Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  It was not only politicians who were trying to rein in the regulator, there were also frequent complaints from banks and other financial firms about the level of the contributions they made to the FSA’s funding though levies. Under pressure to cut costs, the regulator actually reduced its staff in its Major Retail Groups Division by 20 people between 2004–8 at a time when it was taking new responsibilities such as supervision of the introduction of Basel II. In its report on lessons to be learned from the Northern Rock collapse, the FSA also found that where its staff had doubts about the management of banks they were not always raised with senior management at the regulator or with the bank itself.4

  The FSA admitted many of its failings and was abolished and replaced with a new regulator and a new supervisory system. In the report on the Royal Bank of Scotland, Turner describes

  an overall approach to the regulation and supervision of banks which made it more likely that poor decisions by individual bank executives and boards could lead to failure. In retrospect, it is clear that:

  The key prudential regulations being applied by the FSA, and by other regulatory authorities across the world, were dangerously inadequate; this increased the likelihood that a global financial crisis would occur at some time.

  In addition, the FSA had developed a philosophy and approach to the supervision of high impact firms and in particular major banks, which resulted in insufficient challenge to RBS’ poor decisions. The supervisory approach entailed inadequate focus on the core prudential issues of capital, liquidity and asset quality, and insufficient willingness to challenge management judgements and risk assessments. Reflecting the overall philosophy, supervisory resources devoted to major banks and specialist skills in place were insufficient to support a more intensive and challenging approach.5

  For ‘RBS’ in the previous paragraphs we could reasonably substitute ‘HBOS’.

  In his evidence to the Treasury select committee Lord Turner also drew attention to the failures of both the Basel I and Basel II international regulatory regimes. ‘The global capital standards applied before the crisis were severely deficient and liquidity regulation was totally inadequate. Banks across the world were operating on levels of capital and liquidity that were far too low. These prudential regulations have been changed radically since the crisis, with the internationally agreed Basel III standards.’ His conclusion on the Royal Bank was: ‘Had Basel III been in place at the time, not only would RBS have been unable to launch the bid for ABN AMRO, but it would have been prevented from paying dividends at any time during the Review Period, i.e. from at least 2005 onwards.’ In the case of HBOS we could surmise that its pace of growth would have severely slowed had it been required to retain more capital.

  It could be argued that every society gets the regulators it deserves. The last decade was a period when we were all not only permitting bank executives and boards to pursue reckless growth policies, but encouraging them to do so by favouring the shares of fast-growing companies over the more cautious ones and enjoying high dividends, high interest on current accounts and easy low-cost mortgages. Successive governments, encouraged by the banks themselves, urged ‘light touch’ regulation and turned a blind eye to excessive executive salaries and bonuses. The reward was high tax revenue which paid for high public spending. The press was mostly uncritical, fawning over ‘successful’ chief executives. At the height of the boom, very few journalists were calling for tougher regulation and the cost in time and money of supervision was seen as unnecessary and expensive ‘red tape’.

  In an environment like that we can no more expect a financial regulator to stop all bank collapses than we can expect the police to stop all crime. If we want things to change, the remedy is in our own hands.

  24

  The end of history

  In the summer of 1981 during a period of austerity imposed by Mrs Thatcher’s government, English cities erupted in sustained and violent rioting. Afterwards Environment Secretary Michael Heseltine led a party of business leaders to look at the devastation in Liverpool, a city which had been deprived of investment. ‘Where are the financial services companies,’ he demanded? Bruce Pattullo, then Treasurer of Bank of Scotland, replied that once every English region – including the North-west – had had its own local banks, responding to local needs and supporting local industry and jobs. The Bank of Liverpool, founded in 1831, took over Martins Bank and grew to 700 branches before being absorbed by Barclays in 1969. By the 1980s only Scotland and Yorkshire still had financial institutions with any autonomy. Now those too have succumbed to consolidation.

  This is not just a regional loss, it is part of the cause of the national disaster of the banking crash of 2008. A banking system loses its resilience if it is reduced to a handful of national institutions which are too big to fail. A sustainable ecosystem has big and small, specialist and generalist, regional and national. Local banks used to attract managers who were able and talented, but knew the limits of their ambition. I remember in the early 1980s attending the annual results press conference of Yorkshire Bank in Leeds. The chief executive wilfully misheard a question on the bank’s exposure to sovereign debt in Mexico and started talking about what it was doing in Mexborough, a town in the south of the county. His intention was to show that the bank did not take big risks by investing outside its area of competence, but it did know and care about what was happening in its own locality. Mexborough was not without its problems, but it did not have the potential to bring down major financial institutions, which is what nearly happened to much bigger banks that bet too heavily on Mexico.

  That was in a different age. Then the Financial Times could, with approval, call Bank of Scotland ‘the most boring bank in Britain’ for its failure to do any of the spectacular things which regularly hobbled its larger, London-based competitors. When John Smith was elected leader of the Labour Party, newspapers were able to describe him as being like a Scottish bank manager. It was a simile everyone recognised: a bank manager was sober-suited, calm, competent, reliable and possibly also a little boring – but who wanted to deal with an exciting bank manager? Banks were trusted by their customers and regarded by investors as safe and consistent, not ‘growth stocks’ expected to double in size every few years. A fund manager, who was also a director of Bank of Scotland, told me he put all his widow and orphan clients into the Bank’s shares. ‘Money in the bank’ was an everyday phrase which meant ‘secure’.

