Oral evidence: SME Lending Tuesday 17 June 2014

Oral evidence, 17 June 2014.

Witnesses

Chris Sullivan, Deputy Group Chief Executive, Royal Bank of Scotland, and Derek Sach, Head of Global Restructuring Group, Royal Bank of Scotland, gave evidence.

Chair

Thank you very much for coming to see us this morning. I am sorry that the beginning of the hearing has been a bit delayed by the previous session we just had, which overran a little. Why is it that there is still a net reduction in lending for Q1 2014 on top of the £2.4 billion reduction seen in the last nine months of 2013? Mr Sullivan?

Chris Sullivan

Primarily that is caused because of the rundown of the poor-quality lending book of the pre-2008 period.

Chair

Sorry, for the pre—

Chris Sullivan

The pre-2008 period where RBS lent excessively, well above its market share, in particular around property. We have been trying to make the bank much more balanced and safe and, therefore, running down the property-related lending of particularly poor quality. So some £2.3 billion was taken out of that particular portfolio, which obviously caused a net reduction in total RBS charge, although you would look at normal lending and you would see that RBS is still the biggest lender of new loans in the UK.

Chair

This shrinkage is caused entirely by what one might call the Goodwin overhang?

Chris Sullivan

It is not entirely that. There has been a situation over the last five years or so where customers have repaid consistently more than they are contractually obliged to. We have seen increases in our deposit accounts during this time, so there is a bit of a flight to safety with some customers. Although you are seeing some very encouraging signs now of lending starting to move upwards. So many steps that we have taken to encourage people to take loans responsibly, showing I think a 20% improvement year on year as we speak.

Chair

With all that risk aversion there must be some cracking good business opportunities out there.

Chris Sullivan

We have never been averse to taking appropriate risk and I think the problem—

Chair

No, the risk aversion among the customers. If you can—

Chris Sullivan

That was primarily why we asked Sir Andrew Large to come in and look at us and say, “What could we do to improve customers’ opportunities to borrow from us?”

Chair

Yes, which brings us to the Clifford Chance review as well. You have described that as independent. Doesn’t Clifford Chance do business for RBS, other business?

Chris Sullivan

Derek, do you want to answer that?

Derek Sach

Yes, we do business with all the large corporate lawyers. You have to choose somebody of stature. In the case of Clifford Chance, they provided a partner with relevant experience who has never done any work for RBS. You have to presume that people such as that do have integrity. Having seen the report, I have no reason to believe that they did not exercise complete independence and even the FCA has commissioned them to do a similar piece of work for themselves.

John Mann

How many drafts of the report were submitted to you?

Derek Sach

I have no idea because I had no part in it, being the subject of the report. All I was asked to do at the very end—

John Mann

Mr Sullivan?

Chris Sullivan

I have no idea either. I never saw a single draft.

John Mann

So you have no idea of the drafts of the report?

Chair

Before we move on from that question, are you confident that drafts were not seen by—

Derek Sach

Drafts were certainly fact checked by the organisation because, obviously, when you prepare a lengthy document there are going to be errors of fact that need to be corrected.

John Mann

How do you know that, Mr Sach?

Derek Sach

I was asked to check some aspects of the numbers that were used here and there in the report.

John Mann

So there were drafts that were seen?

Derek Sach

There was certainly one but whether there were more I don’t know.

John Mann

Was anything altered in the drafting process?

Derek Sach

So far as I am aware, only errors of fact.

Chair

It might be helpful if we have that confirmed in writing; it would be of some value to us.

Derek Sach

Yes, sure.

Chair

Thank you.

John Mann

You have been with GRG for a long time, Mr Sach. How much has it contributed to the bank’s profits?

Derek Sach

It does not contribute to the bank’s profits at all. Our main objective is to restore the customers’ health and strength and—

John Mann

You are saying GRG makes no money for the bank?

Derek Sach

In total, if you look at what GRG achieved over the five-year period in question, the customers that we looked after in this particular area—the SME area—lost £2.1 billion for the bank.

John Mann

My question is: what does GRG make in terms of profits for the bank?

Derek Sach

It does not make a profit for the bank. It has income in the form of fees. It sometimes has equity realisations if it has taken an equity stake in the past in something, but against that, you have the cost of running it and also these connections there are the impairments.

John Mann

So GRG runs at a loss is what you are saying for the bank?

Derek Sach

If you look at the portfolio we look at, yes, it runs at a loss.

John Mann

I am talking about GRG as an institution within the bank.

Derek Sach

It runs at a loss.

John Mann

It runs at a loss?

Derek Sach

Yes.

John Mann

Has that loss increased or decreased over the last 10 years?

Derek Sach

Increased dramatically if you do it year by year in 2009, 2010, and it is starting to come down now because the impairments are falling.

John Mann

How do you calculate the fees that you charge?

Derek Sach

The fees are related to a number of factors: the amount of work that people are doing on a particular connection; the increase in risk that may be apparent in any particular transaction.

John Mann

Why is it that in the Clifford Chance report they could not work out how the fees were calculated?

Derek Sach

I think, yes, that is a reasonable criticism that it is not as transparent as ideally it would be for customers. It is something that we have been working on since 2012 to try to improve people’s understanding of the fees we charge and to make the fees less onerous for them. We have always wanted to be very much at the leading edge of restructuring and I was a founder member of that sort of movement in the 1990s in the UK when we—

John Mann

Clifford Chance cannot work out how much the fees are but you say that the fees are not calculated to make a profit for the bank?

Derek Sach

No. The fees are there partly to offset the costs that we incur, but also very often to compensate us for the additional risk.

John Mann

They are compensating you for risk, so you are making a profit out of the fees then?

Derek Sach

No, because unfortunately a number of the customers who come to us do cause losses for the bank. We lose capital, so overall there is a loss.

John Mann

But they do not all choose to go into GRG and you choose the fees but, according to Clifford Chance, no one can work out where the fees come from. The Clifford Chance report identified that some perfectly profitable businesses were going into GRG. Why is that?

Derek Sach

I do not think the Clifford Chance report said that profitable businesses were coming into GRG.

John Mann

Clifford Chance identified a number of cases where no event of default had occurred.

Derek Sach

That would be correct because an event of default is when a customer cannot pay his interest or his capital repayment and yes he could still be profitable; I acknowledge that. But they are transferred to us because there is a belief that we can manage them better than the frontline.

