Examination of Witness (Question Numbers
12 JANUARY 2010
Q80 Mr Fallon: But you are telling
us you want to grow the profitability of your investment bank
and if you get it wrong, we have got to pick up the tab again?
Mr Hester: No, actually. Not at
all. What I thought I was saying to you is that I am 100% behind
all of the different streams of measures that should allow banks
in the future in times of crisis not to call on the public purse.
At the moment my great effort is to make RBS safe again, to serve
our customers and allow the taxpayer to get his and her money
back, not the other way around. So far our balance sheet has gone
down by £500 billion. That is £500 billion of assets
no longer at risk in RBS that were at risk a year ago.
Chairman: You mentioned the hundreds
of different ways. We have established a "too important to
fail" inquiry to bring clarity to this issue, so if you could
go back, think of 100 different ways, and give us two or three
ways that you want banks to be safe and sound, then we will be
delighted to receive that evidence, Mr Hester.
Q81 John Thurso: I wanted to ask
a couple of questions on the "too big to fail issue"
but can I go back first of all to what was touched on with Mr
Fallon, which is the question of narrow banking? I respectfully
disagree with your view that there is no evidence in the financial
crisis to support a contention that narrow banking would be helpful,
but I want to put that to one side and concentrate on one point,
which goes back to what your capital is doing and it goes back
to why bonuses are paid. That is that historically, if you go
back, investment banking, merchant banking, came out of a partnership
model. Each member had their total wealth involved and therefore
they had an acute sense of and, I would suggest, ability to manage
risk. The problem, those companies having been acquired by larger
companies or having been listed, is that they now have other people's
capital but they are taking the identical reward. Is that not
one of the core problems, that if people are to have massive reward,
then they must personally be taking the risk? That is absolutely
fine. If people want to do that, that is great. But if you are
using other people's capital, namely shareholders, government
or anybody else, then you cannot be expected to have that same
return. Is that not the cultural divide and is that not the cultural
problem that got us into so much of the difficulties we are in?
Mr Hester: Respectfully, I do
not think so but let me try and explain why. As I have said already,
I believe very strongly that highly paid people in all walks of
life should have a significant alignment between that pay and
the future of their institution and how well it does. That is
why we have introduced share-based payments and clawback and all
these things. To that extent I completely agree. However, if you
look at the evidence of the crisis, the two investment banks with
the highest percentage of employee ownership, Lehman Brothers
and Bear Stearns, went bust. Investment banks with the lowest
proportion of employee ownership, like Credit Suisse, my old employer
of some years ago, had a good crisis as these things go, so there
simply was no correlation that you could draw between the extent
to which the employees felt their personal wealth was at risk
and what happened to the institution. So although I happen to
agree with that alignment, I do not think it has the outcome that
you would look for and
Q82 John Thurso: If I may just interrupt,
there is a great difference between getting a telephone number
salary, 70% of which is in shares, but your personal wealth which
you have acquired over several years is elsewhere, and having
your entire personal wealth at unlimited risk in a partnership
where you and your colleagues are making decisions. There is a
world of difference between the two.
Mr Hester: But you know, then
when you look at the Bradford & Bingleys, the Northern Rocks,
the Wachovias, the Washington Mutuals, the Fannie Mae and Freddie
Mac, AIG, if you look at some of the companies that have lost
large amounts of money, these are not companies that you would
be advocating a partnership model for but they are companies that
managed to lose a lot of money.
Q83 John Thurso: We will agree to
differ on that. Considering the RBS business model, what do you
believe is the relationship between the size of the bank and risk?
This is the "too big to fail" question. To what extent
is the size of RBS relative to the risk that it poses to the system?
Mr Hester: I think that sometimes
when people think about this issue they are making an implicit
assumption that I am not sure goes, and that is to say that only
one bank fails at a time. Of course, if only one bank fails at
a time, then you want lots of little banks but if we actually
look at this crisis, were it not for government intervention,
all banks would have failed, so it did not matter how many you
had. You could have had one mega-bank or a million tiny banks
and you would have had the exact same problem on your hands. In
fact, the smaller number of banks made it easier to deal with
because you have less people to deal with to save things. So I
do not think you can actually say that more banks is safer than
less banks as a public policy issue when you are dealing with
systemic crises as opposed to one-offer banks, which are not the
ones that worry people. As it relates to RBS, I do think that
RBS became too big but the issue was not size; it was in a sense
relationships; it was how big the balance sheet was relative to
the capital resources; it was how unstable the funding was; it
was how many disparate things that RBS was in that were not good;
it was how good the management culture was. There are other banks,
like HSBC, that were bigger than RBS that came through very well.
So again, I think size is a red herring in positive and negative.
