CORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 705- i

HOUSE OF COMMONS

ORAL EVIDENCE

TAKEN BEFORE THE

PARLIAMENTARY COMMISSION ON BANKING STANDARDS

(SUB-COMMITTEE B)

PANEL ON HBOS

TUESDAY 30 OCTOBER 2012

PAUL MOORE

COLIN MATTHEW

JO DAWSON

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Parliamentary Commission on Banking Standards
Sub-Committee B-Panel on HBOS

on Tuesday 30 October 2012

Members present:

Lord Turnbull KCB CVO (Chair)

Mr Andrew Tyrie

Counsel: David Quest

________________

Examination of Witness

Witness: Paul Moore, Head of Group Regulatory Risk, HBOS, 2004, gave evidence.

Chair: Mr Moore, welcome to this Panel of the Parliamentary Commission on Banking Standards. You have appeared before the Treasury Select Committee, and I will say a little about this Commission and why it is operating with a slightly different process. Our purpose is to find out what went wrong in the financial crisis, in particular how it went wrong and, more accurately, how it was allowed to go wrong, what mechanisms failed, what warnings should have been given that were not, and what warnings were given but were ignored or not followed up.

We know a lot about what happened with HBOS, so this is as much about how and why. We know much more about the RBS story, which has been written up in greater detail by the FSA, and we are in effect using HBOS as a case study. The emphasis is on identifying changes for the future rather than assigning culpability; still less is it a disciplinary process.

The broad picture is that HBOS brought together two widely admired brands, and at that juncture had a market capitalisation of about £30 billion, which allegedly increased to £40 billion, but a year later it was apparently worth nothing. It was a pretty dramatic event, with great implications for customers, staff and taxpayers. Clearly, risk is an important feature. This is your specialty, so we want to ask you a series of questions about the structure of risk and how it was managed.

As I said, this is a Panel, and we are using Panels as evidence-gathering processes, which is why I am chairing it rather than Andrew Tyrie, who is the Chairman of the main Commission, but it will be for the Commission as a whole to draw the conclusions. As an innovation in process, much of the questioning will be conducted by a counsel, the appropriately named David Quest, not because we are trying to turn this into a court of law or a formal tribunal, but simply because he is much more practised at questioning than I am and he has been able to focus to a greater extent on the detailed papers. Otherwise, the process is pretty much like the evidence that you would give in a Select Committee hearing.

BQ1 David Quest: Good morning, Mr Moore. You have on your right a file which, for convenience, contains all the material that you have provided, including your previous evidence to the Treasury Select Committee and so on, in case we need to refer to it. I should say that we have all read the materials that you have presented previously, and the purpose of today’s hearing is so that we can take up some of the points arising from that, in so far as they are relevant to this particular investigation.

To start by establishing where you fitted into the HBOS story, you joined HBOS in 2002, in the insurance and investment department. Is that right?

Paul Moore: Yes. I was head of risk for the insurance and investment division in 2002.

BQ2 David Quest: And then you were promoted from that to a position of head of group.

Paul Moore: Yes, as a result of the FSA’s risk assessment visit in 2003. The FSA had identified that HBOS represented a significantly higher risk to their statutory objectives and it was thought that they needed to increase the level of competence in the group risk function, and because I had had such strong positive feedback for the work I had been doing in the divisional level, I was asked if I would take the role of head of group regulatory risk.

BQ3 David Quest: Was that a new role?

Paul Moore: No, it was not a new role. It was part of the governance system that had been set up when Halifax and Bank of Scotland merged.

BQ4 David Quest: Right. Your prime responsibility in that role was to respond to the FSA criticisms.

Paul Moore: Yes. My responsibility was essentially to recommend policy and standards to fulfil the requirements of all the FSA rule book, and then to carry out risk-based oversight-checking; "oversight" it is a strange word because it means missing things out, but in this context it means checking things out-and providing reports and recommendations for changes. So the job was policy setting on one hand, and checking that the policies were put into practice on the other hand, and reporting.

BQ5 David Quest: And you were reporting to the chief financial officer?

Paul Moore: Correct.

BQ6 David Quest: Who else was exercising group risk management functions at the time?

Paul Moore: There was my colleague, Dr Andrew Smith, the head of group financial and operational risk. He was the mathematician, if I can put it that way, who calculated the specific credit risk policies, and it was my job to make sure that the systems and controls in place were implementing all those.

BQ7 David Quest: How did the group risk functions interact with the risk functions of the individual divisions?

Paul Moore: You have asked a very important question. It is commonly referred to as the "three lines of defence" system. Personally, I disagree with it, but that is by-the-by. The first line of defence is at the divisional level, so the business is separated into profit centres for the large businesses; there are executives in each of those with their own risk functions, pertinent to the types of risks in which those particular businesses operate. The second line of defence is the group risk and other group functions, which set the group-wide standards and policies. The third line is internal audit, which sits above the group risk functions.

There was a constant discussion-which is a soft way of putting it; "argument" might be a better way-as to exactly what level of reporting the divisional risk functions should have to the specialist group risk functions. It is commonly referred to as a functional reporting line: that means they report to you in terms of their technical expertise, but they do not report to you in terms of appraisal or performance or such-like. This created a kind of "us and them" culture between the group risk functions and the divisional risk functions, which was dysfunctional. There were plenty of papers in which I was involved-either writing or contributing to-where I pointed out that it would actually have been much better if the divisional risk functions had a hard reporting line into the group risk functions. After all, they were the only ones who could assess whether they were doing their jobs properly.

BQ8 David Quest: Is it right to say that, in effect, rather than the divisional risk functions reporting to group or visa versa, they were reporting in parallel?

Paul Moore: Correct. They reported into their local reporting structures; it could be into the local chief executive, as it was in my case in insurance and investment division, but in other cases, it was not. For example, in the retail division, the risk function reported into the chief operating officer. You can think of the conflicts of interest there, where the chief operating officer is trying to drive performance, and at the same time the risk function is trying to raise the checks and balances and raise the red flags where required. It created a conflict of interest.

BQ9 Chair: There is a word that comes up around this time, "atypical", but in this respect-the operation of three lines of defence-am I right in saying that this was not unusual, but actually pretty common among other banks or insurance companies or whatever?

Paul Moore: Yes, it was quite common. I am happy to go into the detail of why I do not think that system works well and part of it is the reporting line problem, but yes, it was quite typical.

Mr Tyrie: It is still around, isn’t it-still in operation?

Paul Moore: It is still around. I understand-this is a hearsay statement-that in HSBC, they have now created hard reporting lines between business risk functions and the central risk function. Those are much stronger checks and balances.

BQ10 Chair: After Sir David Walker’s review of 2009, risk committees were established, then the group response of a certain seniority, possibly even on the board, would report to that. That would change the balance of power. In this federal model, the barons were very powerful, even in managing their own risk.

Paul Moore: Yes.

BQ11 Chair: I am hoping we will find that, in the banking world as a whole, things have moved on in that respect.

Paul Moore: I took a great deal of interest in Sir David Walker’s review and I fed in significant detail. Obviously I have been a practitioner for a very long time and I have seen what it is like on the ground inside these large organisations-I was a partner in KPMG, advising a lot of big companies on risk regulation, governance and so on.

We have to accept that the current way company law is set up drives executives to focus on short-term profit. In fact, only a few weeks ago the Economist Intelligence did a survey and discovered that 84% of banking business executives still think that they focus on short-term profits. So we have a natural drive to produce short-term profits, because that is what investment analysts want. When you have that natural drive you have to accept that that in itself contains risk. Therefore I have said, and I have been saying this ever since I gave my first evidence in 2009 to the Treasury Select Committee, that risk functions-I call them the control functions: risk, compliance and internal audit-should not report in any way into the executive, but should always report solely into the non-executive. That enables the control functions to do what their job is, which is to raise the issues that they need to raise when they need to be raised. If there are joint reporting lines or mixed messages about where they report, it is very much more difficult for them to raise the challenges they want and be protected when they do so.

Chair: Can we come back to the specifics of HBOS, although that is very interesting?

BQ12 David Quest: Just to stress, we are primarily interested in your experience in relation to HBOS. In terms of the personnel occupying the risk functions, you made some points in your evidence about Charles Dunstone’s position in relation to the retail risk committee. In general, what was the risk experience of people who were occupying the risk functions at that time?

Paul Moore: Part of the governance system was risk committees. Each division had a risk committee; they reported into a group audit committee. My own view was that the experience of the non-executives in running those risk committees was generally inadequate.

BQ13 David Quest: So each risk committee had a non-executive as a member?

Paul Moore: The members of those committees were always four non-executive directors. My view was that, generally speaking, as a rule-not in all cases-they did not have the technical expertise to do so. I was focusing very heavily on the retail side and obviously I did make the specific point. Charles Dunstone is a very good man and I am not making any personal comment about Charles Dunstone, but he had no technical expertise in banking; he had no technical expertise in risk management; he had no technical expertise in what you might call audit and assurance and oversight work; yet he was the chairman of the risk committee for the retail bank, which was the largest part of the bank. We obviously now know-subsequently-that in relation to corporate, there was inadequate oversight. That is quite clear.

BQ14 David Quest: Who was on the risk committee for corporate?

Paul Moore: I cannot remember the names of the non-executives on the corporate risk committee.

Chair: We can find that out. I think it is something like the second or third board meeting of the new company sets up these committees.

BQ15 David Quest: I think what you are saying then is that while it is possible that some members of the committee-non-executive directors-might have risk experience, that would be largely accidental.

Paul Moore: It would be largely accidental, yes.

BQ16 David Quest: There might be committees operating with no risk experience?

Paul Moore: Yes.

BQ17 David Quest: A lot of what you talk about in your evidence relates to retail risk issues-the two reports that you discuss are in relation to retail risk issues. You were head of group regulatory risk as a whole. What engagement did you have with the corporate side and the international side?

Paul Moore: When I was appointed, which was essentially September-October 2003, we had a risk mitigation plan and programme, which is agreed with the FSA, and there was a huge agenda of things that needed to be done. At the same time I inherited a group regulatory risk department that needed to be restructured-I am going to answer your question. So when we restructured the group risk function, we faced individuals off against individual divisions, so I would always have somebody attending a risk committee for each of the divisions. I believe that in that period a chap called Tony Brian was focusing on the corporate side, but as you will see from the evidence I have given, when the regulator and HBOS agreed their risk mitigation plan, one of the areas that they were very concerned with was the atypical credit risk management in corporate, and because it was focused specifically on the credit risk management side, Dr Andrew Smith was accountable for carrying out an oversight investigation or review-whatever you want to call it-into that, so he was doing most of the focusing on that particular side of the equation. I was focusing on the sales culture within retail primarily-not solely, but primarily.

BQ18 David Quest: So the answer to the question is that you had relatively little engagement.

Paul Moore: Relatively little.

BQ19 David Quest: Your own experience at HBOS had been previously in a retail part?

Paul Moore: Yes, primarily.

BQ20 David Quest: Did you feel yourself that you were sufficiently qualified to take on an overall group risk function, which included corporate as well as retail?

Paul Moore: Yes, I did, because I had access to specialists in the group financial risk department who would be able to opine on the technical aspects of whether the credit risk policies were in fact designed appropriately. I would opine on whether there was sufficient monitoring and other systems and controls in relation to those policies. That was an area in which obviously I had a great deal of experience across all different types of business.

BQ21 David Quest: Perhaps this is a question with hindsight. Given the very serious problems we know came out of corporate in the end, with hindsight, would it have been preferable to ensure that really anyone engaged in an overall group risk function should be steeped in the corporate side, as well as in retail?

Paul Moore: Well, yes. I had one senior member of staff focusing on corporate. Obviously, I was not there long enough, because I was dismissed, to carry on the additional work in the following years. There was a change in chief executive in corporate in, I believe, January of-was it 2005 or 2006? I cannot remember exactly when the change took place.

BQ22 David Quest: It is just noticeable that you, Ms Jo Dawson, who succeeded you, and, I think, Dan Watkins after that were all from a retail background, yet all occupying group risk structures.

