HBOS: The Bank That Couldn't Say No

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Banking group HBOS was not driven to point of bankruptcy by the global financial meltdown, but by its own strategy of high-risk lending, over-ambitious growth targets and poor controls, according to a hard-hitting report by the parliamentary commission on banking standards.

The report, which found that HBOS had a funding gap between its loans and deposits of more than £200bn at the time of its downfall, reveals that a "brash" culture developed inside the bank following its creation in 2001.

The funding gap meant it had to rely on borrowing from other banks in the wholesale markets. While this was the "immediate cause" of the collapse of HBOS, it was not the "fundamental issue" the report found. Instead, it concluded that if the problems at the bank had only been ones of liquidity, it would not have needed a combined capital injection of £28bn from the taxpayer and Lloyds to keep it afloat and "there would have been no losses to the UK taxpayer". Instead, the report says, the key problem was vast, and reckless, lending to UK and overseas companies.

Lord Turnbull, the member of the commission who led the HBOS investigation, said: "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."

Sir Charles Dunstone, the founder of Carphone Warehouse and former non-executive director of HBOS, had pointed out in his evidence that under the Vickers ring-fencing proposals intended to shield retail banks from riskier investment banking operations, nearly all of HBOS would have been inside the fence.

In 2001, the bank's chief executive, Sir James Crosby, set ambitious targets for returns to shareholders. He planned to ramp up lending in an attempt to challenge the "big four" banks. But HBOS had a risk department – meant to be on alert for bad lending decisions – that could not keep up with the pace of growth, and a management structure that left decisions about lending to division heads.

The damning report begins with a warning by a former finance director of HBOS telling the board in January 2004 that the Financial Services Authority felt that the rapid growth being pursued "may have given rise to an accident waiting to happen".

But it notes that the FSA – disbanded by the government last weekend – failed to act on its own concerns. "The picture that emerges is that the FSA's regulation of HBOS was thoroughly inadequate," the report said.

"From 2004 until the later part of 2007, the FSA was not so much the dog that did not bark as a dog barking up the wrong tree," the report said, as the regulator moved its focus from prudential risks to a new regulatory system that let banks mark their own homework – using their own models to measure risks – and implement new rules on treating customers fairly.

"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 a too low a level – without sufficient engagement of the senior leadership within the FSA."

While the FSA missed opportunities to prevent HBOS from "pursuing the path that led to its own downfall … Ultimate responsibility for the bank's chosen path lies, however, not with the regulator but with the board itself."

The commission estimated that £47bn of losses was incurred – £25bn in the corporate division, £15bn in Australia and Ireland, and £7bn in the bank's own HQ in its Treasury operations. The report says that those losses on their own would have been enough to bring the bank down. "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. Together they would have led to insolvency," the report said.

To illustrate the scale of the risks being taken on, the report said that in the corporate bank in 2001 the biggest exposure to one single borrower was less than £1m. By 2008 there were nine customers who had each been lent £1bn. One borrower had been advanced £3bn.

"The roots of all these mistakes can be traced to a culture of perilously high risk lending. The picture that emerges is of a corporate bank that found it hard to say 'no'," the report said.

The commissioners said they were "extremely disappointed" that HBOS management had tried to blame the closure of wholesale markets rather than the risky lending. In early 2008, the chairman, Lord Stevenson, had argued that the bank was a "highly conservative institution". But the report said: "Far from being a highly conservative institution in a safe harbour, HBOS was in a storm-tossed sea."

In the days after Lehman Brothers collapsed in September 2008, some £35bn was withdrawn from customer deposits at HBOS. The bank was rescued by Lloyds three days after the Lehman crash. Eventually £20bn of taxpayer funds was used to prop up the enlarged bank while Lloyds used another £8bn to shore up the troubled loan book.

A Treasury spokesman said: "The failure of HBOS was a symptom of the financial crisis and the regulatory system in place at that time."

Architects of the bank's downfall

Sir James Crosby

How did he get to HBOS?

A qualified actuary, James Crosby was said to have a detailed grasp of financial risk. At 38, he joined Halifax in its life insurance business and within five years he was running the newly demutualised – and acquisition-hungry – mortgage bank.

No sooner had he taken the helm than Crosby began plotting a deal that would again transform the business, a bold merger with Bank of Scotland in 2001. He set the group on a fierce expansionary course. Rapid lending to big corporate clients, particularly in property and retailing, was seen as a triumph, and when he departed as chief executive in 2006, Crosby's reputation was unrivalled. He received a knighthood for services to the financial industry, and joined the boards of ITV and catering group Compass.

Ministers and regulators also sought his counsel. Alistair Darling asked him to write a report into the UK mortgage finance market. He also sat on the board of the City regulator, the FSA, from 2004, and a year after his departure from HBOS Darling appointed him FSA deputy chairman.

What does the report say about him?

The commission's report describes him as "the architect" of the strategy that caused the downfall of HBOS.

What is he doing now?

