The pros and cons of breaking up RBS – and why it will not happen

Andrew Lilico
SHOULD RBS be split up in some way, as is rumoured to have been proposed in the draft report of the Parliamentary Commission on Banking Standards? Let us consider some of the pros and cons.

A first reason for breaking up RBS would be to sell off as much as could be unloaded to get it off the government’s balance sheet. RBS’s total liabilities remain comparable to the entire annual output of the UK. In the event that some grim event (like the disorderly collapse of the euro) led to RBS becoming seriously insolvent – in the way that, for example, Cypriot banks were – the government would face a choice. Either it would bail RBS out again (which could potentially involve expenditures so high that the UK sovereign would become seriously distressed, in much the same way that the Irish, Spanish and Cypriot sovereigns became distressed by standing behind their banks) or it would allow a quasi-nationalised bank to default. Either route would see the UK’s credit standing further damaged.

By getting RBS, or much of it, off the government’s balance sheet, the risk that the bank’s failure bankrupts the government is reduced. It would be much easier and more credible to impose bailins or other corrective remedies upon a private sector RBS than on a nationalised entity.

A second reason is that, as quasi-nationalised bank, RBS’s performance is proving as spectacularly efficient as nationalised industries have proved in the past. Breaking it up could allow the pieces to be returned to the private sector, meaning that shareholders and creditors would be forced to monitor its efficiency, and take the fruits of any efficiency improvements or the losses of failure. Profits and losses are much better than regulation or state control for achieving this.

Third, if healthier parts of RBS were separated from unhealthy parts, the healthier parts might be better placed to supply credit to the broader macroeconomy. Weak credit growth has been identified by many economists as an important reason for weak GDP growth. That is said to be a particular problem for the growth engine in the SME sector. A healthy part of RBS could help broader macroeconomic recovery.

Fourth, the banking sector has very ineffective competition. That is partly due to a lack of players and the difficulty of new entry. Metro Bank obtained the first new banking license for a high street bank in a century. The attempt to encourage additional competition via selling off Lloyds branches to Co-op Bank has been a high-profile embarrassment, serving only to expose Co-op’s own financial distress. Eventually, perhaps new reforms such as bailins might make market exit by failing banks more credible, thereby creating competitive space for new entry. But in the meantime, the UK’s nationalised banks make already-weak competition even worse, by benefitting from state aid. The European Commission has recognised the state aid provided and would eventually mandate break-up and sale of the quasi-nationalised banks anyway. It may be better to act in our own time.

Fifth, if break-up could be combined with privatisation, at least those components returned to the private sector might benefit from some de-politicisation, perhaps heralding a wider return to political sanity in the treatment of the financial sector.

There would be three main arguments against. First, the taxpayer would be likely to lose out considerably on the equity injections of 2008 and 2009. Of course, the taxpayer was always going to lose something – bizarre claims at the time that there would be a profit notwithstanding. But breaking the company up could mean that privatisation receipts would be lower, as the smaller entity gained less from economies of scale and scope.

Second, breaking up and selling off the company would reduce the ability of policymakers to use RBS as Sir Mervyn King wanted, namely instructing it to lend to regional and SME enterprises, as an additional macroeconomic tool. Perhaps even worse than this, if RBS were to be broken up and the pieces not sold off, there is a risk that RBS would indeed be used as such a tool, with disastrous implications for capitalism!

Third, and most fundamentally, selling off RBS would create a possible scenario in which a piece of RBS failed not long after it was created, as happened with Bankia in Spain. Could the government survive, politically, if a newly-privatised bank went bust?

My guess is that, although splitting up RBS would on balance be a good idea, the government won’t do it. We’re going to be stuck with state-owned banks for an unhappily long while yet.

Andrew Lilico is chairman of Europe Economics.