Paul Moore: I do not think that is ideal. I would agree with that. The difference was that I had extensive, deep experience of risk management, regulation and governance, whereas neither Jo Dawson nor Dan Watkins had experience of advising or carrying out that sort of work. I had done countless substantial regulatory investigations and review work when I was a partner at KPMG in a whole range of different company-

BQ23 David Quest: We may come back to that. May I turn now to the FSA ARROW report, which, as you said, was really what you were brought in to deal with? To put this in context, in 2003, the FSA sent a number of letters in relation to different parts of the bank identifying concerns in different areas. We have seen the letters, but can you give us an idea briefly, from your experience, of just how serious those concerns were?

Paul Moore: Well, it was very serious. The tone of the letters was very serious. In fact, as part of the actions that the FSA took at the time, it increased the individual capital requirement of HBOS by 1%, which was a very important symbolic act. I had never seen an ARROW risk assessment letter as serious as the one that I saw in that year. That is why I called my operating plan "The Regulatory Challenge: a key strategic driver". If you read the plan that I wrote, I made it absolutely clear that if we were going to gain control, one of the things that we had to do much more vigorously from the centre was to carry out detailed rigorous oversight of the divisions and make sure that they were following the standards and policies that were set at the centre by the policy-setting committees, and that is what we set out to do.

I also made it clear that if we were going to achieve the reduction in the FSA’s assessment of our risk, then we would have to have the enthusiastic engagement of the divisions in that process. That kind of referred to the problem of the reporting lines with the local risk functions and so on. I also warned Mike Ellis at the time, before I even accepted the job, that however politely we did that work, it would be bound to upset a few people because when you are checking people out, it does not matter how politely you do it, some people just do not like it.

BQ24 Chair: What comes out quite early on is that when this challenge comes in from the FSA, there is from the management in general, either at the top or in the divisions, a very strong rejectionist view-"We have to challenge this. We’ve got to change the way the FSA is thinking." Were you worried that these complaints or criticisms were not being taken seriously enough and that people were still too much in the frame of mind of, "We’ve got to beat this off"?

Paul Moore: Yes, absolutely. I am a specialist in finding out what the situation is and in carrying out investigations-I am a barrister by original profession, so I am used to the business of gathering evidence and assessing what that evidence means. I felt that by doing the work that we were doing, we would establish what the position was and then, on the basis of that clear evidence, we would do whatever we needed to do to resolve it. But yes, I remember vividly the chief executive and the chief operating officer of the retail bank going off to the FSA on their own to have a challenge meeting with them, without any representative from the control functions at all, which I considered to be highly risky and inappropriate.

BQ25 David Quest: Do you think that the points raised by the FSA came as a surprise to management, or was it something that they were expecting? Let me break down the question. Was it a surprise that those issues existed, and was it a surprise that the FSA were taking them so seriously?

Paul Moore: It certainly did not come as a surprise to me, because by that stage, although I was operating in one division, I had seen enough to expect that the focus on the sales and marketing was going to be a serious concern to them. I remember being at group audit committee meetings where they were surprised, so certainly some of the key non-executives were surprised.

BQ26 David Quest: It certainly seems clear that they did not agree with them.

Paul Moore: Yes.

BQ27 David Quest: In terms of what was done as a result, in particular what you did in response to these letters, two reports were prepared by you, or under your control: a report into selling practices in corporate bond funds and a report into general sales culture within retail. Those were your two principal tasks that you undertook in response to the ARROW review.

Paul Moore: Yes. There were others, but those were probably the two principal ones. By far the most important was the review of the sales culture.

BQ28 David Quest: We will come to that in a moment. A number of other tasks were undertaken in relation to the corporate criticisms, but they were the responsibility of Andrew Smith.

Paul Moore: That is right. There was a specific review of the atypical credit risk management within corporate, and a review of the solvency in the with-profits business, which was part of HBOS.

BQ29 David Quest: But you were not involved in those?

Paul Moore: No.

BQ30 David Quest: And there was also a section 166 skilled person review?

Paul Moore: There was a skilled person’s review on the risk management effectiveness. So the regulator, being concerned about the overall risk management within the bank, appointed PWC-actually the bank appoints them with the agreement of the FSA-to carry out a skilled person’s report under section 166.

BQ31 David Quest: You say that the sales culture report was the more important report, and we will come to that in a moment. Just briefly to deal with the corporate bond funds report. The corporate bond funds was a product which was under the management of Jo Dawson’s division, or Jo Dawson’s section of the retail division. Is that right?

Paul Moore: Correct.

BQ32 David Quest: And that led, as I think you have described, to some considerable antagonism between your team and her team.

Paul Moore: Yes.

BQ33 David Quest: Just briefly, what exactly was it that you thought that Ms Dawson’s team was objecting to in relation to the investigation?

Paul Moore: Well, generally, they did not want their sales practices in relation to that product, which was generating a huge amount of volume and a huge amount of profit, to be checked. That was what they just didn’t like being checked. In particular, when we insisted that we should contact customers to establish whether they understood the levels of risk that they were taking when they were purchasing that product, that was a particular cause of concern for her.

BQ34 David Quest: But as I understand it, the main focus of the investigation, and indeed the main finding in the report, related essentially to whether these products were being properly sold, because customers potentially did not properly understand them. That was the issue.

Paul Moore: Correct.

BQ35 David Quest: So it was essentially a mis-selling issue.

Paul Moore: Mis-selling.

BQ36 David Quest: So the issue in relation to corporate bond funds was not one that went ultimately to question of the survival of the group.

Paul Moore: No. Corporate bond funds did not, but the sales culture generally went across the entire organisation.

BQ37 David Quest: We will come back to that. I just want to dispose of the CBF report. The corporate bond fund report was into a specific question of mis-selling a particular product. So far as what we are looking at, which is causes of the collapse of HBOS, it cannot really be said that, if there were problems with the practices of selling in relation to that product, that had any consequence for the group as a whole.

Paul Moore: Not specifically, but in terms of similar fact in relation to culture within the organisation, it does have some-

BQ38 David Quest: Let us look at the broader question, then, because the second report, as I understand it, was a much broader investigation into sales culture in retail as a whole. Essentially, the FSA had required this report to be done. Is that right?

Paul Moore: Yes, correct.

BQ39 David Quest: And the board agreed to do it.

Paul Moore: Correct.

BQ40 David Quest: You explain at length the difficulties you had in relation to doing the work for the corporate bond funds report. Did you encounter any similar difficulties in relation to the sales culture report?

Paul Moore: Yes. For the whole business, just the exercise of checking things was always a great difficulty. In fact, I raised this issue, which I have referred to as the cultural indisposition to challenge, in a group audit committee meeting in June that year. I do not know where exactly it came from and how long it had been there, but it did not really matter what you were doing. If your job was to check people out you were, understandably, not welcomed in-that I understand-but there were behaviours that were threatening and unpleasant to the people that were doing those activities.

BQ41 David Quest: As you say, no one really likes to have their own conduct investigated, but are you saying there was something specific about the HBOS environment that was different from other environments you might have seen?

Paul Moore: I think it was worse than other environments that I had experienced, yes.

BQ42 Chair: Do you think the structure of remuneration for people selling these products was a contributor to this? You were actually challenging their pay.

Paul Moore: Of course it was. Sales targets and the bonuses that linked to sales targets were right at the heart of this, and I notice that some banks are moving away from that sales target-driven approach to remuneration. So yes, of course it does.

BQ43 Chair: What other product, apart from corporate bonds, did this, your second, more general, report cover?

Paul Moore: Every product within the retail division: mortgages, personal loans, or creditor insurance, which we now call PPI-the whole gamut of products they were selling.

BQ44 David Quest: Were the criticisms of the sales culture across the board, or were they focused on particular products?

Paul Moore: Across the board.

BQ45 David Quest: You completed that report some time in 2004, and the findings were presented at, I think, a board meeting. We have a copy of the minutes-perhaps someone can give you the other file-

Paul Moore: You have a copy of the actual minutes?

BQ46 David Quest: The actual board minutes, yes. We will provide you with that. I appreciate that you subsequently raised an issue about the accuracy of the minutes.

Paul Moore: Yes, I did.

BQ47 David Quest: They are all tagged, and if you go to tag E3, you will find a copy of the whole minutes. I think you were in attendance for just some items, and the relevant one is item 7 on page 8, "Review of sales and control culture within retail banking". It refers to the review within retail. Pausing there, the full report was not before the board. Is that right?

Paul Moore: It was not placed at the board. It was a shorter report which referred to giving the board directors access to it, but the report that was written was by Mike Ellis.

BQ48 David Quest: Right. Then there is a reference to your comment that "ambitious sales targets inevitably led to tensions in relation to risk management systems and controls. HBOS had the most highly developed and effective sales culture within UK financial services". It then says, "In summary, the GRR review confirmed that the Retail governance framework and high level systems and control were fit for purpose; and Retail regulatory risk appetite was low; but improvements could undoubtedly be made-to meet the growing risk demands". It continues: "This was acknowledged by Retail to be the case: but it was essential to effect improvements without destroying the key strengths of the business." Is that a fair reflection of what the review said?

Paul Moore: Not at all, no. It was not a fair reflection of what I actually said at the board meeting, and in my second evidence to the Treasury Select Committee, I showed the e-mails.

BQ49 David Quest: Yes. We are going to look at those.

Paul Moore: This was the sort of thing that we saw not just in board meetings, but in risk control committee meetings. Obviously, I was in role only for about 11 or 12 months, but their massaging of minutes to give a different flavour-I mean, that clearly gives a completely different flavour from what I actually said.

BQ50 David Quest: Leaving aside for a moment how it was minuted, you were at the meeting and you made your points to the board. The board presumably understood the points you were making.

Paul Moore: Yes. I remember vividly that there was a pregnant pause at the end of my last point, which was that I recommended that the board reconsider its strategy for sales growth if it wished to avoid risks to customers and colleagues, and Lord Dennis Stevenson looked me in the eye and said. "At last we’ve got ourselves a risk director who’s prepared to tell us what we need to hear." That is precisely what he said.

BQ51 David Quest: It seems to me you are saying that it was not a question of the board not wanting to take your point; you seem to be saying that the chairman understood the points you were making and accepted them.

Paul Moore: Well, that is what he said.

BQ52 David Quest: What about the rest of the board?

Paul Moore: If he accepted my points, and was essentially giving positive feedback for the challenge, how could it come to pass that he would permit his chief executive to remove someone who had done that? It does not add up-nor do the minutes reflect what was said.

BQ53 David Quest: Leaving aside the minutes for a moment, when you were at the meeting you had the opportunity to make the points and it appeared that the board was taking them on board.

Paul Moore: Yes, it did.

BQ54 Chair: They were hearing what you were saying.

Paul Moore: It would not be the first time that people have said they have heard and listened, and then done something quite different.

BQ55 David Quest: You referred to the e-mail in which you set out what you say was a proper record. It is the evidence that you gave on 25 February 2009; I think the reference is paragraph 93.

Paul Moore: That is correct.

BQ56 David Quest: I think the points that you said should have been minuted and were not are covered in the four bullets right at the end of paragraph 93.

Paul Moore: Correct.

BQ57 David Quest: You say that you had "a few key observations." I would like to try to distinguish, in terms of the points that were being made in the report, which points were being made about sales culture that relate to mis-selling, which is an important issue but not necessarily a survival issue for the group. Were there also points being made that were relevant to the overall solvency, funding and performance of the group?

Paul Moore: The first bullet in that e-mail to Pamela, which I decided to send to my boss before I sent it to her, covers all types of products, not just non-credit products. You were not just seeing a requirement for wholesale funding just as a result of lending in the corporate division. The lending in the retail division required substantial wholesale funding, and ultimately what created the insolvency of HBOS was not being able to refinance its short-term lending requirements.

At its apex, I understand that it had a wholesale funding requirement above its deposit base of £260 billion, of which 60% had to be refinanced within 12 months. So £165 billion or £170 billion of wholesale funding had to be refinanced. A substantial part of that related to the lending within retail. There is a difference between the default on the loans in corporate, which was one thing, and what actually led to the downfall of HBOS, which was the inability to fund its short-term funding requirements.

BQ58 Chair: Are you saying that you do not think the genuine losses in corporate would have brought the bank down?

Paul Moore: Yes, they would have done, because their size was so great that the capital buffers were completely inadequate. Let us be clear that HBOS was in a position that it needed to be rescued-if I can put it that way-not, at the time, because of the defaults on its loans but because it could not refinance its short-term wholesale funding.

