by Perman, Ray
His leadership marked a radical change in character and culture. Previously the Bank had been constrained by its hierarchy. Information had a long way to climb to get from the customer to top management and decisions wound their way down through many layers before being implemented. Pattullo was open and approachable and, in some ways despite his middle-class upbringing, unconventional, prepared to consider new ways of doing things and to listen to his subordinates as well as to his peers. For the senior executives who wanted to get the new chief’s ear there was another marked change. Unlike previous generations of top Scottish bankers, Pattullo was not a golfer. He played tennis and had a court built in the garden of his Edinburgh home. Several of his senior lieutenants started to work on their serves.
By the time he became Treasurer, he had had two decades to observe how the Bank’s management structure inhibited innovation and made decision-making cumbersome. He introduced a Management Board1, consisting of the top half-dozen or so senior executives who met regularly to discuss the progress of the Bank in their various fields. Everyone, whether they were in International, Treasury, managing the East of Scotland business, the West or London, got an overview of what was happening, where problems might occur and where opportunities were being presented. This group became the engine of change within the Bank, reinforced by the fact that most of its members had offices on the first floor of the headquarters building on The Mound. If they were in the office they took coffee together and often lunched together.
Risk and Pattullo redesigned the governance of the Bank. They created a clear separation of the functions of the main board – now focused on strategy and a role as trustees of the proprietors’ (shareholders’) funds – and the Management Board, which ran the Bank day to day. To link the two, the Treasurer sat on the main board as a full member, and the Governor attended the Management Board. The minutes of Management Board meetings were made available to directors, and executives attended the main board meetings, sitting at the back and silent unless asked to speak.
Pattullo also ended the stranglehold the Inspectors’ Department had over innovation and promotions and focused it on internal audit. He promoted younger, able managers and he changed the culture, abolishing the Business Development Unit, a head office team supposedly responsible for finding new opportunities, and sent a circular to all managers telling them they were all responsible for growing the business. No more would initiative be slapped down: ‘The Treasurer has let it be known that he is open to ideas from anywhere,’ one young manager told me with enthusiasm at the time.
Tom Risk was appointed Governor in 1981 and the two men formed a formidable partnership at the top of the Bank, each passionately committed to its independence and to making it a force to be reckoned with. When the chairman of the Distillers’ Company, Scotland’s biggest whisky producer and by common consent a poorly managed dozy giant, came to suggest that it might buy Bank of Scotland, Risk politely but promptly walked him to the door and closed it behind him. A more credible threat was posed when Barclays, which had owned 36 per cent of Bank of Scotland since its acquisition of British Linen Bank, decided it wanted either to acquire the remainder of the Bank or to sell its stock. There was no appetite on The Mound for becoming a subsidiary of Barclays, which had its own problems and was still in the grip of the founding families. Instead Risk arranged to have Standard Life, Scotland’s largest life assurance company, buy the holding, rather than have it acquired by a possible predator. ‘It was a squalid Scottish stitch-up,’ remarked one Bank executive. Standard Life was criticised for the deal on the grounds that such a big stake, representing over 7 per cent of its equity holdings, would unbalance its portfolio, but it held the shares for ten years and sold them for four times what it had initially paid.
Pattullo turned conventional thinking in the Bank on its head. Whereas the previous generation of managers had seen the ending of the Gentleman’s Agreement as a threat that the English banks would come into Scotland, he saw it as an opportunity. With an English market ten times the size of Scotland to go after, Pattullo saw that he had the best of the deal. Whereas others saw Bank of Scotland’s tiny percentage of the UK banking market as a weakness, he regarded it as a strength. He could realistically aim to double his share, whereas any of the ‘Big Four’ English banks, each with about a fifth or more of the market would struggle to gain any increase.
His strategy was to move into England with a series of carefully positioned branches in fast-growing English regions. Birmingham was the first, quickly followed by other major cities. He recognised that in a new market it would be impossible to make enough profit from retail business to justify the property and manpower costs of opening a large branch network, so the new offices were to concentrate on corporate business, lending and, crucially, taking deposits. That would mean a fewer number of bigger and more profitable deals.
He intended to tackle the English retail market by a twin-approach of getting other people to sell Bank of Scotland products, and pioneering direct sales channels which did not need bricks and mortar. Before long the Bank was providing credit to customers of Marks & Spencer, the clothing retailer C&A, Renault cars, the Henley Group car dealership, British Rail and the motoring organisation the AA. Banks had got over their fear of mortgages, realising that although the loans were granted for 25 years, many people moved house and redeemed their debts long before that. The average life of a mortgage was less than a third of the nominal length. Bank of Scotland processed home loans centrally, but marketed them in this pre-internet age through newspaper ads all over the country. It also launched a Money Market Cheque Account, aimed at people with above-average incomes or wealth – the first account in the UK to offer near-market rates on credit balances above a minimum level. The address of the Bank’s Threadneedle Street branch in the City of London was on each cheque, but the account was run from a computer centre in the Edinburgh council estate of Wester Hailes.
