UK regulators pronounce on HBOS

By Ian Fraser

Published: Financial Intelligencer

Date: 18 November 2015

lloyds-tsb-merges-with-hbos-82875142-5648ec3e5a86fSeven years since HBOS crashed and burned, we are about to find out why, from a report to be jointly published on Thursday morning by the UK’s Financial Conduct Authority and Prudential Regulation Authority (part of the Bank of England).

The Edinburgh-based bank, which had assets of some £667 billion at the time of its failure, was formed from the September 2001 merger of Halifax, a former building society, and the Bank of Scotland. To prevent total collapse in September 2008, the merged entity required a £17 billion taxpayer funded recapitalisation, scores of billions in emergency loans from the Bank of England and the U.S. Federal Reserve, and a rescue takeover by Lloyds TSB. The latter deal almost crippled the “Black Horse” and put severe strain on the UK’s finances and economy.

Update: The report recommends banning up to 10 ex-executives from working in financial services, including Andy Hornby and Lord Stephenson. It is also highly critical of the FSA, whose previous report is described as “seriously flawed.” See: http://www.bbc.co.uk/news/business-34858996 and https://next.ft.com/content/f6ead524-8eb3-11e5-8be4-3506bf20cc2b (£).


If this were Iceland, the regulator’s report could be expected to be hard hitting. It would come down hard on those deemed culpable for this collapse, shine a bright light on the flawed practices and decisions that laid HBOS low and point to lessons for the future – in terms of banking supervision, audit, the role of investors, the corporate governance of large financial institutions, the culture and ethos of domestic banking and more.

However this is Britain, so what can we expect? (The terms of reference of the FCA/PRA report can be read here)

One thing seems likely. At least some of the 15 directors who led HBOS to its demise – probably including its former chairman Lord Stevenson, its former chief executive James Crosby, his successor as chief executive Andy Hornby and the former finance director Mike Ellis – can be expected to face lifetime bans from working in the City.

The regulator has already let it be known, via an apparent leak to Sky News, that it is incapable of fining any of these individuals as a result of the inordinate length of time it has taken to produce its report. This seems unfair given that, in what was widely considered to have been an exercise in scapegoating, the predecessor regulator, the Financial Services Authority, did fine HBOS’s former head of corporate lending Peter Cummings £500,000 and banned him from financial roles in September 2012.

This prompted Cummings to accuse the regulator of “tokenism”. He said it “inherently unfair” that he alone had been singled out for disciplinary action, especially since it was the board that was egging him on to lend even more as the bank careered towards extinction. The FCA is expected to issue a side analysis alongside the 500-page official report on why only Peter Cummings was formally investigated.

The FCA may choose to impose similar bans on the likes of Stevenson, Crosby, Hornby and Ellis. This is likely to be more damaging to Ellis – current chairman of Skipton Building Society, and Hornby – who since July has been chief operating officer at stockmarket-listed bookmakers Ladbrokes Coral PLC – than for Stevenson and Crosby who are semi-retired.

We have already learned from another leak to Sky News that the FCA will accuse HBOS’s management of “leaning on” the bank’s auditors KPMG, to reduce provisions for bad debts in the build-up to the bank’s collapse. We have also learned that the FCA does not regard itself as statutorily capable of holding KPMG to account for alleged audit failures.

A lot of the groundwork to the FCA/PRA report has been done by the Parliamentary Commission on Banking Standards, which was chaired by Conservative MP Andrew Tyrie and sat in 2012-13. In its excellent “An Accident Waiting to Happen” report the Commission, whose members also included former chancellor Nigel Lawson and the Archbishop of Canterbury Justin Welby, identified nine areas which it felt the FCA’s report must – at the very least – cover.

These mostly related to flawed regulation of HBOS by the former regulator, the FSA (which was split into the FCA and PRA in April 2013.)

Relations between HBOS and the FSA do seem to have been unusually cozy in 2004 to 2008 and this seems to have been largely because, from January 2004 until June 2006, the bank’s chief executive James Crosby was also a director of the FSA. He remained an FSA director after he stepped down as chief executive and was the regulator’s deputy chairman from December 2007 until he was forced to quit in February 2009 following explosive revelations from HBOS whistleblower Paul Moore.

