Bank shake-up puts EU firmly in charge

Allister Heath

AS power shifts go, this one takes some beating. After months of listening to what the government, the Bank of England and the FSA have had to say about the future of British banking, it turns out that the body with real power was based a little further away from home. For this morning, barring some last-minute snag, it will be the European competition authorities that will announce their final settlement for the banking industry. It will be one of the biggest ever state-mandated shake-ups of an industry in the UK – though given that all the affected parties were nationalised, the scale and scope of the proposed shake-up is not actually that significant.

The most interesting changes will be those seen at RBS. It seems that the firm has succeeded in retaining the bulk of its global banking and markets division, its investment bank, which contributed £7.83bn in income in the first six months of the year. It will, however, probably sell its RBS Sempra commodities trading joint venture, which accounts for around six per cent of that unit’s income. Other parts may also go, and we shouldn’t forget that large reductions in the unit’s balance sheet have already been pushed through. This settlement would nevertheless amount to a victory for Stephen Hester, the firm’s CEO, who has always been intent on keeping RBS involved in investment banking.

But it also poses him a huge problem. It has proved almost impossible to defend big bonuses for bankers employed by government-owned banks. I have long disagreed with the vast majority of the public on this: I?believe that the fact that they are keeping the rest of RBS going means that the firm’s top traders and investment bankers deserve to be rewarded. However, this is not exactly a popular position and we can be sure that there will be many more rows about bonuses at RBS, especially now that thousands more high street jobs are being cut by the bank. Either Hester will be able to continue paying out to investment bankers, perhaps in some more discrete form; or the division will gradually wither away, as its top staff migrate to other banks or to hedge funds. So perhaps it would have been better for RBS to sell off all of its banking and markets division now, pocket the cash and move on.

But the really big question this morning is whether it will be forced to sell Citizens, its US division. This would terminate its global ambitions and reduce annual profits by about £500m. Citizens is a little too small for comfort; it would make sense to merge it with other regional US players. Had Sir Fred Goodwin not destroyed RBS with his hubristic takeover of ABN Amro, it would have made sense to build the US business through a series of medium-sized, sensibly priced acquisitions. So even if RBS is allowed to keep Citizens, it remains to be seen what its American strategy will be in the years ahead and whether it will have enough spare capital to expand in that market.

The firm is likely to be hit in other ways after this morning’s announcement. Selling off its insurance division and some of its branches will probably reduce profits by £1.5bn out of the £10bn or so it might have been expected to earn in its present shape in a good year. None of this is devastating, of course, and RBS, just like Lloyds, will retain the majority of its operations. Psychologically, however, this morning’s announcement matters hugely: it has reminded the City who is really in charge.