LLOYDS BANKING GROUP 2009 RESULTS

With LBG's share price at only 1.4 times the price of a Royal Mail first class stamp, it seems appropriate to dress my comment on its results with first class stamps issued late last year celebrating London Olympics 2012. 2012 is also the year when our banks should be back on dry land having dived in to bale water out of their balance sheets. FIRST THE BIG PICTURE
Customers' deposits are currently rising but this is not yet shown in year on year changes. What we can see roughly in LBG's accounts is £45bn fall (7%) in customer loans. Why? The main reason is that funding remained expensive through 2009 (causing income from savings and mortagges to fall by 27%) and banks are lending and depositing dramatically less with each other. Interbank lending margins ove LIBOR have since fallen sharply to less than 50bp, even to only 20bp, in part helped by £200bn of Bank of England QE (Quantitative Easing: buying gilts from non-banks which improves banks' liquidity in deposits compared to what it would have been, at first, and then causes a shift by investors to buying high-rated corporate bonds).
In 2009, banks either stopped competing for bank deposits or simply resigned themselves to the steep fall in bank deposits, much of which is cross-border retreat by banks into their domestic backyards. The banks don't want customer loans one third backed by bank deposits, but more closely aligned to only customer deposits, that or they have no choice?
LBG Loans to banks fell £30bn and its deposits at central bank/s increased by about the same. Deposits at LBG from banks fell by over £70bn (7% of total balance sheet). The question is 'could the bank have structured matters differently' to do more to maintain customer lending, that is the £11bn net increase in lending that the government requested (and about £15bn loans growth by RBS that also could not be fulfilled)? Total household net lending by all UK banks only grew £3bn in 2009 despite £143bn in gross (not net) mortgage lending. lending to business in 2009 has been negative through almost all of 2009. In the chart it looks as if lending to other financial corporations has remained very positive in most of 2009, but this is domestic interbank data only and is overtaken by cross border retreat of foreign lenders to UK financial corporations.
In LBG's case total liabilities (mainly deposits) fell by £108bn - so, perhaps LBG did do something to only let customer borrowing fall £50bn, and when customer deposits year on year failed to grow, and when customer loans exceed customer deposits by £220bn (nearly a quarter of total balance sheet), and when it is also said that ousehold customers are reducing their debt levels and businesses are investing less.
Total UK private savings rose £150bn in the year, which should have improved LBG's liabilities (deposits) by about £25-30bn. Instead, depositing customers have gone elsewhere! I hope we see a turnaround in customer lending in 2010 helped by £200bn QE plus £200bn rise in private saving? But, with banks facing higher reserve reuirements, needing to close the funding gap (high in LBG's case), and refinancing much of that funding soon, imposing tighter credit obstacles to new loans, possible continuing retreat by banks in lending and in depositing with each other, it looks as if recovery will have to proceed with negative help by banks as they buckle under pressure to pull in the opposite direction - what in recession is called pro-cyclical behaviour. Yet again, it is government that alone must pull the economy up by its bootstraps.
When our big banks such as LBG say recovery will be weak or slow they should know, because the speed of recovery is very much down to them, to how fast they continue to retreat their balance sheets in the opposite direction to economic recovery?
Note: LBG is the third big British bank to report its 2009 results, following RBS, which reported a smaller net loss on Thursday, and Barclays, which published strong profit figures on Feb.16. HSBC releases its results next Monday.

Comparative note on Barclays and RBS
Barclays shrank it balance sheet too, like RBS, by shrinking/netting its derivatives by £500bn. Barclays has a 130% assets/deposits ratio (RBS: 135%). It grew its lquidity reserve by over £80bn to £127bn. It made a profit of nearly £12bn (after selling BGI for over £6.4bn less £13.4bn impairments and writedowns) on £30bn of income plus £1bn gain from debt restructuring. Customer loans fell by £40bn (over 8%) when net deposits from banks fell by £46bn and customer deposits fell by £13bn. Like LBG, one defence may be that customer loans could have had to fall by another £20bn given the loss of deposits.
RBS also saw customer loans fall by £36bn or 6% (in UK 8% despite £60bn in new loans), when bank deposits fell £109bn and customer deposits by £36bn in 2009.

To those who argue, however sensibly from a liquidity aspect, for a swift return to traditional banking where loans are fully backed by deposits, and therefore outstanding loans rise and fall with deposits - it is a nice idea, but a painful one in a recession or recovery period, and not exactly what government had in mind when it puposefully asked the banks to maintain lending to small firms and customers generally! The 'trad bank' idea is based on 'you can't have loans without deposits', but the opposite is also true. But banks are not competing hard enough for customers deposits - but that's not the real issue!
If the big banks shrank customer loans to match customer deposits, that means by £220bn in LBG, £120bn in RBS, and £100bn in Barclays. If they and HSBC, Santander and other banks reduced UK domestic customer lending to customer deposits, the UK economy could not survive - more than £500bn retrenchment. Even if that is possible over the next 5 years, what would government have to do to ensure GDP recovery, probably double its borrow and spend, which is politically impossible! It must urgently look at what it can do to engage the banks in economic recovery - but how?
banks are anxious to raise their net interest margins to generate more internal capital even if it means shrinking their loan-books in the teeth of economic malaise. Government guarantees of deposits are one thing, the interest paid to term depositors is another. Regulators want banks to do more to make deposits stickier.but can't bring themselves to say how and why banks should shoulder more of the burden of economic recovery - that's a decision above the regulators' pay-grade.

