Cleared Of Fraud Against SMEs, RBS Eases Rules For Distressed Businesses

Last week, The Royal Bank of Scotland Group (NYSE:RBS) was cleared by law firm Clifford Chance over allegations that the U.K.-based banking group deliberately put failing small and medium enterprise (SME) customers out of business to profit from the proceedings. ^[1] RBS hired the law firm for an independent review after a report by Lawrence Tomlinson – adviser to the Department for Business, Innovation and Skills – claimed last November that RBS had on several occasions forced small businesses into default so that it could transfer control of the SMEs to its Global Restructuring Group (GRG). ((Report, Tomlinson’s Website, Nov 23 2013)) The announcement marks yet another step by RBS towards resolving a long list of legal and operational issues on its path to privatization, as the British government holds a majority stake in the group since its bailout in early 2009.

The Clifford Chance report found no evidence to support the allegation, although it highlighted the need for improvements in the way RBS dealt with distressed SMEs. RBS responded promptly by announcing a string of changes to its GRG unit. Notably, the bank continues to be investigated by the U.K.’s Financial Conduct Authority (FCA) over the same allegations. But the report and subsequent changes to the business unit should help RBS rebuild trust among SMEs – a sector it cannot overlook given the British government’s directive for the bank to focus almost completely on retail and business banking in the U.K.

We maintain a $12 price estimate for RBS’s stock, which is about 20% ahead of its current market price.

See our full analysis for RBS’s stock

One of the biggest factors behind RBS’s overall strategy in recent quarters has been the pressure exerted on it by the U.K. government to make sweeping changes to its business model. In keeping with these directives, RBS has reduced its investment banking operations to a fraction of its pre-2008 size, and has shifted focus to its retail and corporate banking businesses in the U.K. over the last two years. However, the bank’s reputation suffered a major setback late last year when a report alleged that the bank was letting SMEs fail to profit at their expense.

RBS took control of the situation by calling for the independent review from Clifford Chance. After all, the GRG unit forms an important part of the bank’s U.K. business division. With roughly £20 billion (~$34 billion) in outstanding loans, GRG manages more than 20% of the bank’s $16- billion business loan portfolio (shown in chart below). To garner additional trust among SMEs after the Tomlinson report debacle, RBS also proposed the following changes to its SME lending operations: ^[1]

• The bank will not charge SME customers based on the significantly higher default interest rate for the first 90 days in case the customer defaults on a payment
• The bank will provide more clarity to SME customers on the various fees and charges its GRG unit imposes on them in the event of a restructure
• The bank will wind down and sell all assets under West Register – an investment vehicle created by the bank to bid for distressed assets sold by SMEs being restructured by the GRG – as it is perceived as a conflict of interest
• The bank will also provide more comprehensive training to its customer representatives so that they can help SME customers better

What remains to be seen is whether these steps are really able to infuse confidence among disgruntled SMEs over subsequent quarters. You can understand the impact of declining business loans on RBS’s share value by making changes to the chart below.

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1. RBS responds to Clifford Chance report into allegation of systematic fraud, RBS Press Releases, Apr 17 2014 [↩] [↩]