Published at 12:01AM, May 6 2015
Royal Bank of Scotland has behaved reprehensibly. Its “global restructuring group” has driven countless small businesses into bankruptcy in an attempt to shore up its own dire finances. GRG staff were trained to strip troubled but viable companies of their assets, then were rewarded for doing so. Stories rarely get more David and Goliath, especially as this Goliath is four fifths-owned by the state.
This isn’t merely a tale of greedy bankers, though. It is a story about regulatory overreach and political interference creating perverse incentives. It’s another of those cautionary tales about good intentions and roads to hell.
At the end of 2010, 18 months after the recession ended, the Bank of England was worried about the level of “forbearance” among lenders. Too many unviable businesses were on life support thanks to low interest rates. Economically, this was a big problem. It tied up productive capital in unproductive areas, rather than releasing funds for the next generation of innovative businesses.
Six months later, the Bank had decided “extending and pretending” was turning both banks and businesses into zombies. Having studied Japan, policymakers feared that Britain could fall into a similar stagnation trap unless the gummed-up cogs of the capitalist machine were cleared. Lenders were told to own up to debts that, were it not for low rates, would be in default.
The reaction was immediate. Corporate write-offs trebled to £3 billion between the first and second quarters of 2011. Writedowns rose from £5.6 billion in 2009 to £6.4 billion in 2010 to £7.6 billion in 2011 and still totalled £6.8 billion in 2012. It is no coincidence that Lawrence Tomlinson, the man who blew the whistle on GRG, traces the origins of the problem to the same period.
In June 2013, the Bank completed an investigation into the big eight lenders’ resilience to another crisis. A capital buffer equivalent to another £27 billion was needed, half of which was attributed to RBS.
Much of the shortfall was due to “elevated levels of forbearance”, with RBS the main culprit. It had understated its regulatory “risk weighted assets” by £56 billion, far more than any other bank. It was implementing a plan, signed off by the Treasury, to fill £10 billion of its £13 billion black hole. Central to that was reducing RWAs, reducing the new capital required and giving the bank’s political masters a chance to sell its shares.
But the plan put small businesses in the line of fire. According to the Bank, a third of all forbearance was in commercial real estate and 40 per cent of that lending was to small businesses. Small business loans were also expensive on an RWA basis. They tied up three times as much capital as a mortgage. RBS needed to hack back small business lending.
Moreover, debts were transferred to GRG only once a covenant was breached, doubling its RWA status. Breaches were often technical, but they imposed higher capital costs on RBS regardless.
The bank’s reaction was brutal, but it was under huge pressure to clean up its books — to fix the bank and do economic good.
Since then, the rules have changed. At the start of last year, regulators acknowledged that RWA distortions encouraged banks to stoke property bubbles rather than seed the next Dyson or Apple. A “multiplier” was introduced specifically for small businesses. RWAs on such loans are now just a little more than twice as expensive as a mortgage.
Two years ago, Andy Haldane, the Bank’s chief economist, said the arrangements at the time were “probably not the risk weights a benevolent dictator, charged with supporting the economy and armed with a PhD in welfare economics, would choose”. He was right. RBS’s shame should not be the bank’s alone.
Philip Aldrick is Economics Editor of The Times