Daily Archives: December 12, 2011

Required reading for the directors of all large companies: the chapter headed “Management, governance and culture” in the Financial Services Authority’s report on the failure of the Royal Bank of Scotland. What this tells us is that the collapse was not just the result of buying ABN Amro at the wrong price and the wrong time, disastrous though that was. Rather, this bid was just one of a whole series of bad boardroom decisions which taken together point to substantive failures of board effectiveness at RBS. And the lessons from what went wrong are relevant well beyond the banking system.

On the face of it, the RBS board’s composition and formal processes met acceptable standards.  Sir Tom McKillop, the chairman, had familiarised himself with the bank’s business, made sure that everyone had a chance to speak their mind and improved the transparency of the chairman’s committee.

And although Sir Fred Goodwin, the chief executive, was a forceful and sometimes terrifying figure, the FSA concludes that the picture was “clearly more complex than the one-dimensional ‘dominant CEO’ sometimes suggested in the media”. He could come across as “somewhat cold, analytical and unsympathetic” but he could also be courteous and professional and would only intervene infrequently in board meetings.

So why were things allowed to go so badly wrong? The answer is that the bank only did what most of its competitors were doing at the time, but took its excesses to greater extremes. The starting point was the extraordinarily successful takeover of National Westminster Bank, which made RBS think it could walk on water. It did almost no due diligence ahead of the ABN Amro bid, which does not appear to have been challenged by anyone on the board. Sir Fred “is and was an optimist”, one of his colleagues said. “And he tended to take an optimistic view of what was likely to happen, and had often in his life been proved right.”

This view permeated the whole business, and was reinforced by incentives that made it rational for Sir Fred and his colleagues to concentrate on increasing revenue, profits, assets and leverage rather than on capital, liquidity and asset quality.  The RBS experience shows yet again what madness it is for banks to focus on the returns on equity, rather than on their overall assets.

With 17 directors, the board was too big for effective discussion and challenge, and seems to have been badly infected by group think.  The non-executive directors were mostly establishment figures, unlikely in the main to be boat-rockers.

The view seemed to be that if others were pushing ahead in one direction – the structured credit market, for instance – then RBS should push even harder. Hence the disastrous decision to expand this business hugely at just the wrong moment and to keep charging on even when the wheels started to fall off. And of course the board was urged on its way, especially in the case of the ABN bid, by advisers who had a direct interest in the company taking on more risk: the fees paid to the investment banks were dependent on the takeover succeeding.

The FSA asks whether it might have helped if there had been more banking experience on the board, but concludes that perhaps not: the same overoptimistic assumptions were shared by many other bankers at the time. And the RBS bankers themselves did not have all the answers: Johnny Cameron, the executive responsible for this part of the business, told the FSA: “I don’t think even at that point (2007)… I had enough information.  Brian (a colleague) may have thought I understood more than I did… And it’s around this time that I became clearer on what CDOs (collateralised debt obligations) were, but it’s probably later.”

The authority frankly recognises its own failings and argues that had the current regulatory system been in place, the bank would not have failed. That may well be true. But since the underlying problem was about governance, it is vital that the broader lessons are learnt.  These are that a forceful chief executive in a complex business and with the wrong incentives is unlikely to be constrained by an over-large board of directors drawn from the same establishment pool – and that the results can be disastrous.

The writer is chancellor of the University of Warwick, a former head of the Confederation of British Industry and previous editor of the Financial Times

Are we on the verge of a Russian spring? Not likely. Angry citizens have taken to the streets to protest the lack of genuine democracy in their country and the economic opportunities they hope it might bring. But the ability of Russia’s party of power to weather this storm is much stronger than in Hosni Mubarak’s Egypt. Russia’s government holds more than $500bn in hard currency reserves – $120bn of which can be injected quickly into popularity-enhancing social projects. Nor is there the sort of division within Russia’s military or security forces that we saw in Cairo, or the Arab world’s demographic swell of unemployed young men.

The country’s political opposition does not pose much of a threat to the current system. In fact, A Just Russia and the Liberal Democratic party – the parties that ran third and fourth in the December 4 parliamentary elections and captured almost one quarter of the vote – are Kremlin-created. Their leaders may begin to push for a semi-independent legislative agenda, but they will not become a focal point for any co-ordinated challenge to Vladimir Putin’s rule. He will again be elected president in March and take office in May.

Much more likely is a slow erosion of Mr Putin’s longer-term legitimacy. The dissent is real and the protesters have demonstrated some backbone. His pivot back to the presidency leaves them worried that if nothing has changed in Russia’s politics, nothing will change in its economy. An explosion of social media inside the country has made vote-rigging much more visible.

But Mr Putin can still rise to the occasion. Once re-elected, will he undertake real reform, the kind he allowed outgoing president Dmitry Medvedev to promise but not deliver? The return of Alexei Kudrin, a respected former finance minister, would be a hopeful sign. So would an honest effort to tackle Russia’s endemic corruption and to streamline its bloated bureaucracy. Or will Mr Putin simply appease some Russians with increased social spending and bully others with the heavy hand of the state?

The signs are not encouraging. Without a credible opponent, Mr Putin apparently feels little need to make new promises. Since announcing his return to the presidency, he has used speeches and interviews to boast of past accomplishments rather than to offer a vision of the country’s future. But Russians want more than stability; they want progress.

Perhaps worries that turmoil in the eurozone will weigh on trade flows, oil prices and Russia’s immediate future have increased Mr Putin’s aversion to the risks that come with change. But the need for economic modernisation and diversification is becoming more urgent. Social spending and defence now account for 60 per cent of Russia’s budget, and reform of taxes and pensions is fast becoming a priority. Gross domestic product growth next year is forecast at about 4 per cent. That is not bad, but it is not enough to keep pace with more dynamic emerging countries such as China, Brazil or Indonesia. It is also probably not enough to satisfy an increasingly restive electorate.

Mr Putin can still turn this around, but so far he has provided no plan. He will not need one to win the next election. But he will if he is to provide Russians with the change they have begun to demand.

The writer is the president of Eurasia Group, a political risk consultancy, and author of ‘The End of the Free Market’

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