It is how well something is managed and its inherent commercial
merits. The thing that I would really hope everyone appreciates
and the thing that makes me still optimistic after a difficult
year, my first year at RBS, is that the core businesses of RBS
are really good businesses. They serve customers well, they are
worth rescuing, and they will provide the wherewithal to pay back
Q84 John Thurso: Last question, if
I may. In the Turner review a whole variety of things are discussed:
minimum capital requirements, living wills, Tobin tax, all sorts
of things. What is your view as to the direction in which countries
and regulators should be going to have the best opportunity of
ensuring that any banking institution does not pose a risk to
the system? I know that cannot be eliminated but to minimise it.
Mr Hester: We have attacked this
in two or three different ways and I think the answer is complicated
but necessary, and so there are a whole series of different streams.
You are inviting me to comment. I will give you some examples.
Clearly, counterparty risk can be mitigated by moving a series
of transactions on to exchanges by using security and netting
agreements and a whole series of things, which is a series of
global initiatives. Clearly, liquidity risk can be dealt with
by requiring banks to hold a lot more liquidity and have a different
funding structure. Capital risk by more capital. I do think that
there is a role ... What I would search for is what I might call
a Chapter 11 for banks; in other words, is there a way that you
can reconstruct a bank's capital structure and apportion loss
to creditors whilst having the bank's day-to-day functions of
payments in ATMs and so on carry on undisturbed? All of these
are what you might call a living will, so I think there are multiple
strands that together will get us to the right place but there
is no one single measure
Q85 John Thurso: There is no silver
Mr Hester: No, I think that is
right, and I think this will take a decade but it is very important
Q86 Jim Cousins: If we look at the
Asset Protection Scheme, these represent assets that are sufficiently
risky to require a government guarantee but if the government
guarantee were ever drawn on, there would obviously be considerable
reputational damage. If we look at these things that have been
placed under government guarantee, we see things like a 30
billion commercial property; 50 billion of loan facilities,
largely outside the UK; over 30 billion of derivative contracts,
largely outside the UK. Do not the people running these things
have you over a barrel?
Mr Hester: The people who were
responsible for getting us into bad situations that we regret
now have been fired. Of course, there are still troops around,
if you like, but the generals have been fired. All of our unwanted
assets have been put into a separate division where they can be
separately managed, either by the restructuring group that I referred
to earlier where we are trying to restore companies to health,
or by what I will call rundown specialists whose only job is to
get us out of something as opposed to the people who got us into
it. It is true that the way we manage the people in our non-core
division is very different. We are asking them, in a sense, to
do themselves out of a job, and that is a specialised management,
and in fact, one of the things I was fortunate about in my career
is on a couple of previous occasions I have used the same device,
most recently in Abbey National in the early 2000s, and have some
experience in it, but we therefore try and do it, if you like,
completely away from the line and the workplace that that was
brought on. So I cannot think of any instance in the management
of those assets where I would describe us as being "over
a barrel" to the people managing them.
Q87 Jim Cousins: Are those rundown
specialists being paid bonuses?
Mr Hester: The assumption will
be yes but obviously the merits of their goals are not about putting
on new positions or making profit. Their goals are about risk
reduction, and then they would be paid competitively whatever
that particular job is to other jobs that they could otherwise
have. In fact, interestingly, one of the things that the Treasury
insisted on in the Asset Protection Scheme is that the RBS people
working on those assets were not disadvantaged in pay terms against
anyone else, and I was of course pleased to accede to that.
Q88 Jim Cousins: Do forgive me. The
Treasury insisted that the people running the assets placed with
the Asset Protection Scheme should not be disadvantaged in terms
of access to bonuses?
Mr Hester: Correct.
Q89 Ms Keeble: There was a kind of
deal that was made with the government, more importantly with
the taxpayers, with our constituents, that in return for bailing
out the banks, the banks would deal with the bonuses and reach
certain lending targets, increased lending. This morning you have
given us very cogent, sanguine arguments about the fact that you
intend to carry on paying bonuses, as do the other banks, and
you have given very cogent arguments about why you have not been
able to reach the lending targets. The British Bankers' Association
figures on lending are actually quite grim and those are probably
a bigger source of grievance for the public actually in some ways
than the bonuses. Are you not concerned that this failure to deliver
on your side of the deal, as it were, is a real source of grievance
for the public and also probably presents the biggest constraint
on public policy towards financial services going forward of anything?
Mr Hester: I think that anything
that can give rise to controversy in the eyes of the public or
our customers is something that I should be concerned about, so
the simple answer to your question is yes. However, I am also
bound to say that I do not regard us as having not met our commitments.