The wholesale funding requirement had grown so rapidly not only because corporate were selling risky loans to people, but because retail was. In fact, I understand that the total loan book of corporate, at the end of the day, was £116 billion, but the total loan book in the retail division was much larger than that. The point about the sales culture is that it applied across all types of products.

By the way, mis-selling does not apply only to insurance products, funds or corporate bond funds; you can mis-sell loans just as easily as you can mis-sell an insurance product. I do not distinguish between loans and corporate bonds for mis-selling purposes. Mis-selling got done because we oversold and mis-sold credit to people, as well as other products.

BQ59 David Quest: Obviously, we know now that there were terminal funding issues at the end of the life of the bank. I just want to explore whether it is really fair to say that, back in 2004 when you were presenting this report, those kinds of issues were on your mind at that stage.

Paul Moore: It wasn’t the liquidity requirements at that time that were on my mind. What was on my mind and the way that I put it in my final comment was risk to customers and colleagues, because when you oversell credit you always end up with a greater credit loss. So I was considering the ultimate credit loss; I wasn’t at that moment considering the liquidity requirements specifically. The answer to your original question is that the first point covers all of those points and so does the last point.

BQ60 David Quest: The last point being the one that says: "Careful consideration should be given in strategic plans as to exactly what level of sales growth is achievable without putting customers and colleagues at risk."

Paul Moore: Yes, exactly.

BQ61 David Quest: That is slightly obscure, isn’t it? What does that mean?

Paul Moore: Yes, it is slightly obscure-it is slightly a morse code- but basically it is actually matching the mis-selling to the customers because you are overselling to them whatever you are overselling, which is not good for them. But you are also putting the bank at risk, and that is what "colleagues" means, because when you oversell credit you always get a much higher degree of credit risk loss at the end of the day.

I don’t know what the losses have been in the retail bank within Lloyds-as everyone is focused on the corporate bank-because clearly once Peter Cummings came in, the level of growth was driven within that division to make up. This is quite an interesting point. When Andy Hornby took over from James Crosby in 2006, in that year he dropped the share of the retail mortgage market in the UK within HBOS to a substantially lower level, which indicates that he had in fact listened to what I had said. To make up the difference, there was a drive for increased sales within corporate. You saw in the FSA’s report on HBOS and in relation to Peter Cummings how the targets were upped to make up the shortfall, time and time again.

BQ62 David Quest: So what you are telling us is that you understood that you were making a point to the board not just about what one might think of as the ordinary risks of mis-selling but that they were actually putting the whole bank at risk by overselling?

Paul Moore: I accept your questioning on that, but the point that I was trying to make in giving my evidence relates to the governance systems and the checks and balances generally that operated within HBOS, and whether the same might have applied to other banks. If risk and control functions cannot speak up and there is insufficient protection for risk functions, both in reporting line terms and otherwise, when you live in an environment in which company law drives directors for short-term profit you will end up with a risky banking culture. So the point that I am trying to make is that simply getting the checks and balances and the separation of power right within these very large and societally important companies is absolutely crucial.

BQ63 Chair: Can you just clarify something? You are saying that this aggressive sales culture was creating two risks: one is that when you expand credit very rapidly its quality goes down and you make more losses; and the other is that you become more and more dependent on wholesale funding. Am I right in saying that at the time you thought it was more likely that the first risk would crystallise, but in practice it was the second risk that crystallised?

Paul Moore: Yes, because it carried on-didn’t it?-after I left. Then, both risks ultimately crystallised. I do not think that Lloyds, when they acquired HBOS, believed the level of loan losses that they were going to get. In fact, if you look at the reports, you will see that they moved from a very small provision of £390 million or something when the capital raising took place in 2008 to somewhere between £11 billion and £15 billion within the corporate division, and it is not clear what it is within the retail division, because it has all been mixed together, so the two go hand in hand.

If the country wants to be safe, you have to have a separation and balance of power inside these huge companies. Company law was not designed for companies of this size. Fiduciary duties drive directors to focus on short-term profits. I referred a moment ago to the 84% of directors who say that their priority is short-term focus. If you do not have a separation and balance of power in these huge companies, where the risk and control functions can speak up almost like an internal regulator, that is when the risks take place, because everything else can be covered up.

BQ64 David Quest: Do you still have the minutes of the board meeting?

Paul Moore: Yes.

BQ65 David Quest: Could you turn back to item 5? It was not an issue that you spoke to, but you were in attendance when it was discussed. It is headed "Overall Review Of Risk Management".

Paul Moore: I do not remember being present for that. I know that it says it on the minutes, but carry on.

BQ66 David Quest: Can I just ask about it anyway?

Paul Moore: Yes, I was very familiar with it.

BQ67 David Quest: It refers to the section 166 skilled persons report, which we mentioned earlier, and says that it is close to finalisation. It then says: "Whilst the Report contained a number of recommendations about improvements that could be made to the Group’s Risk Management Controls and Infrastructure, PWC were clearly satisfied that Risk Management within HBOS was effective and satisfactory. In Mike’s view the FSA (and the Board) should be satisfied with the outcome of this exercise. The final version of the Report…would be submitted to the FSA."

It continues: "Although this had been a costly and time consuming exercise, three years after the merger the Group had received external validation, following a very thorough review, that its Risk Management Infrastructure was sound." So it seems that, despite the-as you described them-four very serious concerns initially raised by the FSA, by this stage, once the skilled persons report had been done, the board were being given the indication that all was well after all.

Paul Moore: One of the points that you need to bear in mind is a general one about the sort of inherent conflicts of interest that apply when the big four firms, with which I am very familiar, operate when they are doing these kinds of pieces of work. I do not think that the system works properly, because clearly it is not in the commercial interest of the big firm to be very hard with the firm. If they were, the chances are that they would not get any fee-generating fees from those-

BQ68 David Quest: I think we should just be clear that you are making a general point.

Paul Moore: I am making a general point.

BQ69 David Quest: Is there anything specific that you have to say about this report?

Paul Moore: Yes. They saw the kind of rigour that I was putting in, which had not been there at such depth previously-in other words, really getting stuck into the oversight and assurance work, and we would have had a plan to do this across all the company if I had still been there-and they took a lot of comfort from that, because they could see that the group risk functions, particularly my function, which was responsible for that kind of systems and controls checking, were actually doing their work. To be fair on PWC, because they had seen that we were in fact upping the ante on checking and actually really checking that the standards were being applied-we really were reporting loudly-to some extent their report reflected that.

Chair: It seems to me that this was an absolutely crucial turning point in the fortunes of HBOS-the pressure that had been on it. What I discern is a visible sigh of relief-"We’ve got the FSA off our back"-and instead of going on really to put effort into tightening up risk controls-well, we have dealt with that. Andrew Tyrie may want to come in at this point.

BQ70 Mr Tyrie: First, I am very grateful to you for giving evidence-the whole Commission is. You were a valuable whistleblower at a difficult early stage in this whole process, and that point needs to be put on the record.

Let me ask some specific questions that relate to what we have just heard. Did the board ever form a view about what you see as the link between risk to the bank and the retail culture? Did they ever say, "Yes, there is such a link"?

Paul Moore: I do not remember hearing anybody making such a comment.

BQ71 Mr Tyrie: Do you think that in cross-examination with me in 2009-I am looking back now at the record-Lord Stevenson was right to say that HBOS failed largely, if not entirely, because of the collapse of the wholesale market and that the allegations you were making had nothing to do with that?

Paul Moore: No, I do not think he was right at all. The bank collapsed because it sold too much, in too-risky ways, throughout its entire-yes, of course, the result of that was the requirement for wholesale funding and ultimately very substantial loan losses in both corporate and, I believe, retail. So I do not agree.

BQ72 Mr Tyrie: He also, which has not yet been brought out this morning, flatly denied something that you put in your evidence at the time-that you and your team experienced threatening behaviours from senior executives when you were seeking to carry out your legitimate role. Do you stand by that allegation?

Paul Moore: Absolutely I stand by it. In fact, if you look through the e-mail evidence, you will see it corroborated very forcefully. There was a particular e-mail, where I-part of the "res gestae", as lawyers would call it-actually wrote to Mike Ellis, appealing to him. People hid pieces of paper. They did not turn up for meetings. They would be rude and sometimes swear at people. In fact, I personally experienced Jo Dawson, who-obviously, I was aware of the upset that reviewing her work had caused. I did not want to upset her.

One thing I must say at the beginning of all these reviews is that they were not performance management reviews, and we made that clear at the beginning of every single meeting. It did not matter what interview we were doing. We would say, "We want to make it clear: this is not an exercise in establishing accountability. We are trying to establish the status quo. Nothing that you say will be held against you. We need everybody to speak up." We had made it absolutely clear that this was not about accountability at the time, but it made no difference.

When I went to try to resolve the previous difficulties with Jo Dawson, she leant across the table, stood up, pointed at me and said, "I’m warning you. Don’t you make an effing enemy out of me." That is an absolute verbatim comment of what she said. That was the most extreme example, but it demonstrates that if a very senior executive, who is clearly a protégée of the chief executive, feels that it is perfectly okay to speak to the head of group regulatory risk in those terms-you can imagine how that kind of culture spreads out through the organisation.

BQ73 Mr Tyrie: This was the point I wanted to get on to. Your concern about this bank at the time, and a lesson that you are inviting us to draw, is not necessarily, "Was the retail side particularly vulnerable?", although you think it was, nor is it nARROWly focused on which particular set of financial transactions brought down the bank. Throughout, it is about the culture of the bank.

When you talk about culture, you are not just referring to a sales-driven culture; you are referring to a way that one part of the bank interacted with other parts of the bank, and you have described threatening behaviours which emanated, you say, from the chief executive, and therefore presumably at board level. Is that correct?

Paul Moore: Yes. My job is risk management. Risk management is about what is going to happen in the future. I am raising a flag that says that if you carry on with this kind of culture, which is sales culture and fear and blame linked together, and if the only thing that counts is sales, everything else gets pushed aside. For example-I do not want too much held by this-the nickname of the chief operating officer of the retail bank was "whacker". That was a celebrated, open nickname, and not one of those that is quietly referred to by staff in the pub-there were many of those.

So, it was a culture that was resistant to any sort of challenge, and if you have a cultural indisposition to challenge, it does not matter what your governance framework looks like, or what your processes are. It generates risk. And in an environment where directors’ duties are focused on short-term profit, if you do not have the balance of power in the boardroom, with the risk functions reporting outside of the executive-where there is a degree of adversarialness in the boardroom-you will continue to have a risky banking sector because they will focus on sales and profit.

BQ74 Mr Tyrie: Can I pursue this for a moment? You are saying that this was the culture of the executives, but are you saying that it was also the culture of the non-executives and the chairman? Is it not the job of the non-execs, led by the chairman, to restrain and to focus correctly the culture of senior executives?

Paul Moore: Yes it is, but I have never witnessed-yet-that being done to a level that creates the balance.

BQ75 Mr Tyrie: I just want to stick with your experience there, rather than your experience right across the piece. Were the senior executives in HBOS, in your view, in any respect attempting to play the role that you felt that they should, with respect to culture?

Paul Moore: No. In fact, I think that I was the first senior risk director at HBOS who had raised an issue of culture in a group audit committee, and when I raised that behaviours had demonstrated a cultural indisposition to challenge, which followed the e-mail to Mike Ellis, it was a complete surprise to them, and considered to be completely unusual. Yet if we want to regulate and supervise, we have to supervise and regulate not just process and structure, but culture and people. That, along with creating a balance of power in the boardroom, is what I have been talking about in the debate over the last few years.

BQ76 Mr Tyrie: When you were threatened in that way, did you consider going to the chairman personally?

Paul Moore: I went to Phil Hodkinson, my previous reporting manager who I had a close relationship with-he subsequently became finance director-and asked him what his advice would be on whether I should make a formal complaint to the HR department and chairman about that behaviour. For better or worse, we decided just to leave it because we thought that the balance of creating even more tension was not worth it. But I certainly considered it.

BQ77 Mr Tyrie: In defence of the non-execs and, particularly, the chairman, what reasonably could they do if you did not tell them what was going on?

Paul Moore: They saw the evidence that I gave them after I was dismissed. They and the FSA should have said to James Crosby, "I am sorry, you can’t simply dismiss this individual like that." He had written the memo saying, "The decision was mine, and mine alone". In other words, he had not followed his own policies for dismissing senior people-or anybody else, for that matter.

