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RBS - Lessons from Failure

Wickland Westcott reviews the Boards of many of the UK’s top organisations. Here, one of our Senior Consultants Stuart O’Reilly, distils the key learning from the failure of RBS.

In October 2008 RBS failed and was part nationalised.The reasons for the failure were much debated in the press, with sentiment largely centring around an ambitious Chief Executive who over reached himself and whose domineering style neutered the Board.  Other points of view expressed were that the failure resulted from a weak board with limited banking knowledge combined with a culture of greed, and poor risk management. The FSA report into the failure of RBS provides a comprehensive analysis of the reasons why it had to be rescued by the Government, and identifies six key factors: 

  • Significant weaknesses in the RBS capital position as a result of management decisions and an inadequate regulatory capital framework.
  • Over reliance on risky short term wholesale funding.
  • Concerns and uncertainties about RBS’ underlying asset quality.
  • Substantial losses in credit trading activities which eroded market confidence.
  • The ABN AMRO acquisition which went ahead without appropriate heed to the risks involved.
  • An overall systemic crisis in which banks in the worst relative positions were extremely vulnerable to failure.

The report states: “The multiple poor decisions that RBS made suggest moreover that there are likely to have been underlying deficiencies in RBS management, governance and culture which made it prone to make poor decisions.”  The FSA considered this as a seventh key factor in explaining RBS’ failure.

It is clear that RBS did make a number of risky decisions, such as keeping RBS lightly capitalised in order to maintain an efficient balance sheet. However, interestingly, the review team concluded that some of these were understandable given the context and period, while others with hindsight were clearly poor decisions. The report has been criticised in some quarters for not providing enough evidence to bring proceedings against key RBS executives and it is true that the report is written in a careful, balanced style, possibly to avoid any potential legal challenge.

In focusing on management, governance and cultural aspects of the failure, the review team asked a number of specific questions. These concerned the effectiveness of the Board’s oversight and challenge as whole, the Board’s supervision of strategy, the CEO’s leadership capability and management style, and quality of risk control and management information. Additionally they looked at the Board’s role in relation to the ABN AMRO acquisition and whether the Board in their desire to make RBS one of the leading banks in the world did not take enough account of the ABN AMRO deal. This acquisition appears to have been the factor that ultimately tipped RBS over the edge. 

Other key questions from the review team centre on the incentivisation of the Chief Executive and the business as a whole which made it rational to focus on increasing revenue, profits, assets and leverage as opposed to liquidity and asset quality. It should be noted that this, however, was no different from any other banks.  

In answering these questions the review team’s conclusion is that the Board included members whose skills and experience were relevant and who had successful track records. The Chairman took care to allow Board members to state their views and to involve them and that the Board followed formal processes.  In this respect there was no evidence of a failing of formal governance processes. However, given that the company ultimately failed and the Board had a responsibility for the stewardship of the company, de facto they did fail. Clearly what this shows is that formal governance alone is not the answer. The FSA are also careful to avoid drawing the conclusion that the absence of poor governance means that the board was in fact well governed.

The review team argue that whilst RBS had an opportunistic strategy, this was not negative in itself. In terms of the dynamics with the Board there does seem to have been very little disagreement on major issues. This is perhaps surprising given the Board contained a number of tough and experienced individuals. In particular there seems to have been very little debate about the extent of the risk associated with the large scale and very complex ABN Amro transaction, and no dissension from any Board member regarding whether they should proceed. This can only be partially explained by the fact that adequate due diligence was prevented by the hostile nature of the takeover. One individual did say that they thought the Board may have been a victim of a groupthink – a syndrome within groups where the desire for harmony outweighs the realistic appraisal of alternatives. This is perhaps one of the most surprising aspects of the report given that with hindsight it can be seen as a calamitous deal with few redeeming features. Even at the time it was criticised outside of the company. There were some views from the Board that RBS’s successful earlier integration of the larger NatWest gave it a level of optimism that it could handle the transaction. Interestingly there is little evidence that the Chief Executive dominated the Board. He is reported to have been courteous, not to have interrupted, and to have followed up on the actions that were given. This said, one individual did say that his mastery of detail and forensic analysis made individuals think carefully before posing questions or putting across points of view. However, despite Board members saying that they were not bullied and that they did effectively challenge the CEO, they could provide few specific examples of where they actually had done this. It was also evident that the FSA’s supervisory team had concerns about the level of dominance exerted by Fred Goodwin as far back as 2003. Additionally, and probably most critically, there were a number of issues with RBS’ risk control and management information. As a result whilst the evidence in not conclusive, there is a suggestion that the Board was not adequately sighted on the aggregation of risk across the Group. No clear conclusions were drawn on the extent to which incentive plans were responsible for focusing the executive team on the wrong outcomes, but the report does question whether the seventeen member Board team may have been too large. 

In summary, the review confirms what we know about catastrophic failures, whether nuclear, aeronautical, military or organisational – they are often the result of many inter-related factors which may not have been obvious at the time. Indeed, in isolation many of the decisions taken will seem to have been reasonable ones. It is the cumulative combination of these successive decisions, within a dangerous broader context, that triggers the calamity.

What then can Boards do to guard against failure?

Pay real attention to high level risk issues and ensure that even the unlikely scenarios are considered, particularly those which might impact on the organisation’s reputation.

Drive a ferocious focus on risk management so that the Board is getting top quality, wide ranging data to evaluate the real risks to the business.

Be confident enough to voice concerns even if they are not supported by a comprehensive set of facts and data.

Ensure that enough of the Board have deep sets of experience in key areas which are relevant to the business. This is not to enable the Board to second guess the Executive but to give themselves the best chance of spotting things that might be wrong. Not all of the Board need to have this experience, as over-doing this might impact negatively on the diversity of the Board.

Take great care with remuneration systems for Executives. This has become a highly technical area often clouded in mystery but ultimately the Board needs to be sure that the way it incentivises its Executives results in the right behaviour.

Ensure that the necessary belief that the business can be successful is accompanied by a balanced willingness to confront reality so that appropriate confidence does not turn into ungrounded optimism. 

These points also highlight the critical difference between the role of the Executive and the NEDs. The Executive needs to be the optimistic driving force of the business, playing the key role in convincing the staff that the direction is not only the right one but likely to be successful. Whilst they need to be alive to any data that illustrates that strategy needs to be changed they cannot allow themselves to be plagued by doubt. The NEDs therefore need to be the predominant counter-weight to this optimism. To do this they must be equipped with a broad enough set of experience against which to test a range of situations, coupled with influence skills to enable them to challenge the Executive without coming across as the play-it-safe prophets of doom.

For a conversation about Boards, call Stuart O’Reilly on 0207 224 2071.

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