How Governance and Risk Management Failures Contributed to Fall of Major UK Bank

By Norman Marks (@normanmarks) Jan 4, 2012

The UK’s Financial Services Authority (FSA) has published its report on the causes of the failure of the Royal Bank of Scotland (RBS). RBS was a massive bank and its failure was significant to the UK and global economy.

The report spends most of its time explaining that the bank failed due to poor decisions and poor oversight by the regulators. It also has an interesting section explaining why nobody has yet been criminally prosecuted.

I want to draw your attention to the sections I consider relevant and important to governance, risk and audit professionals.

You can read summaries from reporters at The Telegraph and inAudit (focusing on the audit profession and related areas of accounting) for further background.

RBS’s Management, Governance & Culture

24 Some of the causes of RBS’s failure were systemic — common to many banks or the consequence of unstable features of the entire financial system. And a deficient global framework for bank capital regulation, together with an FSA supervisory approach which assigned a relatively low priority to liquidity, created conditions in which some form of systemic crisis was more likely to occur. But with hindsight, it is clear that poor decisions by RBS’s management and Board during 2006 and 2007 were crucial to RBS’s failure.

25 Individual poor decisions can result from flawed analysis and judgement in particular circumstances: many of the decisions that RBS made appear poor only with the benefit of hindsight. But a pattern of decisions that may reasonably be considered poor, at the time or with hindsight, suggests the probability of underlying deficiencies in: a bank’s management capabilities and style; governance arrangements; checks and balances; mechanisms for oversight and challenge; and in its culture, particularly its attitude to the balance between risk and growth.

26 It is difficult, from the evidence now available, to be certain how aspects of RBS’s management, governance and culture affected the quality of its decision-making, but the review team’s analysis prompts the following questions, in addition to the conclusion (discussed in paragraph 19) about the ABN AMRO bid:

Whether the Board’s mode of operation, including challenge to the executive, was as effective as its composition and formal processes would suggest.
Whether the CEO’s management style discouraged robust and effective challenge.
Whether RBS was overly focused on revenue, profit and earnings per share rather than on capital, liquidity and asset quality, and whether the Board designed a CEO remuneration package which made it rational to focus on the former.
Whether RBS’s Board received adequate information to consider the risks associated with strategy proposals, and whether it was sufficiently disciplined in questioning and challenging what was presented to it.
Whether risk management information enabled the Board adequately to monitor and mitigate the aggregation of risks across the group, and whether it was sufficiently forward-looking to give early warning of emerging risks.

27 Potential areas of concern about RBS’s management, governance and culture were identified by the FSA Supervision Team during the Review Period. The degree of supervisory intensity applied to these issues, however, while consistent with the FSA’s prevailing practices and approach, was less than the FSA now considers appropriate.

Credit should be given to the RBS internal audit team for surfacing some of these issues. For example, at paragraph 611, this is reported: