Banking practices of the Royal Bank of Scotland referred to City regulators…

DAMNING REPORTS

The latest accusations being levelled at the Royal Bank of Scotland are as incriminating as any in its recent chequered history.

Small and Medium Sized Enterprises (SMEs) have long complained that they cannot get the loans they need, despite protestations by the banks to the contrary. A newly released report from Sir Andrew Large, a former deputy governor of the Bank of England, on the bank’s small-business-lending, confirms that much of the criticism levied at the bank in recent times is justified and the taxpayer-rescued institution must explain why it has not been doing all it could to assist Britain’s economic recovery. In normal circumstances, such practices would be worrying enough for the newly installed chief executive of the bank, Ross McEwan.

But these are not normal circumstances; Mr McEwan is also faced with a more troubling contention. According to another published document from Lawrence Tomlinson – deemed a successful businessman and ‘entrepreneur in residence’ at the Department of Business – RBS may have sunk to even greater depths in its condescending and haughty treatment of Britain’s SMEs. Contemptuous, because not only has the bank been transferring perfectly legitimate and profitable companies into its high-risk Global Restructuring Group (GRG), but the West Register (the bank’s property division), has reportedly been acquiring their assets on the cheap after imposing deliberate and exorbitantly high fees on them. Many companies in this high-risk category, deemed perfectly viable, have been unable to pay these fees imposed and as such have found themselves having their assets taken over by the bank at heavily discounted prices.

Both these reports must be put into context. Prior to 2008, RBS had been reckless over a number of years in its dealings, over-extending loans to many small firms that did not justify such levels of confidence. As the bank now struggles to repair its balance sheet, bad debts are continually being written off and lending practices have been tightened.

The findings contained within these reports have left many feeling aghast, not least Mr Tomlinson himself. His inquiries and formal deliberations suggest something altogether more serious. Vince Cable, the Business Secretary, has acted quickly and sent the evidence to City regulators. For his part, Mr McEwan has called in the law firm Clifford Chance to conduct an internal review of the bank’s practices. Such deviant and acute methods would be inexcusable from any bank, but from one that is largely owned and controlled by the state makes matters even worse.

COMMENT & ANALYSIS

The claims made in Lawrence Tomlinson’s report into the way the Global Restructuring Group at the Royal Bank of Scotland has dealt with struggling enterprises are truly dire.

It rightly is a matter that needs to be examined by the regulators the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

Forcing struggling firms into insolvency when there may have been a chance of survival is bad enough. Ruthlessly seizing property and assets for its own gain is immoral and much worse.

Yet, should we be surprised? RBS had a hand in almost all the post-crisis scandals, including Libor fixing, interest rate swaps and the sale of payment protection insurance. The bank is also being sued by investors for failing fully to disclose the parlous state of its finances ahead of the £12bn rights issue to shareholders in 2008.

Tomlinson and the Department of Business also have some questions to answer. The in-situ ‘entrepreneur in residence’, for example, is a little mysterious. How was he chosen for this appointment, what is the scope of his role and how much did he tell civil servants and the Secretary of State, Vince Cable, about his own business affairs before he took on this rather curious role?

What also of the poor judgement by Tomlinson not to disclose that NatWest, RBS’s main operating offshoot, had granted him an overdraft and that in the last couple of years he was engaged in a major refinancing operation? Financial analysts will find it extraordinary that this was not considered a relevant factor either by Tomlinson or the Department for Business, and that it was not disclosed in the report. Making a strong case against the predatory behaviour of RBS is one thing, the dealings and judgments of Mr Tomlinson are clearly and significantly related.

The published accounts of Tomlinson’s business LNT Group are, even by the standards of many private empires, on the opaque side. They show a group that is indebted and making losses, with a host of intercompany relationships that are difficult to untangle.

The main product of Tomlinson’s dealings looks to be the design and building of new care homes, something the UK badly needs. But this is a notoriously difficult sector in which to operate – as was seen from the fate of Southern Cross – and management often has to choose between keeping costs under control and maintaining high standards of care.

Before giving Mr Tomlinson a government imprimatur one should trust that Vince Cable and his Department looked carefully at all his dealings before approving the appointment.

Bank of England Governor turns fire on bankers…

BANK REFORM

… The bank governor is determined to prevent a Japan-style economic crisis in the UK.

The new Bank of England governor, Mark Carney, has launched a stinging attack on ‘socially useless’ bankers and has called for a ‘change of culture’ in the industry.

The former Golden-Sachs executive, who succeeded Lord King as governor of the Bank of England last month, hit out at self-obsessed bankers who are, he says, detached from reality.

The Canadian has also defended the decision to peg interest rates to unemployment – a move that looks set to see rates remaining at 0.5 per cent for at least another three years.

Mr Carney expressed ‘tremendous sympathy’ for savers who have ‘done the right thing’ but insisted drastic action was needed to ‘secure the recovery’ and prevent a Japanese-style economic crisis in Britain.

• Related: Libor handed over to the Americans…

This followed his announcement last week that the Monetary Policy Committee (MPC) will not raise rates from o.5 per cent until unemployment falls to 7 per cent or lower. Unemployment is currently running at 7.8 per cent and is not expected to reach the new threshold until the end of 2016.

Turning his fire on the banking industry, Mr Carney said:

… There has to be a change in the culture of these institutions.

He said that ‘finance can absolutely play a socially useful and economically useful function’, but added it must focus on ‘the real economy’. The Bank governor said banking is ‘socially useless’ when it becomes ‘disconnected’ from the economy and society and ‘only talks to itself’.

