Hubris: How HBOS Wrecked the Best Bank in Britain

by Perman, Ray

  ‘The corporate senior management soon began to flex their muscles as key contributors to the bank’s bottom line and at times seemed to operate as if they were not part of the bank. Corporate operated increasingly independently from the bank, apparently seeing no need to conform to comparability in such [things] as pay levels and performance management, and operating as if they were a devolved business unit with a separate, distinctive and results-driven culture. This caused much resentment especially among many of the branch managers, some of whom expressed concern about the levels of risk being taken, but the bank executive’s response was to strongly endorse the activities of corporate.

  ‘As a senior HR manager, I expressed concern about the inconsistent approaches to people matters, especially pay and performance, adopted by corporate, but I’m afraid the response usually was – ‘‘the business knows best’’. The traditional bank employment model of high security but limited remuneration was soon replaced, especially in corporate, by one which provided high security and high – even very high – remuneration, encouraging risk-taking without real consequence. Bonuses started to rise well above the norm which in the late ’90s in the Bank was around 20 per cent of salary, a far cry from the 100 per cent-plus I believe that followed soon afterwards.

  ‘I recall that when Sir Bruce was at the helm he made it clear that there should be no egos, as the Bank was what mattered and not the individual members of staff, and stewardship was a critical requirement. I’m afraid that these core values readily got subsumed as the new culture emerged. More’s the pity.’

  In HBOS the high-pressure sales culture led to anxiety and even fear among staff. One manager, who asked for anonymity since he still works at Lloyds, remembered: ‘Counter staff were pushed at the beginning of the day and throughout the day to generate leads. Failure to sell could/would eventually lead to disciplinary action. Managers could record that failing staff had received coaching or support and then the process of easing them out could continue.

  ‘Managers were no safer, they reported to an Area Sales Manager and each day they had to phone the ASM, give their results and explanations for any targets not hit. In an environment based so completely on sales, quality of business and customer care would always be a long way behind hitting bonus figures, whether for the money or to protect your job.’

  Staff learned to subvert the sales culture at HBOS. ‘When Andy Hornby came to the bank from Asda, branch staff were told that he had promised the City that he was going to grow current accounts by one million. Current accounts are one of those things that people don’t usually think about moving, so if you have the current account you have the salary, probably the mortgage, and from there you can sell all of the add-ons. Current accounts became one of the key measures for branch staff bonuses, but without any regard or interest in quality.

  ‘A customer would come in and ask for their card cash account to be upgraded to a current account. Upgraded accounts didn’t count [towards sales targets], so they would be told that a new application had to be done and they got a new account. I’ve seen cases where people went in for savings accounts and were told that they needed to have a current account to run alongside it (they didn’t). I’ve seen cases where the partners of staff had three or four current accounts.

  ‘To get around it the company said that it only counted if it had a credit. Cashiers would have a pot with paper clips and pennies next to the till. At the end of the day interviewers would hand over their current accounts that they had opened for them to be credited with 1p.

  ‘To get around that the company said that it only counted if it had a credit of at least £10. At the end of each month branch managers would use their suspense account to credit each of the accounts with £10, leave it in overnight and then the next day take it back out. One manager I knew was eventually disciplined for this. So to get around that the company said it only counted if it had a salary credited. That brought it to an end, but thousands of unwanted unused accounts had been opened. Accounts that made the bank look good to the City but were of absolutely no value because in many cases people didn’t know they had them.’

  Staff would connive with customers to meet the qualifications to get a home loan. ‘I talked to a mortgage adviser and asked how she was doing and she said: ‘‘I’ve had a good week and I’ve only had to bump up the income on a couple of them.’’ ’

  Another instance illustrates the triumph of sales over customer service. ‘I visited branches across the south-east and staff were usually happy to talk about how the branch bonus was progressing and what they were having to do to keep earning it. I was in a banking hall when a customer came in and in very poor English asked for an envelope to be handed to an interviewer. I was going into the staff room when the envelope was brought in to the staff member, who was making a cup of tea. The envelope was opened and she said to her colleague ‘‘It’s a credit card app[lication] with CCRC’’ [credit card repayment cover]. She was asked: ‘‘This woman speaks hardly any English, I could hardly understand her, how did you manage to sell the CCRC?’’ The answer was ‘‘Tough, if they don’t understand English they get the cover.’’ ’

  Another example: ‘I was asked by a branch manager to speak to a customer who wanted a personal loan. The customer was known to the branch PFA [Personal Financial Adviser]. The customer did not have the income from his job to justify the loan. I told the manager and the PFA that there was no point [in progressing the application] as it would fail. I was told that he had a rental property and that the rent would cover the loan repayments and to include the rent as part of his income. I pointed out that if the tenant left he would be in trouble. I was told not to worry and that it was needed for the branch’s targets. I spoke to the assistant manager who also had some responsibility for risk and compliance and was told by her to ‘‘Just do it’’. The loan went through.’