John Mann

And make a profit out of them.

Derek Sach

No, our objective is to restructure them. We restructured in each of the difficult years numbers like 850 customers that we reorganised. If I could give you an example: something called CFN in Skegness, a manufacturer of polythene bags, lost a major customer and had some difficulties. We helped them recruit a new CEO. We introduced them to someone who worked alongside him to help him develop a new strategy. We lent them some more money, and 70 jobs were saved in an area that is probably quite difficult for employment.

John Mann

How come Clifford Chance identified that in your appraisal system you particularly highlight cases where individuals have generated strong revenues in your section?

Derek Sach

People have a balance scorecard, and, yes, strong revenues would be something that perhaps someone has done. But along that, they would have restored probably half a dozen customers back to health and strength and—

John Mann

It sounds to the small business community, and the rest of the world, that this is a profit centre within the bank whereby you are maintaining your profits at the expense of small businesses, some of which are perfectly viable, to which you give no choice. You are exploiting the lack of competition in the market, aren’t you, and the lack of choice for small businesses and that is what you are about in your section?

Derek Sach

We are not about that. We are very much about helping businesses. Our main focus is not only on restructuring their finances but helping them restructure the business, and this is happening on a large scale for these SMEs. During the period we handled something like 10,000. Less than 10% of them end up in insolvency.

John Mann

The Clifford Chance report says that the GRG training manual suggests threatening to remove distressed businesses’ overdrafts as a way of gaining leverage. It also says that your internal valuations were not carried out in accordance with best practice. Despite that, it is a report that you have commissioned, and you have had drafts of it, it is a pretty damning report and the impression it gives is that GRG is there to boost up the bank’s profits at the expense of the small business customers who are stuck because they cannot go somewhere else. That is a reasonable summary, is it not?

Derek Sach

No, I do not think it is. If you take the two points you have raised, on the training point I would acknowledge there is an unfortunate phrase in a 50-page document that is pre-reading for a training course. I agree with you that the way it is written is unfortunate because it seems to indicate that, as you say, an overdraft should be used to threaten someone. The intent is if there are no defaults but you can see that someone is headed for difficulty. Bear in mind that these are restructuring specialists who also have been involved closely with people who restructure big companies like Thomas Cook where we save companies at short notice; 30,000 jobs saved because we put up £25 million more than our share. It was intended that you should draw to the customer's attention that the overdraft in due course would be hitting its limit and we would not be minded to increase it unless they made some changes to the way the business was operating. That particular phrase has been changed. On the question of valuations, the valuations Clifford Chance are referring to are valuations that are used informally as opposed to any that are used formally where outside valuers are instructed.

John Mann

That is what SMEs are complaining about. Has anyone from GRG met any Government Ministers in relation to its performance and its role with SMEs in the Treasury or the Business Department over the last two years?

Derek Sach

Not that I can immediately recall but I have certainly been consulted personally by people from the Treasury, the Bank of England and BIS on things like the Business For Growth organisation and are there other ways of increasing and improving lending to businesses.

John Mann

But nobody has met, or been asked—I am not suggesting you would be running to meet as it would be a Minister’s responsibility—no one from the Business Department, no Treasury Ministers have been to meet you after the kerfuffle following the Tomlinson Report?

Derek Sach

No, definitely not since then.

Chris Sullivan

I have met many Ministers and Treasury officials over the last five years and discussed a number of people who have been in GRG and various other parts of the bank. It is worth noting that—

John Mann

And on GRG?

Chris Sullivan

Yes. I have spoken to members of this particular Committee about constituents who have been in GRG.

John Mann

No, I am talking about Government Ministers in the context of Tomlinson specifically.

Chris Sullivan

In terms of Tomlinson, we did an independent report via Clifford Chance and I have done a number of other independent reports around allegations from Mr Tomlinson. Those reports have all proved the allegations to be fallacious.

John Mann

I am only trying to clarify that neither the Business Secretary and his Ministers nor the Chancellor and his Ministers have come and met you and asked questions in relation to this, and you are saying that they have not.

Chris Sullivan

No, they have not.

Derek Sach

I have to say I would be very happy to talk to a wider audience than this one if people were interested, and tell them a lot more about what we do because I genuinely believe that we do good overall. If you handle 10,000 customers I acknowledge there are bound to have been some mistakes. I also understand the difficulty that entrepreneurs who fail, or who are close to failing, find themselves in. It is a very traumatic and difficult experience for them. The slightest sign of irritation or not treating them absolutely properly is bound to cause upset, but overall we get quite a lot of letters thanking us for what we have done. To give you another example, a firm called Independent Slitters in Oldbury, a small firm, made an unfortunate diversification. We worked with them, helped them unravel the unfortunate diversification, lent them more money and 20 jobs were preserved. Again, they are very enthusiastic. They have been in the local press in the West Midlands and they cannot thank us enough for what we did. But, as I say, we have a machine. There are 1,300 people sitting out there today watching this, or will watch this when it is on the internet, who feel very aggrieved by the comments of Tomlinson, that he should impugn their integrity in the way that he did.

John Mann

My comments were quoting from your own internal Clifford Chance report.

Chair

If we were to poll these 10,000 customers with respect to their confidentiality of reply, is it your view that the majority would be expressing gratitude for their contact with GRG?

Derek Sach

We do the same survey that Chris’s division of the bank does, asking customers questions about satisfaction. Overall, we are probably about 3% to 5% perhaps behind them. In terms of quality of relationship manager, because our people have a lot more time to spend with the customer and are very thoroughly trained in their restructuring skills, they tend to score a little bit better.

Chair

Is the answer that a majority would be expressing gratitude?

Derek Sach

I would hope so, yes. We do not ask them that question but they are asked if they are satisfied with what we do, are we delivering what we promise, and so on. Then, yes, the majority would.

Chair

When you say that the fees are—I think I was quoting you but correct me if I do not have it quite right—“not ideally as transparent to customers as they should be”, that is about as big a euphemism as it is possible produce, is it not? Frankly, opaque to the point of incomprehensibility might be closer to the mark.

