A little over five years later, HSBC appears to be weathering the banking storm as the unofficial ‘Last Bank Standing’ of the UK banking system, whilst the CEO of RBS has lost his job and the bank itself has had to accept recapitalisation on terms that could concede a majority equity stake to the UK government
Following the extensive financial deregulation in the UK throughout the 1980s, many banks began rapidly growing their product portfolios, taking advantage of the deregulation to explore ever more profitable financial services (Harris, 2007). In recent years, this expansion has encompassed overseas investments, with banks taking on joint ventures and acquisitions in non UK markets in an attempt to access more rapidly growing sectors and markets. The Royal Bank of Scotland was one of the most active banks in this activity, taking a £1.7 billion stake in Bank of China Ltd in 2005, giving it access to around 13% of the overall Chinese market (MarketWatch, 2005). However, the main focus of RBS’ expansion activities in the period focused on increasing the availability of their leveraged financial instruments, with Risk (2002) reporting that RBS spent the majority of 2002 and 2003 increasing the liquidity available to it in foreign exchange and other dealing markets. As part of this, and in response to shareholder concerns about the potential riskiness of some of these instruments, RBS implemented a series of risk management products to increase the level of transparency around their investments and ensure that they were hedged against any market downturns (Corporate Finance, 2003).
In contrast, HSBC’s corporate strategy was focuses on acquisitions in developing markets, including the acquisition of a Mexican pension fund management company in November 2003, together with the purchase of a stake in an Indian retail bank and the acquisition of Lloyds TSB’s onshore and offshore businesses in Brazil, both in December 2003. In addition, several of HSBC’s majority owned subsidiaries entered into joint ventures and acquisitions over the same period, allowing the company to diversify its operations (HSBC Annual Report 2003, 2008). Whilst this was criticised in some areas for not taking advantage of the leveraged opportunities at the time (Davidson, 2003), it enabled HSBC to grow its revenues as the US and UK economies faltered. Indeed, in 2007 HSBC managed to achieve a new high level of earnings in spite of the falling markets in the UK and the US (HSBC Chairman’s statement 2007, 2008). This is partly because HSBC has such a strong focus on emerging markets, but also because HSBC’s operations are not as highly leveraged as RBS’, and hence have not suffered as much from the deleveraging currently occurring in these markets (HSBC CEO’s statement 2008, 2008).
Indeed, RBS’s annual reports show a very different story to those of HSBC, with the bank completing nine acquisitions in 2003, of which four were in the US, three in Europe and two in the UK and Ireland (RBS Chairman’s statement 2003, 2008). These acquisitions were driven by the expansive fiscal and monetary policies of the US at the time, which led many analysts to believe that these markets had come through the worst of the post dot com recession (RBS Chairman’s statement 2003, 2008). However, RBS’ 2005 statement reveals an excessive level of focus on the western world, with the company depending on the UK for 58% of its profits, with the majority of the remainder coming from the US and Western Europe. Even attempts to diversify, including the investment in Bank of China, were driven by disposals of shares in Banco Santander in Spain, thus failing to reduce the company’s dependence on its core markets of the UK and US (RBS CEO, 2005). As a result of this, whilst RBS’ direct exposure to subprime lending was not as large as HSBC’s, the lack of diversity of the portfolio, and the fact that RBS had a more leveraged portfolio meant that RBS was forced to make a £5,925 million write down on the value of its credit market portfolio in 2008, hence leading to a projected record loss of over £1 billion (RBS CEO’s report 2008, 2008). As a result of this, RBS was unable to capitalise itself any longer, and was hence forced to accept recapitalisation by the UK government.
In contrast, whilst HSBC suffered a significant drop in profits due to its direct exposure to the US markets, its lower degree of leverage meant that it was still highly profitable, with the gain from its emerging market investments helping to offset its losses from the US. As a result of this, HSBC was able to continue with its planned acquisition of Korea Exchange Bank, and even attempted to lower the previously agreed price as a result of the credit crunch. This continued strategic focus on the Asian markets, where high savings rates provide capital, and hence reduce the reliance on the now non functioning wholesale lending markets, has enabled HSBC to come through the credit crunch as the unofficial ‘Last Bank Standing’, and is one of the few UK banks not to need a bailout from the UK Government. It is interesting to note that RBS wished to avoid the need for a government bailout, and attempted to seek recapitalisation from its own shareholders by means of a new rights issue. However, this rights issue was significantly under subscribed, meaning that the UK government was forced to buy up most of the shares at a premium to the market price. As a result, RBS is now largely owned by the UK government, and has effectively been nationalised.
In conclusion, RBS’ sceptics were largely correct to be concerned about the bank’s excessive use of leverage and lack of diversity in its revenues. In contrast, HSBC’s decision not to highly leverage its portfolio, whilst greeted with some scepticism, has allowed the company to avoid any indirect losses. As a result, whilst HSBC had the largest direct exposure to US sub-prime lending, it did not have as large an indirect exposure as many of its peers, who depended on the wholesale markets for funding, and hence saw significant indirect losses as they were forced to liquidate positions to cover the loss of wholesale funding. Finally, RBS was strongly involved in highly leveraged investment banking products including foreign exchange and other dealing markets. Whilst this allowed the company to grow its revenues strongly from 2003 to 2007, it meant that when the deleveraging process began the bank was much more vulnerable to forced selling. In contrast, HSBC’s lack of leverage and strong cushion of savings deposits from the Asian markets meant that HSBC’s revenue growth was not as spectacular over the first part of the period, with RBS’ operating profit growing from £6 billion in 2003 to £10 billion in 2007, whilst HSBC’s only grew from $20 billion to $24 billion. However, HSBC’s rise was ultimately more sustainable, and thus the bank has not suffered the same fate as RBS.
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