The areas the Commission has stipulated that the FCA must examine included

  • 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
  • The nature and extent of FSA senior management involvement with HBOS
  • In terms of regulation the Commission said there was a culture of “box-ticking which detracted from consideration of the fundamental issues with the potential to bring the bank down” and that the regulator had been “barking up the wrong tree”, focusing on the wrong things.

In its report, the Commission said the architects of HBOS’s demise were its board of directors – and specifically Stevenson, Crosby and Hornby – who it accused of pursuing a “fundamentally flawed business model”. The commission urged the regulator to examine, as part of its investigation into HBOS’s failure, “whether these three individuals should be barred from undertaking any role in the financial sector.”

The Commission’s April 2013 report added: “[T]he strategy set by the board from the creation of the new group [September 2001] sowed the seeds of its destruction” adding that “the corporate governance at board level [and] represented a model of self-delusion, of the triumph of process over purpose.” One of the cardinal sins was ramping up its lending growth to the UK’s frothiest sectors including commercial property, leisure and hotels, even as the economic outlook was deteriorating. Others included extraordinarily reckless lending in both Ireland and Australia.

The Commission said HBOS directors’ ignorance of banking meant they were “incapable of even understanding the risks that some elements of the business were running, let alone managing them.”

The commission rubbished attempts by HBOS directors to blame their bank’s difficulties on the credit crisis which started in July 2007, saying “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”.

The Commission’s report also stated that, after James Crosby fired the bank’s risk chief Paul Moore in December 2004, “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 … The weaknesses of group risk in HBOS were a matter of design, not accident.”

In an earlier report, published in March 2012, the FSA censured HBOS for “serious misconduct” adding that Bank of Scotland, the brand HBOS used for its corporate lending businesses, had broken principle three of the FSA’s 11 principles of business. The principle reads “A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems.” The regulator added that the Bank of Scotland “was guilty of very serious misconduct, which contributed to the circumstances that led to the UK government having to inject taxpayer funding into HBOS”.

It remains to be seen whether the FCA will tackle the bizarre behaviour of the “high risk” and “impaired assets” arms of Bank of Scotland where widespread alleged wrongdoing, money laundering and fraud, including the allegedly illegal seizure of business customers’ assets, have led to two former BoS Corporate directors and eight others including consultants, lawyers and accountants facing a criminal trial in Southwark Crown Court next year.

It also remains to be seen whether the FCA/PRA report will take enforcement action against any of the HBOS directors or their advisers over the highly dubious £4bn rights issue that HBOS announced in April 2008. The FSA’s censure on Bank of Scotland refered to the prospectus accompanying this rights issue, which failed to even mention the already ludicrously low admission of £369m in impairment losses in its corporate arm. By July 2008, those impairments had risen to £469m, and within six months they had soared to £3.3bn. They later rose to over £25 billion.

In his recently published memoirs Crash Bank Wallop, Paul Moore wrote “It now turns out that the HBOS rights issue was based on what appear to be deliberate misrepresentations to the market which could well amount to various criminal offences.”

The wider political angle seems unlikely to come under scrutiny in the regulators’ report. However as Dr Atul K. Shah, a senior lecturer at Suffolk Business School, has pointed out the “close friendship between HBOS CEO James Crosby and former chancellor Gordon Brown” and the “political connections of Lord Stevenson, who was chair of the Honours Committee in the Cabinet Office” – are almost certain to have had a bearing on the FSA’s failure to properly regulate HBOS.

Shah added that the British people need to know what role the FCA chairman Sir John Griffith-Jones – who until 2012 was chairman of HBOS’s auditors KPMG – had in “the shaping of the agenda of this report, which excluded his own previous firm from investigation”.

Shah also said it is essential to discover why the Financial Reporting Council is sitting on the fence over KPMG’s failed HBOS audits. He said the British public needs to know “how captured are they by the big audit firms they regulate?”

A senior FRC source has already admitted that it had “no stomach” for investigating pre-crash bank audits as to do so would be “just be too disruptive, too damaging”.

Shah for one says he is expecting another whitewash.

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