Ian Fraser tells the story of how Scotland’s reputation for finance was destroyed by imperialistic bosses, toothless regulators and ‘deeply culpable’ non-executives.
THE DAY of reckoning for Scotland’s once proud and swaggering banks came on Monday, 13 October. This was the day that the prime minister announced his £37 billion rescue of the sector, the part-nationalisations of the Royal Bank of Scotland and HBOS, and the departures of their chief executives.
During a series of meetings with the chancellor of the exchequer Alistair Darling and Treasury officials over the preceding weekend, the erstwhile “titans” of Scottish finance, Sir Fred Goodwin and Andy Hornby, had been told in no uncertain terms that there was no more room for shilly-shallying and that they must properly recapitalise the institutions that they had led to the brink of the abyss.
The only area where they were given any choice was whether they wished to source the massive capital injections that were needed from the UK government or seek them elsewhere, perhaps from Middle Eastern sovereign wealth funds.
This chain of events had been set in motion by the collapse of American investment bank Lehman Brothers on September 14, spreading a mood of extreme nervousness, bordering on panic and even terror, throughout the global financial markets. For the first time in living memory there had been a genuine and justifiable fear that a leading UK financial institution could fail.
Speaking on BBC’s Panorama programme last week, Sir John Gieve, the deputy chairman of Bank of England, admitted that by 10 October, “RBS quite honestly was the leading candidate.”
Insiders say that Goodwin and Hornby had still been in denial until that point, having made out as recently as seven months previously that all was fine with their banks and that the debt-fuelled party could continue.
Some investors believe that RBS chief executive Goodwin misled the market by being bullish about his bank’s prospects between December 2007 and February 2008, and are threatening a class action against the former board of the Edinburgh-based bank as a result.
They point to the fact that Goodwin claimed the bank’s exposure to sub-prime mortgages in the US was lower than some analysts were expecting and denying any need for “inorganic capital raisings or anything of the sort”.
In an surpring volte face, he went on to present a much bleaker picture of the bank’s financial position and announced a £12bn rights issue a few weeks later — by which time many investors had been persuaded to buy the shares. As the Sunday Herald has previously reported, both RBS and HBOS also deeply angered the Bank of England governor Mervyn King when they totemically sought to increase shareholder dividends and executive pay in February 2008.
Rather than extending an early apology for the damage they had wrought on centuries-old institutions and indeed on the wider UK and Scottish economies, Goodwin and Hornby initially kept their counsel.
It was only when asked to apologise by a shareholder at a meeting in the General Assembly Hall of the Church of Scotland that Goodwin finally said sorry on 20 November. Separately, Hornby apologised for the “anxiety” caused by the bank’s collapse at an HBOS shareholder meeting in the NEC, Birmingham on 12 December, but both had seemed to be talking through gritted teeth and for many, they had not gone nearly far enough
Alan Steel, chairman of Linlithgow-based Alan Steel Asset Management, says the people that ran both these banks were at the very least incompetent and the non-executive directors “deeply culpable”.
He says: “If they were in the US, these guys might be facing very long jail sentences. They were perfectly happy to spend billions of other people’s money in their quest for scale. Yet, having destroyed both these banks, they walked away with handsome cumulative bonuses. They don’t seem to give a damn about the trail of destruction that they have left in their wake or that millions of people have had their life savings destroyed.”
For both banks, the rot arguably set in around 2000 to 2001. As the dust was settling on the dotcom crash, interest rates had become unsustainably low and the banks suddenly felt the risks normally associated with lending had been banished through things like derivatives and securitisation. The rivalry between the two banks may also have been aggravated after their intense battle over English bank NatWest, won by RBS.
“I think they were far too competitive with each other,” says Steel. “They seem to have become obsessed with the idea of beating each other to be number one. It led to a self-destructive mania about how big they could get and Hornby and Goodwin started to believe they could walk on water.”
The obsession with market share — in almost every financial market in which the bank operated, including lending to private equity and UK mortgages — led to sales-driven cultures in which salespeople were handsomely rewarded but the people tasked with growing the deposit base and compliance were paid a comparative pittance.
In a growth-obsessed culture, corners inevitably get cut and the moral compass of some employees gets demagnetised. Banking fundamentals such as checking that a customer has the ability to repay their loan become less critical when loans are anyway going to be parcelled up, securitised, and tossed into a wider financial sea.
