Part 2: Country spotlights
Part 2: Country spotlights
This section contains two articles:
The UK: The government bails out ailing banks, but questions remain
Chapter links:
- Chapter 2
- Chapter 3
- Chapter 5
- Chapter 11
- Chapter 15
- CF 3.1
As G20 leaders were gathering prior to a meeting in London on 1 April 2009, protesters were also assembling across London, their placards exhibiting a wide range of issues. Wars, poverty and climate change featured, but the global financial crisis – specifically who is to blame - was the most prominent. Crowds gathered at the headquarters of the Bank of England, which many accuse of regulatory failings. Angry protestors also attacked the City of London branch of the Royal Bank of Scotland (RBS). Although most British banks have struggled in the financial crisis, the RBS has attracted particularly hostile publicity. Disquiet focuses on the government's injection of huge sums of public money to rescue the bank, at a time when the executives who were responsible for management failures were awarded generous bonuses and pensions. Here we look at the dramatic downfall of RBS, which highlights the fatal weaknesses of the British banking sector generally. We then assess whether the measures taken by the government are likely to work.
The UK tends to be linked with the US as examples of the capitalist excesses (outlined in the article on capitalism in this update). It has been vulnerable in the global financial crisis because of its huge financial sector. The globalization of finance brought immense prosperity to London as a financial centre, largely due to the attractions of the UK’s tradition of light regulation. However, regulatory failings are now seen as contributing to the pattern of risk-taking behaviour in the country’s banks, which left them exposed to US sub-prime debt. RBS is a good example, whose global banking and markets division made huge losses in 2008. In recent years, the bank has looked to this division, which was its investment banking operation, to achieve high rates of growth. It became involved in financing private equity buyouts and commercial property deals. The bank's international expansion has focused on acquisitions. However, in 2007, the CEO, Sir Fred Goodwin, launched an ambitious takeover of the Dutch bank, ABN Amro, which was to prove fatal. ABN Amro was thought to be a manageable acquisition, with good potential for profitability, but RBS failed to delve deeply enough into the Dutch bank’s finances. Following its success in a bidding battle, RBS discovered that ABN Amro’s finances were not as sound as had been thought. A rapid deterioration in markets and the over-ambitious acquisition left RBS in deep financial trouble.
The regulator, the Financial Services Authority (FSA), advised RBS to sell its insurance business to raise capital, and a £12 billion call for more capital went out to shareholders. As it became clear that the ABN Amro acquisition was a mistake, large depositors withdrew funding, leaving RBS in a precarious position. On 10 October 2008, the FSA announced the injection of £20 billion into RBS, effectively nationalizing the bank, and Sir Fred Goodwin announced his departure.
Public outrage focused particularly on the award of a pension of nearly £700,000 for life (he was 50 at the time). It was unclear whether the size of his pension had been known to government negotiators at the time of the discussions to bail out the bank. Sir Fred Goodwin’s home in Scotland had been vandalized the previous week. In just over a year, British banks descended from being lauded at gleaming examples of global finance to being vilified as reckless risk-taking institutions, whose overpaid executives responsible for the mess were still able to claim millions in bonuses and pensions.
The British government devised a complex plan to allow RBS to continue functioning, by providing insurance to underwrite the bank’s toxic assets. In return, the company is compelled to lend £25 billion to British consumers and business over the next two years (9 in mortgages and 16 to small businesses and companies). The UK government is now a significant shareholder in major banks: 70% of RBS, 43% of Lloyd’s Group (including the failed Halifax Bank of Scotland); and sole owner of Northern Rock and Bradford & Bingley. In theory, the government is in a strong position to impose regulation and control excessive rewards.
The UK government has set up UK Financial Investments (UKFI), an agency which will manage its bank investments. UKFI’s brief is to promote the interests of the taxpayer as shareholder, and to take decisions independently of the Treasury. A concern is that the UKFI, following in the British tradition of self-regulation, will acquiesce in allowing the banks to carry on as before, rather than take bold steps to alter strategy. The UKFI has achieved some success in reining in RBS bonuses, recognizing the public clamour for failure not to be rewarded. An early test came at the RBS annual general meeting on 3 April 2009, when private shareholders turned out in large numbers. The company’s remuneration report was rejected by a 90% majority, which included the UKFI vote. Adding in the abstentions, the remuneration report was approved by only 8.4% of shareholders, the lowest percentage every recorded. Although the Chairman asked Sir Fred Goodwin to relinquish at least some of his huge pension, which was the focus of much public anger, Sir Fred rejected the request.
Regulatory reforms are being considered by the British government, but a change in culture towards responsibility and accountability is also seen as necessary. It is widely perceived that there needs to be a shift from the aggressive, profit-maximizing culture which rewarded individuals so lavishly, to the more traditional culture of banking, which values prudence in both investments and rewards. The UKFI could take an active role in corporate governance to bring about such changes, but it might well be reluctant to do, in the belief that managers rather than government officials are better placed to make strategic decisions. It is also clear that, as the large banks had grown into global institutions with operations in many countries, international regulation is now rising up the agenda. The actions of national authorities, which have organized bail-outs with public money and are now addressing regulatory reform in their own countries, could lead to banks retreating into national markets and create barriers for foreign banks. Recall that the RBS was required to increase lending at home as part of its bail-out package. The FSA met with hostility from foreign banks when it proposed that they should raise the proportion of assets they hold in their London subsidiaries. London's heyday of competitive advantage in financial services based on its light-touch regulation seem over, but a return to national banking would be out of step with the highly integrated global strategies and operations of modern MNEs. International governmental co-operation is needed both to facilitate cross-border financial flows and maintain confidence in the banking sector globally.
Find out more...
- The Economist, ‘The go-between’, 7 March 2009.
