What Dr Andrew McLaughlin saw from a ring-side seat at a bank that failed

Jersey International Business School were pleased to welcome Dr Andrew McLaughlin, Head of Communications and Group Chief Economist for the Royal Bank of Scotland Group (RBS), to talk to our degree students about what he saw from a ring-side seat at a bank that failed. Whilst Andrew visited the school, we took the opportunity to have a chat about what really did go wrong, what could have been handled differently and where we are now…

1.    You’re talking to our students today about what you saw from a ring-side seat at a bank that failed, so, in general terms, what did go wrong?

Lots of things went wrong, but, I think the essence of it is over the course of at least a decade, a series of pressures built up in the economy, bubbles of one kind or another, and many of those pressures in the economy ended up residing on the balance sheet of some of the biggest banks. Banks with big balance sheets found it more difficult to fund themselves. So banks didn’t properly assess and adjust for the big macro risks that were in the economy. Some banks had too much of the same thing, they had concentration risk, whether it being property or in some other kind of asset class, and they hadn’t paid enough attention to the ability to actually fund themselves through a whole business cycle.

2.    If you could go back, what 3 things do you think you would have changed to prevent the financial organisation from failing?

I think the encouraging thing is that, since the crisis, a lot of lessons have been learned and many of the things that you would wish were in place before the crisis are now in place. Throughout the decade leading up to the crisis, the loan-to-deposit ratio of the British banks including RBS kept climbing, climbing, climbing. Most people would take a sensible loan-to-deposit ratio to be 100%, by that I mean for every £1.00 of lending you do you’re taking in £1.00 of deposits. Just before the crisis that ratio climbed above 150% so there was a very simple sign that maybe banks were taking a bit too much risk, they weren’t even backing the loans with deposits, they were borrowing from somewhere else to back up those loans. I think one of the things I would change is simple disciplines around things like that and, indeed, the banks have been changing that since the crisis. The second thing I would say is that banks have to have enough capital, enough shareholder equity, to reassure everyone who depends on them at all times that they are safe and secure, and it’s clear that banks allowed their capital ratios to drop to a level in the good times which took no account for the fact that bad times would come. In the bad times those ratios didn’t look good and it caused funders, investors and customers to lose confidence so I think that’s the other big lesson. We became complacent about risk and therefore complacent about the amount of capital that we should have had. The final thing I would certainly change is culture; I think a decade-long boom from 1997 through to 2007 saw over a period of time ‘hubris’ set into the culture of some of the banks which certainly created the impression that senior people in banks were super human, they almost became detached from society. I remember seeing one bank chief executive turning up at a part with Mick Jagger. It’s very important that the culture of a bank is based on identifying and meeting the needs of its customers. Doing that in a way which thinks about the long term, so it’s prudent about the risks it’s sharing with customers is very important. Banks didn’t look after their customers as well as they should because we have had lots of scandals about products being sold inappropriately. If you get the culture right then most of the other issues we have found will take care of themselves.

3.    Where are we now?

We are 5 years after the crisis and it’s clear that the banks are well advanced in cleaning up and paying for the sins of the past. Substantial progress has been made cleaning up the balance sheet of the banks obviously there has been a complete change in the leadership of the bank and the senior people. Culture obviously takes a while to change because it shouldn’t be something that’s imposed, culture should be derived and not everyone in the bank was doing the wrong thing, and not everyone in banking ever sets out to do things that are harmful to customers, so changing that culture which gradually became inappropriate is probably the last thing that has to happen. But in terms of having a regulatory environment which ensures banks are safe and sounder, we are well advanced, we are almost there, just need to make sure that it’s enduring, that you don’t see any sense of people going back to the sort of things that made the banks weak 10 years ago.

4.    What do you think was the effect/impact on the finance industry and implications to the public, from the crisis?

Companies sometimes forget that they own their brand but they don’t own the reputation. The most enduring impact is reputation damage and a very significant loss of trust with the customers and the rest of society which is going to take years to rebuild and you can’t brand your way out of the problem. Certainly what did happen was that customers’ faith in their banks was shaken, their confidence in the efficiency, effectiveness and integrity of the banking/financial system was shaken and that’s going to take a while to recover from. You buy a service because you can’t do it yourself or you don’t want to. But in buying a service you rely on someone else and give up some control. I think that feeling of losing control is more acute when you are buying a financial service. The antidote to that feeling is trust in the provider of the service. Thankfully, most customers trust our front line staff they see regularly. But they don’t trust the company or its leadership and we need to rebuild this or banks will remain a political football for years.