LBG RESULTS DETAILS
Lloyds Banking Group TODAY reports £6.3bn (underlying) pre-tax loss for 2009 i.e. small change from £6.7bn deficit in 2008. But, of course, in getting there much has changed. With net income at £24bn, two thirds that of RBS, though risk weighted assets (total loans risk exposure) fell only 1% to £493.3bn, which is very similar in size to RBS after its gain from the APS. LBG decided it could do without APS by restructuring its own debt to gain £10.5bn, £4bn redemption of Gov. prefs. and a £13.5bn capital raising. It sees better economic conditions and has several assets it can and must sell following agreement with the European Commission to do so - even if the deal was struck based on mistaken market share statistics.
LBG significantly increased its liquid assets from £104.5bn to £150.8bn and quality by increasing cash at central banks and buying Government debt securities in place of short term interbank borrowings. Like RBS, there has been a roughly 10% rate of growth in customer deposits, which with flat lending, narrows the funding gap. Its own funding gap debt is now maturing at only about £200bn, less maybe £50bn annual balance sheet shrinking of own portfolio investments and non-core banking assets this year for 3 years, which evidences an improvement in its funding risk compared to what Lloyds TSB or HBOS were staring down the barrels of a gun at in Autumn 2008 before they merged. I have to say this liabilities restructuring is a sound achievement - quality dressage. LBG's £24bn net income was roughly half from insurance and half from banking. It has a statutory profit before tax in 2009 of £1bn, compared to £0.8bn in 2008, from recognising a gain of £11.2bn in respect of goodwill because the purchase price of HBOS (at Jan.'09), was below fair value of HBOS net assets due to the stressed circumstances at the time i.e. HBOS's liquidity risk embarassments and short-sellers had cut the bank's value by over half - an important lesson!
Heavy lifting (snatch and hold) of risk out of HBOS's corporate loan book, not efficiency gains from the merger, remains a set of tasks dominating balance sheet clean-up. The bank now has nearly £90bn in liquidity risk reserve. This is far in excess of expected new regulatory requirement that it must reflect the risk of not participating in APS and to give it negotiating power in the cost of funding and restructuring its funding gap - very prudent. It is shrinking its balance sheet more slowly than RBS, reflecting its lower credit and other derivatives exposure. Asset impairments are 61% up at £24bn, but, like RBS, the bank says bad loan losses have passed their peak (in H1 2009). The impairments are mainly corporate property loans and wholesale (actually Wealth and International) generally, but this dates to the first half of 2009 when bank shares hit bottom and the HBOS book with £80bn sub-quality was roughly 20%written down based on a high-level estimates, and then wrestled through in detail - so that has it seems now allowed some improvement to emerge. The funding gap represented by loans/deposits ratio has a target of approx. 140% over the medium term. Nothing is said yet about treatment of its insurance reserves within bank group capital. This adjustment must be imminent.
During 2009 the ratio, excl. repos, improved to 169%. Apart from unravelling or netting off derivatives, the gap is closing with flat household and small, SME and Corporate business lending, about which the banks only states supportive sentiments but provides no data to show it is putting money behind its fine words. New mortgage lending has been slightly below its mortgage book UK market share. This fits with subjective I hear that sound loan requests are being turned down and customers persuaded to go elsewhere! The bank has a very healthy 2% net interest margin.
I don't see why it cannot boost its small firm lending to at least improve its image at a difficult time for the economy. Small firm lending is trivial in the balance sheet. This would help government's recovery targets and be a positive response to what government has asked RBS and LBG especially to do more of; helping small firms. I suspect that the problems of unravelling and reconditioning HBOS's SME loans has blind-sided the bank to the virtues of helping small firms. This should be its number one social responsibility target.It is quite obvious that the bank's story is far too much aimed at bank analysts and not at all at the general public. This is further evidence of an astonishing PR intertia that looks like indifference to political reality when customers so despise their banks and the mob is baying for blood over bonuses and small shareholders still extremely angry and not averse to continuing class actions about information not disclosed to shareholders at times of capital raisings in 2008 especially.
The implied expected future impairments, in my view, reasonable to forecast for 2010 at about £15bn and £10bn in 2011, but substantial recoveries should be appearing by then. Not helping small firms and not being able to quantify what the bank is doing to help the economy pull out of recession is like not recognising that the paralympics are also important sport. banks have to learn how to rediscover how to talk to the public and customers and genuinely regain trust and belief. Helping small firms through to recovery and being able to say something about household and small business long loans and overdrafts are small things in the balance sheet but big in public and economic recovery perceptions. LBG increased its forecast for the cost benefits expected from the acquisition of HBOS. The group said it now expected £2bn of annualised cost savings by the end of 2011, not £1.5bn i.e. an extra £3.5bn squeeze gain over 3 years.
Lloyds’ underlying income net of insurance claims rose 12% to £24bn but this revenue performance was flattered by lower writedowns on fixed income and equity assets and gains from debt swaps and HBOS goodwill. Traditional banking's net interest income fell 15% to £12.7bn despite a healthy 2% margin, reflecting higher wholesale funding gap financing costs.
Lloyds has blamed rise in impairment charges on problematic commercial property loans extended by HBOS, but impairment charges fell 21% in H2 '09. I take this to mean that the bank could not yet feel confident about property values recovery sufficiently to make a bigger improvement to the HBOS impairments, which I think is due, and should therefore appear in 2010.
LBG's stress tests (economic forecasting) expects a “weak upturn” for the UK economy in 2010. This runs against historical precedent, especially if the USA is recovering fast - but of course with the long harsh winter and political anxieties, consumer spending and confidence cannot be relied upon yet. Lloyds suggests the risk of double-dip this year has decreased in recent months. That is true of 4Q '09, but Q1 '10 I expect to be a strong negative blip. LBG say company failures rise and fall during the year but would not peak as high as in '08-'09. This is duplicitous since company failures are small firms and some SMEs and avoiding or reducing their failure rates is eminently within the power of the banks, and relatively trivially so in balance sheet terms! Therefore, if LBG and other banks think small firms are in trouble it is up to them in the first instance to do something to ameliorate that!
The long run reported by Lloyds (necessary to its stress-testing) assumes for purposes of comparison that the bank owned HBOS through 2008 as well as 2009 (excl. the £11.2bn goodwill gain Lloyds made on HBOS and £2.5bn it was charged when choosing not to enter the Bank of England's APS). What amazes me in LBG's reports today (RBS only slightly less so), given Daniels and Tookey are first class-brains, how totally inept it is of them not to address themselves to public policy issues, when the bank is over 40% government owned and has a huge social economic reponibility of owning a quarter of UK banking market. At this critical time, when reviewing what has been 1-2 crisis-ridden years, when it is not staff that needs cuddly assurances but customers, the general public, and indeed the bank's political masters without whom the takeover of HBOS would not have happened, why can these titans of finance not say something grander about their socially-useful relevance - the very question asked of them by The House of Commons Treasury select Committee?
Announcing annual results is the best time of the whole year to grandstand and address customers and shareholders and LBG's 41% owning taxpayers - a slam-dunk moment to say some positive things about banks. But the supporting data for such positive self-promotion to the general public about the economy is not there. The banks remain focused on cleaning up their balance sheets to the extent of ignoring how best to help the wider economy - and thereby in my view also themselves - desperately - to restore public confidence in banks by showing how banks can and do help economic recovery!
LBG was asked today whether it had met lending growth targets agreed with the government. It had promised to lend an extra £14bn in 2009 – £11bn to businesses and £3bn to mortgage customers. Eric Daniels refused to give a net figure. “We didn’t publish net lending this time around,” he said. “What we are focused on is serving our customers through this troubled time” - but we want to know if that really means something - if so, what? The published statements do say LBG its share of gross (not net) UK mortgage lending was 24% (5% below its market share of outstanding mortgage loans),and "Unsecured lending balances were slightly lower, reflecting lower customer demand and tightened credit criteria." This does not square with the accompanying statement, "During the year, we have continued to build our current account and savings customer franchises in what remains a competitive market for customer deposits", which sounds like mere rhetoric on 'franchises' and otherise that deposits growth is more vital than loans i.e. the focus is on shrinking customer loans closer to customer deposits, which in LBG means narrowing a £170bn chasm. Asked whether net lending was positive, Mr Daniels said: “Absolutely, yes.” As the FT observed, "However, it later emerged that he was excluding from his numbers £170bn of “non-core” customer lending, which Lloyds does not want to renew (much of it probably in property development) - closing the customer loans/deposits gap dramatically, totally! LBG customer lending fell nearly £50bn to £660bn in 2009.
Tim Tookey, LBG finance director, talked down concern over the bank’s re­financing needs - the issues that in 2008 sank HBOS - when £157bn of government and central bank funding falls due over the next two years, of top of private sourced funding gap refinancing - maybe £400bn in total (my guess). "The bulk of the funding would not need to be refinanced", he said.
FT Lex offers the cryptic view that UK banks are "a pure bet on economic recovery", which may be true for bank shares, but it is worse than that; the banks are deleveraging too much and this must have a chain and ball drag effect on economic recovery. Serving the need to free up reserves, refinance funding gaps when interbank deposits and loans are still in retreat like a tidal undertow, and generally shrinking banks' balance sheets are contradictory demands. The government's pleas to banks in UK (and in USA)to maintain pre-crisis customer lending levels, followe by pleas (and verbal more than written agreements)to at least go some way to grow customer lending is looking like King Canute's bidding.
The banks are not getting it together to significantly assist economic recovery, and this must again raise questions about their wider responsibility and usefulness.

UK BANKS CAPITAL PRESSURES

The brouha about sovereignty risk including the 87 economists-signed letters to the newspapers arguing the toss about how soon spending cuts are required to secure market confidence in government finances, otherwise banks might shun government bond auctions, is in my view eclipsed by regulatory pressures on the banks forcing them to buy government bonds. Readers want me to explain how that is and the quality of RBS results? I'll try to combine the two topics.

RBS RESULTS
With the share price still at first class postage stamp levels and gross gains at the same return as the rise in postage stamp prices, what are our banks' prospects - can they sustain lending to aid economic recovery while deleveraging and can they buy government bonds issuances? RBS shares were 10p in Jan '09 and are now heading for 40p, but in book value terms should be 80p at least.
RBS report for 2009:2009 net attributable loss fell to £3.6bn from £24.3bn in 2008 -in part this is asset price recoveries and debt recoveries. 2009 operating loss narrowed to £6.2bn from £6.9bn in 2008, with loss before tax falling to £1.9bn from £8.3bn in 2008. The cost in fees other aspects of the APS asset repo swap with government played a large part in this, so much of this loss is nominally taxpayer gain to be realised sometime in the near future. RBS swapped £282bn assets and got £128bn RWA saving (but no clear sign of the effect of the Bank of England cheque except a £60bn narrowing of the bank's funding gap? Let's presume another £100bn or so replaced other funders, hence my guess at least a BoE cheque for £160bn left on deposit at BoE, leaving BoE with plenty of net headroom for funding its £198bn QE?)
RBS's pre-impairment profit, adjusted for fair value of own debt, improved to £7.8bn from a loss of £0.7bn in 2008, but £6bn of this was gains on redemption of own debt and pension curtailments! Impairments rose sharply to £13.9bn, rising £6.5bn in the year, from £7.4bn in 2008, with a third taken as losses and over £5bn as goodwill and intangibles loss, but now appear likely to have peaked.
A problem with summarising the balance sheet of such as large bank as RBS is understanding both sides of the accounts, assets (loans) and Liabilities (deposits, borrowing and equity capital) like strawberries and cream it's not advisable to digest one without the other. The BBC news described impairments as expected irrecoverable loss, which is simply out of whack with where the main gains and losses appear and strictly incorrect anyway since recoveries medium term should normally be 30-55% of impairments. Fourth quarter impairments were 5% lower than 3Q09 and risk elements in lending at year end were unchanged compared with end-September at £35.0bn.
Total income was up at almost £32bn compared to almost £24bn, half of it non-interest income. Core bank operating profit improved to £8.3bn, compared with £4.4bn in 2008. Exceptional trading results in investment banking led. Net interest margin was 1.76% for the full year, which is very healthy given a normal ratio of 1.5%, if down 32 basis points from 2008 but stable in the second half. Fourth quarter NIM of 1.83% was up 8 basis points compared with 3Q09.
Risk in the balance sheet has been reduced, with total assets cut by £696bn in 2009 in unfunded items i.e. 80% of it in derivatives and the rest in APS with a fall in retail customer lending as customer paid off loans faster than the bank could agree new loans - partly by deleting undrawn overdafts. This is in line with Stephen Hester's commitment a year ago to reduce £500bn in derivatives. More worrying is a planned £500bn reduction in the funded balance sheet in constant currency terms, which is 70% though split between wholesale and retail operations, and half is the APS effect, but I wory that RBS is not doing enough to maintain houshold and business lending levels?
On risk capital side, Core Tier 1 capital ratio improved to 11.0%, following the issue of B shares to the UK Government and accession to the APS Scheme (Risk-weighted assets, or net risk exposures, at year-end was £438bn). There is currently a problem as to exactly how preference shares (as hybrid instruments) absorb loss given their bond nature, not pure equity. This brings us to why banks have to buy government bonds.
LIQUIDITY BUFFER CAPITAL RESERVES
Unlike in the USA where issuance by banks of bonds was almost zero, in the UK in the second half of 2008 there was quit massive securitisations for the BoE SLS and others funding sources. Then in early 2009, the big UK banks slowed issuance of term funding, and also reduced holdings of Govt bonds in Q3 2009. This helped margins for end-year reporting by 5bps. Then through 2009 government issued £170bn in bonds and redeemed about £20bn, then BoE bought in £200bn under QE using its balance sheet net liabilities from SLS and APS. The Government needs to sell £230bn in new bonds roughly in 2010. meanwhile the FSA has issued new very firm rules on liquidity reserves that UK banks must posess and these need to be mainly government bonds. Rejecting objections from banks about the burden of providing themselves with hundreds of £billions in liquidity risk buffer reserves to avoid having ever again to ask the government for massive help in a credit crunch, the FSA is interestingly being very forthright; no compromises.
We can now think about banks' capital funding requirement as a weighted mixture of deposits, equity and long-term wholesale funding that is as important as Tier 1 ratio in the FSA view, with loan to deposit ratios becoming obsolete as a liquidity measure. Current CFR of the UK banking sector is about 60%, and assuming banks target 70% (the level in 2000) the gap is a net £250bn of core funds (about half of bank capital!).
The FSA says the banks have 3 years to get there, during which £250bn SLS and CGS funds will also mature – potentially leaving Barclays, LBG and RBS with the need to raise over £500bn as an LR buffer including some superior long term high quality funding gap financing. Government bond purchases will rise sharply – at least £100-150bn purchases that might make insurers and pension funds feel squeezed out in the auctions. Without change in funding structure, UK banks may need to buy £620bn of additional purchases! The banks will have to withdraw funds from properietary investment trading and apply these to liquidity reserves.
By 2012, liability and these liquidity risk pressures may reduce net interest income of major UK banks by perhaps over £15bn per annum, or the equivalent to 100bps on the entire stock of non-mortgage loans! Hence, one impact may be flat margins in 2010and 2011, i.e. margins at sub-2008 levels in the medium term. This may hold back ROE to 15 percent or less, when 15% is a typical performance target currently. RBS's current RoE is 13%. Anyway, that's not the economic point; it is that banks to be safer will have to focus more on traditional banking and less on prop trading, and regulatory pressure means a ready market for government bond issues; only right and proper not least because of how much government has done to save the banks.
REGULATION

