CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 606-xvii

HOUSE OF COMMONS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION

ON BANKING STANDARDS

BANKING STANDARDS

TUESDAY 4 DECEMBER 2012

LORD STEVENSON OF CODDENHAM

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Joint Committee

on Tuesday 4 December 2012

Members present:

Mr Andrew Tyrie (Chair)

The Lord Bishop of Durham

Mark Garnier

Baroness Kramer

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

Counsel: Rory Phillips

Examination of Witness

Witness: Lord Stevenson of Coddenham, CBE Kt, former Chairman (2001-2009) HBOS, examined.

Q1527 Chair: Thank you very much for coming to give evidence. You gave evidence, of course, in 2009 to the Treasury Select Committee. We have that transcript before us and we might come on to aspects of that later.

You are agreed that the failure of HBOS was catastrophic, aren’t you? There is no other word for it.

Lord Stevenson of Coddenham: That is a fair adjective, Chairman.

Q1528 Chair: And when you left you waived your termination salary.

Lord Stevenson of Coddenham: Yes. To be precise, some months before I left I told the chairman of the remuneration committee I wished no pay up to my contractual entitlements. It was not done in response to events at that point; I had decided it some months before.

Q1529 Chair: So it was not connected to the fact that you realised that the bank was in a catastrophic-

Lord Stevenson of Coddenham: Yes, it was. I realised that a lot of people were suffering and it would be outrageous if my contract were paid up.

Q1530 Chair: And what was your total remuneration for your period at HBOS, roughly?

Lord Stevenson of Coddenham: I am guessing. If I could just put my perspective-

Q1531 Chair: I have done a rough estimate myself. It may not be correct.

Lord Stevenson of Coddenham: Well, my balance sheet goes as follows. I think that on average I was taking £600,000 of basic pay a year, then I had a long-term performance incentive. Add to that-I think it is important to emphasis this-I have a very strong view that chairmen of businesses should have complete identity with the shareholders of those businesses, so in any businesses I am in, whether public or private, I invest substantial amounts of my own money. I cannot give you the exact figure for what I invested in HBOS, but it was a very large sum of money. That meant-and quite right too-that when HBOS hit trouble, I lost a great deal of money. So on the one hand I was earning probably £700,000 at the end-I cannot remember-but, on average, £600,000 a year for X years; against that, I also invested a great deal of my own money, which I lost.

Q1532 Chair: Did you make any disposals of those investments or the LTIP in the three years prior to the collapse of the bank?

Lord Stevenson of Coddenham: No. I actually-you may think this was very foolish-continued investing in the business throughout the last 18 months.

Q1533 Chair: Mr Cummings has been identified as the only person against whom the FSA have taken enforcement action and imposed a fine. Do you think that is fair?

Lord Stevenson of Coddenham: I don’t think I am competent to make that judgment. The judgment as to who should be enforced against is an FSA matter in relation to their own terms of reference. I have read the FSA enforcement reports. They have focused, if I could perhaps over-summarise, on what they see as being the mismatch between what they regarded as known inadequate risk management procedures on the one hand and over-aggressive lending on the other; that was their main focus. Now, there is no avoiding the fact that Peter Cummings was in charge of corporate bank, so given that perspective, I am not surprised. I simply cannot make the judgment about whether there were others working there who should have been enforced against. It is really a technical FSA matter.

Q1534 Chair: Okay. If we strip away the technical aspect and just look at it from the perspective of common sense, do you think it is fair? Is it fair in the sense that the man in the street judges these things to be fair or unfair? Would a reasonable man consider it fair?

Lord Stevenson of Coddenham: That he was enforced against?

Q1535 Chair: That he is the only one.

Lord Stevenson of Coddenham: Well, I think the other question is also a good one. You are pushing me, but I do not have the ability to give you an informed answer.

Q1536 Chair: I don’t think we have pushed you very hard yet, Lord Stevenson.

Lord Stevenson of Coddenham: I am sure you will.

Chair: I would just like a straight answer to that one.

Lord Stevenson of Coddenham: I am not trying to avoid the question, but to give you an informed answer I would have to know a lot more detail about what actually went on than a non-executive chairman ever can. As I said to you, my answer is that the FSA had a clear view of the corporate business, which I have summarised; that was their focus-that, and nothing else-and Peter Cummings, a man of huge integrity and, despite everything that happened, of great ability, was in charge of it. I can see, given their view, why they enforced against him. If you are asking me whether others should have been enforced, it would be irresponsible of me to give you what you call a common-sense answer.

Q1537 Chair: Do you think your responsibility here is limited by the fact that you were a non-executive chairman, as you put it in your evidence to us?

Lord Stevenson of Coddenham: I do not think so. I was chairman of the board with the responsibilities that that implies.

Q1538 Chair: But you were non-executive.

Lord Stevenson of Coddenham: I was. Non-executive, part time-call it what you will. I didn’t have an executive job. I was quite heavily engaged.

Q1539 Chair: You wrote a letter on 10 January 2008, which says, "Yes, I am part-time (but not non-executive)". You wrote that letter to the Financial Services Authority. That was incorrect?

Lord Stevenson of Coddenham: I was very interested to see that. I had forgotten all about that letter, and I read it in the pack. Let me give you the background to that, because to understand it, you need the context, I think.

Round about 2003 and 2004, which was also when the investigation took place, I was interviewed by the FSA for the ARROW report. I remember a very short interview-very polite, very charming. I was rather taken aback when we received the ARROW report, letters or whatever they were, to find that the issues on which they expressed concerns about HBOS had not been raised in my interview with them, which I broadly took a dim view of. The letter you are reading was me saying to the FSA: "In this ARROW investigation, please make sure that, if you have concerns, you discuss them with me." In that context, I was non-executive; I was part time, but when writing the letter, I wanted to make sure that they came to see me and discussed their real worries with me. That was why I wrote the letter.

Q1540 Chair: But it is misleading, isn’t it, to write to a regulator saying, "I am not non-executive", when you are non-executive, when it says in the accounts you are non-executive and when you give evidence to a parliamentary Committee that that you are non-executive? Which is it?

Lord Stevenson of Coddenham: With a certain amount of forbearance, I have given you the context. I don’t think my motive was a bad one. I wished the FSA to deal with the substantive issues they were concerned about with me, and I was trying to persuade them to do that. I accept the definitional point.

Q1541 Chair: I don’t think this is a case of the end justifying the means, do you?

Lord Stevenson of Coddenham: I suppose, sort of.

Q1542 Chair: Perhaps I shall read the whole passage: "I can understand a mind set which regards a ‘non-executive Chairman’ as sailing above the battle, not concerned with the detailed day to day realities…perhaps with inputs on strategy, governance and other Olympian matters! Can I make it quite plain that I do not regard myself as that kind of a Chairman? Yes, I am part-time (but not non-executive)."

Lord Stevenson of Coddenham: That is a fair statement of how I felt about my job. I did not feel I was sailing above-

Q1543 Chair: You go on to say, "I am legally responsible for the business and with the modesty for which I am not famous regard myself as being knowledgeable and well briefed."

Lord Stevenson of Coddenham: Yes.

Q1544 Chair: So to suggest, as you did a moment ago in evidence to me that, as a non-executive, you might not have a full grip on the detail of whether Cummings alone should be responsible is stretching it a bit, isn’t it?

Lord Stevenson of Coddenham: I didn’t say that to you a moment ago. What I said to you was that-as a non-executive, but if I could substitute the word "part-time" for that-as a part-time chairman, there is no possibility that I would have known the detail of what was going on in the corporate division.

Q1545 Chair: While you are telling us that you don’t know the detail, you are telling the regulator that you are knowledgeable and well briefed.

Lord Stevenson of Coddenham: Yes, and it is-

Q1546 Chair: That you are not a non-executive and you are not an Olympian chairman.

Lord Stevenson of Coddenham: I see the point you are making, but I don’t think for a moment the regulator interpreted that as me saying, "As a part-time chairman, I know everything about what is going on in the business", because manifestly I didn’t. I reiterate the context of that letter-

Chair: I don’t think there is any need for reiteration.

Lord Stevenson of Coddenham: Okay.

Q1547 Chair: We have had the "end justifies the means" explanation, unless there is another one?

Lord Stevenson of Coddenham: I wished to make sure that the FSA discussed their concerns about the business with me.

Q1548 Rory Phillips: Lord Stevenson, can I start with one or two questions about the chronology? This is right, isn’t it: that after a career in business, you became chairman first of the Halifax Building Society and then of the new merged entity, HBOS, starting in ’99 with the chairmanship of the Halifax, and then chairman of the new group for its entire, but short, life.

Lord Stevenson of Coddenham: Yes.

Q1549 Rory Phillips: Yesterday, as I am sure you know, the Commission heard from the two chief executives who were in post during HBOS’s existence. As you can imagine, the Commission was seeking to establish as between them where responsibility lay. In relation to you, there is no such difficulty, is there? You were chairman throughout the period of HBOS’s existence.

Lord Stevenson of Coddenham: Yes.

Q1550 Rory Phillips: So there is no-if I can put it this way-chronological wriggle room in your case?

Lord Stevenson of Coddenham: No.

Q1551 Rory Phillips: Can we move straight to the heart of this, without further ado? Look, please at D2 in your file, which is a table of various numbers-the product of analysis-and turn to page 2, which is a list of customer loan impairments for HBOS. In relation to these figures, you will see that, unlike when you appeared before the Treasury Select Committee is February 2009, we are now able to trace the full development of this book of business, so it includes figures up to and including 2011. Do you see that?

Lord Stevenson of Coddenham: Yes, I do.

Q1552 Rory Phillips: And the total loan impairments across the group as at that date, 2011, is nearly £46 billion. Is that correct?

Lord Stevenson of Coddenham: Yes, so I read it.

Q1553 Rory Phillips: Yes. We heard yesterday that the corporate loan impairments, as a part of that, were some £26 billion. Again, is that something you are aware of?

Lord Stevenson of Coddenham: I am.

Q1554 Rory Phillips: In terms of the problem of impairments for the group, it was by no means restricted, was it, to the corporate loan book?

Lord Stevenson of Coddenham: No.

Q1555 Rory Phillips: In fact, if you turn to page 4, where we have the international impairments-in Ireland on the one hand, and also Australia-you will see that the international division managed to rack up just under £15 billion of impairments in that division. Is that correct?

Lord Stevenson of Coddenham: I am reading it, yes.

Q1556 Rory Phillips: So not just nearly £11 billion in Ireland, but £3.6 billion in Australia?

Lord Stevenson of Coddenham: Yes.

Q1557 Rory Phillips: Perhaps one can understand the Irish numbers, given the terrible problems of the Irish banks, but the Australian figure suggests an absolutely abysmal lending record, doesn’t it?

Lord Stevenson of Coddenham: They are horrible figures.

Q1558 Rory Phillips: Can you think of an explanation for those figures on that page, 4, other than rank bad lending?

Lord Stevenson of Coddenham: You are asking me about something that happened between four and nine years ago. If I may revert, whether I was non-executive or part time, I was not working full time in either the total business or the Australian business, so for me to give you a detailed, expert answer to that question is a little difficult. What I would say is as follows. First, we invested in Australia because it was felt-we all felt-we were a too-UK-centric business. Secondly, we focused as a board a lot of time on Australia, on the executives. I went there several times, doing it all the time. I thought we had an excellent chairman and an excellent chief executive. In many ways, it was my role as chairman to come over. Thirdly, to revert to what I said, I cannot talk authoritatively about the lending book. We are talking here about £3.6 billion of provisions. I cannot distinguish between the loss of value reflected by the knock-on effect of the closure of wholesale markets and the knock-on effect from bad lending decisions in any markets. That it is a horrible figure is beyond doubt.

Q1559 Rory Phillips: But are you suggesting that the Australian losses are to be explained by the closure of the wholesale funding markets?

Lord Stevenson of Coddenham: Certainly not in their entirety. I do think that if we go back-

Q1560 Chair: Well, give us a sense of the proportion.

Lord Stevenson of Coddenham: I wouldn’t dream of- I am not an economist, still less an economic historian.

Q1561 Chair: The lion’s share? Half?

Lord Stevenson of Coddenham: You are putting words in my mouth, Chairman, and I cannot responsibly swallow them.

Q1562 Chair: I am asking you to put some words in your mouth.

Lord Stevenson of Coddenham: I understand. Look, if you go back and as the sort of bigger question about what happened-where we went wrong-we failed, along with most of the rest of the world, to anticipate the possibility of a protracted closure of wholesale markets, with the two knock-on effects, first, on liquidity, which is what undoubtedly caused our immediate problems, and, secondly, on the writedown of asset values. As you will know, the drop in asset values was very sudden, and-I think you used the word "catastrophic"; one of the two of you did-catastrophic. This was, as far as I am aware, unprecedented. I think I saw at one point that between the Lehman’s bankruptcy and the closure of wholesale markets and February, stock markets dropped by 20% and asset values dropped accordingly. So I cannot tell you what percentage, but I would guess that a large percentage of that reflected loss in asset value because of the closure of wholesale markets. Does that in any way mitigate the awfulness of the losses? No.

Q1563 Rory Phillips: The explanation you have just given in relation to the wholesale markets is the explanation you gave to the Treasury Select Committee in February 2009, isn’t it? That is correct?

Lord Stevenson of Coddenham: I have been back and reread it, but I have to tell you that-

Q1564 Rory Phillips: Well, you came along and you apologised, and said that your bank had been the victim of the markets, roughly. Is that right?

Lord Stevenson of Coddenham: Yes; I would have to go back to the thing.

Q1565 Rory Phillips: Well, since then, as I said to you earlier, we have seen, and been able to trace through, the development of the HBOS numbers, and that is what I was showing you when we were looking together at page 4. There are other pages we will come to in a moment. You cannot conceivably attribute this size of loan impairment, can you, to the problems-the wholesale funding problems-that you have mentioned. Otherwise, your position would be exactly the same as all the other high-street banks, and it is a lot worse, isn’t it?

Lord Stevenson of Coddenham: If I could distinguish between the different bits of that-I think the previous page has the point of comparison-and with a caveat to anything I say that I don’t have visibility to the provisioning policies, certainly of Lloyds Banking Group or of the others, given what I think the FSA rightly described as the niche strategy of the HBOS corporate business, which was the old Bank of Scotland corporate business, I would expect the impairments to be greater, because when you are more exposed to property and SME lending, to take the two, you would expect the impairments to be greater.

To address the question that I think you are driving at-you asked me a question I cannot give you an answer to-about the allocation of loss of value between, on the one hand, mistaken lending decisions, and on the other hand, the destruction of value caused by the wholesale market closures, I would accept both-they must both be there.

Q1566 Rory Phillips: May we look at page 3, which you have now turned to? In fact, the numbers are very simple, aren’t they? They show that the HBOS position in terms of percentage of impairments as at 2011 was over twice as bad as any of the competitor banks. That’s correct, isn’t it?

Lord Stevenson of Coddenham: Yes.

Q1567 Rory Phillips: And that is surely indicative, isn’t it, of something which distinguishes the HBOS book-the HBOS problem-from the problems encountered by the others we have seen along the table?

Lord Stevenson of Coddenham: I agree-just as I have described.

Q1568 Rory Phillips: This is a problem, isn’t it, not just of liquidity but, for example, of asset quality? Your book did a lot worse-it is as simple as that.

Lord Stevenson of Coddenham: Yes. I wasn’t actually trying to suggest that this was a problem of liquidity. I was suggesting and would suggest again that the closure of wholesale markets, which of course caused liquidity problems, but that is not what we are discussing, and a worldwide collapse in values, had an effect on the HBOS book. In a sense, I said what you just said to me, and I agree with you: given the nature of the HBOS-the old Bank of Scotland-corporate book, which had been that way for a very long time and very successfully, if you were trying to make a prediction, you would predict a greater set of provisions-regrettably; most regrettably. So I am agreeing with you basically.

Q1569 Rory Phillips: The other thing about this enormous number of 10.5% for impairments is that the Halifax part of the group-you have talked about the Bank of Scotland part-was a large mortgage provider and frankly, you would expect the impairment numbers to be considerably less, for example, than the competitor banks’ for that reason, wouldn’t you?

Lord Stevenson of Coddenham: I am not sufficiently familiar with their books and their businesses. From your premise, yes, but I need to look at the facts-

Q1570 Rory Phillips: Can we take it that you were familiar with their books and businesses at the time you were chairman?

Lord Stevenson of Coddenham: No, I don’t think you can. To have a detailed understanding of all the other banks would be beyond either a part-time or a non-executive chairman. I can’t put myself back in my mind to five years ago, still less 10 years ago-one would have a 30,000 feet view.

Q1571 Rory Phillips: But do you think that part of the problem here, when we look back at your evidence to the Treasury Committee in February 2009, is that you didn’t know enough about what was in the group’s book to give a clear and comprehensive explanation of what had gone wrong?

Lord Stevenson of Coddenham: You mean to the Treasury Select Committee?

Rory Phillips: Yes.

Lord Stevenson of Coddenham: No, I wouldn’t accept that. I would suggest that-what was the date again?

Rory Phillips: February 2009.

Lord Stevenson of Coddenham: In February 2009, I don’t think any of us knew enough about what had happened to give a comprehensive view. It was far too soon afterwards.

Q1572 Rory Phillips: Can I put it another way, and again, in very general terms at this stage? Did you learn more about the HBOS corporate book from reading the FSA reports-the final notices?

Lord Stevenson of Coddenham: Yes. I read a lot that surprised me.

Q1573 Rory Phillips: And was there any point, when you were reading those final notices about what went wrong in the corporate division, when you felt that you ought to have known more about what the corporate division was up to in the years before the collapse?

