Essay on Managing Operational Risks in Financial Institutions
Historically, RBS was one of the most reputable and renowned banks of the UK, which though used to operate in Scotland mainly. However, the changed economic environment opened large opportunities for RBS to expand its business throughout the UK first, and then internationally. The 2000s marked the unparalleled growth of the bank with acquisitions, which do not always related to the banking industry. As a result, within less than a decade, from 2000 to 2007, RBS became one of the largest banks in the world. However, such expansion eventually resulted in the crisis that led RBS to the bailout. At the same time, one of the major factors that contributed to the downfall of RBS was the poor operational management which prevented the bank from the adequate assessment of risks and threats. Acquisitions made by the bank in the 2000s were too large for the bank to complete them successfully and safely, but the bank’s operational risk management failed to uncover any threats.
Operational risks and problems faced by RBS in 2008
The moment, which sealed RBS’s fate, came in October 2007, with the £49 billion takeover of ABN Amro, the biggest bank in the Netherlands. However, this acquisition was a big but not the only one within less than a decade. In this regard, it is worth mentioning acquisitions of Royal Insurance, Churchill Insurance and Charter One were among the major deals which followed (seven in 2003 alone) as RBS steadily climbed the league table of Big Banks (Boonstra & Gravenhorst, 2008).
However, the problem of RBS was that the bank was buying companies when their share price was at its peak, rather than when shares were at rock bottom (Crosby, 2009). As a result, the bank paid the possibly higher price but could not manage the purchased companies properly. In fact, often acquisitions were close to failures. At any rate, the restructuring and integration of new companies into the bank’s structure became extremely challenging and almost always caused a considerable downturn in the performance of companies acquired by RBS. RBS, in its turn, also deteriorated its performance, while risks grew stronger as the bank continued to acquire new companies, while deals grew more and more costly.
In December 2007, RBS eases investor fears when it reveals lower-than-expected write-downs of £1.5bn for both RBS and ABN Amro following the meltdown in the US sub-prime mortgage market. The bank offsets £250m of the write-downs by using its own cash reserves instead of turning to the increasingly expensive wholesale credit markets (Hamel & Prahalad, 2009).
However, by April 2008, RBS reaches the extremely high level of credit crunched write-downs which have reached UKP 5,9 billion (Hamel & Prahalad, 2009). In actuality, the overall losses of the bank turned out to be much more significant and totaled with a loss of £28 billion, the biggest in British corporate history (Hamel & Prahalad, 2009). After such a loss, RBS’ share prices collapsed from £6.03 in March 2007 to 11.6p in 2008 (Hamel & Prahalad, 2009).
In such a situation, the bank faced considerable financial problems by that time and the disaster was just coming up. In this regard, the major problem of RBS was the fact that the share of high-risk assets owned by RBS became too high, while top executives of the bank failed to notice the upcoming disaster that reveals the ineffectiveness of operational risk management of the bank. At any rate, top executives of the bank should have noticed that every new acquisition becomes more and more challenging and the larger the acquisition is the more difficult it is for the bank to complete the acquisition successfully. In this regard, the acquisition of ABN Amro was the last straw, while the financial crisis in the US and bankruptcy of largest American banks trigged the disaster that had to happen because of too risky policies conducted by RBS in regard to its assets. In 2008, it became obvious that RBS failed to balance its assets and high risk assets became the unbearable burden that led RBS to the bailout.
RBS’ response to the problems
In response to the obvious threat of the rapid and steep downturn, RBS asks shareholders to pump in UKP 12 billion. Europe’s biggest rights issue forces chief executive Sir Fred Goodwin on the defensive, although he dismisses talk of him resigning (Hamel & Prahalad, 2009). Nevertheless, the bank’s troubles became obvious and the urgent need for the government support became essential for the survival of the bank.
In 2013, RBS still had £54.6bn of what it calls non-core assets (RBS Key Financial statistics, 2014). Therefore, even five years after the crisis that put the bank on the edge of survival, the share of non-core assets, which are potentially risky is still very high. More important, the problem of those non-core assets is not just risks associated with them but it is rather the risk that such a large share of non-core assets will prevent RBS from the successful recovery.