There are two schools of thought on regulations, on Basel II (& Solvency II), that specify the level of capital that banks (and insurers) in dozens of countries must abide by. There is much talk of Basel III, but this doesn't exist formally; the term Basel III only means refinements and additions to Basel II, mainly to get banks at last to fully work through how to implement Pilar II of Basel II, especially the economics modeling.
Supporters say the rules’ risk-based approach to capital requirements stops many banks from suffering a worse fate in the financial crisis, that the alternative, US, norm of restricting leverage, or relative indebtedness, of a bank’s balance sheet is useless because banks simply shift risky investments off the balance sheet.
Basel II’s critics, on the other hand, say the rules exacerbated the crisis because they allowed banks prepared to follow the letter, not the spirit, of the rules to increase leverage in their balance sheets enormously, investing in assets that were nominally safe, yet in reality were anything but. This is mistaken. The filure was in the derivatives of the securitised assets and allowing people to buy them as tradeable investments with highly leveraged funds and not ensure they were held to maturity suitable credit enhanced insured with standby liquidity etc.
And, it is argued, one of the principles of Basel II – that a bank’s capital should be based on the riskiness of its assets – was undermined when measures of riskiness, such as many credit ratings, were discredited during the crisis - that as triple A rated investments turned sour, a disastrous unravelling of bank balance sheets ensued. This is not quite accurate. The ratings agencies models had serious bugs as so securities that should not have been triple-A were rated as such. The weight of the rating in respect of the market value of the instruments had to focus on the instrument's collateral while the underlying collateral was taken for granted and falsely rated. It turned out that the instrument collateral could not be relied on an the market value of the bonds behaved independently of underlying credit risks.
The question, then, is whether Basel II should now be ditched, to be replaced, perhaps, by Basel III, is too simplistic? What is happening is an improvment on Basel II to provide more details and more enforceable advice in Pillar II requirements such as in liquidity risk and economic stress-testing.
Basel II is evolving. It was not a contributory factor to the crisis. There is no correlation between where the crisis struck and the adoption of Basel II.
Basel II was not just regulation but also it’s implementation. banks all failed to implement it in time fully. criticising regulations is an oversimplified.
One focus now is central banks building models to understand how banks are networked and cause systemic risk, and to decide who are the systematically most important institutions should be subject to extra scrutiny in regulation and capital requirements.
Systemically important institutions are not the same as too big to fail. That should be solved through resolution frameworks. And, of course, more capital will help.
Central banks want to get rid of the problem of too big to fail. But, simply put it is recognised that biggest institutions need closer oversight. Whether that means additional capital, that is what needs to be decided.
Insufficient liquidity has been recognised as a fatal flaw of the banking system when the crisis came, must also be addressed. But, this is where the intuitive argument goes wrong. Banks nominally (in USA and UK) lost all of their capital in the credit crunch and the same again in the recssion. For example, the IMF predicts banks will have nominal losses of at least $1.5 trillion in only 2010.
In my opinion the idea of looking for points of failure as if a credit crunch is triggered by failures of certain banks only (i.e. micro-prudential failures) is wrong. The centrak banks should be building macro-economic models integrated with macro-financial models, but this is currently intellectually to big for them to attempt - they prefer games-theory models using micro-economics of networked risks.
The regulators are therefore imposing high liquidity ratios that go beyond the guidance they first gave on liquidity management. There will be a global standard for funding liquidity – there will be a stress liquidity for short term shocks and a long-term structural liquidity ratio.
Banks could find their lending capacity limited more closely to their volume of deposits, and if so that will be a huge culture change - but I don't believe such huge changes are likely.
By the end of Q1 2010 is a very significant milestone for financial institutions operating in the UK. The FSA, which by then may be a sub-division of the Bank of England, should have in place the new regime for measuring and managing liquidity risk, a comprehensive framework that is a strategic part of bank strategies. By Q1 2010 banks must have processed large volumes of liquidity data, built stress scenarios and have the ability to drill down to the lowest level to identify the sources of risk and potentially deliver this information continuously!
Multiple decision-makers, business units and systems have created enormous complexity. The experience will be educational for bankers who for years have ignored the liabilities side of their balance sheet and taken liquidity for granted.

RBS - NOT TOXIC BUT TAINTED ASSETS?