BQ78 Mr Tyrie: While you are before us, I think I ought to ask one other question. Whispers are put about that you are a driven man and are still deeply upset, because you have obviously had this very difficult experience, and that therefore, in the words of Mandy Rice-Davies, "He would say that, wouldn’t he?" I think that you should be given an opportunity to respond to that whispered allegation.

Paul Moore: That I would say what?

BQ79 Mr Tyrie: Well, that you would be particularly upset, even after this time, and that therefore by implication your evidence should be taken at a discount.

Paul Moore: Well, I have tried to write it down in a way that is as factual as possible. I don’t blame anybody personally.

BQ80 Mr Tyrie: I am giving you the opportunity to make a response to points that are being made.

Paul Moore: The evidence that I have is the evidence that I have given.

BQ81 Mr Tyrie: You are relying on the evidence.

Paul Moore: I have tried to avoid drawing conclusions without being able to demonstrate the facts.

BQ82 Mr Tyrie: I think that is a reasonable response. Can I take you back to these minutes for one quote?

Paul Moore: I just want to say one thing. You don’t need an awful lot of evidence to see that there is something wrong when a chief executive dismisses somebody who has a long track record of success in a particular area and replaces that person with a sales manager as group risk director. That in itself is evidence, because obviously PWC at that stage were not engaged to come back and say, "Now you have done that, what do you think?" Dennis Stevenson was in a position where he could and should have prevented that. I had excellent feedback from the chairman of the group audit committee, but he didn’t prevent it. I reported all of these matters to the FSA and they did not prevent it. I know, and we need to recognise, that when executives are focused on their short-term results, they lose perspective. That is why you have to have the separation and balance of power, because when they are at their greatest risk, you need to have sufficient power on the other side of the table to speak up, without those people being removed.

BQ83 Chair: Can I clarify one thing that I am having difficulty understanding? I think you said that PWC took comfort from the fact that you were there doing good work, and that was instrumental in their writing the kind of report that they did, which was possibly then overinterpreted by the executives.

Paul Moore: Yes.

BQ84 Chair: But when you were dismissed, if the FSA was taking comfort in the PWC report, you would have thought they might have said, "Yes, but you have pulled away the key prop that was going to make this system work." But what then happens, as I understand it-and this is from the FSA’s own account-is that KPMG, with the agreement of the FSA, is appointed by the audit committee to review this, and KPMG reports that there was no evidence in the report that Mr Moore was dismissed due to being excessively robust. So the FSA, with the help of KPMG, seemed to take this view, and did not raise objections to your dismissal. The FSA did not say, "He was absolutely crucial to the implementation of the advice we gave." That comes back to my point that, at that point, there is a visible diminution of pressure, which then goes on after your time to 2006, when the FSA come back, and writes that there are things to improve but basically the main structure is sound. The management have taken great comfort from the fact that the FSA went along with your dismissal, did not raise objections to it, and then wrote the subsequent report in 2006. It seems to me that the management would have thought, "Phew-seen them off." Then, we get to 2012 and the decision notice on the BOS. One of the things it says is that the management of risk in the company was defective.

Paul Moore: Yes.

BQ85 Chair: So my hypothesis is that, by not pursuing this vigorously around 2006, the FSA gave false comfort, and then allowed another two or three years of aggressive lending and selling to continue.

Paul Moore: Yes.

BQ86 Chair: It then came back, and, although it did not actually say, "We wish we had been more vigorous in 2006," it did say that the company’s risk systems were defective. That does not seem to be a very satisfactory story.

Paul Moore: It is not satisfactory at all. It is perfectly clear that KPMG could not have been independent in investigating my allegations-they were the auditors. We made complaints throughout the entire process about the way they conducted things. We wrote one rebuttal letter to the KPMG investigation, but the FSA never called me back in to say, "Well, what do you say to the KPMG report?" The KPMG report did the opposite; in summary, it said that I was a lunatic and that they were right. So we have an entire system that doesn’t really work.

I have tried to come up with some very simple recommendations to create a separation and balance of power in the boardroom. The first thing is to look at the fiduciary duties of company directors. Currently, they focus on short-term profits. You need to have control functions reporting away from the executive, preferably into a dedicated, expert non-executive. That would leave time for other non-executives to do the broader work. I believe in diversity in the boardroom, but if you had a dedicated non-executive, that would work. You need to have proper professional qualifications for risk directors. Did you know that you can be a director of risk, a director of compliance, or a director of internal audit with no proper professional qualifications? There is a whole list of other things, but those are the most important. Audit is not deep enough and does not do what it says on the tin. I have tried to write about these things. So far as my own personal story is concerned, the evidence is there.

BQ87 Chair: But if we take the mandatory creation of risk committees with a chair who is an approved person, isn’t that effectively your director of something or other by another name?

Paul Moore: It could be, if they were operating in that way. It certainly could be.

BQ88 Mr Tyrie: So you are broadly supportive of what I suppose one could call the Walker proposals times two? His phase 2 proposal is to put in those risk committees.

Paul Moore: The most important thing, in my view, is to have the control functions not reporting in any way to the executive, and for there to be additional protections for heads of control functions, so that they cannot be dismissed without proper procedures. Those people who do control functions are not whistleblowers; it is our job to raise the red flag when the time comes. Unless the regulator can rely to a very large extent on the quality and rigour of the internal regulatory system, the internal governance system, it is very difficult for it to succeed. I wouldn’t separate out risk from audit or compliance. I would put them all in the same place, so long as those control functions report away from the non-executive.

BQ89 Mr Tyrie: We have those trenchant recommendations that you have given us. With your permission, Chairman, I want to come back to one detailed point about the minutes. I want to clarify just one further point from the things I have heard so far. In the minutes of July 2004, in the paragraph on page 8, there is a very interesting phrase: "The balance between sales and controls. A ‘customer champion’ approach demanded that this balance was maintained". What, in your mind, when you read that phrase, did "customer champion" mean, given your scepticism about the handling of conduct risk in this firm?

Paul Moore: It is just wrong that companies can put up these slogans when the evidence simply does not bear it out.

BQ90 Mr Tyrie: What do you think the company thought it meant when it was talking about customer champions, or was the phrase there for the consumption of the regulators when they saw the minutes?

Paul Moore: That is exactly right.

BQ91 Mr Tyrie: What-that it was written with the intention that it should be presented to the regulators?

Paul Moore: Precisely. It is written not to make clear what I said but to massage it so that it did not seem as severe as the points I made at the meeting.

BQ92 Mr Tyrie: I am just trying to get to what you think the person who wrote that phrase meant. "Customer champion"-this is putting customers first.

Paul Moore: I don’t know. They were obviously trying to make it sound better than I said it. My evidence here supports that.

BQ93 David Quest: An issue arises out of this and the sales culture report. You obviously did not remain with HBOS very long after this meeting. During the remaining period you were there, was anything done to implement that report?

Paul Moore: As far as I am aware, there was an agreement to set up a project to deal with the points that I made, but I was not at all involved in any part of the implementation of it, so I don’t know exactly what happened after I left.

BQ94 David Quest: So you don’t know whether anything, in the end, became of your report?

Paul Moore: No.

BQ95 David Quest: I want to ask you about another point. We were talking before about culture and the culture relating to the challenges between divisions in particular. I want to ask you about another culture point. One of the points made in the FSA’s final notice is that there was what they call a cultural optimism at HBOS. I wonder whether that was something you observed during the period you were there, and, if so, what does it mean?

Paul Moore: That is another way of putting the same point, isn’t it? If you want to build your balance sheet and sales are your primary method of doing so, you then have to post facto rationalise why what you are doing is lower risk than, objectively, it is. You would therefore say that things that people wrote, or said or did demonstrated a culture of optimism. Whether they believed that is another matter. As you can see, people write things to justify things that do not really reflect what has happened. The point is-I know I keep repeating it-if your control functions and your non-executives internally cannot speak up and cannot challenge, and they are properly qualified to do so-which relates to the culture, the process, the people, and whatever it happens to be-the executive will win the day. When the separation of personal liability and limited liability was designed, nobody imagined we would have companies with such huge balance sheets and such huge societal importance. Apart from anything else, the complexity and speed with which these organisations operate now need not just a Walker review too but an even further advance in separation and balance of power. That is why in a democracy we have arguments in the House of Commons and the House of Lords. Arguments are good. If I was a regulator-I know this sounds silly-I would CCTV all board meetings and all risk control committee meetings so that I could see whether there was an argument going on. If there is no argument, you can be sure that risks are being lost. I have rarely seen in my professional career proper arguments going on in these companies that affect so many people in our country and around the world.

BQ96 Chair: Where do you think this sales-driven culture came from? Two organisations, both regarded as rather conservative and traditional, come together and woomph within a short space of time they are using words like "pioneering"-a word that appears in these board minutes-and have big, ambitious sales targets.

Paul Moore: My own view is that that was led by James Crosby. The reason I say that is that James Crosby wasn’t actually a banker. James Crosby was an actuary who first of all worked in an actuarial department in Scottish Widows or one of the Scottish life companies and got into fund management. He was then recruited into Halifax to run the bancassurance arm. The bancassurance arm was a direct sales operation. He saw the way you could drive sales through a direct sales operation. So when he took over the Halifax he put that culture into the whole of the Halifax by recruiting people like Andy Hornby and others from outside the banking world. Then when the merger took place he took that to the next level.

One of the reasons I believe he put Peter Cummings in over the previous incumbent was that, although the previous incumbent of corporate was a business man, no doubt about it-

Chair: That was George Mitchell.

Paul Moore: Yes, George Mitchell-he wanted more sales from corporate, and we saw what happened. I believe that he brought the sales culture in. Of course, then all the other banks in the UK started to follow HBOS because HBOS was the outperformer. If you look at the share price and shareholder value, HBOS was outperforming every other bank because the analysts liked the growth in the balance sheet. There were unrealistic demands for 20% return on equity, which is incredibly high for a bank of that nature.

Chair: Thank you for your very interesting testimonies. We are trying to piece together a story not of what happened but of how it came to happen. You have given us some clues on that and we are very grateful to you. Thank you.

Committee suspended until 2 pm.

Examination of Witness

Witness: Colin Matthew, CEO International, HBOS, 2004-2008, gave evidence.

Chair: Welcome, Mr Matthew.

Colin Matthew: Thank you.

Chair: We look forward to your testimony. Can I give you a bit of background? I don’t know whether you have appeared before the Treasury Select Committee.

Colin Matthew: No, this is my first appearance.

Chair: The purpose of the Commission is to find out in part what went wrong during the financial crisis in banking, but also how it went wrong, or, more accurately, how it was allowed to go wrong; that is our particular interest. What mechanisms failed, what warnings were either not given, or ignored, overridden or not followed through?

With HBOS, we know quite a bit about what actually happened, but much less about how or why. We hope to explore with you some of the issues around the structure of the way decisions were made and why they were made at particular times. We know a lot more, as a Commission, about RBS-the FSA has written a huge piece on it. Nothing equivalent has been written about HBOS, although they are working on it, and we do have the two decision notices. We are using HBOS as a case study, to some extent. Why are we doing that? It is a remarkable study-two well-known brands come together in 2001, with a combined market cap of £30 billion, by 2007 we are told that that might be £40 billion, and by 2008 it is nil or negative, so it is a pretty spectacular case.

The purpose of the Panels is to establish evidence that we can then take to the Commission as a whole. It is the Commission that comes to conclusions, rather than the Panel itself; we are primarily an evidence-collecting body.

We also have an innovation: we have employed counsel, in the form of David Quest. I should emphasise that we are not trying to turn this into a court or a tribunal with all the things that that involves. We are doing this simply because he is probably better at questioning than I am, as he does it all the time. It will also allow me to better listen to the answers, rather than having to think about what the next question should be. In that sense, it is an adjunct to our evidence gathering, rather than an attempt to take this to a new, American-style legal hearing.

That is probably all I need to say, by way of history. Mr Quest will ask a series of questions, particularly around the narrative, and then I may come in towards the end to try to draw some lessons. I am looking forward to the evidence that you will give.

BQ97 David Quest: Good afternoon, Mr Matthew. To your left, you have a file of documents; we may need to look at some of those in due course. Can I start by establishing your role and career at HBOS? To summarise, you had a very long career, initially with Bank of Scotland, where I think you started in 1966.

