How Royal Bank came back from the brink

IT IS an intense rivalry rooted deep in history. The hostility between the Royal Bank of Scotland and its arch-enemy Bank of Scotland dates back to the very foundation of the Royal in 1727. It came into being because the Bank was thought to have Jacobite tendencies and dirty tricks were never far from the surface in the early days.

A favourite ruse was to stockpile the rival’s notes, then present them in vast quantities for cash "payment on demand". The aim was to induce bankruptcy and the Royal proved the more adept at the scam, forcing the Bank to close for several months in 1728.

This ushered in a ferocious competitiveness between the pair which peaked with the epic battle for NatWest in 1999. The fight was ultimately won by the Royal, a victory all the more remarkable considering it had been on the verge of disaster less than a decade earlier.

It was 1992. In the words of a senior Royal Bank source: "The bank was effectively broke. We made zero profit."

The 1992 annual report was very different to the 234-page, full-colour blockbuster that thudded onto doormats last month proclaiming a profit approaching 7 billion. It ran to just 44 pages and made very depressing reading.

The accounts for the year to September 1992 showed the Royal’s branch banking business had run up losses of almost 11 million. Pre-tax profits had plunged to just 21 million, against 262 million two years before. The bottom line? A loss of 58 million.

What blew a hole in the Royal’s profits - and in its share price - was a 409 million charge for bad and doubtful debt provisions, fuelled by the property market slump.

It was crisis time. So how did a bank on the edge of catastrophe claw itself back from the brink to post 1 billion profits just six years later? How did this small Scottish bank become the fifth biggest in the world, a corporation bigger than Ford, General Motors, McDonald’s and Nike combined? What are the secrets of its extraordinary success?

Sir George Mathewson, now chairman of the bank and one of the architects of the remarkable transformation, has a simple answer - turning the bank upside down in the early 1990s and consigning its old-style bankers to history.

The catalyst for change was Project Columbus, an appropriate choice for a bank sailing into a new world. It was the brainchild of Sir George, who joined a Royal Bank board (in 1987) in the steely grip of patrician chairman Sir Michael Herries.

He oversaw a very Scottish operation, derided by some as an old boys’ network which had little time for newcomers. Herries turned press conferences on annual results into near-monologues with barely-tolerated interruptions. One insider recalls: "Board meetings were from another age. No-one questioned anything. There was a feeling when new directors joined the board, they couldn’t ask questions for a year."

The late 1980s and early 1990s were one of the blackest periods in the bank’s proud history. It was founded by grant of Royal charter and opened for business in Ship Close, Edinburgh in December 1727. Its early years were characterised by innovation; the Royal is said to have invented the overdraft (in 1728) by allowing a merchant to take out 1,000 more than he had in his account, while in 1777, it produced Europe’s first multi-coloured banknotes to combat fraud, printing the king’s head in red and denomination in blue.

For many decades, it had only one branch outside its Edinburgh HQ, but this office, in Glasgow, became one of the busiest in the UK, paving the way for the Royal to become the dominant force in Scottish banking. By the 1970s, helped by judicious acquisitions, the Royal had an estimated 40 per cent market share in Scotland and a sizeable presence in England. The 1980s saw the group diversify, setting up the car insurance company Direct Line in 1985 and acquiring US-based Citizens Financial in 1988.

But it was a solid rather than spectacular operation and its limitations were exposed by the recession of the late 1980s; it was very much in the second division in UK banking and appeared to have no master-plan to escape from the rut.

Robert Law, a banking analyst at Lehman Brothers, says the Royal Bank was "at best number five among the big five and many didn’t think that counted, it was all about the big four (Barclays, Lloyds TSB, HSBC, NatWest). Ironically, many saw Royal Bank as a takeover target in those days, with NatWest viewed as a likely bidder."

