Corporate Governance and Regulation - A Case Study (RBS) - Essay Example

? Corporate Governance and Regulation - A Case Study (RBS) Table of Contents Profile of RBS: Financial, regulatory and governance facts 3 Corporate governance issues: Collapse of RBS 5 Best corporate governance practices: ways for RBS to avoid this failure 8 References 12 Bibliography 13 Profile of RBS: Financial, regulatory and governance facts The Royal Bank of Scotland is a subsidiary of The Royal Bank of Scotland Group Plc. which was established in the 18th century as a society for protection of the funds of investors from the failed company of Scotland. The society later turned into a company and started to provide banking services. The overdraft facility used in modern day banking was one of the famous inventions of The Royal Bank of Scotland in early days which allowed the merchant customers to withdraw amounts from their bank accounts more than the balance they maintained. The overdraft facility is one of the most versatile instruments in banking today. The Royal bank of Scotland apart from providing banking services in Scotland through 700 branches also provides branch banking services throughout the British Isles in collaboration with the NatWest and Ulster Bank. The Royal Bank of Scotland provides dedicated retail and commercial banking services in Scotland, Ireland and US. The Royal Bank of Scotland has a worldwide presence in about 40 countries where they provide investment banking services, private banking and also banking network channels for payment across Europe, Asia and Middle East. Apart from the core banking divisions, the bank also has non-core support groups to provide better banking services which includes Asset protection group, Global restructuring group, Risk containment group and the legal group. The Royal Bank of Scotland has a strategic plan for fulfilling its long term and short term objectives. The strategies employed by The Royal Bank of Scotland include serving the customers to their delight, containing the risk profile of the bank and finally attain sustainable value addition for the shareholders. The Royal Bank of Scotland is governed by a Board of Directors and the managing and executive committee. The bank is headed by its chairman Sir Philip Hampton and the Group Chief executive Stephen Hester. The platform of principal decision making is formed by the Board members of the group who has the overall responsibility and accountability of not only leading the group in a sustainable fashion but also ensure value and returns to their shareholders. The group also has a performance and remuneration committee apart from its supporting risk and audit structure. Apart from taking the policy-making decisions, the Board members of the group also monitors the operations and performance of the group on a periodic basis. The Group Board and the Committees governing The Royal Bank of Scotland is committed to high standards of adhering to codes on corporate governance. The Board Group scheduled a detail on the company affairs which is reviewed for monitoring effective implementation of the policies on corporate governance. The Royal Bank of Scotland acknowledges diversity and has implemented it worldwide. The Royal Bank of Scotland has around 5000 women workforce globally who are guided by a senior team of personnel. The Royal Bank of Scotland has a designed code of conduct along with defined policies on environmental, social and ethical risk, anti-money laundering, human rights, anti bribery, anti corruption and managing of diversity. These governance and regulatory policies help The Royal Bank of Scotland to maintain a balance of their financial, economic and social goals. Apart from serving their customer well, The Royal Bank of Scotland is committed to be a good employer, fulfil their corporate social responsibilities, open to consultation with their stakeholder for wealth maximization and restoring security and confidentiality of internal information. The Royal Bank of Scotland filed its annual report on 28th March, 2013 with the US Securities and exchange commission. The stock price of The Royal Bank of Scotland is around 275 GBP. From a net profit position of 7549000000 GBP in 2007, the group has incurred a net loss of 23710000 GBP in 2008 and recovered in 2009 with a net loss of 2672000 GBP in 2009. Recent facts suggest that The Royal Bank of Scotland were fined 28.58 million GBP for its engagement in anti-competitive practices against the Barclay’s Bank. The anti-competitive practices were mainly in the areas of pricing of loans and other professional services. The Royal Bank of Scotland is also reported to have prevented their customers from using ATMs of most rival banks in 2011 and in June, 2012 several customers could not access their accounts due to system faults. Thus a lot of issues cropped up in the corporate governance of The Royal Bank of Scotland which affected their performance in financial, social and economic aspects (Royal Bank of Scotland, 2013, p.1). Corporate governance issues: Collapse of RBS The Royal Bank of Scotland which was one of the world’s largest financial institutions reached a point in 2008 when it struggled with liquidity and serious concerns were raised in getting funds required to run its operations. The Royal Bank of Scotland which acquired the Dutch bank ABN AMRO in the previous year with a record takeover in European history with an amount of 61 billion GBP had hit the floor due to the arrogance, incompetence and incapable decisions by the senior management constituted by the Board of Directors (FSA, 2013, p.1). This raises issues on the corporate governance practices followed by the bank at the time of the then Chief executive Sir Fred Goodwin. The collapse of The Royal Bank of Scotland required an amount of 45 billion GBP for immediate bailout with government funds although the bank disbursed around 700 billion GBP more in the form of loans and guarantees. The Financial Services Authority has referred the collapse of The Royal Bank of Scotland as an outcome of poor and bad decision by the Group Board and cleared the managing committees and the then Chairman Sir Tom McKillop, Chief Executive Sir Fred Goodwin of any wrong doings. But the chairman, chief executive and the entire Board Group could not escape the accountability arising out of their irresponsible decision