Background: To better secure the solvency (practically and for regulatory compliance) of major banks, The Bank of England and HM Treasury conceived the APS Scheme (successor to the SLS Scheme). This takes 'assets' (i.e. loans) of banks bundled up and evaluated as an interest-bearing bond based on revenue streams over time (interest plus repayments of principal) generated by the loans. RBS, three quarters owned by the UK Government, agreed with the Treasury to offer 5 million loans worth an estimated £282bn (13% or £43bn down from the value at January 2009 of £325bn) and a very considerable % of RBS's total loanbook. The operation involves BoE taking these assets as collateral to swap for interest-bearing Treasury Bills (gilts maturing within a year) or an equivalent i.e. the novel idea of a zero-interest BoE cheque left at the central bank and only encashable by it. The gain by RBS is that asset value writedowns (market risk), which would hit its capital reserve, of these loans are off balance sheet while any credit risk losses up to 21% of the total are not off balance sheet. The swap is renewable and further assets may be demanded to maintain the collateral value. There is a swingeing fee and a considerable discount and haircut so that RBS does not gain treasury bills or a cheque made out to the full value of the assets, only about 75-80%. RBS continues to manage the loans for a fee. It gains a partial reduction in its risk weighted assets, but more importantly closes its funding gap between deposits and loans considerably and therefore much reduces its own borrowing when interbank borrowing is expensive. The government will take its fee for this swap transaction in terms of more shares in RBS raising its stake to 84% and should also see a better prospect of the bank recording a profit sooner plus a rise in the value of its shareholding.
The whole transaction does not strictly involve taxpayers' money; it is a swap. The financing support totalling over one £ trillion is not in the government's i.e. taxpayers' budget, notwithstanding that it is equivalent in size to half of GDP, but then UK banks' assets totasl more than 4 times GDP as a ratio. It is equivalent however to all of UK banks' capital reserves and then some. The media comment on this point is quite wrong, including by the FT who whould know better, which stated on 17th, "Taxpayers who have stumped up billions of pounds to bail out Royal Bank of Scotland". Taxpayers so far have not been taxed or in any way directly required to 'stump up' billions. All of this, as noted by several BoE public speeches, is not only off-budget in terms of the Government's fiscal budget, but also off-balance-sheet of said (media comment again) that these loans are impaired (also called 'toxic'), but that is mere presumption that has never been based on any factual foundation. The loans may be no worse than any other and merely performing in a manne typical of any such a large number of loans i.e. 5 million loans of which say 125,000 may have some defaults - after all the total has to be of high grade aggregate risk quality, but cannot be risk-free. In any case, default risk to a generous amount is at RBS's risk (and government's only via its shareholding) and there is no repayment risk to government since the paper it has issued may be swapped back for the collateral in whatever condition the latter is, and the collateral assets are off-balance sheet and do not generate any kind of paper or other loss for government or central bank accounts. There is insurance cover too, for which RBS has to pay the premium. The media's fixation on the idea that government is insuring or guaranteeing the assets is quite wrong! The overriding purpose of the whole exercise is to close RBS's funding gap to balance its books more cost effectively and remove credit crunch insolvency fears. Furthermore, given that the bank is nationalised, legally if so desired, the bank is technically free of regulatory compliance.
Just consider, before RBS can call on BoE for asset protection to recover losses (and only credit losses are referred to in the APS scheme, not market value asset losses) above £60bn after typically 50% debt recovery from underlying collateral such as property, the assets would have lost more than 42% in credit defaults, and yet could still have generated the equivalent of much of that to BoE in interest payments. But, anyway, if that happened, given also the more than half foreign element, there would have to have been an almighty global economic and financial system crash and whatever cockroaches came out of RBS there would be many more in all other banks. Therefore, to imagine a significant risk to government or 'taxpayers' is ludicrous - yet everyone maintains such a fictional scenario? I suppose people think someone somewhere is impressed?
All this makes the very precise current market value or longer run real economic value of the pledged assets academic, notwithstanding the European Commission's concerns on this point (including its insistence on first loss from over £40bn to £60bn, which again is mere pouch-posing) to prove that the bank is not being uncompetitively favoured.
The commercial hardness and headroom safety in the deal both would suggest that this is not the case. The bank is not gaining funds that it can speculate with or grow its loanbooks, merely reducing its funding gap borrowing requirement, if by a considerable extent of about half. The bank is in any case in other areas deleveraging i.e. reducing rather than growing its assets, especially in derivateives, but also under European Commission pressure reducing its small firms and SME loan books, albeit that this is directly opposing government's requests that the banks maintain their pre-crisis lending levels especially to small firms.
Alistair Darling overrode a warning from the Treasury’s top civil servant that a government-funded plan to insure Royal Bank of Scotland’s survival by underwriting £282bn of toxic loans could cover legally tainted assets.
The media comment would have us think that this gigantic sum of £282 billions is to be viewed as something more akin to siezures of criminal earnings like black market or forged money or heroin? The toxicity of the assets is not a financial or legal problem, not at all really. So, HMT experts have instead wondered about legal risk, at 'tainted' assets, and as another time-delay or make-work concern, Sir Nicholas Macpherson, permanent secretary at the Treasury, wrote to the chancellor in November saying, “It will be impossible to make the scheme work without providing insurance for some tainted assets – that is, assets whose legality may not be certain.” This is an interesting angle whose reasons for being raised may be obscure and of very remote risks, or merely a deal-making leverage (even if it is in effect between government-owned entities). "Some assets on which the APS [asset protection scheme] will pay out may well not fulfil the standard requirements for commitment and payment of public funds,” Sir Nicholas warned (in an official letter seen by the FT). “These include acting within the law, not tolerating fraud, illegality or corruption and operating controls to ensure these things.”
In RBS's interim report in 7 August '09, the CEO Steven Hester wrote plaintively in his letter to shareholders (page 11): "The APS itself, while conceptually straightforward, has enormous operational complexity which is taking time to resolve. For example, HMG has requested regular reporting on up to one billion lines of data covering assets in the scheme and our own systems and data quality are not well designed for the APS purpose." Given that 5 million loans are involved, this suggests 200 lines of code per loan? It probably really reflects the difficulty of precisely cutting and slicing the loans out of the accounts in a multitude of ledgers since not all detail and types fit into the general ledger - all major banks have similar problems. But, what make this complaint fascinating is why such complexity of reporting should be required and what in any case would be the cost or value to HMT, the FSA, or the BoE, to seek to examine all of that periodically?
Now perhaps we have a clue - government want to check for any legal shenanigans?
The APS deal was agreed in late November by which RBS became 84% state-owned. Technically RBS employees are all now public sector employees - why the analysis cannot be conducted within RBS is therefore puzzling.
This deal is not exactly between arm's length parties even if third party scrutineers are involved.
The FT commented that "Taxpayers who have stumped up billions of pounds to bail out Royal Bank of Scotland might be alarmed to discover that a proportion of the assets they are supporting may have been exposed to legal irregularities such as fraud." This makes two wrongheaded presumptions that taxpayers not only stumped up money but are supporting the assets, but suggests there is nevertheless a scandalous view that could very well emerge - perhaps I would think as a result of legal actions and investigations current in the USA by SEC and class action suits over RBS's board statements about its financial solvency and market conditions preparatory to capital raisings i.e. that collateral values, funding gap, default risk, expected writedowns or even underwriting risk and financial enhancement costs to the bank's own and third-party securitisation issues, or perhaps somthing about assurances or loan ontracts related to property or dealings with non-bank financial institutions or some aspects of its economic capital model accounting treatment, or the risks of gaming associated with inability to cleanly define the 5 million loans precisely? We do not know - the above list is mere speculation? There may be nothing at all to worry the deal or any of its hidden associated codicils.
What is perhaps worrying is that HMT was raising a major concern at the last minute that might have scuppered or long delayed the whole deal - why? Is this another case of mandarins playing party politics ahead of an election the government is widely expected to lose, and this is why the letter has now been leaked to the FT? Perhaps HMT senior mandarins had conceptual problems in understanding the nature of the off-balance sheet off-budget deal and were worried that moves in the USA to bring Treasury Bills formally on balance sheet of US Federal Debt if applied here would blow the UK's national debt ratio totally out of the Maastrict water! This was and is a real concern - similar to that of treating all of RBS's deposits and borrowings as part of national debt, a game that some commentators play rather than accept that the bank's balance sheet is precisely that - in balance.