Colin Matthew: I did indeed.

BQ98 David Quest: You rose to become chief executive of business banking at Bank of Scotland.

Colin Matthew: That is right; I was a main board director at Bank of Scotland

BQ99 David Quest: You carried over that role initially into HBOS after the merger.

Colin Matthew: Correct.

BQ100 David Quest: Then, in January 2004-I think it is January 2004, there may be a mistake in your statement here-you became chief executive of the international division.

Colin Matthew: It was in 2006 that the international businesses were formally put together.1

BQ101 David Quest: I see. In addition to that role, you subsequently took on a role as chief executive of the treasury and asset management division.

Colin Matthew: That is correct. The confusion, perhaps, on the 2004 point is that some of the businesses in what became the international division in 2006 were part of business banking from 2001.

BQ102 David Quest: Right. While we are on that, was the distinction between what fell within the international division and other divisions of the bank essentially geographical?

Colin Matthew: Yes. For example, in Australia, the international division looked after all the business done in Australia-retail; we did quite a lot of insurance and SME banking; and we did a limited amount of corporate banking. All of that was within the international division. It was done on a geographic basis.

BQ103 David Quest: I think you said that you were on the main board of HBOS for the whole of its life?

Colin Matthew: From its formation, yes.

BQ104 David Quest: With that being so, and with Lord Turnbull having indicated the rather extraordinary decline that took place in the fortunes of HBOS, are you able to summarise briefly, from your understanding, what it was that really caused this extraordinary collapse?

Colin Matthew: Gosh. How long do we have?

BQ105 David Quest: First, before you answer that, do you think at this stage you understand what caused the collapse?

Colin Matthew: Yes, I believe I understand what the final triggers were, and it is perhaps important for us all to understand. I believe that this actually started not as a crisis of credit quality or indeed as a shortage of capital, but as a shortage of liquidity. That was the original manifestation: a shortage or tightening of wholesale funding in the wholesale funding markets. People were increasingly uncertain and unsure; they were aware that economic times were changing and things were getting rather more difficult, and they were either therefore placing their wholesale funding with, in their eyes, safer houses or, much more particularly, were placing it short term with central Governments. That was certainly the first time that had happened in my experience-as you say, I have been in the banking business since 1966, and I have not seen a liquidity crisis like the one that we suffered through 2007.

That then led on, I believe, to what we then saw with banks, institutions, commercial clients: essentially, a quest for safety, which then in turn led to different approaches in different countries-I am being very sweeping here, I accept-by Governments reacting in different ways to the crisis. Which were most apparent, obviously, in the financial sector. That liquidity crisis clearly was of a scale and substance that could not be solved in the short term, and led in turn, by consequence, into fundamental trading difficulties for the banks.

BQ106 David Quest: Two points arise out of that. First, of course we had unprecedented financial conditions, but why was it that HBOS as an institution was so particularly affected by those conditions?

Colin Matthew: I think probably for two reasons: one was our sheer size and scale. We were one of the most active UK banks in the wholesale markets, not just for funding in taking wholesale deposits from essentially around the globe, but also using the wholesale markets to offload assets.

BQ107 David Quest: More so than other banks?

Colin Matthew: Yes, probably more so. We were, and had been for a number of years, a very active securitiser of residential mortgages, which was a way of continuing to grow and write business, but not keep all of the assets on the balance sheet. That market through 2007-essentially from the middle of 2007-completely froze up. It just closed shut.

BQ108 David Quest: So HBOS was, in general terms, more exposed to the wholesale markets than some of its competitors?

Colin Matthew: Than some of its competitors, I suspect, but not as much as others. We were active players in the wholesale markets on both sides of the balance sheet.

BQ109 David Quest: The other point that I wanted to put to you is that you have discussed the liquidity and funding issues, but, as we will see, there were also massive write-offs and massive impairments, particularly in the corporate sector. Is it not the case that HBOS was really doomed anyway, simply on a balance sheet basis, by the need to write off these loans?

Colin Matthew: What is fact is out in the public domain, in terms of the impairments and the write-offs in the corporate division, for which I obviously wasn’t responsible; I was running the international division. But clearly the challenge for banks in that position and for Governments in the broader sense-if I go back to liquidity-the unknown was: would the outcome have been different if the liquidity crisis could have been resolved or minimised, such that funding would start to recover and the distribution markets for assets would start to recover? While I am not saying that banks would not have suffered pain, what could hopefully then happen is that it be taken over a longer period. If I look at the past downturns in the UK that I experienced in my time at the Bank of Scotland, I know that we did see major downturns, but they were not accompanied by a crisis of liquidity, and over a period-over a period-many of these were worked back to health. That simply-no, "simply" is the wrong word-that factually was not possible this time, because the markets completely closed.

BQ110 David Quest: A distinctive feature of HBOS’s position might be that it was facing at the same time this liquidity problem as well as, for HBOS, enormous and unprecedented impairments of its loan book. It was a twin problem really, wasn’t it?

Colin Matthew: Again, this has been made public through the FSA’s conclusions. Within the corporate division-the UK book-we did have a higher exposure to higher risk lending in our portfolio than a number of our competitors, but what, clearly, we did not expect-very few people did, I suspect-was the extent or the severity, and the length of time it has sustained for.

BQ111 David Quest: As you said, you had considerable experience at the Bank of Scotland prior to the merger, particularly in the corporate banking sphere. What changes did you observe in the culture of corporate banking between the Bank of Scotland days and the post-merger days that might account for this increased risk?

Colin Matthew: Clearly these are purely observations, but probably the major change was, by definition, that we, Bank of Scotland, were coming from a relatively small UK-based bank2, were coming together with Halifax, a major building society in the UK-both had very long and proud histories-to form this large financial conglomerate called HBOS. So I think the principal change, which probably would apply to other areas of HBOS as it would to our colleagues in the corporate division, would be that we were now part of a much bigger financial organisation. Secondly, and this would be peculiar to the corporate division, they would clearly have more financial muscle in the markets.

BQ112 David Quest: Exactly. One of the stated advantages of the merger-I think there is a reference to it in one of the annual reports at the time-was that it would give a much larger balance sheet, which would enable the corporate side coming from Bank of Scotland to trade on the Halifax’s balance sheet and make more. That was thought to be an advantage of the merger.

Colin Matthew: Yes, and as far as I can recollect, it was put into being, but clearly when we talk about as markets got very difficult through 2007, the syndication market-the corporate division’s ability to distribute assets-just completely froze up. In previous years, they had been able to do that. I think there was actually an analysis in certainly in some of HBOS’s annual reports, under the corporate division, where there was a figure quoted for annual lending growth, both gross and net of sell-down.

BQ113 David Quest: To return briefly to the point about funding and liquidity as against loan impairment, I want to raise another point with you. You were talking about the problems experienced with liquidity as the markets closed down, but there is a link, isn’t there, between impairment problems and liquidity problems to this extent: that presumably as credit becomes more squeezed, the desire of the markets to lend to HBOS is affected by the perception of the quality of the loan book?

Colin Matthew: Yes.

BQ114 David Quest: So as there is a perception, rightly, that the loan book is becoming more and more impaired, that, in itself, affects the availability of funding?

Colin Matthew: Yes.

BQ115 David Quest: So the two things are linked?

Colin Matthew: Yes.

BQ116 David Quest: I want now to turn to the board and operations of the board and to see how they worked and whether they worked effectively. I’m afraid I am going again to focus on the corporate division and to ask you some questions about the final notice that the FSA produced into Bank of Scotland. That is a document that you have read, I take it?

Colin Matthew: Yes, I have.

BQ117 David Quest: What they say in summary is: "Between January 2006 and March 2008, Corporate pursued an aggressive growth strategy, with a specific focus on high-risk, sub-investment grade lending. Corporate did so despite known weaknesses in the control framework". We know also-it is a matter of public record now-that as a result there were very, very substantial write-downs in the corporate loan book for 2008 and afterwards. When this final notice came out and you saw it, did the points that the FSA were making come as a surprise to you?

Colin Matthew: What I would say first is that my main day-to-day job was running the international division as part of the organisation-

BQ118 David Quest: I am sorry to interrupt you, but the reason we are pursuing this is that, while we appreciate that that was your division, one of the points we are interested in is what degree of board supervision there was of the corporate division. That is why I am asking this.

Colin Matthew: In terms of the board awareness, if I try to answer that as a member of the HBOS board from its formation in 2001, obviously all of the other executive directors and non-executive directors received the same information flow from the corporate division, if that is what I am being asked-

BQ119 David Quest: Yes.

Colin Matthew: That would principally come in the form of the monthly management information pack, which was a group pack with all of the divisions. All of the divisions, as part of that, would submit their monthly financial performance, as well as a commentary of the key issues around the business. Part of that pack was also a report from group risk on the issues as they saw them happening in the various businesses, and the non-executives and the executive directors obviously read that. There clearly was a limit to the amount of information that we could physically get and physically read. We were not running the corporate business. Also, obviously, at monthly meetings there were discussions around the board and the committee meetings on what were seen as the key issues.

BQ120 David Quest: These are not points of detail in the FSA report. These are pretty major issues. What I am asking is are these issues-for example, in relation to concentration, high risk, lack of controls-points that came as a surprise? Was it simply that the board was not aware?

Colin Matthew: No, if I perhaps take these. In terms of high risk and the type of business being written in the corporate division, I would not have said that there was any change in terms of the type of business. The activity under focus, I think, would principally be in the leveraged finance in the private equity part of the corporate book3. That is an area where HBOS had been active for some time. In 2007, I suspect that a number of transactions were written on the basis that they were going to be sold down, and they could not be sold down because, as I have already described, the sell-down markets were shut; therefore, there would be additional exposure on the balance sheet than was expected of these high-risk loans.

BQ121 David Quest: For example, in the passage that I read, the FSA says, "Corporate pursued an aggressive growth strategy, with a specific focus on high-risk, sub-investment grade lending." First of all, do you agree with that characterisation of what corporate were doing; and secondly, did you know that was what they were doing?

Colin Matthew: On the growth strategy, if I just go back to the point I made, which I think was in the 2006 annual report, it is quite important to appreciate the difference between the growth achieved pre-sell-down of transactions and post-sell-down of transactions. That obviously is the completion of the transaction, and they are quite different figures. I suspect in 2006 one was double digit and one would actually be in single digits.

In 2007-clearly, not being involved in the day to day of corporate division, as I have already said, I am describing what I suspect happened-first, they had written business expecting to sell down and could not sell down. They were facing a complete cessation of refinancings-any element of a banker’s business involves loans being repaid and refinanced from time to time for a whole multitude of reasons, and those all stopped. Thirdly, as part of the crisis, we saw customers draw on their undrawn facilities to preserve their own access to liquidity. Fourthly, I should not forget to say that fundamentally we wanted to stay in business for those customers, who are important to the UK economy and get access to finance. So I acknowledge the high risk of the sub-investment grade as compared with the other banks. That is a business that HBOS’s corporate division was active in.

BQ122 David Quest: The other thing that the FSA says is, "The Corporate portfolio was high risk, highly concentrated in its exposure to property and highly concentrated in its exposure to significant large borrowers." Again, is that a strategy that you were aware of?

Colin Matthew: HBOS, and indeed Bank of Scotland before it, always had a reasonably substantial exposure to construction and property. Some of this for the corporate division is in the annual report, trying to differentiate in the property market between property development, property investment and property buy to let; these are all very different businesses, but all are categorised as property. But yes, concentration of risk in property was something that was discussed on a reasonably regular basis at the board. It was included, to my recollection, in the group business plan.

BQ123 David Quest: What is there in this final notice that you did not know about and that came as a surprise to you, if anything?

Colin Matthew: I am not sure that there was very much that came as a surprise. I really was not focusing on what the outcome would be; clearly, having left the organisation when I did, I had no further involvement after that time. During the FSA’s review, I had one meeting with them in 2009 and one follow-up written exchange in 2010, and that was the extent of my involvement.

The final point I do not think I have answered is on high risk. There, obviously, the board-the other executive directors and the non-executive directors-were dependent on the management information coming forward in terms of the categorisation of loans, the movement into high risk and the treatment of them as a result.

BQ124 David Quest: It seems to me that what you are saying is that the board appreciated that the corporate division was pursuing these strategies but were happy to let them get on with it.