Innovation was now the Bank’s guiding principle and this was dramatically illustrated by the introduction in 1985 of HOBS – the Home & Office Banking System, the first electronic banking system in the UK. It was initially run on Prestel, an early electronic network. For the first time customers could see their account balances and move money between deposit and current accounts from a screen on their desks or on their home televisions. We now take this for granted with internet banking, but at the time it was revolutionary. The Bank was freed from its dependence on a branch network largely confined to the most northerly quarter of the country and customers did not have to telephone their branches or visit them to find out what their balance was. HOBS brought Bank of Scotland tens of thousands of new accounts, but it failed to make the most of it. ‘We still had a Presbyterian culture,’ Pattullo remembered later. ‘We didn’t believe that we were that much ahead of any other bank. It was a great success, but we could have expanded the account base twice as fast if we had thrown everything at it.’
Other electronic developments followed: an internal network which allowed any manager to access the account details of any customer – another ground-breaking system – and an international payments system which was used by the Government to pay pensions and other benefits to British citizens living abroad.
There was financial innovation too. In the early days of North Sea exploration, when the Bank began participating in oil field financings, it had learned new skills by being able to forecast cash flows and structure lending deals. Archie Gibson, one of Pattullo’s closest allies, and Gavin Masterton, Gibson’s young protégé, began to apply these techniques to a new corporate phenomenon – the management buyout.
In boom times big corporations had often acquired companies without obvious logic and diversified conglomerates became fashionable. As the economy tightened in the early 1980s, these same big groups began to sell off unwanted subsidiaries, often to their managements, who understood the business and recognised its potential to grow if freed from the burdens and restrictions imposed by
the parent group. Unlike later leveraged deals, these were usually companies in basic industries, with long track records and predictable cash flows. The Bank realised that the companies could afford to borrow a large proportion of the purchase price, with the loans being repaid a few years later when the firm was either bought by another trade buyer or floated on the stock market. It set up a unit to specialise in management buyouts (MBOs) and quickly became the leader in the field, topping the league table of lenders ahead of banks many times its size. Crucially, it began to gain a UK rather than just a Scottish reputation as a shrewd corporate lender and its younger managers got to work on bigger and more complex deals than they would have done had they worked for one of the big London banks.
The core retail market in Scotland was not neglected. In 1984 Pattullo launched the ‘Friend for Life’ campaign, an attempt to shake off the Bank’s ‘stuffy and dour’ image and replace it with an attempt to provide ‘the most friendly, efficient and constructive service of all the banks’. The advertising was backed up with staff ‘training and retraining’, to ensure that the actual service experienced by customers lived up to the hype.2 The Bank also supported the Institute of Bankers, and put any of its managers it believed had potential through the Institute courses and exams. Exceptionally talented people were sent to Harvard to take the Advanced Management Programme.
In 1985 Pattullo presented figures to his senior managers at an internal conference. Over the past year the Bank had increased its pre-tax profit by 35 per cent, marginally behind its old rival the Royal Bank, but well ahead of any of the English clearers. Over five years the record was more impressive: the Bank was well ahead of the pack with an almost doubling of profit. Over ten years it had achieved an increase of 474 per cent, beaten only by Lloyds. Its return on equity – a measure increasingly looked at by professional investors – was running at 23–25 per cent in the late 1980s, a very high rate of return for a bank which was still regarded as well capitalised and not unduly risky. In 1989 The Economist magazine’s survey of the financial sector resulted in the Bank being voted by its peers as ‘the most admired bank’ for its technical innovation, and the Institution of Electrical Engineers asked the Bank to deliver the annual Faraday Lectures, under the title ‘Electric Currency’.
For all his willingness to try new things, Pattullo remained innately a cautious man. While trumpeting to a management conference that the Bank was now ‘advances led’ – that is its growth was being propelled by its success at lending – he exhorted them to match this by bringing in more deposits. Although he sanctioned large corporate loans, he wanted to be sure that there was a near-certain chance of the money being repaid and he often expressed his belief that banks ‘should not be in the risk business’.
The philosophy that the Bank was a custodian of its depositors’ funds lay behind its governance structure. In addition to the main board, there were area boards in the East and West of Scotland and in London, whose members included the responsible senior executives of the Bank and non-executives, usually the heads of prominent local businesses. Another board shadowed the international department. They would scrutinise lending propositions, using their business expertise and local knowledge to challenge the executives. The main board also discussed lending proposals in a process known by the Victorian term ‘homologation’. The board, drawn from the captains of the various industries with which the Bank dealt – oil, property, engineering, shipping, investment – would closely question executives on what they were doing. ‘The idea,’ remembers one board member, ‘was not to second-guess the executives, but to make sure we understood what they were proposing and also to make sure they understood it too.’
The Bank board of the 1970s–1980s, exclusively male – white, middle-aged, middle-class with the occasional member of the aristocracy – would not pass muster today. ‘It was non-PC,’ remembers one executive, ‘but it worked.’ In a small country like Scotland conflicts of interest must also have occurred frequently, with board members sitting in judgement on the business plans of their competitors. But standards then were different. Directors were expected not be partisan or further their own interests and trusted not to do so.