The FT gamely or casually state, "It is well known that the toxic loans and investments RBS siphoned off into a government-backed insurance scheme carry a higher risk of default." Actually, not so! FT added, "But it was the possibility that they may have also been subject to criminal conduct that caused consternation in Westminster as the final details of the scheme were thrashed out late last year." This can mean either criminality by the bank or by its customers, which so far is merely libellous. But we are not talking about insuring the Titanic here; it is not a ship that with one hole under the water line the whole ship sinks. Sir Nick wrote to the chancellor in November to say he was unable to satisfy himself that the risk posed to the Treasury by insuring the assets would be ­negligible. This appeared to be a fear based merely on the bank's technical system difficulty in precisely defining the 5 million loans. The bank’s systems “could not confidently distinguish assets which it is unsuitable for the public sector to deal with”. Did this mean only that US or other foreign assets were involved that on some legal interpretation are outwith public sector support? The problem of the international assets of major banks is an item on the G20 agenda - how to wind up or divorce the domestic part of a bank from its foreign parts? Citicorp could not be made insolvent or nationalised in the US for the very reason that it was too complicated and would involve too many other countries - according to the FDIC. This view is supported by the FT's comment that "However, people familiar with RBS’s asset book claim that the legal issue came to the fore because of the extensive government assistance given to the bank, rather than its being a signal that a big problem was lurking in the shadows." The FT found an industry expert who surmised, "It was reviewed whether it was right and proper for the government to be insuring assets that potentially could have fraud in them.” but adding sensibly, "However, it was an entirely theoretical exercise.” This suggests to me that there are as yet no actual grounds for such suspiion, merely abstract speculation. It is all too easy to raise what may be red herrings simply because the assets involved come from RBS's retail, commercial and investment banking divisions. These should be separated, in my view, into 3 separate deals, and indeed should be so because the analysis to determine asset values (current, over the cycle, and the European Commission's Real Economic Value) each involve very different modeling and detailed analysis in each case. If the assets involve US assets including from Citizen Bank's retail loans, then again there should be more separate deals.
But, this defeats the overall purpose and the safeguard margins built-in plus the off-balance sheet nature of how it is all being accomplished without drawing on taxpayers' money. Therefore, the chancellor was absolutely right to override Sir Nick's concern and claim a wider public interest. He is aware that just as US government support for its banks involve support for foreign including UK loans, so too does UK government support for its banks - and this is also accommodated for by currency swap agreements between the central banks. Trying to disentangle that is not worth the effort.
This, however is spectacularly so in the case of RBS. The FT reports that of the assets to be placed in the APS 60% are held outside the UK, mainly in continental Europe and the US. We immediately think of ABN AMRO's investment banking and its baroque structured products that doubked RBS's exposure to toxic assets, Citizen Bank's retail banking and RBS Greenwich's involvement in about $1 trillion of relatively low quality securitisations many of which may be subject to class action law suits or suits by othet financial firms! But, whatever the risks are, can they exceed the £60bn first loss to be borned by RBS - the most plausible answer is NO!
Therefore, what else is afoot. It may be that what is of concern here are losses that could hit the bank directly and be of such scale that they would have to count on budget of the government because of its 84% ownership and also of such significance that the prospect of selling off RBS in whole or piece by piece suddenly becomes hard to work out, even remote.
In the case of Northern Rock, the bank was split between good bank and bad bank, so as to be able to sell-off the good bank. The problems of dividing up the general ledger and the operating units of RBS appears now to be much more problematic.
The FT says that Treasury insiders say the potential legal problems highlighted by Sir Nicholas stemmed from the lack of knowledge among the big banks about exactly what risks they had taken on during the lending boom – a central cause of the banking crisis. “The nature and complexity of the RBS balance sheet meant it would be impossible to go through every single asset. We did due diligence for eight months and, as part of that process, (and) excluded £43bn of assets from the scheme.” I interpret that as plain silly. There was no point in such detailed assessment given the structure of APS. Moreover, the £43bn looks to me more like amortisation of assets over a year rather than exclusion of assets for any particular reasons, though could be a mix of both, mainly the former. I suspect this 'insider' is just another speculatiing with lesss than expert intuition.
The government stresses there is no evidence of any illegal assets on the RBS books. But, of course, what is being demanded is positive not negative assurance, i.e. full audit - but how rediculous that 8 months auditing cannot provide surety - what does that say for quarterly and annual audits? Also, the scheme would not cover assets where there is any sign of “material or systematic criminal conduct on the part of RBS or any of its representatives”. This comment by an 'insider' places the criminality fear directly on the bank's side? FT comments The Treasury stands by its assessment that losses on the assets were not expected to exceed £60bn – the amount RBS would have to absorb itself before the scheme pays out - but pays out to whom, to government, it's 8% or whatever the assets as a bond pays. Therefore, “the direct cost to the taxpayer is expected to be nil”, it said. This is nonsensical. The government's risk in an asset repo swap is limited really only to its expected income while it holds the assets before handing them back in exchange for the return of its paper. The repo deal cannot mean the government has to make good the value of the pledged collateral or the underlying since it is merely a temporary investor on a swap basis in the bond - therefore the talk of £ billions at risk makes no sense unless there is truly an insurance scheme involved to compensate for loss in value of the assets (beyond their amortisation - i.e. as loans are paid off presumbly pro-rata between the first £60bn at the bank's risk and remaining £222bn, supposedly at the government's risk, for which it could seek thirdy party cover, probably quite inexpensively without excessive further due diligence?)
RBS said due diligence on the insured assets had been exhaustive and there was no information or evidence to suggest that any of the assets were irregular, legally-wise. Banking analysts (that breed who rarely see beyond what is in the published accounts) said that the fact that those assets had been insured at a high cost to the bank meant they clearly all posed a risk of default. Not so, if the premium is dictated by BoE and given that European Commission insists the premium has to curry no favour. It is therefore further nonsense to deduce the quality of the assets merely from the premium charged.
According to published accounts in 2009, RBS made its largest loss provisions on the investment banking side, for structured products such as asset-backed securities and derivatives i.e. the £10bn that wiped out the purchase price for ABN AMRO, in a sign that this is where it expects the brunt of the losses might arise. Again, not so. The provisions had to reflect market values that have since recovered for assets that may be held to maturity i.e. these are paper not economic losses and are not strictly an estimate of future losses, merely current paper losses as yet unrealised and that may never be so realised!The FT provides an interesting potted profile of Sir Nicholas Macpherson. He is a cerebral mandarin, 25 years a civil service, and close ally of the prime minister with his hand on the tiller of Number 11 under Gordon Brown during boom and bust. Hang on a second, there was no boom and bust under Brown's helmanship of the Treasury? His one great feat was avoiding going into recession with the USA in 2001/2, a feat unprecedented for over a century! In fact Sir Nick was only appointed as Treasury permanent secretary in '05 albeit at the height of the lending boom, and knighted in '09 for overseeing the banking bail-out, including nationalisation of Northern Rock, Bradford & Bingley, RBS and almost too LBG.
The 50-year-old worked with both Tory (Clarke) and Labour chancellors (Brown & Darling) – and in FT's words is a stickler for civil service protocol. His e-mails reminding colleagues not to leak to the press are a regular feature of the run-up to each Budget - that's not being a stickler, that's routine. Popular with Treasury officials, Sir Nick’s elusiveness can irritate the more down-to-earth MPs on the Commons’ Treasury committee. That says little - it is axiomatic that civil servants should cover themselves in fish-slime in any public fora sufficient for any human hands to fail to grab onto.
His salary is £161,000. He is an Old Etonian, ex-CBI and Peat Marwick economist before joining HMT in '85, including working on EU economic & monetary union, and played a sterling role in negotiating the Maastricht treaty in '91.
In response to his letter of concern, he got a formal “direction” from chancellor Darling to override the question of potential misuse of public money in the APS.
The FT says this is only the 2nd such direction since '97, which I very much doubt. There was a similar direction in late '08 over the reference of the Lloyds and HBOS merger. Eching this latter one precisely, Darling asserted the “wider public interest” in maintaining confidence in the banking sector meant it was “right to live with the residual risks” the Treasury highlighted - quite right too.
The FT goes on to mention recent mortgage frauds, where criminal gangs have worked together to obtain credit using false data - but that is surely not at all the issue, and in any case the property remains as security. The Treasury on Wednesday declined to be drawn on the nature or estimated maximum amount of the potentially tainted assets - of course not, it's not possible. HMT stressed it had “no specific information that shows any of the assets are irregular or tainted”.
In evidence of Opposition playing honest daft laddy, Lord Oakeshott, Liberal Democrat Treasury spokesman, said of the letter it “must be the most shocking a Treasury permanent secretary has ever had to write as accounting officer – he could not satisfy himself on the risk to taxpayers from underwriting RBS’s wild loans ... taxpayers cannot condone, never mind reward, fraud and corruption.”
To digress, this is kneejerk ignorance of the kind that George Osborne and some others including Vince Cable reserve for claiming government finances are in a mess or, sadly in my view, Ken Clarke recently, who said that public spending cuts will have to be the most severe in British history. He is an ex-Chancellor I much admire for talking right while walking left, who is merely happy now to be dishing back the same unfounded accusations at New Labour that New Labour levelled at him in the '97 General Election campaign, despite the fact that Brown on assuming office kept to Clarke's budget projections for two years - something Clarke himself would not have done and sensibly never did do when in office. New Labour accused Clarke of having over-borrowed and he mysreiously never responded with the telling question "what would you have done different to get us out of recession?"