Colin Matthew: No. I think the board recognised that in 2007 there were extreme difficulties in actually controlling a banking business when markets were completely closed. Strategies that we had previously implemented successfully, such as selling down assets and securitising mortgages, were simply no longer available. At that time-again I would not have access to or knowledge of the actual date-but there would have been a point when the corporate division would have said, "That’s it. We are no longer able to write new business."

BQ125 David Quest: Yes. No doubt there came a point when it was too late to do anything about it, but before that point, was there ever a time when the board or anyone on it was asking corporate whether that was the right strategy for corporate to be following?

Colin Matthew: The questioning that I would recollect would be, as you have highlighted, probably on two main aspects. One would be the size of individual transactions and, linked to that, the organisation’s ability to sell down the risk in underwritten deals. These were issues debated.

BQ126 David Quest: But no one was challenging corporate’s strategy of taking on-growing-its loan book with a view to being able to sell them down. Everyone was happy with that.

Colin Matthew: The strategy was enshrined in the annual group business plan, which, as far as the corporate division was concerned, would be discussed with the group chief executive. I think I have described in my answers that all the divisions had discussions with the group’s CEO and the group finance director, to finalise their element of what became the HBOS group plan.

BQ127 Chair: May I come back to the general picture that you started with? It is a characterisation of HBOS as, in a sense, an unlucky victim. The one particular aspect of its structure and policies-how it funded itself-proved to be its Achilles heel. There is another view, which is to look at each of the individual businesses: corporate was being expanded at breakneck speed and taking extra risk, and international was doing something similar, though maybe not as much. We may come on, in David Quest’s questioning, to what international was doing, particularly in Ireland. It ventured, it turned treasury into a profit centre, and was not only selling securitised assets but was actually a buyer of them, and lost money in that process.

The retail business was being expanded. It was already huge by virtue of what was brought in from Halifax, but expanded particularly by going into different and riskier classes of mortgage lending. All those aspects were high risk and yet the funding strategy, instead of mitigating that, was itself very high risk.

So when you added it all together-and I’m not sure anyone was doing that-it was a very high-risk organisation. The different parts were not off-setting one another. Everything was being run at maximum revs, and in the end it was a collective failure that brought the bank down, rather than the particular thing about the closure of the liquidity markets. That is admittedly a reflection with hindsight, but do you think that is incorrect?

Colin Matthew: As you say, that is with the benefit of hindsight. Perhaps I could pick up on one aspect of that on funding as an example, where as part of the annual planning exercise, we-HBOS- always put together a separate group funding plan, which was summarised to the board. That looked at how much growth in customer deposits could come from the business divisions, so it could come from corporate, retail and international. The balance obviously was from Treasury through the wholesale markets. That then was a balanced judgment at the HBOS board on how far we wanted to grow assets, and on how far up the group funding plan risk we felt comfortable in going. That document was refreshed on a regular basis, but clearly it did not forecast the markets freezing.

BQ128 Chair: What document? This is a business plan, or-

Colin Matthew: Yes. It was part of the HBOS annual group planning. There was a group funding plan.

BQ129 Chair: But all the way through, each part of this business was in a very expansionist or innovative mode. No one in this organisation said, "We are pushing this at the limit". It was not just in one area, but across the whole front of the company’s activities, it was adopting the same behaviour and being very ambitious.

Colin Matthew: Yes, although it is important to note that the tone of the chairman’s statement in the HBOS annual report was consistently one of long-term growth. We believed fundamentally in running a long-term business and therefore, in needing to make long-term decisions as a result. An element of that-perhaps I go back to previous comments-is that when the difficulties came, when you have long-term assets on your balance sheet, in reality there is a limited amount as to what you can do in the short term.

BQ130 Chair: And no one was saying, "Let’s temper our growth ambitions to make sure that we are better protected against a future downslide."

Colin Matthew: Obviously, I am best placed to talk about my own division in international. I had discussions with the group chief executive and group finance directors in the normal planning cycles, and there is no doubt that we could have grown faster in international. We could have written more assets across our three strands of international business. We chose not to do so.

BQ131 Chair: In this process, which I am familiar with in other ways-where you put together a business plan by individual businesses saying what they think they can achieve, and it is put together at the centre-was the nature of that challenge to say, "You can do more", pushing you to go even further, or was it sometimes trying to rein you in? Was that pressure from the centre always in one direction?

Colin Matthew: I can only talk about the detail of the challenge in respect of the international businesses and the debates and discussions that we had. It covered the range of, for example, customer deposits-the discussion pretty generally was, "How can we get more customer deposits in these businesses?" On the asset side, it was a debate around, "How fast do we want to go in the differing jurisdictions? Where are the different overseas economies in terms of their economic cycle?" Lastly, we were building up, for example in Australia, a wider business across the various product lines.

BQ132 David Quest: Is not the point that, although you were trying to get your deposits and obviously trying to increase your assets, what was actually happening was that you were not able to get the deposits fast enough to keep up with your asset growth, but you were pressing ahead with the asset growth anyway?

Colin Matthew: That is not the case within the international business. The deposit growth in the international business was broadly similar to the asset growth4.

BQ133 David Quest: Right. But in the business as a whole?

Colin Matthew: It was broadly similar.

BQ134 David Quest: In the business as a whole, the gap was widening was it not?

Colin Matthew: In the business as a whole.

BQ135 David Quest: Can I show you a couple of documents to see how this process works? They are all tabbed. If you go to E1, more or less towards the back. Just to put some chronology on this, it is board minutes of a meeting that you attended. Section 3 on page 5 refers to the FSA Group ARROW risk assessment, which had taken place at the end of 2003. Do you recall that process?

Colin Matthew: Yes, but not instantly in detail.

BQ136 David Quest: You will see that it sets out more or less the FSA’s conclusion and says, "Four letters have been received from the FSA in relation to retail IID commercial property. The conclusions being drawn by the FSA and the shift in internal capital ratio were significant warning shots. The individual points raised were not new, in that they had already been identified by the group and, in some cases, were already being addressed. But the FSA’s perspective was that the group’s growth had outpaced the ability to control risks. The group’s strong growth, which was markedly different from the position of the peer group may have given rise to ‘an accident waiting to happen’ in their view".

Even back in 2004, the issue of whether growth was too aggressive seems to have been very much on the agenda. Was there ever any challenge as to whether you were growing too fast?

Colin Matthew: Obviously, I was not asked in the written answers-

BQ137 David Quest: I appreciate that you are just seeing this now, but "accident waiting to happen" was a pretty stark judgment.

Colin Matthew: This was some time ago. What I would do is make the broad statement that the HBOS board, both executives and non-executives, took issues raised by the regulators-whether the FSA or otherwise-extremely seriously. The FSA, I recollect, often came to present at board meetings.

BQ138 David Quest: To be fair to you, I should say that one of the curiosities is that, having raised such serious concerns, the FSA then seemed subsequently to have slightly backed off from them. Is that something you recall?

Colin Matthew: It is some time ago, isn’t it?

BQ139 David Quest: In terms of growth, the other document that I want

to show you is in the same file at B3. It is an executive committee away day. You may remember it. It was at Gleneagles Hotel. It was a committee that you sat on.

Colin Matthew: Yes. The executive committee. I recollect that we had two away days once a year, again in the build-up to the planning.

BQ140 David Quest: I raise this one because a key topic that seems to have been discussed on this occasion as it was on others was how growth could be increased. I appreciate that you may not have seen the document for a long time-

Colin Matthew: I haven’t seen it for six years... seven years

BQ141 David Quest: The first section is headed "introduction" by Andy Hornby. In the second paragraph, perhaps picking up the Chairman’s point, he says, "Overall, the Group had outperformed its peers over the past four years, driven in particular by strong performance in Retail and Corporate. Current Plans would reverse this profile, however-with the strongest planned growth being in I and I and International. This approach begged the issue of whether sufficient emphasis was being given to growth ambitions in Retail and Corporate. This, in turn, led to a key question for consideration at these Away Days, namely: ‘what is the right level of growth that HBOS should target...’" That suggests-tell me if you disagree-that the general approach of the management to questions of growth was how you could push more growth out of the business.

Colin Matthew: This was in 2006.

BQ142 David Quest: Yes.

Colin Matthew: But I come back again: at its core, as the Chairman reiterated in his Chairman’s statement, HBOS did have a long-term growth strategy, among other core principles, of cost-leadership, and certain other things.

BQ143 David Quest: There is nothing wrong with a long-term growth strategy, but it was a particularly aggressive growth strategy, wasn’t it?

Colin Matthew: I have not seen this for six years, but if the question that is raised is, "What is the right level of growth that the core UK businesses should target?", clearly, I would expect that to mean, "What is the right level of growth of the right type of business that HBOS wanted?". That should go without saying.

BQ144 David Quest: What in fact happened, as you may recall, is that there was growth of 10% or more a year, and in your division, International, it was sometimes 20% or 30%.

Colin Matthew: Yes.

BQ145 David Quest: They are pretty extraordinary-

Colin Matthew: Perhaps just a word on International, because it came out in the previous document and has come out in this one, as well. One of the reasons, in putting-these were businesses already owned across HBOS, but in 2006 we put them all under one division; some were in insurance investment, some were in business banking, for example, so they all came together. They had different strategies for different countries, so in Australia the figure was owned by 100% of Bank West5, the largest bank in the west of Australia, but with a very small market share on the east coast. Bank West was principally a retail and SME bank with a small corporate business. We believed-as in part, hopefully, was proved to be the case-that we could grow this business really quite meaningfully from very or relatively small numbers. So the growth that we could achieve was across the retail mortgage book and the SME book on the east coast, where we had virtually no business. We were able to write that business. But importantly, I think, as I have already said, also the customer deposit growth in Australia grew at roughly the same pace.

BQ146 David Quest: Right. What about in Ireland?

Colin Matthew: In Ireland we had HBOS and before that Bank of Scotland. We had been, I suppose, operating in Ireland for over 20 years with a book that is principally an SME business banking book, which is why it was in business banking. We then felt that there was an opportunity for us to grow in Ireland, across the retail, SME and a small amount of corporate business, and we bought-I can’t remember the number, but I think it’s about 50-stores from the electricity board and we combined that physical presence and developed an online presence, and that was to grow our Irish business, but again, principally in the retail and SME markets.

BQ147 Chair: Can you just clarify something for us? Does this mean that the lending to these big property deals in Ireland were not part of your business, but were part of corporate’s business?

Colin Matthew: No, if business was done in the South of Ireland-not in the North-then it would be in the international business.

BQ148 Chair: Right, yes.

BQ149 David Quest: And there was significant lending to Irish property companies.

Colin Matthew: There was.

BQ150 David Quest: Through Bank of Scotland-

Colin Matthew: But it is important to make the difference; the Irish book was something of the order of £20 billion. Some 30% of the book was first charge residential mortgages, but 50% of the book was retail and SME was the next largest part6. We had-I haven’t got the detail-a small number of larger corporate loans in the Irish book, but it would be a very little number. I do not know for us, in Ireland, £25 million would be a large transaction. Of course, not many people foresaw what would happen in the global economy. I suspect even fewer expected the outcome that we have seen in Ireland, where essentially the whole economy collapsed and all banks operating in the Irish market have suffered. I obviously haven’t been aware of what has happened since I left, but all banks have suffered in Ireland.

BQ151 David Quest: In terms of growth, you were continuing to grow the Irish business-I think the American business and the Australian business, too-through 2007.

Colin Matthew: The Irish business, the growth in 2007 when the liquidity crisis came upon us-so in the summer of 2007-we had virtually stopped new lending. We were seeing the same again: people drawing down some uncommitted loans. Obviously, we had residential mortgages in the pipeline.

BQ152 David Quest: But by that time, it was too late.

Colin Matthew: Yes.

BQ153 David Quest: You had already exposed yourself.

Colin Matthew: Although, in context, the amounts, while of themselves large, were relatively small in the context of the wider HBOS.

BQ154 David Quest: In relation to growth targets, how were they set between divisions? To what extent did each division set its own targets, or were the targets imposed on the divisions?

Colin Matthew: From the outset of HBOS, if I go back, there was a five-year plan, if you like, constructed from the various people involved in the business at the time. What then happened annually would be a refreshing of that, an updating of that, as markets changed. As I think I mention in the answers, every division had a very detailed one to two-year plan, and then a higher level three, four, five-year plan. That was the final outcome in aggregation that went to the HBOS board after having been discussed at executive committee.

