5 December 2009 - Global Markets Review

Good Morning Ladies & Gentlemen,

It didn't take long did it?

Banks back in focus as bonuses are back where they were at the levels preceding the financial crisis.

Oh what a fickle bunch these Bankers are!

For Friday, let me look at Banking on two fronts; UK banking via The Royal Bank of Scotland and Barclays in particular; and European Banks in general.

The UK Treasury signaled this week that it was prepared to veto a £1.5 billion bonus pool at Royal Bank of Scotland in a move that could trigger the resignation of the bank's board.

RBS directors have been advised by the bank's lawyers to resign if a Treasury bonus veto means they are unable to run the bank commercially and in the best interests of all shareholders.

People close to the Treasury said this week that Alistair Darling would throw out any bonus plan at RBS that was much higher than last year's £1 billion. "We would not expect to see any significant increases in bonus payments. I think most people would see 50% as a major increase," one Treasury insider said.

RBS is expected to make £6 billion in profits this year from investment banking, implying a bonus pool 50% higher than last year.

Ronnie Fox, principal of Fox Lawyers, said: "If you are put in a position where you can no longer do the job you are paid to do then I cannot see how you can remain in place as a director. I would advise the board of RBS to resign in this situation."

Vince Cable, the Liberal Democrats Shadow Chancellor, said: "I would welcome their resignations. The bank cannot hold the taxpayer to ransom."

The Treasury has intervened directly to demand the right of veto over this year's bonus payments at the bank, which is 70% controlled by the taxpayer.

Institutional shareholders have raised concerns that restricting RBS's ability to make reasonable bonus payments this year will impede the bank's ability to compete commercially and retain top bankers next year. Investors have urged Stephen Hester, the chief executive, to drive a hard bargain with the Treasury over the final size of the bonus pool.

RBS said Wednesday: "Our agreed business plan requires us to operate commercially in competitive markets and this plan underpins the prospects of recovering value for taxpayers and other shareholders alike. We understand and embrace the need to ensure pay meets the new G20 and Financial Service Authority requirements and will continue to advocate this and other ways to address public concerns relating to banks and always pay on the principle of no rewards for failure."

Mr Darling demanded control over RBS bonus payments as a condition for allowing the bank to join the Government's insurance scheme for troubled assets and pumping a further £25.5 billion of taxpayers' money into the bank. The Treasury has already forced RBS to agree to pay bonuses in shares to all staff who earn more than £39,000 a year, and in stages over three years.

Mr Hester told MPs that RBS has not yet set a precise figure for the bonus pool that it will submit to the Treasury, and UKFI, the body that manages the Government's shareholdings in banks, for approval. He said: "No determination or proposals have been made over bonuses. I do think that this is a tightrope to be walked."

He acknowledged that the Treasury's intervention in RBS's bonus policy had made life more difficult for the bank. "If RBS is unable to retain and motivate staff then it will be very difficult to fulfil our goal of making the bank safe, serve our customers and enabling the taxpayer to sell out at a profit," he said.

Now correct me if I am wrong here; after the latest 'injection' from the UK Government, RBS will be 84% owned by the 'people'.

18 months after the biggest financial debacle on record - caused ostensibly by the banks - how on earth can this Board of Directors hold the UK Taxpayer to ransom?

Mind-boggling.

At the same time, that Bastion of British Banking, Barclays, is set to offer huge pay rises to its Asset Management arm.

Barclays is preparing to hand 150% pay rises to staff at its 'casino' banking division.

In a pre-Christmas give-away, some 20,000 workers at the Barclays Capital investment bank will see their salaries jump sharply, sources said.

High-flyers could enjoy massive hikes of 150% or more, pushing their basic pay up to as much as £300,000.

With bonuses, scores of Barclays Capital bankers regularly take home between £1million and £2million a year.

The pay rises, which will be backdated to June, are an attempt to circumvent a stringent new pay regime due to come into force early next year.

Like many other investment banks in the City, Barclays is raising basic salary levels ahead of the clampdown, which will rein in cash bonuses and force banks to stagger pay-outs over a number of years.

But the new rules do not affect basic salaries.

On top of the salary hikes, Barclays Capital is also expected to increase the size of its bonus pool this year after enjoying bumper profits.

Earlier this week it emerged that Barclays president Bob Diamond, 58, made £27million from the sale of his stake in Barclays Global Investors to the American giant BlackRock for £9.1billion.

Barclays said Mr Diamond had bought his shares in Barclays Global Investors with his own money, and would pay tax on the profit; well that justifies it all then!

