The Bankwatch

Tracking the consumer evolution of financial services

UK government, RBS, and Lloyds begin the bad asset removal process

In the first real appearance of specific moves towards the inevitable Great Unwinding RBS announce plans to reduce their balance sheet by 25%.

RBS to cut balance sheet by 25% |

Royal Bank of Scotland will this week unveil plans to shrink its balance sheet by up to a quarter over the next three to five years as Stephen Hester, chief executive, sets out a strategy to return the state-controlled bank to the private sector.

Note the timeframe of three to five years – I suspect this will be on the shorter end of that timeframe or even less than three years.  More significantly I wonder if 25% is enough.  In any event the key is that it results in assets being valued at a level that is justifiable, and realistic.

The methodology for management of this writedown is to transfer loans to some “to be described” government vehicle.  Ths involvement of the government and allowing entire loans to be transferred has risks associated with the approach.  First of all which loans will be transferred and how will RBS owners and bondholders be made to pay for the benefit of removal of those loans?

Secondly, what of the loans that remain on the RBS balance sheet?  How will they be valued, and thus what is the true equity value of the new smaller RBS.

Lastly what of the derivatives, and how to unwind them.  With a world moving to less assets and less asset value these must have far less if any basis for existence.  Note RBS is the largest bank in the world measured by Assets and note the size of the derivatives that are more than double the base amount of loans.

At the end of June, RBS’s balance sheet had swelled to almost £2,000bn, the largest of any bank in the world. Excluding matching derivatives contracts, it currently has assets of £1,000bn-£1,100bn.

Lloyds are also going to be participating and above comments apply equally.

Lloyds Banking Group, which includes HBOS, is also expected to seek cover for hundreds of billions of pounds of assets. Treasury officials will over coming days finalise the details of the scheme, which is the centrepiece of the government’s plan to kick-start lending to the economy.

Relevance to Bankwatch:

The approaches here will have to be waatched carefully and focussed on the appropriate end outcome.  That outcome should be a realistically value bank.  In the event that bank value is negative which is the real unsaid issue here, then the government may need to stand behind the despositors to avoid unprecedented bank runs and chaos, but that cannot change the goal of getting to realistically valued assets.

As the extent of the value of derivatives for each bank relative to their loan totals, the real story of unwinding the ponzi elements of the financial markets will appear and we will get closer to a smaller yet more realistic world financial market.

Written by Colin Henderson

February 22, 2009 at 22:17

Posted in Uncategorized

Tagged with , , ,

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