The initial input, which I think is your question, the group-so essentially the group chief executive and the group finance director-issued outline guidance to all divisions of some very high level planning parameters, in part based on what the existing plans were. Then there was the ability for individual divisions to submit their own bottom-up plan, or what they believed, within the overall parameters, they could do. There then was, I am sure, in the centre an aggregation of what people wanted to do, and then the group chief executive and the group finance director came out and went round to the individual divisions. There was debate and iteration, and the end result was a group business plan.

BQ155 David Quest: Was this solely a process for each division between the chief executive and the division? As a board member, to what extent did you have an input into growth targets for other divisions?

Colin Matthew: Probably in two main ways. One would be, as you have surfaced here on the 2006 minutes, we had strategy away days once a year. Now I am talking from memory, but there the heads of the divisions would bring thoughts, ideas-what could be done, what could be done differently. There would be debate around those. Quite high level, but there would be debate around those. That would be one occasion, and the other occasion would be when, in terms of the process it went through, the group plan came to the executive committee before going on to the board. There would be some discussion at the executive committee, and then at the main board there would again be the ability for the executives, but obviously more so for the non-executives, to provide their input.

BQ156 Chair: On this question of ambition, I am struck by the note you prepared for us. At one point you say, "In terms of overall growth-the lending book-as far as I can recall HBOS was broadly consistent with its competitors", and later on you say about the macro level, "I do not think we were taking excessive risk compared to our competitors". Each of those sentences then has a kind of "but" in it. The first then says, "however, there were certain higher-risk areas in which growth was sustained at higher levels, for example the UK leverage market", and the second then says, "although HBOS was more active than others in certain higher-risk sectors".

The impression I get is that on the one hand you are saying, "We’re not exceptionally risky," but you go on to exemplify a number of ways in which you were achieving this higher growth, through taking on, quite deliberately, more risky segments of the market. That is what corporate were doing, and that is what I think retail were doing-international perhaps less so than some of the others-but it was a conscious decision to sustain growth by accepting greater risk. That is what seems to come out of those two sentences.

Colin Matthew: As we have discussed, in the corporate division it was known that they were active in sub-investment grade lending. The leveraged-the private equity business-quite a chunk of that is of sub-investment grade. Again, I accept that with the benefit of hindsight, but these were assets that up until 2007 we were able to sell down, successfully, to a whole range of banks and institutions. Other banks were willing to take on significant parts of this risk, but obviously when the market stopped we were left with this.

BQ157 Chair: One of the general themes of our work is really around dogs that didn’t bark. Were you aware of other people within HBOS, or analysts, shareholders or your competitors, remarking on the riskiness of the HBOS strategy?

Colin Matthew: I will make perhaps two observations, if I may, which will give the range of it. One would be: what was the view of the market in terms of the share price, and the P/E that was put on our earnings? So what did the market think HBOS was valued at, and how sustainable would this be? I haven’t got the figures in front of me, but I would have thought that compared with our comparator group we were broadly similar.

What I think would be a consistent theme would be an acknowledgement-a commentary, perhaps-that within the corporate division we were active in a significant number of the higher-leveraged corporate transactions taking place.

BQ158 Chair: But you are not aware of feedback of this kind being discussed in board meetings. In the CFO’s report there is often something about what the market is saying about you.

Colin Matthew: As I recollect it, the principal discussion around that, which we came back to on a number of occasions-i.e. it was raised more than once-was, "Do we still have the ability to sell down these assets?" Obviously, without that ability we would not be able to write the assets in the first place. One should follow the other. So one of the continuing challenges that would be made of the corporate division would be, "Do you continue to be happy you can sell down these assets?"

BQ159 Chair: This time as a board director, where you are held responsible for the whole business, you are talking about the retail division and particularly mortgage lending: was there any acknowledgment that, "We are going into higher riskier kinds of mortgages, buy-to-let or low or nil certification mortgages"?

Colin Matthew: No, I think the board was satisfied from the presentations from retail colleagues in the different sectors, whether it is buy-to-let or self-certification, in terms of what their underlying models showed for the quality of business they were writing, and the pricing that they were making against that business. That was something that came to the board on a regular basis.

BQ160 Chair: In the decision notices-both of them-reference is made to a culture of optimism. That was a reference to the board as a whole rather than the particular business. Is that something you recognise?

Colin Matthew: If we are talking about the FSA’s notice, so this is in the corporate division, I think it is probably fair to say that the character of the beast, if I put it that way, in some parts of the corporate business, is that these are generally optimistic people. They are keen to be involved in transactions.

BQ161 Chair: You had two chief executives over this period. That was true of both them?

Colin Matthew: I don’t know what they would think themselves. But I should say, to be clear on the optimism, if I am describing the character of some of the people in the corporate division, they did not have the ability to write business themselves. They had to go through due credit processes-that was independent of the customer-facing parts of the division-to get formal sign-off to complete on a transaction.

BQ162 David Quest: Was there not also, to some extent, a similar culture of optimism in your own department in terms of the ambition to expand in Australia, Ireland and America?

Colin Matthew: No, I don’t believe so. I think it was a widely debated issue, partly at these away days, that we felt we had this opportunity in a very limited number of international businesses. But where we had been active for some considerable time-we had been in Australia for over 20 years, in Ireland for over 20 years and in the USA for over 30 years-and in quite different market sectors, obviously benefiting also from the geographic spread, we felt that we could take this opportunity to grow. I remind the Committee again that what we are talking about here in the international division; of a book of 60-something billion, 40% were residential mortgages.

BQ163 David Quest: The Chairman asked you a question about the passage in your statement about the risk associated with the leverage finance market. In that same passage, you go on to say that few people appreciated that markets could freeze up in the way that they did, which effectively nullified any risk mitigation strategies, and that is a point that you have made a number of times.

You also say that you joined the Bank of Scotland in 1966 and had never experienced such market conditions as those that arose in 2007-08. Is there not another point here that, in the later years, HBOS’s trading and lending strategy was far more exposed to those kinds of markets than it would have been in the 1970s or 1980s?

Colin Matthew: Yes. I think, in two areas, both of which I have tried to touch on in the answers, and one would be in the quantum of the deals and the second would be-one almost follows the other-the number therefore that are composed of debt syndicates and, therefore, in times of the stress, the need to discuss and obtain agreement from those syndicate lenders.

BQ164 David Quest: As your business becomes more reliant on the wholesale markets, either in order to syndicate loans or in order to raise finance, the possibility that they might not be available obviously becomes more relevant. You can say, "It never happened before," but it may well have been that it simply would not have been as important had it happened earlier.

Colin Matthew: No, that is a valid observation, but in selling-down debt in the corporate division we tried to sell it down to the right types of organisations that we believed would be co-operative, when things did not quite go to plan.

BQ165 David Quest: Looking at the second page of the B3 document, which I just use as an example, and the question of reliance on wholesale funding, there are lists of bullet points. The first list is a "range of competitive strengths" and the second set are "strategic weaknesses". Number three in the second list is "over-reliance on wholesale funding". That weakness had obviously been recognised in 2006, but it had been recognised sometime earlier and it continued to be recognised as time moved on. Is that right?

Colin Matthew: Yes, and it caused HBOS to take a number of actions to improve our wholesale funding capacity on both sides. On the asset side, we found more assets that we could structure and securitise. On the liability side, we found markets that were new to HBOS to access wholesale funding. A number of those were in the far east. Coincidentally, our involvement in Australia helped us significantly to obtain increased wholesale funding from the far east.

BQ166 David Quest: You were also hunting around for deposits in Australia as a way of trying to solve the issue.

Colin Matthew: This is wholesale, not customer deposits. When I say in Australia that the deposits, the growth was in line with the asset growth, I am talking of customer deposits, not wholesale.

BQ167 David Quest: Right. You took these steps, but the problem was never solved, was it? At this stage, as Mr Hornby was saying, HBOS continued, as it always had been, to be over-reliant on wholesale funding.

Colin Matthew: That is why, as part of the planning process-I recollect the discussions-around the group funding plan, we were continually seeking to ensure that we would have access to the wholesale markets. The other thing-this was mentioned in the annual reports-that we did in, I guess, 2005-06 was consciously to push out in the maturity of quite a lot of our wholesale funding.

BQ168 David Quest: It might be said that another, perhaps better, way to address it would be to reduce your reliance on wholesale funding.

Colin Matthew: Again, as I said, there was a discussion around the board on how far we could take wholesale funding.

BQ169 David Quest: I do not know whether you recall, but some time in 2008 you prepared a paper on funding.

Colin Matthew: I probably prepared quite a number of papers on funding.

BQ170 David Quest: We think we can have a look at it, since it is in here. It is referred to in the document B10. That is actually a reference to what Mr Ellis had been saying on current market conditions. The point I wanted to make is that one of the views that you had expressed-I don’t know whether you remember-was that HBOS was more reliant on wholesale funding than any of its competitors by that time.

Colin Matthew: I would not have access to all other banks’ wholesale funding dependence, so I couldn’t comment. It was something-as comes out from these and, I’m sure, other documents-that was continually in front of us.

BQ171 David Quest: The alternative-presumably there was a conscious decision not to take it-would have been to cut back on the growth.

Colin Matthew: Absolutely. If there was a belief reached across the HBOS board that we could not achieve the extent of the wholesale funding, or indeed the customer deposit funding that was implicit in the plan, then we couldn’t do the asset growth.

BQ172 David Quest: When was a decision finally taken that the assets could not grow any more? When do you think the turn happened?

Colin Matthew: I am talking from memory, but I suppose the time in August 2007 when essentially the syndication market closed. We knew, therefore, at that point that we couldn’t move any paper at all.

BQ173 Chair: I think that means that you didn’t decide that; the market decided for you.

Colin Matthew: Absolutely. We were not in control of the market.

BQ174 David Quest: So by that time, essentially, the moment had passed for you to take that decision advantageously.

Colin Matthew: In August 2007, it was impossible to sell anything.

BQ175 David Quest: I have just found the reference I mentioned earlier. It was in section 5. If you still have the B10 document in front of you. On page 9, section 5. Can you see that? The section is on comparative treasury positions. It refers to a paper that you produced. You say, "HBOS had the largest mismatch in respect of loans to deposits." Although you say, "In absolute terms the external funding requirement of HBOS was less than both RBS and Barclays."

Colin Matthew: Which was factually the case.

BQ176 David Quest: I want finally to ask you about the treasury function. Obviously, the principal function of treasury was to raise funding and liquidity for the group. It also had a subsidiary function of making profits by proprietary investments. At what stage in the life of HBOS did that become a significant function in treasury?

Colin Matthew: It is important for the Committee to understand that irrespective of how treasury was structured, its fundamental purpose in life was to handle group funding and liquidity, not just in the UK but internationally, and also to handle foreign exchange and derivative business coming from HBOS’s own balance sheet and from the FX and derivative activities from our customers.

The underlying proprietary business within HBOS was always very modest. I cannot tell you the individual proprietary limits off the top of my head, but they were all documented in the treasury trading policy statement, and they were modest. It simply was not part of itss raison d’être.

Lastly, in terms of evidence that it was not there for the profit motive, it had a basis point income-I am talking from memory-on its funding activities, irrespective of what happened. That was a basis point agreed by the board.

BQ177 David Quest: If I have understood correctly, it seems to have recorded some pretty extraordinary losses in the 2008 financial year.

Colin Matthew: Once again, with the benefit of hindsight, in treasury, for liquidity, we had quite a strict group of criteria for what types of assets could be bought for the liquidity portfolio and what percentage had to be triple A. All that is in the annual report: what could be double A and what could be single A. The percentage that could be single A was really very small, so the vast bulk of the book was triple A both by our internal credit rating people, and all assets also had to be externally rated.

BQ178 David Quest: But nevertheless, it managed to book a loss of £3 billion in 2008.

Colin Matthew: Again, I do not know the figures-

BQ179 David Quest: Well, that is the loss sustained.

Colin Matthew -but I would have thought that most holders of this type of paper will have taken impairment losses. Again, it was based on internal and external rating agencies. All the major rating agencies rated the bulk of this paper triple A.

BQ180 David Quest: To what extent did other members of the board appreciate what kinds of investment treasury was holding?

