The FSA's report into the failure of RBS - Treasury Contents


4  Report approach and value

The need for transparency and accountability

94.  The financial crisis that began in 2007 had a very serious impact on both the financial system and economy of the United Kingdom. In order to maintain financial stability the Government of the day took unprecedented action: it took ownership of Northern Rock and of part of Bradford & Bingley, and bought large stakes in Lloyds Banking Group and the Royal Bank of Scotland (RBS). These interventions are still weighing on the Government's finances. According to the National Audit Office:

The total outstanding support explicitly pledged to the banks as at 31 March 2011 is £456.33 billion, down from £612.58 billion as at 31 March 2010, and from a peak of some £1.162 trillion. The total outstanding support is 31 per cent of Gross Domestic Product as at March 2011. Of the total support, £123.93 billion was provided in the form of loans or share purchases, which required a transfer of cash from the Government to the banks. A further £332.40 billion relates to guarantees and other forms of contingent liability where the Government will only provide cash if certain events arise.[129]

95.  The sheer scale of the Government intervention as a result of the financial crisis underlines the necessity of properly understanding the causes of the crisis, and the causes of individual bank failures.

96.  By far the largest recipient of capital from the Government was RBS, who received a total of £45.8 billion in cash injections during and after October 2008.[130]

97.  In putting out a one-page, 298-word summary of their decision not to take enforcement action against the bank or any individuals after their investigation into RBS, the FSA showed an astonishing lack of appreciation of the understandable public interest in the failure of RBS. At the time, Lord Turner argued in an opinion piece in the Financial Times that:

The causes of the crisis and the role of ill-designed international regulations, poor supervisory practices and bank risk-taking are well understood. In April 2008 the FSA published a report into the Northern Rock failure and set out, more openly than any other financial authority, the inadequacies of our approach. A complete reform of FSA supervisory approaches followed. Then in March 2009 we published my own Turner Review, which detailed how globally agreed capital adequacy and liquidity rules were woefully deficient pre-crisis, allowing banks to take dangerous risks. The international community is midway through radical reforms to put this right too.

It would be possible to add a report looking just at the RBS story. Such a report would be more comprehensive than the FSA's internal investigation, which focused solely on whether individuals broke FSA rules. But it would add little, if anything, to our understanding of what went wrong.[131]

98.  The assessment of Sir David Walker was that putting out a one-page statement was both "unreasonable" and "a mistake".[132] In a letter to the Chairman of this Committee on 11 December 2011 Lord Turner acknowledged the "legitimate public interest in receiving a detailed account of this very major bank failure",[133] and at the time of his appearance before the Treasury Committee on 30 January 2012 he admitted that he had underestimated the strength of public feeling in relation to the RBS failure:

I entirely accept that what we, and I personally, failed to focus on at the time was that it is important when something has gone wrong that there is a public account of it. We stuck too narrowly to our existing procedures. [...] I wish that back in 2009 I—or other people might have suggested it—had realised that the failure of RBS was such a big thing that we should have a public accountability report. That is what I now believe.[134]

He also agreed with Sir David's assessment that the FSA had made an error, saying that they were "not being imaginative enough in realising that this would require a wider accountability. That was a mistake."[135]

99.  The public interest in the failure of RBS in part reflects a desire simply to understand what went wrong. Transparency is also necessary to ensure that Parliament is equipped with the information it needs to ensure that the raft of financial services regulation being proposed at the moment reflects the lessons learnt from mistakes made in the run-up to the crisis. Transparency is, moreover, crucial to our ability as a Committee publicly to hold regulators to account. Hector Sants acknowledged the necessity of this when he appeared before the Committee, stating, "I also strongly believe—and this report and this process is part of it—that the regulators should be accountable for what they have done and the actions they have taken."[136]

100.  There is a clear need in cases of bank failure of the magnitude of RBS for public accountability about how and why that failure has occurred. Where public—that is ultimately taxpayers'—money is used to support a business in the private sector there is a need for a full public explanation. In December 2010 the FSA initially felt that a 298-word statement about RBS's failure was explanation enough. This reflects serious flaws in the culture and governance of the regulator. It also reflects a fundamental misunderstanding of its duty to account for its actions to the public and Parliament. In view of the vast amounts of public money committed to propping up RBS, Lord Turner's comment that a Report into the demise of RBS "would add little, if anything, to our understanding of what went wrong" was inadequate. He should have grasped the need for a public explanation of how that situation had arisen, something which he has subsequently acknowledged. We would not expect the new chairmen of the regulators to repeat the error.