Derek Sach

I think that is a little extreme, but certainly they could be clearer, I fully acknowledge that. It is something that we are working on and we have introduced recently a 90-day moratorium on adding default interest to customers who get into difficulty. That is something every bank does so it will be interesting to see if the industry follows suit to give them a period of time to try to sort their affairs out. We have also undertaken to give people 30 days notice of changes in fees because, again, that gives them a chance to discuss if they do not understand.

Chair

Your earlier point a moment ago was that you get involved because—again, I am more or less quoting, I hope—“There is a belief that we [that is RBS] can restructure these businesses for their own good”, for their benefit, and therefore the businesses have benefited from your involvement. Whose belief is this? Who forms that judgement?

Derek Sach

I believe we have been a feature of the restructuring scene for quite a long time. I joined RBS at the end of—

Chair

That was not quite the question. I am sorry to interrupt. The question is somebody at the beginning of each of these processes before a firm encounters GRG forms a judgement about whether there are benefits to be had from restructuring. My question to you is who forms that judgment?

Chris Sullivan

It is probably worth me taking that. It is a great question. We would rather that GRG or the restructuring unit was never necessary in the bank. Its primary use is when one of our customers gets into financial difficulty.

Chair

We will be pressed for time today. We do know that. The question I am trying to get at is who is forming this judgment?

Chris Sullivan

It will be formed by a combination of the relationship manager who will see an event, some deterioration in business performance, a particular contract that is lost, excessive use of overdraft, excessive limits, behaviour that is generally—

Chair

At that point they go and consult GRG. Is that correct?

Chris Sullivan

No. At that point they go and talk to our Credit Department and then a group is put together of the relationship management team, the Credit Department and a member of GRG to discuss the case to see whether or not we believe the GRG unit would be beneficial in terms of getting involved.

Chair

In forming that judgment and in offering the advice in that group you have just described, is GRG acting as a cost centre or a profit centre?

Chris Sullivan

GRG is acting as a service to the client.

Chair

I am going to ask the same question again. In forming that judgment is GRG acting as a profit centre or a cost centre?

Chris Sullivan

A cost centre. In the terms you just asked they would be a cost centre.

Chair

Then GRG is not, as is commonly supposed, a profit centre?

Chris Sullivan

It is absolutely not a profit centre.

Chair

In the bank?

Chris Sullivan

In the bank, absolutely not.

Chair

It is inappropriate to describe this activity as has been described?

Chris Sullivan

Totally inappropriate.

Chair

The activities of GRG are a business cost.

Chris Sullivan

They are a business cost, helping customers if they can to get back to normal.

Chair

Having worked in a bank, and there are people around this table who have, the distinction between profit centres and cost centres is well understood and is a crucial one for the internal running of the bank. You are saying this essentially operates entirely as a cost centre.

Chris Sullivan

Absolutely, unequivocally I am saying that this is a cost centre.

Chair

It has always done for the period we have under review?

Chris Sullivan

Correct.

Derek Sach

If I could just add to that, the asset remains with the donor division, because there are many divisions across RBS and we manage their assets. The asset remains with them and any income accrues to the division.

Chair

That is very helpful clarification.

Mr Ruffley

Mr Sullivan, on the question of the terms of reference it was quite specific—was it not?—and I am quoting from the terms of reference, “The independent review will be undertaken by Clifford Chance. It will review the most serious allegation made in the Tomlinson Report”, namely, that RBS through its GRG division was “culpable of systematic and institutional behaviour in artificially distressing otherwise viable UK SME businesses and through that putting businesses on a journey towards administration, receivership and liquidation”. What do you say to those people who believe that is quite a high hurdle? It is very easy to refute the charge. Why was that remit so narrowly drawn?

Chris Sullivan

That was the allegation that was made and it was a very, very serious allegation that needed to be proven to be untrue and was.

Mr Ruffley

There were several allegations, were they not? I am asking you why you chose one particular one.

Chris Sullivan

Because that was by far the most serious.

Mr Ruffley

Let us turn to some of the charges referred to in the Clifford Chance report. I just want to have another go at a question Mr Mann asked. RBS in terms of its internal valuations, and I quote, “Internal valuations were not carried out to the standard of the Red Book”. What action are you taking in relation to that deficiency?

Chris Sullivan

That is not really my area. Mr Sach could answer that for you.

Derek Sach

That reference is to valuations that people do within GRG as part of the process of looking at a customer and seeing their state of health. You have to remember that 60% of this particular portfolio is property. They are pure property transactions. They are not businesses that are going on to the next generation or anything. They are often just a one-off property transaction, and 20% is very heavily property-related; hotels, pubs, that sort of thing, nursing homes. It is often very useful for someone internally to say, “I would estimate that property is worth X”. But no significant decision is ever taken on the basis of that sort of valuation. It is an informal part of the internal process. If we want to take action and the customer disagrees, then we would have a formal valuation done by a third party that the customer would instruct in nearly all circumstances. The reason we do it internally sometimes is because it saves the customer money because you need a figure to talk. Particularly in 2009 and 2010 most of this property was unsaleable, so somebody saying, “This is worth £1 million” is a sort of benchmark and to spare the person £5,000 to get a valuation—

Mr Ruffley

I take the point. Can we have another go at this charge about the training manual? You said you had amended the wording of the training manual. What about the underlying business practice of threatening to remove a business overdraft in order to get more leverage in negotiations about equity? I know you have changed the wording of the manual, but what about that practice?

Derek Sach

The reality is not so either.

Mr Ruffley

You just deny that ever took place?

Derek Sach

Yes, and I have found no examples of it. Clifford Chance asked me about that in my interview with them and it would be something that concerned me. I and they can find no evidence of that happening.

Mr Ruffley

No evidence of that. Clifford Chance say in turn that they could not understand the RBS fees in your part of the bank, and I quote, “We found it difficult to understand how the bank calculated the fees it proposed to customers in any particular case and therefore found it difficult to assess allegations of unfairness”. Those are Clifford Chance’s words. I declare an interest, having formerly worked at Clifford Chance, many years ago. If very clever lawyers at Clifford Chance found it difficult to understand how the bank calculated the fees does that not suggest they are too complicated for customers?

Derek Sach

Yes, and I acknowledge that we have been working on this since 2012 to try to make them simpler. We stopped charging a number of fees to make it clearer for customers during 2013 before any of this occurred and, more recently we are giving people 30 days notice of any change or charge and suspending default interest for 90 days.