  The change did not come suddenly, but by the fin de siècle banks were regarded as either predator or prey: being efficient, dependable but unexciting was not an option. This coincided with a progressive deskilling of banking, partly as a result of technology but also through the rise of the profession of ‘manager’ as a generic skill. The MBA replaced the banking diploma as the passport to the top.6

  The professional manager did not need to know every aspect of the business because he could rely on other professionals – risk specialists, consultants, auditors, ratings agencies. Risk was no longer a matter of experience and judgement and you did not have to be cautious because the market would prevent you from going too far. You could take any risk as long as you priced it correctly. If the price went too high, no one would buy and you would not run the risk. The correct price could be determined by mathematics and calculated on a computer. Amazingly this belief persisted after the collapse of Long Term Capital Management in the US in 1998, a company that had two Nobel Prize-winning mathematicians on its board. As we have seen, professional managers turned out to be incompetent, mathematical models were inadequate and some risks were not worth taking no matter what the return.

  Another ingredient in the sour mix was the change from regarding lending as a service to be provided to account holders, to being a product to be sold to customers. If a bank offered products, then why would it not employ the same techniques as a retailer? No one stopped to think of the difference. Years after selling a customer a tin of beans, a supermarket does not ask for it back in per
fect condition. But a bank does expect the money it lends to be returned. A better analogy would be with a car hire company, except that the car hire firm may own its cars, a bank does not own the money it lends – that belongs to its depositors.

  Losing sight of that fact was fundamental to the collapse of HBOS. Depositors’ money is finite, whereas the money borrowed from the wholesale market was infinite. Although the savings of millions of ordinary people were nice to have, they were not essential because you could go on borrowing and lending eternally from the global market. There was no limit to the growth of the bank. The Philosopher’s Stone had been discovered – except, of course, that the interbank market was not everlasting, at least not for banks like Northern Rock and HBOS. In 2008 it came to a halt. Base metal could be converted, but only into fool’s gold.

  The banking crisis destroyed public trust in banks and bank managers. They regularly now feature in lists of the top ten hates. Senior bank executives – like the other titans of the corporate elite – are seen as greedy. It was not always like this. Thirty years ago Lord Kearton was a highly successful chief executive of the textile company Courtaulds, who went on to chair the British National Oil Company for the Government of the day. When he retired it was revealed that he had never taken a salary from BNOC. I asked him why. ‘I had enough money already,’ he replied. Now men and women who are already millionaires many times over, demand more millions for running banks – and we give it to them. I am not sure why. Does running a bank take more skill than, say, being a brain surgeon? Do bank chief executives work longer hours than the Prime Minister? Are they more knowledgeable than the President of the Royal Society? Banking is complicated because the men who run banks have made it so, yet the most successful banks are the simplest.

  Even after the crash, banks have hardly changed their ways. Public trust no longer seems important to them. Go into a bank and attempt to deposit a reasonable sum of money and you will be urged to speak to an ‘investment adviser’, who is, of course, nothing of the sort: his or her primary aim is not to give you dispassionate investment advice, it is to sell you a product which will make money for the bank. It is so transparent. No wonder people are cynical. Is it ever possible that we could get back to a situation where banks are trusted, where banks realise that their success depends on the long-term well-being of their customers, not on selling them products which produce a profit for the bank, but may actually do the buyer financial harm? Will we ever see again banks which know and care about the communities in which they operate, above a superficial level required to fill the pages of ‘corporate responsibility’ reports? The enforced sale of branches from Lloyds gives that possibility, but doesn’t guarantee it.

  The character of Bank of Scotland took 300 years to evolve. It is tempting to think it changed overnight when the Bank merged with Halifax, but in truth it had been gradually shifting for years, if not decades. The sales culture had been creeping in, dependence on wholesale funding had been increasing and most pernicious of all, the growth imperative had become ingrained. The Bank believed that if it stopped growing it would lose its independence. So it made a Faustian bargain, it gave up its independence in order to keep growing.

  It is fruitless to speculate on what might have been if the HBOS merger had not taken place. It did and Bank of Scotland was destroyed in seven years by men who were intelligent, hard-working and meant well, but focused only on growth. Everything else was subordinated, with the result that they lost sight of the simple rules of banking, which had not changed since 1695.