Lord Stevenson of Coddenham: I don’t think so. I found the reading, a lot of it, very shocking, a lot of it very surprising. But just to be clear-and you can judge it for yourselves-we as a board had access to very detailed management information about what was going on. We regularly reviewed the risk framework for the corporate business. We regularly discussed their policies and frameworks with them. To put it into context, this was hugely sudden. Go back to the beginning of 2008. We went into 2008, like everyone else, not feeling good about the environment-obviously, because markets had started to close, although people were beginning to be a little more optimistic; not us, but the world in general. In 2008, we had a good tier 1 capital ratio, I think twice the required amount. We had good ratings from credit agencies. We had received from the FSA advanced approval under Basel II, and, if you look at the corporate business at that point, it was performing in line with history. If you look ahead to the half-year results, as I recall, we had normal provisions.

Q1574 Rory Phillips: Is this in 2008?

Lord Stevenson of Coddenham: 2008, yes.

Look, I have to caveat. This is a long time ago, and I am getting myself back into the mindset. Obviously, reading these has refreshed my memory a bit. In 2008, as we had been in 2007, we had been fairly preoccupied by the stage we were at in the cycle, but with greater reference to our housing finance business than to anything else, hence we took a decision at some point to lower our exposure to the housing finance business and so on.

Addressing your question, if you go back to, shall we say, June or May 2008, and you read the monthly management information reports and the board papers, you will find that we reviewed in a forensic, anal way the detailed risk management guidelines and so on. I am sure that, if you go back to board meetings and the meetings of the corporate risk control committee, there would have been extensive discussions about our policies.

Going back to your question, reading the FSA enforcement reports, I found deeply shocking, but no, I did not- There was some surprise, because they- I was sitting there. We had had all the debates and the dialogue owing to the Basel process during which issues had been raised by the FSA about the risk management function of corporate, which we took very seriously as a board. I suspect that, if you go back to the minutes in 2007, you will find regular discussion of them, but, in the end, we had had advanced clearance, so, no. If you had said to me, "What else do you want to know?" in May 2008, given that we had a huge amount of information and we had been through all those discussions, I could not have said-

Q1575 Rory Phillips: Just to be clear at the end of that-I have chronology in my mind-you are saying, are you, that, as far as you are concerned, things were continuing in the regular and detailed way that you have explained until about May 2008, when something suddenly went wrong in the markets?

Lord Stevenson of Coddenham: No. To put it into a longer context, from whenever it was in 2007 that there was the first sign of markets stalling in different parts, we were on a fairly red alert, as some of the correspondence that you have included makes plain. Moving into 2008, we would have much rather, as would the rest of the world, that this was not happening in markets, but we felt that we were monitoring it well and keeping up with it. Since we are into chronologies, we had a horrible shock. I think it was March 2008 when there was a short-selling attack. I do not think "attack" is too strong a word.

Q1576 Rory Phillips: This was just after your rights issue?

Lord Stevenson of Coddenham: No, it was before our rights issue. I got into the office and found that the share price had dropped by 20%.

Q1577 Rory Phillips: What message did you think the markets were giving you about that short selling? Were they seeing you as vulnerable?

Lord Stevenson of Coddenham: Yes. I will lose my train of argument. I think what had happened-the background to that-was that, not just in this country, but all over the world, banks exposed to housing finance had been seen by markets to hit problems. In our country it was Northern Rock, Bradford & Bingley and so on. It was natural that markets would know who they were –and look through to us. That was what was happening to us, but as a result of having taken the decision some years before to take a substantial profit-and-loss hit, permanently, in exchange for lengthening our wholesale exposures, we were able to manage our process through the wholesale markets stalling in the way they did-not, may I say, satisfactorily. Nothing was satisfactory about that-it was a daily monitoring grind-but, as I think I said in one of the letters, we felt we had it under control, so, no, that wasn’t something that hit us in May. What hit us was Lehman’s. The following morning, the world changed.

It is important to have in mind, I suggest, although it is difficult to go back and think, that that point is well established-that if the Fed had not intervened a large number of the large American banks would have gone bust. To put it in context, all over the world-Dexia, the Fannies, Washington Mutual-strong, housing-exposed banks hit a huge amount of trouble. It was not May; Lehman’s was the horrible shock.

Q1578 Rory Phillips: Certainly the impression that the Commission, I am sure, had from Mr Hornby’s evidence yesterday is that from about the middle of 2007 he was in a totally different-

Lord Stevenson of Coddenham: Daily monitoring.

Q1579 Rory Phillips: Daily monitoring and firefighting, bluntly, to keep the thing going.

Lord Stevenson of Coddenham: Yes.

Q1580 Rory Phillips: That is the first point. The second question I wanted to ask you goes back to the short selling. Surely the position that the market had worked out in March 2008 was that you were a potentially vulnerable outlier, to use an expression coined by George Mitchell, in his evidence to the panel. They understood that you were relatively weak, compared to the other banks-already by then, in March 2008-didn’t they?

Lord Stevenson of Coddenham: Look, producing theories about what happened in the past is hypothetical and conjectural, but I will join in. I am still not entirely sure what happened in March 2008. I am not convinced that it was the purest of processes by the people who did it, but that is another issue. Undoubtedly, if I could de-emotionalise it and de-sensationalise it, to use modern jargon, I think for a period of time we were being shorted-not necessarily what I call shorting raids like that. Without a doubt-this relates to what I said to you three or four minutes ago-we were seen as vulnerable. The vulnerability was entirely predictable. If you have a situation where housing financing banks all over the world are getting into trouble and being seen to be vulnerable, it would be astonishing if people did not look through to us.

Q1581 Rory Phillips: Can I now come to the question of why the bank found itself in the position it did and see whether you accept the following suggestions? Perhaps they, too, were in the minds of the short sellers. First, the bank had grown too far and too fast, hadn’t it?

Lord Stevenson of Coddenham: Sorry, are you going to give me a list?

Q1582 Rory Phillips: Do you accept that?

Lord Stevenson of Coddenham: No, not put in that simple, soundbite way.

Q1583 Rory Phillips: You had embarked upon a plan of aggressive growth, which was unsustainable in anything other than benign economic conditions, hadn’t you?

Lord Stevenson of Coddenham: That is a big question and not one that is, frankly, simply dealt with in a sentence or two. To put it into context, if you look at the growth-growth of profits, growth of assets-from the beginning of HBOS, you had a three-year period with very high growth of assets and profits. That was largely planned. During that period, it was a result of-to use the modern jargon-the synergies of the merger, mainly on the costs side. A deliberate decision was taken round about year 4 that we should grow at a lower rate, and from then on-and please do not hold me to this because I obviously have not been back to all the documents-I think you will find we were targeting rates of asset growth of 5%, 6%, 7%, 8%. There was not, as it were, a tearaway, desperate run for growth. We felt we had competitive advantages and we wanted to exploit them.

There is a quite separate issue, which may be a question behind the question, as to the wholesale funding market, whether we were growing faster than the wholesale funding market finance, but in terms our growth targets, we actually grew at 15%, 16% for three or four years, then deliberately lowered it. I think there is a case for saying that the process of putting the budget together for 2006 and 2007, with the wisdom of hindsight, one might have adjusted it by one or two percentage points, but no more than that.

Q1584 Rory Phillips: But do you accept, for example, that the growth that did happen, and we will look at the figures in a moment, over the entire life of HBOS, was sustained by an ever-increasing reliance on wholesale funding?

Lord Stevenson of Coddenham: Yes, it could be put like that. One could also say, because I have not had the opportunity to watch or read all the previous interviews, but I have had access to some of them and there have been some very interesting discussions on them. Yes, is the short answer, but, hold on, I think it would be easy to give a simplistic answer to a somewhat simple question. We took deliberate steps to broaden the nature of the financing. We took deliberate steps to accelerate the rate of deposit growth and, if I may, I know that in earlier questions Lord Turnbull and Mr Quest asked a lot of questions about saying, "Hey, you identified wholesale markets as an issue back in 2003, why was it not dealt with?"

We indeed understood the role of wholesale markets. They were not all wrong. They were a very good alternative. They were a longer-term source of finance than retail deposits as events showed, because I think we lost £38 billion of deposits after the Lehman collapse, which flowed out of this. On our worries, I am addressing Lord Turnbull and Mr Quest in saying this; I am not sure in Phil Hodkinson’s interview they were dealt with. The worries we had then were long-term worries about wholesale markets. Looking five years ahead, as Phil Hodkinson said, could they go on financing us? Never for a moment were they addressed as short-term worries. Had we for a moment thought there was a risk of protracted closure of wholesale markets, we would have been bound to take very strong action.

If you look at the stress tests, which of course we did regularly-they were regularly discussed with the board, and effectively hand in hand with the FSA-it would have been astonishing if we had not included that as a risk. There would have been huge consequences, by the way, which I think the Commission will no doubt deal with, because it is an important issue for public policy. Yes, we were very well aware we were using wholesale funding. We thought about it, talked about it, debated it; if you look at our risk register, I am sure every year it would be there, but I hope you will find that it was properly and responsibly discussed.

Q1585 Rory Phillips: Just to deal with the problem as it emerged at the end of the bank’s life, you have talked a great deal about the amount of effort and work that went into it. It was a problem, wasn’t it, to use Mr Hornby’s words in his evidence to the Commission, that proved to be insoluble? Is that fair?

Lord Stevenson of Coddenham: Which problem?

Rory Phillips: The problem of the dependence on wholesale funding.

Lord Stevenson of Coddenham: The problem was the first protracted closure of wholesale markets since, I believe, 1913. Had that not happened, even if we had gone on limping along in Andy’s description-we reacted very fast, and I think you have included, as it happens, some correspondence with Callum McCarthy about this. We reacted very fast to the warning signs in the wholesale market, with daily monitoring. There was a terrifying chart that the board looked at on a regular basis and so on. Had wholesale markets continued not completely closed, I think that events would have been different, but it was the closure of wholesale markets that, effectively, did for us.

Q1586 Rory Phillips: But the reason why that mattered for you in your bank was because although you had built up your assets significantly, you had failed to build up your deposits to anything like the same extent. The ratio got worse and worse during the life of the bank, didn’t it?

Lord Stevenson of Coddenham: The funding gap got worse and worse. Actually, I think you will find that as a result of deliberate decisions taken to build up deposits, and linking people’s rewards to them-as I remember-the rate of growth of deposits relative to the rate of growth of wholesale funding improved. Of course, when you are going like that, the gap and the absolute figures widen.

But can I just make the key point-the Commission is trying to understand what happened and to learn lessons for the future, and this is that key area-that no one, not our regulators nor anyone else, predicted the possibility of a protracted closure of wholesale markets. I freely admit that we were very well aware of all the things that you are talking about. We considered and looked at them regularly, and we did not regard what we were doing as imprudent in the circumstances. As events turned out, since wholesale markets closed down on a permanent basis, it was awful.

Q1587 Rory Phillips: You were also vulnerable because of an over-concentration on property and on the other sorts of high-risk lending that you see from the FSA final notice that the corporate division specialised in. That made you vulnerable, didn’t it?

Lord Stevenson of Coddenham: I think, again, that context is important. There was the merger of Halifax and Bank of Scotland, and Bank of Scotland’s main business was corporate. That business had operated in those areas for a very long time-and rather successfully. It had patterns of provisions that, historically, looked very stable. Just to be quite clear, I would be surprised if three board meetings went by without the issue of our property exposure being seriously raised and debated-it was frequently discussed. The equity holdings were discussed less so, but they were also constantly challenged.

Someone said to me-not recently-that it was an example where experience counted against us. There was a long-term pattern-as I said earlier on, it continued into the half-year results in 2008-of the corporate bank, which was described rightly by the FSA as a "niche bank", trading well and knowing its business. The people in it, having worked in it for long periods of time, were not tearaway investment banking-type people; they were solid bankers. Suddenly, as a result of the closure of wholesale markets, and as I said earlier in our interchange about the appalling provisions, the fact is that a niche bank operating in those areas was more vulnerable to bigger write-downs in provisions than a less niche bank. But it is not that, in 2004, we suddenly said, "Wow. We must go into property and these things." This was a long evolution.

Q1588 Rory Phillips: Yes, but what happened on the merger was that the Bank of Scotland model, which you have described in some detail, expanded enormously with the greater firepower of the merged group. It became a much bigger business, didn’t it?

Lord Stevenson of Coddenham: No question. Just to be quite clear, I am sure that if you go back-you probably have-to the documents, you would find that that was an explicit intention. The presumption was that this was a good model that served society well. We had people who had worked it for a long time and understood it well, and one of the benefits of the merger, by making available a larger balance sheet, was to expand the business. There was no question about that.

Q1589 Rory Phillips: Well, in corporate specifically-we can look at the numbers-you went from £35 billion to double that in a couple of years. That was the plan.

Lord Stevenson of Coddenham: I cannot remember, so I am not going to say yes to that-I would need to see the figures-but that would not surprise me. It was definitely part of the merger strategy.

Q1590 Rory Phillips: Two more points on broad themes before I try to move us on to more detail. The first is that this was a bank with over-mighty divisions and a relatively weak central fund of expertise and control. What is your comment on that?

Lord Stevenson of Coddenham: I think you are putting words into my mouth-

Rory Phillips: I am making a suggestion-

Lord Stevenson of Coddenham: Over-mighty is a highly emotive term. There was definitely a strong belief in allowing people to run their business, which is nothing to do with being decentralised. I do not accept for a moment, however, that the centre was weak. You were dealing with some very strong characters; some very able characters. As events turned out, they-like me-feel "Oh dear!"

I would not accept it all. It was definitely a philosophy of decentralisation and of allowing people to run their own business, but on the other hand there was former chief executive, James Crosby, who was a very forceful-and some would say quite interventionist-chief executive. If you look through the finance directors, ignoring Mark Tucker who was there for a very short space of time, Mike Ellis and Phil Hodkinson were two of the ablest finance directors I have ever worked with. So I would not agree with that at all.

Q1591 Rory Phillips: The final point I wanted to suggest to you as a contributing factor was the culture of the group. The FSA report describes in great detail a culture that privileged business development-selling-over risk assessment. Is that a fair comment?

Lord Stevenson of Coddenham: First, could I clarify-I am sure you did not mean otherwise-that the FSA report was of course about the corporate business, not the group as a whole?

Rory Phillips: Yes.

Lord Stevenson of Coddenham: I did not recognise that in the report. A part-time or non-executive chairman, by definition, does not work day to day in any one part of the business. I see what it is getting at, but I did not recognise the idea that there were people on the road selling, selling, selling, with supremacy over the risk functions. I did not see that at all, and as I have said to you, I was not there day to day. We did review as a board. There was a board manual and there were risk manuals for each part of the business, which went into great detail, and we had to read every darn word at least once a year and to go over it in detail. We did meet the risk people at regular intervals, so it is conjecture. I think that that would be an oversimplification.

Q1592 Rory Phillips: Let us now look back at the final set of numbers-this is page 1 of these tables. The suggestion I am putting to you is that the problems of HBOS were solvency problems, rather than liquidity problems. Do you see that the table shows that the total book value in 2011 was just under £23 billion pounds? Listed in detail below are the contributions from the taxpayer-the Treasury-and from Lloyds, which was also perhaps partly from the taxpayer. You will see there that despite the injection of £28 billion, the total book value was only £23 billion, so was not the bank set on a course at the time of its demise that was inevitably going to lead to it going bust?

Lord Stevenson of Coddenham: Again, that is a very leading question, to which the short and simple answer is no. As I said earlier, I accept completely that it needed the capital but, just to be clear, the bank hit 2008 with twice the required regulatory tier 1 capital. Under Crosby’s leadership, we went to get more equity capital, at a time when markets were very cross with us for doing it, as they would have rather that we had taken more risks and gone for less capital. I think you will find that if you study our capital ratios over seven or eight years-which, in retrospect, I must confess that I have not done-you would find that we paid a great deal of attention to them, with possibly greater conscientiousness than some other banks. That is not very surprising, because of course-this is my recollection-that was the main focus of the FSA. It was rightly focused on capital ratios, although in a sense it was not so focused on liquidity. So, no, this is what happened as a result of the liquidity problems: we needed more capital and the provisions that follow upon it. But until that point, I think you will find that we had very good capital ratios.

Q1593 Rory Phillips: But, if I may say so, that is an entirely hypothetical answer. What these numbers show cannot really be disputed, can it?

Lord Stevenson of Coddenham: I am not-

Rory Phillips: Injections £28 billion; value £23 billion. On my basic maths, that means you are £5 billion short.

Lord Stevenson of Coddenham: I am not disputing them. I cannot remember the exact words you used, but I was not agreeing with those words. There is no question that in the world that we found-not "we", because I wasn’t there, so the world that LBG found-as a result of the extraordinary provisions write-downs, the bank was short of capital, so there were capital issues. There is absolutely no disputing that; I agree with you completely. What I do not agree with is that it was run in such a way as to make that an inevitable consequence-quite the reverse. If you go back and study our board meetings, our interactions with the FSA and what we actually did, for a period of time we were very preoccupied with solvency ratios.

Q1594 Rory Phillips: Indeed, but being preoccupied is not necessarily the same thing as achieving an answer. What I am suggesting to you, so it is absolutely clear, is that the model that you pursued-and continued to pursue-would have made the bank insolvent in any event.

Lord Stevenson of Coddenham: I am suggesting to you back that I absolutely agree that we failed to foresee, first, the possibility of a protracted closure of wholesale markets, and therefore, secondly, the knock-on effects on liquidity and on values, and therefore on solvency ratios. I completely see that. To be fair to us, and I am not trying to mitigate this, no one saw it-certainly not our regulator, certainly not the Bank of England, and certainly not the Treasury. It was not on the agenda, and it hadn’t happened for nearly 100 years.

