Parliamentary Commission on Banking StandardsWritten evidence from George Mitchell
Introduction
It is now seven years since I left HBOS and as such there are some points of detail I find it difficult to recall. I have however responded to every question to the best of my ability based on my present recollection. My responses are of course based on the position that existed at the time of my departure. I have no knowledge of any changes to strategy, processes or approach that may have taken place thereafter.
The numbering of my responses matches the numbering in your letter of 9 October.
1. Personal
I joined the Bank of Scotland in 1966 and at the time of the merger with Halifax I was an Executive Director with specific responsibility for the Bank’s Corporate Division. I took up the same role in the merged bank, which I held until my departure at the end of 2005. For a period which, as far as I can recall, began at the beginning of 2004, I also oversaw the Treasury Division until it became part of a combined Treasury and Asset Management Division.
2. Growth of the business
(1.) I can only comment on the position in the Corporate Division up to the time of my leaving, but having read the FSA’s Final Notice and HBOS’s Annual Reports, I would make the following observations:
(a.)
(b.)
(c.)
(d.)
(e.)
(2.) It was fully recognised by the Board and the Bank’s stakeholders that HBOS’s overarching strategy was to become the “New Force in Banking”. Starting with a relatively small share of the overall banking market, this could only be achieved by the Bank growing faster than its competitors. This strategy applied to all of the Bank’s Divisions. It was however also recognised that this growth needed to be in the right markets at the right time and that the growth had to be achieved in a controlled manner both in terms of risk and reward.
(3.) Growth and profit targets were prepared by each Division and submitted to the Finance Director. There would then follow a process of challenge by the Finance Director and the Chief Executive. The amalgamated Business Plan for the Bank as a whole would be considered by the Executive Committee and finally submitted to the Main Board for approval, where it was the subject of a full discussion.
In my own Division, the Plan was prepared on a bottom-up basis following which I held meetings with each Business Head to challenge their submission. The Plan would then be considered and approved by the Corporate Board before being submitted to the Centre.
(4.) See response to 2(2) above.
(5.) As far as I recall, there was unanimity within the Board and Management about the desirability of the strategy set out in 2(2) above.
(6.) The Corporate Business Plan would be cascaded throughout the Division by the Business Heads. How this was done in practice was up to each individual Business Head.
3. Risk Management
(1.) HBOS had a comprehensive risk management framework in place, which I believe was in line with best practice. Based on the concept of “three lines of defence”—the model favoured by the FSA—all the standards, policies, systems and controls you would expect to be in place, were in place. The Board set the Group’s risk appetite and approved all risk policies and standards. Although largely delegated to the Audit Committee, which was supported by Divisional Risk Control Committees (effectively Divisional Audit Committees), the Board was also responsible for regularly reviewing the effectiveness of the risk systems and controls that were in place throughout the Bank.
(2.) The primary challenge to the Division’s credit risk function came from the Centre ie from Group Credit Risk. The Centre exercised oversight of the risk management arrangements and ensured there was Divisional compliance with agreed policies, standards and limits. The Centre also set sector and country lending limits.
Board challenge was primarily through the Audit Committee and the Corporate Risk Control Committee (which included at least two non-Executive Directors). The Risk Control Committee met regularly to review the Division’s portfolio and the adequacy of the Division’s risk management practices.
(3.) The management information available to the Board, the Audit Committee and the Divisional Risk Control Committees was extensive and detailed and should I believe have generally been sufficient for them to make sound risk judgements.
(4.) As set out in 2(2), HBOS’s stated strategy was to grow and gain market share. Based upon my experience up to the time I left HBOS, the Board’s perception was that this would be achieved in a controlled way.
(5.) There were numerous models used to assess risk, from a variety of scorecards in Retail to computerised risk rating models in Corporate. These models were maintained in each Division but with oversight and review by Group Risk. I cannot recall the exact nature of the stress scenarios that were run or at which forums they were considered.
(6.) I do not believe that HBOS was exposed to an excessive level of risk during my time. As stated above, I cannot comment on what happened after the end of 2005.