The review process: efficiency, value for money and objectivity

VALUE FOR MONEY AND EFFICIENCY

101.  The FSA Report into the failure of RBS took the form of an internal review (that is, the bulk of the review was conducted by FSA staff), supplemented by the oversight and observations of independent reviewers appointed by the Treasury Committee. The Report therefore not only answers the need for public accountability about the failure of RBS, but also acts as a test-case for this approach.

102.  Evidence we received on the approach focussed on two main areas: efficiency and value for money, and objectivity. In his evidence to us, Sir David highlighted one considerable advantage of this approach:

In relation to the efficiency of the process, my expectation would be that if as an alternative route this Committee or whoever engaged lawyers and accountants to do a full investigation [...] it would have taken a much longer time, perhaps two or three years, not 12 months, and would have been hugely more expensive. It is quite interesting that the FSA review team was a bit more than 10 man-year full-time equivalent and the total cost of that was between £2 million and £3 million. The PwC investigation [which supported the enforcement case] cost very significantly more than that, and that was focused exclusively on the enforcement part of the exercise, not on the history, which probably is of larger interest certainly in bringing the facts to light. So, the cost consideration is also relevant.[137]

103.  The original investigation undertaken by PwC to support the possible enforcement action was reported to have taken 19 months and cost £7.7 million.[138] Mr Knight agreed with this assessment. He said that an advantage of this approach was "speed and cost and getting the facts out."[139] He also noted that "experience shows, certainly in the case of Companies Act inspections, that such inquiries take a very long time, cost a great deal of money and often are quite noncommittal."[140]

104.  The internal review approach may have time-and cost-saving benefits, but Lord Turner did highlight in his evidence to us that it was still a resource-intensive process for the FSA. He noted:

One of the problems on the whole—although I think this process has been incredibly successful, the combination of an internal process with external reviewers has produced a high-quality report—it is very time consuming for a lot of our best people. It is time consuming at a senior level. It has been very time consuming for myself. So a bit of me thinks that the best thing would be simply to pay somebody else to do it at that stage.[141]

OBJECTIVITY AND THE ROLE OF SPECIALIST ADVISERS

105.  Cost and efficiency are clearly important issues, and there is likely to be a benefit to the report authors having existing institutional knowledge when examining failures in their own organisation. The most difficult question thrown up by having a largely internally written report is whether an organisation is able to be sufficiently self-critical for the report to be meaningful. The Governor of the Bank of England highlighted this issue, saying:

With respect, one of the great weaknesses of the FSA report was that it was the FSA writing a report on the FSA. I do not think that that is a model for the future, and nor does Lord Turner. In future, if you are going to have reports or oversight, it is rather important that the people whose behaviour you are overseeing are not actually members of the board responsible for that.[142]

106.  The Governor's comments go to the heart of the question of whether an internal review can be sufficiently objective to add value. An additional question is whether, even if an internal review is objective, it will be perceived to be so. Despite the Governor's claim that Lord Turner did not think the FSA's Report into the failure of RBS provided a model for the future, Lord Turner's own words seem to suggest otherwise. In a letter to the Chairman of this Committee Lord Turner noted that he believed the FSA's Report "should stand as an exemplar of high quality, dispassionate and, when necessary, self-critical analysis".[143]

107.  Our specialist advisers agreed with Lord Turner's assessment of the objectivity of the Report. Sir David noted that he believed the Report was "adequately critical"[144] and summarised his view of the fairness of the FSA Report as follows:

There is nothing [...] that has not been published that in our view has any materiality or which if you had it would lead you or us to reach a different view of the story, the narrative, the account.[145]

Mr Knight acknowledged that "where an institution reports into itself they do have the advantage of being able to put their own point of view"[146] but he felt that despite this the FSA Report "does state the facts" [147] and that the Report "is a good, fair and balanced summary that hides nothing".[148]

108.  Nonetheless, the FSA's work in this area was improved by external oversight. In particular, a much greater degree of objectivity in the Report appears to have been secured by the work of the independent specialist advisers appointed by the Treasury Committee. In a letter to the Chair of this Committee Lord Turner highlighted the importance of the external reviewers as follows:

The role of the external reviewers has been extremely valuable ... if in future there are reports into major financial failure which are produced by the regulator itself, I believe that the device of external reviewers should be used to provide challenge, variety of external perspective, and external assurance that there has been an appropriately self-critical approach.[149]

109.  Major changes were made to the report as a result of the specialist advisers' intervention. They highlighted five material areas in which they had suggested alterations to initial drafts of the Report, largely aimed at getting fuller and more detailed explanations of areas they felt were particularly important. The five areas were:

  • a fuller explanation of the reasons for selecting the three areas for enforcement investigation;
  • greater emphasis on the delegation responsibilities of the RBS CEO and the adequacy of their discharge, in particular in respect of the credit, sales and trading business;
  • a fuller description of the nature and degree of involvement of the FSA Board in setting or endorsing the relevant policy approaches of the FSA executive during the review period;
  • more detailed review and conclusions on the FSA's response, even within the policy approach and framework at the time, to the exceptional complexity, method of execution and risks inherent in the ABN AMRO acquisition, given the seriously constrained due diligence process that was undertaken; and
  • a clearer assessment of the substantive functioning as distinct from the formal process of the RBS Board, in particular in relation to oversight of the very rapid balance sheet expansion in the review period and the ABN AMRO acquisition.[150]

Both our specialist advisers were satisfied that the FSA had adequately addressed the issues they raised in the final Report. They noted that "while the structure, content, editing and conclusions of the FSA Report are the responsibility of the FSA, we were able to comment freely on all aspects of the FSA's review and there are no material points on which our work has led us to disagree with the FSA."[151]

110.  The role of the external reviewers was important because of the function they performed in commenting on the various iterations of the FSA's Report during the drafting process. Their role was also significant, however, because the very existence of external reviewers and the knowledge of external oversight is likely to have had implications for the behaviour of the FSA reviewers, encouraging them to be more conscientious in ensuring that the Report was a full and frank examination of the issues relating to RBS's failure.

111.  Objectivity of an internally authored report can also be secured by ensuring that it is endorsed by the board of the institution involved, thereby making board members individually and collectively responsible for its content. This point was made by Mr Knight:

I think it is absolutely vital if you go for this model that the board or the governance of the organisation concerned accepts, individually and collectively, responsibility for ensuring that the report is fair. I think that is absolutely vital. That is what they have done here. The board of the FSA have given us an assurance that in their view this is a fair and balanced account.[152]

112.  The FSA Report was reviewed in detail by four of the FSA's Non-executive Directors, who were tasked with "providing direct Board-level scrutiny of the Report and of the independence and objectivity of the processes by which it had been produced."[153] Beyond that, the FSA confirmed in its Report that:

The Report as a whole, and the judgements made within it, had been reviewed by the full Board.

On the basis of the quality assurance processes described above and its own discussion of key conclusions and judgements, the Board agreed to confirm to the specialist advisers that, in its opinion, the Report represents a fair and balanced summary of the evidence gathered by the FSA and by PwC during their review of the failure of RBS, that it fairly reflects the finding of the FSA's investigation and that it is a fair and balanced summary of the FSA's analysis of its regulatory and supervisory activities in the run-up to the failure of RBS.[154]

113.  The FSA's Report into the failure of RBS was largely written by FSA staff, with additional scrutiny being provided by the Treasury Committee's specialist advisers Sir David Walker and Bill Knight. We believe that this model has proved successful in giving our Committee and the public a reasonable degree of confidence that we now have a true and fair picture of what went wrong at RBS. We also have a better grasp of the failings of the FSA.

114.  A report produced by an organisation into itself will not be completely free from subjectivity. However, the appointment of external reviewers in this case appears to have improved the report and greatly improved its objectivity.

115.  The work of the independent external reviewers appointed by the Treasury Committee enabled Parliament to scrutinise a powerful regulator in a new way. The approach sets a precedent for the Treasury Committee in the future, and it may also be of use to other select committees.