To the extent that we failed to do that, you are right. Absent that, and I think we pursued-I don’t want to use emotive words-reasonably prudent policies on capital solvency.

Q1595 Rory Phillips: Do you accept that there was a time earlier in the cycle-your statement to the Commission talks about the cycle-when you could and should have changed course, and that that would have avoided some of the problems that hit you from 2007?

Lord Stevenson of Coddenham: I think you are talking corporate aren’t you?

Rory Phillips: No, I’m talking about the group.

Lord Stevenson of Coddenham: Because we did make some fairly major decisions that were cycle-driven in our main business, which was housing finance.

Q1596 Rory Phillips: In your evidence to the Treasury Committee in February 2009, you said that you accepted that the bank was over-exposed at the wrong point of the cycle. At that stage you were putting it very simply.

Lord Stevenson of Coddenham: It’s true.

Q1597 Rory Phillips: Is that still your view?

Lord Stevenson of Coddenham: It is true.

Q1598 Rory Phillips: Had you failed to respond to the way economic conditions were changing?

Lord Stevenson of Coddenham: No-

Q1599 Rory Phillips: That was a criticism made by the FSA, wasn’t it?

Lord Stevenson of Coddenham: If we can go back to your question, rather than the next one. You want to find out what happened and to learn lessons, and I am really anxious to help in that. I don’t want to be defensive; I just want to get it right.

We took the view-if you read the guidebook pages we produced-that it was not necessary to reach the top of the cycle, as I put it. We were rightly worried; you saw the housing market going up, and all those things going on. Rightly or wrongly, and it was both right and wrong-right to do it; wrong in its exclusive emphasis-we focused much more on the housing market than anything else in being prudent. Of course, we were the No. 1 in that. We took-I think on Andy Hornby’s watch-a very brave decision to cut our share of the housing market, and we got rained on from all sides: from the Palace of Westminster, markets, customers, and everything else in sight.

To come to your question, of course-I think I referred to this earlier-if you look at the growth targets for 2006 and 2007, which I think were 6% and 8% in corporate, with the wisdom of hindsight, it would have been good if they were lower. Let us be quite clear, however, that had they been lower, I do not think it would have changed anything. After Lehman’s went and wholesale markets closed, exactly the same thing would have happened. The provisions figure would be a bit lower, although not hugely.

So yes, with the wisdom of hindsight, I wish we had done that. Having said that, just to go back to what I said before, you were dealing with a corporate business that had evolved carefully over a long period of time, with very good historical provision rates. Okay, we perhaps should have been wiser, but it is quite a difficult thing to do.

Q1600 Rory Phillips: But the corporate business was now operating on a completely different scale, wasn’t it? You have already accepted that.

Lord Stevenson of Coddenham: It was a bigger business. It was broadly the same people, the same training and the same skills.

Q1601 Rory Phillips: Do you think there was a problem in the corporate division, that they failed to adapt? In other words, they were using the same skills, the same approaches and the same strategies, when in fact the economic conditions around them were changing.

Lord Stevenson of Coddenham: That is a perfectly fair question, and I cannot say no to it; I do not know. You would have to have been living with it day by day. On fundamentals, the thing that hit corporate was the post-Lehman’s closure of wholesale markets. In response to your question, "Could they or should they have modified their game in the light of events?" the answer is: possibly.

Q1602 Rory Phillips: Will you look, please, at the FSA final notice, which is at F1, page 17? Paragraph 4.54 picks up precisely the point that you have been making. The FSA say, "Prior to the start of 2006…the Firm"-not corporate; the firm-"had recognised that the economic cycle was at or reaching its peak." If you turn to the next page, however, you will see what actually happened: "Despite this, from the outset and throughout 2006, Corporate focused on revenue generation. The Firm did not take reasonable steps to assess, manage and mitigate the potential risks of this strategy."

There are two criticisms there by the FSA. The first is that they saw the economic cycle changing, but they still focused on revenue. Secondly, the firm, by which the FSA means the group-you, at the head of the board-did not take reasonable steps to assess, manage and mitigate the potential risk. Do you think that is a fair criticism, made by the FSA?

Lord Stevenson of Coddenham: I am trying to give a considered answer to a very simple question. First, and please bear in mind that this is referring to things that happened a long time ago where I do not have access to the detailed figures, there is an element in page 18 that is highly relevant to your question and that, from memory, is more than a little misleading. As I recall, a large amount of the increase in profit before tax was a result of realising equity investments, which is something I and the board thoroughly approved of, and I still do. It was the right thing to be doing at the time. I would like to see the aggregate figures here with the amount-I seem to remember that that was a huge amount of the profit figure. It did not result from people rushing out and getting fees for lending more money; it resulted from selling equity shares and realising legitimately bookable profits on them. In response, I think this is a rather extreme picture painted. I think I have already given you the answer to your question, which is that the firm-we as a whole-recognised that the cycle was not breaking, but it was topping. I think I said in my submission to you some weeks ago that the external pressures were to grow faster, from analysts and shareholders. From Mr Greenspan down, it was not conceded at all that we were at the end of the cycle. I think I said to you earlier that yes, of course, I wish we had at that point been wise enough to say, as we did with housing, "Hold on a moment. Let’s pull it back a bit." I do not think it would have made much difference to outcomes.

Q1603 Rory Phillips: Look at two paragraphs on, because it is a little more extreme than the position that you have outlined: "During the Group challenge process the Firm"-again that is the board-"had directed Corporate to double the profit target contained in the plan." In fact, what the FSA is outlining is this situation, isn’t it? Corporate comes with their plan and at board level they are told to go back and double their profit target.

Lord Stevenson of Coddenham: That is inaccurate. Again, in an exchange like this where you are asking me questions and I am doing my best to answer them, there is a risk of my over-simplifying my answers. I want to stress that I have not had the chance to go back to see all the papers. I do not remember the board directing corporate to double its profits. I think it is terribly unlikely that we would have. It is just not the way that we operated as a board.

Q1604 Rory Phillips: Will you turn to page 19, please? Paragraph 4.65 relates to the following year: "Corporate had originally proposed targets for 2007 of 10 to 12% UPBT growth. During the Group challenge process the Firm directed Corporate to increase this target substantially." Are you saying that the FSA has also got that wrong-the next year?

Lord Stevenson of Coddenham: I think it is your definition of what the firm means.

Q1605 Rory Phillips: Will you look at page 1 of the document? You will see it is not my definition, Lord Stevenson. It is the FSA’s definition: "The FSA gave Bank of Scotland Plc (the ‘Firm’) a Decision Notice."

Lord Stevenson of Coddenham: Okay, but you are interpreting the firm as the board. Your words were, "the board directed". I do not believe the board did either of those directions. I cannot rule out the possibility that in the interchange between divisions and executive management there was direction. I would be a little surprised if the word "directing" was the right one. I am as certain as I can be without referring to it that there was no direction from the board. It was not the way the board operated. We were there to challenge and it was up to the executives to work out.

Q1606 Rory Phillips: Let us look at it from the other perspective. The evidence that Mr Cummings gave to the panel inquiring into HBOS is that the first time he was told by the board during this challenge process to rein back a bit in the corporate division was in June 2008. Does that fit with your recollection?

Lord Stevenson of Coddenham: Not at all.

Q1607 Rory Phillips: Did you ever at any point before that, when you were seeing what corporate was doing in its reports to the board, suggest that the division should rein back a bit?

Lord Stevenson of Coddenham: Can I make it plain? There is this confusion between the firm and the board in definition. I think somewhere in this great pack there is a letter from me to Callum McCarthy that certainly predates June 2008. It refers to the fact that since wholesale markets started to close down on us-not completely-in 2007, decisions had been taken to rein back on asset growth and that Andy Hornby was implementing that. I think I referred to the fact that he was doing that without fear or favour and spreading the pain equally. You may infer from that that it was happening long before June 2008.

Q1608 Rory Phillips: So Mr Cummings has got that wrong.

Lord Stevenson of Coddenham: I do not know the context. Mr Cummings is a very open, honest guy who has had a very rough time. I do not know the context in which he said that, so I am not going to say that he got it wrong. I can tell you that it is a matter of fact that, of course, we-the firm, the business-were reining back our growth when wholesale markets started to close.

Q1609 Rory Phillips: You are not suggesting to the Commission that you at the board were unaware of what Mr Cummings was doing in the corporate division, are you? You were getting regular reports.

Lord Stevenson of Coddenham: Of course, we got the monthly information reports.

Q1610 Rory Phillips: Can we look at some of those, please? G8 is the first one. It gives a snapshot of lending during September 2002. Then the head of corporate was George Mitchell. You will see his name on the top right-hand side. It shows, doesn’t it-at the top of the page, third column-that there were four facilities over £500 million. Now turn, please, to G9, and the second page on the left-hand side. This is three years later; he’s still in charge. You will see that the total number of such facilities has now risen to 12-the first 12 numbers-and that the highest is now £2.1 billion.

Turning to 2006, we now have an entire page of facilities over £500 million, don’t we? There are 17 in all. Turning to the next page, for 2007, there are 18. And finally, in September 2008, could you look please at G12? Again, an entire page, and the two at the top are bigger than any of the facilities we’ve seen on the previous pages, I think you’ll agree: £2.8 billion and £2.4 billion. This is a very good way to see how this division was expanding and continued to expand over the years, and it was material that was being put before you and your fellow directors on the board.

Lord Stevenson of Coddenham: Yes.

Q1611 Rory Phillips: What was your reaction?

Lord Stevenson of Coddenham: Just to be quite plain, there was a question in the questions you sent us which appeared to imply that the board took credit risk decisions, which of course we didn’t, and the FSA explicitly, as I remember, forbids us from doing it. This was retrospective information that the board was given: the highest outstanding credits-if that’s the right word for it-to inspect, and they would typically provoke discussion, sometimes, as I recall, about the principle. There was a concern-a correct concern, as it turned out, and one I personally shared. It wasn’t against our exposure to these very successful entrepreneurs, but I did worry a bit about it, and we would have that discussion quite frequently. Every now and again, one of us, from personal knowledge, would see an exposure to a particular person and raise questions about it. That was its purpose; it was retrospective information, so that we knew what happening and we could ask questions about it.

Q1612 Rory Phillips: So if a name came up, on an ad hoc basis, you’d ask him a question about it.

Lord Stevenson of Coddenham: The names have been blocked out, very properly, but they were here. We would all read through it. I can’t, and wouldn’t-you wouldn’t expect me to-give you actual chapter and verse; I can’t remember any. But there were situations, I think once or twice, where I had visibility into something that was happening and I’d say, "Are you quite sure that we should be doing this or that?", and sometimes, it had an effect on what was happening. But it was to give us a feel as to what was happening.

Q1613 Rory Phillips: These were in very large part individuals, or individuals controlling companies, in the field of property development and speculation, weren’t they?

Lord Stevenson of Coddenham: They were a mixture. That was, as it always had been, the nature of the business, and it contained quite a large number of entrepreneurs. It also contained a lot of the less entrepreneurial companies-let’s get this into perspective-so it was a mixture.

Q1614 Rory Phillips: And you knew, presumably-as summarised by the FSA at F1, paragraph 4.11, on page 8 of their final notice-that this was a very high-risk book that corporate were writing, for the reasons they give there?

Lord Stevenson of Coddenham: I think that that, if I may say so, is a retrospective judgment.

Q1615 Rory Phillips: Well, can you just look at the paragraph in the report, please-4.11, page 8, at F1? Were you, as chairman of the group, aware that this-

Lord Stevenson of Coddenham: Hold on-which page?

Rory Phillips: Page 8, 4.11, where they describe the risk profile of the corporate book. Did you know that that was the nature of the book?

Lord Stevenson of Coddenham: We all knew that we were a bank business; I think they use somewhere the niches-entrepreneurs, exposed to property, equity investments and so on. We all debated that and were concerned about it, but just to get it in perspective, this is the FSA talking about a period of time during which they gave us advanced approval under Basel II. It is very important you understand this: there had been-they had raised worries about corporate, which I am sure if you look through this sequence of board papers you can find, and which we had taken very seriously. By the way, as they acknowledged-although possibly not enough-Peter Cummings had thrown himself into improvement. If I try to imagine what was going on in my own head at the time, yes, of course, we all knew this was by definition a different kind of business from a conventional banking business, and on one level it could be said to be higher risk exposures. However, we took comfort from, first, the regular stress testing and, secondly, the fact that we had advanced approval under Basel II from our regulator.

Q1616 Rory Phillips: But did you specifically know that your corporate book, as it says in paragraph 4.10, "had a higher risk profile than equivalent books at other major" banks?

Lord Stevenson of Coddenham: I cannot say that it was seven out of 10 as opposed to six out of 10. I go back to the answer I have just given you; if you are a bank that is focusing more on entrepreneurs, commercial property and equity investments, that is by definition higher risk and you need to have risk systems and risk management to cope with it. Personally, and I think this would apply to the board, I felt that we did. I took comfort from the stress testing and the advanced approval under Basel II. As it turned out, with what was, as we said, the catastrophic depreciation of value post the protracted closure of wholesale markets, that was wrong.

Q1617 Rory Phillips: Can we look, please, at your statement on this point? It is C3 in the file: paragraph 3(6), on the third page-they are not numbered-at the bottom. I am just going to read it out: "The Corporate Division, for example, was known to have a significant exposure to the commercial real estate market and to be dependent on wholesale funding. The division had operated very successfully for a number of years. We believed that the risks in that business were known, and were constantly being addressed. With the benefit of hindsight, it seems apparent we did not understand properly all of the risks." That was the problem, wasn’t it? The Bank of Scotland professionals, many of whom had been in post, as you have been saying, for many, many years, long before the merger, were doing their magic and producing remarkable numbers, and you in the board did not really have a handle or a grip on it. You did not know enough, did you?

Lord Stevenson of Coddenham: You stopped reading.

Rory Phillips: Please continue.

Lord Stevenson of Coddenham: "In particular, we did not understand or address what would happen if the wholesale funding market closed." I do not accept at all what you say. First of all, there are emotive terms in your language. I did not see the Bank of Scotland professionals "doing their magic"; and I would be very interested to see a comparison of the asset growth and the profit growth businesses of our major competitors, but I do not think you would find it that much out of line. I saw them. They were typically people like Peter Cummings, who had worked for the bank for 20 or 30 years, very loyally-most of them had refused higher offers to go elsewhere, as Peter did on many occasions-doing a job they understood well. It was not about magic: it was hard graft and work. But when I say here that "it seems apparent we did not understand properly all of the risks", that is an accurate statement of what I believe. If for a moment I personally had thought-or even if I hadn’t, the board had thought-there was the risk of wholesale markets closing for a long period of time, we would have had a real problem, and we would have reined back that business. That is the risk we did not understand.

Q1618 Rory Phillips: But as the FSA point out, the book was inherently high risk. You did know that, or you should have done. Why were you not concerned, as it grew and grew and grew over the years of your chairmanship?

Lord Stevenson of Coddenham: With respect, I answered that question about 10 minute ago. The issue of the risk controls in corporate was pored over by the board, and you can see paper after paper on it. I think they were looking at 2006 to 2008, and as it happens, that is the period of time during which we had a close and continuous discussion with the FSA about Basel II advanced clearance, where the issue of the corporate risk management system was high on the agenda and constantly looked at.

It is one thing to say that, yes, these were higher risk than plain vanilla lending to large corporations; it is quite another to say that we did not understand that and did not have risk systems to cope with it. As I said here very openly, we clearly did not understand the risks involved and we did not understand the knock-on effect of wholesale markets closing. But I think it was not unreasonable. We had debated it at great length; if you look through the eight years, you will find constant board papers on the risk management function. In that period, we had huge debate on it precisely because of the Basel II process.

Q1619 Rory Phillips: But is not the problem here that perhaps you were spending so much time getting yourselves Basel II compliant and working on rather technical risk management systems that you took your eye off the basic problem, which was that this division of yours was continuing to grow at a time when the cycle had changed? Because of its property base, and all the other matters you have just discussed, it was particularly vulnerable, whatever risk system had been applied.

Lord Stevenson of Coddenham: I have already said that in 2006-07, with the wisdom of hindsight, it would have been a good idea if the target growth rates had been lower. I have also said that I do not think it would have made any difference to outcomes. But given that, I think the answer to your question is no, there was not a problem. The management information and the discussion with corporate business continued relentlessly, and there was frequent challenge of what it was doing.

Q1620 Rory Phillips: Talking about challenge and the composition of the board, in relation to the experience and expertise of the non-executive directors during your time, which of them had banking experience?

Lord Stevenson of Coddenham: Sorry, of the directors?

Rory Phillips: The non-executive directors.

Lord Stevenson of Coddenham: During my time, Kate Nealon had been in charge of group compliance and legal matters at Standard Chartered.

Q1621 Rory Phillips: When did she join the board?

Lord Stevenson of Coddenham: Oh, 2003 or 2004, something like that. I cannot remember, but she was on for a longish period of time. John Mack, who was on the board for the last two years, had been the treasurer of Bank of America. I think they would be the only two who had been cradle to grave bankers. There were a number of other people on the board, including myself, who had had considerable involvement in the banking system, one way or another; I think Mr Quest talked to Tony Hobson, who is a very experienced man.

There is something that has not emerged in this whole discussion about "If the banks of the world had had professional bankers as non-executives." I actually looked hard at that in about 2009 or 2010, because when something like this happens you re-examine and re-examine. I think you would be hard pushed to make the case for distinguishing between banks that survived without assistance-of which there were very few-and banks that had to be helped in whatever countries they were in, and the number of bankers on the board. However, I would like the Commission to be aware that I was personally very keen to up the number of non-executives with banking experience. I have read articles-not from the Commission-about that, of which there have been a lot over the last few years, because for obvious reasons, this subject keeps coming up. It is very difficult to achieve.

