Parliamentary Commission on Banking StandardsWritten evidence from Michael Foot
1.1 Briefly summarise your role in the supervision of HBOS giving the relevant dates of your involvement.
I was one of three Managing Directors of the FSA from its inception in June 1998 to the second quarter of 2004 (ie I completed two terms of office of three years each).
The structure of the FSA, not surprisingly, underwent change over time, especially initially as we had to work within the structure set by previous law until the passing of the Financial Services and Markets Act in 2000. For my second term which is what I believe is relevant to this Commission, so far as I recall, my title was consistent throughout, namely I was MD of the Deposit-Takers and Markets Directorate, a less-wide ranging role than I had had during my first term.
I reported first directly to the Executive Chair of the FSA (Howard Davies) and later, from 2003 on, to the new CEO John Tiner. Throughout the period, I was an ex-officio member of the Board of the FSA and reported to it.
Following my term, I remained for a few months (to end-September 2004) as an Adviser to the new Chairman (Callum McCarthy) and the relatively new CEO (John Tiner). I then worked abroad for some time as Inspector of Banks and Trust Companies in The Bahamas, returning in 2007 to be Executive Chair of the private sector consulting firm Promontory Financial Group (UK) Ltd.
I attach an organogram of the FSA as at March 2003. So far as I recall, the number of my direct reports (and the individuals filling these slots) remained constant until a reorganization in Q2 2004. These 5 were:
Oliver Page, Director Major Financial Groups.
Philiip Robinson, Director (other) deposit-takers.
Gay Huey Evans, Director markets & Exchanges.
Clive Briault, Director Prudential Standards.
Ken Rushton, Director Listing (covering our regulatory responsibilities taken over from the London Stock Exchange).
From memory, the budget for my directorate was around £55 million and the full-time staff equivalent was around 450.
My duties varied over time between 2001 and 2004 with, in addition to the ones attaching naturally to the job, my having to give considerable time to the consequences of (and Inquiries upon) the closure of The Equitable; I also played a leading role within the FSA and the industry in improving Business Recovery and Continuity Planning, post 9/11.
From its inception, I was also the FSA’s lead contact on the Tripartite Committee formed following, and in accordance with, the Tripartite Agreement between the FSA, the Bank of England and HMT to plan for and respond to possible policy shocks. From memory, I believe I attended all bar one of the first 50 meetings of that Committee.
Like all senior management at that time (and since), I spent considerable time reviewing and helping to shape new policies, particularly in the prudential area (this was the period when Basel II took shape).
Prior to June 1998, I had been at the Bank of England—1969–98 (occupying a wide range of jobs but becoming a senior bank supervisor in 1993 and Executive Director of Banking Supervision in March 1996).
HBOS was supervised between 2001 and 2004 within Major Groups Division. I have not had time to check with FSA exactly how the structure ran at that point, nor the numbers of staff involved; the Director MFGD would have had perhaps three Heads of Department, one of whom would have had below him/her the relationship Manager responsible for direct supervision of HBOS.
We were also able to call upon expert risk teams elsewhere in the FSA, notably covering credit, market, operational and insurance risk, which were developed over time.
External resources were also available, including in the form of commissioning reports from third parties under section 166 of the Financial Services and Markets Act, 2000, though this was not a supervisory tool that was used much at that time, building upon teams started at the Bank of England.
For what were perceived as serious firm-specific threats, the main forum for debate was the weekly Firms and Markets Committee that was normally chaired by the Chair or (later) CEO. At the end of each meeting, a formal view would be taken as to whether anything sufficiently serious had been raised to warrant formal notification the Chancellor; and decisions were often made also about the speed and nature of the FSA’s own handling of a major issue.
For myself, a vital channel of communication was the use of regular bilateral meetings with each of the five Directors reporting to me, at which we would discuss firm-specific issues and also thematic or forward-looking policy issues. These were supplemented by extensive meetings at need—for example many meetings were held in 2002–03 as the equity markets fell sharply, bringing a number of potential risks in the financial sector; and there was a steady (and sizable) diet of possible policy changes, including the very complex changes being proposed in the Basel Committee (Basel II) and within the EU.
