Bank Regulation in the UK: The Proposed Break-Up of RBS after the Financial Crisis - Case Study Example

Bank Regulation in the UK: The proposed break up of RBS after the financial crisis The Royal Bank of Scotland was proposed to be broken up, following its high risk investment functions, which have often put the interest of the customers at risk. The investment function of the RBS bank in the ABN AMRO, where the bank used a substantial amount of resources to purchase the control of this financial institution was one of such risky investment. This purchase eventually resulted to huge losses incurred by the RBS bank in its subsequent operations, during the 2008 financial crisis (Thompson & Jenkins, 2013:n.p.). Consequently, the UK tax payers, through the Britain government was forced to bail out the RBS bank, so that it could help the bank avoid an eminent collapse, which would have in turn affected the UK economy adversely. As a result, the British government purchased a 58% stake in the RBS shares, while holding that the ownership held by the government in the bank was not permanent. It was meant to be a temporary solution to assist the bank undergo the financial crisis period without collapsing, and then revert to the normal private ownership structure, after the recovery of the bank (Lowery & Salmon, 2013:n.p.). In this respect, the government purchase of the RBS shares served as an emergency rescue plan to help the bank from sinking, prompting the concern regarding the inability of the RBS and other major UK banks to stand up for themselves during financial crises (Edmonds, 2013:7). Consequently, a need to restructure the UK banking and financial sector’s operations into a more secure and less volatile sector arose. The resulted in a series of proposals being formulated, to establish how the UK financial sector could be strengthened and stabilized, to avoid a repeat of the same problem during future financial crises. Consequently, the Vicker’s commission was established to look into the ways of resolving the problem. The commission generated a report, which presented a series of proposals to reduce the risk exposed to the bank’s customers and the taxpayers by the investment functions of the bank (Edmonds, 2013:2). The Vicker’s commission proposed several solutions to the Royal Bank of Scotland’s problem. The proposed breaking up of Royal Bank of Scotland after the financial crisis, was meant to ensure that the bank would not force the taxpayers to bail it out, on the event of a financial crisis, as had happened previously during the 2008 financial crisis that could have caused most of the big banks in the UK to collapse (Thompson & Jenkins, 2013:n.p.). Instead, the suggestions sought to ensure that since the RBS bank would be broken up, then, it was the bond holders, as opposed to the retail customers who would be affected by the losses arising from the investment risks (Edmonds, 2013:3). Thus, the proposal for breaking up the RBS bank would ensure that the universal banking functions of the bank comes to an end, while a new structure of retail banking, on the one hand and wholesale and investment banking, on the other hand emerge as different sections of the bank (Edmonds, 2013:17). Thus, the proposal sought to create another private company that would specifically handle the investment portfolios of the bank, while the banks remains with the sole functions of executing the deposit taking and the lending functions to its customers (Edmonds, 2013:13). This is because; such risks and losses would be traced to the wholesale and investment banking section, as opposed to the retail banking section. In this respect, the Vickers’s reported proposed the breaking up of the Royal Bank of Scotland, through separating the deposit and lending functions of the bank from those of the investment functions. As a result of the breaking up of the RBS bank, the deposit and the lending functions of the bank would operate under the category of the ‘good banks’, while the investment function would operate under the category of the ‘bad banks’ (Treanor, 2013:n.p.). However, the Rothschild report, found that the breakup of RBS bank into two completely different institutions was not a sustainable option for the bank. Owing to the nature of the high potential risks associated with the investment functions, the Rothschild reports proposed a partial breakup of the RBS bank into retail and investment sections, but retain a universal banking structure (UK HM-Treasury, 2013:12). This proposal sought to ensure that the customers of the bank would not be adversely affected by the occurrence of a major financial crisis such as the one that occurred in 2008, considering that the banking functions for the customers would be operating under the ‘good banks’ category, involving only the lending and the deposit taking functions (Jenkins, 2013:n.p.). In this respect, the interests of the customers will be protected against a possible loss of their assets that have been committed to the bank. The Rothschild report proposals sought to minimize the exposure of the retail service banking and the tax payers from the risks of global wholesale and investment banking risks. Further, the new proposals of the Rothschild report supported the suggestions by Vicker’s commission, which includes the proposal that the bank should maintain an equity ratio of at least 10% in the retail banking section of the bank, as opposed to the international banking sector equity ratio requirement of 7% (Edmonds, 2013:7). The report proposed that the required international equity ratio of 7% could be maintained for the wholesale and investment banking section, while the high requirement for the