Just to be clear, we spent-in 2003, 2004, 2005, something like that-the best part of a year head-hunting throughout continental Europe and the United States of America to find career bankers to join the board. It is very, very difficult to find them in this country, for the obvious reason that they are working, or have been working, for competitors. We pretty well drew a blank. I had one quite serious conversation with a very distinguished man who was effectively the chief executive of a major continental bank, and got quite close to landing him. In the end, he said that although he did not think there were conflicts there and then, he could see conflicts coming up, and I could see it from his point of view. Secondly, he was quite worried about the time commitment. It is much easier said than done.

Q1622 Rory Phillips: But it does at least suggest that you were aware that the banking expertise of the non-executive directors needed to be supplemented. It needed to be strengthened, otherwise you would not have been looking.

Lord Stevenson of Coddenham: I think that is giving me too much credit. As a matter of prejudice, I felt that it would be a good idea to have one or two people from the banking community and found it very difficult to achieve. In practice, I felt no lack of challenge from the lack of banking backgrounds on the board.

Q1623 Rory Phillips: What about the executive directors? For most of the HBOS period, it looks as though the real experts in terms of experience were Colin Matthew, who became the head of international, and George Mitchell first and then Peter Cummings, who were the head of corporate. Is that right?

Lord Stevenson of Coddenham: You are talking on the board, as opposed to the internal challenge?

Rory Phillips: On the board, yes.

Lord Stevenson of Coddenham: Yes. Although a number of the other executives at various points in their careers had been involved with corporate banking, and I assure you that none of them were pushovers at all.

Q1624 Rory Phillips: No, but as it has turned out, of course, those are the two individuals at the head of the divisions that had the giant loss-the gigantic amount of money-that we went through together.

Lord Stevenson of Coddenham: That is true.

Q1625 Rory Phillips: Is not the problem here that there was not sufficient strength and expertise to challenge those main board executive directors as to what on earth they were doing? Nobody knew enough to give them the real challenge they needed.

Lord Stevenson of Coddenham: I do not agree. I think that in practice, if you take an oil company, the chances of there being specialist, non-exec directors who would challenge the fundamental, long-term investment strategy in refineries are very small. There is a hugely important role for non-exec directors, but I think that is a misconception. I would say about the board-you have talked to some of my colleagues-that it was very transparent. There were absolutely no shrinking violets. It was an atmosphere where people were able to be very direct and blunt. There were one or two occasions when great offence was caused, but we had a very open society. There was constant challenge, not just of corporate, but of the other divisions.

Let us say that we had managed to get the recently retired head of the corporate division of Wells Fargo, to take one of the few banks in the world that appears to have sailed through this. Let us say that we had managed to get that person. He or she would be a good addition, but they would come to a board meeting once a month, perhaps one other meeting at the same time, and read the papers, and I frankly think that they would be unlikely to mount a challenge that would fundamentally change the business. There were challenges around the table, but there were built-in challenges from other sources.

Q1626 Rory Phillips: But doesn’t that suggest that there was an inbuilt weakness in your structure? If even somebody as distinguished as that would not have been able to make a difference because of the very short board meetings once a month, was there not a problem with the way you were governing and running the group?

Lord Stevenson of Coddenham: I would like you to tell me what it was. By the way, I note the reference to the very short board meetings. I have picked up that someone at some point said they were short. If you would like to come to it, they were not, just to be absolutely clear.

Q1627 Rory Phillips: Well, it was a question that came up yesterday. It was suggested that they were two hours long, and I think Sir James indicated that they were longer than that. But for a group of this size, meeting once a month, did that not inevitably limit the potential for challenge that non-executive directors had?

Lord Stevenson of Coddenham: If we may-if you want to-could we come back to the issue of the length of the board meetings? But, first, my reflections are on the nature of boards and the role of non-executives. I would actually say, and I say this not at all defensively-I made it plain that it is awful what happened; hardly a day has gone by when I have not thought about it-that it is actually rather the reverse. Quite a lot of low cunning and malice aforethought went into trying to make sure there was a lot of challenge and different ways of challenging. There are the obvious ones. The executive challenge was built in. We have discovered that there is no way that the people in the centre of the divisions were pushovers. However, you will have gathered that we invented the so-called risk control committees. That came out, funnily enough, from me. Before I became chairman, I was given a letter from whatever the equivalent of ARROW used to be called at the FSA, which had swingeing criticisms of the audit function in the old Halifax. I thought about this and I met the chairman of the audit committee, who seemed very good, and I realised that it is asking too much to have the entire audit function under one roof, so we should devolve it.

Secondly, although Halifax, compared to a lot of banks, was a relatively simple business-even after HBOS, it was a relatively simple business-I reckoned, precisely to your point, the idea that a board, meeting for however long it was meeting for once a month, could actually encompass the totality of everything going on was a little far-fetched. So we set up the corporate risk control committees, populated and chaired by independent directors, and populated, in addition to independent directors, by executive directors from other parts of the business, and with the innovation that we brought people from outside. I do not know whether you have read anything in the papers. They were very long meetings. If you looked at the corporate ones, from memory, they would be three or four hours, and they really exhumed everything and went over them.

So, going back to your question, no, I do not accept it. I think the governance was rather good. That does not mean to say it was perfect. I am open to any suggestions how it could have been. The board meetings were functional and gave huge opportunity for challenge.

Q1628 Rory Phillips: We will come back to the risk issue later.

Lord Stevenson of Coddenham: Do you want to come back to the length of timing?

Q1629 Rory Phillips: Yes, please do. What do you want to say about that?

Lord Stevenson of Coddenham: It is simply not the case that they were two hours long, although I do not think we had stopwatches out. I seem to remember that the standard time that they started was 10.30. The aspiration was to end at 1, but it rarely ended before 1.30. It would often run on. Furthermore, a lot of thought went into how to make them productive. Again, when I became chairman of Halifax, I spent a weekend reading-it was quite a tiresome process-the board minutes for the last five years, and I concluded that they were spending the majority of their time doing pro-forma non-contentious items. So I sat down with the company secretary and with James Crosby, and we worked out a way to limit those items to 15 or 20 minutes in each board meeting, and we put a lot of the others into committees. We embarked on a procedure, which we then refined by saying that we must have at least two major discussions on key strategies at each board meeting.

I personally have a rooted objection to taking the trouble to read a paper of, say, 15 pages, with 20 pages of annexes, and spending an hour or two on it, and then coming into the meeting to find the executive re-presenting it with the magic of PowerPoint. So we brought in a regime that said to the executives-let us say, Phil Hodkinson, who was running investment and insurance-if you produced a detailed paper, a strategic review, you should assume that the non-executives have read it, and I will do my level best to make sure that questions that reflect lack of reading do not get asked, and you can ring them at home up to and including the board meeting. You-I give Phil Hodkinson as an example-are not allowed to repeat the paper. You can speak to it for five or, maximum, 10 minutes, thereby freeing up a much greater space of time to discuss the strategic issues. That is a robust rejoinder.

I would say that the board meetings not only were not too short, but they were very effective and worked very well. Outside of the board meetings, there were considerable opportunities, of which corporate risk control committees were only one, for non-executive directors to be engaged in the business, on top of which I myself made it my business to stay close to the non-executive directors to get feedback and feed-in.

Q1630 Rory Phillips: On the governance and structure point, Mr Cummings also told us that he had argued strongly for an end to the divisional structure of the group and that that argument had failed. In other words, the divisional structures, we know, remained until the time of the bank’s collapse. Didn’t that structure with the divisions that we have been talking about-at least some of them-make it more difficult in itself for the centre, for the group, to challenge, control and direct in a way that was effective?

Lord Stevenson of Coddenham: In all organisations, there is no perfect structure. Secondly, I cannot remember that debate. It may be that I have forgotten it. It may be that it did not get to the board. If Peter Cummings was putting it forward, it would have been well argued and thoughtfully presented. I do not quite know what he had in mind. It is quite difficult to imagine how it would have worked. I would not personally say that the divisional structure was the only structure that we could have had; there could have been other structures that would have worked. I think the divisional structure, as you will appreciate, is a very conventional structure in businesses. The difficulty in having this conversation with all of you is that, given what happened, I may say it worked rather well, but you will say, "Come on." Actually, I think it was working pretty well, but like all these things, it had pluses and minuses and I am absolutely certain that there were alternatives that could have been debated, and it sounds as though Peter Cummings did discuss alternatives. It is a rather academic-there’s an academic point here-but I would be quite interested to hear what it was.

Q1631 Rory Phillips: The final question from me. Can you turn please to F1 of your file, which has the FSA report on the bank? On page 13, at paragraph 4.26, is the FSA’s summary of the culture as it perceived it in corporate, which we have touched on briefly. It states: "(1) staff were incentivised to focus on revenue rather than risk"-I put that point to you earlier-"which increased the appetite to facilitate customers, increase lending and take on greater risk…(3) the business was resistant to change, which would impede any efforts to improve the control framework and to prioritise risk management". The fourth point is that there was a culture of optimism and the fifth states that "risk management was regarded as a constraint". Now, you have given the impression to the Commission this morning that risk structures and risk management were high on your agenda and something you spent a great deal of time on. Can I take it therefore that you reject each and every element of the cultures described there by the FSA?

Lord Stevenson of Coddenham: You are very good, Mr Phillips, at laying down a presumption and drawing an inference from it that does not necessarily follow.

Q1632 Chair: Will you just tell us which of those you agree with?

Lord Stevenson of Coddenham: Can I just answer the question please, Chairman, because the question is being put and I think it is fair? I, indeed, said that risk was taken seriously and I would suggest that any examination in any period of time of our board papers will bear that out.

Q1633 Rory Phillips: Can we take it that you do not agree with the fifth point on risk management?

Lord Stevenson of Coddenham: I will come to the Chairman’s point, if I may. I do not recognise some of these points. On the first point, that staff were "incentivised to focus on revenue rather than risk", I tried to find the substantiation to that. I have forgotten the detail of our remuneration policies, but they developed in such a way as deliberately to focus people on the long term. I would be interested to see the FSA substantiation for that. I find it difficult to comment on the second point, because I do not feel competent to do that. The business was not resistant to change under the leadership of Peter Cummings. He was changing a great deal, as you can read in the papers-indeed, even the FSA concedes it at various points. The culture of optimism is a subjective view. I did not feel that the kind of human beings doing it or Peter Cummings himself were eternally smiley, optimistic people wanting to believe the best. On the fifth point, that "risk management was regarded as a constraint on the business rather than integral to it", I am absolutely certain that there must have been someone aged 30 who tried to do something and fell out with risk management for stopping them doing it, but that was not my impression of risk management. So, broadly, no, I do not recognise all of these points. More importantly, I did not see a substantive justification of them in the text.

Chair: We have been running for more than an hour and a half and other colleagues have not had a chance to cross-examine you. We will take a 10-minute break now and resume at 11.15 am.

On resuming-

Chair: It would be very helpful if you could try to stick a bit closer to the direct question that is put to you with a direct and, if possible, shorter answer.

Lord Stevenson of Coddenham: Sorry. I will do my best, Chairman.

Q1634 Lord Turnbull: Lord Stevenson, could I go through what are quintessentially the duties of a chairman? One is a question of strategy. You were there right at the start. You use a phrase in your evidence: "taking advantage of a balanced portfolio between the three largest divisions of the bank." I suspect that this business model was not balanced at all. If you read the transcript from yesterday you will also see how I put it. You had one division-corporate-expanding very fast and expanding its risk. You have another division-international-which slightly later in time expands very fast and expands its risk. You have a mortgage business which is already so big it is quite difficult to expand but it expands quite substantially in so-called specialised mortgages, which is a euphemism for self-certified and buy-to-let. You introduced a way of managing treasury which accepted more and more risk. What this was built on were the foundations of wholesale funding, which itself was a risk. You now recognise that there were interactions. So instead of synergies, some of these things compounded themselves. This whole thing, from the start, I suggest, was nothing like the safe, balanced portfolio you are portraying.

Lord Stevenson of Coddenham: Stopping the clock now or in 2008, 2009, I can see exactly why you are saying what you are saying. Go back to the early 2000s-you are absolutely right; it may be a false premise, but the premise was that there were synergies between the two and for a period of years there definitely were. There are the results, there were cost synergies, there were revenue synergies and so on. It is undoubtedly the case that given what happened, with the wisdom of hindsight, it did not achieve the balance that was required. Two comments on the narrative. First, you said that although treasury was a profit centre fundamentally set up to fund the group, that it failed to-ironically, because it was seen as a conservative source of liquidity-was entirely because the markets closed up. Secondly, in the mortgage business within what I call the retail division, which, of course, had quite a number of other products and developments-you are quite right about the mortgage business; we were No. 1-there was not huge growth. In fact we eased back on growth. But if you are saying to me, "As it looks now, did the balance strategy work?", no, it didn’t; but it was thought about a great deal.

Q1635 Lord Turnbull: We then come to this question of your use of the word "hindsight". How far was the weakness of this model foreseeable? There were warnings from the FSA and warnings in various corporate plans as early as 2002, talking about wholesale funding as a risk. At one point you said that Phil Hodkinson described it as long-term risk-five years. In other words, by 2002, it was a risk. But by 2007, it had become even more of a risk. In other words, something that was a risk-a structural weakness of the business-was addressed, in one sense, in that you pushed out the maturities, but you never made the real push to bring the growth of assets and deposits into better alignment, so that by the time you got to 2007, the wholesale funding gap was even bigger than it was at the start.

Lord Stevenson of Coddenham: First of all, at the risk of sounding repetitious, I underline that in describing the wholesale funding as a risk, no one envisaged it to be a short-term risk. It was about the question, looking into the long term, will we be able to draw, as our business grows, on wholesale funding to the same extent?

Secondly, we took steps-I think, with some hindsight, rather good and intelligent steps-to guard against what seemed to us and our regulator to be the maximum risks, which is why we were able to survive through late 2007 and right through 2008, to lengthen the exposure to wholesale funding.

Thirdly-I can’t remember whether this was an interchange with the Chairman or with Mr Phillips-you were quite right to observe that the aggregate amount of wholesale funding increased. But we also were taking steps to increase the rate of deposit growth. The hypothetical, conjectural question, which is a perfectly reasonable question to ask, is-

Q1636 Lord Turnbull: But by 2007, the corporate treasurer was pointing out-in bold letters in one of the corporate plans-that your wholesale funding gap was bigger than the other banks put together. Surely you must have thought that you must do something-not just pushing out maturity, which buys you time, but doing something about this fundamental issue, which, along with the corporate risk-taking, turned out to be the two things that brought the bank down. They were identified as early as 2002-03. Having these pointed out to you and discussed, they still did not get addressed four years later.

Lord Stevenson of Coddenham: As a matter of fact, what brought the bank down were global wholesale markets the day after Lehman. That was it.

Q1637 Lord Turnbull: I would contest that, because there was a series of feedback loops here. One is, why were property prices going up so much, which enabled people to borrow more? Because you yourselves, along with one or two other banks, were fuelling it. Someone should surely have been looking at what was happening to property prices.

If you look at the four last banking crises, property was absolutely at the heart of them. Yet this is a bank that increased not only its corporate lending, but the proportion of property lending, and it did so by funding entrepreneurs. By and large this money did not go to big plcs with big balance sheets, but to highly leveraged entrepreneurs. You also added these structured finance riders. Having known, with a sense of history, just how dangerous the property market can be, you plunged on in continuing it.

Lord Stevenson of Coddenham: In the generality, that is a fair comment. With hindsight, I wish we had been as reactive to the growth in property prices as we were in house prices. I would go back, and we can debate it, but I don’t think, as I said earlier, that if we had eased off the rate of asset growth in 2006-07, it would have made any difference, in corporate, to the outcome.

Going back to your original question about wholesale, we did identify the long-term availability of wholesale markets as a risk. I was very interested to read in some evidence a quote from Lindsay Mackay from some internal meeting, which I had not seen because it was not a board paper. I do, however, remember having a conversation with Lindsay Mackay about whether we would be able to access wholesale markets to the same extent five or 10 years out, and we identified that as a risk. We shared that with our regulator. It was us who raised it and there was no secret about it. It was on our risk register. We took proper steps to deal with it.

Where we failed was that, if you look at our stress-testing, which we took very seriously and looked at regularly, we did stress tests for short-term closures in the wholesale markets, but we did not stress test for protracted closures in the wholesale markets. I’m basically taking this head-on and saying that we definitely identified the risk and we did things about it. There is a tendency now to say, "Wholesale funding bad, deposit funding good," but I would not agree with that. Deposit funding can disappear overnight. Wholesale funding gives you security for one to five years, depending what the period of time is. We tried to get a balanced approach to it.

Q1638 Lord Turnbull: Can I take you back to the table at G12 that Mr Phillips referred you to? It shows the corporate facilities over £75 million, as approved by 30 September. Psychologists talk about the phenomenon of confirmation bias. People can look at evidence, and they draw from it the conclusion that they want to draw. You had two pieces of evidence. One was that you had advanced approval from the FSA for the Basel II model. It was advanced approval, but there were a number of conditions. The other is that if you look at a table like this, I cannot understand how your board could say that you are lending getting on for £3 billion to a single borrower for property investment and development: £1.8 billion for hotels, £1.5 billion for design, sale and marketing of wall covering-I hope that that is not Osborne & Little-property investment and so on. Surely, people could have said, "Just look who these people are."

That is just corporate. Similarly, in international, they would have been a lot of the Irish names that we now know about. People with their ears to the ground would have said, "If you want a large sum of money and you want it quickly, BOS corporate are the people to go to." That is what other people knew about HBOS. It was the go-to place for such people. To look at this table and say, "This is fine," I find astonishing.

