David Prosser: Hester plays it safe at Royal Bank

In this post-credit crunch world, what sort of banks do we want to have? Most people, including regulators, politicians and the majority of the rest of us, believe banks ought to be more risk-averse, eschewing the sort of behaviour that got us into this mess in the first place. But City reaction yesterday to the news that Royal Bank of Scotland is considering launching a limited rights issue suggests that the Square Mile is not quite of the same mind.

The disappointment is not that RBS is hoping to insure fewer toxic assets via the Government's asset protection scheme, asking shareholders to stump up £3bn of additional capital instead. On the contrary – the City seems to think RBS is not being aggressive enough about reducing its participation in the APS, especially given the scale of ambition down the road at Lloyds Banking Group. There, the chief executive, Eric Daniels, believes he may still be able to raise sufficient cash to avoid the APS altogether. At the very least, its right issue – and thus the reduction of the APS participation the bank can achieve – is likely to be much larger.

There's no doubt the APS is the sort of insurance policy that bank shareholders would like to avoid in an ideal world. It is expensive – the taxpayer is demanding his piece of flesh – and comes with a hefty excess, requiring the banks to shoulder the first £25bn of losses on the assets they insure. Above all, the only way Lloyds and RBS can meet the cost of the scheme is to hand over a further slice of equity to the Government. Some 85 per cent of RBS could end up in public ownership under the scheme, while the figure at Lloyds is an unpalatable 65 per cent.

Moreover, since the two banks first opened negotiations over the terms of the APS six months ago, their share prices have recovered and confidence has begun to return to the banking sector. Leading shareholders appear to have indicated they would now be prepared to support cash calls.

It is for these reasons that there were mutterings yesterday about the cautious approach of Stephen Hester, the RBS chief executive parachuted into the bank earlier this year following its near total collapse.

Such mutterings are quite misplaced, however. For one thing, RBS's intention has always been to insure a greater chunk of assets than Lloyds – it wants to cover £325bn (versus £260bn at Lloyds) at a cost of £19bn (compared to £15.6bn). Unlike its rival, it has no chance of avoiding the APS altogether.

Moreover, Mr Hester knows that many of his shareholders are still smarting from the last RBS rights issue. The disastrous fundraising launched by his predecessors last summer pulled in £12bn at 200p-a-share – despite the recent share price recovery, the participants are still sitting on some very heavy losses.

Much more to the point, however, this is hardly the time to be taking a gamble on the continuation of the fragile economic recovery of which we are only just seeing a beginning.

Last month, Mr Daniels surprised many with an upbeat assessment of Lloyds' trading prospects, reporting losses of £4bn but signalling that the bank's bad debts had peaked. What he seems to be saying now is that Lloyds does not actually need the APS – even though it has already racked up losses on the toxic assets it would insure which amount to close to half the £25bn excess.

Let's hope he's right about the bad debt cycle. But what happens if the recovery proves shortlived, or the assets in question prove to be even more toxic than at first thought?

RBS, on the other hand, seems to want to play it safe – an approach that outside the City will rightly be applauded. It could probably persuade shareholders to support a larger rights issue, but it is resisting the temptation to do so.

One final thought: what explains the conflicting approaches of Messrs Hester and Daniels (the RBS chief has also been markedly more pessimistic about the short-term economic outlook)?

Could it be that having joined the bank only recently, and having been applauded for stabilising it, Mr Hester's job is not at stake? Unlike Mr Daniels, say, who still fears the consequences for his continued employment of his bank's merger with Halifax Bank of Scotland – and whose interests therefore lie in painting as rosy a picture of the future as possible.

Should we keep scrappage fund on the road?

The campaign for an extension of scrappage starts here. Figures from the motor industry suggest the Treasury is set to make a £100m profit on the scheme, which offers cash incentives to drivers who trade in an old motor for a shiny new vehicle.

While the project, which has boosted the struggling motor industry, comes at a cost to the taxpayer of £1,000 for each new car bought, it also raises VAT. And at the current VAT rate of 15 per cent, any car sold for more than £7,600 produces more than £1,000 of tax. With the average car in the scheme going for £9,000, the Treasury should make £100m of extra VAT, assuming that 300,000 vehicles are sold through the initiative, which is what scrappage funding currently provides for.

Case closed for an extension of the scheme, then, which is what the motor industry wants. Well, not entirely. For one thing, it may be that people are simply diverting spending from other areas to pay for their new cars, in which case the Treasury would have got its VAT anyway, without having to pay for it. Also, the aim was always to kick-start a sustainable recovery – at some stage, the motor trade has to stand on its own two feet.

Still, one thing which might help the industry persuade the Treasury is the end of the VAT concession, with the tax rate due to go back up to 17.5 per cent at the beginning of next year. That will increase the value of the scrappage windfall, should the scheme still be running.

It is an interesting dilemma – not least because the retail trade is set to mount its own campaign for further VAT concessions, arguing that the current 15 per cent rate should be extended into 2010. Retailers vs car dealers it is, then.