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

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.

221   Q 849 Back

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Prepared 5 April 2013