The Politics of the R.B.S. Settlement

LONDON - The British government is taking aim at an unlikely target in the latest rate-rigging case: the British government.

On Wednesday, the Royal Bank of Scotland reached a $612 million settlement with authorities over rate manipulation, a deal that leaves British taxpayers liable for part of the fine.

It is another costly legacy of the financial crisis.

In 2008, the British government had to bail out the Royal Bank of Scotland after the firm led a consortium to buy ABN Amro for $97 billion. R.B.S. contributed around $37 billion for the ill-advised deal. The government, which plowed roughly $71 billion into the bank in the bailout, now owns 82 percent of R.B.S.

With the majority stake in the bank, the British government finds itself on both sides of the case.

The Financial Services Authority, along with its global counterpart have been pursuing a broad investigation into the manipulation of benchmarks like the London interbank offered rate, or Libor. Last summer, Barclays greed to pay $450 million to settle accusations that it reported false rates. In December, UBS struck a sweeping $1.5 billion deal with authorities in which its Japanese subsidiary pleaded guilty to felony wire fraud.

With taxpayers on the hook, the case against the Royal Bank of Scotland has been politically sensitive after British politicians demanded that bankers’ bonuses should be used to pay for the settlement.

“There is a legitimate concern that British taxpayers, who already have bailed out the bank, will be asked to pay for past mistakes at R.B.S.,” said Pat McFadden, a British politician who is a member of Parliament’s treasury select committee that oversees the country’s finance industry.

On Monday, George Osborne, the British chancellor of the Exchequer, also called on the bank to use bonuses to pay the Libor fine.

Regulators have also been attuned to the issues. The Financial Services Authority did not take the holding into consideration with the settleme! nt, according to a person with direct knowledge of the matter, who spoke on the condition of anonymity because he was not authorized to speak publicly.

The bank did receive a 30 percent discount on the penalty from the Financial Services Authority, the British regulator, for agreeing to the fine. Under British law, firms that settle are able to receive a reduction on any potential regulatory fine. Without the reduction, Royal Bank of Scotland would have been forced to pay local authorities $197 million.

The overall settlement hardly seems like a sweetheart deal either. The Justice Department extracted a guilty plea from the bank’s Japanese subsidiary, in addition to the fines.

The management at Royal Bank of Scotland has heeded the warnings from politicians and regulators.

To pay for the settlement, the British bank said it would claw back past and present bonuses totaling $470 million from both the traders implicated in the rate-rigging scandal and from employees in the bank’s oerations, particularly its investment banking unit, that have not been caught up in the wrongdoing.

Royal Bank of Scotland said the clawbacks were related to the reputational damage caused to the bank, as well as to cover potential future legal liabilities. The money will primarily be used to pay the fines levied against the bank by U.S. authorities. As the British firm is majority-owned by local taxpayers, the fine from the Financial Services Authority will be recycled to the British government.

John Hourican, head of the firm’s investment banking division, also resigned on Wednesday in the wake of the scandal, and he will forgo past and present compensation worth a combined $14.1 million. Mr. Hourican, who took over the investment banking unit in 2008 and has not been implicated in the wrongdoing, will receive a one-time payout from the bank of around $1 million.

The moves in response to Libor come after efforts to reduce the firm’s bloated balance sheet and to eliminate 30,00! 0 job sin! ce the beginning of the financial crisis in a bid to increase profitability.

“This has been a soap opera for the last four years because of the ups and downs of this job,” the bank’s chairman, Philip Hampton, told reporters on Wednesday. “The bank was in a hell of a mess.”

But the renewed scrutiny also presents a problem for the British government. The case could hinder the country’s ability to sell its stake for a profit, as private investors remain wary of the bank’s future liabilities. Since the bailout in 2008, the bank’s shares have plummeted, and are currently trading around 32 percent below the initial purchase price.

“The settlement raises the question about how will we ever sell the shares in R.B.S. that are now toxic,” said Teresa Pearce, a British lawmaker who is a member of Parliament’s treasury committee that oversees the finance industry. “It’s another large amount of money that taxpayers have to pay for failures at the bank.”

As part of plan to sell the government’s stake in the bank, Vince Cable, the British business secretary, said Royal Bank of Scotland should have been fully nationalized when the bank was bailed out in 2008. In a speech on Wednesday, he added that one option could be to return shares in the bank to British taxpayers.

“The early hope of reprivatization now looks a very long way off, unless at an unacceptable loss,” Mr. Cable said.

The potential losses facing British taxpayers contrast with the $182 billion bailout of the American International Group in 2008. Over the last two years, A.I.G. issued a series of stock offerings to reduce the United States government’s ownership, generating profit of around $22 billion for American taxpayers.

The British government’s holding in Royal Bank of Scotland is overseen by U.K. Financial Investments, which also manages a 42 percent stake in the Lloyds Banking Group, another British bank that received a bailout during the financial crisis.

Governm! ent offic! ials have held preliminary discussions with a number of investors about selling stakes in Royal Bank of Scotland, according to a person with direct knowledge of the matter, who spoke on the condition of anonymity because he was not authorized to speak publicly. But the talks are still in the early stages.

The Libor case - and the size of the fine - may put additional pressure on the bank to reduce its remaining investment banking activity. The much-diminished group has already been hampered by the European debt crisis and other macroeconomic challenges.

On Monday, Mr. Osborne said regulators would have powers to split up banks that failed to separate their retail businesses from riskier investment banking units.

The fine “sends a message to shareholders that they should pull their finger out to improve corporate governance,” said Mark Garnier, a Conservative politician, who also sits on Parliament’s treasury committee. “The more you look at the R.B.S. bailout, the more it looks lie the government paid too much for the shares.”