Mr Carney, who is also chairman of global banking watchdog the Financial Stability Board, added:

… A lot of what we are doing internationally is to strip out this type of behaviour.

The Canadian said the decision to peg interest rates to unemployment – a tactic known as ‘forward guidance’ by central banks – would boost the economy by ‘more than half a percentage point of GDP’ over the next three years.

Amid a fierce backlash from savers he insisted low rates were required to ensure the economy finally recovers from the biggest boom and bust in history.

‘The best way to get interest rates back to normal levels is to have a strong economy,’ he said. ‘We’re in the very early stages of a recovery from the weakest period on record.’

He said Japan made two mistakes after its recession in the early 1990s – failing to fix the banking system and pulling back from measures to stimulate the economy too quickly.

… As a consequence, almost a quarter of a century later, interest rates are still at rock bottom levels in Japan… We don’t want to make those mistakes here in the UK.

COMMENT

Mark Carney’s predecessor, Lord King, started a hard line on the need for banks to reform their cultural practices, by being useful contributors to society and by insisting that they strengthen their balance sheets so they no longer expose the taxpayer to excessive risk.

In some recesses of the banking sector, the appetite for running their operations on wafer-thin levels of capital remained undiminished by the worst financial crisis the world has ever seen.

Some in the City of London had hoped that Mr Carney would administer a snub to King by letting off bankers more lightly.

Given the governor’s role as chairman of the Financial Stability Board, and his personal championing of higher leverage ratios whilst at the Bank of Canada, that always seemed improbable – and so, thankfully, it has proved.

The Bank of England governor, Mark Carney, has defended the decision to peg interest rates to unemployment – a move that looks set to see rates remaining at 0.5 per cent for at least another three years.

In his first public pronouncement on the subject Mr Carney made it crystal clear that he, no less than King, wants the banks to start serving the real economy instead of just themselves. He made a point of praising King’s work in improving bank balance sheets and of name-checking Andrew Bailey, who heads the Prudential Regulation Authority, the body that controversially forced Barclays and Nationwide to raise more capital.

The governor’s backing for the moves to make these two financial institutions formulate credible plans to increase their base capitals can longer be in question.

The great myth put about by the banking lobby is that higher levels of capital automatically constrain their ability to lend to households and firms and so hold back growth at a time when the economy is weak.

Whilst this seems to be a notion that has been swallowed wholesale by some in the Treasury and the Department of Business, it is not true.

Banks can improve their capital position by retaining earnings, scaling down bonuses and cutting back on other types of less socially useful business.

The new rules will, over the long-term, increase lending to the real economy, not harm it, and will give us safer and more secure banks, which can only be good for stability and growth.

Undoubtedly, there are plenty of questions over Mr Carney’s big idea of forward guidance, from the impact it will have on savers and on pensions, the risks to inflation and the distinct absence of a clear message due to the get-out clauses.

But on bank reform and conditions for capital holdings, Mr Carney should be applauded.

Lloyd’s Banking Group: A return to profit but there are still too many unresolved issues…

UK BANKING MARKET

Lloyds reported last Wednesday a return to profit in the first half of 2013. There has been an air of quiet satisfaction both in the City and in Whitehall following the banking calamity of 2008.

The Government is now preparing for a sale of its 39 per cent stake in the lender. For the first time since 2008, the bank’s chief executive, Antonio Horta Osorio, is considering paying shareholders a dividend. Expectations of a dividend payment sent the share price up to 74p following the disclosure of the bank’s half-yearly profits.

But the market shouldn’t be so optimistic. A swathe of unresolved issues surrounds Lloyds Banking Group, not to mention the structure and impending reforms of the wider UK banking system.

Ministers in Whitehall have spoken about getting the best possible value for taxpayers from the sale of its stake in Lloyds, but suspicions remain that they will offload the bank at a price that effectively short-changes the public.

Selling above 61p will mean the national debt falling, below that price it rises. The attractiveness of a quick sale at the current market price for a Chancellor who has been embarrassed by his inability to bring down the national debt on his promised timetable should be obvious.

The price the previous government paid for its £20bn in shares was 74p a share. That amounts to being the true ‘break-even’ price, and sales below that should not be countenanced. Even at that price it is meaningless to suggest a ‘profit’ because one should only think what returns the state could have received for that £20bn investment elsewhere. The accounting is important to understand.

Then there is the matter of Lloyds’ lending to the real economy. The bank says it increased its net supply of credit to small firms by 5 per cent in the first half of the year. Financial analysts will hope that is accurate because the most recent figures from the Bank of England (which only go to March) tell a strikingly different story. They suggest Lloyds has contracted its lending to households and firms by some £6.6bn since last August, while availing itself of £3bn of cheap funding from the Bank of England.

And what about the size issue? Following the disastrous merger with HBOS in 2009, Lloyds is enormous. Lloyd’s Bank now accounts for twice as much of the loan stock to home and businesses as the next biggest bank, the Royal Bank of Scotland. The size of Lloyd’s balance sheet will fall next year when 630 branches are floated off following an EU directive, but the bank will still be excessively large. UK firms and borrowers need a broad range of credit providers, not a market dominated by a few such as RBS, Lloyds and Barclays.

Lloyds has increased its provision for the mis-selling of payment protection insurance. This is a reminder of how just egregious the bank (and other high street banks) behaved towards its customers in the boom years. Leaving this cartel untouched would risk this kind of abuse happening again.

A return to profit by Lloyd’s is good news. But we need a bank – and a wider banking system – that is able to sustainably serve the needs of the real economy.