116.  Although the FSA board endorsed the Report, non-executive directors of the FSA should have held the FSA's executive to account and themselves commissioned a review of the Authority's performance, as routinely happens within the private sector. The collapse of RBS should have been a prime candidate for such retrospective internal review. We have recommended in our Report on the Financial Conduct Authority that legislation provide for the Treasury Committee to request retrospective reviews of the future FCA's work. We would not, however, expect a properly functioning board to need such prompting from Parliament to conduct such reviews. We will expect non-executive directors of the future PRA and FCA to ensure that regular reviews of performance are undertaken and that appropriate governance structures are in place to support them in this task.

The value of further reports from the FSA into the crisis

117.  As noted above, the FSA's report into the failure of RBS has value in that it meets the need for public accountability. When questioned about the value of the Report to the FSA in terms of learning lessons, Lord Turner said:

If we go back to what the lessons learned from this report are, many of them we knew already. The basic fact that the capital and liquidity regimes were, to be blunt, rubbish, we knew already, and we were putting them right. The supervisory approach was wrong and we were putting that right.

When we produced this, I strongly urged all staff members to read it, particularly those going to the PRA. We have something here that all prudential supervisors, at least for the next 10 years, ought to read as part of their training programme. Indeed, all non-executive directors of banks ought to read it, because I think, when you have a lengthy and, I believe, high-quality report of what went wrong, there are a lot of lessons that you can get out of it, and they just tell you the story of a bank that made a collection of mistakes that reached a failure. That is very important for people to read.[155]

118.  Sir David supported this opinion, stating that "having done this exercise, there emerged matters of understanding that have been hugely beneficial for the regulator [...] I would think the regulator has learned a huge amount from this process."[156]

119.  In acknowledging that there are "a lot of lessons that you can get out of" the FSA's Report,[157] Lord Turner seems to have had a welcome change of mind from his earlier assertion that a report into the failure of RBS would "add little, if anything, to our understanding of what went wrong."[158] Recommendations for further change to the supervisory structure, in addition to proposals for change identified through earlier work, such as the FSA's internal audit report on the failure of Northern Rock and the Turner Review[159], are identified at the end of each section of Part 2 of the FSA's Report and summarised in Appendix 2A, Table 2.[160]

120.  HBOS was another major bank which failed during the financial crisis. Lord Turner committed the FSA to the production of a report once its enforcement action had been completed, stating that the FSA had:

Put in place a small data gathering team. They will not write down anything that is a judgment, because we cannot do that without potentially prejudicing the enforcement process, but we are going through the process of gathering together the files, doing some of the straightforward calculation analysis that we did with RBS on capital and liquidity, having done it before, so that as and when we get beyond the enforcement case—but I do stress we have no control over the overall timescale of that—we will be in a position to launch it.[161]

121.  On 9 March 2012, the FSA announced that its investigation of the firm itself had been completed and that the FSA judged that HBOS had been guilty of very serious misconduct. Given the exceptional circumstances of the firm being part-owned by the taxpayer, the FSA decided not to levy a fine, but instead issued a public censure.[162] On 12 September 2012 the FSA concluded its remaining enforcement action in relation to HBOS when it fined Peter Cummings, former executive director of HBOS plc and chief executive of its Corporate Division, £500,000 and banned him from holding any senior position in a UK bank, building society, investment or insurance firm.[163] Following that announcement the Treasury Committee wrote to Lord Turner as follows:

We will require of the FSA the same comprehensive assessment of the reasons for the bank's failure, and of the FSA's conduct, as was case with RBS. External advisers, appointed by the Committee, should again be employed during the drafting process to provide assurance that the report is a fair and balanced reflection of the evidence. We will need to discuss whom to appoint. The report should cover the reasons for, and the consequences of, both the Lloyds/HBOS merger and the earlier Bank of Scotland/Halifax merger.[164]

On 28 September 2012 Lord Turner replied to the Committee that:

On the report, the most important next step will be to agree the Terms of Reference and governance arrangements. The FSA Board has created a sub-committee to overview the development of the report: this Committee will be chaired by Sir Brian Pomeroy who also chaired the sub-committee which oversaw the production of the RBS report, and who in the course of that liaised extensively with Sir David Walker and Bill Knight. [...]