In fact, I am absolutely adamant that we have met our commitments,
and if you are someone in search of a mortgage, nine out of ten
times we will say yes to you. I think that is an appropriate statistic
and eight and a half times out of ten we will say yes to you if
you are asking for a small business loan. I am afraid to say to
you that I think that those are absolutely hard evidence that
we are meeting our commitments. We have something like £30
billion of undrawn overdrafts available to UK businesses, that
at any time they could get that money if they needed it without
any more negotiations with us or conditions or anything. So we
are absolutely clear. I have a legal obligation to meet those
commitments on behalf of RBS and we have, but do I worry about
what our customers think and the public think? Absolutely, I do
Q90 Chairman: Since the bonuses are
discretionary, on what basis did you decide to pay the record
amounts to some of these executives in the investment bank?
Mr Hester: As I mentioned earlier
on, there have not been any decisions made to pay anything.
Q91 Chairman: You have paid people.
It is just that you are not reporting it until a couple of months'
Mr Hester: No, no, no. The bonus
decisions have not been made.
Q92 Chairman: You mean at the end
of the calendar year that finished in December you do not have
Mr Hester: They cannot be done
until after because you need to know the results, which you do
not know until you have the books.
Q93 Chairman: You know roughly. Come
Mr Hester: As the timetable currently
looksit might moveI would expect in late February
our people will be told whether they will get a bonus and, if
so, what it would be. That is what I expect the timetable to be,
and then the bonus would be made available to them over the ensuing
three years according to the vesting schedule. That is what I
expect. To answer a different bit of your question, you are asking
on what basis. For each individual there are in effect two processes
that go on. Part of it is: what did you and your team and your
area do this year and how does that compare to what we asked you
to do? Is it better or worse? You get some sort of balanced forecast
because obviously everyone has different objectives that you set
them. Secondly: what is the market rate for that sort of a job?
Because, as I have said many times, I do not want to pay a penny
more than we need to and so I need to understand what we need
to as well as what is deserving, and to bring those two things
together, and then of course that is scrutinised by very many
people. That is the process but it will not be until late February
that any of our people know what, if any, bonus they have.
Q94 Chairman: Yes, but you have a
fair idea what is happening at the moment as you come to us. Have
institutional investors raised concerns or given you directions
Mr Hester: My summary of the position
as I understand it from our institutional investors is that they
are all highly conscious of the very difficult challenges that
exist in turning RBS around successfully and making them money.
They believe that we need highly qualified and motivated people
to do that and to compete against people, and they want to make
sure we have that. Subject to that, they would like the biggest
profits possible and therefore the lowest bonuses.
Q95 Chairman: So the answer to my
question is they have not raised concerns or given you directions?
Mr Hester: They want us to optimise
the balance between having the lowest possible expenses
Q96 Chairman: I think it is a very
simple question, Mr Hester. Have they raised concerns or given
you directions? That is all I want. Just a simple answer.
Mr Hester: They have raised concerns
about our ability to keep and motivate good people. They have
raised plenty of concerns about that, and the institutional shareholders
all continue to have rules as it relates to remuneration on the
Q97 Chairman: You said that a safer
banking system will reduce the pace of economic growth. You said
that here. Do you think the City has woken up to the fact that
the rest of the economy may value stability more than innovation
and the spirit of breakneck growth that we have seen in the past
Mr Hester: It is hard for me to
comment on the City in general but I certainly would offer you
my personal observation, which is, in general, banking is a mature
industry and should experience single digit growth rates. Part
of the problem was that banking started to think that it was a
growth industry, with double digit growth rates and revved the
engine too fast and, by the way, economies made exactly the same
mistakes and banks were the mirror image of what was going on
in the economy. But I do think that banks will be better managed
if they are managed appropriately for a mature industry rather
than in a dash for growth.
Q98 Chairman: The investment bankers,
the traders and the top management whose actions have contributed
to this crisis seem to be getting telephone number bonuses still
but the vast majority of bank employees get a fraction of that.
What does that say about the way that banks value their employees
or the penalties that exist for failure?
Mr Hester: Clearly, there are
very important matters of political philosophy as it relates to
income distribution and I think it is probably not my place, and
it is not the right time anyway, for us to go into those. With
respect to how people in banks are paid, I submit to you I think
it is very similar to how you would pay people in accounting firms
or in any other walk of life, which is to say that individual
jobs are compared against other comparable individual jobs and
there is a wage rate and, obviously, the more diverse a company,
the more diverse you will have those wage rates
Q99 Chairman: It is not your place
to comment on public policy but have you gone into this issue
in your own institution regarding income distribution, particularly
in light of the job losses of over 20,000 that have been postulated
at the moment?
Mr Hester: I do not have a political
goal for a particular range of income distribution in RBS. My
goal is to help RBS recover, to serve our customers well and to
rebuild the share price, I want us to be as efficient as possible,
and I want our costs to be as low as possible, in each case subject
to having good and motivated people in our different businesses.
That is what I am trying to do.