And so the banking system, shaken and stirred, was launched into the new post-crisis era. In the final months of 2009, there were signs that the recession was coming to an end. Any return to growth would provide a boost to banks with the hope that the values of their troubled assets would start to recover. Barclays had pushed on without any direct government assistance while Lloyds, with only a minority government state, was moving ahead without being part of the asset protection scheme. That left just RBS, majority taxpayer-owned, with a large chunk of assets pledged to the APS. The emphasis from Whitehall was very much on turning the banks around and preparing for the day when the government shares would be back in private hands.
As the finishing touches were put to APS, the Labour government’s fortunes appeared to be waning. Alistair Darling clashed with Gordon Brown over whether to raise VAT as a means of grappling with government borrowing. Darling’s desire to push up VAT in his pre-Budget report in early December was rejected by the Prime Minister. As the Chancellor later admitted, the speech and its measures were not well received and lacked a compelling economic argument. But there was plenty of debate about one of his surprising and headline-grabbing measures. Darling announced he was slapping a tax on bank bonuses, 50 per cent on everything above £25,000. He knew he was tapping into a public mood of revulsion about banks, which had gathered momentum since the bailout. The willingness of bank boards to contemplate bonuses for their already highly paid staff when the taxpayer had been forced to prop up the ailing financial industry was greeted with incredulity by any voters ‘vox-popped’ on street corners. Yet the City view was that traders and executives needed to be rewarded for helping rebuild profits after the previous year’s disasters. HSBC and Barclays could argue that they were not beholden to government because they had not received any direct financial support. Lloyds and RBS resisted what they portrayed as direct government interference in their pay policies. The RBS board even threatened to resign en masse if there was any Whitehall attempt to reduce their planned bonus pool.
Brown and Darling had to endure the wrath of banking chiefs after the bonus tax announcement. There were threats by some to reduce their presence in the UK because of a move they branded as punitive and outrageous. But this public row with bankers did not cause ministers any political damage, far from it. They could count on almost unanimous public support outside a few postcodes in central London. The deep-set problem was how to handle Lloyds and RBS, where the government had the power to call the shots on pay but did not want to be seen to be pulling the strings.
In theory, the government wanted to maintain an ‘arm’s-length’ relationship with the banks, allowing them to focus on rebuilding their finances ahead of a share flotation. Those banks’ boards had duties to protect the interests of minority private shareholders so they would not be steamrollered by the dead hand of the state that held the taxpayer-funded share stakes.
A body called UK Financial Investments (UKFI) had been set up to manage the taxpayer stakes in the bailed out banks. At the end of 2009, Robin Budenberg was preparing to leave UBS and take over at the helm of the new entity. He had the job of handling relationships with the bank boards and allowing them to carry out their duties as directors while knowing that no major strategic decision could be made without the approval of the Chancellor. It was a delicate position and critics argued that it could never be made to work. It was argued that either Lloyds and RBS should run their own affairs with no state involvement, or the banks should be run like nationalised industries. The tension went right to the heart of the post-bailout debate. Should the state-controlled banks be agents of government economic policy, expanding lending as a means of stimulating growth? Or should they be quasi-commercial entities focussing on profits and the earliest possible return to normal life on the stock market? The government in late 2009 and early 2010 seemed to favour the latter course.
As the political dogfights were waged in the early months of 2010, Lloyds and RBS continued the arduous reconstruction process and strived to do so away from the spotlight of political scrutiny. One factor moving in their favour was the return of growth and, in the final quarter of 2009, the ending of the deepest recession since the Second World War. Frustratingly for Brown and Darling, the first estimate of the growth in economic output for the fourth quarter of 2009 had showed only a marginal increase. It was hard for them to claim any political brownie points for what looked like an anaemic recovery. But the preliminary estimate is a first draft of economic history and subsequent revisions have taken that quarter’s performance up to a more respectable growth rate. The first three months of 2010 also saw a solid continuation of post-recession expansion. For banks, growth is high-octane fuel. A recovering economy makes it easier for banks to sell assets and make profits. For Lloyds and RBS, as well as their competitors, the economy was providing some much needed medicine.
Into this more benign economic environment stepped the new coalition government. The hung parliament delivered by the May 2010 general election in turn produced a Conservative and Liberal Democrat coalition. Setting out plans to reduce government borrowing by more than Alistair Darling intended was a top priority for the new Chancellor, George Osborne. With parts of the Eurozone ablaze amidst fears of possible defaults, the British government felt it had to make plenty of noise about its deficit reduction strategy. But an important set of policy briefings were sitting high in the departmental in-trays of Osborne and the new Secretary of State for Business, the Liberal Democrat Vince Cable. The future of Lloyds and RBS was now open to the new ministers to determine. A new and different path could be chosen if the coalition partners so wished.