Lord Stevenson of Coddenham: Can I remove the characterisation of the Irish names? Typically, few of the names were filled in on these. A number of names were seen as very aggressive entrepreneurs. Quite a number were seen as being very successful and not particularly aggressive. The board would frequently ask the question you are asking. Typically, looking at the second column-the increases-I would get concerned if there were huge increases with a particular person, and we would ask what the justification was. I think there were occasions, as the result of board challenges, where adjustments were made. You may say, "Well, they would say that, wouldn’t they?" But there is a limit to how far you can push. Normally, we were talking to some pretty successful business people, not fly-by-night merchants. Normally, there were very good, detailed answers.

Q1639 Lord Turnbull: In the property world, very successful business people frequently go bust and then resurrect themselves. That is the nature of the property business.

Lord Stevenson of Coddenham: The point that I am making to you is that when we would query on an ad hominem-or an ad whatever the Latin for concern is-basis, we would be given detailed answers that would stand.

Going back to the point about HBOS or BOS being the go-to place for property, there is of course a distinction, a very fine distinction, between saying this is a specialist business which is known to be very entrepreneurial and very quick to react in property and saying this is a set of suckers who will lend you money, or a set of people who will lend you money. I don’t accept for a moment that BOS was seen as a soft touch. However, just to be absolutely clear, as a result of the sequence of events, there were appalling provisions.

Q1640 Lord Turnbull: You just said yourself, it has been pretty successful, but surely £2.88 billion on a book of under a hundred-

Lord Stevenson of Coddenham:-£110 billion, yeah.

Lord Turnbull: Wow, that is a hell of a lot.

Lord Stevenson of Coddenham: 2%, or-

Lord Turnbull: These two between them-the top two-2.4 and 2.9-

Lord Stevenson of Coddenham: You’re getting into the detailed discussions, but just to-

Q1641 Lord Turnbull: The point is that that is surely the kind of analysis that a non-executive director is perfectly capable of doing; whereas non-executive directors are completely disfranchised from the validity of the Basel II model, it is all so technical, and stress testing is always technical. This is good common-sense stuff that you could actually see with your own eyes.

Lord Stevenson of Coddenham: If I could take you into our board meetings of some years ago, you would have heard a lot of good common-sense stuff. I have to repeat what I said before: this was not a business that was dreamt up overnight, it was a business the Bank of Scotland fomented over a long period of time with its own ways of doing business. The executives had a lot of know-how and commanded a lot of respect. I wish I could remember what the £2.8 billion is. I’d be very surprised if it wasn’t unpicked and referred to in the common-sense way you discussed and quite a structured argument would come back showing the different components, the internal risk components of it. If I may say so, I think you are being slightly unfair. That common-sense view was brought to bear in the boardroom.

Q1642 Lord Turnbull: It may have been expressed, but it doesn’t seem to have been acted on.

Lord Stevenson of Coddenham: I think you’d be wrong about that. The fact is-

Q1643 Lord Turnbull: Well, here they are and these people are still here.

Lord Stevenson of Coddenham: No, I’m sorry. I made that point as a prelude. The point is that this was the Bank of Scotland business model. You may say that perhaps we should have completely changed the business model, but given that it had been uniformly successful over a very long period of time-remember, up to and including the last half-year results in 2008, there was no evidence of seriously out-of-line provisions-that would have been rather a remarkable thing if the executives had said, "Well, hold on a moment. We’ve been doing this for 30 or 40 years"-

Q1644 Lord Turnbull: That is the nature of booms that you go on looking successful when, in fact, the seeds of your own destruction are already there.

Lord Stevenson of Coddenham: I am sure you have heard this before but Bank of Scotland had been successful in managing through booms and busts.

Q1645 Lord Turnbull: Let us come to it in a different way. The second duty of the chair is to assemble a board and an executive team with the right characteristics. You referred to Bank of Scotland’s own model and the way they did things. It sounds to me as if you put together this merger and the Bank of Scotland people came with it. I still don’t think you have given a satisfactory answer to the question: were there people elsewhere in either the executive team or the board, other than Colin Matthew, who was doing the same thing in a different geography, who could really question the soundness of this kind of lending?

Lord Stevenson of Coddenham: The short answer is yes. When the merger was put together-I can’t remember the exact proportions but I think it was roughly 50:50 of the old Bank of Scotland and the old Halifax directors-there was a series of directors on the HBOS board who had grown up with the Bank of Scotland, people like Ron Garrick and Bob Reid, who knew a great deal about their business. As I explained to you earlier, I/we deliberately set up the corporate risk control unit to provide an opportunity for non-executive directors to go up the learning curve of this business. I can’t remember who was on it, apart from Ron Garrick, but I assure you that people of the calibre of Richard Cousins, Karen Jones, John Mack etc. learnt a great deal very quickly, and strong challenges were mounted.

What there was not a challenge to was the basic business model, for the reasons that I have explained: the basic business model had worked over a long period of time through boom and bust. I understand the point that you are making but-to get the figures approximately correct-after Lehman’s, what appeared to be the normal pattern of provisions increased by something like £1.5 billion-it might have been £1.7 billion. Shock! Horror! At our last board meeting-this is a long time ago, forgive me, but it is etched in me-on December 12, I think that we had another £1 billion plus into it, so when we handed over to Lloyd’s Banking Group, we are talking about £3 billion.

Over a period of three months, there had been abnormal provisions in the corporate book. It was a horrible, horrible day at the end of February when LBG announced results doubling them, and then the rest you have laid out here. As I said, we did not change the basic business model. We did challenge the specifics in precisely the common-sense way you are describing them.

Q1646 Lord Turnbull: You changed the basic business model because you allowed BOS to go on lending with all those risk characteristics on twice the scale. That is the change in the business model. In fact, it was more than twice the scale: they started off with a book of about £30 billion and ended up with a book of nearly £100 billion. That alone changes the nature of the proposition. You cannot simply assume that you can go on doing what you were doing beforehand at the £35 billion level and carry on doing it at over twice that size.

Lord Stevenson of Coddenham: That is absolutely fair comment, to which I would say: however, throughout that we had very detailed management reporting and management information. We were watching the provisions like a hawk and watching the risk management systems. As I said to you a moment ago, we had no reason to think-there were no warning signs until shortly before the bank merged with that of LBG. You mentioned previous recessions: they had been more gradual events.

Q1647 Lord Turnbull: Surely the warning sign was the pace at which commercial property-fuelled, in effect, by your own lending-was rising. That must have been a warning sign.

Lord Stevenson of Coddenham: Just to be absolutely clear, in at least one in three board meetings this issue was raised. I remember, first of all, George Mitchell and then Peter Cummings giving detailed presentations, rationalising the growth of property lending and the extent to which we were basing it on pre-lets, pre-sales and the use of syndication markets. The other thing to say, by the way, is that with the wisdom of hindsight it is easy to look at the rates of growth, but I think you will find that during the years in which I personally regret that it was not reined in, 2006 and 2007-to a point, I am agreeing with you-other banks were growing at the same rate and sometimes more. We could have, and it would have been good if we had, reined it in, but it wasn’t blindingly obvious. The challenges were being made, as you put it, on a common-sense basis.

Q1648 Lord Turnbull: On the question of structure, you said that the centre wasn’t weak but I contend that one part of the centre was weak. You set up a group risk control function and you appointed someone who as new to that area. When you look at it, on the executive board you have Jo Dawson, new to that, ranged against two grizzled veterans of corporate finance who were also group board directors. Realistically, what chance in terms of authority had she got, given that her status in the company was so much lower than theirs, of really mounting an effective challenge?

Lord Stevenson of Coddenham: The answer is huge. Jo Dawson was not a shrinking violet. I cannot remember when James Crosby appointed her, but one of the reasons would have been that she was one of our three or four ablest executives. She was a future chief executive in the making. She is-tough is a pejorative word in our society.

Q1649 Lord Turnbull: She may be tough, and I am not disparaging her abilities, but she told us that the role-the role, not her-lacked authority. She could see it herself.

Lord Stevenson of Coddenham: People say lots of things. I would say that that just simply is not the case. One whisper from her to the chief executive, or the finance director, would have huge authority-and she is the kind of human being who would not need a whisper. Your characterisation of Messrs Cummings and Matthew as grizzly old whatever it was-I am pretty sure that she would have no respect for that; she would be straight into them. That is just how it was.

Q1650 Lord Turnbull: That is not how she felt.

Lord Stevenson of Coddenham: Okay, but now it is 2012 and we have all been through this great trauma. It is a different thing. You asked me a question. She did not lack authority. She was there and she knew it. She was one of our ablest executives. She had been trained for greater things. She was absolutely not shy about putting her hand up and she did, I am quite certain.

Q1651 Lord Turnbull: The third role of the chair is to set a kind of culture and tone. The culture was "a new force in banking." Just reading these papers, somehow or other that has morphed into "new kids on the block." Was this an organisation that was too pleased with itself and not sufficiently self-critical? Letters you wrote to the chairman of the FSA in the spring of 2008 spoke of lending money to a "highly conservative institution." There is nothing here that tells me that HBOS was a highly conservative institution. Somehow or other, the self-image you had was not really borne out by the reality.

Lord Stevenson of Coddenham: I am not quite sure what the question is, but I will make an observation. This was not an organisation that was obsessed by growth or had a culture of optimism. You can go through the history of any organisation and find decisions taken that look over-ambitious. If you go through HBOS, you will find quite a lot of decisions that were quite conservative. James Crosby’s decision, which was totally backed by the board, to get capital from the market when it was least expecting it and did not like it was a very conservative decision. Andy Hornby’s decision to lower our share in housing was absolutely-a go-go organisation would have said, "Hey! We’re the number one. We can go on doing it." I could go on. The culture was absolutely not one of relentless optimism.

Q1652 Lord Lawson of Blaby: Lord Stevenson, I will not ask you any questions of detail, because time presses, and anyhow, you have said that, as a part-time chairman, you were not really immersed in all the details and that, since it was such a long time ago, you do not remember it.

Lord Stevenson of Coddenham: Both are true.

Q1653 Lord Lawson of Blaby: I have noticed, however, that when a detail seems to suit your defence, it suddenly and miraculously pops back into your memory. Leaving that aside, I will ask some simple, general questions. First, looking back at this catastrophe, over which you presided as chairman, what would you say was your biggest mistake?

Lord Stevenson of Coddenham: Failing to anticipate the long-term closure of wholesale markets.

Q1654 Lord Lawson of Blaby: You are living in cloud-cuckoo land, aren’t you? You were not responsible for the closure of the wholesale markets. What you were responsible for was a strategy of high and, having read the FSA report, it is impossible not to say, reckless growth, and that is what led you into difficulties. As Lord Turnbull and Mr Phillips have pointed out, you had a rapidly growing lending book. The worst was corporate, but the growth in mortgages was not much better, and I will come on to that if you want me to. In corporate, you went down-market in order to achieve this growth, taking bigger and bigger risks. Indeed, in your own written evidence to us, in paragraph 2 you say, "it is clear, with the benefit of hindsight, that mistakes were made in the degree of corporate lending." So what you went in for-something which has brought banks down in the past but yours is probably the biggest disaster-was sheer bad lending, wasn’t it?

Lord Stevenson of Coddenham: Your original question was what was the biggest mistake, which is approximately the question of why it went wrong. I gave you a completely straightforward answer which I give you again: it was the failure to anticipate the closure of wholesale markets. It is kind of you to observe that we could not have affected that. That is right, but we could have anticipated it. I am not saying we did not make other mistakes and I have already said in correspondence when I was the chairman, or to Mr Phillips, that with the wisdom of hindsight I would like the rate of asset growth in 2006 and 2007 to have been slower. To that extent, although in slightly less lurid terms, I agree with you.

Q1655 Lord Lawson of Blaby: As Lord Turnbull pointed out, you said in your letter to Callum McCarthy as late as March 2008 that HBOS was a "highly conservative institution". This was clearly, despite what you said a moment ago, the reverse of the truth. The evidence has been displayed, as I said, by the FSA in its final report. Either when you said that you were being dishonest, or else, if you believed it to be correct, you were delusional. I prefer to believe that you were not dishonest, and you were simply delusional.

Lord Stevenson of Coddenham: Can I-

Lord Lawson of Blaby: Is this not a big failure in a chairman?

Lord Stevenson of Coddenham: I will let others judge. I am trying to find the letter because the context-

Chair: It is H1, I think.

Lord Stevenson of Coddenham: Yes. This was in the context of post the short-selling raid on HBOS. Callum McCarthy rang up to inquire how we were feeling. I am just trying to find the particular point, because I remember the phrase very well. That paragraph referred to something that we put in hand as soon as the funding crisis broke. We had teams of people touring mainly north America talking to the large suppliers of wholesale finance and checking out on a weekly basis their attitudes to us. That sentence, "The commonsense of the situation is that we are dealing with lenders looking to lend money to a highly conservative institution", is a paraphrase of the views of our customers at that point, which, as you might imagine, was high on our minds. So, it is not me saying that-as it happens, we could tangle about how conservative we were-but at that point the fact is we had survived because big wholesale lenders in America were prepared to go on lending us money. They saw us as being a safe, conservative institution. That is what the thrust of that is.

Q1656 Lord Lawson of Blaby: You survived only because you were in a raging bull market at the time, particularly in property.

May I ask you one question about how the staff were remunerated or, rather more precisely, how they were incentivised? The FSA’s report points out that staff were incentivised "to focus on revenue rather than risk". How were they incentivised? They were given sales targets and they were incentivised on the basis of those sales targets, weren’t they?

Lord Stevenson of Coddenham: I referred to this earlier on in my response to Mr Phillips. I think I said that I thought this was one aspect of the FSA report that was inaccurate, or at best an oversimplification. You would have to go back-

Q1657 Lord Lawson of Blaby: How were they incentivised? Could you answer my question?

Lord Stevenson of Coddenham: I am about to tell you. You would have to go back to get the detail from the remuneration committee’s reports, but the common sense of our incentivisation processes was that we tried to ensure that a large amount of any short-term profit share had to be held in escrow, if you like, for a period of years until there had been sustained performance by the business. That disincentivised staff from going out on some of the things that some of you have implied we might have been doing-to sell, sell, sell. That was why I said earlier to Mr Phillips that that is not a strictly accurate statement. The answer is that they were incentivised on a long-term performance basis. We are talking about eight years, and the remuneration committee would have changed it over time. I was not on that committee, of course, but you can get chapter and verse from its meetings.

Q1658 Lord Lawson of Blaby: Performance was sales performance, wasn’t it?

Lord Stevenson of Coddenham: I do not know what you mean by that.

Q1659 Lord Lawson of Blaby: Well, the amount of business they did-the amount of lending they did.

Lord Stevenson of Coddenham: By definition, but their remuneration was not driven short term exclusively by their sales performance. It was actually driven by a number of things, one of which was a deliberate mechanism to get over precisely what I think you are driving at: that there should not be reckless short-term targets. I am not selectively remembering and not remembering, as was implied before, but basically you got a bonus and you had to keep it in escrow for x years, and when the performance had continued for three years, you got it. It was deliberately designed to disincentivise people from being overly short-term sales-led.

Q1660 Lord Lawson of Blaby: I do not know what the term was in which they were incentivised, but it was certainly sales-based. I think what lies behind my question is the fact that any fool can lend. The skill that a banker is meant to have is the assessment of risk when lending, but that was conspicuously absent.

We have heard at great length-I do not want to go over the ground again-about the nature of the corporate lending. Even in the mortgage business, where you lost a cool £2 billion to £3 billion, the growth was overridingly on two parts of the housing market. One was buy to let-that is really a euphemism for "buy to gain"; people buy a house not to live in it, but to make a capital profit, and they obviously let it because they are not living it-which was, in other words, speculation on property prices. The other was self-certified mortgages, which are notoriously unreliable. Those were the two areas of greatest growth. This was high-risk, reckless lending growth, wasn’t it? What were you doing, as chairman, to prevent this?

Lord Stevenson of Coddenham: The answer to your first question is no. There was another area-there is a smart term for this, which I have forgotten-just to add to your list, where you are lending to less good risks and having higher returns. All these areas were the subject of detailed, careful analysis by executives, which was carefully discussed by the board.

I seem to recall-please do not accuse me of selective memory, because five years is quite a long time to remember back-that in the last year of the business, the provisions were getting worse in the non-mainstream mortgage areas, but they were well within the levels that the modelling had allowed for. I have not heard anything to suggest that they have moved outside that since, which would be the thrust of your question. I do not have the evidence to show me that it was reckless-"reckless" is the wrong word; I mean that they were mistaken judgments-and I can assure you that they were not reckless judgments. They were carefully considered and the pricing was taken to assume greater voids, or whatever. They certainly were not reckless.

Q1661 Lord Lawson of Blaby: You mentioned a moment ago that the incentivisation of the staff was not at all short term-and you were very keen on that. Maybe this is because your memory of this time is fallible, but I am advised that, in fact, the incentivisation of staff was linked to the annual operating plan, generally team-based and built around line-of-sight issues. These were short-term incentive payments, but staff were given the option of enhancing them by 50% by investing them in shares to be held for three years. In fact, they were short-term-based incentive payments.

Lord Stevenson of Coddenham: I am sure that the scheme changed over the eight years. If you want to go into it, you should question over the eight years. All I can tell you is that my recollection was of a serious intention on the part of the executives running the business-Mr Hornby, Mr Crosby and the others-to try to produce systems and incentives that would encourage people to think long term.

Q1662 Lord Lawson of Blaby: Lastly-or very nearly lastly-you will recall that the FSA final notice to HBOS of March 2012 said, among other things, "The Firm adopted an optimistic approach to levels of provisioning despite repeated warnings"-repeated warnings, I repeat-"from HBOS’s auditors and the Corporate Division’s risk function of the need for a more prudent approach." You were clearly being imprudent. What were you doing about it as chairman?