Crosby hung on as deputy chairman of the FSA throughout the 2008 banking crisis and the demise of HBOS. It was not until damaging accusations about him from the bank's former head of regulatory risk Paul Moore were aired in parliament in February 2009 that he stepped down. The former HBOS bossCrosby insisted there was "no merit" in claims that he fired Moore after the risk expert warned of dangerous lending practices at the bank.

Crosby left ITV later that year, amid widespread criticism of the board. However, he remains on the board at Compass.

In January 2009, Crosby was appointed a director of FTSE 250 banking software group Misys, becomingchairman eight months later. Last summer, after a fierce bidding war, he agreed to sell Misys to a US private equity house for £1.27bnHe also remains on the advisory board of Bridgepoint, the private equity group behind Pret a Manger and Fat Face.

Two years ago he became chairman of subprime car loans group Moneybarn, where he is also a shareholder.

What does he say?

Crosby offered no comment. It took him until December to apologise for his role at HBOS. He told the banking commission: "I am apologising. I played a major part in building a business that subsequently failed."

Andy Hornby

How did he get to HBOS?

A stellar student at Oxford, Hornby and went on to graduate was top of his 800-strong class at Harvard. He cut his teeth in business at Asda in the 1990s as the supermarket group emerged as a serious challenger to the likes of Sainsbury's and Tesco. Asda was seen as the executive talent factory of the day, run by Archie Norman and later Allan Leighton. Despite having no banking experience, Hornby was poached by Crosby and, as his protege, became part of the new team at the top of HBOS. He was tasked with bringing his retail expertise to the high street banking business. In 2006, at the age of 38, in 2006 it was announced he was to succeed Crosby as chief executive. He used the Halifax brand to launch a series of challenges to the dominance of the "big four" – Lloyds TSB, Royal Bank of Scotland, Barclays and HSBC. The message was hammered home in advertising campaigns fronted by Howard, the singing bank manager.

What does the report say about him?

He "failed to address" HBOS weaknesses.

What is he doing now?

Hornby was pushed out of HBOS as it was rescued in a taxpayer-backed merger with Lloyds TSB in October 2008. If his banking reputation was in tatters, his skills as a retailer were still in demand. He was soon appointed chief executive of Britain's largest private equity-backed firm, Alliance Boots.

Two years ago he took a similar role at Coral bookmakers, another private equity-backed group that had been through a painful refinancing. He is also chairman of the online chemists Pharmacy2U.

What does he say?

Through Coral, he refused to comment. In December he told the banking commission: "With hindsight, at times it may have been the case that the sheer volume of information supplied by every division … made it harder for the board to fully understand the potential issues facing the business."

Dennis Stevenson

How did he get to HBOS?

Lord Stevenson was already well known in the City when he took on the chairmanship of Halifax in 1999. It was a post he juggled with non-executive directorships at Manpower, English Partnerships, BSkyB, Lazards and the wealth managers St James's Place. He was also chairman of Pearson, owner of the Financial Times. Together with Crosby, he quickly set about hatching the audacious merger with Bank of Scotland that would result in both men heading the enlarged business. Already knighted, the merger's apparent success led to his being recommended for a life peerage in 1999.

What does the report say about him?

"Responsibility [for the near-collapse of the bank] lies particularly with Lord Stevenson".

What is he doing now?

Records at Companies House show Stevenson remains a director of a number of charities including the foundation behind the Tate art galleries and the Institute for Government, which provides advice "to improve government effectiveness".

What does he say?

Stevenson did not comment. In December, he told parliament's banking commission that he "felt awful" that the board had failed to foresee problems in the bank funding markets on which the bank relied.

Peter Cummings

How did he get to HBOS?

Peter Cummings, once head of commercial lending at Bank of Scotland, is the only HBOS executive to have faced official sanction from the now-defunct Financial Services Authority (FSA) – an action he complains was unwarranted scapegoating. His division had been seen as a star performer within the HBOS group, but was eventually forced to book bad debt provisions on its poor quality loans of £26bn. He has described the figures as "horrendous".

A quiet Glaswegian who had worked his way up from his local Dumbarton branch, it was not until 2006 that he was appointed to the HBOS board. He was well known for helping finance high-profile entrepreneurs including Sir Philip Green and Sir Tom Hunter.

Cummings stepped down in early 2009 after the full extent of poor-quality loans from his division had emerged.

What does the report say about him?

"The downfall cannot be laid solely at the feet of Peter Cummings."

What is he doing now?

Last September he was banned from the City for life by the FSA and fined £500,000. But a A furious Cummings said: "This is tokenism at its most sinister, and has made it feel throughout like institutional oppression."

Latterly his health has deteriorated and he only gave evidence to the banking commission at a closed session near his Glasgow home.

A year ago the FSA made clear HBOS itself, now part of Lloyds Banking Group, would have faced a "very substantial penalty" had it not been rescued by with financial support from the taxpayer. However, the regulator stopped short of direct criticisms of Cummings' former bosses by name.

What does he say?

"I am absolutely heartbroken about what happened, and I live with it every day, but it would be inappropriate of me to point the finger at any colleague."

Simon Bowers

Powered by Guardian.co.ukThis article was written by Jill Treanor, for The Guardian on Friday 5th April 2013 01.10 Europe/London

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