making and inefficient corporate governance and complacency shown in subsequent monitoring (Hawley, Kamath and Williams, 2011, p.301). As a result, Sir Fred Goodwin who was knighted in 2004 for his services in the field of banking was debarred of his knighthood in 2012 due to the massacre of financial wealth of The Royal Bank of Scotland as a result of poor corporate governance under his leadership. The Royal Bank of Scotland had a policy of continuous growth and acquisition. As a strategic move in 2000, the then chairman Sir Tom McKillop supported the vision of the then Chief executive Sir Fred Goodwin for acquiring the National Westminster Bank when around 18000 jobs were dissolved but to the little effect on the banking giant’s performance (Sun, Stewart and Pollard, 2011, p.55). But the decision of the governing body to acquire the Dutch bank ABN AMRO in 2007 proved crucial. Apart from that The Royal Bank of Scotland increased its investment in securities and disbursed loans in the subprime market of US. It is incredible to note that the Board of Directors of The Royal Bank of Scotland despite watching at the emerging US subprime crisis in 2007 decided for assuming the leading role in the take over of ABN AMRO overlooking the fact that their core capital ratio and capital adequacy ratio would reduce below the buffer level. The FSA acting as the regulator to the financial industry also allowed The Royal Bank of Scotland in taking part in the takeover. Subsequently the devaluation of underlying securities in the US subprime market led to the fall in the value of investments of The Royal Bank of Scotland. The fair value of the bank and subsequently the share price plunged raising liquidity concerns of the bank. Thus devaluation of the shareholder’s wealth and the drastic fall in company valuations were a result of extraneous and irresponsible decision taken the members of the bank’s governing body which reflects issue pointing at ineffective corporate governance. In order to rescue The Royal Bank of Scotland, the British government allocated a bailout package of around 45 billion GBP. Apart from that the government also guaranteed around 325 billion GBP to bailout part of its bad investment in loans and securities. Apart from the financial crisis in the market, the financial losses and subsequent down-gradation can be attributed to the shortcomings of the decisions taken by the management which includes uncalculated risk taking steps taken by the management and inability to recognise bad investments, loans, etc. Also there was no proper due diligence taken prior to the takeover of ABN AMRO by The Royal Bank of Scotland in terms of risk profiling of the investment, expected profitability calculations and judging feasibility of the investment. The management was also neglected the monitoring aspect of their investments which led to their collapse. Several corporate governance strategies that led to the downfall of The Royal Bank of Scotland include the following. The management chose a model of wholesale funding which led to incurring a high amount of liquidity risk. The governing body adopted the policy of increasing their investments in the real estate markets in US as they offered unexpectedly higher returns. These investments were in line with their growth objective but the management lacked adequate monitoring and assessing viabilities before investing. The governing body gave little consideration on maintain the proportion of capital resources with respect to debt acquired for acquisitions like ABN AMRO. The company pursued on expanding its credit policies when the market already signs of devaluation of prices of property in the market. The policy makers of The Royal Bank of Scotland could not avoid their accountabilities to the shareholders and faced extremely high anger for losses incurred on the face value of their investments as a result of ineffective corporate governance. The malicious effort of a part of the senior management was also observed to show inflated balance sheets to their investors by which The Royal Bank of Scotland had raised 12 billion GBP months before their collapse. The collapse of The Royal Bank of Scotland also reflects a serious weakness in the corporate governance policies of the Financial Services Authority. As a regulator, the Financial Services Authority should have looked into the reduction of capital base that was going to occur when The Royal Bank of Scotland was playing a lead role in the ABN AMRO takeover for which the liquidity crunch of the bank was inevitable in the face of increased credit by RBS and prevailing market conditions. The role of supervision in the financial industry was passed on from the hands of Bank of England to Financial Services Authority under the regulatory system in UK. The Bank of England, however, was passive in responding to the role of FSA and the near fall of The Royal Bank of Scotland leading to its bail out by the government and the tax payers. Best corporate governance practices: ways for RBS to avoid this failure The Royal Bank of Scotland could have avoided its collapse in a market which showed symbols of underlying crisis with the help of adoption of best practices of corporate governance. The responsibility for implementation of policies on corporate governance and its subsequent monitoring is bestowed on the Board of Directors and the managing and executive committees. Since the strategies on aggressive acquisition were adopted to achieve the desired growth rates for The Royal Bank of Scotland, the board members should have stressed on judging the feasibility of the investment proposals on take over of ABN AMRO. This should have included the risk aspects of the investment, fluctuating conditions in the market, the level of reduction of capital adequacy ratio as a result of the investments taking into consideration that the shareholders’ wealth is sustained and at the same time increased subsequently (Balling, Hennessy and O'Brien, 1997, p.222). When these aspects of due diligence were overlooked on one hand, the managing as well as the executive committee also showed an easy going attitude on monitoring the performance to restrict the losses. The Royal Bank of Scotland board group should have consulted with the stakeholders of the bank before investing in securities and offering loans in the subprime market which reflected