I also received regular Management Information about the performance of each Division (such as on its compliance with the agreed supervisory programme and policy initiatives).
I inevitably became involved also in the supervision of specific firms through being consulted on major supervisory decisions. I was, for example, very heavily involved in the consideration of the various attempted take-overs that led to Halifax’s merger with Bank of Scotland in 2001.
Supervisory Approach
2.1 What was the balance between prudential and conduct supervision between a) 2002–2004 and b) 2005–2008?
I do not recall any attempt formally by the FSA to measure the balance between prudential and conduct supervision, though successive Annual Planned Budgets put a good deal of information in the public arena about proposed priorities. During my time in office, a growing proportion of the FSA’s time was devoted by the FSA to additional conduct work across the whole retail sector. But this was a very conscious decision (or rather succession of decisions). At the time the FSA came together, the prudential rule-books and approaches were generally well-developed and, though they needed much integration, were thought generally fit for purpose, at least in respect of deposit-taking. In respect of conduct of business, however, we had seen various mis-selling scandals (such as in respect of endowment policies) and also the need to improve wholesale market conduct in a number of areas (notably to curb market abuse). In due course, by 2003, we had concluded that a wide ranging and lengthy effort to improve financial literacy was also necessary. All of these factors increased the resources devoted to conduct issues; but, during my time in office, I never felt that this had resulted in undue pressure on what was available for prudential purposes.
2.2 How many resources were devoted to the supervision of HBOS? Did that change during the period 2002–2008? How does this compare with now?
I am not able to answer this; you would need to refer to FSA.
2.3 Did HBOS have a constructive relationship with FSA supervisory team and senior management? How did interaction work? Did the relationship change during the period 2002–2008? The FSA’s report, “The Failure of the Royal Bank of Scotland” explained that the FSA could grant banks a regulatory dividend when, in the FSA’s opinion, it demonstrated that it was “well managed, had effective control systems and had dealt openly with the FSA”. From your recollection, was HBOS granted a regulatory dividend by the FSA at any point during the period 2002–2008?
As noted above, I had contact with senior Halifax and Bank of Scotland executives before and during their merger. I also personally spent some time in negotiation with Halifax (James Crosby) over their possible purchase of part of The Equitable Life’s administration systems. My main Halifax contact on both occasions was with James Crosby; and I continued to see him periodically up to my departure because of his involvement with the FSA. I never found him anything other than open and frank.
I cannot recall any “regulatory dividend” going to Halifax during my period; indeed, early in 2004, I believe the reverse happened, with Halifax’s minimum capital ratios being put up, though I have not reviewed the relevant papers.
2.4 How often did you, personally, meet with the Board of the bank during the period 2002–2008? What kinds of issues were on the agenda?
Given the huge number of firms for which I was responsible, it was never sensible for me to meet formally with the Board of a Bank. That is something that, where it was necessary, would generally be done by the relevant director below me. However, I did always attend a wide range of industry functions and, in other ways, make myself available if chairmen or senior executives wished to talk, eg over what the FSA was doing.
2.5 How often did you, personally, have interaction with the executives of the bank? Who were the relevant executives? What kinds of issues were on the agenda?
I have tried to answer this above.
2.6 What other areas of HBOS did the FSA interact with on a regular basis?
The periodic ARROW visits and the resulting recommendations by the FSA for action would have structured nearly all prudential contact between Halifax and the FSA.
2.7 What other areas of HBOS did the FSA interact with on a regular basis?
Please see 2.6 above.
Control Framework and Risk Management
3.1 Following the 2004 ARROW report, a 8166 report was commissioned and undertaken by PWC. Did that report address your concerns about the control framework? Was there a change in the supervision team’s focus after the PWC 8166 was issued?
I’d already left FSA.
3.2 What were the supervision team’s and FSA senior management’s views on the framework for controlling risk within the firm, which involved devolution of risk management to divisions?
I do not recall any specific concerns up to early 2004, other than what was in the relevant ARROW letters.
