Jeremy Warner's Outlook: Sir Fred's head may be part of the price that has to be paid for Royal Bank rights issue

First he insisted he wouldn't make any acquisitions. Then he denied he needed capital, only now to launch a rights issue
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The Independent Online

There have long been two views in the City on Sir Fred Goodwin, the chief executive of Royal Bank of Scotland. One paints him as an imperious egomaniac whose reckless hubris has placed his bank in such extreme financial danger that it needs to raise some £9bn to £12bn of new equity from shareholders, the largest such rights issue in UK corporate history.

Schadenfreude is the order of the day among those who hold this view. He's had it coming. "Fred-the-Shred", as he has been known since his days as a young banker with the Clydesdale, must be made to pay by being shredded himself.

Yet the City also loves a bully, and there is an altogether different school of thought which has Sir Fred down as one of the most brilliant operational managers of his generation with plenty more still to give to the bank that made his name.

According to this camp, to make the skipper walk the plank just when his skills as a banker are most needed would be folly. With the ABN acquisition still to be properly integrated, Sir Fred's task is far from complete. For the time being, it is hard to know which of these two views might triumph. For what it is worth, knee-jerk reaction in the City yesterday was overwhelmingly that whether brutally or more sensitively after a suitably respectful delay, Sir Fred would have to go.

More worrying for Sir Fred, one fund manager warned that the City might make its backing for the rights issue conditional on Sir Fred's departure. According to this line of argument, Sir Fred would never go voluntarily, so shareholders need to act while they still hold all the bargaining chips.

The case for the prosecution is easily made. Over the past year and a bit, Sir Fred has repeatedly misled the City over his intentions, only eventually to do the opposite of what he said.

First he insisted he wouldn't make any acquisitions, then he entered the fray for ABN Amro, then he refused to back out even after it became apparent that he was overpaying. Then he denied he needed more capital, only now to admit that he's launching a rights issue. The excuse that circumstances changed may be partially true, but, having lost half their money since last August, shareholders are in no mood to listen.

Sir Fred has always run RBS on the narrowest possible of capital bases. In the days of easy money before the credit crunch hit, this used to be a subject of some pride, for it meant the bank's return on equity was higher than most. With each successive acquisition, solvency ratios would again become compressed to wafer-thin levels but Sir Fred would then defy the sceptics by swiftly rebuilding capital through internally generated profits. Even so, the City worried about the constant stream of acquisition-making. Eventually, Sir Fred was forced into a self-denying ordinance: no more acquisitions.

It was only a matter of months before the vows of chastity were broken. An agreed merger between Barclays and ABN Amro threatened to eclipse RBS's position as Britain's second largest bank. Together with Santander of Spain and Fortis of Belgium, Sir Fred determined to thwart Barclays' ambitions with his own break-up bid. This was both applauded and condemned with equal measure in the City.

Yet ultimately it proved unwise. Sir Fred found himself locked into paying a top-of-the-market price as the credit crisis began to bite. Whether out of pride, or misplaced loyalty to his partner, Santander, he refused to cede the prize, pushing on with steely determination against much outside advice.

Sir Fred then compounded the mistake by defiantly and repeatedly insisting there would be no need for more capital. Only two months ago he also raised his dividend in an ill-judged attempt to demonstrate his capital prowess. The authorities have since held a gun to RBS's head: raise more capital or you won't get the gilts-for-mortgages liquidity package you seek.

The defence is a rather more nuanced affair. Essentially it lies in the idea that even if RBS hadn't done the ABN deal, it would still be launching a rights issue, which in turn is a bold and brave attempt by Sir Fred to position RBS ahead of the pack. If everyone else is eventually going to have to follow suit, there could plainly be some first-mover advantage. Investor appetite for bank rights issues is bound to be limited. It may pay to get in first.

On ABN, Sir Fred may have a point. He didn't buy the whole thing – much of it went to other consortium members – and what he did buy was partially funded with equity.

Core tier-one capital degenerated a bit as a result of the acquisition – from 5.1 per cent to 4.5 per cent – but the deal wasn't as destructive of solvency ratios as sometimes portrayed. Capital was already stretched before Sir Fred bought. Regulators raised no objections at the time.

Sir Fred would have us believe that he's being forced to raise capital as part of a wider package of measures to bolster confidence in the banking system. Rights issues are depicted as the price that has to be paid for the banking bailout now under discussion with the Bank of England and the Government.

RBS's position as the pride of the Scottish nation will help protect Sir Fred's position to some degree. Edinburgh will instinctively rally behind to defend him from the City wolf pack.

Yet no one is indispensable and there is a certain inevitability about the personal drama now being played out. The board has already lined up Johnny Cameron, head of corporate markets at RBS, to step into the breach should it be necessary to deliver Sir Fred's head on a platter. He'd be a popular choice in the City as successor, even though as a board member he was also very much a part of the decision to bid for ABN.

Whatever Sir Fred's talents, it is often the case in business and finance that radically changed circumstances call for a matching change in approach and command.

Those that have presided over a period of dramatic expansion are often not best suited to the more constrained times that come after.

With Sir Fred, there is a separate worry. If shareholders provide more capital, it will be for the purpose of repair, but what's to stop the acquisitive Sir Fred blowing it on yet further balance-sheet expansion? ABN seemed to demonstrate that he just can't help himself. I wrote yesterday on the spur of the moment that I had a sneaking suspicion Sir Fred would survive.

With 24 hours to reflect on it, this now seems less likely. Whatever the excuses and the mitigating circumstances, nobody raises £12bn from the City in a deeply discounted rights issue without penalty. It is possible that RBS will seek to cushion the pain by seeking part of the new capital from sovereign wealth funds, or perhaps Bank of China, in which RBS took a stake a little while back.

However, in the round, the City would prefer to cough up the readies than take the dilution of sovereign wealth fund capital.

Whatever the outcome, RBS's act of capitulation has to be seen as a positive development in the unfolding credit crunch.

Back in 1991, a rescue rights issue from Barclays after the bank had racked up calamitous losses on commercial property, came to mark the bottom both for the Barclays share price and the stock market as a whole. Likewise, the RBS rights issue is one of the building blocks vital to the restoration of confidence in the UK banking system. Next week's £100bn Government bailout ought further to help unfreeze credit markets.

The credit crisis is by no means over yet, but we do seem finally to have hit bedrock. Ascent from the depths now begins to look possible again. Some of the right things are beginning to happen. Regrettably, the economic impact is still largely to come.