George Osborne had made it plain during the election campaign that he favoured a ‘people’s’ privatisation for Lloyds and RBS, with the public being offered shares at a discount to the market price. Lower income groups might be entitled to an even bigger reduction. He called the policy the ‘people’s bank bonus’ and argued that it would be in recognition of the vast amount of financial support which had been provided by taxpayers. Osborne’s free market instincts pushed him firmly towards some sort of share sale for each bank. Allowing the banks to seek sustainable profitability in preparation for privatisation seemed the obvious option for the Conservative Chancellor.
Vince Cable had acquired something close to celebrity status thanks to his pronouncements in opposition on the banking crisis. A former economist at Shell, Cable knew his stuff and gained a reputation for incisive analysis about the dangers facing financial markets before Northern Rock crashed. In 2003 he had warned that rising house prices and ballooning borrowing looked unsustainable. Wearing his trademark wide-brimmed hat, long scarf and raincoat he looked rather menacing as he paced the pavements of Westminster answering a steady stream of calls from broadcast news programmes. He seemed pleased to be tagged as a ‘Jeremiah’ and joked a few years later that readers of the Old Testament would know that Jeremiah was usually proved right. Cable’s book, The Storm, which looked at the causes of the financial crisis, was well received by a public trying to make sense of the drama. The book’s cover tried to reinforce Cable’s image as an economic visionary – with dark clouds over his head, Cable looks sternly into the distance. His desire for RBS and Lloyds, made clear during the general election campaign, was that they should stay effectively under public control for a decade. His primary objective for the banks, he said, was promoting lending and supporting the recovery.
The Osborne/Cable axis was never going to be an easy alliance. Their views of what to do with the banks were a reminder that they were poles apart on the political spectrum. The coalition agreement suggested that banking reform was a priority for both parties in government, stating: ‘We will reform the banking system to avoid a repeat of the financial crisis, to promote a competitive economy, to sustain the recovery and to protect and sustain jobs.’ But the detail of the reforms and how they were to be achieved was the subject of much haggling. The agreement document contained a pledge to set up an independent commission to investigate the separation of retail and investment banking. This was to be the main focus of the coalition’s reform programme for the first years of the parliament.
George Osborne was reported to have won an early victory a few days into the life of the new government. The Treasury would take control of the banking reform agenda and the establishment of a banking commission. The Independent Commission on Banking would be chaired by Sir John Vickers, formerly chief economist at the Bank of England, then head of the Office of Fair Trading. The brief was to look at the structure of banking and recommend reform. Vince Cable was keen to break up the major banks, separating what he called ‘risky casino banking’ from high street retail finance. From an independent perspective, the function of the Commission was to examine how feasible a banking break-up would be. Cable acknowledged that he would not, as hoped, have a formal role in this policy area but he seemed satisfied that the Commission would deliver a genuinely independent verdict on the bank separation question.
There were other pieces of bank legislation in the coalition’s armoury, such as a levy on bank balance sheets which ministers hoped would raise £8 billion over four years. The theory was to penalise the riskier end of their operations with the levy applied to wholesale borrowing. It was part of a joint initiative with France and Germany, which made moves to impose similar levies. On top of all that, sweeping changes to banking regulation were planned with the Financial Services Authority having to hand back many of its powers to the Bank of England. Treasury ministers were certainly going to have their hands full in delivering this extensive suite of proposals. It was estimated that the work of the Vickers Commission would take more than a year. With the banking reform agenda likely to be full for some time, little thought was given to how RBS and Lloyds might actually be managed and what their role in the UK economy might be. At that stage, with growth forecasts looking fair there did not seem to be many reasons to challenge the banks’ performance or strategies.
But the ‘good bank, bad bank’ idea had not gone away. Work under the bonnet of the RBS balance sheet had continued, with managers painstakingly working out which lower-quality loans would move into the insured APS. A body to manage the process, known as the Asset Protection Agency, oversaw this process and monitored the management of the assets with the objective of protecting the taxpayer’s interest. The agency was managed by Stephan Wilcke, recruited by the Treasury in September 2009 with extensive experience of European financial services. The agency also advised government of the projected scale of the losses and whether they were likely to go beyond the £60 billion ‘excess’ which was being covered by RBS. In effect, a ‘bad bank’ was being created inside RBS with the assets that had been put into the APS. To all intents and purposes, everything else was a ‘good bank’. Neither the organisation nor the structure of RBS had been split. But it was clear which parts of the RBS loan book were on which side of the divide.
