Royal Bank of Scotland - Essay Example

?Royal Bank of Scotland (RBS) Introduction The Royal Bank of Scotland Group (RBS) is a global financial and banking services group. The holding company is operational in the United States, United Kingdom, and internationally through two principal subsidiaries: The National Westminster Bank Plc (NatWest) and The Royal Bank of Scotland plc (the Royal Bank). Both the principal subsidiaries are clearing banks. From the Royal Bank of Scotland’s domestic origins, the bank has grown and developed to be a major global banking operation about 42% of the bank’s income come from international operations. The Royal Bank of Scotland is now the world’s sixth largest by market capitalization and the second largest bank in the UK and Europe. Majority of the bank’s success in the last decade has been accomplished by a combination of internal innovation, organic growth, and significant acquisitions (Aoki, 2000). The performance of the bank in 2005 demonstrated the capability of the company’s growth, with the growth of customers in all its divisions. The average customer loans and average customer deposits were up to 23 percent and 17 percent respectively during this period. However, the bank has had its pitfalls and failures leading to resignation of the CEO, Fred Godwin with hefty pension (Barba, 2005). This brings up the questions, what are the reasons behind the failures of Royal Bank of Scotland? To what extent were the corporate governance practices responsible for these failures? And how could Royal Bank of Scotland avoid these failures? In order to answer these questions, this paper will discuss the case of the Royal Bank of Scotland’s corporate governance. Through this discussion, the paper will: provide a profile for Royal Bank of Scotland as well as its key financial, regulatory and governance facts; the underlying corporate governance issues that have contributed to the collapse of Royal Bank of Scotland; and how Royal Bank of Scotland could avoid the failure reflecting on the best corporate governance practices. RBS profile, key financial, regulatory and governance facts The Royal Bank of Scotland is a large international financial and banking services company. The Group, from its headquarters in Edinburg, serves over 30 million customers in Europe, United Kingdom, Asia, The Americas, and the Middle East. Royal Bank of Scotland functions as an international financial and banking service group offering a broad range of services and products to commercial, personal, and big institutional and corporate customers through its two major subsidiaries. Royal Bank of Scotland was behind the launch of the first successful UK offset account of mortgage with Virgin. This model has currently been translated to the US and Germany successfully. The primary aspect of the Royal Bank of Scotland strategy is to establish the strategic options and the constituent flexibility and diversity mean that growth is independent of one specific market development or economic scenario. This kind of approach and its associated benefits are reflected in the results of Royal Bank of Scotland (Citrin, and Smith, 2003). In 2005, the Royal Bank of Scotland’s total income rose by about 14% contributed to mainly by its organic growth. This accounted for 70% of the increase. The company’s income ratio and critical cost was up held at 41%. Continued growth in profits, income and earnings are seemingly certain due to the innovation teams who operate in both the insurance and retail banking areas of the business. The developments of the 2005’s internal innovation included the Royal Bank of Scotland being the very first main international bank to publicly declare that it went live with the FX spot streaming trading through the Bloomberg Professional Service (Clarke, 2004). This kind of development of model electronic commerce complemented the existing electronic trading capabilities of the Royal Bank of Scotland on Bloomberg enabling the clients to trade Fixed Income and Foreign Exchange online from a single platform. Nevertheless, Royal Bank of Scotland appointed, in order to drive further innovation across its business, one of its rivals, Global Innovation Director, mirroring Citibank. The Royal Bank of Scotland is an ancient company with its origin in the 18th century. Royal Bank of Scotland pursued an acquisition and growth strategy under the leadership of its CEO, Sir Fred Goodwin. The strategy that included the National Westminster Bank acquisition in 2000 was accepted by the board of the group, chaired by Sir Tom McKillop. In fact, the CEO because of axing around 18000 jobs earned himself an in-house name: Fred the Shred. However, the advances began to prove disastrous with the subsequent ?10 billion acquisition of Dutch Bank and investments in American sub-prime loans in 2007. Even though it should have been noted that the Dutch Bank acquisition had a bright side, the Royal Bank of Scotland included one of the most successful brokers in the City of London, Hoare Govett (Cohen and Boyd, 2003). The Royal Bank of Scotland signed an agreement of strategic investment and co-operation with the China’s second largest bank, Bank of China in August. This led a consortium and an association that took a 10% stake, investing $3.1 billion, taking a 10% stake. Royal Bank of Scotland invested $1.6 billion, and is working closely with Bank of China in order to develop cooperation of business initiatives in areas like wealth management, credit