retail section was meant to ensure that the taxpayers were held off the hook, so they are not required to bail out the banks again on the event of a financial crisis. In addition, the Rothschild report also proposed the establishment of the ring-fence system for the bank, where the banks would be required to maintain certain retail to capital asset ratio throughout the financial year, without shifting the retail assets and resources to the wholesale and investment section of the bank, for the banks that operate universal banking system (UK HM-Treasury, 2013:27). This would also provide a system of internal breaking up of the bank, where the assets and resources for the retail section are not mixed up with those of the investment section (Treanor, 2013:n.p). This would ensure that the customers are shielded from the risks associated with the investment functions of the banks. This internal breaking up mechanism was meant to ensure that the bank does not deplete its capital through investment functions, as had happened when the RBS bank invested in the ABN AMRO, depleting its available resources and forcing the government to invest its resources in the bank, so that the bank could be assisted from collapsing (Thompson & Jenkins, 2013:n.p.). This alternative method of internal banking break up would be an essential method of maintaining the universal banking structure, while at the same time limiting the bank’s freedom of capital utilization, which poses the risk of capital depletion through investment. Further, the breaking up of the RBS bank was introduced as a measure to ensure that the protection enjoyed by the bank, as well as the other major UK banks from the government would be waived, and in its place a free market competition introduced (Jenkins, 2013:n.p.). This would enhance the health of the economy, as well as that of the bank, since it would make the banks take responsibility for its investment actions, while at the same time ensuring that the interests of the retail customers are well protected (UK HM-Treasury, 2013:35). Why didnt it go through? However, while the proposal to break up the RBS banks had been presented as one of the most effective measure of ensuring the stability of the bank, and thus ensuring that it did not expose both the retail customers and the tax payers to risks of losses during the financial crises, it did not go through. This is because, the Rothschild report measures observed that splitting the RBS bank into the retail banking section on the one hand, and the wholesale and investment section on the other hand, would create a weak bank (UK HM-Treasury, 2013:47). The Vicker’s reported presented that a universal bank is the suitable banking structure, since the investment function would support the retail function of the universal bank, at a time when the investment is doing good, but the retail function comprising of deposit taking and lending is weak (Edmonds, 2013:17). Consequently, the Rothschild report proposed for a partial RBS breaking up, which would take the form of ring-fencing, where the capital structure of the RBS bank is separated between the retail banking assets and the investment banking assets within the bank, while it is still operating as a universal bank (Treanor, 2013:n.p). This way, the bank would still continue to enjoy the benefits of a universal bank, while protecting the interests of the customers and the tax payers from investment risks and losses, by shifting the same to the bondholders, through the ring-fencing banking system (Edmonds, 2013:17). What does it signify about the proposal for breaking up banks in the UK? The fact that the RBS breaking up proposal did not go through simply signify that breaking up banks in the UK is not a viable option, considering that there exists some form of dependency between the retail banking and the investment banking functions of the UK banks (UK HM-Treasury, 2013:33). Consequently, the complete breaking up of the UK banking sector would pose the challenge of banking sector sustainability. This is because, under conditions where the deposit taking and the lending functions of the UK banks are low, the banks would not have an alternative of boosting this function (). Therefore, the failure of the proposal for breaking up RBS bank to go through, signify that the UK banks shares interdependence between the investment and the retail functions, and thus the universal banking structure is the most viable system in the UK. References Edmonds, T. (December 30, 2013). The Independent Commission on Banking: The Vickers Report. House of Commons’ Library. 1-26. Jenkins, P. (June 20, 2013) Rothschild set to advise on split of RBS’, The Financial Times. Retrieved April 8, 2014, from The Financial Times. Retrieved April 8, 2014, from http://www.ft.com/intl/cms/s/0/4ed9dd9e-e27b-11e2-a7fa-00144feabdc0.html#axzz2yIA6rN15 Lowery, A. & Salmon, J. (19 October 2013) ‘RBS set for break-up into good and bad banks as Osborne says decision is imminent’, This is Money. Retrieved April 8, 2014, from http://www.thisismoney.co.uk/money/news/article-2467170/RBS-set-break-good-bad-banks.html Thompson, J. & Jenkins, P. (June 20, 2013). ‘Osborne puts bad bank proposal back on drawing board’, The Financial Times. Retrieved April 8, 2014, from http://www.ft.com/intl/cms/s/0/9970c3f0-d9c9-11e2-98fa-00144feab7de.html Treanor, J. (3 July 2013) ‘RBS: Rothschild to consider good bank/bad bank split’, The Guardian. Retrieved April 8, 2014, from http://www.theguardian.com/business/2013/jul/03/rbs-rothschild-royal-bank-scotland UK HM-Treasury (November 2013) ‘Rothschild Report: ‘RBS and the case for a bad bank, the Government’s Review’, Crown copyright. 1-58. Read More