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September 2009 | ifr special report | 3 UK

When Lehman Brothers collapsed a year ago and sent the global financial services industry into meltdown, the UK’s three investment banks were thrust into the eye of the storm. Since that watershed moment they undergone a transformation, with two now partially owned by the government. And while it looks like the worst could be over, they still face a stern test of their strategies. David Rothnie reports.

Back from the abyss I

n the aftermath of the collapse of Lehman Brothers, the point at which the credit crunch threatened to turn into a complete financial collapse, the UK's banks looked like they would lead the march into oblivion. The Royal Bank of Scotland, which suffered the biggest losses in the subsequent market carnage, was especially vulnerable: its ill- timed acquisition of ABN Amro had weakened its capital base, triggering a rescue rights issue and a bailout by the UK government. Meanwhile HBOS, which relied heavily on the wholesale financial markets for its funding, was forced into an emergency merger with Lloyds TSB and a taxpayer bailout.

The crisis had first threatened to engulf

Barclays, but the bank has emerged as a winner. It snapped up Lehman’s US and Canadian investment banking businesses, embarking on a dramatic transformation into a full-service investment bank. But Barclays’s expansion and survival has come at a price: in seeking to remain independent of state aid, Barclays sought a controversial capital injection from the Middle East and sold off its asset management arm, Barclays Global Investors.

With markets rebounding and the Bank of England restoring confidence with a series of initiatives, the UK’s banks are on a more stable footing. Their investment banking businesses have returned to prof- itability. Yet stiff challenges remain. RBS faces unprecedented scrutiny following its part-nationalisation, and must prove its recovery is sustainable. Its new management team must deliver on an aggressive programme of asset disposals. Barclays Capital must succeed where it previously failed and prove it can build a full-service investment bank, following an expensive high-profile recruitment drive. Lloyds Banking Group, which had the least exposure to investment banking, neverthe- less has a big integration challenge following its shotgun marriage.

Back from the brink

RBS has endured a torrid time in a year that saw its plans for global domination through the €71bn acquisition of Dutch bank ABN Amro reduced to tatters. The architects of that strategy, led by Sir Fred Goodwin, the bank’s former chief executive, were forced to step down. The

bank, 70% owned by the UK taxpayer following a £20bn bailout last October, has a new chief executive in Stephen Hester. He has launched a new strategy and set about reversing the empire-building synonymous with Goodwin’s regime. Where Goodwin was obsessed with expansion, Hester is focused on consolida- tion. But RBS’s banking and markets division, which caused the massive losses and damaged its reputation, remains crucial to its survival in the post-crisis environment.

In the first half of the year, RBS limped to a profit at group level, but operating profits from its investment banking division more than quadrupled from the same period a year ago. Booming activity across its interest rates trading and credit market businesses helped reverse the losses of last year.

Stellar revenues from sales and trading in interest rate and money market products, as well as in credit markets, helped propel operating profits in global banking and markets from £1.12bn last year to £4.87bn (US$7.9bn). Revenues from RBS’ global banking and markets were £7.83bn – up 113% on last year – with fees and commissions rising 13% to £728m, although revenues from the division’s trading activities provided the bulk of the total income at £5.73bn.

It would be generous to ascribe the success of the bank’s trading activities to Hester’s new strategy: all banks with strong trading arms reported huge profits from their fixed- income businesses in the first half. Nor is Hester, who worked at Credit Suisse First Boston before becoming chief executive of UK property group British Land, under any illusions. He warned good results, buoyed by fixed income, could be "unsustainable" and are unlikely to be repeated in the second half of the year. Instead, Hester will be judged on how quickly he can complete the asset disposal plan, and whether the new management team he put in place in the markets and banking division can deliver and make the acquisition of ABN live up to the promises made when the deal was done in 2007. The new-look markets and banking division is led by John Hourican. Peter Nielson runs markets and Marco Mazuchelli, who worked with Hester at CSFB, is in charge of banking. Other

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