- Larsen, P., ‘Goodwin’s undoing’, Financial Times, 25 February 2009.
- Larsen, P., ‘RBS scheme is verging on state control’, Financial Times, 27 February 2009.
- Treanor, J., ‘Sir Fred Goodwin defies revolt of RBS shareholders’, The Guardian, 4 April 2009.
- Larsen, P., ‘A lot to be straightened out’, Financial Times, 31 March 2009.
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India: Business receives welcome lift in India
Chapter links:
- Chapter 2
- Chapter 3
- Chapter 4
- Chapter 5
- Chapter 7
- Chapter 11
- Chapter 15
- CF 2.2
- CS 9.2
Following the convincing re-election of the Congress Party in May 2009, India, the world’s second largest emerging economy, is optimistic that it will weather the global economic downturn and boost annual growth to 8%. Recent turbulence in the country has made foreign investors wary. The prospect of an inconclusive election result, giving regional and caste parties power to determine the make-up of a coalition government, looked likely to lead to political instability and a weakening investment climate. The election of a strengthened Congress government, needing the support of only a few smaller parties to govern, offers the prospect of continued economic growth, although with provisos that a fragmented political landscape still prevails, and the country still has much to do to improve social and economic conditions for its society.
Corporate India can point with pride to attaining global status in sectors such as IT outsourcing and pharmaceuticals. However, its prestige was dealt a blow when scandal erupted at Satyam Computing Services, the country’s fourth largest outsourcing company. Its Chairman, Ramalinga Raju, confessed in 2008 that he had been operating an elaborate fraud over the past several years, amounting to $1 billion. He admitted to inflating profits and even inventing employees. Following the shock announcement, the immediate worry for India’s business community was the apparent failure to spot anything wrong by the company’s auditor, PricewaterhouseCoopers (PwC) and the regulators, including stock market authorities in India, the US and the Netherlands, where Satyam is listed. The scandal drew attention to weaknesses within Indian business, including crony capitalism and weak disclosure standards. Many of India’s companies, including over half of its listed ones, are controlled by families, whose members have links with government. Satyam was a family-controlled company, in contrast to its two larger rivals, Tata Consultancy Services (TCS) and Infosys, which are managed by professionals. Ramalinga Raju was proud of his rags-to-riches story, having risen from a humble background and earned an MBA from Ohio University. Although India’s corporate governance is still considered better than that in many emerging markets, the example of Satyam indicates that boards with nominally independent directors are not the safeguard that they seem to be, as selection is controlled by the family. The Indian regulator, the Securities and Exchange Board of India, is taking steps to tighten disclosure rules, but this reform has been in the pipeline for years, suggesting that progress towards transparency and independent boards is slow.
India has made strides in opening its economy to foreign businesses, which are attracted by its huge market and location advantages, such as low-cost labour. However, social and religious tensions are never far beneath the surface (see feature on Tata in the update of 20 November 2008). Furthermore, attacks have sometimes been targeted at foreigners. A co-ordinated set of terrorist attacks in Mumbai, 26-29 November 2008, killed 170 people. The attacks targeted hotels and other venues used by businesspeople, both Indian and foreign. The Indian police and military seemed to be caught unprepared and were criticized for their handling of the incidents. The government has been keen to show that it would now be better prepared. Blame for the attacks was laid on Islamist groups from Pakistan, where growing instability has spilled over into neighbouring countries.
The political scene in India has become more fragmented since the elections of 2004, with the continuing rise of religious, regional and caste parties. It was feared that these disparate parties would gain the upper hand in the 2009 election, reducing the standing of the two major national parties. In the event, the two main parties accounted for 47.3% of the vote. Voter support for Congress itself rose from 26.5% in 2004 to 28.5%. This was not a resounding victory over the smaller parties, but it did give Congress a significant increase in parliamentary seats, from 145 (of a total of 545) in 2004 to 206 in 2009. The Congress Party chose as its campaign song the theme from Slumdog Millionaire, the Oscar-winning film about the slums of Mumbai (although many in India consider the British-produced film not to be truly Indian). The party’s traditional electoral support comes from India’s vast swathe of poor, rural inhabitants. Agriculture accounts for only 20% of GDP, but 60% of the workforce. Although this sector has not seen the levels of prosperity enjoyed by the urban middle classes in service-sector jobs, rural incomes have improved and rural projects have had an impact on reducing India’s widespread poverty. A write-off of rural debt for 43 million farmers in 2008 was popular with voters, although it cost the government 1.6% of GDP. Rural Indians are expecting continued improvement in their lives, however, and the new government is aware that it needs to raise economic growth from the current 4% to 8%, to provide jobs for the 14 million people who enter the jobs market each year. The Prime Minister, Manmohan Singh, now assured another term of office, has acknowledged the challenges of meeting voter expectations.
Foreign investors have reason to be optimistic that continued economic reforms will take place, opening up key sectors of the economy, albeit slowly. In particular, they are hoping for the government to ease the restrictions on foreign ownership in sectors such as telecommunications and retailing. The government will also be expected to rein in India’s corruption and reform its creaking bureaucracy, which hamper both domestic and foreign businesses. India can be proud that its 417 million voters in this, the world’s largest democracy, have delivered a workable coalition government. India is a pivotal country among emerging markets, and its new government is in a position to take a lead role on global issues such as trade and climate change. However, the domestic social and economic environment still looms large on the political agenda.
Find out more...
- The Economist, Special report on India, 13 December 2008. This contains 7 articles on Indian business and society.
- Leahy, J., ‘Calamitous confession’, Financial Times, 14 January 2009.
- Financial Times, 30 January 2009, ‘India and globalisation’. This is a special report, which contains a number of articles.
- The Economist, 23 May 2009, Briefing on India’s election.
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