Mr Ruffley

You are quite proud of suspending the default interest for 90 days and stating that other banks do. Are you the only major SME lender who now does not charge for the 90 days?

Derek Sach

So far as I am aware.

Mr Ruffley

Has that come as a direct result of this report?

Derek Sach

Yes, in parallel with it.

Mr Ruffley

Clifford Chance found that RBS sought to encourage or incentivise a specific course of action by the customer for its pricing, such as an exit or sale of assets to reduce the customer's debt. It is clear that Clifford Chance did not want to pass any censorious judgment. They merely say, “It is difficult for us to say that it is wrong in principle for the bank to use fees as a lever”. Have you amended your practice in that respect, even though Clifford Chance does not wish to pass judgment?

Derek Sach

I think they are observing something that we do and you are probably familiar with and, again, I do not think RBS would be alone. If the customer fundamentally disagrees with, say, the desire to sell a property within a certain timeframe or he is confident he can sell it within six months, you may reach an agreement with him that he can have six months to sell it, but if he has not sold it by the end of six months then, because we feel we are taking additional risk, the interest rate would go up. I do not think that is unfair practice and I think it is a reasonable commercial thing to do with somebody.

Mr Ruffley

I have a final question for Mr Sullivan. There were also allegations in the Tomlinson Report, and you having acknowledged, Mr Sach, this did happen in some cases and was inevitable, given that you have several thousand customers, of rude, insensitive or aggressive behaviour on the part of a minority of your employees. Can I ask, Mr Sullivan, did you ask Clifford Chance to do any detailed report on instances of that kind, and if not, why not?

Chris Sullivan

I did not commission the report so again you should ask Mr Sach. But, quite clearly we would not condone any behaviour that is aggressive or impolite and certainly all our relationship managers are well aware of that.

Mr Ruffley

What active steps have you taken since the Tomlinson Report to ensure that instances like this are kept to a bare minimum?

Derek Sach

If I could make it clear that the Clifford Chance report and the management of all the process was managed by John Kane, who is the head of regulatory affairs in the bank, working closely with the bank’s legal department. Like Chris, I would never tolerate aggressive behaviour in any of the team and because of the nature of the work they do they are trained in how to deal with people in what are very difficult circumstances. There were 13 customers that referred to aggressive behaviour. Our internal legal department investigated all of them completely independently of me or anybody in GRG and found that there was absolutely no evidence to substantiate that behaviour. Also—can I make it clear?—the 135 cases that Clifford Chance looked at were very much an adverse selection to try to find if the, I think appalling, allegation that was made of systematically distressing companies had happened, then we would want to find it because even if there was one, that is one too many. So they were targeted at the very worst 135 in the portfolio and the 13 are out of that 135. I would hate the Committee to say that is 10% are going to say that, because I think they were a particularly distressed and feeling hard-done-by group of customers.

Mr Ruffley

That is very helpful, thank you.

Chair

Can we just go back to this question of whether you are a profit centre or a cost centre? I did not have to hand the Large review, although I have had several conversations with Sir Andrew about this. I am just reading from the review on page 52, “GRG is run as an internal profit centre”. He then explains that this leads to conflicts of interest for GRG for RBS's treatment of customers. For the avoidance of doubt, he then explains what a profit centre is, “with its profit and loss account based on the incremental income that it generates for the bank, less its operating costs”. Why did Andrew Large get it so wrong? I presume you are sticking by your evidence.

Derek Sach

Yes, I am and he will have seen a piece of paper that records for GRG the costs and the income. But what it does not record are the impairments and the internal costs allocations. The thing we are judged on is very much our costs. We submitted a note to this Committee when we were going to come here in March that explained we are not a cost centre and we also—

Chair

Not a profit centre.

Derek Sach

Sorry.

Chair

That is all right. It might have been a Freudian slip or not. Do carry on.

Derek Sach

That we are not a profit centre and a copy of that was sent to Sir Andrew.

Chair

So he just got it wrong?

Derek Sach

I believe so, yes.

Chair

Therefore the whole of that part of Sir Andrew's report is, to put it mildly, misconceived because on the basis of this point he carries on to explain the governance process for the critical decision of whether a business has reached the point of non-viability. It is therefore opaque both to the relationship management part of RBS and to the SME itself, that may be unaware of or unprepared for the consequences of changes because, and I am paraphrasing now, it is unclear whether GRG is taking its decisions on the basis of what is in the interests of the firm or in the interests of the bank.

Derek Sach

There is another piece that I think you would find he is linking that to.

Chair

I have paraphrased that to avoid reading out a whole paragraph.

Derek Sach

I appreciate that. Just the one important point that he picks up on somewhere around there is that GRG has the right to insist on the transfer of a case. That is designed very much for the larger customers, things that belong to the investment bank—

Chair

When he says, “GRG retains the ultimate authority over which customer relationships are transferred”, he was also pretty much wrong there. He was misleading us. That only refers to large customers. Is that correct?

Derek Sach

Yes, and I am not sure he would have even known that because he would have seen some part of our policy and procedures that does make that statement. But it is only ever used for the large companies where investment bankers tend to want to hang onto their customers rather more than perhaps the people who manage SMEs. We have checked and that right has never, ever been used in the whole period on an SME. But, as Chris described earlier—

Chair

It is a bit depressing that your chairman called in arguably one of the best men around in this field with huge experience both of commercial banking and central banking and he has written a report and drawn conclusions that are fundamentally misconceived.

Derek Sach

I think he has misunderstood the nature of how those two things would link together because we have never, ever used that right on an SME. If you have not done that then that rather weakens his first argument.

Chair

It is very helpful that we have clarification at this point.

Steve Baker

Mr Sach, you mentioned that you are overall judged on your costs. Could you just explain how you measure the performance of the individuals in your team and how you therefore incentivise them?

Derek Sach

They will have a balance scorecard in the sense that they will be expected to restore customers back to the good bank. They will be expected to restructure customers. They will not be expected to receive complaints or if they do receive complaints there should not be very many. There will be a lot of subjective judgment on how well they handle things, their capacity for work and their ability to come up with answers to difficult problems. A whole range of things and yes, for each grouping of people there will be a cost base that is primarily salaries they will have to keep control of.