Lord Stevenson of Coddenham: I think the evidence from the audit committee and the finance director says that that is plain wrong.

Q1663 Lord Lawson of Blaby: The FSA has got it plain wrong.

Lord Stevenson of Coddenham: Yes, I think that that is plain wrong. That is my understanding-not my recollection or memory. But I would say that, first, as chairman of the business, I was never aware of any area where we were in disagreement with our auditors. Secondly, as you would expect, I met alone with the auditors-the two main partners-at least once a year, and, in our meeting, they could air anything that they found difficult. Although we had interesting discussions-they were very helpful about the business-there were never any issues raised.

Q1664 Lord Lawson of Blaby: The culture of corporate and retail banking in which HBOS operated-I am not talking about investment banking, because you were not an investment bank or a merchant bank-has traditionally been, or should be, a culture of caution and prudence. The chairman of a bank is, above all, responsible for two things: the strategy and the culture. On both fronts you failed, didn’t you?

Lord Stevenson of Coddenham: That is a very aggressive, direct question, and I do not want to give a sound-bite answer. I do not believe so. It comes back to Lord Turnbull’s question about strategy. I think that there is a perfectly arguable question, with hindsight, that the strategy that led to the merger may have been a mistake. I accept that completely. It is an ifs and buts type question.

On the issue of culture, absolutely not. Confronted with any situation concerned with risk, the FSA or worries, there was no way in which I and my board were encouraging a culture of overwhelming risk-taking. It was quite the reverse: if you read through the board papers and see when the FSA challenges came up, you will see the extent to which they were discussed, taken seriously and acted on. So, to that point, I would say no; the other one is more arguable.

Q1665 Chair: About an hour and a half ago, Lord Stevenson, you said that your business was not growing too fast, even after 2006. And about 20 minutes ago, you said, "This was not an organisation obsessed by growth." You produced a business plan in the second half of 2006, which is in the bundle in front of you. Do you happen to know, roughly, what growth you were planning in your business plan per annum?

Lord Stevenson of Coddenham: I read it last night, but my short-term memory is-

Q1666 Chair: It is a pretty basic to know, as chairman of a major company, how fast you are planning to grow.

Lord Stevenson of Coddenham: Can I say, first of all, that I did not say that the business was not growing too fast? I actually have said consistently-this is hindsight-that sometimes I wish we had grown more slowly in 2006 and 2007. I set two caveats to that: first, I do not think that would have made any difference to the outcome post Lehman Brothers and the closure of the wholesale markets; and, secondly, if you compared the business with another of our competitors, you would find that we were much of a muchness. I have got the corporate figures.

Q1667 Chair: I am going to try to keep you to answering the question. The question is: do you know roughly now?

Lord Stevenson of Coddenham: Are you talking about growth of assets or growth of profits?

Chair: What you were intending to grow the business by.

Lord Stevenson of Coddenham: The growth of assets was about 9% and, overall, corporate about the same. Assets was the one that we were focusing on.

Q1668 Chair: So you do know the answer: it is between 9% and 10%. In fact, for three of those five years, it is 10% and for two, with rounding, is it 9%.

Lord Stevenson of Coddenham: It had previously been much higher.

Q1669 Chair: Do you consider that to be rapid growth?

Lord Stevenson of Coddenham: These are relative judgments. Looking back to the past, no. It was a deliberate decision to lower the rate of growth.

Q1670 Chair: You said that was because of the synergies falling out of your growth merger plan.

Lord Stevenson of Coddenham: We could have taken a decision to grow faster and there were a lot of pressures to do so.

Q1671 Chair: Of course you can always take a decision to grow faster. I am asking you whether you think that 9% to 10% a year, in that environment, was rapid growth.

Lord Stevenson of Coddenham: At the time, no. Looking back, yes.

Q1672 Chair: So you do accept that, with the advantage of hindsight, the growth plan that you set out at 10% was too fast.

Lord Stevenson of Coddenham: Yes, I said so.

Q1673 Chair: Okay. You said earlier that you took steps to accelerate the rate of deposit growth. Do you happen to know, broadly speaking, what happened to your ratio of deposits to funding in the period?

Lord Stevenson of Coddenham: I remember there being considerable improvements in the rate of deposit growth, but I cannot remember that figure.

Q1674 Chair: Well, it increased from about 140% to 190%.

Lord Stevenson of Coddenham: Sorry, what was that?

Q1675 Chair: That is the rate of deposit growth as a proportion of total funding. You said to us that you took steps to accelerate the rate of deposit growth, but they were wholly unsuccessful, weren’t they? In fact, the protection afforded by the increase in deposits declined over this period.

Lord Stevenson of Coddenham: Well, that is a different qualification. Can I say, first of all, that whether I was a non-executive or a part-time chairman, I do not have all the facts at my fingertips?

Q1676 Chair: Did you prepare before you came to see us today?

Lord Stevenson of Coddenham: Yes, within the limited time. This document caught up with me on Sunday and I have been preparing ever since. I did some preparatory work before that.

Q1677 Chair: Okay. The loan to deposit ratio rose to 196% in 2008 from 141% in 2001.

Lord Stevenson of Coddenham: But there is the rate behind that. There are statistics, statistics and damned lies. I referred to that earlier.

Q1678 Chair: That is a pretty basic-and generally held to be useful-measure.

Lord Stevenson of Coddenham: I think if you looked at the rate of growth of deposits versus the rate of growth of wholesale funding, you would find different figures, and rates of growth of deposits that were more in line with and had increased to the wholesale funding. As I observed right at the beginning, in a growing business, even when that is being achieved, the gap continues to widen, which is what you now refer to.

Q1679 Chair: I do lean towards the delusional rather than the mendacious in the binary offer that Nigel Lawson made earlier, because the evidence is overwhelming that this was a business growing too fast and becoming more vulnerable all the time in the way it funded itself. You are disagreeing with that, aren’t you?

Lord Stevenson of Coddenham: No, I am not. I told you a few moments ago that, having reduced the rate of growth to 9% to 10%, I wished, with the wisdom of hindsight, that we had reduced it further in 2006 and 2007. I am in complete agreement with you about that.

Q1680 Chair: Okay. Now let’s go back to the letter of 18 March 2008, in H1, to which Nigel Lawson referred. Let’s just go through what you were telling Sir Callum McCarthy in that correspondence. You began by saying, "I and we"- presumably "we" corporately-"are feeling about as robust as it is possible to feel in a worrying environment."

Lord Stevenson of Coddenham: Which we’d rather did not exist.

Q1681 Chair: You say, "We have faced into the need to be boringly boring for the next year or two." Would you say your bank was in a boringly boring-that is, boringly safe-condition as you entered 2008?

Lord Stevenson of Coddenham: I did not use the word "safe" there.

Chair: Well, that is what "boring" normally means with reference to banks.

Lord Stevenson of Coddenham: No, I didn’t use the word.

Q1682 Chair: You didn’t; so you could be a boring bank and unsafe?

Lord Stevenson of Coddenham: Well, I’m not going to trade labels.

Q1683 Chair: Well, then, why open up the question? "Boringly boring"-everybody knows what that means. You were referring to the bank being safe. That is what "boring" means in banking, so you are going to trade words with me. Are you going to disagree with that?

Lord Stevenson of Coddenham: This letter followed the short-selling raid on HBOS and the regulator was concerned about this. I wanted to get across to the regulator-and it may be that my language was not of the best-that we were taking the new situation very seriously and that Andy Hornby was doing everything possible to rein in the rate of growth of assets. I think I go on to say he was facing into talking to the divisional heads and telling them they couldn’t have what they wanted and they had to give up their plans and slow their growth. In that sense it was "boringly boring", which is a rather colourful form of language I wish I hadn’t used now.

Q1684 Chair: If we turn over the page, we come to the following sentence: "My soberly considered view is that given the extraordinary external environment HBOS, in an admittedly uncertain and worrying world, is in as secure a position as it could be." Given that you have just told us that you had a growth plan running for two years at a higher level than you thought appropriate, that is just simply not true, is it? It could have been much safer, much more secure.

Lord Stevenson of Coddenham: Well, hold on. Of course it could have been, but that is not in conflict with what I said. We are into March 2008. Wholesale markets had started to disappear-not entirely, thank goodness-whenever it was in 2007: shock horror, and very frightening and very worrying.

Q1685 Chair: So your base date for "as secure as it could be" is compared to the day before you wrote the letter, or the week before you wrote the letter, or the month before you wrote the letter?

Lord Stevenson of Coddenham: Can I just-I am trying to help.

Q1686 Chair: I don’t think you are helping us at all. Clearly, this is trying to say, "Don’t worry, HBOS is a safe bank," when clearly it is not a safe bank.

Lord Stevenson of Coddenham: It absolutely is not-the chairman and the regulator knew on a daily basis what was happening to our book. There was no sense in which this letter was trying to give him spurious comfort. I was trying to respond to his very genuine question, and I think I would say the same again. Because we had taken steps to lengthen our wholesaling profile, in the new situation we found ourselves in, we were finding it possible to live within the semi-closure of wholesale markets.

Chair: Okay. I am going to come on to those in a moment

Lord Stevenson of Coddenham: Good. The phrase "in an uncertain and worrying world is in as secure a position as it could be" does not mean we were in a completely secure position. It means what it says.

Q1687 Chair: Okay. You then go on: "I am happy to be cross-questioned on this"-that’s what’s happening now, actually-"but I hope you know me well enough to know that this is neither a bravura nor an ill-considered statement." In retrospect, would you like to take either of those back?

Lord Stevenson of Coddenham: Where are we?

Q1688 Chair: The next line. Was it bravura, in retrospect?

Lord Stevenson of Coddenham: No, it absolutely wasn’t.

Q1689 Chair: What about ill-considered?

Lord Stevenson of Coddenham: It was very much considered and it reflected the reality of the time. We had a more than adequate capital ratio. We had good credit ratings. As a result of lengthening our wholesale profile, we were surviving not easily but okay in the markets, and I was trying to communicate to him what the truth was. I think that was the truth-and the reasonable truth-as I saw it at the time.

Q1690 Chair: Okay. Let’s go down to the next main paragraph, which says, "as I mentioned to you many months ago", we have the problem-I am paraphrasing only very slightly-"of rumour feeding upon rumour and creating a wholly irrational ‘hit’ and ‘run’" on the bank. But it wasn’t an irrational hit and run, was it? The markets were right. You were a basket case, weren’t you? And the markets had rumbled it and, correctly, they were pricing the risk, weren’t they? They were getting out, just like James Crosby did, when he sold most of his own stock.

Lord Stevenson of Coddenham: Are you referring to the short-selling raid on HBOS?

Chair: I am referring to "the 24/7 problem of rumour feeding upon rumour and creating a wholly irrational ‘hit’ and ‘run’ on the institution".

Lord Stevenson of Coddenham: I am not quite sure what the question is.

Chair: I am asking you whether you thought the markets were behaving rationally or irrationally in getting out of HBOS.

Lord Stevenson of Coddenham: Given that Lehman’s was about to go bust and given that wholesale markets closed-with some heroic retrospection-rationally. At the time, what I was warning Callum McCarthy about was the possibility of certainly unscrupulous and possibly criminal activity with short selling. It was as simple as that.

Chair: Were the markets behaving rationally or irrationally in getting out of HBOS?

Lord Stevenson of Coddenham: Look, the answer depends on the price. There is not an absolute answer to the question.

Q1691 Chair: The share price was plummeting, wasn’t it?

Lord Stevenson of Coddenham: No, it completely depends. It is not a question that one can answer without a precise reference. At that point, however, it was quite clear that there was no thought of wholesale markets closing. The Lehman’s thing had not happened-

Q1692 Chair: If you had been in the market at that time and nothing to do with HBOS, would you have considered it rational to buy HBOS stock?

Lord Stevenson of Coddenham: I regret to tell you: I think I did.

Chair: I know very well that you did, because you told us at the beginning.

Lord Stevenson of Coddenham: I think I bought stock-

Q1693 Chair: If you had been outside this institution, looking in as a market participant, would you have considered it rational to buy this stock?

Lord Stevenson of Coddenham: Actually, you have given me the best possible answer to your question.

Chair: Well, you have to buy-

Lord Stevenson of Coddenham: With the wisdom of hindsight, it was not wise to buy stock, but at about this time, I did, because I thought it was underpriced and too cheap.

Chair: Well, it turned out to be overpriced and too dear.

Lord Stevenson of Coddenham: Indeed so, but we weren’t to foresee Lehman’s-I am sorry to keep harping back to it, but it is the key point to learn from the past for the future-and the complete closure of wholesale markets.

Q1694 Chair: Okay. Let’s just go on with this letter a little further: "This tells you, by the way, I am not aware of any lurking horrors in our business or our balance sheet." There were lurking horrors all over the balance sheet, weren’t there?

Lord Stevenson of Coddenham: As it turns out. However, just to be clear, I mentioned earlier on that in the half-year results, there were normal provisioning patterns for the corporate business. So, is this a strictly accurate and truthful observation? Had I been aware that there were worrying, mounting provisions? I was a part-time non-executive chairman. If the executives had been aware of mounting provisions, they would have been taking action. They weren’t.

Q1695 Chair: Let’s go over the page to the third page, where things don’t really improve in this extraordinary letter. We arrive at a point where you remind us that the FSA had been warning you about the risk of liquidity drying up completely: "How would we fare if liquidity completely dried up, you asked?"-that was Sir Callum McCarthy asking you. So you were asked about this question.

Lord Stevenson of Coddenham: Can I make the observation-

Chair: Not yet. I think other people need to hear what you then went on to say: "Does that keep me awake at night? Well yes of course one worries about everything, but the answer is no!" In retrospect, you should have been very worried about liquidity, shouldn’t you?

Lord Stevenson of Coddenham: I have said to you consistently throughout this meeting that the big hindsight mistake was failing to see the possibility of complete closure of the wholesale markets. So, yes, I agree with that. However, I must make this observation to you: of course, in March 2008 the FSA were worried about liquidity, but that had not been a worry of the FSA’s. We had been more concerned about it than the FSA; their main concentration had been on capital ratios. The concern about liquidity was very new.

Q1696 Chair: How do you feel, in retrospect, about your last sentence: "we feel that HBOS in this particular storm and given its business characteristics"-we have gone through those business characteristics in detail this morning-"is in as safe a harbour as is possible while at the same time feeling commercially rather frustrated"?

Lord Stevenson of Coddenham: With the wisdom of hindsight, post Lehman’s, I do not feel great about it. But, to be quite clear, if you do the fair thing, which is to put one back to that time, we had capital ratio twice the minimum required, we had decent credit ratings, we had lengthened our exposure to the wholesale markets so that we could navigate our way through the closures in those markets, we had a chief executive, as I have covered, who was very aggressive at getting down to slowing the asset growth, and so I do not think it is an unreasonable thing to have said. With the wisdom of hindsight, if I had known Lehman’s was going bust and the wholesale markets were going to close, I would not have said it. But I didn’t know that.

Q1697 Chair: With the wisdom of hindsight, do you think that the lending of this bank could be held to have been competent?

Lord Stevenson of Coddenham: "Competent" is a very emotive word. From my position as chairman of the board, and from the board’s position, we devoted a huge amount of time to the systems for controlling risk, the management of credits and so on. We took a great deal of outside advice. You can check it for yourself, and go into the papers: we did a great deal.

Chair: With the wisdom of hindsight, was this competent lending? It is the same question as I asked Sir James yesterday; I am sure you are aware of that.

Lord Stevenson of Coddenham: With the wisdom of hindsight, there was a lot of mistaken lending. I was not there in the trenches with the people making the lending decisions, so I can’t answer you authoritatively; I was only there, at the most, part time. But I do not think I would use the words incompetent or competent, one or the other; I would say it was mistaken, but within systems that were carefully thought about and carefully established.

Q1698 Chair: I am going to press you. Lending that is not incompetent is, by definition, competent. Lending that is not competent is, by definition, incompetent. Which of those, in retrospect, was this lending?

Lord Stevenson of Coddenham: Chairman, it is a false antithesis. As far as the board was concerned there were, if I can use your language-

Chair: I am going to ask you again.

Lord Stevenson of Coddenham: There were very competent systems.

Chair: You are going to have to answer this question. I want you to-

Lord Stevenson of Coddenham: In which case you force me into a corner-

Chair: I want you to tell us whether it was competent lending or not, in retrospect.

Lord Stevenson of Coddenham: I would say there was a lot of mistaken lending.

Chair: Yes, we have heard that mistakes were made.

Lord Stevenson of Coddenham: I am terribly sorry, but I do not think it is a correct antithesis. I think there were systems that I believe-and with the wisdom of hindsight they may not have been-

Chair: The antithesis of competent is generally held to be incompetent. There is virtually no other possible word that is closer to the antithesis of competent than incompetent. So I would like to ask you again, was this competent lending?

Lord Stevenson of Coddenham: I think the processes that were followed were competently reached, but it is not an adjective that applies. There was mistaken lending, and some non-mistaken lending. I guess there was a bit of both.

Chair: Was this competent lending?

Lord Stevenson of Coddenham: If you want to push me, I would say there must have been some lending that was incompetent, as well as a lot that was competent, but, as a general classification, you cannot say the whole lot was competent or the whole lot was incompetent.

Q1699 Chair: I haven’t asked you if all the lending was competent. You have now said that most of it was competent and a small proportion was incompetent.

Lord Stevenson of Coddenham: I haven’t. I haven’t put competence on it, Chairman.

Q1700 Chair: Well, you did, actually, and the transcript will show that you have. Do you think most of the lending was competent?

