Wednesday, March 9, 2011

RBS Crisis: Regulators did not know how much capital was needed

As part of its analysis of the RBS crisis, the Telegraph wrote an article on how the regulators did not understand how much capital was needed at RBS or throughout the UK banking system to restore solvency.

Regular readers of this blog know, that one of the benefits of adhering to the FDR Framework is that the regulators and the market are looking at the same information.  As a result, regulators do not have to rely only on their internal assessment of the situation.  They can ask independent experts as well as competitors for their assessment of the situation.

Another benefit is that it supports functioning structured finance markets and allows these securities to be valued.  This is important when the issue of bank solvency arises as solvency is defined as the market value of the bank's assets exceeding the bank's liabilities.  If the markets are not functioning, it is harder to determine if the market value of the assets exceeds the liabilities.
The Financial Services Authority (FSA) was in denial about the scale of the banking crisis right up to the week of the historic multi-billion-pound bailout in October, 2008, an investigation by The Telegraph has found. 
Just days before the rescue, FSA officials, under chief executive Hector Sants, believed the most the banking system would require in emergency equity was £20bn and insisted that their problems were to do with a lack of liquidity rather than low levels of loss-bearing capital. In fact by the time the crisis was over, the total equity raised by the banking sector came to around £100bn. 
The City watchdog’s failure to identify the key cause of the financial crisis was the culmination of more than a year’s lax governance of banks’ capital levels. 
... In the week of the rescue, while the FSA was claiming £20bn would be enough, the Bank was arguing for a recapitalisation of £75bn-£100bn. 
On October 8, the Treasury outlined a £25bn-£50bn industry-wide recapitalisation plan. Days later Royal Bank of Scotland (RBS) alone was forced into a £20bn equity injection from taxpayers, while HBOS was made to take £11.5bn and Lloyds TSB £5.5bn. By the crisis’s end, the total figure was £100bn. 
The FSA delivered its £20bn estimate to Treasury and Bank officials between October 3 and October 6 2008, based on a worst-case projection for the banks. However, under pressure from officials, it subsequently conducted a second set of tests with more pessimistic inputs and on October 9 decided that RBS alone required £20bn. “There was definitely a big move at the FSA,” one senior source involved in the bailouts said. 
RBS’s collapse was in large part due to billions of pounds being withdrawn by large companies. However, one former manager said the regulator had never required it to stress-test its business for such an eventuality. 

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