Steve Baker

Presumably there is a bonus pool. How does that scorecard feed into the calculation around who is getting what?

Derek Sach

The whole of GRG's bonus system is discretionary, including mine, and there is no formulaic bonus system whatsoever. I have always fought—I do not have to fight because I can insist—that bonuses are going to be discretionary. People often say, “If I restructure 10 companies I surely should get more than someone who does five” or whatever. But the difficulty has to be taken into account and sometimes five difficult problems in a depressed area of the country is a much greater achievement than maybe restructuring a very large corporate where you have a lot of other professionals all around. So, it is all discretionary and let me say that people who handle these SMEs get relatively small bonuses in relation to their salaries.

Steve Baker

Could you give us an indication of what sort of levels and quantum those bonuses and salaries are?

Derek Sach

As a percentage, most of them would be in the 20% to 40% bracket.

Steve Baker

Of a salary of on average what sort of level?

Derek Sach

Their salaries would probably range from £30,000 to £50,000, £60,000.

Jesse Norman

Mr Sach, I am going to go back to this issue of profits and profit centres. Just to be clear, Andrew Large, banker for 20 years, chairman of the Securities Investment Board, member of the management board of the Swiss Bank Corporation, deputy chairman of Barclays Bank, Bank of England Monetary Policy Committee member; you would expect him to know what a profit centre and a cost centre of a bank was, right?

Derek Sach

Yes.

Jesse Norman

It is evidence of catastrophic misjudgment or misunderstanding or misinformation if he has failed to understand the nature of your business.

Derek Sach

I think that is a rather extreme statement of what he has said. He has linked two facts together in a way that to me is not logical, particularly because the second one just is not exercised and is not there, so far as these customers are concerned.

Jesse Norman

You entirely discount the possibility that he might understand the true function of business better than you are prepared to admit?

Derek Sach

Yes. I am not trying to cover anything up.

Jesse Norman

You said that people's bonuses are calculated on the basis of costs. It is very easy to run costs, right? You keep your salaries low, you try to avoid impairments and if businesses fold, they fold. Why is that not an effective way of managing costs if you are a member of GRG?

Derek Sach

I am sorry, I am not sure I follow exactly what you mean.

Jesse Norman

I am saying if you are entirely cost-focused it sounds like your bonus system is not giving any credit to people who extract businesses that avoid costs and in fact, potentially generate upside for the bank.

Derek Sach

They get credit for restructuring businesses. That is the thing they are really about; something like 850 a year.

Jesse Norman

I understand the advertisement. Let us pause there for a second. A cost avoided is an upside for you, is it not?

Derek Sach

A loss avoided, yes.

Jesse Norman

A loss avoided.

Derek Sach

Yes, and that is always is going to be a much bigger number than any fees you can earn. As I said to you, we lost on this segment of the bank £2.1 billion over the five-year period of 2008 until 2013.

Jesse Norman

Is the bonus conversation you described affected by losses incurred or not incurred on the portfolio you are responsible for?

Derek Sach

In the thing that Andrew Large refers to as a profit and loss, the losses and any recoveries are not part of the equation. That is why it just is not a profit and loss. It is a record of income and costs. It is not a profit and loss account.

Jesse Norman

But the point I think that we are trying to get to is the question of whether or not there is upside for the bank and whether or not the job of GRG is to gain upside and what kind these upsides are. One of our concerns, and one of Andrew Large’s concerns appears to be that one of the things that GRG was doing was seeking to make profits for the bank at the expense of the wellbeing of some of the companies involved. That is why he potentially sees it as a profit centre.

Derek Sach

It cannot be a profit centre because we are making a loss on this particular segment that we are looking after, but you can minimise the losses and, yes, you are right there are occasions when upsides are earned. Again, they are rarely of any significant amount of money in this sector but if you take larger companies, something like Samsonite, where we took the risk of putting up some more money when the banks had to convert their debt to equity, we managed to recover 500 million by putting up 20 million at a moment of difficulty.

Jesse Norman

When there is a conflict between the bank and its customers, is your policy to put the customer first or the bank first?

Derek Sach

The customer always.

Jesse Norman

So why is it that one GRG employee has been quoted as saying, during the crisis, they were called in and told, “Save companies if you can but first and foremost get our money back and save the bank”?

Derek Sach

I do not know where that is coming from.

Jesse Norman

We can supply the information if you want. I think it comes from the Channel 4 video report that they did on this.

Derek Sach

Oh well, the Channel 4 video report is one of these whistleblowers.

Jesse Norman

It is certainly a former employee.

Derek Sach

So they say, but I honestly do not know.

Jesse Norman

So you would discount that?

Derek Sach

I am not sure I do discount it because I do not believe anyone would have said it and I am not sure—yes, I know which was the Channel 4 one, I spoke to the director of that programme and told them the subject of the programme, both the husband and wife had been disqualified as directors for seven and five years respectively. I was told by the director that was not really relevant.

Jesse Norman

I cannot comment on that but the same report quoted whistleblowers saying, “It was an immoral survivalist tactic the bank used, which had a huge amount of losses on their balance sheet to try to survive something. They have managed to destroy a number of businesses that did not need destroying.”

Chris Sullivan

There was no upside, absolutely no upside in this bank or any bank in destroying a perfectly viable customer. Viable customers are sources of income generated for the organisation. If they become non-viable then we damage the organisation as a whole.

Derek Sach

We would never get any advantage from destroying a customer. Insolvency is always the last resort.

Jesse Norman

Are there any rules or regulations that prevent you from charging whatever you like to customers?

Derek Sach

Not that I can immediately think of other than just—

Jesse Norman

You can charge whatever you like?

Chris Sullivan

There are codes of conduct.

Jesse Norman

Codes of conduct, okay.

Derek Sach

But we wouldn’t, we are always reasonable—

Jesse Norman

It sounds like Mr Sach is disagreeing with you, Mr Sullivan.

Derek Sach

I am not disagreeing at all, but I cannot think of a regulation that says you cannot charge more than X. But internal pressures—Mr Sullivan and others sit on what we call the Executive Committee of GRG so there is considerable oversight of what we do within the bank.

Jesse Norman

Is it true that RBS staff were pressured to raise the amount of fees charged to GRG customers?

Derek Sach

No.

