that are necessary for a country like Portugal or Italy to deal with the level of the euro. Regardless, the process will take years, look how long it took a rich developed nation (West Germany) to change a poorer one (East) when it had far more control, wealth and helpful global demand. It is easy to forget that German unemployment was at 12.5% in 2005.

Extremely high unemployment, a feeling of imposed austerity and loss of sovereignty and pride are a highly volatile and dangerous mix in Europe.

Imagine if China slowed down.

Timing a Greek default;

There are three main mechanisms that could precipitate a default;

1. EZ and IMF pull future lending
2. Greek banks face a domestic run on deposits
3. Greece finally starts running a primary budget surplus and political cover allows them repudiate "odious debts".

(1) seems unlikely. Not because I believe that these institutions are committed or well organized, but because it would require action, as we have seen they clearly need a lot of prodding to do anything.

(2) would be very hard to predict as it is based on group confidence, so in modelling or thought process terms, its just a poisson process. 

(3) on the other hand *should* be easy to forecast. (well if one could have any confidence that Greek reported figures were accurate or not deliberately manipulated).

There have been several rumours that Greece has been inflating their budget deficit figures.

Their most recent projections however show that they should be running a primary budget surplus next year. In which case it makes even more sense that they promise reform programmes that kick in with savings in 2015 to secure immediate loans.

I am cynical so it is easy to speculate that Greece is deliberately trying to maximize the receipt of a fiscal transfer. What I find much more difficult to understand is the German position.

Many commentators have tried to explain their actions as 'pot committed politicians'. That it is just politicians trying to save their pride and hide the folly of their euro project designs. In reality the polls and general German media commentary actually suggests that not to be the case, that the population actually support some form of action, perhaps because they don't understand the true cost?

It appears to me that Merkel is deliberately obfuscating and is reluctant to face the consequences on ANY decision, be they supporting the euro, drawing a line in the sand, or turning their back. That is very weak.

Roland Berger published a plan which they called "Eureca". Which essentially said that Greece should take €125bn of assets (clearly overvalued for the purpose) and put them into a SPV in Luxembourg, and sell them to the EZ, use the proceeds to do a massive bond buy back. Then the SPV could be unwound, if the proceeds were lower than 125bn Greece would be liable to top it up, but would retain any upside if the assets were more.

There were some worrying features;

1. Putting the assets in an SPV in Luxembourg really is meaningless, if Greece decided to nationalize the assets again International law would be pretty much useless, or they could apply huge tax rates to those assets and perform a defacto nationalization.
2. Clearly this is just a secured loan, because Greece would still be liable for any shortfall, in which case unsecured creditors would still be wary on an ongoing basis of making new loans to Greece.
3. For the assets to have real value rather than to be trophy assets, then they must have some associated cashflow, in which case the secured loan must actually have a cost, ie. If they include public offices, then clearly the SPV must be paid rent, in which case the improvement in fiscal position is a lot smaller than the headline figure.
4. The point which was repeated several times that was most worrying however was the boast that such a plan would "burn speculators". Which they believed would cause spreads on the rest of the peripherals to collapse.

This last point just shows that they don't have a clue.