cards, and corporate banking. The bank also supports Bank of China in infrastructure aspects, including human resources, financial and risk management, and information technology. Together with the bank’s continued growth in Europe and US, this deal cements the position of Royal Bank of Scotland as a major company and a global player that looks to garner opportune advantages from the China’s growing economy (Especial Expo Management 2004). The bank began to experience substantial failures in 2009 when the market valued it at less than ?5 billion (10p a share), when it had been valued at ?75 billion (?6.02 a share) in 2007. The British government chipped in and gave the bank afloat of ?37 billion in 2008 and other subsequent funds, taking the 58% of the bank’s equity at stake. In spite of the government’s ?325 billion guarantee of the bank’s toxic loans in an insurance scheme, the bank still reported a ?24 billion loss. This was a record in the United Kingdom. There were views of extravagance that mentioned the 900 Falcon executive jet and a roll of office wallpaper at ?1000. This again resulted into in-house names: a modest man without a sense of responsibility and graces and airs (Federowicz and Aguilera, 2003). This led into investigations into the activities of the bank due to unexpected failure and collapse despite the funding by the British government. Consequently, the CEO, Sir Fred, resigned in 2008 November. His position was taken by Stephen Hester. Surprisingly, Sir Fred took home a hefty retirement package: a pension of ?703,000 annually for life. The package resulted into cries of reward for failure and raised huge public ire. He was being paid ?15,000 by tax-payer per week, and at the same time employees lose their livelihood and shareholders their savings. Sir Fred was criticized that his business decisions incurred enormous social costs, but his package of compensation grant vast personal benefits. The collapse of the Royal Bank of Scotland was inevitable (Fraser and Wallace, 2000). The underlying corporate governance issues that have contributed to the collapse of RBS Conclusions could have been made that the collapse of the Royal Bank of Scotland was inevitable due to the failure of the corporate governance of the company. Corporate governance a broad and pivotal subject covering a wide range of issues from transparency and accountability and the connection between the management, board of directors, and shareholders in order to help determine the performance and path of the corporation. The issues of system of the corporate governance are designed so as help in overseeing the best interest and the decisions of the shareholders (Fuller, 2003). This system should work efficiently and accordingly in ensuring election of directors by shareholders who hire management in turn in order to make the day to day executive decisions on behalf of the business owners. The position of the board of directors in the company is ensure the interest of shareholders is being served and to oversee management. This is applicable to all companies, Royal Bank of Scotland inclusive. The role of the corporate governance is to improve the company efficiency, promote enterprise, and to address disputes and conflicts of interest burdening the company, as in the case of Royal Bank of Scotland. From this description of corporate governance issues, we can infer that such issues failed to take effect in the Royal Bank of Scotland and hence the collapse. The corporate governance failed to ensure clearness, and truth in the businesses of the company. In a nutshell, corporate governance which is a control system for ensuring investors assures themselves of getting their investment back, failed to do so. The Royal Bank of Scotland ended up reporting a loss of ?24 billion. In spite of previous successes, the bank still made this huge loss and ended up collapsing (Institute of Directors publication 2005). What could have been the proximate cause? Is it poor risk management and bad corporate governance? The proximate cause of the collapse of the Royal Bank of Scotland was blamed on the issues of corporate governance. For example, the Financial Services Authority criticized that the regulations encouraged by the Labor government for the Royal Bank of Scotland were "light touch" in nature. The authority added that the regulations called for an overhaul of the rules that are used to regulate bankers. The corporate governance issues come to light due to the fact that no particular person was held responsible legally for the collapse of the Royal Bank of Scotland (Zahra and Pearce, 2004). No action had been taken for the failures and no particular individual was charged. In the economy of the market, as in corporate governance, companies take risks on shareholders’ behalf, and therefore if any mistake is made: collapse of company, the shareholders is responsible for sanctioning the board and management by firing them. The case of banking industry could vary in that excess risk taking by financial institution, for example via aggressive acquisition, may lead to bank collapse and failure, broad economic harm, and taxpayer losses. The bank failure is actually a shareholders’ public concern. The case of Royal Bank of Scotland was associated by all these corporate governance issues: taxpayers lost their livelihoods and the shareholders paid the CEO huge amounts on weekly basis (Kirton et al., 2005). The Royal Bank of Scotland collapsed because of poor risk management