Jesse Norman

Why could Clifford Chance not understand your fees? I just do not understand that. Why was it not possible for them to understand? It sounds like they could not understand any single case of your fees, in any particular case.

Derek Sach

I do not know even which cases they looked at.

Jesse Norman

I think that is very—

Derek Sach

So I cannot comment. Yes, fees historically have—

Jesse Norman

Presumably they raised these fees with you? They said, “Could you explain it to us?” Were you able to explain these fees?

Derek Sach

Yes, all the cases are different. The complexity varies,

Jesse Norman

But it does sound as though your institution could not retrospectively explain the fees to Clifford Chance in any particular case; that is what it sounds like from their report.

Derek Sach

I was never asked about any particular case and if I were to see a particular case I would have an explanation as to why the fee is what it is.

Jesse Norman

But you would accept that if it is the case that others down the chain—you are after all the boss—could not even in retrospect, with thoroughly intelligent people on the other side, justify or explain those fees it is not clear that there is any accountability behind it at all. It sounds like they are charging whatever they like. Whatever the market will pay. There is not a structure to it.

Derek Sach

I do not think that is the case. The fees are for different purposes.

Jesse Norman

But you have not given any evidence as to why not. All we know is that Clifford Chance have said these could not be justified in any particular case. They have discussed it with RBS and there has been no justification. Now you are saying, “Well, I do not think that is the case” but that is not evidence; that is a psychological first-person report of your view. You are in charge; you would be expected to have that view.

Chris Sullivan

I do not think we said there is no justification. There is absolutely justification. What Mr Sach is saying to you is that every single case is different. There are different levels of risk, different levels of stress within the organisation, different facilities for each customer. On the basis of the mix of all of those things the relationship manager will take a decision that would relate to the amount of risk the bank was were taking and an appropriate reward for that risk. The appropriate reward element comes from market practice and internal checks that are made both by the managers of the bank and then the internal audit department above them.

Jesse Norman

But you would agree not having a decision procedure that allows some kind of basic structure for the charging of fees across different clients is a very strange thing, do you not think?

Chris Sullivan

That is not true, we have one.

Derek Sach

No, but there are—

Jesse Norman

You have one so you could give that to Clifford Chance; they could have understood that; they could have seen how it worked in each case?

Derek Sach

There are guidelines for different levels of risk.

Jesse Norman

Why did Clifford Chance not explain this or mention it? Why were they not able to understand why these fees are being charged? Did you give them to Clifford Chance?

Derek Sach

I imagine they saw them—they saw 1,200 documents—but I do not specifically know whether they saw that. Over the period we have become more and more focused on being able to explain things and being transparent. In the early days of 2008, 2009 you were looking at an organisation in terms of GRG that multiplied 10-fold over nine months as the bank was obviously in a very difficult circumstance. But the fees are charged for different purposes. There are fees for the time spent—which I think as lawyers they would find hard; we do not keep timesheets; there is an estimate—but any fees that are charged are always approved by somebody else so it is not just the relationship manager.

Jesse Norman

Thank you. Final question. I do not think it is appropriate to talk about the early days. As I understand it you joined RBS in 1992 to set up a specialised—

Derek Sach

I did.

Jesse Norman

—lending service that became GRG. So by 2008 this institution had been running essentially under your guidance for 16 years. You cannot suggest it is somehow a new thing. I do not know how long you have been charging inexplicable fees.

Derek Sach

No, the quantum was just phenomenal. Any business that multiplies 10-fold in nine months is going to have stresses and strains. But one of the things I did when I first joined RBS was to take them from top of the league—appointing more administrators or receivers as it then was than any other bank in the UK and RBS was very small then—within a year to being bottom and appointing fewer. The mission was to try to do something constructive for these customers and that has always been the ethos, and it still is, of what GRG does. It is about restructuring. I was very much a founder member of the London approach and the Bank of England’s initiatives in the 1990s, which led in London to a complete world-leading position on restructuring. That has persisted right the way through.

Jesse Norman

Final question just on this, Clifford Chance stated that it found it difficult to assess allegations of unfairness regarding fees and so the question is this: is a fee that cannot be explained a fair fee?

Derek Sach

I would say it is not a transparent fee if it is not well explained to the customer.

Chair

Is an untransparent fee an unfair fee?

Derek Sach

You are bandying words—“untransparent”.

Chair

I think it is fairly reasonable.

Derek Sach

If fee is not a transparent—

Chair

In other words, were the fees fair?

Derek Sach

Generally banks need to be much more transparent and we are trying much harder.

Chair

All right, unless you want to carry on with that line of questioning I think we have arrived at a pretty clear conclusion on that.

Jesse Norman

I think if Mr Sach were on the other side of a non-transparent fee he might be inclined to call it unfair, Mr Chairman.

Chair

We will think about that as a group privately. You said that the bank was in very difficult circumstances, I think that is undeniable. Was there no pressure within the bank to rebuild the balance sheet in the short term as fast as possible?

Derek Sach

There was a need to, yes, rebuild the balance sheet and improve capital but so far—

Chair

Therefore was there not a time problem, time horizon differential, between the interests that you might have perceived on behalf of a customer and what would be best for the ban? That is, when you said earlier destroying a customer would never be in the interests of the bank, if you had a shorter time horizon it might well be in the interests of the bank if it could strengthen the balance sheet.

Derek Sach

That is absolutely right and, as you will know, the Asset Protection Agency came into being in 2010 and they were always pushing us to go for more foreclosure for exactly that reason, which is something I robustly resisted throughout the period. There is quite a bit of correspondence between me and them of threats and counter threats and not being prepared to do that.

Chair

So those who have made that general allegation are barking up the wrong tree?

Derek Sach

Yes, and one other explanation for that as well is in the totality of the GRG portfolio, which peaked at £80 billion, the portfolio we are looking at here, the UK SMEs, were only six. So in particular as we move through 2010 and 2011 we were focused on capital targets to reduce the risk-weighted assets because at one time we had about a third of the group’s capital under our management. One was not frankly going to spend a lot of time squeezing some poor entrepreneur in Bromsgrove to realise his £1 million when we had huge exposures of £1 billion or more where the risk-weighted assets could be £2 billion or £3 billion. So that is where all the focus of capital reduction went. It was never applied to these people.