The biggest error made by HBOS was probably to believe its own self-serving hype that UK house prices were on a permanent upwards trajectory — even though so much evidence was already pointing to the contrary. The problem almost seemed to become delusional when the bank paid top dollar for equity stakes in Scottish housebuilders like Tulloch and Miller Group long after the UK property bubble had burst.
At RBS, the biggest strategic errors included overpaying for the Dutch bank ABN Amro in October 2007 and making a headlong expansion into derivatives and so-called “toxic assets” based on subprime mortgages at the worst possible time in the cycle. A third error was to maintain very low reserves of core tier one capital (a measure of financial strength and the vital reserve set aside to cover losses).
Goodwin, however, invariably swept the naysayers aside, confident in his own genius. His management style has been described as “so brutal that you didn’t dare to disagree with him”. One former senior executive says he came to loathe the regular Monday morning top executive meetings because, he says, you always knew that somebody would get a bollocking, even if totally undeserved.
If this is not bad enough, there was another stonking “elephant in the room” for the boards of both banks, their auditors, their investors and most financial journalists: neither HBOS nor RBS had a deposit base of sufficient scale to finance their headlong rush for growth.
Instead they seemed entirely comfortable with the notion of throwing in their lot with the future health of the wholesale funding markets. Given these had seized up after the 9/11 terror attacks, it was a risky strategy. When these markets completely seized up as they did after the collapse of Lehman Brothers, both banks were effectively scuppered.
But as long as the profits kept rolling in and the shares continued to defy gravity, few raised any concerns. Many Scots seem to have bought into the idea that the economic party would last forever, and would proudly parrot the line that their country was now home to two of the largest banks in Europe.
Nor were politicians particularly eager to root out the culture of recklessness and greed that overran the banking system and by extension the society it served. Indeed it suited the politicians, who rather liked the chimera of wealth that a massive housing bubble can create. How else were they going to prop up post-industrial economies?
Then there was the Financial Services Authority (FSA), the main City regulator, which seemed happy to give the bankers the benefit of the doubt on funding.
“As far as I’m concerned the UK regulators have been utterly useless,” says Steel. “The guys at the top of the FSA should get the bullet. There are 3,500 of them at Canary Wharf just farting about. They make the lives of people like us very difficult but what they’ve let through at the top of banking and finance has been extraordinary. They haven’t got a clue about the real world.”
Liz Watson, leader of the One Voice Action Group, claimed that the FSA has been turning a “Nelsonian blind eye” to malpractice across the UK banking sector and has not been doing enough for victims.
When the bankers’ party came to an abrupt end on October 13, the collective suspension of disbelief could endure no longer. Goodwin and Hornby were shown to have feet of clay and the transformation from hero to villain happened more or less overnight. As Scotland seeks to pick up the pieces, a lot of soul searching is still going to be required — and not just from the main protagonists.
BANKING: THE NEW FACES
The unparalleled events of 2008 mean a change at the top of what is left of Scottish banking. Susan Rice will be queen of the new Lloyds Banking Group Scotland, and will need to focus on integrating the operations of HBOS with those of Lloyds TSB.
Her appointment as managing director came as a modest surprise given that Scotland also houses Archie Kane, chairman of the Association of British Insurers, who also sits on the main Lloyds board. Some had thought that one heavyweight in Scotland would have been all we could have expected.
A popular figure, Rice will need to use all her diplomacy given the widespread opposition to Lloyds TSB’s recue takeover of HBOS north of the Border, and the fact that she is likely to oversee branch rationalisation and probably the loss of up to 7,000 of the merged banks’ 24,000 Scottish jobs.
Over at RBS, Stephen Hester formally succeeded Sir Fred Goodwin as chief executive on 21 November, just weeks after the government bail-out was announced. The fact that Hester was chief operating officer of mortgage bank Abbey — before later becoming chief executive of British Land — gives an indication of the government’s more modest future ambitions for its recently acquired majority shareholding.
Hester has already expressed a desire to “shrink and sell RBS’s weaker operations” and rebuild the group around businesses that have growth potential and clear competitive advantage. Speaking last month, he said: “I’m full of vim and vigour. I’m very confident in telling you RBS will embrace change.”
This article was published in the Sunday Herald on 28 December 2008