Royal Bank of Scotland

And the cupboard was bare

Banks pass round the begging bowl

EVER since the emperor bought new clothes, there have been few instances of self-delusion quite as stark as that of cavalier British bankers at the start of 2008. Just as rivals in America and other parts of Europe were writing down billions on their investments in dodgy mortgage loans and frantically raising money, the bosses of Britain’s biggest banks were instead blithely increasing their dividends in a blustery display of financial strength. Just how hollow it was became apparent on Friday April 18th when it emerged that Royal Bank of Scotland, the country’s second biggest bank, might have to raise money to satisfy bank regulators.

The amount will not be trivial, not will be its impact on shareholders. Analysts reckon that Royal Bank may have to raise between £10 billion ($19.9 billion) and £13 billion, about a third of its current market value of £37 billion. It is expected to do so through a share sale which will probably be announced at its annual shareholders’ meeting on April 23rd.

At issue is Royal Bank’s “core capital”—a cushion composed mainly of shareholders’ money that regulators insist banks hold against bad times—which stands at about 4.5% of risk-weighted assets. This is the lowest of any big British bank and well below the 6% that most banks consider a reasonable minimum level. For Sir Fred Goodwin, the chief executive of Royal Bank, the prospect of having to go cap in hand to shareholders for a bailout would be a deep humiliation and many believe that Sir Fred’s head may well be the price that shareholders demand in exchange for supporting a share issue that may dilute their existing holdings by as much as 50%. If that is the case it would mark the end of a career that was marked by both brilliance and hubris.

Sir Fred made his name at Royal Bank after its hostile takeover of NatWest, another British bank in 2000. Although he was not the main architect of the deal, he was responsible for making it work. He did so skilfully and ruthlessly, in the process earning the moniker “Fred the shred” when he cut some 18,000 jobs. His reign at Royal Bank was characterised by a curious mix of authoritarianism and prickliness. (He once started to sue a big newspaper for libel after it joked in a column that he had wanted a private road built from his bank’s headquarters to the airport and had been denied membership of a swanky golf course. He denied the suggestions entirely.)

More important is that in recent years Sir Fred has alienated shareholders with a spate of contentious acquisitions abroad that, although vastly expanding the empire he manages, has served mainly to depress his company’s share price. The most recent of these was his bank’s participation last year in the €72 billion ($101 billion) takeover of ABN AMRO, a Dutch bank, by a group that also included Spain’s Santander and Fortis, a Belgian-Dutch bank. This deal, which was paid for mostly in cash, is the main reason that Royal Bank’s balance sheet is so stretched (although writedowns on the value of credit derivatives have not helped).

And, although analysts have speculated for months that the bank would need to raise new capital, he has brusquely brushed aside their concerns. On February 28th when he presented the bank’s annual results, he unequivocally told analysts that he had “no plans for any inorganic capital raisings or anything of the sort.”

Rival bankers, however, are advised to keep their Schadenfreude in check. On Friday Citigroup posted a $5.1 billion loss for the first quarter and said it plans to cut 9,000 more jobs. And in Britain, analysts expect other banks to follow in Royal Bank’s footsteps in beating a path to shareholders’ doors. Analysts at JPMorgan Chase, an investment bank, reckon British banks need to raise about £37 billion. Among the worst affected are HBOS, which they reckon may need to raise as much as £11 billion, and Barclays, which could be short of about £8 billion. Self delusion may be dying hard among Britain’s banks, yet the sooner they face facts, the sooner they can move on.