Commenting on the publication of its Fourth Report, the Chairman of the Parliamentary Commission on Banking Standards, Andrew Tyrie MP, said:
"The HBOS story is one of catastrophic failures of management, governance and regulatory oversight.
The sums would never have added up: the Commission has estimated that, taken together, the losses incurred by the Corporate, International and Treasury divisions would have led to insolvency, regardless of funding and liquidity problems, had HBOS not been bailed out by both Lloyds and the taxpayer.
The Commission concluded that primary responsibility for these failures should lie with the former Chairman of HBOS, Lord Stevenson, and its former Chief Executives, Sir James Crosby and Andy Hornby.
Only Peter Cummings has faced regulatory sanction for HBOS’ failures. The Commission was surprised by this.
It is unsatisfactory that the FSA appears to have taken no steps to establish whether the former leaders of HBOS are fit and proper persons to hold the Approved Persons status elsewhere in the UK financial sector. The Commission has therefore asked the regulator to consider whether these individuals should be barred from undertaking any future role in the sector.
For the future, more needs to be done. Those responsible for bank failures should be held more directly accountable for their actions and face sanction accordingly. The Commission will return to this issue in its Final Report.
The regulators also have a lot of explaining to do when it comes to their role earlier in the HBOS debacle. From 2004 up until the latter part of 2007, the FSA was ‘not so much the dog that didn’t bark as the dog barking up the wrong tree’.
The FSA responded favourably to a Treasury Committee request for a comprehensive report, similar to that prepared on RBS, not just into the failure of HBOS but also into the FSA’s own conduct. The Treasury Committee has appointed specialist advisers whose job will be to ensure that this work is done thoroughly."
The lead member of the Banking Commission’s Panel on HBOS, Lord Turnbull, added:
"As a result of our work on the failure of HBOS, light has been cast on an issue that had previously received very little public scrutiny.
The evidence we have gathered is of singular importance to the Commission's consideration of banking standards and culture. It will also help the new regulators as they conduct their own investigation into HBOS
In 2001, two well established organisations were brought together with a combined market capitalisation of around £30 billion. Just seven years later all that value had been destroyed.
This is a story of a retail and commercial bank, rather than an investment bank, brought down by ill-judged lending, poor risk control and inadequate liquidity. Its strategy was flawed from the start.
In evidence to the Commission, its leaders consistently refused to acknowledge the extent to which HBOS contributed to its own demise, preferring to present it as a victim of circumstances.
There are lessons too for the regulators, who briefly identified the key shortcomings – poor credit control and excessive reliance on external funding – but who subsequently shifted their focus to the processes of risk management and large scale models rather than on asset quality and liquidity."
The ‘new force in banking’
The strategy set by the Board from the creation of the new Group sowed the seeds of its destruction. HBOS set a strategy for aggressive, asset-led growth across divisions over a sustained period. This involved accepting more risk across all divisions of the Group. Although many of the strengths of the two brands within HBOS largely persisted at branch level, the strategy created a new culture in the higher echelons of the bank. This culture was brash, underpinned by a belief that the growing market share was due to a special set of skills which HBOS possessed and which its competitors lacked. The effects of the culture were all the more corrosive when coupled with a lack of corporate self-knowledge at the top of the organisation, enabling the bank’s leaders to persist in the belief, in some cases to this day, that HBOS was a conservative institution when in fact it was the very opposite. Para 19
The avenues to impairment
Although separate reporting for the former divisions of HBOS has ceased since it became part of Lloyds Banking Group, we estimate that aggregate customer loan impairments on Corporate Division loans in the period 2008 to 2011 totalled some £25 billion, equivalent to 20 per cent of the end 2008 loan book, not counting further impairments and write-downs on equity and joint venture investments. Para 28
The growth of HBOS’s Corporate Division was not the result of superior performance but of its high-risk strategy...When the Division later incurred huge losses, these too were due to the particular nature of its business and resulted directly from its high-risk strategy. Its losses were on a larger proportionate scale than those incurred by any other major UK bank. Para 30
In view of the reckless lending policies pursued by HBOS Corporate Division, we are extremely disappointed by the attempts of the most senior leaders of HBOS at the time to attribute the scale of the consequent losses principally, or in significant measure, to the temporary closure of wholesale markets. The lending approach of the Corporate Division would have been bad lending in any market. The crisis in financial markets was merely the catalyst to expose it. Para 32
