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Analysis of the Financial Health of Royal Bank of Scotland (rbs)

Essay by   •  May 11, 2011  •  Case Study  •  3,818 Words (16 Pages)  •  1,971 Views

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1. Analysis of the financial health of RBS, plc.

2. Financial Statement analysis of RBS financial statements 2008 - 2010

RBS at the Brink of Disaster:

Can this Bank Save Itself?

The Royal Bank of Scotland ("RBS," "The Group") was created in 1727 by Royal charter. Since then, the group has grown into a large bank holding corporation, doing business in more than 50 countries, and holding £2.4T in assets. The growth of the group in the past thirty years has been rapid, resulting in a large amount of exposure to the world credit markets. Overpaying for two banks in the mid 2000s has compromised the group's capital position. Furthermore, unwise lending standards throughout the world have recently resulted in a credit bubble that has further harmed the capital positions of financial institutions throughout the world. The damage that has been dealt to the balance sheet, as seen below, of RBS has resulted in the UK government taking a majority stake in the bank, giving a capital infusion in exchange for an ownership portion.

Although Her Majesty's Treasury has had to take a 70% stake in RBS to avoid the bank's failure, the measures now being taken by the group will not only prevent complete nationalization, but also put RBS in a better position to profit once market conditions return to normal.

The story of the Royal Bank of Scotland dates back to the failed Darien Expedition, an attempt by the Scottish government to establish a colony in Panama. The expedition failed for many reasons, and many Scottish people were financially ruined by the occurrence. As a result, His Majesty's Treasury paid to indemnify the Darien investors. The corporation that was formed to disburse these funds is what was to eventually become the Royal Bank of Scotland in 1727 by Royal decree (Barbour, 1907, 192). From here, growth was slow, with the bank opening its first branch in Glasgow in 1783, and finally moving beyond the borders of Scotland in 1874 (Datamonitor - Royal Bank of Scotland plc, 2009, 8).

In the early 1900s, the bank made acquisitions throughout England, including Williams Deacon's Bank and Glyn Mills, which gave it an expanded presence. In the 1960s, RBS merged with the National Commercial Bank of Scotland, which significantly increased RBS's customer base and branch network. The 1970s saw the group expanding the scope of their business, launching a leasing company and a financing company. Additionally, this was the first decade that saw RBS expanding internationally. (Datamonitor - Royal Bank of Scotland plc, 2009, 8).

The 1980s saw a further broadening of the scope and scale of the bank. In 1985, RBS set up a company to sell auto insurance directly by telephone, a subsidiary that came to be known as Direct Line Insurance. RBS bought a very successful commercial bank holding company in the United States, Citizens Financial Group ("CFG"), in 1988, which brought RBS to a large number of new consumers. The new US presence also allowed RBS, through CFG, to purchase several troubled banks throughout the Northeast (Datamonitor - Royal Bank of Scotland plc, 2009, 8).

As time has passed, RBS has become more and more important in the financial services sector on a worldwide scale. Financial services are vital to the economy as a whole, as well as to individuals and corporations. Nearly everybody uses a bank for savings, even more for borrowing, and more still for transactional accounts. Corporations use banks even more extensively, especially for transactional accounts and borrowing. Investment vehicles come from other places, such as brokerages, mutual funds, hedge funds, private equity firms, and investment banks, all of which come under the umbrella of financial services.

Borrowing is vital to corporations, both for capital expenditures, as well as day-to-day expenses. Capital expenditure ("CapEx") borrowing allows businesses to spread out the cost of large expenses, such as acquisitions, equipment, or real estate. Revolving lines of credit are used to smooth cashflow from month to month, and allows short-term expenses to be paid when the funds to pay them have not yet arrived, but will within a brief period.

Businesses rely on both short-term and long-term borrowing to maintain their operations. A corporation that has filled its space with employees and equipment may be able to expand, and hire new people, if it is able to secure financing for the purchase of another facility. In this case, a CapEx loan may benefit many different people. This expansion can help current employees who now have higher earning potential, future employees who may now find employment, customers who may now be able to purchase more products, shareholders who will earn more on their investment, and the economy as a whole because output has increased. Furthermore, the benefits are extended to employees, potential employees, and shareholders of the lender, who can also expand.

Short term loans may allow a business to continue to pay out wages during a season when sales are higher. When a company sells products, there are often payment terms, a period when the customer is not yet responsible for payment. Receivables cannot be paid out to employees or vendors directly, but a loan provides cash which can be dispensed. This type of loan helps the same people that would benefit from a CapEx loan, but in a more immediate fashion.

Banks act as the intermediaries that connect borrowers and lenders. Without this intermediary, it would be difficult for somebody who had a need for funds to find somebody who had extra funds. Likewise, it would be difficult for somebody who had extra funds to find somebody to lend it to. Banks occupy both roles, lending to those who need to borrow, and borrowing from those who need to lend. In this sense, banks are the lubrication that allows an economy to function.

According to Hoggarth, Reis, and Saporta, a banking crisis, by itself, can result in the decrease of economic output by 6%-8%, and by greater than 10% when coupled with a currency crisis (Hoggarth, Reis, and Saporta, 2001, 11). Consequently, what happens to the banks, and the financial services industry as a whole, has an immediate effect on all, from corporations, to the government, and to consumers and employees. Companies that are unable to borrow will not only be unable to expand, but also unable to smooth their cashflow through lean times, which may result in job losses.

From the end of the 1990s, the financial services sector has had a nearly unprecedented opportunity for growth. The Financial Services Modernization Act of 1999, also known as the

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