In the UK, the Bank’s success in oil and management buyouts was increasingly bringing it into London – although with typical Edinburgh disdain Tom Risk categorised it as ‘an inefficient place to do a day’s work’. In the late 1980s came the ‘Big Bang’. The deregulation of financial services allowed clearing banks to move into previously prohibited activities. There was a wholesale rush of banks buying stockbrokers, fund management firms and merchant banks. Names which had been a fixture of the City for decades or even centuries disappeared into huge financial conglomerates and the city gents who had been partners in these firms retired with wealth unimagined even by their accustomed comfortable standards. In their place came a new breed of younger, sharper, better educated and more aggressive operators. ‘My word is my bond’, the motto of the Stock Exchange, gave way to caveat emptor. Long lunches gave way to sandwiches at the trading screen. Bank of Scotland stayed aloof from this movement, preferring to stay as a pure banking operation and in a statement of its defiance, contributed to a capital-raising by Cazenove, the Queen’s stockbroker and the most conservative of the city institutions, which had decided to remain independent. The Bank and ‘Caz’, led by its senior partner, the patrician David Mayhew, appeared to share a similar ethos.
The Bank also refused to be drawn into the increasingly fashionable proprietary trading of derivatives or other complex financial instruments which were forming a growing large part of banks’ profit-generating strategies. A treasury dealing room had been set up in London, but Pattullo always regarded the operation, which lent and borrowed in the inter-bank market, as a service department. Its job was to ensure that the Bank always had sufficient liquidity – that it never ran the risk of running out of cash. If there was a shortfall in customer deposits, Treasury had to make up the deficiency as cheaply and effectively as possible by borrowing on the wholesale market. It also bought and sold currencies on behalf of the Bank’s customers. What it was not there to do was take unnecessary risks – which the Bank’s board regarded as gambling – even if this meant it might miss out on profitable opportunities.
There was one fashion, however, which it did not shun. The Bank’s entry into the mortgage market at the end of the 1970s had been a great success. There was an increasing demand from couples to own their own homes and the Conservative Government, headed by Margaret Thatcher, encouraged the trend and offered a tax incentive which made mortgage interest payments more attractive than paying rent. By 1984 home loans made up 10 per cent of the Bank’s lending3and its advertising campaigns were producing more leads than it could handle. This was low-risk business. Borrowers knew that they could lose their homes if they failed to meet the repayments and would tighten their belts elsewhere rather than default on the monthly mortgage. The Bank carefully screened applicants to satisfy itself that they had steady incomes and could meet the repayments even if the economy turned down. It also took security over the house, or over an endowment life assurance policy. Besides the loan, there were other gains for the Bank: it insisted that mortgage customers open a current account to channel their monthly payments and tried to sell them insurance, on which it earned a commission. The loans themselves were very profitable: the Bank not only charged a premium on the interest rate, but a set-up and administration fee as well. The problem was that home lending was growing much faster than the Bank could attract deposits. It wanted to do more, but how was it to find the money to lend?
The answer was to sell the loans on to someone else, a process now known as ‘securitisation’. The Bank formed syndicates with other banks and they parcelled up thousands of mortgages together. They now represented a very large amount of lending, which was being repaid in regular and predictable instalments. The risk was low, partly because the Bank had taken care to vet the borrowers, but also partly becau
se of the diversification effect of this huge portfolio which was spread over different parts of the UK, different ages and types of homes and borrowers, whose occupations and incomes were different. It was very unlikely that many of them would default at the same time. These packaged mortgages could be sold to life assurance and pension companies which had cash to invest and needed predictable, reliable incomes to meet monthly pension payments.
The Bank kept the fees it had charged to borrowers and took a small share of the interest payments to cover the cost of continuing to administer the loans, collect the repayments and process any early redemption of loans when borrowers moved house. It also kept the risk and undertook to buy back any outstanding loans at the end of seven years.
Borrowers were oblivious to any of this. As far as they were concerned, their loans were with Bank of Scotland, to whom they continued to make their repayments and to whom they addressed any queries. But with the money it received from selling the mortgages, the Bank was able to make new loans, collecting set-up fees and a margin on the interest payments each time. As long as the demand was there it could carry on doing this indefinitely.
Had he been able to see 300 years into the future, William Paterson would have approved; this was near to his ideal of a bank benefiting from interest on money it was creating out of nothing. Some of the Bank’s board, however, did not approve.
‘Who were these mortgages being passed on to and what responsibility did we have?’ one director remembers wondering. ‘We asked these questions, but they were never satisfactorily answered.’ The non-executives were uneasy about the whole process. Their concerns were quietened by assurances that the Bank carefully vetted the borrowers, retained the risk and would buy back any outstanding loans at the end of the process, but doubts remained. ‘If you can pile up loans and get them off your balance sheet and believe you have no responsibility for them, whereas the people who took out the loans believe you are still responsible – that is not good business. However, it became very fashionable and everyone was doing it the same way, so we did it.’