Soon after the election the question of whether ‘good bank, bad bank’ should be pursued with a formal division of RBS was raised in government. Those in favour of the idea thought the new government had a promising window. Politically, the coalition could afford to take RBS in a new direction with a radical policy. The honeymoon period, such as it was, had not ended. Economic growth in the UK was looking positive and from June 2010, once the Eurozone crisis had seemed to subside the stock market was climbing steadily. The opportunity to nationalise and then split RBS was, in the view of some advisers, there and worth seizing. On the downside, it would be complicated and would involve unpicking the UKFI structure. The process might also take more than a year but it should be complete by the end of 2011, allowing a flotation in 2012. Failure to press the button in that summer of 2010, the supporters of such a move argued, could close the door for good. Stalling on the policy, they said, could mean the government and the bank being overtaken by events.
The Bank of England favoured activation of ‘good bank, bad bank’ and there was support too at the Asset Protection Agency which by then had got to grips with what was on the RBS books. But the FSA was against the idea as was UKFI, which feared that any such strategy would alienate the RBS management, some of whom might quit. The Treasury seemed divided and unable to come down either way – whatever private discussions took place, it did not pick up the ball and run with it. One senior source, who backed going ahead with nationalisation and then dividing up RBS, said ‘the new government bungled it – they were afraid of taking political responsibility for RBS’. It was easier for the Treasury to let the bank’s management keep plugging away without any strong political direction. Ministers probably felt there was enough to worry about with the Vickers Commission at work and the reform of financial services regulation. But the ‘good bank, bad bank’ proponents were frustrated that an opportunity had been missed.
Relations between Bank of England and Treasury staff had become frayed over this issue. The Bank was driven by a strong belief that running RBS at one remove from government with UKFI as the buffer had been a mistake. At senior levels of the Bank there had been scepticism since the beginning of APS. The idea of RBS operating like a private sector bank with the government standing back despite holding the dominant shareholding seemed wrong-headed to policymakers in Threadneedle Street. Mervyn King’s enthusiasm for ‘good bank, bad bank’ in the final months of 2008 had not ebbed. The Labour government had not heeded his advice – now he was pushing the new Chancellor to pursue the policy.
The RBS senior management had no desire to have ‘good bank, bad bank’ imposed. Stephen Hester and his team were committed to turn the bank around as it was. Yes, they might have to shed some businesses through asset sales but they wanted to see the task through to flotation. Key to their plan was holding onto the investment bank, which may have been unpopular with politicians but was seen by Hester as a cash generator for the rest of the group. He was later to fall out with Osborne. But at this stage, in 2010, neither Osborne nor Vince Cable had the inclination to square up to him and force a major shake-up at the bank. Hester later insisted that keeping the RBS bad assets together with the good side of the bank had not inhibited its ability to make loans. He argued that ‘we created our own bad bank inside RBS and there was no effect on the rest of the bank’s lending’. An external bad bank, he believed, would not have been a better answer either for RBS or the government. Hester’s view was that much of the economy did not want to borrow and RBS would not have lent more if the bank had been split.
The opportunity came and went. From 2011, the Eurozone crisis dominated market thinking and triggered a highly volatile ride for shares. UK growth had seemed particularly buoyant in 2010, generating hopes of a rapid recovery. But by the following year growth was patchy, with a slide backwards in the final three months of the year. The banks themselves encountered more challenging conditions. Predictions that the Euro would break up sent tremors around European markets. Speculation about a Greek default reached fever pitch. The fear of cracks appearing in the much larger Spanish and Italian economies was seeping around financial markets. Banks across Europe found that their funding costs were higher and, in a repeat of some of the worst weeks of the summer of 2008, inter-bank lending almost dried up.
Senior government sources have since made clear that ‘good bank, bad bank’ was a serious runner in May 2010 and a case was made for it inside Whitehall. But while the benign conditions immediately after the election led the government to believe that a split of RBS was not an urgent priority, the sharp fall in markets the following year ruled it out at that time. Market volatility and a worsening investment climate made valuing assets near impossible. George Osborne has since acknowledged that he could have acted more decisively on RBS soon after taking office. He said, when asked in September 2013, that not tackling the RBS issue was one of his major regrets.
RBS found the going much tougher in 2011 than it had the previous year. Losses nearly doubled to just under £2 billion partly thanks to write-offs on loans to the Greek government. The Ulster Bank subsidiary was still deeply in the red with exposures to the woeful Irish property market. The process of deleveraging, i.e. reducing the colossal RBS balance sheet, was proving prolonged and painful. More than £700 billion had been removed from the RBS books thanks to sales of assets or loans reaching maturity and not being renewed. When the results were announced in February 2012, Stephen Hester told BBC News that the clean-up process would take a total of five years so there were two more years of pain ahead.