Your letter set out the Committee's desire to appoint external reviewers, as with the RBS report. As you know, my letter to you of 11 July 2011, which said that we believed we should produce an HBOS review once we had completed the legal enforcement [process], also stated that the external reviewers had played an extremely useful role on the RBS report, and that we should use this device again on the HBOS report. [...][165]

The Committee and the FSA will discuss further the details of how the report on the failure of HBOS will be undertaken.

122.  The FSA Report into the failure of RBS, alongside previous reports on other aspects of the financial crisis and pre-crisis regulation, highlights the respects in which pre-crisis regulation was misguided. The document will be of long-term value for those involved in the regulation and corporate governance of banks. A similar exercise in relation to the failure of HBOS will now be undertaken.

Reports from other bodies

123.  In the absence of pressure from the Treasury Committee the FSA Report into the failure of RBS would never have been produced. Lord Turner asserted, however, that the FSA has set out "more openly than any other financial authority" the inadequacies of their approach prior to the financial crisis.[166]

124.  HM Treasury has gone some way to addressing this with the publication of an internal report on their performance during the crisis entitled Review of HM Treasury's management response to the financial crisis[167], which this Committee will examine in due course.

125.  The Bank of England has been much more reluctant to undertake a similar 'lessons learned' review, despite multiple requests from the Treasury Committee for them to do so. In a letter to the Chairman of this Committee the Governor of the Bank of England argued that "the way the Bank used the tools available to it in the first phase of the crisis has been thoroughly reviewed and that far-reaching reforms have been made."[168] He noted that the only tool available to the Bank in dealing with the crisis was its balance sheet and that:

The Bank's balance sheet, was, and is, used to achieve two objectives: the implementation of monetary policy decisions taken by the Monetary Policy Committee, and to provide liquidity insurance to commercial banks. It proved challenging in the very first phase of the crisis to meet either of these obligations.

In response, the Bank conducted a major review of, and consultation on, the use of its balance sheet.[169]

126.  The consultation to which the Governor referred set out proposals for the development of the Bank of England's market operations.[170] It suggested improvements to existing operations which were designed to respond better to the stressed market conditions prevailing at the time. Following the publication of this document the Bank implemented a number of changes to its operations. In addition, a number of the extraordinary operations that were put in place by the Bank, such as the Special Liquidity Scheme, were significant in preventing further failures in the financial sector. The Governor noted in his letter of 31 January 2012 to the Chairman of this Committee that all of the actions taken by the Bank to revise its operations since the crisis had been set out in published documents.[171] While this is the case, these documents do not constitute a thorough review of the Bank's response to the crisis. This remains to be done.

127.  In the same letter the Governor hinted at the two other arguments previously deployed by the Bank to suggest that it should not be obliged to undertake a comprehensive review. First, that many of the actions undertaken by the Bank during the crisis were in fact decided upon and implemented by the Bank, FSA and HMT so any review should not be done by the Bank but by an external body examining all three members of the tripartite.[172] Secondly, that while there was still a crisis continuing, it was not appropriate to devote the time or resources to undertaking an internal review.[173]

128.  These arguments, particularly the latter, may have merit, but they were significantly undermined when, on 21 May 2012, the Bank of England announced that its Court had commissioned three reviews into areas of the Bank's performance during the financial crisis. The reviews are being led by independent external experts, supported by Bank staff, and cover the following areas: the provision of Emergency Liquidity Assistance in 2008/9; the Bank's framework for providing liquidity to the banking system as a whole; and the Monetary Policy Committee's forecasting capability.[174] They are expected to conclude in October 2012 and the Committee will examine these reviews in due course.

129.  HM Treasury has published a review of its performance during the crisis, which the Treasury Committee will review in due course. The Bank of England has also belatedly announced a number of reviews examining aspects of its own performance in this period. While this represents some progress, it falls well short of what is required. A comprehensive review of the Bank's role in, and response to, the crisis is needed and we will return to this issue after publication of the three reviews commissioned by the Court of the Bank of England. Moreover, by waiting so long before conducting any review, the Bank of England has diminished its value as a guide to better regulation for the future. Any lessons learned as a result of even these limited reviews will also only be available in a very late stage in Parliament's consideration of the Financial Services Bill. Incorporation of them into legislation may therefore be more difficult and this is regrettable.


