FSA sees mix of factors behind the failure of RBS

In a much awaited report published this morning, the Financial Services Authority concludes that there were seven factors which, when combined, led to the near-collapse of Royal Bank of Scotland (RBS). One such factor was the bank's poor management decisions.

Those same factors were, in turn, aggravated by flaws in the FSA's supervisory regime, "which provided insufficient challenge to RBS."

More specifically, the report states that, "the FSA was too focused on conduct regulation at the time and its prudential supervision of major banks was inadequate. (...) This approach reflected widely held, but mistaken assumptions about the stability of financial systems and existed against a backdrop of political pressures for a 'light touch' regulatory regime.

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The seven factors mentioned are:

1. Significant weaknesses in RBS's capital position.

2. Over-reliance on risky short-term wholesale funding.

3. Concerns and uncertainties about RBS's underlying asset quality.

4. Substantial losses in credit trading activities.

5. The ABN AMRO acquisition, on which RBS proceeded without appropriate heed to the risks involved and with inadequate due diligence.

6. An overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure.

7. The multiple poor decisions that RBS made suggest, moreover, that there are likely to have been underlying deficiencies in RBS management, governance and culture which made it prone to make poor decisions.

Interestingly, the Financial Services Authority holds that had Basel III been in place at the time, not only would RBS have been unable to launch the bid for ABN AMRO, it would have been prevented from paying dividends at any time during the Review Period, i.e. from at least 2005 onwards.

Lastly, the FSA's chairman, Adair Turner, highlights two areas were further reform may be necessary.

First of all, in the future major bank acquisitions should require explicit regulatory approval.

Secondly, a way must be found such that bank executives and boards strike the right balance between risk and return. Turner puts forth two alternatives.

One of those would see a bank failure like RBS's be followed by successful enforcement actions, including fines and bans.

The other option would be "an automatic incentives-based approach" involving either rules which automatically ban senior executives and directors of failed banks from future positions of responsibility or major changes to remuneration to ensure that a very significant proportion of pay is deferred and forfeited in the event of failure.

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