3.3 Were you able to assess the competency of the Group Risk function? Was the Group Risk function effective at managing risk in the firm? Was it equally capable/effective in monitoring all of the main divisions? Were their concerns listened to and addressed?
Please see 3.2.
3.4 Were you satisfied with the bank’s internal ratings approach? Was it applied across the bank’s entire portfolio?
I do not recall the order in which, the detail or the timing with which issues arose in this area. I do not recall the issues affecting Halifax being significantly different from or greater than the major banks.
3.5 What was your relationship with the firm’s external auditors? How often did you meet them? What was the nature of the discussions? Were serious concerns over asset quality raised and if so, when? Were there any concerns over the validity of the accounts? How often did you meet with the bank’s internal auditors?
I did not meet with the external auditors in respect of individual firms. I did meet with the main firms periodically to discuss their overall performance in respect of all their audits of FSA-authorized firms.
3.6 What did you perceive the risks to be in the Corporate and International divisions?
Please see 2.6 above.
Capital Adequacy
4.1 What was the HBOS capital add-on in 2008 and how did that compare with the other major UK banking groups? How did any capital add-on change between 2006 and 2008?
I left FSA in 2004.
4.2 From your recollection, what was the impact of Basel II on HBOS’s regulatory capital position?
Did it result in an increase or decrease in regulatory capital?
I cannot recall from memory. I do recall that we periodically ran peer group reviews to check that broadly similar banks were being treated in broadly similar fashion and that the “answers” were sensible.
Funding and Liquidity
4.1 In your view, was the approach to managing the bank’s liquidity position adequate (both in terms of the bank’s own internal approach and the FSA’s regulatory approach)?
I do not recall any specific concern being raised by the supervisors over liquidity or dependence on wholesale funding in the period up to March 2004. I was involved in a number of policy discussions about the extent to which all major UK banks were seeking to exploit new funding opportunities, especially off-balance sheet. But I do not recall Halifax being a particular firm-specific subject of conversation.
I might also note that various aspects of liquidity in the UK system as a whole had been the subject of periodic debate for many years, at least since a Bank of England paper (which I helped to draft) in 1980. A similar lengthy debate had taken place internationally.
4.2 What supervisory action was taken to address concerns about the firm’s reliance on wholesale funding during the period 2002 to 2007?
Beyond the relevant ARROW letters, I do not recall any particular supervisory action up to early 2004.
4.3 Did the FSA have contingency plans in place, or was it aware of the existence of other plans, for managing HBOS’s solvency and liquidity as the 2007/08 crisis developed? How and when did these plans evolve? What was the nature of those plans?
This is well after my time at the FSA.
4.4 Did the supervision team have a good understanding of the risks inherent in the bank’s portfolio of asset backed securities?
I think this would have become a major potential issue only after my time at FSA.
4.5 Did the bank have adequate stress testing arrangements in place? To what extent was the FSA involved in dictating what scenarios and assumptions should be used? Did the FSA run its own stress tests on the bank? What form did they take?
I believe that formal stress testing began only well after my time at the FSA. In my time, the focus was on business recovery, as from a 9/11 style disaster.
Provisioning Policy
5.1 Were you satisfied with the firm’s provisioning policy during the period you were involved in its supervision?
I do not recall any firm-specific issues with Halifax—ie my memory is that they were broadly consistent with banking accounting practice at that time.
5.2 The Final Notice to BoS of 9 March 2012 states that “the firm adopted an optimistic approach to levels of provisioning despite repeated warnings from HBOS’s auditors and the corporate division’s risk function of the need for a more prudent approach”. Please can you expand on this point? In particular, were the repeated warnings visible to the FSA? How did the FSA respond? Did the bank’s external auditors or corporate division ever raise any concerns directly with the FSA over the level of provisions held in respect of the corporate division’s exposures?
Not relevant to me.
Corporate Governance
6.1 Do you consider there was adequate banking expertise on the bank’s board?
This is the kind of issue that would have been taken as part of the ARROW review. The whole FSA approach to corporate governance in those days was much less aggressive than it has become since 2009.
6.2 Do you think the Board was in a position to challenge divisions effectively and did it do that?
Please see 6.1.
22 November 2012