129   HM Treasury, HM Treasury Annual Report and Accounts, 2010-11, Certificate and Report of the Comptroller and Auditor General, HC 984, July 2011, p89. The peak figure of £1.162 trillion is the sum of the cash outlay (e.g. for purchasing shares in RBS and Lloyds) and the maximum support pledged (e.g. through schemes such as the Credit Guarantee Scheme and the Asset Protection Scheme) by the Government during the crisis, including amounts that were not used. Schemes under which support was pledged were not necessarily available at the same time, so the peak figure of £1.162 trillion was not available at a single point in time. Back

130   HM Treasury, HM Treasury Annual Report and Accounts, 2010-11, Certificate and Report of the Comptroller and Auditor General, HC 984, July 2011, p93 Back

131   Opinion, Financial Times, 7 December 2010 Back

132   Q 1 Back

133   Letter from Chairman of the FSA to Chairman of the Treasury Committee, 11 December 2011 Back

134   Q 88 Back

135   Q 90 Back

136   Q 189 Back

137   Q 16  Back

138   "Royal Bank of Scotland investigation: the full story of how the world's biggest bank' went bust", The Telegraph, 6 May 2011 Back

139   Q 22 Back

140   Q 22 Back

141   Q 190 Back

142   Oral evidence taken before the Treasury Committee on 17 January 2012, HC 1753, Q 21 Back

143   Letter from Chairman of the FSA to Chairman of the Treasury Committee, 11 December 2011 Back

144   Q 53 Back

145   Q 11 Back

146   Q 16 Back

147   Q 16 Back

148   Q 52 Back

149   Letter from Chairman of the FSA to Chairman of the Treasury Committee, 11 December 2011 Back

150   Evidence to the Treasury Select Committee by Bill Knight and Sir David Walker, specialist advisers to the Committee in relation to the report by the Financial Services Authority into the failure of The Royal Bank of Scotland', p 2 Back

151   'Evidence to the Treasury Select Committee by Bill Knight and Sir David Walker, specialist advisers to the Committee in relation to the report by the Financial Services Authority into the failure of The Royal Bank of Scotland', p 2 Back

152   Q 21 Back

153   The Financial Services Authority, The failure of the Royal Bank of Scotland: Financial Services Authority Board Report, December 2011, p 18 Back

154   The Financial Services Authority, The failure of the Royal Bank of Scotland: Financial Services Authority Board Report, December 2011, p 19 Back

155   Q 189 Back

156   Q 49 Back

157   Q 189 Back

158   Opinion, Financial Times, 7 December 2010 Back

159   The Financial Services Authority, Internal Audit Division, The supervision of Northern Rock: A lessons learned review, March 2008; The Financial Services Authority, The Turner Review: A regulatory response to the global banking crisis, March 2009 Back

160   The Financial Services Authority, The failure of the Royal Bank of Scotland: Financial Services Authority Board Report, December 2011, Part 2, and Appendix 2A, Table 2 pp 300-302 Back

161   Q 190 Back

162   "FSA publishes censure against Bank of Scotland plc in respect of failings within its Corporate Division between January 2006 and December 2008", FSA Press Notice, 9 March 2012 Back

163   See http://www.fsa.gov.uk/library/communication/pr/2012/087.shtml Back

164   Letter from Chairman of the Treasury Committee to Chairman of the FSA, 13 September 2012 Back

165   Letter from the Chairman of the FSA to the Chairman of the Treasury Committee, 28 September 2012 Back

166   Opinion, Financial Times, 7 December 2010 Back

167   HM Treasury, Review of HM Treasury's management response to the financial crisis, March 2012 Back

168   Letter from Governor of the Bank of England to Chairman of the Treasury Committee, 31 January 2012 Back

169   Letter from Governor of the Bank of England to Chairman of the Treasury Committee, 31 January 2012 Back

170   Bank of England, The Development of the Bank of England's Market Operations : A consultative paper by the Bank of England, October 2008 Back

171   Letter from Governor of the Bank of England to Chairman of the Treasury Committee, 31 January 2012 Back

172   "Sir Mervyn King scrutinised as Bank of England orders review," The Telegraph, 21 May 2012 Back

173   Letter from Governor of the Bank of England to Chairman of the Treasury Committee, 31 January 2012 Back

174   "Court of the Bank of England commissions a set of reviews to learn lessons", Bank of England Press Notice, 21 May 2012 Back


 
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Prepared 19 October 2012