Lord Stevenson of Coddenham: You are forcing me into a corner, which I don’t think is a fair corner. I don’t know quite what you mean by competent. I think the lending was done by people who had worked in the same job for a very long time, who were well trained within systems where a lot of trouble had been taken. Yes, they will have made mistakes; mistakes that looked a lot worse after the catastrophic affect on asset evaluations, following the collapse of Lehman’s.

Q1701 Chair: Now, the question was whether the majority of the lending was competent. Was most of it competent?

Lord Stevenson of Coddenham: I don’t think it’s a question that I have the ability to answer. I was not in the trenches doing it. I was a part-time or non-executive chairman, whichever you-

Q1702 Chair: A moment ago, you said "competence" was an emotive word. Actually, it is the word used to describe whether people are fit and proper for the purposes of the approved persons regime by the FSA. Do you want to review your assessment of the word "competence" as emotive?

Lord Stevenson of Coddenham: I find it difficult applied to-if it is abstract-the abstract concept of lending. Applied to people, it begins to make more sense to me. There was a lot of mistaken lending, but whether it was incompetently done, I cannot judge.

Q1703 Chair: Are you, in your view, a fit and proper person to run a financial institution for the purposes of the approved persons regime?

Lord Stevenson of Coddenham: I am absolutely the wrong person to ask.

Q1704 Chair: Well, I am asking you, and you are going to be asked until you give me an answer.

Lord Stevenson of Coddenham: Well, it is rather academic and I am way past wanting to do that and I am not familiar with the criteria for it, so I have no idea. My answer is I don’t know.

Q1705 Chair: Has this thought crossed your mind from time to time?

Lord Stevenson of Coddenham: Well, it is a somewhat academic thought, since (a) I have no intention of working in financial services-not surprisingly after the experience that has taken place-and (b) frankly, at my ripe old age, I would much rather spend time with my grandchildren. So, I don’t think it has really, and my answer is I don’t know.

Q1706 Chair: Have you held any approved positions since 2009?

Lord Stevenson of Coddenham: I don’t think so.

Q1707 Chair: Are you a non-executive director of Loudwater Investment Partners?

Lord Stevenson of Coddenham: Yes…no, no, I am not. I used to be.

Q1708 Chair: When did you cease to be?

Lord Stevenson of Coddenham: Some time over the last year.

Chair: We have looked this up, and it appears that you ceased to be a non-executive director last week.

Lord Stevenson of Coddenham: That is nothing to do with this session at all. I have taken on two very major responsibilities-

Chair: Okay, well, I am not interested in the major responsibilities.

Lord Stevenson of Coddenham: I am just-

Q1709 Chair: I want to clarify the position with respect to the approved person regime. Are you aware whether the position that you have been holding at Loudwater Investments is one that the FSA deem an approved position?

Lord Stevenson of Coddenham: Not as I sit here, no.

Q1710 Chair: So it hasn’t crossed your mind either?

Lord Stevenson of Coddenham: It may have done, but this is going back a large number of years to when I first took it on.

Q1711 Chair: Okay. When did you take it on?

Lord Stevenson of Coddenham: Five years ago; six years ago-something like that.

Q1712 Chair: So you are on a board; you don’t know whether you are an approved person for the purposes for the approved persons regime.

Lord Stevenson of Coddenham: No, but, I said-

Q1713 Chair: You came off it last week. Did you know you came off it last week-a week before you give evidence to us?

Lord Stevenson of Coddenham: I knew the decision was taken some months ago that I had come off it and it was being implemented, but I didn’t know last week because I had taken on two other major responsibilities and I didn’t have the time.

Q1714 Chair: Well, let’s go back to the question I asked: are you, in your view, a fit and proper person for the purposes of the approved persons regime?

Lord Stevenson of Coddenham: And the answer I gave you is I don’t know.

Chair: You don’t know.

Q1715 The Lord Bishop of Durham: I would just like to ask Lord Stevenson two questions around the issue of culture. You described the Bank of Scotland as a niche bank several times this morning.

Lord Stevenson of Coddenham: The corporate-

The Lord Bishop of Durham: The corporate lending function of the bank.

Lord Stevenson of Coddenham: Yes.

Q1716 The Lord Bishop of Durham: Yet, when the merger happened, you described it as a new force in banking.

Lord Stevenson of Coddenham: HBOS or the corporate banking?

Q1717 The Lord Bishop of Durham: The corporate bank was included in that. That was part of the selling process of the bank. The corporate bank then grew very rapidly. You made the comment also this morning that the provisions figure would have been lower if you had reined in after 2006, but not much. You said a bit later that it would have made no difference to the outcomes. It seems to me that the culture was not that of a niche bank, which is typically a very specialist, small, careful operation. It was much more one of seeking extremely rapid growth, perhaps in line with the rest of the banking industry. It was well away from anything that could be described as niche banking.

Lord Stevenson of Coddenham: It depends. I mean, the word "niche" actually, I think, was suggested to me by reading about it in the FSA report-something I have read recently. In a sense, if you have in mind a niche business-a rather small business, growing in a particular corner-I agree with you that the sense in which I applied the word "niche" to the Bank of Scotland corporate bank is one where perhaps the word "specialist" might be better. If I turn the thing around the other way, I would say that you could argue, to make the same point as you are ending up with, that precisely because of the niche elements in the corporate bank, it was exposing itself to greater risks than if it had been a middle-of-the-road bank. I do not want to get tied up in the word "niche". The fact is that the Bank of Scotland, as we have observed in our discussions, did a number of things that were different-it’s a matter of emphasis-from its competitors and had done them very well over a long time, but they stood it in very bad stead when huge write-downs came.

Q1718 The Lord Bishop of Durham: You also said that it is a different kind of business from a normal banking business, and you have just reiterated that, essentially.

Lord Stevenson of Coddenham: Yes.

Q1719 The Lord Bishop of Durham: And that it was specialist in areas that are well know to be relatively high risk, with commercial property being the classic. My own experience-of a different industry, admittedly-was that when we were doing something high risk we made sure that we planned not merely for stress but for catastrophe. We wanted to know what would happen when everything went wrong. It seems that you were high risk on the assets side and high risk on the liabilities side.

Lord Stevenson of Coddenham: You are talking about the oil industry and the energy industry, from what I have read in the newspapers. That is a very interesting analogy and a completely fair one. It is also consistent with what I have been saying. We failed to plan for catastrophe, defined as the closure of markets and the effect on asset values. That is the truth: we did not. We did regular stress testing and we were supervised-I do not think that is too strong a word-by the regulator in doing it, who had every opportunity to change the stress testing, but to use your language, it did not include catastrophe assumptions, so I agree with you.

Q1720 The Lord Bishop of Durham: So the challenge that you talked about as being robust and regular was on the assumption of life going on more or less as it had been, rather than what I would call a robust challenge, which is a challenge to the basis business model.

Lord Stevenson of Coddenham: No, I do not think that is fair.

Q1721 The Lord Bishop of Durham: You said that earlier. You said that there was no challenge to the basis business model.

Lord Stevenson of Coddenham: Well, the words have been taken out of context. Moving away from just words to facts, there was regular annual or biannual stress testing. In those stress tests, we test pretty extreme negative things happening, to check that we would survive, that we would be able to finance ourselves and what would happen to our capital ratios. That happened at a regular meeting with the chairman of the FSA. We did not, however, anticipate-to use my perhaps unfortunate words-the world falling out of bed, a total catastrophe, in those models. Neither, to be fair, did anyone else. But we did not, and that, basically, was a failure.

Q1722 The Lord Bishop of Durham: So the culture was to go with the crowd then?

Lord Stevenson of Coddenham: What do you mean by the crowd?

Q1723 The Lord Bishop of Durham: The rest of the banks. Nobody else was making this; you were not making this.

Lord Stevenson of Coddenham: No, I would not say that. If you are saying that we did not stress test the complete, protracted closure of wholesale markets, actually we didn’t go with the crowd. At a time when, as far as I am aware, there was no regulatory interest in it, we took decisions to lengthen our wholesale funding, which was not absolutely going against the crowd. We were right to do so. So I would not accept that. But I do regret that we did not anticipate the closure.

Q1724 The Lord Bishop of Durham: What I am baffled by is that it is clear from the figures that your capital was wiped out.

Lord Stevenson of Coddenham: That’s true.

Q1725 The Lord Bishop of Durham: Which is the definition of a complete banking failure. To use an analogy, it seems to me that you are saying that it is like someone who has a fatal heart attack at home and is in a bad car crash on the way to hospital in the ambulance, and the cause of death is put down as the car crash-the car crash being the failure of the wholesale market. There seems to be no realistic analysis or acceptance of a completely failed banking model and culture that wiped out your capital. That is what I am at a loss to identify.

Lord Stevenson of Coddenham: I understand your question, and it is a question that has been bobbing beneath the surface of a lot of the others. The Commission’s objectives are to learn from the past and to learn for the future.

Q1726 The Lord Bishop of Durham: Well, that is what I am looking for really.

Lord Stevenson of Coddenham: I am not trying to defend something or gloss it over-I really am not-so if I may try to put it the context of the timing of it. I am wondering whether to use your metaphor of the heart attack and the car crash. I think I will. We were not aware-this may be a fault-until very late in 2008 that we were suffering from a heart attack. That is the truth. As I said to you before, we published our half-year results for the corporate bank, which had perfectly normal, historic provisions. We were not very worried about the housing cycle. We perhaps-this is a point that has been made-were not worried enough about the commercial property cycle. But to be quite clear, had Lehman’s not been allowed to go bust and had the wholesale markets not closed, I think it is a reasonable presumption that we would not have hit the liquidity buffer, so we would not have had our car crash.

Now, the million dollar question-which, I think, in response either to Mr Tyrie or Mr Phillips, we touched on very early on-is if you look at the volume of provisions in our corporate book, what percentage of them resulted from the huge diminution in the world of asset values as a result of the closure of wholesale markets, and what percentage of them resulted from mistaken or incompetent lending, whichever it is? I do not have an answer to that, but it is a reasonable question. I just proffer it for what it is worth. But we really did not know that we had a heart attack. If we had not had the car crash, perhaps we would not.

Q1727 Mr McFadden: Lord Stevenson, you have been asked lots of questions today, but you have really only given one answer, which is that it is all about the collapse of the wholesale markets. You have clung to that answer through questioning on a whole range of different subjects. What you are effectively saying to us is that it does not matter how bad the lending was. Your lending turned out to be twice as bad as RBS’s, in terms of write-offs. RBS is not exactly held up by many as a model of good, sound banking through the crisis. You have effectively said that it doesn’t really matter what the FSA say about your lack of risk controls, or the culture within the bank, and it does not really matter that you still had your foot on the gas in terms of lending, as late as September 2008, in terms of the list of lending decisions that Lord Turnbull read out, including lending over £2 billion for property investment to single clients on the very eve of the crash. You did not really know what you were doing, did you?

Lord Stevenson of Coddenham: We didn’t know everything we were doing, but going back on what you were saying, I hope I didn’t give the impression that it did not matter about the lending, or it did not matter about the FSA report, because that was not my intention. To be quite plain, we did not have our foot on the gas at the end of ’08. The figures you saw were cumulative figures of lending over the years to particular people. These were not loans made in the previous period; they were historic loans. I can understand the reaction of anyone in this room. I must have sounded like a repeater, a gramophone, when talking about the closure of wholesale markets, but it is the truth as I see it, and in terms of learning for the future-

Q1728 Mr McFadden: Sorry, to interrupt on a point of fact, in this September 2008 table, the column is "new facilities". It is not historic lending: new facilities-£2.9 billion to one loan on property. It is G12.

Lord Stevenson of Coddenham: I would be very surprised if we went into it-yes, I can see it. Almost certainly, I would be astonished if that was a new facility. Quite often, you have things where a loan was taken off and renegotiated. I can not give you the-

Mr McFadden: The point I am making is that-

Lord Stevenson of Coddenham: Hold on a moment; I am looking down it. Just to be quite plain, this is language. I know what they are saying. "Existing", it says-"new facilities". If you look at every single one, it is the same amount in the so-called existing or so-called new facilities. These were not new facilities in the sense you are talking about.

Q1729 Mr McFadden: The point I am making is that you have responded to every question today by saying that whatever the quality of lending, whatever it is you are pitching to me, this is all about wholesale markets. You said in a different letter from the one to the FSA which you have been asked about that you are not an Olympian chairman, that you are well-informed and you are hands-on. You also said that you were legally responsible as chairman for the bank, which is of course correct. What does this say about leadership, if in response to everything that has been put to you today your reaction has been that it is all about an unforeseen event?

Lord Stevenson of Coddenham: With respect, that it is not the impression I have tried to give. I quite understand that is a dominating theme, because I believe it to be true. But just to be entirely clear, I found the FSA report completely shocking; I hated it. There are bits in it I do not think I agree with. I said frequently today that we did over-lend, and it would have been a good idea to have restrained it in ’06 and ’07. That is my view. You cannot look at those provisions and not be horrified and appalled. However, in terms of trying to understand what the truth of the matter is, I think the question I am proposing as to the extent to which they were affected by the closure of wholesale markets and the extent to which there was incompetence is a very real question, which I do not have the ability to measure. But please, please, please, I am not trying to avoid the finger saying that we over-lent in corporate, because we did.

Q1730 Mr McFadden: What degree of personal responsibility do you feel, given that the closure of wholesale affected everyone, and that the bank you led for eight years ended up with greater write-downs than all your competitors and double the level of write-downs of the other huge bank that had to be nationalised? Double the level of write-downs-how do you feel about that?

Lord Stevenson of Coddenham: Let’s be clear: all over the world, banks were caught like HBOS was, both before Lehman’s-which we were not-and after Lehman’s. As I said earlier on, it is widely acknowledged that if the Fed had not intervened, a number of the most famous banks in the world would have gone down the pan. The answer to your question-me, personally, I feel awful. I wish that we had seen the possibility of wholesale markets closing.

Q1731 Mr McFadden: But how responsible?

Lord Stevenson of Coddenham: I was chairman of the board. I feel responsible. My colleagues do too, but I was chairman. I can’t escape that. I feel awful about it. There are very few days that I do not think about it.

Q1732 Chair: There are very few days that you do not think about it-and all the detail has disappeared.

Lord Stevenson of Coddenham: I think that is slightly unfair. The detail has not disappeared. Five to 10 years, going back, is quite a-

Q1733 Baroness Kramer: Lord Stevenson, earlier you said that you were not aware-the bank was not aware-that you had had a heart attack. In a previous part of the conversation exchanges, you said at some point that HBOS had-I am now quoting; I wrote this down as you were speaking-"by definition a higher risk book", and you went on to say "and you need risk management systems to cope with this". We have heard you praise your risk management systems quite extensively.

But if I go back and take a look at the testimony that we had both from Paul Moore, who was part of the group risk operation-perhaps it was retail, but you can correct me on that-and from Jo Dawson, who became the head of group risk, they both used strikingly similar language. Paul Moore described the culture between group risk functions and the divisional risk functions as "dysfunctional", with the divisional risk functions reporting to group on a functional basis, but not having a hard reporting line-there are some interesting questions there. Jo Dawson used very similar language. She said, "Given the advisory/oversight role afforded to Group Risk, the ability to challenge individual divisions effectively depended on the quality of relationships between the Group Risk team and the divisional CEOs and their teams. The relationship between Group Risk and the Corporate division…was probably the most challenging of these".

So essentially, you have a description of a risk management system that you yourself have said is crucial, because of your risky book of loans, and it is effectively dysfunctional. Would you not say that there is just a fatal flaw in the risk management system that you had oversight of?

Lord Stevenson of Coddenham: I was chairman of the board; I wouldn’t say I had oversight of it. I have also said repeatedly that we took risk management very seriously, as any study of our pages will show. I did not say it was perfect-just to get those two general points out of the way.

On Paul Moore and his observations, I hope it has been covered by colleagues-I don’t know-but what happened with Mr Moore is that during or just after a redundancy conversation he said that he had reservations that he wanted to make about the risk management systems. James Crosby, who rang me up to tell me he was going to do it, immediately reported that to the FSA, which then commissioned a completely independent study. There has been quite a lot of muddle and-

I find Jo Dawson’s observations very interesting and I cannot sit here-I was chairman of the board but I was not involved in the trenches-and say they are wrong. As I think I said earlier, they surprised me a little bit, partly because I know-it is one of the reasons she was put in that job-that she is a very strong, definite character. She was working with, at the centre, very strong, definite people. While, yes, I can imagine that there would be, as someone was trying to imply, people in the corporate risk division who tried to keep her off, I would find it quite difficult to keep her away. Overall, on risk, we tried very hard to get good risk systems in place; we took a lot of outside advice; and we looked at it regularly. It will not have been perfect-it clearly was not. It was not enough.

Q1734 Baroness Kramer: May I go back and quote you again from statements that you have made today? You talked about the board and the attention that it paid to risk, and I think you used the phrase, "there is a limit to how far you can push." You also talked, particularly in reference to Bank of Scotland-

Lord Stevenson of Coddenham: I have forgotten the context in which I said that.

Q1735 Baroness Kramer: That was in the context of questioning risk issues around the table and the strong character of the individuals.

You then said, on Bank of Scotland, that it had its own way of doing business, and you talked about the directors having a lot of know-how and a lot of expertise. Essentially, did you not allow these individuals to become dominant, to the point that people might raise a challenge, but that a highly articulate and dominant individual could always successfully push back even a Jo Dawson?

Lord Stevenson of Coddenham: It is possible, but I don’t think so. There were some very good people, and I would fully concede that, as in anything in life, where you are dealing with people who are very professional and on top of their game, it is quite difficult to come up against them. It is possible that, to some extent, you are right. I had a lot of respect for them myself.

Q1736 Baroness Kramer: And they believed in themselves, obviously. Let us go back prior to Jo Dawson’s appointment in 2005. The presence of group risk on the board was through the person of the chief financial officer.