If the RBS board and financial regulators had expected a better 2012 their hopes were soon dashed. The Eurozone crisis raged on with a bailout for Spain’s banks and the European Central Bank President Mario Draghi making a dramatic pledge to do whatever it would take to save the Euro. Economic growth in the UK faltered, apart from a brief spurt around the time of the London Olympics. With a sizeable chunk of British exports of goods and services sold to Eurozone countries, any fragility in that region was sure to undermine confidence in the UK. Against this dreary backdrop, RBS limped along. Losses were racked up for the fifth year in succession. Yet more write-offs had to be taken on loans judged unlikely to be repaid in full – Ulster Bank was again a source of losses on disastrous Irish lending. Fines for previous scandals, including allegations of rigging the benchmark interest rate LIBOR, had to be accounted for. RBS described it as a ‘chastening year’ during which it had tried to ‘put right past mistakes’.
There was one piece of good news for RBS towards the end of 2012. It was able to announce that it had quit the Asset Protection Scheme. The departure from APS came at the earliest possible time allowed under the scheme. The bank had parted with £2.5 billion in fees to the Government by then, but had not made a single claim on the scheme. That did not mean the scheme had not been worthwhile. Its very existence, acknowledged by RBS, had restored market confidence in the bank at a critical moment and then provided a breathing space for implementing a recovery plan. At the start of APS, a vast array of dodgy assets nominally worth £282 billion had been insured. But Hester and his team had successfully chopped out more than half to leave a total of £105 billion. The insurance was no longer needed and there was agreement on that with the Treasury and the Financial Services Authority. Hester described it as ‘a significant milestone in RBS’s recovery’.
When the 2012 results were published in February the following year, Hester endeavoured to put on a brave face on the result and described them as the light at the end of the tunnel. He predicted that the bank would be ready for some sort of share flotation before the general election due in 2015. Later, briefings by RBS management mentioned the end of 2014 as a time when the bank might be ready for the beginning of a sale process, if the government wished to see that happen. A new script was being written by RBS bosses, aware perhaps of frustration in the Treasury about the slow pace the bank was taking in the long march back to profitability and a future free of the state. The message emanating from the City offices of RBS was that ministers would not have to wait too much longer until there was an opportunity at least to fire a starting gun on privatisation.
By May 2013, RBS chiefs were more openly bullish. They were able to report a profit for the first three months of the year, the first such outcome since before the banking crisis. The chairman, Sir Philip Hampton, said that the bank would be ready for the start of a share flotation by the middle of 2014, possibly even sooner. Stephen Hester said in interviews that the long clean-up of the RBS books would be substantially complete by then. There was a clear and uncoded message to the Chancellor – please give the green light to a share sale and allow us to start preparations for that. There was one obvious problem for Hampton and Hester – getting the share price back within 12 months to a level that would at least allow taxpayers to break even on their investments. On the day of Hampton’s plea to the Treasury, the RBS price hovered around 290p per share. But, depending on how the government’s intervention price was calculated, it would need to get back to at least 440p, probably 500p, to allow ministers to say a fair value had been achieved. The silence from the Treasury was noteworthy – there was no nod to even the possibility of a share sale in 2014.
Little more than a month later, RBS was in turmoil again and the reason for the Treasury’s muted attitude on the day of the results became obvious. In a shock to the City and media alike, it was announced on 12 June that Stephen Hester was to quit as RBS chief executive later in the year. A rather convoluted explanation was given by the bank. It was said that UKFI had told the RBS board that the Treasury wanted the bank to have cleared the decks in readiness for a share flotation by the end of 2014. Given that Hester would have been there for six years by then it would be likely, the bank argued, that he would not want to stay much longer. Selling shares in RBS might, it was said, be easier if there was no doubt about the career plans of the chief executive. Better, so this thread went, to have a new chief executive in place well before the end of 2014. That was the official version of events. Another view was that George Osborne and Stephen Hester simply did not get on. The Treasury strongly denied that it had blood on its hands. It was the decision of the RBS board and Mr Hester, officials briefed. Sir Philip Hampton and his colleagues may have decided that having a chief executive who was clearly not singing from the same hymn sheet as the majority shareholder was a less than sustainable position.
The City seemed to believe the less charitable interpretation of Hester’s departure. The RBS share price plunged more than 7 per cent the next morning, although it recovered some losses later in the day, as analysts publicly blamed the Treasury for interfering with RBS and pushing out a highly respected chief executive. Lord Myners, still wearing his Labour hat, suggested that the RBS board was ‘doing the bidding’ of George Osborne. It looked like a mess and a reminder of the realities of the governance of a company with more than 80 per cent of the shares held by HM Government. Having the RBS board, UKFI and the Treasury all with fingers in the pie was arguably a recipe for trouble.