REGULATING BIG BANKS?

Demonstrators protest outside the Goldman Sachs building in New York, - a national protest against major U.S. banks calling on Congress to take action on banking reform.
Are governments really getting to grips with financial reform? Or, are they being stymied or diverted by myopic bankers? One of the successes of responses by states to the credit crunch crisis has been the almost measure for measure coordination of responses between the USA and the UK. When it comes to weight in world banking and finance the UK alongside USA at the top of the totem pole wholly disproportionate to the relative size of their underlying economies. Last Thursday, Obama called for the biggest regulatory crackdown on banks since the 1930s (when Glass-Steagal separated traditional banking from investment banking), proposing strict limits on the size of financial institutions (none to have more than 10% of the US market) and a ban on proprietary trading (speculation by the banks for their own profit and not on behalf of customers) and therefore also no banks to have internal hedge funds. If enacted by Congress, Mr. Obama’s proposals could force Wall Street names like JPMorgan Chase and Goldman Sachs to spin off their huge hedge fund and private equity operations and stop making trading bets with their own money, or de-register as deposit-taking banks. In the UK Adair Turner, head of the FSA (regulator) and others have coat-trailed similar ideas. New, unspecified controls on liability risk ar also envisaged – this would catch up with the UK where tough new rules are enacted and will be followed shortly by the EU. Banks will have to prove their liability management systems and hold reserves of high quality that may add 30% to banks’ capital reserves. The liability risk rules extend to non-banks. Commercial and investment banks are to be prevented from growing so large as to anytime again pose a systemic risk.
This last intention is a deeply flawed hope. The network risks of a bank causing a systemic crisis such as Lehman Brothers or WaMu, or HBoS in the UK, may be triggered at far lower than 10% market share. Moreover, the problems of one bank if not caused by a technical operational failure but due to changes in the economic environment are bound to be common to all banks. Banks that were seen to survive with less need of Government support did not do so because they were inviolate to the problems – it was relative, and the equity investors and short-sellers only had so much appetite to dump the banks – it was a matter not of all skittles being liable to fall but merely which fell first. Any of the big banks could have been first – there was a certain amount of luck and bad timing so that, if we think of the credit crunch as a fire fight some banks took the bullets aimed at all of them. Those first in line to be shot were those who had to go to market to refresh their funding gap finance before the others in the worst months of 2008.
G20, UK and USA reform proposals represent an intelligent shift to look at the liabilities side of banks’ balance sheets, previously ignored in Basel II regulation. The popularly phrased idea however of building up reserves in good years to cushion the lean years is flawed. The credit crunch + recession is wiping out banks’ capital by 200% gross (before recoveries and continuing internal capital generation). Therefore even if banks had double the reserves they had in 2006 they would still be in crisis!
At this stage, the primary focus is on banks, but double-default risk (part of Basel II Pillar II) remains an issue in respect of the capacity and role of insurers in underwriting banks’ risks. Insurers are competent to cope with single failures, but not when a whole banking sector faces capital wipe-out, and a 90% wipe-out is normal in for a normal recession (one not preceded by highly borrowed banks failing to turn over their medium term debts as these became due).
In Europe there is a broadly based approach where Solvency II for insurers is almost identical to basel II for banks. The USA must attempt this also - a wide-front approach that applies to non-banks and insurers in much the same way as applying to banks. In fact this is now implicit in the global IFRS accounting standard,
Restoring the New Deal era Glass-Steagall Act’s complete separation of investment and commercial banking activities is argued by banks and their supportive economists in Wall Street firms as not the right direction to go in because it does not solve the “too big to fail or cause systemic crisis” problem. Whether separation is necessary or desirable, the argument does not hold water. The essence of Glass Steagal was to make commercial banks solely dependent on the economy and not put large amounts of their capital (retained earnings) at risk supporting investment speculation fuelled by banks’ borrowing their bets from others. Banks necessarily have to hold deposits with each other. They have to provide liquidity to markets either directly or by lending as they do to prime brokers and other markets traders. Glass Steagal merely ensured that banks’ speculation in markets for themselves was at one remove. The collateral they hold from borrowers also means they have many ways of participating in customers’ businesses.
What could be limited is the practice of wrapping up loanbooks and securitizing them for sale as bonds. This enabled the banks to push the growth of their loanbooks faster than the rate at which they attract deposits. When government borrowing is low and therefore private savings rates are also low (they are exact counterparts in ratio to GDP) then banks are forced into relatively low growth as they see it. In effect therefore, the restrictions being proposed are for big banks to only grow at the rate of the economy plus inflation. Big German and Japanese banks have traditionally used bonds indirectly (not directly) backed by loanbooks, and big US banks too that did not have extensive retails networks. There are other options; structured finance is extremely flexible and creative. Therefore this is not a genie that can be pushed back into Aladdin’s lamp. More vital is to try and ensure that banks’ lending profiles are less driven by where they feel they can get biggest profit returns and more by risk diversifying across the whole economy. When mortgage lending is 20 times greater than lending to small firms something is wrong!
Some bank economists argue for lower capital requirements coupled with greater restrictions on securitization, for which read wholesale borrowing, as opposed to higher capital requirements and liquidity risk controls - the direction of new regulations. They object to the new regulatory attention to the
liability side (deposits and borrowing) of the balance sheet. But it is this side where the credit crunch happened! They want regulation to do what it was doing before – only focusing on the asset side of the balance sheet (credit risk of loans and market risk of investments ). Governments made the banks pay insurance premia to them to insure all deposits. This was a classic confidence restorative. But, it was the loss of confidence by lenders to banks that caused the credit crunch, and not the credit risk defaults by mortgage and other borrowers – those could be coped with. What could not be coped with was sudden technical insolvency when banks could not get their liabilities to balance their assets.
What made big banks not too big to fail was not their balance sheet size; it was the size of the funding gaps that had burgeoned between deposits and loans, so that a third or more of liabilities could b short to medium term borrowings. Capital was then wiped out too, not by credit risk losses but by market risk writedowns and massive equity falls in the stock markets.
With that in mind, many activities of the banks need to be capped, banned, taxed and/or substantially re-regulated.
One idea canvassed in the USA is for government to continue to guarantee all banks’ depositors and bondholders, not just to the present $250,000 deposit ceiling but totally. With banks funded without limit by government-insured deposits and loans from the central bank, discipline should entirely focus on the asset side. This may work, but it does mean that bondholders should not expect yields above those on government paper. This may by itself limit the ability of banks to over-borrow. If not, then caps are required on how much banks can borrow as a % of their assets. Such discipline must include limiting banks to assets deemed ‘legal’ by the regulators and restrictions on off-balance sheet activities (mainly derivatives including credit derivatives. That will limit leverage-financing to non-banks who have relied on credit derivatives to emulate the liquidity of interbank money markets. Money markets would themselves deflate in size as interest rate futures and other plays become less justifiable.
There is a mistaken argument about enforcing higher capital ratios that is commonly subscribed to by banks. That is that capital ratios going higher act functionally like a tax to restrict the banks’ ability to lend, and thereby raise the returns demanded from the borrower. This is simplistic. What really happens is that banks have to retain more earnings and in the first instance withdraw a lot of own-capital presently committed to proprietary trading and apply that to capital reserves and vest these in money market funds or directly in government stocks.
Given that banks have capital committed to proprietary trading that could be recovered for capital reserves, then higher capital ratios (built up over a reasonable period) should not restrict traditional lending even if it does raise the common cost of funds for banks, which can effectively be passed onto household and business borrowers i.e. onto consumers, i.e. marginally higher borrowing rates or narrower net interest income to the banks. The result will also be lower dividends for bank share investors. In the decade before the credit crunch bank profits and shareholder gains were double the average for stock markets. There is therefore some grounds for actions to restrict this. A related question is how higher capital ratios can also be gamed via risk accounting scams – but that’s for the regulators to sort through in fine detail.
Banks are set up and supported by government for the benefit of the economy. Consequently, banks should be prohibited from engaging in secondary market trading – this is a compelling view, why, because it serves no public purpose and may result in severe social costs in the case of regulatory and supervisory lapses. Banks should only be allowed to lend directly to borrowers and then service and keep those loans on their own balance sheets – the idea of a return to traditional banking.
But another key objective is to ensure via financial reform that markets remain liquid and deep. This means relying on a large number of smaller institutions carrying on traditional banking activities including trading in the markets, rather than having these activities concentrated in the hands of a small number of dominant highly capitalized global institutions. Truth is that generally in the major markets no players have over 5% when looking at all data properly single-counted. But that is enough to move the markets. We need to renew our studies of the quality of markets and bring over-the-counter trading back onto regulated exchanges – ideally banning algorithmic automated trading, many of the games that go on, and ending much of the anonymity of automated central order books and balance this with direct contact between buyers and sellers but via the exchanges. In regard to proprietary trading, hedge funds, private equity operations, and other pools of unregulated funds should be allowed to continue to operate. But they should be allowed to fail when their bets go bad. What is needed is a protected and closely regulated large core of the financial markets for those who do not want excessive risks.
In the USA, the top 4 banks (BofA, Citi, JPMorgan-Chase, and Wells Fargo) hold half of the country’s deposit base. In the UK, 5 banks (HSBC, LBG, Barclays, RBS, Santander) hold 75%. But these %’ages do not translate into wholesale markets which are not national but global! Banks seeking to grow beyond their borders have veered back and forth between doing so by buying retail networks or more investment banking capacity, sometimes both. The major consequence of thirty years of financial deregulation is that it has rewarded destructive competition in domestic banking rather than constructive competition, with big banks getting bigger, and domestic banking more concentrated, so as to finance big banks’ ability to seek bigger shares of global markets, where they all have a long way to go. Arguably, an acerbic view, is that regulation has so far rewarded banks who grew their market shares by any means without any consideration for others (especially the financial well-being of borrowers or the general economy), and it punishes financiers who refused to resort to unprofessional underwriting practices even if it meant a drastic reduction of their market share. The time has come to construct regulation which rewards the latter (usually smaller banks practicing traditional ethics) and punish the former.

BoA-M-L = LTSB-HBoS

Not exactly a palindrome, but a bull in a palindromic situation. BofA is to "pay $425m over toxic assets" as the FT words it; in fact of course this is an FDIC/Federal Reserve/US Treasury TARF scheme that starts just like a repo swap in the BoE/HM Treasury APS scheme, where LBG has agreement to repo swap £245bn or thereabouts (and RBS £325bn or so).
In the APS case there are delays while waiting for EC scheme & case approval, which everyone who looks into it assumes will come with requirements on LBG to restructure in alignment with Competition advice (the very same that was by-passed by an Act of Parliament to permit the Lloyds TSB takeover of HBoS). The US integrated multi-state regulatory supervisory system does not need to wait on a higher authority to validate the real economic value and competition issues involved.
In the US equivalent of the UK scheme, there is unlike in the UK case a speedy transition to the exit door marked TARF whereby US authorities provide soft loans to another financial institution or a groups of them, maybe hedge funds, to buy the impaired assets on soft (relatively risk-free) terms. Bank of America agreed late last night, after hurried discussion to dot and cross the terms, to pay $425m to federal regulators thereby to extricate itself from an agreement struck last December with federal authorities (involving probable repayment of protection subsidy) and to protect the bank from any further asset writedowns on $118bn worth of toxic assets, most of which came from Merrill Lynch (echoes of LBG's claim that most of its impaired assets come from HBoS). The terms 'toxic' and 'impaired' relate to assets that have fallen below book value, but can also mean simply assets that have an immediate downside of too high a risk weighting so that the amount of capital reserve required to support them (in addition to liability funding) costs more than the possible medium term upside.
By getting rid of $118bn toxics saves on the same again in liability funding at say 8% ($9bn) plus say $15bn in capital reserve. Then the other saves about $22bn in capital and perhaps another $100bn in liability funding = total of $53bn or 12.5% of the total assets. Assuming a 20% discount plus 5% fee means $80bn p/l writedown against net gain of $47bn = $33bn (new world according to GAAP), but gaining $319bn (less $45bn payback) in treasury bills at half the rate of funding gap funding worth say $10bn plus perhaps $10bn in annual net interest gain & fees from new business growth; net result = $-13bn + say 20% return on $21bn capital refershment = final cost of $7bn year 1 and $10bn profit year 2.
What do the authorities get? They get to expand the balance sheet by $319bn with enough head-room to issue the soft loan (more T-bills), which with roll-over after a year to keep everything off-federal budget, and then net $60bn profit + $45bn pay back over 2 years. The hedge funds or whoever contribute say $60bn and get a 30% return over 2 years of $20bn. Nice - everyone makes money including the taxpayers whenever the net proceeds are taken on budget, probably not in deficit reduction where the amount could pay for a month of Medicare etc., but by reducing the Federal debt by 1.5%.
The decision to pay the money to the US Treasury, the Fed and FDIC brings an end to one of BofA’s financial entanglements when it was aided to take over Merril-Lynch and lets the bank pay back $45bn in funds to TARP, freeing it to pay what bonuses it likes to top execs - maybe?
Just like when UK Government, Brown, Darling, Vadera & Mandelson acceded to, or actively encouraged, Blank & Daniels of Lloyds TSB to takeover HBoS, so had Paulson, & Bernanke enticed, encouraged or gone along with, Lewis & Thain to proceed with the BoA takeover of M-L. What no-one cared to worry about was that this scuppered attempts to save Lehman Bros. a year ago last week about which many are agreed was the funeral pyre worst moment of the Credit Crunch, a fire that consumed the independence of many firms, not least the two big Scottish banks. UK government stands to make considerably more out of its stakes in RBS & LBG than US federal authorities will make out of BoA-M-L, some of which it may book quite soon.
In the US case, the September 13th takeover was sweetened by a loan of $20bn in T-bills, on top of the $25bn already earmarked for BofA and Merrill, to make sure the transaction was consummated, plus a guarantee over $118bn worth of troubled assets (troubled = impaired = toxic = regulatory capital burden = writedown risks).
BofA, however, never formally signed a contract for the ringfence protection and in May decided against entering into the asset insurance programme. For the last quarter, the bank has been in negotiations with FDIC to determine fair value of the perceived insurance provided by the guarantee. That delay should have saved the bank maybe another $1bn or so in premiums?
Meanwhile in another part of the dark forest, the SEC says it is considering adding charges to its lawsuit against BofA for allegedly failing to give investors details on executive bonuses. The SEC’s statement that it would “vigorously” pursue the charges against BofA came after a federal judge refused to agree to a proposed settlement between the regulator and the bank. Whether the current deal gets BoA out from under that is unclear? In a scathing ruling only last week, the judge said the settlement made no sense unless the SEC identified the individuals who allegedly made false or misleading statements.
Separately, BofA on Monday named Charles Holliday, former chief executive of DuPont (also famous for its Du Pont ratios that formed the basis of Credit Risk Agency models, by the way, that have been such a massive bugbear on the credit crunch decades later, though no fault of Du Pont), as a director, furthering its effort to overhaul its board. The arrival of Mr Holliday means that six new outside directors have joined BofA’s board since the April 29 annual meeting, when shareholders voted to strip Mr Lewis of the additional role of chairman. Similar musical chairs have been played at RBS and LBG - more support for my prediction a year ago that by the end of this whole shenanigans no key executives in charge of the big banks before the Credit Crunch will still be in their seats by the end of it!