4. Board Qualifications
(1.) I cannot recall in detail what information the Board, Audit Committee and Risk Control Committees received but I do recall it being comprehensive and certainly sufficient for these bodies to be able to judge the risks being taken by the Bank. The non-executives on the Board during my time had a variety of skills, some more retail-oriented than financial, but the Audit Committee at the time of my leaving had in its membership an ex-Finance director of Legal & General, an ex-Head of Compliance of Standard Chartered Bank and two ex-partners of Deloitte.
(2.) As mentioned in 4(1) above, Board members during my time had a mix of skills and backgrounds but I do believe there were sufficient Directors, both Executive and non-Executive, with appropriate business and financial backgrounds. Whilst it postdates my departure, I think it is fair to say that more directors with direct banking experience may have been beneficial as the financial crisis took hold.
(3.) Challenge predominantly came from Group Risk but also from the Board, Audit Committee and Risk Control Committees. To the best of my recollection, there was sufficient knowledge outside of the Divisions for this challenge to be effective.
5. The Divisions
(1.) I do not believe the issues as listed can, in and of themselves, be blamed for HBOS’s demise. The overriding consideration has to be one of the quality of the individual loans granted by the Bank.
(2.) I believe the Corporate Division was more relationship-driven than other banks and tried to work with customers, in good times and bad, to find solutions that would meet their needs. As far as risk appetite is concerned, the Bank was admittedly less conservative than some but was certainly no more aggressive than many against whom it invariably competed for business. I think a key indicator of its credit appetite is that during my time the Bank had little difficulty in selling down its underwritten positions to other banks who were therefore taking on exactly the same risk as HBOS.
(3.) Most Banks’ Treasury operations engage in proprietary trading in addition to their funding and liquidity responsibilities. Bank of Scotland and Halifax were no different and this carried forward into the merged Bank. The asset backed securities (ABS) portfolio was already in place at Halifax at the time of the merger and operated to a strict limit which was increased over time by the HBOS Board.
The vast majority of the ABS portfolio was Triple A rated by both Moody’s and Standard & Poor’s. I think it is fair to say that everyone, regulators included, would have considered these assets to be extremely low-risk. Clearly with hindsight this was not the case but HBOS would certainly not have been alone in believing there were fewer safer assets you could hold than securities rated Triple A by the two major rating agencies.
(4.) See response to 5(3).
(5.) I fully accept that in a serious recession impairments will rise significantly but I do not believe, even with hindsight, that the extent of the Corporate Division’s problems was inevitable. I have set out in 2(1) above some of the processes that were in place at the time of my leaving and cannot comment after that period. As stated above, the overriding consideration is one of quality.
(6.) As a larger Bank, HBOS was clearly able to lend more in a single credit than Bank of Scotland could have done on its own but the main difference following the merger was that the Corporate Division was able to move from being a participant Bank to being a lead Bank, underwriting larger transactions. This necessitated the creation of a loans syndication capability. Irrespective of loan amount, the same control, care and attention was required for each loan, albeit there were stepped approval levels for increasing loan amounts.
(7.) The Division was under regular scrutiny by Group Risk. At Board level, scrutiny was mainly by the Corporate Risk Control Committee and the Audit Committee, with the Board (as I mentioned previously) relying to a greater extent on these two bodies to fulfil that function.
(8.) I recommended Peter as my replacement as he was the outstanding internal choice and I believed he would be capable of taking on the responsibility.
6. Wholesale Funding
(1.) The amount of wholesale funding required by the Bank increased year on year as the growth in customer lending outpaced the growth in customer deposits. This was however accompanied by a clear recognition of the need to expand the Bank’s wholesale funding sources and lengthen the maturity profile of such funds.
(2.) During my time, liquidity management was given considerable focus within HBOS. Liquidity policy was set by the Board with responsibility for managing that policy delegated to the Group Asset and Liability Committee which established a number of limits for Treasury to adhere to in its day to day operations. There was also a framework in place that was meant to identify liquidity stress at an early stage.
30 October 2012