In interviews after the announcement of his departure, Hester never pointed the finger directly at Osborne. He remained diplomatic about the circumstances leading up to the decision by the board to find a new chief executive. ‘George and I never had a discussion,’ said Hester after leaving the bank, ‘there were a few things he wanted which I couldn’t make a shareholder case for’. Those things included the disposal of the RBS American subsidiary Citizens Financial Group. Valued potentially at £10 billion, Citizens looked to the Chancellor like a pot of gold which could be easily cashed in as RBS focussed on building up UK banking operations. Hester’s view was that Citizens should be sold only when the price was right and at a profit.
Hester departed wearily, reflecting on how RBS had become a political football: ‘It was frustrating on a human level. Politics and business don’t make good bedfellows – everyone had views on RBS, from the Archbishop of Canterbury to the former Chancellor, Lord Lawson. If nobody can agree on what the problem is, then it is hard to find a solution.’ There was no easy answer or magic bullet, Hester believed, and if they had existed then the management would have found them. The political uncertainty had in his view slowed down the recovery of the bank and made it harder for bank executives to concentrate on the job.
To compound the frustrations for the RBS board and senior management, a wide-ranging report on the future of banking came up with some thought-provoking ideas and harsh conclusions. The Parliamentary Commission on Banking Standards had been set up by George Osborne in mid-2012 in response to the scandal over rigging of LIBOR, the key market interest rate which influenced many mortgages and business loans. The intention had been for the Commission to focus on the ethics and culture of banking, but under the determined and forensic leadership of the Conservative MP Andrew Tyrie it lifted up many stones across the banking terrain. Having Bishop Justin Welby, later to be Archbishop of Canterbury, on board added to the gravity and stature of the body.
The Commission highlighted the important role of RBS in the wider economy, both because of its scale and history of lending to small businesses. Given that, it argued, ‘the current state of RBS and its continued ownership by the government create serious problems for the UK economy’. There was praise for Stephen Hester and his team for their efforts to sort out the bank’s balance sheet. But the Commission concluded that after five years, the strategy for returning RBS to the private sector had to be reappraised – the bank was not in a position to provide the lending or competition required to help bring about the UK’s full recovery. UKFI, the Commission continued, was not fit for purpose as it had not stopped the Treasury interfering – the body should be wound up.
For RBS, the most significant conclusion of the Banking Standards Commission report was a call for the ‘good bank, bad bank’ issue to be reopened. Evidence had been heard from supporters of the idea – one leading proponent, Lord Lawson, was actually a member of the Commission. One of the arguments aired in favour had been that the ‘good bank’ could concentrate on UK retail and commercial lending, freed from the toxic legacy assets which had held back the expansion of new loans. But it was noted that it was not clear whether a split would result in the ‘good bank’ getting back on the stock market more rapidly than an undivided RBS would. The Commission called for the Treasury to carry out an analysis of the policy and publish it within three months. George Osborne accepted the challenge and set up a Treasury review of the ‘bad bank’ option. But he rejected the idea of abolishing UKFI, noting that it had valuable banking expertise and was doing a good job of managing government stakes in the banks. He made it clear no more taxpayer money was to be put up in pursuit of any new goals set for RBS.
Lloyds, meanwhile, had steered a course free of political controversy. Sir Victor Blank and Eric Daniels had both moved on by early 2011. Antonio Horta-Osorio, a Portuguese banker who had previously run Santander UK, took over as chief executive in March 2011. After an uncertain start and health problems caused by overwork, which forced Horta-Osorio to take extended leave, the share price had been rising fairly steadily since late 2011. Markets perceived that Lloyds was a better candidate than RBS for recovery and a share sale. When the board announced results for 2012 they showed an increasing underlying profit, stripping out factors like fines for misdemeanours such as mis-selling of Payment Protection Insurance (PPI). Taking everything into account, a pre-tax loss of £3.5 billion the previous year had been cut to £570 million. Speculation about an impending sale of the government’s stake was fuelled by the revelation that the Horta-Osorio’s bonus was linked to the share price reaching a level above what the taxpayer had shelled out and staying there for a sustained period.
The Parliamentary Banking Commission had little to say about Lloyds other than that it had ‘suffered far less from the effect of public ownership and the perception of political interference than RBS’. It was hard to argue for government intervention at Lloyds, said the Commission, and it was better placed to return to the private sector without additional restructuring. In early August, when Lloyds announced a sharp rise in profits for the first half of the year, the Treasury let it be known that a start of the sale of the government’s shares was imminent. Although not quite as imminent as some expected, the starting gun was formally fired in mid-September. A 6 per cent stake in Lloyds was put up for the sale by the Treasury and in a late-evening process, banking advisers lined up institutions such as pension funds to bid for the shares. The following morning it was announced that £3.2 billion was to be raised with buyers paying 75p per share – this was a fraction above the average 74p price paid by the government to recapitalise Lloyds back in 2008. The publicly owned stake in Lloyds had been reduced to just under 33 per cent.
