'An accident waiting to happen': The failure of HBOS - Parliamentary Commission on Banking Standards Contents

1  Introduction

1. On 27 January 2004 the Board of HBOS plc was told by the Group Finance Director, Mike Ellis, that, in the view of the Financial Services Authority (FSA):

    the Group's growth had outpaced the ability to control risks. The Group's strong growth, which was markedly different than the position of the peer group, may have given rise to "an accident waiting to happen".[1]

Neither the FSA nor HBOS followed through on the implications of this characterisation. The accident happened. HBOS failed, with dramatic consequences for its shareholders and for the taxpayer. In this Report we examine why HBOS failed and what that failure says about culture and standards in UK banking.

2. At its peak in 2007, HBOS had a market capitalisation of over £40 billion, when its tangible book value was £18 billion.[2] Former HBOS shareholders have seen 96 per cent of its peak value disappear, and what remains is the result of support from the UK taxpayer and the acquisition by Lloyds TSB. The taxpayer has injected £8.5 billion directly into HBOS. Lloyds Banking Group (LBG) has provided a further £20.5 billion for HBOS and has itself also received £12 billion from the taxpayer. The total of £20.5 billion provided by the taxpayer to both groups has therefore all been channelled into HBOS.[3] The market value of the Treasury holding in LBG is still £5 billion below the £20.5 billion invested.[4] There have also been wider effects of the catastrophe, with HBOS weakened in its ability to lend to retail customers and small- and medium-sized enterprises (SMEs) and the banking market less diverse.

3. Two of the three large domestic bank failures of the banking crisis in the UK have previously been the subject of detailed scrutiny. The retail bank run on Northern Rock and its consequences were subject to near contemporaneous consideration by the Treasury Committee.[5] At the initiative and insistence of the Treasury Committee, the FSA—which had initially published only a 300 word press release to accompany the conclusion of its enforcement process—published a substantial Report into the failure of RBS, which was, also at the instigation of the Treasury Committee, subject to independent review by specialist advisers appointed by that Committee. Subsequently the Treasury Committee produced its own Report following that from the FSA.[6] The fall of HBOS has so far received less public scrutiny, consideration being largely limited to sections in a Report by the Treasury Committee in 2009. [7]

4. In July 2011 the Chairman of the FSA wrote to the Chairman of the Treasury Committee describing progress with the Authority's report on RBS and the "extremely valuable" role of the independent reviewers. In view of the public interest in knowing what happened at HBOS, and probably in anticipation of the foreseeable requirement of the Treasury Committee, he said that it was the FSA's intention also to produce a further report on the collapse of HBOS once the enforcement process was complete.[8] In evidence to the Treasury Committee in January 2012 Lord Turner acknowledged that it had been a mistake on the part of the FSA not to have decided earlier to produce a public accountability report on RBS, and repeated his intention of producing a report on HBOS equivalent to that which the FSA had published on RBS. [9]

5. On 9 March 2012, the Financial Services Authority (FSA) announced that it had completed its investigation of HBOS and that the firm had been guilty of very serious misconduct. Given the exceptional circumstances of the firm being part-owned by the taxpayer, the FSA decided not to levy a fine. Instead the FSA issued a public censure.[10] The FSA concluded its remaining enforcement action in September 2012, through an action in relation to an individual which we consider later in this Report.[11]

6. In response, the Treasury Committee exercised its powers in a novel way. It wrote to the FSA welcoming Lord Turner's commitment to producing a report into the failure of HBOS, requiring that it be a "comprehensive assessment of the reasons for the bank's failure", and envisaging that the Treasury Committee would appoint external advisers, employed during the drafting process, to provide assurance that the report was a fair and balanced reflection of the evidence.[12] The FSA acceded to this requirement.[13] The Treasury Committee has recently announced the terms of reference for the independent reviewers, which are to:

a)  review and report on the extent to which the FSA report on the failure of HBOS is a fair and balanced reflection of the available evidence;

b)  review and report on whether the FSA's report is a fair and balanced summary of the Authority's regulatory and supervisory activities in the run up to the failure of HBOS.[14]

7. The report by the FSA into the failure of HBOS and the independent review on behalf of the Treasury Committee are unlikely to be published before this Commission publishes its final Report. In order to ensure that a full picture of the UK bank failures in the financial crisis was available to us, we decided to examine HBOS ourselves as a case study of banking failure, in order to identify lessons for our wider work on banking standards and culture.