Chair

It is helpful that we have that repudiation of the frequently made allegation with respect to RBS. You said earlier, with respect to this profit centre, this vexed question of profit centre versus cost centre issue, that you clearly were not a profit centre because your costs exceeded your profits. Was that what I heard you to say?

Derek Sach

We have never made a profit because we have costs. We do have income and we have big losses, which are the impairments of those customers, and a cost that we have never even tried to identify is the cost that divisions like Chris’ has to pay for all the centralised computers, offices and all the infrastructure.

Chair

The fact you never made a profit has no bearing on whether you are a profit centre; it is whether you are seeking to generate income with a view to minimising your losses.

Derek Sach

Yes.

Chair

So that amounts to a profit centre by another name?

Derek Sach

I do not think it is a profit centre as such, but, yes, we are earning income that is offset against the losses.

Chair

You checked the Clifford Chance report for errors of fact. Did the Large report go to your bank in draft?

Chris Sullivan

Yes.

Chair

Why in that case was this glaring error, which was central to a large chunk of these recommendations, not flagged up?

Chris Sullivan

I can only surmise that the view was taken that that was a misinterpretation of a profit and loss. You asked a question, is this a profit centre? Quite clearly it is not operated as a profit centre and the description was overlooked.

Chair

But he put this before you in draft you have just told us, and you allowed him to go ahead with page 52, which is a key part of his report, which you are flatly repudiating today, line by line. Why were you not repudiating it flatly when he showed it to you in draft?

Chris Sullivan

Because it was not put to us in the manner in which you put it and the connection that Mr Sach quite clearly said to you was not an appropriate connection. So the comments that did, I think, emanate from that particular part of the report, which said we must ensure that the GRG behaviour is completely aligned with the customer and with the rest of the core bank was the element that we were looking at and was the element we took action on.

Chair

That is a very confused reply, if I may say so, to a simple question, which is, why did you not just say to Andrew Large, “You have it wrong”?

Chris Sullivan

Because we were not looking at every individual single sentence within it to—

Chair

But this is not an individual single sentence—

Chris Sullivan

We were looking at the underlying.

Chair

—this is a main conclusion on the basis of which he makes recommendations. He says that RBS governance structures do not do enough to address potential conflicts of interest, and he then cites GRG as needing—

Chris Sullivan

That was the element we took action on.

Chair

So it is true? There were conflicts of interest. He was right.

Chris Sullivan

We took action to ensure there were not.

Chair

So was GRG a profit centre at the time that he made his report?

Chris Sullivan

No, it was clearly not a profit centre as you alluded to it. It had a statement of its income and its costs in isolation from all the other economic elements of that customer’s relationship with RBS.

Chair

Sir Andrew will have an opportunity to respond to the slightly bizarre story that seems to be developing.

Mr Love

In an earlier answer to a question on valuations, Mr Sach, you drew a distinction between formal external valuations and the internal valuations that your group carries out. What do you use the internal valuations for? What purpose are they?

Derek Sach

We try to do things with customers in a consensual—believe it or not—and as cheap and effective manner as we can. As I said, in the very difficult period of 2009 to 2010 selling properties was a fairly academic pastime because there was not a market. So to use an internal valuation in our discussions with customers, if they were broadly in agreement, was quite an effective way of progressing and saying, “All right, from a security point of view we have a property that is worth, say, £1 million”. If ever we were doing anything to rearrange their affairs or doing something legal then they would want a proper valuation. That would be done through the Red Book using a formal valuer externally to the bank.

Mr Love

The Clifford Chance report comments about the use of the assumption of a short marketing period being used consistently for internal valuations. Did that mean that with internal valuations the price was suppressed from what you would get for the formal external?

Derek Sach

Everyone would understand the basis on which it was done but the object of the exercise would be to get a fairly realistic valuation, which, as you say, is probably going to be a shorter time for marketing than if you go for the Red Book; 12 months, willing buyer, willing seller.

Mr Love

Let me turn to West Register. According to your reports, it purchased and held many properties sold by distressed SMEs on your patch. Did West Register intend to turn a profit on those properties?

Derek Sach

No, and again it is an area of loss mitigation. West Register was set up 20 years ago and it has waxed and waned since. It probably peaked in the late 1990s with a portfolio of about £1 billion and reduced again to no more than about £10 million in 2007. You are right that since then it has bought a lot of properties rather than dump them on the market and get absolute fire-sale prices for them. During the period in question we bought 160 properties from SMEs for a cost of about £450 million. The actual loans we would have made on those properties are more like £900 million to £1 billion. So, even if we were to sell them in a year or two’s time and make a book profit on the price we bought it in at, overall, we have still lost a lot of money.

Mr Love

Explain to me what the role of West Register was. If it was not intended to turn a profit are you in fact saying, “We were buying these properties out of the goodness of our heart in order to sustain the business”? If it was not a profit centre what was it?

Derek Sach

Most of the properties that West Register has bought in this cycle have been from pure property positions, as opposed to a trading company. Its origins were doing things like, say, in the leasebacks for trading companies where you could provide some cash for the company and relieve them of perhaps a big burden of overhead. This time round a lot of them would have been incomplete developments that needed to be completed. Often the entrepreneur did not have the ability to do that. In every case where we have bought one it is always marketed on the open market. If any other purchaser bids more than West Register they can buy it and West Register is never allowed to bid again. So, to keep it absolutely fair and without anyone feeling they are being dispossessed of their property unfairly, if someone bids more than West Register they get it.

Mr Love

You will be aware of the controversial nature of West Register and the accusations made about under-valuation of customers’ assets. You did not ask Clifford Chance to test the accuracy of the valuation methodology. Why not?

Derek Sach

I did not instruct Clifford Chance, so I honestly cannot comment on why we did or did not ask them to do any specific thing. But they do comment that there is no evidence that West Register tried to buy things at under-price, because these assets are marketed and if somebody else bids more they will get it. That to me is a market price.

Mr Love

That may well be the case but, Mr Sullivan, perhaps you can shed some light on why Clifford Chance, were not asked to look at this. This was obviously an area of great controversy, the valuations that were made of assets and the consistent complaint that they were under-valued. It would have been simple to ask Clifford Chance to look carefully at this to see whether there was any merit in the criticism. Why was it not done?