  And again: ‘We had a client who was in trouble, he was self employed, but business wasn’t great so he came in on a regular basis for larger and larger loans. Branch staff were warned about ‘‘churning’’ [repaying one loan by taking out a bigger one]. I saw him one day in the banking hall and said to the manager and the assistant branch manager that it was only five months since his last loan and we couldn’t give another loan to him. I was told that it was his decision and he always took PLRC [Personal Loan Repayment Cover], which was a key bonus measure. I refused to see him, but somebody else did and he took £25k with another £7k for the insurance.’

  While this was happening in retail lending, there was similarly extraordinary behaviour in corporate banking. A newspaper investigation in 2013 discovered that in early 2008 Bank of Scotland had lent £12.2 million to the company which owned the Dunfermline Athletic Football Club ground.5 Two features of the transaction made it controversial: the first was that the chairman of both the company which owned the ground and of the football club itself was Gavin Masterton, former Treasurer and Chief General Manager of Bank of Scotland. The second aspect was the condition on which the loan was granted. Unless the ground was sold, no capital or interest was payable until the end of the term of 35 years. Some fans smelt a rat and immediately alleged corruption, but the loan was entirely above board and subject to the Bank’s normal credit approval process.

  The truth is far less colourful than some disgruntled fans would like to believe and illustrates the prevailing optimism of the Bank and the borrower at the time. Neither expected the loan to run for anything like the full term. Dunfermline hoped to emulate its Scottish rival St Mirren, which had sold its old ground in the centre of Paisley to a supermarket and with the proceeds cleared its debts and built a new stadium out of town. But Dunfermline’s timing was bad and the property crash ended any hope of selling the ground at anything like enough to repay the loan for the foreseeable future, leaving the Bank with an embarrassing uncollectible debt.

  Also in 2013 a serial fraudster named Achilleas Kallakis was jailed for seven years. This former estate agent
and his counterfeiter accomplice pretended to be high-rolling developers backed by a major Hong Kong property company. Their fraud was breathtakingly simple, yet it took in several banks. The crooks rented offices in Mayfair, produced reams of fake documents and hired an actor to impersonate a Hong Kong executive.

  They didn’t have to be terribly sophisticated. Like all good illusionists they could rely on their audience to be easily distracted and to believe what they wanted to believe. Bank of Scotland lent Kallakis A26 million to convert a 100-metre long passenger ferry into a luxury yacht. The court was told that it disregarded warnings from their own legal advisers and relied on letters of assurance from a Swiss lawyer, believed by the prosecution to be part of the conspiracy. The Bank wasn’t alone. Allied Irish lent the fraudsters £750 million, and other banks duped included Bristol & West (now part of Bank of Ireland), Barclays and GE Capital, which financed a private helicopter and a corporate jet.

  Why were all these bankers so easily fooled? It all becomes explicable when you remember the changes in management organisation in banks over the past 20 years. Under the old system managers stayed in post for years at a time, so the originator of the loan remained responsible for it. When he (it was usually ‘he’) made the decision, he had to weigh the profit the bank would make against the risk it was running. If the loan went bad it could blight his career. By the time of the credit boom the two functions had been separated. The dealmakers worked to sales targets – and their bonuses and their future prospects depended on reaching or exceeding them. Risk assessment was outsourced to risk departments and risk committees, who were regarded within banks as a lesser form of life.

  As the FSA report into Bank of Scotland Corporate found, the dealmakers had no problem in brow-beating the risk department, and a ‘culture of optimism’ reigned. But optimism proved to be no substitute for hard-headed risk assessment.

  It was against this background of emerging examples of lax standards and shirked responsibility that the Parliamentary Commission on Banking Standards announced that it would investigate the collapse of HBOS and call former managers and directors of the Bank to give evidence. The commission had been set up in response to an entirely different scandal, the manipulation of the LIBOR interest rate, which banks use to lend to each other. The comparison of the LIBOR scam to the collapse of HBOS could not be more marked: HBOS cost taxpayers £20 billion, yet the only fine imposed had been the £500,000 paid by Peter Cummings. No public money was lost in the LIBOR fraud, yet three banks had been fined a total of £1.5 billion by US and UK regulators, the chairman of Barclays resigned and the chief executive was forced out of his job.

  HBOS really did appear to be the officially forgotten disaster, which only increased the smoldering anger of those who had suffered real loss and hardship. It was this sense of injustice – that the top men had not been held to account – which explains the welcome to the commission’s decision from the victims of HBOS, and the close attention its subsequent findings received.

  26

  Called to account – at last

  There was a low-key start to the parliamentary commission hearings1 at the end of October 2012. One or two reporters from the financial press attended the early sessions, but most of the media took time to wake up to the extraordinary human drama slowly unfolding in the airless committee rooms of the Houses of Parliament. The scale of human suffering caused by the banking crisis had faded from the news schedules.

  The HBOS panel was chaired by Lord Turnbull, accompanied by one or two other commission members. Witnesses, who appeared for an hour or more, were questioned patiently and courteously. Bankers, including Lord Stevenson and Andy Hornby, had been hauled before parliament before, but then the questioning had been by MPs keen only to get their soundbite onto the television news, so there were few follow-ups and little new information was elicited. This time the cross-examination was by a professional, David Quest, one of the two counsel engaged for the investigation. He had read the background papers and meticulously took witnesses through their evidence, steadily adding incremental facts to the story.

