Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  This was effectively the first run on a bank in British history and the directors of Bank of Scotland learned one of the fundamental lessons of banking: always ensure you do not run out of cash.

  But before the crisis came to a head Paterson dropped his campaign. His shareholders had put their money behind an ambitious and romantic vision to propel Scotland from parochialism into the first rank of global powers. Paterson himself had sold it to them with poetic descriptions of Scotland one day controlling ‘the keys of the Indies and the doors of the world’. Lending money to each other was not part of the dream and, it transpired, a lot of the lending done by the Darien Company was to its own shareholders. Worse than that, the running of the company was inefficient, there had been embezzlement of some of the funds and the lending decisions it had made were poor. The company had trouble in getting its loans repaid on time and bad debts began to mount.

  Paterson had learned another fundamental lesson: make sure the people to whom you lend have the means to repay you.

  By this time he had unveiled his vision of a colony at Darien to the directors of the Company of Scotland and put all his energies into making it a reality. The banking business was soon forgotten.

  The reverse for Paterson was nothing compared to the tragedies to come. Darien was a catastrophe on a national scale for Scotland, which lost a substantial proportion of its national wealth in the ill-conceived venture. Disease, an appallingly difficult terrain and hostile attacks made the colony untenable. The trauma and financial loss was one of the factors which led in 1707 to the Scottish Parliament voting to give up its independence and merge with the English Parliament at Westminster. Individuals suffered much more: many of the original settlers died or were killed. Others lost their wealth and/or their health. Paterson’s wife and child both died in Panama and he became so ill that he lost his reason for a while. He recovered enough to become an MP in the newly merged parliament at Westminster, sitting for a rural constituency in the county in which he was born. He also continued to write pamphlets and essays projecting his views on money or state finance, but he was never again as visionary, persuasive or effective.

  Bank of Scotland had survived for the time being, but its future was by no means secure. Under the Treaty of Union, which combined the two parliaments, Scotland was to receive considerable sums of money ‘equivalent’ to the loss of Scottish taxes, which would now go to the joint exchequer in London. Those who had lost their fortunes in the Darien fiasco were also to be compensated and there was money to redeem public debts, to pay for a re-minting of Scottish coins and to pay the expenses of the Scottish commissioners, who had brought about the union.18 Importantly, there was also an end to discrimination against Scottish goods and traders and access for Scots to the English empire in India, the Americas and beyond.

  The years following the Act of Union saw an improvement in Scotland’s economic fortunes and the Bank, which also profited from a commission on the re-minting of the coinage, did exceptionally well, paying a tax-free 20 per cent dividend every year from 1707 to 1714.19 But the good fortune could not last.

  William III had died in 1702. Mary, his co-regent and Queen, had succumbed to smallpox eight years earlier and they had no children. He was succeeded by Mary’s sister Anne, who reigned until her death in 1714. She was also childless, although it was not for the want of trying. Anne had been pregnant at least 17 times; she miscarried or gave birth to stillborn children at least twelve times. Of the five children born alive, four died before reaching the age of two years. Her final pregnancy ended with a stillborn son.20 Parliament again looked for a member of the Stuart family who was Protestant – a condition now enshrined in law – and invited George, the Elector of Hanover, a great-grandson of James I & VI, to become monarch of the United Kingdoms of England and Scotland. He ruled as George I, first of the Hanoverians.

  The move provoked a renewed upsurge in Jacobite unrest. James II, who had been deposed in 1688 by William (his nephew and son-in-law) and Mary (his daughter) had died in exile in France. In 1715 an insurrection in Scotland and parts of England aimed to displace George and put James II’s son James Francis Stuart, known as the Old Pretender, on the throne. An army was raised in the north and many members of the Scots nobility rallied to the cause, including two directors of Bank of Scotland, the Earl of Panmure and Lord Basil Hamilton. Hamilton was captured at the battle of Preston (and subsequently pardoned) and Panmure at the battle of Sheriffmuir, although he escaped to live in exile.

