Appendix 1: PRA/FCA report - Summary of main findings
1)On 1 October 2008 HBOS was approaching a point at which it was no longer able to meet its liabilities as they fell due and so sought Emergency Liquidity Assistance (ELA) from the Bank of England. While the failure of the Group was directly triggered by a lack of liquidity, in large part this reflected underlying concerns about the solvency of the firm - concerns that turned out to be justified.255
2)The failure of HBOS can ultimately be explained by a combination of factors:
(a)Its Board failed to instil a culture within the firm that balanced risk and return appropriately, and lacked sufficient experience and knowledge of banking.
(b)The result was a flawed and unbalanced strategy and a business model with inherent vulnerabilities arising from an excessive focus on market share, asset growth and short-term profitability.
(c)This approach permitted the firm’s executive management to pursue rapid and uncontrolled growth of the Group’s balance sheet, and led to an over-exposure to highly cyclical commercial real estate (CRE) at the peak of the economic cycle, lower quality lending, sizable exposures to entrepreneurs, increased leverage, and high and increasing reliance on wholesale funding. The risks involved were either not identified or, where identified, not fully understood by the firm.
(d)There was a failure by the Board and control functions to challenge effectively executive management in pursuing this course or to ensure adequate mitigating actions. HBOS’s underlying balance sheet weaknesses made the Group extremely vulnerable to market shocks and ultimately failure as the crisis of the financial system intensified.
(e)There was an extended period of inflows of capital to developed economies, resulting in low yields, declining awareness of risk and asset price bubbles, in which market discipline - investors, analysts, rating agencies and other third parties - failed to constrain firms from undertaking risky strategies.
(f)An overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure. HBOS was one such bank.
3)Ultimate responsibility for the failure of HBOS rests with its Board. However, another striking feature of HBOS’s failure is how the FSA did not appreciate the full extent of the risks HBOS was running and did not take sufficient steps to intervene before it was too late.
4)The FSA Board and executive management failed to ensure that adequate resources were devoted to the supervision of large systemically important firms such as HBOS. This gave rise to:
(a)A risk assessment process that was too reactive, with inadequate consideration of strategic and business model related risks;
(b)Insufficient focus on the core prudential risk areas of asset quality and liquidity in a benign economic outlook; and
(c)Too much trust being placed in the competence and capabilities of firms’ senior management and control functions, with insufficient testing and challenge by the FSA.
255 All text in Appendix 1 from PRA and FCA, The failure of HBOS plc (HBOS), 19 November 2015, p 14-15
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22 July 2016