  Paul Moore, sacked as a risk officer by James Crosby, repeated the allegations he had made to the Treasury Select Committee. Jo Dawson, appointed Group Risk Director after Moore’s departure, clearly could not have challenged the prevailing sales culture and characterised her role as having influence rather than authority. Colin Matthew, head of International from 2005–8, described the rapid growth and ambitious targets of the group in Australia and Ireland. It subsequently incurred heavy losses in both markets. Mike Ellis was finance director during two crucial periods in the brief life of HBOS – in the first three years when its fast growth strategy was being set and again from the autumn of 2007 until the Bank’s end. He appeared nervous. He told the hearing that he was not trying to be evasive, but came across as just that, ducking many questions with phrases such as ‘I was no longer with HBOS when those accounts were struck,’ and ‘I was not there, I could not possibly comment,’ and ‘I really can’t comment. I was not there.’

  As the Autumn wore on a few moments of drama occurred. George Mitchell, who resigned as head of corporate banking in 2006, was incredulous that after slowing the growth in corporate lending in 2005–6 because he felt the market was peaking, it had again been ramped up after his departure. He came out with one of the most memorable quotes when he described the reason for the liquidity crisis which hastened the Bank’s demise. ‘Once you have spooked the market and once confidence in your name has gone, it doesn’t matter if you are trying to raise £50 billion or £150 billion, you are not going to get it because the markets close to you. They might be global, but they are a veritable village when it comes to gossip and rumour. If they are spooked by, for example, the speed of growth in HBOS, confidence in your name gets eroded.’

  The inquiry uncovered some new facts. Lindsay Mackay, head of treasury, had warned the HBOS executive committee in 2006 that the Bank had the highest wholesale funding requirement of any UK bank and in fact was close to the Big Four banks combined. He had warned them that in the longer term the position was ‘untenable and unsustainable’. But the growth had continued.

  The non-executive directors who gave evidence, Sir Charles Dunstone, chair of the retail risk committee; Anthony Hobson, the audit committee chair; Sir Ron Garrick, senior non-executive director and chair of the corporate risk committee, cut pathetic figures, at pains to say that they had done their jobs conscientiously, followed the correct procedures, asked all the right questions, been given all the information they needed – yet at a loss to explain how things had gone so disastrously and hideously wrong. In the end they all resorted to what Lord Turnbull described as the ‘innocent victim defence’, that everything would have been all right if the US sub-prime mortgage collapse had not led to the closure of wholesale markets.

  There appeared to be no connection in their minds between the catastrophic end result and any failure in corporate governance by directors. Garrick stunned the hearing with his assertion that the HBOS board was by far and away the best he had ever sat on. ‘My recollection of the culture and characteristics of the board was one of openness, transparency, high intellect, integrity, good working relationships between the chairman and chief executive, and a suitable diversity of backgrounds, mix of experience and expertise to maximise effectiveness . . . If with the benefit of hindsight I was asked if I wanted to sit on this board again I would be saying yes.’

  By December the commission had interviewed 16 witnesses from HBOS and the FSA, including travelling to the home in Dumbarton of Peter Cummings, who was recovering from an operation. A private session was held to take evidence from an FSA official who felt he/she could speak more freely if his/her identity were not disclosed, although there was not much new in the transcript after it was published. The commission had also received 20 written submissions, examined HBOS board and executive committee minutes and other reports spanning the life of the Bank and looked at lette
rs and papers from the FSA. It added up to the most thorough investigation of a bank’s strategy and actions undertaken in recent times.

  At the beginning of December the pace and character of the hearings abruptly changed as the commission confronted the men who had led HBOS. In contrast to previous hearings, which were attended by one or two commission members, all ten members turned out for the cross-examination of Sir James Crosby, with Andrew Tyrie in the chair, flanked by the senior of the commission’s two barristers, Rory Philips QC. After his opening statement the tone of Tyrie’s questioning was direct and aggressive:

  TYRIE: I have just described a terrible catastrophe, and Lord Stevenson and Andy Hornby were also part of that. They have apologised – have you?

  CROSBY: I have not had that opportunity; I would like to take it now. As you know, I stood down from the role almost three years before HBOS was taken over by Lloyds, but nonetheless I was horrified and deeply upset by what happened. It was hugely distressing in every sense to see the impact on shareholders and former colleagues, and also the consequences for taxpayers. I am very sorry for what happened at the Bank.

  TYRIE: What exactly are you apologising for? For the mistakes of the Bank, for which you were partly responsible?

  CROSBY: I am apologising for the fact that I played a major part in building a business that subsequently failed. I was not there for the last few years, but I think it would be wrong for me to dissociate myself from what happened in the end.

  TYRIE: So you do associate yourself with it?

  CROSBY: I think it would be wrong not to.

  TYRIE: Your total remuneration over the five years you were there was nearly £8 million, excluding your pension. Your pension is, I think, £572,000 a year indexed. Did you volunteer to waive any of those entitlements when the Bank failed?