  The rising was crushed, but not before there had been another run on the Bank which forced it to stop trading for eight months, with loss of business and profit. The participation of the two directors in the insurrection and the fact that the Bank’s Treasurer raised funds for Jacobite prisoners, were enough to brand the Bank as sympathetic to the rebels, with substantial political and commercial consequences. When its 21-year monopoly on Scottish banking came up for renewal the following year, parliament had no hesitation in ending it. The Bank had been weakened and its enemies saw their opportunity to strike. Those men fortunate enough to receive government money under the ‘equivalent’ provision of the Act of Union had formed a company which traded bills secured against the funds. For several years they had been trying to formalise the arrangement into a bank. In 1727 they succeeded and the Royal Bank of Scotland gained parliamentary approval. Bank of Scotland (henceforth known as the ‘Old Bank’) made a last ditch attempt to stop the birth of a rival, but the political mood was against it.

  From the start the Royal (the ‘New Bank’) was a formidable competitor. It was better capitalised than Bank of Scotland and its charter and its political connections gave it access to government funds and lucrative business. From the start it used its position and its muscle to try to drive the Old Bank out of business, collecting large quantities of Bank of Scotland notes by offering its own in exchange and presenting them for payment without warning.21 The Bank was again forced to call in loans, delay payment and eventually shut its doors. Yet despite a campaign of harassment which lasted two years, the Old Bank survived, rejected the New Bank’s takeover offer, and – inspired by the competition – revitalised itself, again opening branches and expanding its business.

  Scotland now had a two-bank system (unlike England which still only had one). The Royal and the Bank learned to get along, sometimes co-operating, sometimes in fierce rivalry and both seeing off many other competitors, or absorbing them along the way. They were tempered by periodic financial crises and boosted by times of economic boom. Adam Smith credited Scotland’s banking system, of which these two were the pillars, with being responsible for the dramatic change in the Scottish economy during the eighteenth century from a poor agricultural base to one of the leading industrial powers. A twenty-first century banker has described the relationship between the two banks as like that of two brothers – intensely competitive between themselves, but standing united against any outside threat. It was a sibling relationship which was to culminate in a bitter bid battle in the last years of the twentieth century and a simultaneous collapse in the first decade of the twenty-first.

  3

  A cosy world

  It is not the intention of this book to be a detailed history of the Bank,1 so we’ll fast forward 250 years. By the 1970s there were three banks in Scotland rather than two: the Bank and the Royal had survived booms, busts, banking crashes and world wars and were still headquartered in Edinburgh. Glasgow was home to their younger and smaller rival, the Clydesdale, although it was owned by an English bank, the Midland. Since 1720, however, dozens of banks had come and gone, some lasting centuries, others just a few years.

  A walk through Edinburgh’s Georgian New Town from St Andrew Square, along George Street to Charlotte Square, or along Glasgow’s George or St Vincent Streets, takes you through much of the country’s banking history. The first action of new banks in the nineteenth century had been to build headquarters in the Greek or Roman style, with columns, porticos an
d pilasters to give the impression of solidity and longevity. It was not enough. Their buildings may have had foundations of rock, but their finances were built on sand; most succumbed sooner or later to bankruptcy or predators. The institutions may have been ephemeral, but their head offices live on, imposing stone facades now often housing bars and restaurants rather than banking halls and teller counters.

  By the 1970s Bank of Scotland, as befits the ‘Old Bank’, was headquartered in a grand Victorian pile on The Mound, a man-made causeway which leads up to the Castle rock and a short walk from its modest first premises on the High Street, heart of the Old Town of Edinburgh. A substantial head office had been completed in 1806 at the then enormous sum of £43,000, but half a century later it was doubled in size; new wings surmounted by domes were added on either side and the central dome was replaced with an enlarged version. From its three flagpoles flew the Union Jack, flanked by the St Andrew’s cross of Scotland and the Bank’s own standard, a saltire with four gold discs to represent piles of coins. The building spoke of confidence and complacency. From the boardroom windows its directors could look down on the city spread below them. The Royal, the ‘New Bank’, appropriately had its head office in the New Town (still called ‘new’ although it was largely completed 200 years ago) – an upstart junior lower down the hill, beneath the eyes of its elders and betters.