Trust versus Confidence?

an ATOMISER of the traditional kind.
Andy Haldane, the Bank of England’s head of financial stability, says enduring recovery depends on trust being restored to the financial system, and called for smaller and more diverse banks, and a return to mutuality. This may be a bit of a slap to the FSA for placing high hurdles in the path of a couple of dozen or so new banks seeking to form in UK o register branches or subsidiaries in the UK. Many banks want to do more to gather in retail deposits and the UK is a good place for that including the UK’s liabilities guarantee regime. Haldane attributes the slump in economy & credit in the financial system to a loss of trust between banks and households, among banks and between banks and investors over the past two years. “Loss of confidence” is perhaps a soft phrase for disdain, hatred and deep suspicion. “It is lack of trust – and hence credit – that may shape the recovery. Based on past evidence . . . we might anticipate a protracted period of repair,” he told his business audience in Leeds.
Recovery from past recessions in the UK, trust and credit for non-financial companies recovered well once the economy had started to grow. Actually there was always usually a 6 month delay before banks started to expand credit and trust in recovery. In the immediate future, Haldane accepts that trust in the financial sector has been substituted for by govrnment guarantees (insurance paid for by the banks) plus state intervention measures. He says, “Extending public sector credit on this scale relies on the deep pockets and prudence of our grandchildren. It can be no more than a stop-gap – a temporary bridge – until private sector trust can be restored.” I take issue with this. I expct the government’s measures to be highly profitable for taxpayers. Moreover, the vast bulk (let’s say all of it) is in fact off-budget (swapping short term treasuries for bank assets after large discount + fees) and therefore not involving taxpayers’ money. Taxpayers are exposed only via the fiscal deficit, hich I expect the profit on bank aid to recover at least 40% of.
He also called on banks to seek to rebuild trust in their activities without regulatory intervention, by insisting that banking should not be commoditised like car manufacture, and pressed the case for smaller, more local banks, pursuing diverse strategies. An examination of FDIC data on US 8,400 small banks may put this idea into perspective; just parcelling risk out ino smallest chunks (like how Lloyds of London disperses underwriting risk). Haldane says,
“If large-scale processing of loans risks economising on the collection of information, there might even be diseconomies of scale in banking. . . Within the space of a decade, banks went from monogamy to speed-dating and that big was not best.” He called for a return to greater mutuality in financial services to prevent shareholders pressing for too much risk-taking in the knowledge that taxpayers would stand behind losses. This is an attack on the FSA for having encouraged de-mutualisation on the basis that the market knows best how to value banks, and ensures banks can raise capital – a fine idea in mico-prudential terms, but not much good in a macro-prudential crisis. “I am happy to say that reports of the death of the building society sector are greatly exaggerated. Indeed, mutuality may do a better job of aligning stakeholder incentives than some alternative forms of corporate governance”, i.e. better than shareholders, but begs the question how do stakeholders or shareholders actually challnge excutive boards. Company La needs major changes in shareholder voting process and information rights and similarly in mutual society member comparable rights.
Alongside banks rebuilding trust in their own abilities, he said that a return of credit – which comes from the Latin word for trust – would also be helped by strict new regulations aiming to strengthen banks’ financial resources, their ability to spot and deal with severe risk including in their governance.
He argues that new regulations are unlikely to be the answer alone. “One reason why regulation might not be the whole answer is that trust in financial regulation is itself one of the casualties of crisis.” I think this is defeatist. The new Basel II Accord (FSA and CEBS responsibility at law) has hardly touched down. We need to give it more time to discharge all of its responsibilities onto the banks. Haldane says there is a difference between confidence, which he said had returned to the business world, and trust, “an altogether different animal”. “Moral compasses take rather longer to self-correct than magnetic ones. This has implications for the path of recovery in the period ahead.”
Lord Turner has had as much, in fact much moe to say recently, and thereby restored some trust in the FSA’s efficacy. The Bank of England by denigrating he role of regulation does not look as if it wants to embrace the FSA’s role and thereby end the UK’s tripartite regulatory system.

