The only certainty that seemed to stem from the financial crisis was that the UK banking system had to undergo a process of posthumous but very necessary regulatory reform. What was not clear from the start was what the cost of such regulation would be. Now that we are seeing that this necessary but costly process has begun to impact on the long term return on equity of banks in general, it becomes clear that money invested in the crisis era may be hard to recover for a good while yet.
The cost of de-risking RBS, both in terms of its balance sheet (selling riskier business) and its regulatory capital (raising a larger buffer) has eaten into perceived future earnings and ‘book value’ – both of which drive the share price. UKFI has already made the point to HMT that the cost of a "safer" regulatory environment for banking (which may well save us money in the long run) has been to wipe value off the asset it owns – that same asset which prior to 2008 was the natural beneficiary of the lightest touch regulatory regime. Even George Osborne has begun to talk about the ‘social value’ of RBS, perhaps aware that obtaining a huge windfall to fund tax cuts in the build-up to a 2015 election now looks pie-in-the-sky.
However, RBS and Lloyds continue to suffer from further headwinds as many investors struggle to decide whether these are commercial enterprises or, in effect, government ministries. The size of the balance sheet in RBS in particular and the ruinous systemic effect that any misstep might have on the UK economy, make this an even more pressing issue. For instance, if Hester and the current management team were to walk due to political pressure, the credit market’s loss of confidence in the ability to contain the risks could be catastrophic. As such, the real questions for the taxpayer are not “what did I invest?” and “when will I get my money back?”, but rather, “are my chances of recovering my money better if the banks are back in private hands?” and “how dangerous is it to leave these companies in public hands?” With the shares in both banks far below the government’s “in-price” it becomes hard to see how all these questions can be answered simultaneously.
Improvised sporadic sales of tranches of the stock are predictable (and therefore easily exploited by the markets – see how much the US government lost on AIG) and are likely to take so long as to ensure that the destruction of value becomes self-fulfilling by dint of both companies continuing to be seen as government ministries. By the same token, holding onto the stakes for a period of many years looks self-defeating, once one prices in how much value that in itself destroys.
That is why the Government should consider again the idea of share distribution outlined in the CPS pamphlet ‘Give us our fair shares’ last year. The proposal put forward does its best to solve for all of the questions above. It is structured to ensure that the banks are placed into private hands in one go, by means of a free distribution to taxpayers, instantly removing the risk of a long term cultural shift in the state owned banks which (bonus discussions aside) could be perilous for the UK balance sheet. But it also allows for any future improvement in the valuation of the banks to pass directly into the hands of the taxpayer, and by extension, back into Treasury as a floor price set by the Government is paid on sale.
One of the proposal’s advantages is that it is “price agnostic”. That is to say, that irrespective of which ever price Treasury deems that it is more sensible to sell/distribute at, the idea of a broader distribution combined with an institutional placing is preferable to well flagged sales of stock. But perhaps its main advantage is that in terms of any sales below the government’s “in-price” it is the only solution that ensures that the taxpayer and not the markets are the natural beneficiaries of any improvements in the companies’ valuations. It therefore avoids the ‘Gordon Brown selling the gold cheap’ headlines for the Government, which we would be the likely result of a fast sell off.
Whether it is preferable to hold on to the stakes in the hope for sunnier days in the companies’ valuations, as Michael Fallon implied on Thursday’s Today programme, is of course a matter for government to decide. But given that every time the banks have to pay those charged with defusing, as Mr Hester says, “the largest balance sheet risk time bomb ever assembled in history,” we seem to focus more on their pay than the job they are actually doing, one might be forgiven for preferring this to be sooner, rather than later.