Abroad as at home, HBOS took what it saw as the relatively quick and easy path to expansion without acknowledging the risks inherent in that strategy...In two markets alone—Australia and Ireland—it incurred impairments of £14.5 billion in the period from 2008 to 2011. These losses were the result of a wildly ambitious growth strategy, which led in turn to significantly worse asset quality than many of its competitors in the same markets...The repeated reference in evidence to us by former senior executives to the problems of the Irish economy suggests almost wilful blindness to the weaknesses of the portfolio flowing from their own strategy. Para 39
As the financial crisis hit, the HBOS Treasury Division turned from a source of profit to another source of loss. The aggregate profit and loss charges attributable to the Division in the period from 2008 to 2011 totalled £7.2 billion. Para 42
The bank was, of course, far from unique in incurring losses in structured investments; many other banks, both in the UK and in other countries, also incurred such losses. However, HBOS was excessively confident that its understanding of UK residential mortgages and related securitisations gave it the ability to understand and evaluate the risks in a wide range of asset-backed investments. Para 43
The massive impairments in HBOS were not confined to a single division...Both the relative scale of such large losses and the fact that they were incurred in three separate divisions suggests a systemic management failure across the organisation. Taken together, the losses in these three divisions would have led to insolvency. Para 47
A failure of internal control
The weaknesses of the federal model
The HBOS Group operated a federal model, with considerable independence given to the divisions. Central challenge to the divisions from senior executive management appears to have been inadequate in the case of the three divisions that ultimately caused the most significant losses (Corporate, International and Treasury)...The key role of assessing exposure to future credit risks was dominated by the executives of the individual divisions. These weaknesses in senior management were instrumental in the pursuit by these three divisions of the policies and practices that led to devastating losses. Para 53
The risk function in HBOS was a cardinal area of weakness in the bank...The degradation of the risk function was an important factor in explaining why the high-risk activities of the Corporate, International and Treasury Divisions were not properly analysed or checked at the highest levels within the bank. Para 64
The weaknesses of group risk in HBOS were a matter of design, not accident. Responsibility for this lies with Sir James Crosby, who as Chief Executive until 2005 was responsible for that design, with Andy Hornby, who failed to address the matter, and particularly with Lord Stevenson as Chairman throughout the period in question. Para 65
A failure of regulation
The picture that emerges is that the FSA’s regulation of HBOS was thoroughly inadequate. In the three years following the merger the FSA identified some of the issues that would eventually contribute to the Group’s downfall, notably the risk that controls would fail to keep pace with aggressive growth and the Group’s reliance on wholesale funding. The FSA failed to follow through on these concerns and was too easily satisfied that they had been resolved. The FSA took too much comfort from reports prepared by third parties whose interests were not aligned with those of the FSA. Para 83
From 2004 until the latter part of 2007 the FSA was not so much the dog that did not bark as a dog barking up the wrong tree. The requirements of the Basel II framework not only weakened controls on capital adequacy by allowing banks to calculate their own risk-weightings, but they also distracted supervisors from concerns about liquidity and credit; they may also have contributed to the appalling supervisory neglect of asset quality. The FSA’s attempts to raise concerns on these other fronts from late 2007 onwards proved to be a case of too little, too late. Para 84
The experience of the regulation of HBOS demonstrates the fundamental weakness in the regulatory approach prior to the financial crisis and as that crisis unfolded. Too much supervision was undertaken at too low a level - without sufficient engagement of the senior leadership within the FSA. The regulatory approach encouraged a focus on box-ticking which detracted from consideration of the fundamental issues with the potential to bring the bank down. Para 85
Regulatory failings meant that a number of opportunities were missed to prevent HBOS from pursuing the path that led to its own downfall. The priorities of the supervisor also reinforced the senior management of HBOS in their own misplaced priorities. Ultimate responsibility for the bank’s chosen path lies, however, not with the regulator but with the Board of HBOS itself. Para 86
‘The best board I ever sat on’
The corporate governance of HBOS at board level serves as a model for the future, but not in the way in which Lord Stevenson and other former Board members appear to see it. It represents a model of self-delusion, of the triumph of process over purpose. Para 91
There was insufficient banking expertise among HBOS’s top management. In consequence, they were incapable of even understanding the risks that some elements of the business were running, let alone managing them. Para 93
Judging by the comments of some former Board members, membership of the Board of HBOS appears to have been a positive experience for many participants. We are shocked and surprised that, even after the ship has run aground, so many of those who were on the bridge still seem so keen to congratulate themselves on their collective navigational skills. Para 95
The full picture