In my humble opinion, Barclay's would be in a similar position to RBS were it not that the former through sheer good luck (not business sense) failed to acquire ABN Amro and that the US bail-out of AIG saved Barclay's from billions in losses that would have dropped them into exactly the same position as RBS.

Barclays is still standing through a mixture of good luck, taxpayer bail-outs (wherever those taxpayers come from) and selling themselves to Arabs.

The whole British banking system would not exist Friday if it were not for taxpayer bail-outs - and that is a fact!

But in itself, the actions of the RBS Board and Barclays' 'salary setters' should not really surprise us because it seems the whole of the European Banking system has not just taken off where it left off in October 2007, but with a vengeance and could be the catalyst that causes yet another financial meltdown.

European banks are emerging from the credit crisis bigger than before, posing more risk to their national economies.

BNP Paribas, Barclays and Banco Santander are among at least 353 European lenders that have increased in size since the beginning of 2007, according to data. Fifteen European banks now have assets larger than their home economies, compared with 10 lenders three years ago.

While the European Union has grabbed headlines for breaking up bailed-out banks, regulators haven't reined in firms that shunned state aid and are too big to fail. European bank assets have grown 25% since the start of 2007, compared with a 20% increase at US lenders.

Now don't get me wrong, this does not condone the 20% increase in US Bank Assets as being healthy, it just proves that for all of my haranguing of the US Banking System, we don't need to look as far afield as the US to see a larger problem brewing - it is brewing on our own doorsteps.

Surely this is sowing the seeds for the next crisis - What we have been doing in the last two years is making banks much bigger - it really goes against the currents of the time.

Banks expanded their balance sheets during the credit bubble, borrowing cheap money in the wholesale market to fund loans and investments.

Royal Bank of Scotland's assets ballooned 2,914% in the 10 years through 2008 as it made acquisitions, boosted trading and increased lending. Edinburgh- based RBS spent $140 billion on takeovers during the period, culminating in the purchase of ABN Amro Holding in 2007 that triggered the world's biggest bank bailout.

Paris-based BNP Paribas, the world's biggest bank by assets, increased its balance sheet by 59% to 2.29 trillion Euros ($3.5 trillion) since the beginning of 2007, an amount equal to 117% of France's gross domestic product. Assets at London-based Barclays jumped 55% to 1.55 trillion Pounds ($2.6 trillion), or 108% of UK GDP. Santander's rose 30% to 1.08 trillion Euros, about the size of Spain's GDP.

RBS has pledged to reduce its balance sheet by 40% over the next five years, and the European Commission, the executive arm of the EU, has ordered banks including Commerzbank, ING Groep and Lloyds Banking Group, to sell assets as a condition of approving state aid.

The EU doesn't have authority over banks that weren't bailed out, many of which continued to expand as European economies contracted. Banks such as BNP Paribas and Santander have taken advantage of their rivals' woes to make acquisitions. Thirty-eight of Europe's 100 biggest financial institutions have more assets now than they did at the beginning of the year

Deutsche Bank AG, Banco Bilbao Vizcaya Argentaria SA and UniCredit SpA, all of which expanded over the past three years, have below average risk-adjusted capital ratios, a measure of their ability to withstand losses, according to a Nov. 23 report by Standard & Poor's.

More weak banks may be exposed as the European Central Bank withdraws cheap loans that propped up the financial industry last year. Commerzbank, based in Frankfurt, and Dexia SA fell as much as 4.4% on Nov. 20 after central bank President Jean-Claude Trichet explained the need to slow the flow of cash.

The credit crisis shows that large institutions pose too great a risk to their home countries, especially in Europe's relatively small economies.

Breaking up banks that are too big to fail has is most certainly not a bad thing I feel. If we were to have another systemic shock and one or more of these very large banks would fail, I have serious concerns whether some of the smaller countries would be in a position to absorb the losses for a second time.

Britain, with an economy one-fifth the size of the US's, faces widening budget deficits, rising unemployment and increased taxes after four bank bailouts, including the 45.5 billion-Pound rescue of RBS.

The damage was even greater in Iceland, which had to seek emergency assistance from the International Monetary Fund after the country's banking system collapsed. The island is now struggling to recover from the deepest recession among the world's advanced economies, according to the IMF, after the stock market plunged 98%.

European governments overall have provided $5.3 trillion of aid to banks in the past two years.

Bailed-out banks are the nine worst performers in the 64-member Bloomberg European Banks Index since Lehman Brothers Holdings Inc. filed for bankruptcy on 15 September 2008. RBS plunged 85% for the biggest decline. Lloyds dropped 63%, Commerzbank 58% and Dexia 43%, compared with the 18% decline in the index.