8. There have been a number of unusual features of the way in which we have carried out our work on HBOS compared with the general working practices of parliamentary committees. In particular:

a)  The Commission appointed Counsel, David Quest and Rory Phillips QC of 3 Verulam Buildings, to participate in the examination of witnesses, the first use of Counsel by a parliamentary committee of this kind;

b)  We gathered a much larger amount of original documentary material than is customary for select committees, including papers of the HBOS Board and correspondence between HBOS and the FSA which would usually be confidential;

c)  We established a panel to undertake the initial phase of our work, led by Lord Turnbull, to collect initial written statements from those invited to give oral evidence and others;

d)  The panel then held 8 meetings between 30 October and 30 November and took evidence from 16 witnesses who had worked for HBOS, served on its Board or been involved in its supervision, enabling evidence to be collected from a broader range of witnesses than can usually be examined by a parliamentary committee for a particular case study;

e)  The panel heard evidence on two occasions from witnesses in private, on one occasion due to the personal circumstances of a witness and on another occasion to maintain the anonymity of a witness from the FSA below executive level;

f)  We deployed high quality bank analysts as staff to assess the evidence on what happened and to provide advice.

In the light of the panel's evidence-gathering, the Commission heard evidence from Sir James Crosby, Chief Executive of HBOS from its creation until 2006, Andy Hornby, its last Chief Executive, and Lord Stevenson of Coddenham, Chairman of HBOS throughout its short life; Counsel also took a lead role in the examination of these witnesses.

9. We are most grateful to all those who assisted us in our work, and in particular to Lloyds Banking Group (LBG) and the FSA for their cooperation on the production of documents, and to Rory Phillips QC, David Quest and their supporting team from 3 Verulam Buildings.[15]

10. The work we have undertaken on HBOS will continue to inform our consideration of banking standards and culture in advance of our final Report. We have decided to report separately in advance on HBOS in order to ensure due prominence to some of the lessons from its failure and in order to help shape the agenda for the forthcoming Report by the FSA on the failure of HBOS, the external review of it and subsequent consideration by the Treasury Committee. This Report identifies issues which the FSA should further examine in that Report, but does not contain broader public policy recommendations arising from the case study; these will form part of our final Report.

1   B Ev w 363; emphasis in the original. For attribution of the last phrase, see Q 1328 and BQq 330-332. Back

2   HBOS, 2007 Annual Report and Accounts: Delivering our strategy..., pp 154, 155, 207 Back

3   National Audit Office, HM Treasury Resource Accounts 2011-12: The Comptroller and Auditor General's Report to the House of Commons, July 2012, p 10 Back

4   Lloyds Banking Group, 2011 Annual Report and Accounts: Becoming the Best Bank for Customers, pp 290, 303 Back

5   Treasury Committee, Fifth Report of Session 2007-08, The Run on the Rock, HC 56 Back

6   Treasury Committee, Fifth Report of Session 2012-13, The FSA's report into the failure of RBS, HC 640 (heareafter cited as HC (2012-13) 640), paras 1-8 and passim; FSA, The failure of the Royal Bank of Scotland: Financial Services Authority Board Report, December 2011 Back

7   Treasury Committee, Seventh Report of Session 2008-09, Banking Crisis: dealing with the failure of the UK banks , HC 416, paras 39-47, 120-128 Back

8   Letter from Chairman of the FSA to Chairman of the Treasury Committee, 11 July 2011, www.parliament.uk/treascom Back

9   Oral evidence taken before the Treasury Committee on 30 January 2012, HC (2012-13) 640-I, Qq 88,90 190 Back

10   "FSA publishes censure against Bank of Scotland plc in respect of failings within its Corporate Division between January 2006 and December 2008", FSA Press Notice 024/2012, 9 March 2012 Back

11   See paras 130 -135 Back

12   HC (2012-13) 640, para 121 Back

13   IbidBack

14   "Treasury Committee appoints specialists to review FSA report into HBOS", Treasury Committee News, 1 March 2013  Back

15   In addition to David Quest and Rory Phillips QC, Ian Higgins, Kate Holderness and Anne Jeavons of 3 Verulam Buildings were also appointed as specialist advisers for the Commission's work on HBOS. Back

previous page contents next page

© Parliamentary copyright 2013
Prepared 5 April 2013