Sir George, who became deputy group chief executive in 1990, recalls the dark days: "Soon after I joined the board the share price dropped to a low of 128p. It was depressing. The picture inside the bank was not at all good. We did an analysis of the group; it was in bad shape."

Sir George describes the bank’s old-fashioned structure at the time as "a series of fiefdoms" - and it was time for the feudal banklords to go. So Sir George went to Viscount Younger [the former Tory Cabinet minister who became Royal Bank chairman in 1991] with a plan. It was time for the putsch.

"It all happened at a single board meeting [in late 1991]," Sir George recalls. "It was revolutionary and triggered total change - but the culture of the bank had to change."

The management consultants came in and said radical change was needed. The old guard was old, literally. Herries was almost 68 and vice-chairman Sir Austin Pearce nearly 70. They were two of three board members to step down, although Herries carried on as a non-executive director for a further year before retiring to his 350-acre farm near Castle Douglas. Four other board members, including the Earl of Airlie, did not seek reappointment, as the grandees accepted they had exhausted their options and had no fresh ideas to rescue the bank.

Sir George took over from Charles Winter as chief executive in January 1992. The old order had gone; a new one, feisty and impatient for change, had blasted its way in.

One senior RBS insider says: "Many of us firmly believe the NatWest deal would never have happened without Columbus. It was that important."

The changes saw RBS become a more aggressive bank. It was more prepared to lend as it came out of the 1990-1992 recession and gained market share as a result.

Some believe Sir George Mathewson also had an important factor on his side - luck. The mid-1990s saw a strong economic recovery, creating a firm base for banks to thrive. By 1998, Royal Bank was in good shape - and dynamic in profit terms. That year, it was the first Scottish company to turn in profits of more than 1 billion - up 32 per cent that year alone - with the UK operation turning in profits of 680 million and Citizens adding 247 million from the US.

Other big earners included the burgeoning Direct Line insurance company, with two million policies in force and profits of 64 million. Revving up to go was the group’s tie-up with Tesco, for which it ran bank accounts, insurance and credit cards under the Tesco Financial Services umbrella.

As the group grew, talented new blood was recruited. In 1998, a young face joined the board - Fred Goodwin, a former chief executive of the Clydesdale and Yorkshire banks.

Few could have predicted how quickly his star would rise as the Royal Bank entered a crucial new phase. The bank was on the charge; big changes had been made but far bigger ones were to come. The Royal Bank was about to renew its age-old rivalry with Bank of Scotland - and to spring the biggest acquisition in its history.

BRIEF HISTORY

1727: Founded by grant of Royal charter in May, opens for business in December.

1728: Invents overdraft, allowing a merchant to take out of his account 1,000 more than it held.

1777: Produces Europe’s first multi-coloured banknotes to combat fraud.

1783: Opens first branch - in Glasgow. Within 30 years, the branch was doing more business than Edinburgh HQ.

1825: Moves head office from Edinburgh Old Town to Dundas House in New Town.

1864: Acquires Dundee Banking Company.

1874: Opens London branch.

1924: Buys first English bank, Drummond of London.

1939: Buys leading private bank Glyn, Mills of London.

1960: First office in New York.

1963: Orders first computer.

1967: Installs Scotland’s first 24-hour cash dispenser at Edinburgh West End.

1969: Merges with National Commercial Bank of Scotland, creating Royal Bank of Scotland Ltd.

1974: First Far East office opened in Hong Kong.

1981: Subject of rival takeover approaches from Standard Chartered Bank and HSBC, both ruled out by old Monopolies & Mergers Commission.

1985: Sets up Direct Line, first UK insurer to use phone as main channel of business.

1988: Acquires Citizens Financial in US.

Nov 1999: Enters bidding war for NatWest.

Feb 2000: Wins NatWest.

2001: Citizens pays 1.33bn to buy Mellon Financial Corp’s retail banking arm.

2003: Buys Churchill for 1bn.

May, 2004: Announces it is buying Charter One Financial for 5.8bn, a significant US expansion.