  In the preceding two and a half centuries the Bank had absorbed many of its rivals, including the Central, the Caledonian, the Thistle, the Ship, the Glasgow Union, the Paisley Union, Perth United, the Kilmarnock, Hunter’s Bank, Sir William Forbes Bank and more recently the Union Bank in 1955 and the British Linen Bank in 1971, the last nearly as old as the Bank itself. The Royal had gone through a similar Darwinian process, picking up smaller and weaker institutions over the centuries.

  Natural selection had allowed Scottish banking to evolve into a closed and comfortable world. Banks competed with each other, but not too fiercely. One manager, newly promoted to be in charge of his own branch in a small rural town, suggested he might write to every business customer of his rivals in the area inviting them to meet him to discuss moving their accounts. He was soon slapped down by his superior: ‘This is banking, it is not total war.’ Senior bankers from the three Scottish banks met together in the Committee of Scottish Clearing Bankers, ostensibly to discuss items of mutual concern, but in effect to collude on interest rates, fees and charges. No one wanted to get too far out of line and the law took a more relaxed view in those days. The lack of competition even extended across the border. A ‘Gentlemen’s Agreement’ made in 1876 prevented English banks from opening branches in Scotland and Scottish banks from expanding in England, apart from small offices in London.

  Similarly banks did not poach each other’s staff. Typically a boy (they were still mostly boys) would join the Bank straight from school and stay with the same employer until retirement. If passed over for advancement, leaving to go to a rival Scottish bank was not an option; they simply would not consider employing you. Even moving to England was not a guarantee of a job, so in the post-war period many left Britain for British banks in the old empire, the Far or Middle East or Southern Africa. The Hongkong & Shanghai Banking Corporation was especially keen to recruit bright, well-trained young men from the old country, so much so that it was sometimes joked that the initials HSBC really stood for Home for Scottish Bank Clerks.

  And they were well-trained. A typical bank recruit would be a boy who had done well in his Higher certificate exams at school. Where today he would probably go on to university, then he would try for an apprenticeship with an industrial firm or enter a bank or insurance company. He might not earn much at first, but he would be paid something, would gain working experience and get an education which would equate to degree level. On his first day in a branch a new recruit would be shown where to sit and then given the time and place of the enrolment for night classes for the ‘Institute’ exams. The Institute of Bankers in Scotland,2 established in 1875, was the first banking institute in the world and its professional qualification, taken after years of study in night classes or by correspondence, gave a thorough theoretical grounding in all aspects of the business. On top of this the Bank imposed its own practical training by moving recruits of promise around branches and head office departments so that by the time they had been in the Bank for a decade or so they had experienced most things that day-to-day operations were likely to throw at them.

  Unlike English commercial banks, Scottish banks (and those in Northern Ireland) had retained the right to issue their own bank notes. Each bank liked to dispense only its own notes, but in the normal course of business they would accumulate piles of their rivals’ notes as well as Bank of England notes. This meant that they had to co-operate closely. In towns and cities a regular ritual would be enacted where clerks from different banks would meet to exchange notes, giving up those of their competitors and taking back their own. One apprentice banker remembers walking through the mining town of Cowdenbeath, Fife, in the late 1960s lugging a suitcase containing £500,000 in used notes to be exchanged in the branch of another bank – a grown-up version of exchanging cigarette cards or playing happy families.

  Very few people were recruited from other professions and if they were it was generally acknowledged that their careers would be limited. Unless you had ‘passed money over the counter’ you could not reach the top. Time-served bankers filled every post, in personnel (not yet called HR), in the management of computer departments (not yet called IT) and in marketing. This led to an in-bred, conservative culture, but also to an immensely strong sense of shared values. Talent and hard work were no guarantee that you would rise. After the merger of Bank of Scotland and British Linen Bank it was agreed that promotions would be in turns, one from each bank, rather than on merit.3

  It was a paternalistic world. Margaret Taylor4 remembers the Bank as being ‘a very sleepy sector and was seen as full of dusty old men and dusty old offices, and actually was. The sector was entirely different to what it is now, banks didn’t really have to go out looking for custom at that time, people came to them, and there wasn’t the same competitiveness. The old idea that if you work in a bank you’re well looked after and you’ve got a job for life and a cheap mortgage still prevailed.’

