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Thursday, 26 February 2009

Good riddance to Goodwin

Goodwin shares with James Crosby the distinction that both rose to the top of a large bank with very little experience of banking. And quite frankly it shows. Crosby came from investment management and operations whilst Goodwin came from accountancy and the BCCI workout, via Clydesdale Bank's operations. It may not be blindingly obvious but the skills required for investment management and accounting are very different from those required for banking.

There are parts of the financial press and most of the accounting industry who would have the world believe that an understanding of risk goes hand in hand with accounting. Well I am sorry it doesn’t. There may be many accountants wearing a hat labelled “risk management”, but they are mostly the cogs in the machine that ensures the risk management systems running smoothly rather than the risk decision makers.

And banking is very different from investment management. Investment managers hope that the very high returns from some of their positions will offset any of their losing positions. Bankers don’t have that luxury. There is very little upside in banking but a lot of downside. For every loan that goes unrepaid the bank needs the profit from 100 more to recover the loss. The decisions have to be very careful. The accountant can look at a company’s accounts and decide that a loan is likely to be repaid, but that view is a taken on the date the accounts are drawn up. If it goes bad ten days later based on some unexpected incident the auditor shrugs his shoulders. It wasn’t his job to consider. The banker on the other hand has to take a forward view and understand what lies behind the assets he holds, understanding the real probability of not being repaid and whether the earnings he makes from that asset justifies the risk.

Bankers know about company accounts. They may not know the ins and outs of every accounting standard, but they know enough to determine what really matters to them from the accounts: cash flow. A company can’t repay its borrowings out of accounting profits, only cash flow. But the other aspect of banking that non-bankers don’t get is the idea of business strategy in the face of competition, which is something neither the accountants nor, to a certain extent, the investment managers, who have the option of selling positions in the short to medium term,

The wizard of Competitive Strategy is Michael E. Porter, a Harvard Business School Professor whose writings are required reading for any MBA since the late 1970’s, but he is only one of a myriad of such thinkers. To someone like Fred Goodwin, Porter is just an academic exercise, but to a true banker Porter’s thinking (look it up yourself) makes most of Goodwin’s errors look foolhardy. Let’s run through a few:

  1. The $10.3 billion purchase of Charter One Financial, a Cleveland-based bank, expanding RBS's footprint in the Rust Belt.

  2. Why would anyone want to do this? Buying into post-industrial America’s ex-industrial heartland. What particular advantages did RBS have that would make it a better owner of these assets than an American bank? Answer: None.

  3. The $101 billion acquisition of ABN Amro

  4. ABN was in difficulty, so why pay a premium to acquire its assets? Why should RBS do a better job of managing the problems? Answer: Beats me.

  5. Massive commitment of capital to investment banking, securities trading, and poor credit controls?

  6. On the positive side, there was a risk that traditional loan syndication could be swept away by the capital markets, but let’s face it. RBS was always a sensible bank, but it was never going to match the calibre of Wall Street banks. NatWest Markets and before that County or Greenwich or whatever they wanted to call themselves was full of people who could never hack it at one of the top banks, so should it be different just because RBS throws money at it. It takes more than money to break into Goldman’s lunch box, and RBS was always going to lose.

  7. The Investment in Bank of China

  8. So what does this do apart from putting some money in a foreign bank. Sure it gives your shareholders some exposure to China, but do you not think they can’t do that themselves. You wanted exposure to the east because it is a growing market. Well now you have all the time you need to visit China. But I still don’t see what this has to do with RBS’s core business, and neither do the new management who are in the process of unwinding all such foreign ventures.

Goodwin should be a lesson to the business world. Accountants are useless at strategy, and to run a big company you don’t need bean counters, you need switched on strategists.

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