No wonder George Osborne was making the most of the developments at Lloyds. He said the news was positive for the taxpayer and an important step in plans to repair the economy. He kept his cards close to his chest when asked when a second chunk of Lloyds shares might go on sale. He was keen to stress, however, that he would think carefully about an offer of shares to the general public – an enticing prospect for him in the year before the general election. The Lloyds story fitted perfectly his narrative – a bank on the road to recovery, ready to help the economy with more lending, and with the government retrieving money for the taxpayer through a successful share sale. But with RBS he was no closer to getting back any of the state’s investment. The RBS saga was dragging on and the Chancellor was bitterly regretting not grasping the nettle after the 2010 election.
The fifth anniversary of the dark days of October 2008 was approaching. RBS remained a mammoth in the room both for the Treasury and the economy. It was still deleveraging, reducing the burden of historic bad assets. Lending to businesses and consumers was still falling according to data from the Bank of England. Taking into account new loans and debt being repaid, net lending by RBS to households and corporate borrowers was down by £6.7 billion over the year to the second quarter of 2013, leaving the total loan stock at £208 billion. A share flotation seemed as far away as it had done at any time in the previous few years. The possibility of a root-and-branch review hovered over the bank. The brutal truth was that successive Chancellors had not worked out a viable path for an institution that was an important pillar of the whole economy. To put it another way, RBS was still in the mire five years on from the rescue. The question being asked more forcibly was whether a ‘good’ RBS separated from the toxic loans would generate more lending for the economy and also provide a quicker return for the taxpayer through a stock market flotation.
The coalition government’s handling of RBS had taken a hammering a few months earlier. Sir Mervyn King had come out into the open with his hostility to the governance of RBS. Giving evidence at the Banking Standards Commission, the Governor said:
The whole idea of a bank being 82 per cent owned by the taxpayer, run at arm’s length from the government, is a nonsense. It cannot make any sense. I think it would be much better to accept that it should have been a temporary period of ownership only, to restructure the bank and put it back. The longer this has gone on, the more difficult that’s become.
King argued that it should still be possible to split RBS into a ‘good’ and a ‘bad’ bank, the aim being to create a new, clean ‘good’ bank which could be a major lender to the economy. And, with a swipe at both Alistair Darling and George Osborne, the Governor said policymakers had not been sufficiently decisive in recapitalising and restructuring the banks. He concluded: ‘This has dragged on unnecessarily long. I don’t want to blame anyone for this but I think the lesson of history is we should face up to it.’
King’s salvo had initially been dismissed by Treasury sources as a frustrated Governor wanting to get something off his chest during his final weeks in office. They made clear that the Chancellor wanted RBS to press on as it was and aim for a flotation at some stage in the next couple of years. Giving evidence at the Commission a couple of weeks earlier, the Chancellor had rejected the idea of splitting RBS as it would require nationalisation of the whole bank and he would not support the use of public money for that purpose. That was in March. But little more than three months later, George Osborne was agreeing to a review of the ‘good bank, bad bank’ policy. Such was the state of flux around RBS. In November 2013, the review complete, Osborne decided not to split RBS. Instead he demanded a complete ring-fencing of £38 billion of bad assets and a faster process for selling them off as well as a quicker timetable for the disposal of Citizens. Hester’s achievement had been to reduce the £258 billion mountain of toxic debt to that £38 billion figure.
At the same time as the decision not to go ahead with an RBS carve-up, an independent report commissioned by the bank said it had performed poorly on small business lending. There was an acknowledgment from Hester’s replacement as chief executive Ross McEwan that the bad assets had held back the bank: ‘Five years ago we were broke – and when you get broke because you’ve lent money to the wrong people and can’t get it back, you tighten up – we probably tightened up too much and we need to get the bank now back to being more normal with how it works with customers.’
Sir Mervyn King (knighted in 2011 and then awarded a peerage two years later) was not alone questioning the policy adopted for RBS. Five years on from the rescue and bailout of the bank, there has been wider scrutiny of the use of the Asset Protection Scheme and the government taking only a back seat in the management of the bank. Talking to some of the architects of RBS post-crisis and the APS gives the strong impression that they wished they had done things differently. Lord Myners, who played a central part in decision-making regarding RBS in late 2008 and early 2009, conceded that a different course might have been taken. He said: ‘The case for nationalisation followed by a “good bank, bad bank” policy looks with hindsight to have been a stronger option than we probably considered it to be.’ If any economic forecasters had predicted that it would be several more years before UK economic output got back to its pre-recession peak, Myners argued, then the case for a radical policy in 2008 would have been a lot clearer. Given what we know now, he suggested, nationalisation of RBS would have been the best option back in 2008.