and bad corporate governance. In general, the issues of corporate governance that led to the failure of the Royal Bank of Scotland were associated with the credit crunch. Some of these issues include: Failure by the Royal Bank of Scotland to manage and appreciate the interconnection between the remuneration incentives and inherent business risks The bonuses and structures of remuneration in the bank system that encouraged short-terminism excessively, this never worked in the interest of shareholders or supported risk management prudently. Although the CEO was linked to the prime minister, the departments of risk management in the bank lacked sufficient power or influence. Royal Bank of Scotland experienced significant weaknesses in reporting financial and risk transactions There was a general lack of accountability in the Royal Bank of Scotland especially between the company and the customers. Lack of management understanding of the risks and over-complexity of their services and products Royal Bank of Scotland excessively relied on leverage in models of bank business. Lack of interconnections with other financial institutions The misalignment between investor interest and that of originators with complex financial services The Royal Bank of Scotland failed to appreciate motivational and cultural factors, rigid thinking by the board, and minimal desire to change, management greed, and ‘it is not my problem’ attitude. The complacency after a long-drawn-out bull market Insufficient training to allow board of members and senior management in order to understand underlying models and business products, this results into lack of rigorous challenge and poor oversight by senior executives. Lack of ethics of the boardroom (Koke, 2002) On the hand, the cultural capital enabled the Royal Bank of Scotland win support from the City for taking Dutch Bank propelling Royal Bank of Scotland onto the international state. it has been argued that the executives of Royal Bank of Scotland missed the challenges of bad debt and toxic assets in the period of expansion since the bank was disrupted by efforts to legitimate themselves through successfully competing in opposition to the English banking elite leaders. In this respect, the UK Corporate Governance Code of 2010 suggests that need to develop a transparent and official procedure for establishing policy on remuneration of the executive for amending the packages of remuneration of specific directors. The Royal Bank of Scotland failed to appoint a remuneration committee to work on Fred Goodwin’s pension package. If the shareholders formed a remuneration policy based on: shareholder return, profit based measures, earnings per share, return on capital, share prices, and director performance, then the selfish pension package that the CEO, Fred took home would have been very minimal (Spencer, 2005). In this respect, the Royal Bank of Scotland collapsed due to failures in corporate governance issues. In addition, the Royal Bank of Scotland failed on issues of corporate governance that led to the untimely collapsed. These issues included: The Royal Bank of Scotland capital position weaknesses due to the decisions by management and permitted by lack of framework of global regulatory capital. Royal Bank of Scotland over relied on very risky whole sale short-term funding permitted by inadequate approach to the liquidity regulation. Royal Bank of Scotland uncertainties and concerns about the underlying asset quality of Royal Bank of Scotland due to little essential Financial Services Authority analysis The substantial losses by Royal Bank of Scotland in activities of trading credit that eroded the confidence of the market and both the regulator and the bank underestimated the losses. The acquisition of the Dutch Bank took place with insufficient due diligence The general systemic crisis through which the banks in relatively worse positions were vulnerable extremely to failure, Royal Bank of Scotland was such like bank. The prevailing deficiencies in the management of Royal Bank of Scotland, culture and governance leading to poor decision making (Koke, 2002) How could RBS avoid this failure reflecting on the best corporate governance practices The Royal Bank of Scotland could have avoided the collapse if the management stood to the principles of corporate governance. The executive summary of Royal Bank of Scotland also pointed out that management individual decisions resulted into flawed judgment and analysis in specific circumstances. This is because majority of the decisions made by the Royal Bank of Scotland seemed poor with the hindsight benefit. The patterns of the Royal Bank of Scotland are considered poor suggested the underlying deficiency probability in the capabilities of Royal Bank of Scotland management and style, checks and balances, governance arrangements, mechanisms for challenge and oversight. The culture of Royal Bank of Scotland and its attitude to the growth and risk balance. The acquisitions by the Royal Bank of Scotland should have required approval by the regulatory authorities and public debate. This would have ensured that the directors and the executives of the bank face consequences personally from the collapse of the bank. The bank ought to have punished those responsible for the collapse of the bank and up hold principles of corporate governance (Institute of Directors publication 2005). In summary, the collapse of the Royal Bank of Scotland resulted primary from issues of corporate