greediness to achieve higher short term returns at the cost of taking high uncalculated risks. As a part of better corporate governance practice, the governing body of The Royal Bank of Scotland needed to have a better and wider oversight on the market conditions and subsequent assessment of individual profile of the bank for its sustainable existence (Davies, 2012, p.163). Apart from the capability and quality of leadership the control systems of risk and compliance, management information systems and other support structures needed to be compact and efficient to avoid the collapse. The Chairman of the group who chairs the Board Group and also the Board Nominations Committee should have taken initiative in succession planning of the Group Chief Executive and other members sensing an emerging crisis. The Group Chief Executive on the other hand should have discussed his vision and strategies for growth which also includes taking into account the risks involved. On the other hand, cutting down the jobs after takeover and announcements of pension plans by Mr. Goodwin to an amount of 700000 GBP per year faced the ire of the investors and was thrown away by 90% of the shareholders in the annual general meeting. This did not provide any relief to either employers or the shareholders. This is because of the fact that in addition to loss in their share values, the shareholders also would have lost part of their savings in retained earnings of the bank. Also the employers had to pay a tax of 15000 GBP per week which multiplies to 60000 GBP per month. So, the pension offered to the employees was not sufficient to earn their livelihoods. The replacement to Mr. Goodwin was Stephen Hester whose remuneration package was also opposed by the shareholders. Stephen Hester was given a remuneration package of 12 million GBP along with a bonus for 2009 – 2012. The abnormally high remuneration to the new Group Chief Executive when The Royal bank of Scotland was facing a collapse did not justify the salary at par with the responsibilities fulfilled by the senior officials. Thus Stephen Hester waived off his bonus for 2009 which was a good example set from the part of the senior management. The new chairman Sir Philip Hampton assured of open discussions with the stakeholders for fixing remuneration packages in future. The regulator of financial services industry needs to employ experienced people who have knowledge about the industry and its market and would be able to align themselves with the performance of the industry. The regulator should keep itself free from political interference and must be able to keep away external interventions of the industry thereby enabling them to cope up with the pressure of the market. The government’s role also becomes crucial as they the finance ministry should make wise decision in judging the recession cycle in the market and show prudence in removing powers of supervision from one body and awarding supervisory powers to another body as happened in the cases of Bank of England and Financial Services Authority. Since the Financial Services authority (FSA) has not been able to cope up with the powers of supervision of financial services under pressure, the FSA is set to be split into two agencies in 2013. The newly formed Financial Conduct Authority (FCA) is again going to operate as government agency and the other part namely Prudential Regulatory Authority (PRA) would be put back again as a part of the Bank of England. Thus the supervisory powers removed from the Bank of England would be returned partly. Thus retaining a part of the supervisory control, the government would create an environment where ideas and suggestion could be exchange for effective regulation between the government agencies. Also the concentration of focus for Financial Conduct Authority and Prudential Regulatory Authority would be greatly increased in their respective areas of supervision on financial industry thereby reducing the scope of a future collapse like The Royal bank of Scotland. The Financial Conduct Authority would be mainly responsible to maintain the integrity of the financial markets in UK by regulating both the retail and wholesale financial services offered by the companies in UK’s financial market. The Prudential Regulatory Authority would contribute to ensure stability of the financial markets in the areas of both banking and insurance. The objectives of the Prudential Regulatory Authority as would include mitigation of adverse effects and risk faced by the financial services organizations and promotion of safe and sound operation of the financial services industry for a sustainable growth in future. Thus effective corporate governance and regulation is helpful in safekeeping the health of financial services industry and protecting the interest of the investors (Mallin, 2007, p.2). References Balling, M., Hennessy, E. and O'Brien, R. 1997. Corporate Governance, Financial Markets and Global Convergence. Springer; Great Britain. Davies, A. 2012. Best Practice in Corporate Governance (Ebk - Epub) Building Reputation and Sustainable Success. Gower Publishing, Ltd.; Great Britain. FSA. 2013. Management, governance and culture. [Pdf]. Available at: http://www.fsa.gov.uk/static/FsaWeb/Shared/Documents/pubs/other/rbs-part2management.pdf. [Accessed on 1 April, 2013]. Hawley, J. P., Kamath, S. J. and Williams, A. T. 2011. Corporate Governance Failures: The Role of Institutional Investors in the Global Financial Crisis. University of Pennsylvania Press; USA. Mallin, C. 2007. Corporative Governance. Oxford University Press; Great Britain. Royal Bank of Scotland. 2013. The Royal Bank of Scotland plc. [Online]. Available at: http://www.rbs.com/customers/complaints-data/the-royal-bank-of-scotland.html. [Accessed on 1 April, 2013]. Sun, W., Stewart, J. and Pollard, D. 2011. Corporate Governance and the Global Financial Crisis: International Perspectives. Cambridge University Press; UK. Bibliography Bagus, P. and Howden, D. 2011. Deep Freeze: Iceland's Economic Collapse. Ludwig von Mises Institute; USA. Calder, A. 2008. Corporate governance: a practical guide to the legal frameworks and international codes of practice. Kogan Page Publishers; Great Britain. Martin, D. L. and Martin, D. M. 2006. Corporate Governance: Practical Guidance on Accountability Requirements. Thorogood Publishing; Great Britain. Read More