Chris Sullivan

I did not instruct Clifford Chance either but, nonetheless, I would have been very comfortable to do so. It is worth understanding where West Register was used. Generally West Register would buy a property or such like from a customer that had failed. So the business could not meet any of its debts and was not then trading. Therefore, this asset had to be realised. Bids were put out and taken from the external world. If we believed that the market was not valuing those highly enough then West Register would put a bid in at a higher level, thus reducing the loss that the bank made and holding that for some time to realise at perhaps a better point of the cycle. So this was not taking properties off people and profiting from them, it was mitigating the loss the bank already had.

Mr Love

Surely the first test in all of this is to check for manipulation of valuations and to see whether there was a systematic bias. Surely that could have been done fairly simply.

Chris Sullivan

But as Derek says—

Mr Love

That would have answered the criticisms that have been made about valuations.

Derek Sach

I am sure Clifford Chance did address this. They addressed the main accusation of deliberately distressing companies. Alongside it, or as you go through the first three or four pages, there are about eight separate sub-headings of things that Clifford Chance addressed, one of which is West Register and buying at the right valuation. I am sure it is there in some way.

Mr Love

Let me reverse this. Probably you do not know the answer to this but perhaps you can find out for us. Did Clifford Chance ever suggest that this would be a sensible thing for them to do in order to address this criticism that was being made? Presumably, if you were not involved in the report, you cannot tell us whether that is the case. Chairman, I think it would be helpful if we could have more information on exactly what Clifford Chance were or were not asked to do in this regard, because it would seem sensible for them to have looked at this systematic bias issue and they clearly have not done so. If I can come on finally to this issue of threatening the removal of overdrafts. You indicated earlier—and you mentioned also the unfortunate drafting of the manual—that you were not aware that anyone had taken this seriously. Mr Sach, do you deny that there was any behaviour of this sort that went on in your particular division?

Derek Sach

Yes, we would not treat someone in that fashion. We would say to them, “If you are not prepared to make changes you are going to reach your overdraft limit and we will not be renewing it” or “we will not extend it” but we would not threaten to do what I think is suggested there, just threaten to take it away on a capricious basis to force someone to do something.

Mr Love

Do you think that someone saying, “If you do not play ball with us we will not renew your overdraft” is a threat?

Derek Sach

I think that is the commercial way that banks have to operate because we have to have a regard to our shareholders to protect our money.

Mr Love

I fully understand that. What I think we are trying to get to the bottom of is this criticism that was made that it was the threats that were issued against your small business customers that made them feel that you were not on their side; that this was a regular occurrence reported by a number of small businesses that they were told that overdraft facilities would be cancelled. You only need to give a day’s notice to withdraw overdraft facilities. This was used regularly in order to—if I can put it colloquially—soften up the customer.

Derek Sach

Yes. I mean I can only say that is not done. Invariably we extend people’s overdraft and the forbearance, which we are quite famous for and again got into conflict with the APA over, is we frequently allow customers to go over their overdrafts. In addition to that, over the last three years we have formally advanced £100 million of new money—more than £100 million, £120 million—to these SMEs to help them with their problems. We just do not do that. We have been examined as well by other independent people with a different perspective. The APA commissioned McKinsey to look at us in 2010, and they concluded that we were a good comparator with other organisations they had seen in Europe and the United States. The FSA did a visit to GRG with a team of about half a dozen people in 2011. They produced a report whereby they said we were fit for purpose. So again these things would have been looked at by both of those.

Stewart Hosie

Mr Sach, you said a bit about the salaries of your staff. You said they were in the £30,000 to £60,000 range. These seem very modest for people who the bank would put in to restructure businesses that would have substantial liabilities if they get it wrong, not just to the bank but at the moment to the taxpayer.

Derek Sach

These are the sort of range of salaries of the typical person who is dealing with an SME. We are looking at a very discrete part of the overall portfolio, the 10,000 SMEs. But let me just check with Chris. I would not like to mislead you.

Chris Sullivan

We are talking about the relationship managers who would be dealing with small to medium-sized enterprises. We are not talking about relationship managers who would deal with very, very large restructurings, so I think the £30,000 to £60,000 range that Mr Sach described is appropriate.

Stewart Hosie

It did strike a number of us as very low salary figures for staff—

Chris Sullivan

It is not often we get accused of that.

Stewart Hosie

I am sure your staff will be pleased to hear that. It has been said earlier that GRG can insist on a transfer of a business into GRG, but it has never been used for any SME. This is for larger businesses. Can I confirm, Mr Sach, that what you said at the beginning would still apply, that the assets and income from the business being transfer would still remain with the donor division?

Derek Sach

Yes.

Stewart Hosie

So, even though you insist on it and handle it completely, the assets and income still remain with the donor division?

Derek Sach

Yes. What transfers is the management.

Stewart Hosie

All right. If I can also go back again to where you spoke about how you deal with businesses in relation to valuations in a cheap and effective manner. You will be aware—and we are all certainly aware—that businesses have come to us complaining bitterly about multiple valuations at your insistence but at their cost. That does not really chime with the cheap and effective manner argument that you made earlier.

Derek Sach

We would never charge for the internal valuation but, yes, on occasions the documents will require, or the situation they are in will require, that a formal valuation is undertaken and, yes, regrettably they do have to pay for that.

Stewart Hosie

Again the criticism is that these are multiple valuations. It is not just once, it is every six months or every year. You will be familiar with these arguments, I am sure.

Derek Sach

I am not familiar with people having to have multiple valuations at our request. Sometimes a customer will want to have his own. Usually we try to agree with them who is going to do the valuation. We have a panel of valuers who we use and we will offer them four or five and say, “Is there one of these that you would like to use?”

Stewart Hosie

I was going to ask about that because, again, it has been put to me that the bank have insisted on a particular firm, whereas the business would prefer a different firm who have much more understanding of that portfolio. Why would the bank insist on one from their panel rather than a professional valuer who knows the portfolio better?

Derek Sach

Like all hypothetical examples you need to see the particular to be sure, but I would surmise that, for some reason or another, the bank would not be confident that the valuer the customer wanted was going to provide the right valuation. I would have to look at the particular situation.

Stewart Hosie

Of course, but presumably it would be the correct valuation rather than the right valuation?

Derek Sach

Well, valuation is an art as well as a science so I am—