Restoring the reputation of Scotland’s banks

from the FT by Brian Groom and Andrew Bolger
August 8 2009 01:41
First they called themselves The Voodoo Club, a group of 20 disgruntled members of Scotland’s financial community who held a wake last January in The Voodoo Rooms, a fashionable bar/restaurant in Edinburgh. It was for their nation’s two largest banks, The Royal Bank of Scotland and Bank of Scotland, which had collapsed into the arms of the government as a result of the credit crisis.
“Scotland has a few icons: tourism, whisky, but also financial probity – and that icon has been smashed,” says Peter de Vink, a veteran corporate financier who is a leading member of the group. Many Scots who invested their savings in the banks’ shares have lost much of what they had, he says. The name did not stick: the word “voodoo” got caught in e-mail spam filters. So now the group – many of whom had been involved in a failed legal challenge to prevent HBOS, of which Bank of Scotland was part, being taken over by Lloyds TSB – has been reconstituted as the 50-member Scottish Banking Renaissance, lobbying to restore the independence and reputation of the banks.
The anger remains palpable. De Vink says: “Our two banks fell foul of the pressure to seek scale. This happened over 10 years and the directors failed to ask the correct questions. The whole boards should be called to book. It should not just be shoved under the carpet, because what has happened is an utter disaster.”
Although feelings are still raw, however, Scotland’s appetite for recriminations may finally be waning. The financial community is doing its utmost to put the catastrophe behind it. Much is at stake because Scotland is far more than a banking centre. It also has substantial operations in life assurance and pensions, investment management and asset servicing, which, although affected by recession, are in a much healthier state than the banks. After London, Edinburgh is the UK’s biggest financial centre – and it is the fourth largest in Europe in terms of equity assets under management. There are also substantial concentrations in Glasgow and other cities. In seven years to early 2007, Scotland’s financial services grew by 60 per cent – more than four times faster than the overall Scottish economy and outstripping the UK financial industry, which grew by 47% in the same period.
Apart from creating the prospect of redundancies, the banks’ collapse has political ramifications. Scotland’s minority nationalist administration, which has run the devolved government since 2007, had hoped to hold a referendum on independence next year. Alex Salmond, first minister, saw Scotland’s destiny as part of an “arc of prosperity” of small, independent countries stretching from Ireland to Iceland. Those countries’ problems, coupled with the UK taxpayer’s bail-out of RBS and Lloyds Banking Group (including HBOS), are among the factors making it unlikely that referendum will now be held.
A deeper hurt, though, is the damage done to Scotland’s pride as a land of prudence, where a considered view is taken, away from the hurly-burly of London and New York – a place where you can trust the professionals with your money. That reputation, based on notions of caution and Calvinist honesty, was built over 300 years by a financial industry that arose amid catastrophe. The Bank of Scotland was founded in 1695 to fund Scottish commerce – just before the Darien scheme (Scotland’s effort to set up a trading empire in what is now Panama), which ended in failure with many losing their lives and the nation losing one-third of its wealth. That led to the Act of Union with England in 1707 and indirectly also to the foundation of the Royal Bank in 1727.
Over the succeeding centuries Scots pioneered many familiar features of the financial world, such as the overdraft, branch banking, payment of interest on deposits and savings banks. Investment trusts were pioneered in the 1870s by Robert Fleming of Dundee. Scots financed 19th-century land purchases and railways in north America. “It was a Scot, William Paterson, who started the Bank of England. All five Canadian banks were started by Scots and all five are still standing high,” says de Vink.
Much of the blame for the banks’ collapse has been heaped on two Scots – Sir Fred Goodwin, RBS’s ousted chief executive, and Peter Cummings, HBOS’s former head of corporate lending, who lost £7bn by pouring money into property development when others were drawing back. (Although Sir James Crosby, HBOS’s Yorkshire-born former chief executive, and his successor, Andy Hornby, also took a lot of flak.) Goodwin and Cummings are both examples of what Scots call the “lad o’ pairts” – young men who made their way by talent rather than social position. Both came from modest backgrounds in the once-industrial west of Scotland, both went to state schools and both worked their way up. Cummings started by making tea and sweeping the floor in the Bank of Scotland’s local branch at 18. Thus has this tragedy dented another cherished Scottish myth. To add to these misfortunes, Dunfermline Building Society was taken over in March after a mad burst of commercial lending just as the market turned. The society, founded in 1869, was regarded as a historic pillar of the financial establishment and some of Scotland’s best-known business leaders have sat on its board.
All these events have brought pain. It is etched on the face of Sir George Mathewson, who stood down as chairman of RBS in 2006, but is still a highly respected figure who chairs Salmond’s council of economic advisers. He and Sir Peter Burt, former chief executive of Bank of Scotland, made an unsuccessful proposal in November to take over the running of HBOS as an alternative to a Lloyds TSB takeover. Mathewson masterminded RBS’s takeover of NatWest in 2000, still widely regarded as a good deal in spite of criticism of the bank’s subsequent expansion. Now he seems torn between criticising what happened under Goodwin, his chosen successor, and pointing to extenuating factors. “I am not an apologist and I think it’s a tragedy as to what’s happened to RBS,” he says. “I have seen an institution that I thought would outlive me for many, many years collapse.” With hindsight, he says, it was a mistake that RBS bought part of ABN Amro – it was so full of bad assets that “if they had got it for nothing it would still have been a disaster”.
One of the most hurtful things was discovering how far RBS had strayed from its culture of caution in investment banking. “When this sort of exposure first came out at Citibank, I thought, well, RBS will be put in a really strong position because they won’t have these. The amount of the exposure just shocked and amazed me,” Mathewson adds. He feels he could not have seen the tragedy coming, even though critics allege that failure to rein in Goodwin during his time as chairman sowed the seeds of RBS’s downfall. Yet he says there were “many other people to blame” than Goodwin and insists RBS’s problem was shared by the whole western world.
“Barclays are just as guilty as RBS, in fact more so,” he says. “John Varley [chief executive] and Bob Diamond [president] were gagging to buy it [ABN Amro]. They were prepared to give up the Barclays name to buy it. That was after they had been inside the bank for six weeks on a friendly due-diligence deal. They were going to buy all of it, not one-third. They must wake up every morning and say, ‘thank God for Fred Goodwin’. I would also like to say 94 per cent of the [RBS] shareholders voted for it.”
Like Mathewson, Burt believes that when he left Bank of Scotland it was in good shape: the deal he engineered in 2001 to merge with Halifax had created a credible future for the bank. With a small Scottish retail base, it was becoming over-dependent on wholesale funding and would have been “mopped up” if it had not merged, he says. Instead, there was a combination of Halifax’s mortgage and retail deposit base with Bank of Scotland’s expertise in corporate and specialist lending.“I retired in January 2003 and I thought it was still a well balanced business. But they seemed to go off the rails. They seemed to drive faster and faster over the next five years,” he says. For him, it felt like “one of those teenage parties where the parents go out and find the house has been trashed”.
Both Burt and Mathewson now fear for the future of Scottish banking. Burt suggests it will now revert for several years to the excessive caution of its past, and that Scotland will see a damaging loss of senior jobs as control of Lloyds is exerted from the south. “In the case of RBS, maybe a third of them will go. In the case of HBOS, how many will be left – 10 per cent?” RBS is expected eventually to regain its independence as the government sells off its stakes in the banks, but views are divided about the chances of Bank of Scotland ever re-emerging from Lloyds as an independent, Scotland-based entity. Last autumn, Sir Peter Burt (former chief executive BOS) and Sir George Mathewson put forward a package to run an independent HBOS – and lead it away from Lloyds TSB, its state-sponsored suitor. Eventually, though, the government’s wishes prevailed and Burt now fears a damaging loss of senior jobs from Scotland.
Archie Kane, representative for Scotland on the Lloyds board and its executive director of insurance, attempts to dispel the anxieties. From his Edinburgh base, Kane is now running an insurance empire with the biggest customer base in the UK, including the enlarged bank’s general insurance businesses, Scottish Widows and Clerical Medical – the life office acquired with HBOS. Kane is concerned that Scots are exaggerating the damage done to their financial institutions, and stresses that Scotland’s life assurers and fund managers have come through the financial crisis “rather well”. “Some of the institutions may be reshaped and may have a different focus, but that is the same if you were in New York or London or Frankfurt … We have to keep reminding ourselves that this is a global crisis – and it is not something we could have opted out of in Scotland,” he says.
Sir Angus Grossart, chairman of merchant bank Noble Grossart, says posterity will tell whether the damage done to Scotland’s reputation is long-term. “There has been a remarkable resilience over the 40 years I have been involved, through many ups and downs. If you have any sense of history, you see that the test is not really to avoid adversity but how you come through it.” There have been crises in the past. In 1772 several Scottish banking houses failed after the Ayr Bank collapsed. The City of Glasgow Bank failed in 1878, leaving many people penniless. In recent times, the City of London’s secondary banking crisis in 1973 had echoes in Scotland, and later some banks that financed North Sea exploration were burned by fluctuations in the oil price. But there has been nothing quite like what has just happened. Grossart thinks the crisis could prove cathartic. “We are approaching the time of classic opportunity for those who have a bit of courage and who are good and well-backed. You have to see these things in terms of a Darwinian cycle of evolution,” he says.
Politicians and business leaders have seized with alacrity on “green shoots” – a decision, for example, by Tesco to site the headquarters for its planned full-service retail bank in Edinburgh, adding more than 200 jobs to the 250 already working at its finance office in the city. It cannot have escaped notice, however, that Tesco hopes to capitalise on public disenchantment with the established banks, not least RBS and HBOS. One recent start-up is Nucleus, a company that aims to shake up the life assurance industry by allowing clients to choose financial products from a technological “wrap platform”. It employs 24 in Edinburgh. The downturn has put back its break-even point to later this year or beyond, but David Ferguson, chief executive, says the damage to Scotland’s reputation has not affected the company because it does not sell itself as a Scottish brand. He thinks others in large organisations might take the entrepreneurial route if they find their careers blunted by the crisis. “They are going to say ‘do I really want to hang around here another five or 10 years while this all sorts out, or can I invest my intellect elsewhere?’,” he suggests.
The non-banking giants of Scottish finance are at pains to distance themselves from the banks’ humiliation. “There may be a rebalancing [of the financial sector] towards the life side and asset managers as against the banks, which had come through very strongly,” says Otto Thoresen, who heads the Edinburgh-based UK arm of Aegon, a Dutch life assurer. “But I feel the sector would be none the worse for that.” Willie Watt, chief executive of Martin Currie, one of Edinburgh’s most successful fund managers, says: “I don’t think the man in the street is equating the problems that RBS and HBOS had with Scottishness – I’d be very worried if they did, but I haven’t felt that.”
The Scottish reputation for prudence, argues Owen Kelly – chief executive of Scottish Financial Enterprise, which promotes the industry – “still resonates in markets like China, where you are looking at a lot of wealth hopefully to be put under management by people with the kind of historical perspective that perhaps is valued more now than before”. Some take comfort from the fact that Scotland missed out on the hedge fund and private equity boom and thus avoided the downturn in those sectors. That can be seen as reinforcing the conservative Scottish approach, although, as Kelly points out, it was not a “consciously chosen strength”. He adds: “If you had asked two or three years ago ‘would you like that [the hedge fund industry] to be in Scotland?’, I am sure I would have said yes.”
Perhaps the most hopeful sign for Scotland comes from the experience of Sir Sandy Crombie, chief executive of Standard Life, who helped save the Edinburgh-based life assurer from a near-death experience five years ago. He sees parallels between the banking crisis and the tougher solvency regime imposed on UK life offices after the dotcom bubble burst. Crombie was parachuted into the role of chief executive of Standard Life in 2004 after it clashed with the City regulator over its solvency. The crisis forced the company to drop its long-held opposition to demutualisation, review its products, cut policyholders’ bonuses and slash its bloated cost base. The workforce has subsequently been cut from 15,000 to just over 10,000. Reputations have “undoubtedly” been affected by the banking crisis that engulfed RBS and HBOS, says Crombie, “but it is not as if what has happened here is isolated and confined to Scotland, and I think the swift action of the government has ensured that the patients have been kept alive. My experience with Standard Life is that sentiment can be made to move on quite quickly.” Crombie has now joined the RBS board as senior independent director.
Scotland, meanwhile, waits to see how deeply the crisis will damage its economy. Until recently, the recession was felt less severely there than in other parts of the UK, but unemployment is now rising rapidly. Margo MacDonald, independent member of the Scottish parliament for Edinburgh, says: “When the banks were seen to have stumbled, I think it did affect the sense of well-being in the city. It was palpable before that. People felt confident. They were more aspirational. They had finally accepted the fact that we were a European capital, albeit a small one.” MacDonald, a former leading figure in the Scottish National party, believes, however, that there is no going back to Scotland’s past subservience to the Westminster parliament. Whereas once there was a feeling that “big things” such as financial and economic management should be left to “big London”, people “don’t think like that any more”. She says faith in London has been severely dented by issues such as the scandal over MPs’ expenses and the government’s decision to take part in the Iraq war. “There is a greater appreciation of the subtleties of sovereignty in a global economy,” she says, arguing that Scotland should exert influence as part of a group including the UK, Ireland and offshore islands around their coasts.
Salmond may not have the majority to hold his referendum but, if Labour does badly in the UK general election due by next spring, the SNP is likely to benefit. A lot of Scots seem comfortable with a nationalist-led devolved government asserting Scotland’s rights even if they do not want full independence. As for Edinburgh, MacDonald thinks it could be healthy for the capital to become less dependent on financial services and exert its strengths in education, research and life sciences. Few expect the financial sector to revert quickly to the heady growth of recent years. They will expect future expansion to be built on more secure foundations.
Brian Groom is the FT’s business, regional and employment editor.
Andrew Bolger is the FT’s Scotland correspondent