  Staff were expected to open accounts with the Bank and use them to conduct all their financial affairs. David Jenkins, who joined from academic life as the Bank’s Economist in 1976, was shocked to be told that not only must he move his own account to Bank of Scotland, but his wife must do so too. This was partly so that the Bank could keep an eye on its staff and know if any of them were getting into financial difficulties which might affect their work, but it was also a big source of business. ‘Staff Branch’ was very profitable.

  Systems within the banks were still mostly paper-based at the start of the 1970s. Bank of Scotland had bought its first IBM computer in the 1950s, but it performed only very basic accounting tasks and ‘cashing up’ at the end of each day was still the method by which branch managers knew how much business they had done.

  They had no idea whether their branch was profitable or not, because they were not told its costs and it is doubtful whether Head Office knew which branches made surpluses and which did not, let alone which products made money and which lost it (not that banks spoke of ‘products’ in those days). The Chief Accountant (not actually a qualified accountant, but a banker who had done his Institute exams and come up through the ranks) was the guardian of the balance sheet. His was the responsibility for making sure that the Bank was always solvent. The profitability of the Bank was a secondary consideration: as long as it earned a profit and could pay a dividend that was enough. No one in the management thought much about the share price and shareholders (‘proprietors’ in the Bank’s seventeenth-century terminology) seldom complained. Banks were expected to be solid, not to grow.

  In England newly affluent workers were opening chequebook current accounts, which
paid no interest and incurred charges. But canny Scots clung to their deposit accounts and the Scottish banks were slow to move them. Frequent bank mergers had left branches dotted along High Streets, often within a few hundred yards of each other, so it was no hardship for a Scottish bank customer to pop into a branch every time he needed to withdraw cash to pay a bill, rather than use a cheque. In the meantime his balance earned interest and he paid no bank charges. No wonder the profitability of the Scottish banks lagged behind their southern neighbours.

  Scottish banks were austere institutions. The Institute of Bankers did not teach ethics (it does now), but a strict ethical code was implicit in the Presbyterian character of each of the banks. Lines were imaginary, but everyone knew where they were and once crossed there was no way back. If you were asked to leave the bank, your career in banking was over. Discipline was maintained by the bank inspection department, which scrutinised lending applications down to very small amounts and made unannounced visits to branches. Gavin Masterton, who later became the Bank’s Treasurer, remembered his time in the department: ‘Bowler hats were mandatory and you had six white collars delivered every Saturday. Not too many people in Dunfermline wore bowler hats, so I had to smuggle mine across the River [Forth] to Edinburgh every day.’5

  The relationship was not quite that of the KGB to the Soviet Union, but the sudden arrival of the bank inspectors, typically wearing black overcoats and bowlers, could induce anxiety in a branch manager. The story is told of the inspectors arriving in a northern town, checking into the station hotel during the evening and having dinner and a few drinks before retiring, so that they were less than fully alert on the doorstep of the branch the following morning when the manager arrived to open up. After spending the day in the vault, counting money and matching totals against the ledgers, they summoned the manager to his own office for the verdict. All the sums were correct, everything balanced, but the inspectors never liked to leave without finding at least one fault: ‘You have a large amount of Royal Bank notes in your safe,’ they challenged. ‘Well of course,’ replied the puzzled manager, ‘this is the Royal Bank. The Bank of Scotland branch is on the opposite corner.’ Despite this momentary lapse, the inspection department grew very powerful in the Bank, exercising sway over promotions as well as over lending. If the inspectors remembered a bad debt they thought could have been avoided, it might hold back your career.