The increasing complexity of banks makes it difficult for regulators and governments to monitor risks, even at firms that appear transparent and stable. UBS was understood to have very good management, but that failed dramatically.

The market is placing an enormous amount of faith in banks to regulate themselves, and it is hard to know whether they're doing it properly. From that perspective, smaller banks are a safer bet.

Zurich-based UBS AG has reported 57.5 billion Swiss francs ($57.8 billion) of losses and writedowns since the credit crisis began, the most in Europe, and received a 6 billion-franc bailout from the Swiss government. The bank has reduced its assets by 37% since the start of 2007.

Leaders of the Group of 20 countries, including France, Germany, Italy and the UK, agreed in September to develop by the end of 2010 rules that will make banks hold more and better- quality capital and discourage the use of leverage.

In addition, regulators and government officials across Europe have proposed solutions including forcing banks to separate retail operations from riskier investment banking and requiring lenders to write so-called living wills that would outline how they would be broken up in the event of a collapse.

How is that going to help? I wish someone would tell me how that is going to help AFTER THE FACT!!! If those banks cannot get it right in terms of running their businesses and end up going under, who can say that they are in a credible position to advise on how best to break up their assets?

Sheer madness! A bit like asking a criminal to write a will dictating the punishment he will get if caught.

"Banks increased both the size and leverage of their balance sheets to levels that threatened the stability of the system as a whole," Bank of England Governor Mervyn King said in a 20 October speech in Edinburgh.

"If our response to the crisis focuses only on the symptoms, rather than the underlying causes of the crisis, then we shall bequeath to future generations a serious risk of another crisis even worse than the one we have experienced."

Nice start Mr King, one would feel.

But here's the rub; he's not said a thing on the matter since!

In the UK, the five largest banks - HSBC Holdings, Barclays, RBS, Lloyds and Standard Chartered - have 6.1 trillion Pounds of assets, or about four times GDP. A decade ago, the top five banks had 1.2 trillion Pounds in assets.

European banks report assets under International Financial Reporting Standards, which require them to list the value of all derivatives. US Generally Accepted Accounting Principles allow lenders to report the net value of such securities.

Europe's bank bosses have gone on the offensive in recent weeks to head off stricter regulation, arguing that the quality of a lender's assets, not the size of its balance sheet, determines the threat to the economy.

Deutsche Bank Chief Executive Officer Josef Ackermann said Nov. 16 that indiscriminately breaking up banks will slow economic growth because large institutions are needed to finance development projects and large companies.

"It's the amount of risk, not size in itself, that justifies higher capital requirements," Ackermann said at a conference in Frankfurt. "In a market economy, the size of a company per se shouldn't be automatically deemed damaging."

Mr Ackermann is obviously singing from his own hymnsheet there!

HSBC, based in London, was the top-rated bank in the S&P survey, with a risk-adjusted Tier 1 capital ratio of 9.2% at the end of June. Customer deposits totaled $1.16 trillion, compared with $925 billion of loans. Only 18 of Europe's 100 biggest lenders by assets have more deposits than loans, reducing their reliance on wholesale financing. HSBC's assets have grown 30% since the start of 2007.

Santander CEO Emilio Botin says his company's business model, with 85% of revenue coming from retail and commercial banking, helps control risk. Also, the capital of the bank's international units remain independent of the parent and under the control of local regulators, reducing the risk of contagion, Botin said last month at a conference in London.

So Santander feel that if they keep the small amounts in Lesoto separate from their trillions in Madrid, this will make them a 'safer' bank?

"Limiting or penalizing the size of banks through greater regulatory capital requirements will not solve the problem," Botin said. "It could even have adverse consequences, such as creating an unlevel playing field and harming financial flows toward the real economy."

Notwithstanding of course the fact that the Real Economy is what suffers when these banks go under.

In contrast to Santander, Barclays increased its reliance on investment banking after it bought Lehman's North American unit and hired bankers in Europe and Asia to expand the business. Barclays may get half of its profit from investment banking by 2011.

That move alone flies in the face of the whole October 2007 - March 2009 debacle - it was ;Investment Banking' and 'Asset Management' that created a huge mess - surely one would expect those divisions of a bank to be reducing manpower (and bonuses by the way), not increasing them.

It all boils down Ladies and Gentlemen, to not solely the European Banking Sector or the US Banking Sector suffering from Amnesia - it is the whole Global Financial system that seems to have forgotten far too quickly the horrors that those 18 months created.