3 March 2009

Financial tale of the tortoise and the hare

Financial tale of the tortoise and the hare

Danny Kelly

This is a tale of two Scottish financiers whose fortunes serve to illuminate the wisdom of Adam Smith, who perfectly encapsulated the root of the current global banking crisis in The Wealth of Nations, 200 years ago: "Capitals are increased by parsimony and diminished by prodigality and misconduct".

Contrasting the fortunes of Sir Fred Goodwin, former chief executive of Royal Bank of Scotland, and Gerry Kay, chief executive of Scottish Building Society (SBS), is almost to offer a modern reworking of Aesop's fable about the tortoise and the hare.

While Goodwin was being named as Forbes Man of the Year, knighted by then prime minister Tony Blair, advising then chancellor Gordon Brown and flying into Edinburgh airport on his private jet en route to his custom-built £350m headquarters at Gogarburn, Kay was driving to his modest office in Dalry Road, Gorgie.

In a decade Goodwin transformed a small regional bank into the world's fifth largest, on the back of some hugely leveraged global acquisitions, beginning with NatWest and culminating in the hubris of the ABN Amro takeover.

Kay, meanwhile, was cele-brating the launch of SBS's Aberdeen office, the society's first branch opening in 22 years.

But as any canny, old-school Scottish financier will tell you, it is the bottom line and the cash flow that counts.

Whereas Royal Bank has just posted a £24.1bn loss, the biggest in UK corporate history, SBS is preparing to announce record results at the end of this month.

Kay and his team will reveal that they have boosted their balance sheet by 14% in the last year and beaten their new savings target by 400%.

"We are highly liquid and have a very strong capital ratio,"

says Kay, who enjoyed a baptism of fire at SBS as he took charge just a fortnight after the Northern Rock debacle saw the first run on a British bank since Victorian times.

"We have funds to lend, which is unusual. We have exceed profit and lending targets. We are very liquid so able to withstand shocks and exploit opportunities in the coming year. When those fabled green shoots do appear, we are well-placed."

It is telling that while former building societies that demutualised have come to grief - Bradford & Bingley, Halifax, Northern Rock to name but three - those that have remained mutual are doing well.

Kay endorses the merger of Britannia, the UK's second-largest building society, and Co-operative Financial ser-vices: "This a healthy develop- ment as it creates a super mutual. There will be more mergers in the sector."

Other big beasts in the building society sector have been predatory recently. In what sounds like a game of risk with English counties, the Yorkshire swallowed Barnsley and the Nationwide annexed the Cheshire and Derbyshire.

While the pressure for consolidation intensifies, Kay is not preparing to capitulate: "Our commitment is to be independent, Scottish and mutual. We reiterated and endorsed that at the last board meeting."

While the Royal Bank retail banking side was an extremely well run and innovative operation it suffered from the extremely high-risk and highly- leveraged strategy conducted elsewhere in the group.

Kay is clear that the financial services industry must go back to the future to restore trust: "Banks should revert back to their traditional methods. We are steeped in caution and control. We stick to our knitting and we reinforce that is where we should be. It was pointed out to me the other day that I am only the third CEO in 30 years - there is continuity there."

While former building societies such as Bradford & Bingley and Northern Rock plunged recklessly into such areas as buy-to-let, self-approved mortgages and 125% mortgages, SBS refused to be lured by the empty promise of big prizes, realising that if something looks too good to be true then it probably is.

"We lend only as we take in retail savings," notes Kay. "Eighty-five per cent of funds are retail savings against the 70% norm in the sector."

With savers in revolt as the prime minister and chancellor penalise the prudent to bail out the profligate, Kay acknowledges that he and his team must manage the equilibrium between the interests of savers and borrowers.

"We realise that mortgage customers want low rates and savings customers want high rates and we need to balance their needs. We keep our savings rate above the average. Our SVR is 18th lowest out of 54 in the sector. We do not com- pete with the Nationwide because if we pay more for funds then we have to balance the books."

It is an approach that is striking a chord with SBS growing number of savers, of whom there are seven for every borrower.

However, lest this vision appear altogether too utopian, the society is not altogether isolated from the gloom of the greatest banking bust since the Great Depression. Like others, SBS has been dragooned into bailing out feckless rivals through the Financial Services Compensation Scheme. Kay is as scathing about the moral hazard of the scheme as any victim of an extortion racket.

"It is appalling that our members have to suffer because of the imprudent actions of Bradford & Bingley and IceSave." The other galling aspect for Kay is that the the Financial Services Authority has still not confirmed exactly how much the SBS is obliged to contribute.

"It's a three-year minimum levy but we still only have an estimate from them. It is an uncontrollable cost that is not of our doing".


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