8 Conclusion: a manual for bad banking
137. The downfall of HBOS provides a
cautionary tale. In many ways, the history of HBOS provides a
manual of bad banking which should be read alongside accounts
of previous bank failures for the future leaders of banks, and
their future regulators, who think they know better or that next
time it will be different. We will ourselves seek to draw further
lessons from the case of HBOS as we frame recommendations for
the future in our final Report.
138. One lesson relates to structural
reforms. As Sir Charles Dunstone, non Executive Director of HBOS
2001-08, observed, if HBOS had survived as an independent entity
in the form it took in 2008, it would almost all fall within the
proposed ring-fence.[221]
HBOS had no culture of investment banking; if anything, its
dominant culture was that of retail banking and retail financial
services more widely, areas from which its senior management were
largely drawn. Whatever may explain the problems of other banks,
the downfall of HBOS was not the result of cultural contamination
by investment banking. This was a traditional bank failure pure
and simple. It was a case of a bank pursuing traditional banking
activities and pursuing them badly. Structural reform of the banking
industry does not diminish the need for appropriate management
and supervision of traditional banking activities.
139. Another lesson is that prudential
supervisors cannot rely on financial markets to do their work
for them. In the case of HBOS, neither shareholders nor ratings
agencies exerted the effective pressure that might have acted
as a constraint upon the flawed strategy of the bank. By the time
financial markets were sufficiently concerned to act as a discipline,
financial stability was already threatened.
140. HBOS throughout its short life
failed adequately to recognise and act upon the principal risks
to its business models, including asset quality and liquidity
risks. It may be possible for banks with small market shares to
outperform the averages and avoid losses the industry as a whole
is incurring. However, when the market shares are as significant
as at HBOS, notably in the more vulnerable areas, it is highly
unlikely that exceptional single name credit selection can be
sufficient protection against a whole industry downturn. In fact,
such selection is likely to be illusory and provide false comfort.
This lesson also applies to international expansion plans which
target significant market share growth from strong local incumbent
banks; history has shown that foreign banks frequently have weaker
franchises and are exposed to higher risks in downturns, and in
this respect HBOS was simply another example.
141. The FSA is currently conducting
the review commissioned by the Treasury Committee on the failure
of HBOS, which we expect to shed further light on both the regulatory
failures of the FSA and on the failings of HBOS itself. Through
our work, we have identified some of the themes on which we expect
the FSA to expand. In particular, we require the FSA study to
shed further light on the following issues:
a) The extent of losses in each
division, which we have had to estimate;
b) 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;
c) The reasons for the reliance
placed on reports commissioned from third parties as to the adequacy
of controls within HBOS;
d) The reasons why the FSA closed
the issue of the prudence of HBOS's corporate credit provisions;
e) 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;
f) The extent to which regulatory
decision-making at all levels was influenced by the protests of
HBOS senior management, including claims about disadvantage to
its competitive position;
g) The nature and extent of FSA
senior management involvement with HBOS;
h) Whether, rather than having
their Approved Persons status simply lapse, Lord Stevenson, Sir
James Crosby and Andy Hornby (and anyone else presiding over a
similar failure in the future) should be prohibited from holding
a position at any regulated entity in the financial sector;
i) The extent to which the judgements
in the FSA Enforcement Final Notices in respect of HBOS reflect
judgements that either were, or should have been, reached by the
FSA during the course of their supervision of HBOS.
We expect the Treasury Committee
to monitor how far and how effectively the FSA pursues these issues.
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