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Will Britain Tide Over Banking Blues?

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When The Royal Bank of Scotland Group plc (RBS - Free Report) became the fifth largest in the world in terms of assets, it was easily deemed Scotland's economic miracle. However, this brainchild of Sir Fred Goodwin, which broke numerous records on its way to nearly 26 acquisitions in 7 years (up to 2007), is still reeling under recessionary pressures.

When the banking crisis erupted, triggered by the fall of Lehman Brothers in the U.S., it became obvious that many of the assets against which Royal Bank of Scotland had borrowed money were worth only a portion of its previous value. This had prompted the British government to step in with the biggest bailout in history for the Royal Bank of Scotland. Five years later, the British government is still struggling to recover that amount and put the past behind.   

The Rise and Fall

Royal Bank of Scotland is an eyesore in the British banking system, a key reminder that all is not well with the sector. The bank, which is a major threat to the stability and health of the country’s economy, is an example of a fancy deal that has backfired.

Once the shining example of Britain’s banking system, RBS has established that market dominance is transient. After being rescued by the government with £45 billion ($70 billion) in 2008, the bank is still 81% owned by U.K. taxpayers. Private ownership looks unlikely and the Bank of England is now forcing the U.K. Treasury to consider splitting up Royal Bank of Scotland into a nationalized bank and a commercial banking unit.

Is a Split Possible?

The feasibility of the split is, however, in question. The Royal Bank of Scotland plodded on for years since the economic crisis without restructuring its troubled and non-profitable units. This was partly because of the government's decision in 2008 to take a passive approach to manage its stakes in the deeply troubled banks, including Lloyds Banking Group plc (LYG - Free Report) .

Anticipating the banks’ quick return to their private ownerships, the government did not intrude on their strategies. This was in sharp contrast to the U.S. government, which strategically forced bailed out giant banks like Citigroup Inc. (C - Free Report) and Bank of America Corp (BAC - Free Report) to vend their toxic assets.

Additionally, the nagging Eurozone crisis is slowing down investments and trade, throwing further challenges to the already beleaguered financial sector. It also faces stringent regulations and higher taxes on the face of tougher immigration rules. Even international regulations like Basel III that will force all banks to increase capital adequacy, are expected to be detrimental. In short, banks will be heavily regulated with little scale for racy profits but will have a much less chance of failing.

Has Government Taken a Stand?

Initially, the British government was commended for its efforts in dealing with the financial crisis in 2007. While Lloyds is looking up, the long process of restructuring banks is hurting the still-weak British economy.

However, after years of a muted approach, the Treasury is adopting a strapping strategy for The Royal Bank of Scotland. The British administration has pressed the bank to reduce its investment bank, shrink its U.S. unit and refocus on the U.K. business.

The potential split of the bank is likely to be a topic of hot debate, as it is evident that taxpayers will surely incur huge losses. Further, it is expected to hit roadblocks with regulatory authorities. However, we believe that separate banking entities will be easier to regulate. Then again, with impending regulations posing threats, we do not foresee much respite in the near term.

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