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It’s the real economy, stupid

Investment bankers at RBS might once have been able to argue that building a global investment bank was the best deal for taxpayers. Not any more. In the current climate, ditching that ambition is the right thing to do.

The decision by UK chancellor George Osborne to make Royal Bank of Scotland serve the UK economy first and its bankers’ egos second is a good one. The UK owns 84% of the bank. And taxpayers are now suffering from the public spending cuts brought about by what the government needed to spend to rescue the bank and its peers a few years ago.

This makes it entirely correct that RBS now be used by the state as a vehicle for generating economic growth.

That doesn’t mean it would have been a simple decision to take. Senior bankers at RBS have argued since the crisis that the firm should be allowed to attempt to make itself a global investment banking power house. They say this is the best chance of generating a decent yield for the taxpayer when the day finally comes for the government to sell its equity in the firm.

And there is a lot of truth in this argument. Or rather, there was until the last 12 months or so. A sluggish economy was always to be expected — and RBS can indeed be used to help mitigate this a little. What has changed is that it is now clear that any ambitions RBS had to be a global investment banking powerhouse are probably unachievable and certainly outdated.

The investment banking business model, as it was in the good old years at the start of the millennium, is gone. Capital is more expensive now and rightly so. Even those firms that are already genuine full-service global investment banks are having to rethink whether they are able to continue to be so in the new world of scarce capital and even scarcer liquidity. What hope does that leave for a firm like RBS — big in a few areas, subscale in many others?

Against this backdrop, it is far better to use RBS as a tool for generating lending and growth within the UK economy. If it can get capital flowing through the private sector once more, the multiplier effect will reap benefits for the country far beyond what a one-off sale of equity would provide (a sale, incidentally, that would have no chance of being attractive for many years, given the state of equity markets and ECM transaction business over the last year).

It might not sound quite as sexy as turning yourself into an international M&A big beast or a cutting edge derivatives shop — if such a thing will be possible for anyone under incoming regulations. But in any case, RBS has had a bash at that once and failed.

That’s not quite the story one always hears, of course. With so many parts of the business boasting how their bit made money, it’s a wonder that the bank had to be bailed out at all.

But it was bailed out, and that was thanks to the state. With the prospect of growing an investment banking business now worse than it has ever been before, the state now has an obligation to use this institution for the benefit of the country. And part of that is ensuring that it is never too big to fail again.

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