5.    So you think it will never happen again?

Sadly we have been here before; something similar happened in the 1920s and 30s in different European countries and the US. It’s almost the nature of banking that it finds itself very difficult to step aside from what’s happened in society. It’s not just central banks that have to take the punch bowl away before the party’s finished, clearing banks have to be more prudential and more risk averse in many instances than the societies they serve, otherwise they will get swept along by it. If we maintain the regulations we’ve now got in place it should be easier to fix individual banks and the system if they get into trouble, that’s the hope.

6.    RBSI is mostly still owned by tax payers in the UK – what are your thoughts about the government bailing out the banks? Could it have been handled differently?

Hindsight is a great clarifier but it is still difficult for some people to comprehend how acute the crisis actually was. The chancellor at the time, Alistair Darling, has my long-standing admiration because there were very big judgement calls which had to be made very, very quickly and I don’t think anyone now really says ‘look, Alistair, you should have just let all those banks go, because the Americans let one bank go and it created mayhem’, so I, like anyone else who works in the bank, think it’s a matter of profound regret that any bank should ever have had to be rescued by tax payers’ money, and the whole point of any reforms since 2008 has been to get us to a point where the chances of that happening again are as small as we can possibly make them.

7.    Leading up to the crisis, how important and how big a factor was the human factor?

Any person’s power in part comes from how they behave and their personality but I don’t think it’s so much a question of personality. I think if we look at an individual level, that it does appear to be the case that over a period of time the executives of the companies, not just the chief executives, seem to me to become too powerful. I think it took a crisis to clarify that the chief executive and management team should be accountable to a board, which has a majority of independent non-executive directors on it and that board is accountable to the shareholders. Many boards were simply too weak or ill-equipped to really effectively provide oversight and stewardship of the company alongside the chief executives.

8.    Offshore financial centres are very much in the spotlight; what are your views around governments targeting offshore centres in the fight against tax evasion?

I think it’s inevitable that this is now in the political agenda because you’ve got austerity across Europe, across most of the developed world and governments always become more concerned with fiscal degradation at times of austerity. So, I don’t think it’s a surprise that it’s happening. I would say there is a straight forward antidote to an allegation that you are evasive and that is to be open. If you’ve got nothing to hide you can be transparent, if you’re not transparent you can create an impression you’ve got something to hide.

9.    Where next do you think for the world economy?

I think world growth overall will be OK in the next 5 years, but what will change is the mix, you will see a bit more contribution from America and a bit less contribution from China and that’s no bad thing that it rebalances and changes. I think unfortunately the laggard in all of that will remain the major European economies and Europe has a lot more work to do to deal with the legacy of the crisis and improve its competitive position with the rest of the world.

10.  In your opinion should the UK government dispose of its banking assets?

I think it’s not for me to tell the government what to do with its shares in the banks. The reality is the tax payer bailed out the banks when no-one else would give them the money, so the tax payers deserve to get any upside from that investment. It’s the job of the executive and management of the bank and the staff to try and get the bank in the best possible shape so that the government has the option of selling its shares.

11.  Is there anything else that you feel is an important factor in the failure of the bank?

There are many suspects and they are all guilty. There is a play called ‘An Inspector Calls’ by J. B. Priestly about the death of someone, and when they try and solve the mystery of the death, they discover that directly or indirectly everyone ended up having something to do with it. A crisis of this magnitude and scale is usually multifaceted, there is usually many causes for it.

12.  What are your thoughts about Mark Carney being appointed as the new Governor of the Bank of England?

Hiring from abroad has become a bit of a trend in England. They can’t find an Englishman to run their football team and now it’s the same with the central bank, but by reputation he is one of the most well regarded central bankers in the world. It’s true to say that the Canadian economy’s banking system came through the economic financial crisis in much better shape than many others, so you’re recruiting someone who’s got a good track record in the crisis and it’s probably a good thing to have a completely fresh face in the Bank of England.