  25

  Gone, but not forgotten

  In 2012, the Financial Times called HBOS ‘the UK’s forgotten banking disaster’,1 and nearly four years after the crash, officialdom – the Government, the Bank of England and the FSA – appeared to be doing its best to put one of the worst banking failures in history behind it. In marked contrast to the Royal Bank where, responding to a media clamour for retribution, the Prime Minister personally encouraged the honours committee to strip Fred Goodwin of his knighthood, the men at the very top of HBOS appeared to have got off Scot-free. Crosby was still ‘Sir James’ and chairing big companies, Lord Stevenson still held his place in the House of Lords and at corporate top tables, and Andy Hornby had quickly found high-paying jobs, firstly as chief executive of the pharmacy chain Alliance Boots, then as head of the betting business Coral. Astonishingly, with the apparent approval of the regulatory authorities, finance director Mike Ellis had become chairman of another mortgage lender, the Skipton Building Society. These men knew they were now safe from any regulatory action. After fining and banning Peter Cummings, the FSA had drawn a line under its enforcement proceedings. Lloyds, whose shareholders were carrying the HBOS burden alongside the taxpayers, preferred to get on in silence with the gory work of disposing of the vast mountain of bad and doubtful debts it had blindly acquired.

  But the tens of thousands of people who had lost their jobs and the millions who had seen the value of their investment plunge by 95 per cent could not forget. By the Spring of 2013 the number of people made redundant had reached 35,000 and the job cutting was still not over. Many had worked for HBOS, Bank of Scotland or Halifax for most of their adult lives and now found themselves in middle age trying to find new careers in an economy flattened by the banking collapse. They faced a difficult employment market where banking skills and experience were the last things in demand. For most of those still lucky enough to be employed by Lloyds, life was hardly comfortable. HBOS directors may have walked away with pay-offs and annual pensions in the hundreds of thousands of pounds, but after a series of pay-freezes or rises of less than inflation the average salary in Lloyds was just £17,000 a year – so low that many had to rely on tax credits.

  Aditya Chakrabortty, writing in the Guardian, highlighted ‘Karen’ (not her real name), a mother-of-two. She and her husband were struggling to pay the gas, electricity and council tax bills. They had given up going out or taking holidays or buying treats for their children. ‘I’m going through my own financial crisis,’ she said. ‘Some of my colleagues are on payday loans; it wouldn’t take much for me to join them.’2

  Yet she counted herself fortunate. Of workmates who joined HBOS around the same time as her, dozens had had to accept redundancies or move office, meaning in some cases a two-and-a-half-hour commute to work. For those left, Karen added, the result had been ‘doing a lot, lot more work with a lot, lot less staff’. The stress had been so great that she had been ill. In a trade union survey of nearly 11,000 Lloyds employees, 85 per cent said they felt stressed at work and nearly 20 per cent said they were suffering stress-related symptoms. Eight out of ten staff said they had insufficient time to do their jobs in their contracted hours, were set unrealistic targets and were under unremitting pressure to perform well. Seven out of ten said they had too much work to do and too many objectives. Three out of every five respondents stated that they believed Lloyds had an unfair pay system, which failed to recognise achievements. There was a lack of training and they were uncertain about their future.3

  Having already left the bank before the crash was no guarantee of immunity. Gordon Dickson joined Bank of Scotland as a 16-year-old school leaver. In a career spanning more than 30 years he built up shares and options worth over £1 million, a useful nest-egg to supplement his pension. The HBOS collapse wiped out nearly all of it. Now he earns his living as children’s entertainer in one of two personae, Mr Giggles or Pirate Pete.

  He described his career to the BBC: ‘You came in to the bank as a boy. You worked your way through the ranks. You learned the trade properly. You were a cautious person, because the people before you were cautious and you learned from them.’ He rose to become a senior risk and compliance officer: ‘My responsibilities were primarily to ensure that the bank adhered to all the rules and regulations. We ran a very tight ship. We would jump on anything. If there was anything untoward, we wouldn’t touch it. But the whole mentality changed. We were no longer a bank
that was providing a service,’ he said. ‘We became a bank that wanted to sell to you – regardless of whether you wanted it. And the one thing it’s very easy to sell is money.’4

  Following the publication of the first edition of this book, former HBOS or Bank of Scotland staff contacted me to tell me of their experiences. Some pointed out that the sales culture had been coming in the old Bank long before the merger. One former HR manager told me that cultural change had started when Capital Bank, formerly Bank of Scotland’s Cheshire-based finance division, North West Securities, began to attract the attention of some senior Bank executives because of its successful sales record.

  ‘There was some overlap especially in retention products and frequently Capital Bank performed better on these. So Bank of Scotland staff were ‘‘encouraged’’ to adopt some of the Capital sales methods in the hope of similar success. However, Capital set themselves much more challenging targets, adopted much more aggressive sales methods, and were apparently less concerned about longer-term customer satisfaction. Many Bank staff were very uncomfortable with this approach and saw their role to be just to get the numbers, with the threat of failure to meet targets always present. However, management continually delivered the message that sales was what it was all about, and so the arrival of a similar culture from HBOS just speeded up the pace of a change which was already well underway.

  ‘This drive to achieve profitable outcomes was also becoming something of a mantra in the business and the corporate banks, and was seen as the way to achieve further success. Its ability to create unimagined revenue soon made corporate bank the new powerhouse. Many new staff, most of whom had accountancy backgrounds, were hired and quickly became imbued with the fast developing culture which portrayed them as the ‘‘real guys’’.