FSA: Fair value accounting contributed to RBS failure

FAIR VALUE ACCOUNTING was partly to blame for RBS’s failure in 2008, the Financial Services Authority has concluded.

A weaker-than-expected capital position created by a “severely deficient” definition of regulatory capital was also highlighted, as well as excessive dependence on short-term wholesale funding.

Significant loan losses suffered in late 2008 were not clear at the height of the crisis, but uncertainty about potential losses and the quality of RBS assets undermined market confidence, the FSA said.

Large fair value losses – as plummeting market prices undermined the assumed value of assets – at RBS and other banks “directly eroded equity buffers and created huge uncertainty about how large eventual losses might be”.

That RBS’s losses were so significant is a reflection of “deficient strategy and execution at the firm”, the regulator continued.

The bank’s investment banking losses for the period in question stood at around £7bn, but it managed to raise £12bn extra capital, meaning the £7bn loss should not have knocked it over.

However, the £32bn of normal loan losses – due in part to a perfect storm of fair value accounting and incurred loss provisioning – was what really pushed the bank to the brink.

Regulators believed the bank’s capital stood at around £60bn, when in fact it was closer to £15bn. This was partly due to confounding going concern capital, provided by ordinary shareholders’ funds, with emergency run off reserves.

RBS therefore only had to lose around £15bn for its going concern status to be in jeopardy, not the £60bn regulators assumed.

The report chairman said “people want to know why RBS failed” and whether those responsible should be subject to sanctions.

As no “strict liability” of RBS staff has been established, the FSA said legal proceedings would be unlikely to succeed, and claimed strengthened regulations should prevent future failure of this nature.

“Poor regulation made it more likely that there would be a systemic crisis and thus set the context for RBS’s failure, and a flawed supervisory approach provided insufficient challenge,” the report said.

“But ultimate responsibility … must lie with the firm,” it continued, saying “underlying deficiencies in management, governance and culture “made it prone to make poor decisions”.

The FSA also acknowledged some of its own supervisory shortcomings, saying the liquidity regime before the crisis was “severely flawed”.