Royal Bank of Scotland, Northern Rock and Lloyds Banking Group - Treasury Contents

Examination of Witness (Question Numbers 40-59)


12 JANUARY 2010

  Q40  Sir Peter Viggers: It is very rare for programmes to slip to the left. What are the main factors that might cause the programme to slip to the right? What are the main problems that you envisage in meeting your target?

  Mr Hester: I think that one of the most important aspects of last year was that most of the things that could really blow us up we got past; most of what I will call the blow-up risks we got past, so most of the risks we have now are ones that are likely to be setbacks as opposed to really big blow-up events. I do think that we have particular risks over the next few months in what you might call general election season, because we obviously are the focus of lots of debate which can get caught up in that, and that can be a distraction to our staff and customers in dealing with us. I am not in any way trying to make my previous clumsy point about politicisation because I completely understand why I am here and why these are matters of interest. I was not complaining but I was saying that, since your question was narrowly on our recovering, our commercial recovery and how well it does, as I said before, the more we can be on the business pages for our recovery, the easier my job is to restore the share price but please do not take that as a complaint; it is just trying to answer your question.

  Q41  Mr Plaskitt: Mr Hester, how much tension are you finding between having to rebuild the bank's capital on the one hand and on the other hand being under pressure to increase credit lines?

  Mr Hester: We have tried to be thoughtful in the way we set out our strategy to avoid that tension. What do I mean by that? It is clear that we need to reduce the size of our balance sheet by a larger amount than any bank in history ever has. In fact, I am pleased to report that we are two-thirds of the way towards our target in doing that already, but the way that we chose to do that was, instead of saying we are going to reduce everyone by a bit, what we said was we are going to stop altogether the following lines of business, relationships with people and so on and so forth, and by stopping a whole bunch of things altogether, which takes a number of years to wind off, we can behave normally with what I call our core businesses. So the businesses that you would recognise as our core business—our mortgage lending in the UK, our business support in the UK—are not being constrained artificially as to their balance sheet. Of course, they have commercial constraints in terms of pricing but not in terms of quantum. It was very deliberately our strategy. We will only succeed if we serve customers well and therefore our businesses that are the core businesses on which we will succeed in the future must be unconstrained in their ability to do that other than through risk and commercial constraints.

  Q42  Mr Plaskitt: Can you put a number on the value of the recapitalisation you have done so far?

  Mr Hester: I am not sure I entirely understand you.

  Q43  Mr Plaskitt: Can you give us a percentage point or how many billions of capital have you added to the bank? I am talking about your capital adequacy level.

  Mr Hester: I believe that we have taken all of the capital bolstering measures that we need to take for our plan already, and from this point onwards there will be additional capital that will be retained once we get back to making profits, but the major recapitalisation is done, and in fact, the recapitalisation, the most recent part of that associated with the Asset Protection Scheme, was sized in a way to allow our capital to absorb the losses we expect to make for one more year and still be enough. All of this has to be said with square brackets because the world's regulators are tossing up the capital rules in the air and they may come down in a completely different way but, so far as we know now, we are well capitalised against what we expect, and in particular against one more year of losses. Then I hope I will turn a profit.

  Q44  Mr Plaskitt: Can you quantify it in any way for us?

  Mr Hester: Our core tier one capital ratio, which is probably now the most popular measure used, we have presently a long-run target of 8% for that ratio. It was running at 4% before I joined RBS. It currently is over 10%, which gives us, as I say, some cushion for it to absorb some more losses and still stay above our target.

  Q45  Mr Plaskitt: As you know, the Basel Committee are looking again at capital adequacy requirements, and I am sure you are monitoring what they are doing. The reports we are getting are that it will put additional capital adequacy rebuilding pressures on European and British banks. Have you yet assessed the impact on your bank?

  Mr Hester: We have spent a huge amount of time on this subject, as you would expect us to do. It is impossible to assess where it will finish because the proposals have not yet been made or quantified or the time period for their introduction set out, so all we can do is engage in an ongoing process where there is not yet clarity as to the end position.

  Q46  Mr Plaskitt: Have you any sense yet as to what the impact is going to be?

  Mr Hester: The impact generally is to make the banking industry safer, better capitalised and to hold more capital in different forms but I do not think we can yet quantify it. One of the places where the rubber will really hit the road in the next year or two is that a safer banking industry means less credit for economies and more expensive credit for economies, so there is a tension in all of this in economic policy makers' minds between getting what you wish for, which we might like here and might not like the consequence of there, and I think all of these issues have still to be worked through.

  Q47  Mr Plaskitt: Do you anticipate that the outcome of the discussions at Basel could force you to need to stay above 8% or even 10%?

  Mr Hester: All of these things are possible.

  Q48  Mr Plaskitt: If you had to do that, where would the extra capital come from?

  Mr Hester: As I say, we are currently above 10% and I hope and believe that, whatever the new Basel rules are, there will be a number of years to get into compliance for banks and that should allow us to start making profits again, which I obviously anticipate that we will, and to build up the traditional way.

  Q49  Mr Love: Mr Hester, can I turn to your lending agreements with the Treasury? When you entered them in the beginning of last year, almost a year ago, do you think they were set at a realistic level, especially considering the financial situation that RBS was in at the time?

  Mr Hester: I think they were set at a completely realistic level in terms of our capability to meet them. If that was your point, I have no issue at all with our capability to meet them. The other aspect of the setting of the level was guesswork, because what we and the Treasury were having to do was guess what the demand for credit would be and guess how many market participants would disappear, changing that demand. The guess has proven to be wrong in both directions but, in terms of our ability to have the wherewithal, most certainly we do; we did and do.

  Q50  Mr Love: Can you tell us how well you have done in terms all of those targets?

  Mr Hester: Clearly, we are only part-way through the relevant financial year.

  Q51  Mr Love: You must have a much better idea of whether you are going to touch them.

  Mr Hester: Of course. At the moment it looks like we will handsomely exceed the targets for mortgage lending, and the reason for that is, although there is not a lot of demand for mortgage lending, a lot of people have disappeared from the market and therefore we are stepping into the breach. As it relates to business lending, the inverse has happened: not many people have disappeared from the market, there is also not a lot of demand, and therefore it looks like on the business lending no-one is going to lend a material amount more even though we would very much like to.

  Q52  Mr Love: So is it a lack of demand? Earlier on, when you were talking about the amount of money not being constrained, you did mention risk. Which one is it? Is it that risk has been much greater or is it that the demand has not been there for business loans?

  Mr Hester: I guess, inevitably, that is not a black and white question because clearly, if you were to say "I will lend you money regardless of whether I think you will ever pay it back," you can lend more money. I guess that is axiomatic. It must be true that in a recession there are more people who have a troubled credit outlook who you might worry about lending to than not in a recession. Those must be true but what I can say as it relates to both our mortgage lending and our business lending is that we have very, very high rates of approval to people who ask us for money. So in mortgages on average we give 90% of people who ask us for a mortgage a mortgage, and the equivalent figure for businesses is 85% and those percentages have not significantly changed since pre the recession, and so in that sense, although risk is obviously a part, it does seem to me that people who want money in the large majority are getting it from us.

  Q53  Mr Love: Let me press you on that because the accusation is made specifically by the small business groups that the terms on which the money is offered are both high in terms of interest rates and restrictive in terms of conditions. To what extent would you go along with that? Has the recession made that much of a difference that it is now prohibitive for many small businesses to take the loans that are on offer?

  Mr Hester: Again, I suppose I have to say the answer is a bit of a yes and a no, so let me explain that. In cost terms, the average interest rate on our small business loans is half what it was three years ago, so in cost terms it is absolutely not prohibitive; in fact, it is cheaper. Of course, that is because interest rates have come down, and what is true is that our lending margins had to go up because our borrowing margins have been destroyed and, as I said, our total profit margins have reduced. So there has been a change; the power has shifted from the borrower to the saver in the economy and that means some margin changes even though total affordability has improved because of lower interest rates. In terms of terms and conditions, I think that the period that preceded the financial crash was one of significant instances of unwise borrowing and lending, where the economy was propped up by too much borrowing, not enough saving, and the banks of course played more than a significant role in that whole process. If you were to compare terms and conditions today with their period of greatest laxness, they would have tightened and they should have tightened and I think properly the criticism lies before rather than now. The second thing that I would say to you is that we have instructed our lending officers to try to meet people's need for loans and sometimes therefore if a company is weaker in credit terms than was once the case, rather than saying no, as we might have done in the past, our people are instructed to try and work with the company to come up with a basis on which we can say yes. That might mean some more restrictions than there would have been but it is better than saying no. In that sense, as I say, I think it is a mixed answer.

  Q54  Mr Love: Let me come back to the first question I raised. You have just indicated that you were not pricing for risk effectively before the recession so you knew you had to price more effectively. You knew there was a recession coming, and everybody by the time you reached agreement, and now in 2009, we are out of the depths of the recession. Was it realistic to say that you could reach the figures for business lending that you agreed to and have we raised expectation where we should not have?

  Mr Hester: All of the discussions I was involved in with the Treasury at the time were all about trying to smooth the path of economic adjustment. It was never about lending a particular sum; it was about trying to remove the panic factor of people being starved from credit improperly, which could have happened. The great fear was a disappearance of foreign banks from the market that would leave a big gap in provision even if credit demand was muted. Everyone accepted that the UK had borrowed too much and needed to save more, and therefore that the path had to be actually to borrow less and save more, but the desire was to have that path be a smooth one where companies had the time to adjust. As I said to you, in the mortgage market the commitments were needed because a lot of people did disappear; we have done way more than our commitment by stepping into a gap that was left, which I think was exactly what we were designed to do. That was the point of having them. That gap has not appeared in the business market, foreign banks have not withdrawn in anything like the extent that they did in the mortgage market, so I would say the whole purpose of the lending commitments has in fact been fulfilled but in different segments. It has come about in different ways but what we were always trying to do was to smooth the path of the economy to adjust, and I think that is how it has operated.

  Q55  John Mann: How long have you worked in this country, Mr Hester?

  Mr Hester: I guess ever since I left university.

  Q56  John Mann: How long have you lived in this country?

  Mr Hester: On and off since I was five.

  Q57  John Mann: How many of your staff have indicated that they are thinking of leaving the country should there be any change to the taxation system this year?

  Mr Hester: I am afraid I have not taken that survey.

  Q58  John Mann: You are not aware of any who have indicated?

  Mr Hester: Perhaps I should just answer the question I think you are driving at, if I may.

  Q59  John Mann: Others have given the figures.

  Mr Hester: I do not have a figure to give you. I believe that London and the UK have strong and enduring advantages in financial and business services, some basic ones like language and law and so on and so forth, in addition to location and time zone, and I think that those are advantages which have led to a very big bit of GDP for the UK, which should be encouraged, along with other things that we need to build up, and I do not believe that the UK's position in financial and business services will disappear overnight because of the vagaries of particular tax or other decisions, but I do believe more generally that economies have to figure out what they are good at and try and do that as well as they can and create those conditions, and that goes just as much for encouraging pharmaceutical R&D in this country as it would for encouraging financial and business services.

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