governance as discussed. The management failed to up hold the principles from which the business if founded. For example, the issue of the computer glitch at the Royal Bank of Scotland that left majority of customers with inability to access their bank accounts. This problem was negligence and the bank alleged that it was a minor problem that may have been caused by a technician. This fails to add up to corporate governance (Fraser and Wallace, 2000) In order to avoid the failure by reflecting on the corporate governance, the Royal Bank of Scotland ought to have executed the responsibilities that corporate governance dictate to financial businesses. Some of the responsibilities that would have helped the Royal Bank of Scotland avoid the failure include: economic responsibility, for instance the societal responsibility to remain a market driven and profit oriented business; legal responsibility, for example adherence to the regulations and laws of the society in order to remain profit oriented; ethical responsibilities, for example honoring the wider social norms of the society and behavior expectations above and over the law; and discretionary responsibilities, for example undertaking voluntary expenditures and activities exceeding the minimum expectations of the society. Many companies no longer consider corporate social responsibility management as an extra cost. Therefore corporate governance would have helped the Royal Bank of Scotland in making good decisions and contributed to the prolonged prosperity and company survival (Fuller, 2003) Among the many failures that ultimately resulted into the collapse of Royal Bank of Scotland, corporate governance failure was a major concern. Therefore as other reviews are being considered in order to avoid the failures, an effective review of the corporate governance must be put in the lime light. Particular, the Royal Bank of Scotland had Sir Tom McKillop as a non-executive chairman. This post is often designed to restrict over mighty CEO, however, the chairman failed to put restraints to Sir Goodwin Fred, with the severe consequences for the taxpayer and the bank (Cohen and Boyd, 2003). Conclusion In summary, the Royal Bank of Scotland could avoid the failures by doing the following: defining the roles of the CEO and the chairman as well as the senior directors. The code of corporate governance should encourage non executives to seek advice before big decisions, for example decision to make acquisitions. The rules and regulations governing the bank operations also need to be strict and defined. The corporate governance of the company also need to encourage that there should be an active shareholder involvement in questions of corporate governance (Anne, 2003). The corporate governance in the Royal Bank of Scotland needs to uphold characteristics such as: building the capacity, understanding the capacity, stakeholder relations, questioning business as usual, and strategic view of the company. This paper has generally provided a profile for Royal Bank of Scotland as well as its key financial, regulatory and governance facts; the underlying corporate governance issues that have contributed to the collapse of Royal Bank of Scotland; and how Royal Bank of Scotland could avoid the failure reflecting on the best corporate governance practices. Bibliography Aoki, Masahiko. 2000. Information, Corporate Governance, and Institutional Diversity: Competitiveness in Japan, the USA, and the Transitional economies. New York: Oxford University Press, Inc. Barba Vera, Santiago. 2005, La Sucesion de un CEO: La Gestion de la crisis. Universia Business Review Barinaga, Ester. 2002. Levelling Vagueness. A Study of cultural Diversity in an International Project Group. Stockholm: Elanders Gotab Citrin, James M. and Smith, Richard A. 2003. The 5 Patterns of Extraordinary Careers; The Guide for Achieving and Satisfaction, New York: Crown Business. Clarke, Thomas. 2004, Theories of Corporate Governance; The Philosophical Foundations of Corporate Governance, New York, Routledge. Cohen, S and Boyd, Gavin. 2003. Corporate Governance and Globalization. Edward Elgar Publishing Ltd. Especial Expo Management 2004. Executive & Excellence. La Revista del Liderazgo, la Gestion y la Toma de Decisiones. Espanola. Madrid: Executive Excellence, S.L. Federowicz, Michael and Aguilera, Ruth V. 2003, Corporate Governance in a Changing Economic and Political Environment. New York: Palgrave Macmillan. Fraser, I., Henry, W., and Wallace, P. 2000. The future of Corporate Governance: Insights from the Netherlands. Edinburgh: The Institute of Chartered Accountants of Scotland. Fuller, J. 2003. Harvard Business Review on Leadership at the Top. Boston: Harvard Business School Press. p 45 Anne-Marie 2003. Harvard Business Review on Leadership at the Top. Boston: Harvard Business School Press. p 45 Institute of Directors publication 2005. The handbook of international Corporate Governance. A definitive guide. Boston: Harvard Business School Press. Kirton, Gill, Greene, Anne-Marie. 2005, The Dynamics of Managing Diversity, A critical approach. Great Britain, Elsevier Butterworth-Heinemann. Koke, Jens. 2002. Corporate Governance in Germany: An Empirical Investigation. Physica-Verlag Heidelberg Spencer Stuart. 2005. Espana 2005. Indice Spencer Stuart de Consejos de Administracion. Madrid: Spencer Stuart. Zahra, S.A. and Pearce, J.A. 2004, Boards of Directors and Corporate Financial Performance. Journal of Management, 15 (2), 291-334 Read More