The state-supported bank is to close much of its once-profitable investment bank.
This has been a good morning for shareholders in Royal Bank of Scotland (LSE: RBS) -- including the British government, which owns 83% of the bailed-out bank.
As I write, the RBS share price is up more than 8%, at 23.6p, in the wake of a much-anticipated announcement regarding the future of its investment-banking operations.
RBS plays to its strengths
This morning, RBS chief executive Stephen Hester unveiled wide-ranging changes to the group's investment bank and wholesale business. These changes are aimed at continuing the strategy announced by RBS in 2009, in the aftermath of its £45.2 billion bailout by UK taxpayers.
What's more, all UK-based banks are undergoing a period of enforced change, thanks to the ring-fencing of risky assets recommended by the independent Vickers Commission, plus higher capital requirements set out by the Basel III banking standards (and the UK government).
These regulatory changes have made certain capital-intensive aspects of banking much less profitable. As a result, RBS has joined other banks in streamlining, downsizing and exiting certain investment-banking functions. In future, RBS Global Banking and Markets (GBM) and Global Transaction Services (GTS) will evolve into two new divisions: 'Markets' and 'International Banking'.
Markets will provide corporate and institutional clients of RBS with support for fixed income (bonds), debt capital raising, securitisation, risk management, foreign exchange and rates. International Banking will combine the corporate-banking business of GBM with the international businesses of GTS to provide clients with access to debt financing, risk management and payments services.
Both new divisions will report to John Hourican, current CEO of GBM, who is allegedly soon to receive a £4.5 million bonus for last year.
3,500 more jobs to go
As well as bolstering these key divisions, RBS is taking an axe to non-core businesses where it lacks strength and market share.
As a result, the bank will exit its cash equities, corporate broking, equity capital markets, and mergers and acquisitions businesses. RBS is considering whether to sell or close these groups, which generated income of £220 million in the first nine months of 2011, but are currently unprofitable. Indeed, the bank is already in discussions with a number of potential buyers.
Over the next three years, RBS expects these changes to lead to the loss of 3,500 jobs worldwide, on top of 2,000 positions to be cut in the first half of this year.
A smaller, leaner RBS
RBS has been forced to reinvent itself for these three simple reasons:
First, to reduce the size of its bloated balance sheet, which had swelled to £2.4 trillion (almost twice UK national output) before the global financial crash of 2007/09. The changes to RBS Global Banking and Markets are expected to reduce its balance sheet by £120 billion, from £420 billion in mid-2011 to £300 billion three years hence.
Second, to reduce the bank's reliance on unsecured wholesale funding. At GBM, this is expected to decrease by £75 billion over three years. Also, RBS aims to have its domestic and international corporate-banking businesses wholly funded by their deposits, with a 100% loan-to-deposit ratio.
Third, RBS aspires to improve its return on equity to 12% over the medium term. By shedding risky assets and capital-intensive operations, the bank will progress towards this target.
Lower returns for shareholders?
Looking ahead, with a smaller balance sheet and bigger capital cushion, RBS should be stronger and more resilient to Mr Market's periodic shocks. However, it will also be a much more conservative, stable business.
Therefore, this suggests that the bumper profits of pre-2008 are a thing of the past, so shareholders may need to lower their future expectations regarding earnings and dividends!
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