Lord Turner, who was chairman of the Financial Services Authority until mid-2013, is clear that HBOS should have been nationalised and he thinks that RBS should probably have been taken into full state ownership as well. Having an external minority stake in RBS in his view did not help the clarity of purpose which both government and management needed from the start of the reconstruction process. There was a lack of public understanding about what RBS was trying to do and whether it really was attempting to run itself like a private sector bank on behalf of its minority shareholders. Nationalisation of RBS would, with hindsight, have been the best outcome according to Turner, though he is doubtful about whether a ‘good bank, bad bank’ split would necessarily have had to flow from that. The most important thing under public ownership, he thinks, would have been to make sure the bad assets were moved into their own workout area.
Alistair Darling, as Chancellor, presided over the creation of the Asset Protection Scheme and took the decision to press on with RBS operating as a commercial bank which just happened to have a large government shareholding. Darling’s main concern at the time was to keep RBS in a state that made an early sale back to the private sector as straightforward as possible. There was a widespread assumption that after a deep recession, there would be a sharp rebound for the economy which would allow a disposal of RBS shares within a year or so. Doing that with a stock market listing, he felt, would be much easier than launching a privatisation of a wholly government-owned business.
He rejected nationalisation during the early October crisis because he wanted to create a complete package which involved Barclays and HSBC as well as those who were obviously struggling. As he saw it, they were simply offered a straight choice of raising capital from private investors or the government if there was no other source.
Darling said he wanted a package which had ‘the buy-in of all the big British banks – if you had said, by the way, this included nationalising anybody who’s a bit slow off the mark, they would have been off’. One of his fears at the time was that nationalisation of either RBS or HBOS, let alone both, would generate unwarranted fears about the health of the whole banking system both at the other healthier banks and in the financial markets: ‘At that time, it didn’t take much to scare them. We wanted them to see the British government was playing a major role but not saying the entire banking system was bust.’
The Chancellor’s anxiety at the time went beyond the well-being of individual banks. He had half an eye on what investors might conclude about the state of the British government’s balance sheet. Given that RBS was bigger than the UK’s annual economic output, taking it into full state ownership might raise concerns about what was affordable. Darling argues that the cost of any nationalisation would have been a major stumbling block and he was reluctant to run the gauntlet of an adverse reaction in the markets:
I do wonder, looking back when the world was so febrile, if it looked like the UK government was busy nationalising banks, the market might have said how many banks can you nationalise? I wouldn’t have said it at the time because people would have immediately said you are dead right – but five years on I can say you do need to have regard to how much money you are spending, any Chancellor does, but at that time you don’t want people to doubt your sovereign creditworthiness.
Darling remains convinced he made the right decisions in late 2008 and early 2009. He does not recall hearing strong arguments at the time in favour of ‘good bank, bad bank’ and nationalisation. Even if the case was being made inside the tripartite authorities, there were few, if any, independent commentators calling for full state ownership. There does not seem to have been any evidence of dissenting views inside the Treasury. Investment bankers working on APS were clear that it was the most efficient way of boosting the capital ratios at RBS. Taxpayers’ money would be needed to nationalise the bank if that route was chosen and more state funding might be required as a buffer against losses in a bad bank. As one senior adviser put it: ‘You would need more public money for a bad bank and getting it capitalised – that seemed less efficient if you could achieve the same positive capitalisation at RBS without a huge funding requirement – why would you not do that instead?’
But the premise to the case for the Asset Protection Scheme was that it provided a safety net for RBS with the aim of stabilising it and preparing for the long-term goal of re-privatisation. According to one senior banking source, the focus was on ‘how do you keep it alive – not how you make it run fast’. There was no talk in early 2009 of the Treasury using RBS and Lloyds as vehicles for boosting lending in a recovering economy, and no focus on using the state-controlled banks as agents for credit supply. Decisions were made only with a view to preparing the banks for life at some stage in the future without a lifeline from Whitehall. This was the brief to the banking advisers who were hired to devise plans to deal with capital shortfalls at the main banks after October 2008. The question put to them, according to a senior banking executive was: ‘What’s the most efficient way of effectively creating more capital in RBS? The question of lending more to the UK economy was never an agenda item’.
Beyond Downing Street and the Treasury, critics of the Asset Protection Scheme claimed it was too complicated and that the process of trying to separate the bad assets from the good was enormously difficult and time-consuming. APS, they argued, did not provide bank managements with any incentives to lend – it was simply a clever ploy to reduce the capital needed on the balance sheet. Loans to small businesses under banking industry rules needed more capital allocated to them as they were deemed to be riskier. There was thus a greater incentive for RBS management to put loans in this category into the APS and so reduce the capital required for them. There could arise a bizarre situation where one part of the bank was trying to increase lending to small firms while another was taking exactly the same sort of loans, labelling them ‘bad assets’ and shunting them into the insurance scheme. One senior banker who had advised the government, though not on this scheme, summed it up: ‘You wouldn’t do APS if you wanted RBS to play a part in lending and helping revive the economy.’ The same source argued that if the government had said the priority was to lend, then advisers would have kept small business loans away from the Asset Protection Scheme.