Lord Stevenson of Coddenham: Well, I cannot remember the precise structure, but we had a very good man called Andrew Smith, whom I think had formerly been in charge of risk practice at KPMG, and he was the person responsible for risk.

Q1737 Baroness Kramer: I am sorry. Was he the head of group risk?

Lord Stevenson of Coddenham: Yes, he was. I cannot remember the exact-

Q1738 Baroness Kramer: I thought we understood that Jo Dawson was the first to be appointed to the executive board.

Lord Stevenson of Coddenham: It may be that he reported to the finance director, and that Jo Dawson was independent of it. I remember this happening. As chairman, I was rarely involved in interviewing people-quite rightly; it was not my job-but on this occasion, I met him on I think two occasions before we hired him. Wherever he fitted in the reporting structure, he was the key person on risk.

Q1739 Baroness Kramer: The point I am trying to make is that there is a substantial difference in stature between someone who sits on the executive board and someone who is below board level, and whose concerns are represented at board level by a chief financial officer, who frankly-you have talked about the stresses and strains, and the challenges, of funding a bank such as HBOS-has an overwhelmingly full plate and, by definition, does not have credit risk expertise. Up to that point in 2005, your risk management structure was, by institutional definition, sitting with lower status than the divisions. Is that correct?

Lord Stevenson of Coddenham: That is absolutely not my recollection at all. I met Andrew Smith, when I was the chairman and as the chairman of the board, a great deal. I do not know the extent to which he was at group executive meetings, but I bet you he was there a lot. He briefed the board a lot, and he was the person who introduced the concept of risk management into the group. He was very powerful and very influential.

Q1740 Baroness Kramer: But not at a board level.

Lord Stevenson of Coddenham: He may not have been on the board, but he was very powerful and very influential on the board, there is no question.

Q1741 Baroness Kramer: So then we go to Jo Dawson, whom I think, as you established earlier, came out of line operations.

Lord Stevenson of Coddenham: Indeed so.

Q1742 Baroness Kramer: Therefore, her risk perspective was very much shaped by the structure of a line person’s perspective. Then, she was gone in just about a year, if I understand that correctly, back to the line. There is no point, is there, at which you have an experienced voice on risk-who sees risk as the heart of what they do for their career-on that board?

Lord Stevenson of Coddenham: I think, on the Jo Dawson move to Peter Hickman, that is an absolutely fair critique. Those would be decisions made by the chief executive, but I think there was an aim on the part of James Crosby to try to get a number of the outstanding executives into the risk function-to get the quality of the people and the experience. I cannot remember what management change forced the need for Jo to be shifted, but it was definitely less than desirable.

Q1743 Baroness Kramer: So in conclusion, we have used the word "delusion" in the past, somewhat. Looking back, to what extent do you think that there was some degree of delusion at the board level? Do you think that they thought they had a rigorous risk management system but, if they had looked down into the granularities of it, they would have found dysfunction, tension and lack of voice?

Lord Stevenson of Coddenham: I don’t think so at all. It is one thing to say, as I have completely agreed, that it is less than desirable to have someone shifting, but I just ask you to go, if you want any convincing, and read the papers about risk management, which the board read. There was no delusion at all and there was no lack of focus or concentration on it. It is entirely appropriate for you to observe that it would have been better if Jo had stayed in the job for longer.

Q1744 Baroness Kramer: So they all got it wrong?

Lord Stevenson of Coddenham: No. You are discussing Jo moving. The board was very focused on risk, very well briefed on it, with very bright and able people in the job.

Q1745 Chair: No one’s denying that you had sophisticated systems in place. The question is whether they were at all effective.

Lord Stevenson of Coddenham: I agree.

Q1746 Chair: Were they?

Lord Stevenson of Coddenham: I think so.

Chair: They were effective?

Lord Stevenson of Coddenham: You come back to KPMG-we constantly externally audited, constantly internally audited, and I am sorry to return to the same point, but the real risk provisions followed from the collapse in wholesale markets and the downward pressure on asset values. I believe it to be the case that if you examined our retail business and if you examined our insurance and investment business now, you would find that they had been very effective over a long period. Corporate business? No, we got it wrong.

Q1747 Mark Garnier: Your risk management systems were certainly very complex, weren’t they?

Lord Stevenson of Coddenham: I guess.

Q1748 Mark Garnier: You guess? You were the chairman.

Lord Stevenson of Coddenham: I haven’t got much to compare them with.

Q1749 Mark Garnier: We heard from Andy Hornby yesterday that you had five divisions, and each had a risk department. Each department was made up of a head, and below them three sub-managers, credit regulation and operational. So that is 20 people involved with a significant role in the risk department. They would then report to group risk, which then would report to the FD or the CEO. That sounds quite complex to me.

Lord Stevenson of Coddenham: I think that is a fair comment.

Q1750 Mark Garnier: You also said at one point that the board was there to challenge. At what point did you challenge because that risk structure was too complex? There was risk in your risk structure.

Lord Stevenson of Coddenham: I think not just at the board, but at a lot of other parts of the business-the risk control committees-there would be constant debate about the structure. I cannot necessarily agree with the view that there was risk in the risk structure. I can accept that, in an inevitably quite large, complex business, there was necessarily quite a lot of complexity in the management. But these issues were openly discussed.

Q1751 Mark Garnier: Your head of risk, Jo Dawson, was somebody who had no experience of risk.

Lord Stevenson of Coddenham: Not as a risk manager. She had been on the other side of the fence, at NatWest and then for us, for 25 years.

Q1752 Mark Garnier: But when you are running such a complex department, surely you need somebody who has a complete understanding?

Lord Stevenson of Coddenham: As I said to Baroness Kramer, the judgment was taken by James Crosby-I think it must have been James who appointed her-and again it had been discussed, that we would take one of our outstanding executives and put her into the risk job, surrounded by a lot of risk professionals to help her, because we wanted to get one of the key leaders of the future.

Q1753 Mark Garnier: But how would she challenge that if she was surrounded by risk professionals? What experience did she have to challenge the risk department?

Lord Stevenson of Coddenham: Jo Dawson would have no problems in challenging.

Q1754 Mark Garnier: And yet she said that the department was dysfunctional, and just now you said it was difficult.

Lord Stevenson of Coddenham: Well, actually this was four or five years ago. It is my judgment that there is no question of her ability to challenge.

Q1755 Mark Garnier: If she was so good, why was she promoted? Why was she moved on so quickly?

Lord Stevenson of Coddenham: I cannot remember. I don’t think it was a demotion at all.

Mark Garnier: No, no. Promoted.

Lord Stevenson of Coddenham: I cannot remember. Let me just try to think.

Mark Garnier: She was replaced by Dan Watkins.

Lord Stevenson of Coddenham: She would have moved on to run one of the divisions and I can’t remember which one. She is very good indeed. [Interruption.]

Chair: Order. There is a Division on a private Member’s motion. Does anybody want to vote on it? No? In that case, we will carry on.

Q1756 Mark Garnier: Dan Watkins had no experience either.

Lord Stevenson of Coddenham: It was exactly the same. This was the view-the philosophy of trying to give our outstanding executives experience of the risk function.

Q1757 Mark Garnier: It was part of a progression or process for senior staff that they spend a bit of time in one of the most important divisions of the organisation and then move on. As soon as they got the hang of it, you moved them on.

Lord Stevenson of Coddenham: I can’t-I’m not trying to move away from the decision, but these were executive decisions made by the chief executive; it was not my job to do it.

Q1758 Mark Garnier: But your job was to challenge it?

Lord Stevenson of Coddenham: Yes. We would discuss it.

Q1759 Mark Garnier: But did you think it was a good idea? Did you think that a department as incredibly fundamentally important as risk management was one to be seen as a training ground for senior people? Did you not realise that in its own right it was an incredibly important department?

Lord Stevenson of Coddenham: It would be interesting-I am sure there were board papers discussing the pros and the cons, which you can go back and retrieve and look at. It was seven years ago, but I think that I probably bought into the idea that it made sense to get quite outstanding people into a job where, pace something someone has already said, there is always a risk of it being seen as an alien species and lacking power. Whether I was right to think that, or whether they were right to, is another matter. I am trying to be as open as I can, but that was the thinking-to get really outstanding people into a hugely important job.

Q1760 Mark Garnier: Turning this whole risk thing on its head, coming back again to your point that the board was there to challenge, presumably from 2001 you were gaining market share, you were the new kids on the block, you came out shooting from the hip, you were like Butch Cassidy and the Sundance Kid at the end of the film. You were trying to create market share. Did anybody ever turn round and say that your very quick growth was not due to your superior capability or your new kids on the block approach, but was actually due to the fact that you were taking risks that other banks were not prepared to take?

Lord Stevenson of Coddenham: First, can I correct you? The cultural characterisation is certainly not the case. In the very good results of the first three years, what we were actually focusing on was the much less glamorous thing of taking out cost and exploiting the cost synergies.

Q1761 Mark Garnier: Your asset book-your loans book-was growing at 11.9% compound annual growth rate.

Lord Stevenson of Coddenham: And that, I think, you can compare with our competitors. Going back to the question Lord Turnbull asked about the plan, it was precisely in line with the plan. To your question, yes, that is why the rate of growth of assets was lowered. There was huge internal debate about whether we were going too fast, and we lowered the rate of asset growth. As I said to you very frankly, it’s not a total repeat-a gramophone-of the same thing. I wish we’d lowered it further in 2006 and 2007; it was just a mistake. There was a lot of challenge, yes.

Q1762 Mark Garnier: What troubles me is that there seems to be this extraordinary group thing about the fact that you were just in the wrong place at the wrong time-that it was Lehman’s blowing up that resulted in the wholesale markets freezing up-and at no point did there seem to be any acceptance that it was just a bad strategy.

Lord Stevenson of Coddenham: You heard me say to Lord Turnbull- just to be absolutely clear, because I am rather sensitive to the remark that was made-that with the wisdom of hindsight it may not have been a good strategy.

Q1763 Mark Garnier: I do not mean with the wisdom of hindsight. Nobody seems to have said at the time, "We got this wrong."

Lord Stevenson of Coddenham: Well, it was quite difficult, because for a long period of time we were doing rather well in relation to the strategy, but people were constantly challenging aspects of it. As I have said to you, the whole point about this is that disaster hit at very short notice, very suddenly. There were no early warning signs.

Q1764 Mark Garnier: I would challenge that. I think there were plenty of hedge fund managers who were looking at this and were taking a view on it as far back as 2005. This is reasonably well documented. There are a number of books out about it. They were saying that the entire system was about to blow up. All you had to do was to look around Mayfair. Just the fact that there were so many Aston Martins there must have given you a clue that there was a credit bubble going on. The writing was on the wall and a lot of people saw it. It was not the case that people did not see it. You, as chairman of a bank, did not see it.

Lord Stevenson of Coddenham: You may be right. We may have been concentrating on the wrong thing. We were worried about the cycle. We focused very hard on the housing side of things. Also, which has hardly been discussed today, we focused very hard on the insurance and investment side, where we were very worried about the effect of stock market falls and insolvency ratios. We may have missed the trick on the corporate lending book, but we were focusing. We were not rushing in on other things.

Chair: "May have missed a trick on the corporate lending book." Yes.

Q1765 Mr Love: I am still trying to get my head around the issue about the blow-up of Lehman’s-

Lord Stevenson of Coddenham: Of what?

Mr Love: The blow-up of Lehman Brothers-and the reason you are giving for all the difficulties about the protracted closure of wholesale markets. Impairments for HBOS have come out at £46 billion to £50 billion. That is 10.5% of customer loans. More important, that is double any of the other domestic banks. Why would it be double the other banks? They all suffered Lehman’s. They all suffered the protracted closure. Why was the result for HBOS so much worse than every other bank?

Lord Stevenson of Coddenham: I do not have sight on the provisioning policies of any other banks, nor for LBG, and it is fair comment-it is widely established-that LBG were trying to reduce their balance sheet, so that may have contributed.

Q1766 Mr Love: But it was an order of magnitude greater than any other. Even though they might have had a different mix of policies and different plans, the reality is that HBOS’s result was so much worse than that of any other domestic bank.

Lord Stevenson of Coddenham: I completely agree, and it is shocking.

Q1767 Mr Love: We are not looking for a description of it, because you have rejected catastrophic failure and reckless lending; we are looking for an explanation.

Lord Stevenson of Coddenham: I was about to. I said earlier on, when talking about the same subject, that there is an element of comparing apples with oranges when comparing with the other banks. Of the banks, HBOS was by a long way the most UK-focused, and the UK economy was the economy most badly hit by what was going on in the world. Secondly, as we all agreed, the HBOS book was distinctive in its exposure to commercial property and what I call general sub-investment-grade equity investments, which were always likely to suffer much greater impairments. Those two things put together account for a great amount of the difference.

Q1768 Mr Love: Let me just posit that Lloyds is a domestically oriented bank and it never suffered anything like the difficulties that HBOS suffered. HBOS is, in the main, a mortgage bank. These are low-risk assets. It would be expected that the provisions would be less. How come you ended up with double?

Lord Stevenson of Coddenham: I have tried to explain.

Q1769 Mr Love: But you are not providing a proper explanation currently. There is an explanation that has gone around this table all today, which is of course that it was a question of asset quality. In that balance between the loss of value as a result of the protracted closure and a problem with asset values, you have suggested that it all lies in one area. We are suggesting that asset quality was appalling. It was indeed a catastrophic failure.

Lord Stevenson of Coddenham: Actually, I think I did not communicate it properly. That is what I meant. I agree with you. There was an issue of asset quality. When the balloon went up, being exposed to commercial property and sub-investment-grade, which were lower asset quality, were going to take bigger hits, which they did. Basically, I am agreeing with you.

Q1770 Mr Love: So would you accept responsibility? Would you accept that the asset quality was a significant feature in the demise of HBOS?

Lord Stevenson of Coddenham: Put like that, no, because what happened to HBOS as a matter of fact was that almost immediately after the collapse of Lehman’s-I am sorry to say this but it is the truth-markets closed as we ran out of money, and that is what caused the demise of HBOS. Does that in any way contradict the fact that there emerged a huge problem of asset quality? The fact is that the Bank of Scotland’s long-term strategy was found wanting in those circumstances and caused huge, shocking provisions.

Mr Love: I would like to go back to the issue of the Bank of Scotland, but I will resist the temptation.

Q1771 Chair: When you apologised to the Treasury Committee on 10 February 2009, you said that you were unreservedly sorry for the turn of events. What exactly were you-and are you now-apologetic about?

Lord Stevenson of Coddenham: That it happened. I am extremely sorry that it happened. I am extremely sorry that the employees got hit, the taxpayers got hit and the shareholders got hit. It is as simple as that.

Q1772 Chair: You are not apologising for a particular share of personal responsibility for it?

Lord Stevenson of Coddenham: I was chairman of the board. That is what I was, and I told you very frankly that we failed to anticipate or stress test for the car crash-to use the Bishop’s analogy. I am very sorry for that and I wish that we had. We clearly made other mistakes, and I am sorry for them, too.

Q1773 Chair: I am sure you understand that although this may not be an easy session for you, it has not been an easy session for us. I am sure you also grasp that millions have lost out on what they thought they were going to get from their pension; that 3 million Halifax shareholders have more or less been wiped out; and that all UK taxpayers are now going to be footing the bill for a very long time.

Lord Stevenson of Coddenham: Indeed so.

Q1774 Chair: Do you understand that when you come out with phrases or sentences such as, "We may have missed a trick on the corporate loan book", people may wonder whether you really are in the real world?

Lord Stevenson of Coddenham: I hope-

Q1775 Chair: Do you know what the losses were?

Lord Stevenson of Coddenham: I do know what the losses were.

Q1776 Chair: How much were the losses on the corporate loan book?

Lord Stevenson of Coddenham: About £25 billion.

Q1777 Chair: Yes, £26 billion. Do you know what the corporate tax yield is in the UK?

Lord Stevenson of Coddenham: I don’t.

Q1778 Chair: Okay; well, it is about £38 billion. We are talking about two-thirds of the whole of the UK’s corporate tax yield going down the swanee because of appalling loan decisions in the corporate loan book, which you are describing as having "missed a trick".

Lord Stevenson of Coddenham: Listen, that was taken as and that was a wrong and ill-judged remark. Can I make it plain? Beyond peradventure, I take very seriously the fact that we failed to foresee the outcome of events. It is not missing a trick; it is missing a huge avalanche, and I deeply regret it.

Q1779 Chair: I think we have taken this about as far as we can today. Some witnesses have been very frank with us, and it has been clear to us from their evidence that some have been looking the reality of this catastrophic series of events in the face, and some have not. I regret to say that on the basis of what I have heard over three and a half hours, the evidence today has been in the latter category.

Lord Stevenson of Coddenham: Might I ask what you think I have not been frank about?

Chair: You have been evasive, repetitive and unrealistic.

Lord Stevenson of Coddenham: Evasive about what, because I would like to put that right?

Chair: If you want to put it right, we may have another evidence session-and we will consider whether we need that as a Commission. But it being nine minutes past 1, it is time that we adjourn.

Lord Stevenson of Coddenham: May I just say-

Q1780 Chair: I will give you an opportunity for one final set of remarks.

Lord Stevenson of Coddenham: Looking at the past, I cannot resile from the observation-I think it has huge implications for future policy for regulators and for Government-that we failed to understand the permanent collapse of wholesale markets. It has huge implications for public policy. Just to make it plain, I would not want anyone to have any other illusion than that I deeply regret the mistakes made in the corporate lending book. With the wisdom of hindsight, I wish we could have done things to obviate them, and I am sure that that is true of all my fellow board members. I am sure there were other mistakes as well. I may have given an impression, but, boy, do I wish that that had not happened.