Experts (RBS Key Financial statistics, 2014) recommend to “manage the run-down of high-risk assets” of around £38bn by the end of 2013. “The goal is to remove 55-70% of these assets over the next two years (RBS Key Financial statistics, 2014). However, the bank has not done it so far.
In such a way, the current financial position and policies conducted by RBS show that the bank is recovering but its recovery is too slow and uncertain. In this respect, the poor operational management of the bank is evident since the bank cannot get rid of high risk assets and non-core assets, which are often all the same. Probably, the government involvement prevents the bank from the effective management of operational risks that would allow RBS to sell off its risky assets fast, even if it resulted in job cuts and possible negative effects on certain companies or local economy. Instead, the board and executives of the bank are currently taking cautious decisions and cannot cut off high-risk assets immediately.
Recommendations to RBS to manage operational risks
On analyzing roots of the problem of RBS and its deepest crisis in 2008, it is important to place emphasis on the fact that the major problem of RBS was the poor operational risks management. The bank pursued fast growth and leadership in the industry at cost of purchasing high risk assets at the peak of their price, when they were the most expensive. However, these assets did not bring the bank desirable effects. Moreover, the accumulation of such assets made the bank incapable to resist to the negative impact of the financial crisis. Therefore, it is non-core, high risk assets that are the primary cause of the operational risks and problems of the bank at the moment.
Hence, willingly or not, the bank will have to get rid of all of its high risk, non-core assets. This step may confront the opposition within RBS as well as from the part of the government but this decision is essential to help RBS to recover faster. Otherwise, RBS will keep stumbling until its final downfall since any new downturn in the economic development of the world or financial markets of the US, the UK or the EU, and RBS will be on the edge of survival again with its high risk assets.
Furthermore, the bank should enhance its operational risk management through regular auditing and monitoring of its assets to identify immediately risky assets. At the same time, auditing and monitoring will help to assess the actual potential of the bank. In other words, auditing and monitoring will help the bank to assess adequately its resources and position in the market. Therefore, the bank will not take risky decisions, which may lead to uncertain effects, because executives will be aware that those decisions will be unaffordable for the bank.
At the same time, it is possible to recommend changing the system of control over top executives. In fact, the downfall of RBS in 2008 was, to a significant extent, the result of policies conducted by Sir Fred Goodwin. In this regard, the model of decision making needs changes since the CEO of the company should not take decisions one-sidedly. Instead, it is the board that should participate in the decision making process that means that all top executives should conduct the marketing analysis and the analysis of existing risks and threats before taking the final decision of the board.
Finally, the bank should consider options to change its asset policies. What is meant here is the fact that the bank should integrate acquired assets or sell them off (Brown, 2003). There are no other alternatives for RBS so far. The bank cannot spend substantial resources on the maintenance of assets that pulling the bank down and the bank may eventually sink, if it fails to optimize its assets not only through sales but also through organisational changes that will help the bank to integrate non-core assets and make them either core or just refuse from those assets.
Conclusion
Thus, the financial crisis of 2008 revealed the vulnerability of RBS to numerous risks and threats associated with the unreasonable investment into non-core assets, many of which are high risk and, therefore dangerous for the stability of the bank. Moreover, the main problem of RBS was and, to a significant extent, remains the problem of the large share of non-core assets which the bank cannot fully and successfully integrated into its organizational structure. As a result, after making an expensive acquisition, because RBS often made acquisitions at the peak of share price of target companies, the bank acquired high risk assets that required substantial financial resources, while their performance and the performance of the bank deteriorated consistently. The bank is trying to recover but it fails so far because of its non-core assets that still comprise a large share of the bank’s total assets. In such a situation, it is possible to recommend RBS to sell off non-core assets finally. At the same time, the bank should conduct changes in its operational risk management introducing auditing and monitoring policies to control top managers of the bank and to assess adequately the current position of the bank as well as to forecast decisions that the board is going to take. Finally, the bank should consider ways of optimization of its complex organisational structure with the possibility of integration of existing assets that still can be used effectively by the bank.
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