The problems of liquidity were the occasion for the failure of HBOS, not the cause. If HBOS’s difficulties were solely the result of funding and liquidity problems, their lasting effects would have been much more limited, including for the taxpayer. LBG has now repaid all the Government backed funding raised during the financial crisis. Without solvency pressures, HBOS would not have needed equity support from the taxpayer. Para 115
The HBOS failure was fundamentally one of solvency. Para 116
The explanation by senior HBOS management given to the Commission for the scale of the Group’s losses is entirely unconvincing. The impairments and losses incurred were substantially worse than for the peer group. Para 122
Poor asset quality was the direct result of the company’s strategy, which pursued asset growth in higher risk areas. This asset growth was compounded by a risky funding strategy. The combination of higher risk assets and risky funding represents a fundamentally flawed business model and a colossal failure of senior management and of the Board. Para 123
Their misjudgements were toxic for HBOS. The problems of solvency were a direct consequence of the strategy set by the Board and the failure of controls on the practices that were fostered by its commitment to an asset-led, high-risk approach to growth. Para 124
The Commission was very disappointed by the attempts of those who led HBOS into the abyss to acknowledge, even now, either the nature of the problems that eventually consumed the bank or the extent to which they flowed from their own decisions rather than unforeseeable events...the apologies of those at the top of HBOS for the loss imposed upon the taxpayers and others ring hollow; an apology is due for the incompetent and reckless Board strategy; merely apologising for having failed to plan for an unforeseeable event is not much of an apology. Para 125
The price of failure
The analysis that we have undertaken of the circumstances of the downfall of HBOS leave no doubt that that downfall cannot be laid solely at the feet of Peter Cummings. While his personal responsibility for some staggering losses should properly be recognised, significant and indeed disastrous losses were also incurred by other divisions, whose heads have not been held personally accountable in the same way. Losses were incurred across several divisions. The losses were caused by a flawed strategy, inappropriate culture and inadequate controls. These are matters for which successive Chief Executives and particularly the Chairman and the Board as a whole bear responsibility. Para 134
In the view of this Commission, it is right and proper that the primary responsibility for the downfall of HBOS should rest with Sir James Crosby, architect of the strategy that set the course for disaster, with Andy Hornby, who proved unable or unwilling to change course, and Lord Stevenson, who presided over the bank’s board from its birth to its death. Lord Stevenson, in particular, has shown himself incapable of facing the realities of what placed the bank in jeopardy from that time until now. Apart from allowing their Approved Persons status at HBOS to lapse as their posts were wound up, the FSA appears to have taken no steps to establish whether they are fit and proper persons to hold Approved Persons status elsewhere in the UK financial sector. In cases of this importance the Commission believes that simply allowing Approved Persons status to lapse is insufficient. The Commission therefore consider that the FSA should examine, as part of its forthcoming review of the failure of HBOS, whether these three individuals should be barred from undertaking any role in the financial sector. Para 135
Conclusion: a manual for bad banking
Whatever may explain the problems of other banks, the downfall of HBOS was not the result of cultural contamination by investment banking. This was a traditional bank failure pure and simple. It was a case of a bank pursuing traditional banking activities and pursuing them badly. Structural reform of the banking industry does not diminish the need for appropriate management and supervision of traditional banking activities. Para 138
Through our work, we have identified some of the themes on which we expect the FSA to expand. In particular, we require the FSA study to shed further light on the following issues:
- The extent of losses in each division, which we have had to estimate;
- The decision-making processes within the FSA which led to the effective retreat from a position of warranted close supervision up to the start of 2004;
- The reasons for the reliance placed on reports commissioned from third parties as to the adequacy of controls within HBOS;
- The reasons why the FSA closed the issue of the prudence of HBOS’s corporate credit provisions;
- The reasons why the FSA did not undertake serious analysis of the quality of the HBOS loan book in the period from 2005 to 2007;
- The extent to which regulatory decision-making at all levels was influenced by the protests of HBOS senior management, including claims about disadvantage to its competitive position;
- The nature and extent of FSA senior management involvement with HBOS;
- Whether, rather than having their Approved Persons status simply lapse, Lord Stevenson, Sir James Crosby and Andy Hornby (and anyone else presiding over a similar failure in the future) should be prohibited from holding a position at any regulated entity in the financial sector;
- The extent to which the judgements in the FSA Enforcement Final Notices in respect of HBOS reflect judgements that either were, or should have been, reached by the FSA during the course of their supervision of HBOS.
We expect the Treasury Committee to monitor how far and how effectively the FSA pursues these issues. Para 141