FSA supervision was an 'insufficient challenge' to RBS

Flaws in the Financial Services Authority's (FSA) approach to regulation proved an 'insufficient challenge' to the Royal Bank of Scotland (RBS) and contributed in part to its eventual collapse, according to the results of a long-awaited investigation into the bank's failure.

Poor decisions made by the RBS management team and board were also to blame, along with deficiencies in the global capital regime, the FSA's detailed study concluded.

Taken together, these two issues made the crisis that followed much more likely, however flaws in the FSA's own supervisory approach to monitoring credit trading and assessing the quality of RBS' underlying assets were also to blame.

'People want to know why RBS failed and why no-one has been punished,' said FSA chairman Lord Adair Turner.  'This report aims to answer those questions. It describes the errors of judgement and execution made by RBS executive management which, in combination, resulted in RBS being one of the banks which failed amid the global crisis.'

But while the FSA said decisions made by the RBS management and board were ultimately responsible for the bank's collapse, Lord Turner drew attention to the fact the 400-page report into RBS' downfall had also touched on the FSA's own role, and looked at why the regulator's enforcement division deemed the evidence insufficient to carry out enforcement action.

Its report backs up the findings of the investigation into Northern Rock's demise and in a section devoted specifically to the regulator's supervisory approach, priorities and resources, it concluded the FSA's 'deficient' approach resulted in inadequate resources being directed to large, systemically important banks, a risk assessment process that was too reactive and placed too much emphasis on senior management and firm's control functions, poor consideration of strategic and business model related risks, too little attention being paid to investment banking activities and the core prudential risk areas of capital adequacy, liquidity, asset quality, balance sheet composition and leverage.

RBS had also earned an FSA 'regulatory dividend' as part of its 2006 interim and 2007 full, ARROW risk assessments.  These dividends - handed out where a firm had demonstrated it was well managed, had effective control systems and dealt openly with the FSA - are no longer in use as part of the regulator's approach to supervision, but at the time firms with the dividend required a 'less intensive' approach, the FSA said. 

Six triggers for RBS' failure

There were, however, six additional contributing factors aside from the FSA's own approach, and the regulator's study cited these as key.  These factors were:

• significant weaknesses in RBS’s capital position, as a result of management decisions and permitted by an inadequate global regulatory capital framework;

• over-reliance on risky short-term wholesale funding, which was allowed by an inadequate approach to the regulation of liquidity;

• concerns and uncertainties about RBS’s underlying asset quality, which in turn was subject to little fundamental analysis by the FSA;

• substantial losses in credit trading activities, which eroded market confidence.  Both RBS’s strategy and the FSA’s supervisory approach underestimated how bad losses associated with structured credit might be; 

• the ABN AMRO acquisition, on which RBS proceeded without appropriate heed to the risks involved and with inadequate due diligence;  and

• an overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure.  RBS was one such bank.

In addition, the report blasted the 'multiple poor decisions' that RBS made, arguing there are likely to have been underlying deficiencies in RBS management, governance and culture which made it prone to make incorrect decisions.