Proponents of ‘good bank, bad bank’ like Sir Mervyn King were convinced that once so much public money had been pledged to RBS and Lloyds, there was no point pretending they were stand-alone, quasi-commercial entities. They pointed to the dangers of a Japanese-style slowdown, where banks remained haunted by historic toxic loans, unable to value them with any confidence. As long as this overhang of bad assets stayed there, so the argument ran, banks would be unwilling to take risks with lending on new projects and to vibrant start-up businesses. Better by far to withdraw the poison totally from the more promising areas of RBS and Lloyds and allow them to flourish back in the private sector, lending normally. The toxic waste, meanwhile, would sit out of harm’s way on the state balance sheet. Continuing as a single entity, so this line of argument went, RBS was doing the economy no favours.
The Bank of England opposed APS and said it was too complex. ‘Treasury civil servants,’ according to one well-placed source, ‘got themselves completely bogged down by having a massively complicated scheme and it has probably cost them a lot of public money by not going down the right route.’ From this viewpoint, the government failed to provide enough capital both in late 2008 and in early 2009 after market conditions had deteriorated and ducked the radical restructuring required. The government, according to the same source, was too hung up on trying to steer clear of any further state support for the banks when the state of their balance sheets required just such an intervention: ‘Someone’s got to get a grip on them in order to get them back in the private sector as quickly as possible – otherwise they just linger in the public sector or as crippled banks where we have to support them the whole time.’ In other words, radical and expensive surgery early in the reconstruction process would have prepared the way for a new, clean RBS to grow and thrive (perhaps using the NatWest brand and dropping RBS altogether).
The arguments about what should or should not have been done with RBS, Lloyds and HBOS and when will run and run. It is always easy with the benefit of hindsight to look back at decisions made in the heat of a crisis and suggest that different choices should have been made. At the Treasury, and amongst advisers who devised APS, there is a view that the best decision from a range of difficult options was made at the time. As far as Lloyds is concerned, those who defend the policies adopted by successive governments point to the eventual sale of some of the taxpayers’ shareholding in September 2013. Not nationalising HBOS and allowing it to continue with the Lloyds marriage and then permitting the combined group to steer clear of APS in late 2009 were the key political decisions. But it took more than four years to get Lloyds to the stock market starting gate. Net lending by the group to households and businesses was down by £5.3 billion over the 12 months to mid 2013, although there was an uptick in the final three months of that period. What will never be known is what a ‘clean’ Lloyds might have done for the economy, while HBOS and its ‘dirty’ assets were sorted out under the umbrella of state ownership.
The surprising success of those banks that were nationalised and split up is evidence of how ‘good bank, bad bank’ can operate. Northern Rock was nationalised and then divided, with the government taking on a large chunk of the mortgage book. The rest of the bank, which had come to symbolise the credit crunch with the images of queues at branches repeated in every TV news piece on the financial crisis, finally found a home in the private sector. The retail side of Northern Rock was sold to Virgin Money for just under £750 million in November 2011. The Treasury could receive up to £280 million more, depending on whether the business is floated on the Stock Exchange. The Northern Rock name is no more, with the branches rebranded as Virgin Money, but there were reported to be cheers at the Newcastle headquarters when the deal was announced to staff.
The government resolution of Bradford & Bingley had passed the branches and customer accounts smoothly over to Santander. Most of the mortgage book, including some of the extravagant loans of the boom era, stayed on the government’s books. It was combined with Northern Rock’s to form a new quango called the UK Asset Resolution Agency. These loans were due to sit like nuclear waste for decades till they were all paid off or as much money as possible recovered from the borrowers. There were indications by late 2013 that a profit might even be made once the process had ended.
What might have been is a familiar debate in many walks of life, particularly sport and politics. What if Brighton’s Gordon Smith had scored in the final minutes of the 1983 FA Cup Final against Manchester United? What if Jim Callaghan had called a general election in late 1978 rather than waiting and enduring the ‘Winter of Discontent’? The ‘what ifs’ over RBS and Lloyds in one sense are more important. They are central to the direction of the whole UK economy – jobs and livelihoods. The big banks’ presence in the economy and ability to lend to families and businesses was secured by the Labour government’s intervention in October 2008. But Alistair Darling and then George Osborne made decisions about the how the banks were structured and organised that could be seen to have impaired the flow of credit from two dominant players in the banking market. What if there had been a free-standing Lloyds, shorn of HBOS and lending freely to households and businesses? What if there had been a ‘good’ RBS back on the stock market with no government stake and pumping out loans? The problem with ‘what ifs?’ is only being able to guess at the answers.