Colin Matthew: Again, just on our group structure, the treasury risk control committee, for example-I cannot remember who they were, but as I described in my written answers, every division had a risk control committee composed of executive and non-executive directors of HBOS-the reports that went to that committeeincluded a review of the assets, the underlying internal and external ratings of the assets and the shift in ratings.

BQ181 David Quest: They had that information. Do you think they understood what the items were?

Colin Matthew: Yes.

BQ182 David Quest: What about the alt-A assets?

Colin Matthew: Again, the alt-A were all rated principally triple A by the external agencies. They were all approved as asset classes by the group wholesale credit committee. They were held both in the liquidity and in the banking book, and, I think, in the conduit as well. I give the same answer as before; at the time they were acquired-I cannot remember exactly when they were acquired, but some years ago, some years before 2007-they were internally and externally rated and they were rated by all the external agencies as triple A.

BQ183 Chair: The impression we are getting is the extensive decentralisation of the risk function; that the key fora were the risk committees of the individual businesses.

Colin Matthew: I am sorry if I have given you the wrong impression; these risk committees I am describing, the divisional risk committees that every division had and that the HBOS non-executive directors sat on, were quite independent of the businesses. Those committees reported to the group audit committee, not to the businesses, and the group audit committee reported to the main committee.

BQ184 Chair: These things were all brought together at the group, at that stage.

Colin Matthew: The Group Audit Committee

BQ185 Chair: Of course, this is all pre-Walker. You did not have a group risk committee?

Colin Matthew: We had a group risk committee as well, so we had the three lines of defence. The first line was the business. The second line was the group committees-the group operational risk committee, the group credit risk committee and the group wholesale credit risk committee, which would do the alt-A, for example. The group chief executive, the group finance director and group risk are in that second line. The third line of defence was the audit committee. The risk control committees-I am sorry, I keep on throwing out committees-reported to the group audit committee and were quite independent of the businesses.

Chair: There is a full list in the 2005 annual report, so I will study that, rather than detain you further. That brings us to the end of our questioning. Thank you for assembling the jigsaw puzzle-you have certainly filled in some pieces for us, which is helpful in piecing together a rather interesting story, even if it is not a happy one. Thank you very much.

Examination of Witness

Witness: Jo Dawson, Group Risk Director, HBOS, 2004-2005, and Group Executive Director Insurance and Investment Division from 2006, gave evidence.

Chair: Let me explain a bit about the Commission, the panel and our process. We have been set up to find out what went wrong in the financial crisis in banking across the piece, but in particular how it went wrong or, more accurately, how was it allowed to go wrong. We are looking particularly at issues such as what mechanisms failed, what warnings should have been given that were not given and what warning were given but were ignored, pushed back or not followed through.

On HBOS, we know quite a lot about what happened in the end. We know less about how it happened. We are treating it as a case study in particular because we know rather more about RBS, because the FSA has written it all up for us-500 pages of it. Apart from the decision notices, we know less about HBOS, so we are doing an exploration of it as a case study. The emphasis is on identifying changes for the future, rather than assigning culpability, still less running a quasi-enforcement action.

The broad picture is that two highly respected brands came together in 2001, with a market capitalisation at the time of £30 billion. By 2007 it was supposedly valued at £40 billion, although it was probably not actually worth that, and a year later it was worth nothing. That is a pretty spectacular story. Risk and the management of risk are clearly a key element in that, and that is why we are interested in talking to you early on in our process.

In terms of the work of the panel, the panel’s job is to assemble evidence, which will then be reported to the main Commission. The conclusions will come out of the main Commission, and we are principally an evidence-gathering forum. To help us in that-this is an innovation-we have retained counsel in the form of Mr David Quest. I emphasise that that does not turn us into a court or a tribunal or a disciplinary hearing or anything of that kind. It is simply because he is probably better than I am at asking questions. It helps to have one person, particularly when you are trying to establish the narrative of what happened, to follow that through. He will start asking questions, and I will follow through from that point. With those preliminaries, I will ask David Quest to begin.

BQ186 David Quest: Good afternoon. Let me just establish your positions at HBOS. You joined the Halifax in June 2000 just before the merger.

Jo Dawson: Yes.

BQ187 David Quest: And you started as general manager of retail sales.

Jo Dawson: Yes.

BQ188 David Quest: You were then promoted, just post-merger, to head of regulated sales.

Jo Dawson: Yes.

BQ189 David Quest: And from there to head of advisory sales until January 2005, when you became group risk director.

Jo Dawson: Yes.

BQ190 David Quest: And you held that position until February or March 2006.

Jo Dawson: February, yes.

BQ191 David Quest: And then you became a divisional head of the insurance and investment division.

Jo Dawson: Yes.

BQ192 David Quest: And that carried with it a main board appointment.

Jo Dawson: I joined the board two months later. It was not at exactly the same time.

BQ193 David Quest: So it is right to say, is it not, that with the exception of the interlude when you were group risk director, you have always been in a retail position in the bank?

Jo Dawson: Retail or insurance and investment, so I guess the majority of my time in Halifax and HBOS was dealing with insurance and investment businesses. Prior to that, I spent 12 or 13 years at NatWest, where I did retail, commercial banking, head office roles and credit sanctioning.

BQ194 David Quest: I want to start by asking you this question. You had a short time at the Halifax before the merger. The Halifax and Bank of Scotland were obviously very different institutions in that the Halifax, as a former building society, was essentially a retail business. Did you observe anything in the difference of approach and culture of the two institutions when they came together that might educate us in any way about what subsequently went wrong?

Jo Dawson: At the time of the merger in 2001, I was 100% involved in the investment part of retail, so I had no interaction, apart from group fora, when all the management would get together with any other part of the group, so my comments are about the retail side. The difference there that I would have observed was that the retail business in the Bank of Scotland was both a smaller and a less important part of the overall group, whereas for the Halifax, as you rightly say, it was 100% of the group. I think that answers your question.

BQ195 David Quest: You had little or no contact with the corporate side of the merged group, at least before you became group risk director.

Jo Dawson: Beyond annual management fora and so on, no.

BQ196 David Quest: You became group risk director in January2005, but I think you said in your statement, which we have read, that that was a new position in the bank. Can you briefly explain why it was thought necessary to create a new position at that stage?

Jo Dawson: I was the recipient of it; I was not the person who decided, so I think addressing that to Sir James Crosby would probably provide a more precise answer.

BQ197 David Quest: Was it explained to you why the position was created?

Jo Dawson: From a purely logistical perspective, Mike Ellis, the group CFO, had previously also been the executive director with responsibility for risk, so all the risk teams had sat under him, as well as all his finance teams. He was retiring. We had an incoming new CFO, Mark Tucker, and I believe that the decision was taken that risk management and the risk focus, especially with the upcoming Basel work, was of such import that it warranted a separate seat around the table, so a new position was created around the executive committee table, rather than it being a subordinate role to one of the executive committee.

BQ198 David Quest: That role was one that gave responsibility for risk management group wide.

Jo Dawson: For the group risk functions.

BQ199 David Quest: How did the group risk functions connect with or interact with the risk functions of the individual divisions?

Jo Dawson: As you found-it was in my appendix-the report and accounts set out the three lines of defence in terms of that. That was the theory, and indeed I think it happens in many organisations. I heard from evidence given earlier today that there was tension between the different bits. I would describe it as a lack of clarity; the functions were two or three years old at the time, post merger, so everybody was really working out how it all fitted together. As I understood the roles when I took responsibility, we had within the business various risk functions, checking functions, business standards, compliance and all the functions within each business and the retail business that we did. As for the group functions, there was a credit risk team, an operation risk team, and a market and a balance sheet management risk team. Prior to my arrival, it had been a group regulatory risk that was then split into regulatory risk and business risk. Those teams were below me.

BQ200 David Quest: They were not reporting to you.

Jo Dawson: No, the group teams reported to me. I beg your pardon.

BQ201 David Quest: The individual risk committees were reporting somewhere else, were they?

Jo Dawson: As part of the function of the group risk director, I chaired four executive risk committees, with representatives from all the divisions and the relevant group functions, obviously including group risk. The group credit risk committee would have my head of group credit risk there. By way of example, there were a couple of other risk committees chaired by the CFO in terms of the group funding committee and capital committee-the share activity committee-so all the market announcements and so on would go through there. Those executive risk committees informed the group executive committee.

BQ202 David Quest: At some point in your statement, you referred to your role as an advisory or influence function rather than one with authority. I am trying to work out your relationship with the risk functions in the individual divisions.

Jo Dawson: They had a dotted line. My function provided functional leadership-expertise-of them.

BQ203 David Quest: What do you mean by "dotted line"?

Jo Dawson: In practice? When the boss of the head of credit risk and retail-the head of overall retail risk-was doing his annual appraisal, he would have asked for input from the group function, because they would have had a fair amount of interaction as feedback. It was probably never as formal as a formal note asking, because there would be regular dialogue.

BQ204 David Quest: With the risk decisions that were taken within the individual divisions, what was your role in influencing, authorising them or overseeing them?

Jo Dawson: I am sure that you have heard lots of this before but, under the group’s federal model, the prime responsibility for risk management rested with the individual divisions who were responsible for putting in place appropriate monitoring and controls to ensure the effective management of those risks within the stated risk appetite in executing their business plans. The group functions were there to set overall group standards, to provide functional leadership and oversight activity and to undertake some themed structured reviews.

BQ205 Chair: Could you clarify this devolved model? Did it survive all the way through to the crash or was it subsequently modified after you had moved off into other responsibilities?

Jo Dawson: As a matter of the group operating philosophy, in principle it survived. In reality-I wasn’t close in the last six months-a lot of the activity was with the CFO and the CEO, obviously around the funding issues and the emergence of all the corporate credit issues. I wasn’t close at that time, but I think it became all hands to the pump.

BQ206 Chair: I was really referring to the warning signals, and I suppose the events of the summer of 2007. Up to that point, this highly devolved model was still in place and the people who succeeded you also had the same limited set of powers as you.

Jo Dawson: Prime responsibility continued to rest with the divisions.

BQ207 David Quest: You were the only individual with oversight of all the divisions, because each individual division was just looking at its own position.

Jo Dawson: Me and the rest of the executive committee. They were executive risk committees. Any member of the executive risk committee had de facto membership and could come along. They were provided with all the papers of the executive risk committee.

BQ208 David Quest: But it was your committees that had oversight of all the divisions.

Jo Dawson: Yes.

BQ209 David Quest: There was no other function in the bank that was also overseeing all the divisions.

Jo Dawson: From the risk perspective, no. Sorry, I beg your pardon-the group audit function.

BQ210 David Quest: You were in that role, I think, until the first part of 2006 before you went on to a division. That is a relatively short time-just over a year. As far as we can tell, your successor, Dan Watkins, was also in that position, again, I think, for less than a year, and then he went on also to be head of a division. It looks as though there is a bit of a pattern of it being a relatively short-term appointment before you move on to a divisional role. Is that how it worked?

Jo Dawson: The facts, as you lay them out, are 100%. I am not sure that that was the intent.

BQ211 David Quest: When you were appointed group risk director, were you expecting at that stage to remain there for a long while or to pass on?

Jo Dawson: Certainly longer than I ended up staying. A lot of people moved around within the retail side in management roles quite a lot, to develop or whatever, but I expected to be there for a reasonable time. When Sir James Crosby decided to retire and Andy Hornby was appointed as the COO and de facto successor, Andy then decided to change the structure. Mark Tucker was leaving around that time. Phil Hodkinson was taking over as CFO, so it was a combination of circumstances. Nobody told me if they intended that I would only be doing it for 14 months; I was under the impression that I was doing it for longer.

BQ212 David Quest: So when you started, you expected to be doing it for longer. This was your first risk job-at least in HBOS.

Jo Dawson: I regard running a business as a risk job as well. I had run businesses with regard to that first line-prime responsibility for risk management-but as a dedicated function, it was my first risk job.

BQ213 David Quest: Let me just explore that point a little. You might say that all banking is a risk job, because that’s what it is about, but there is something of a difference between the position of someone in a bank who is in the business selling products or making loans and a risk function, which is supposed to be monitoring that. They are different activities.

Jo Dawson: I agree with you about the difference between risk management and risk monitoring.

BQ214 David Quest: Yes. In general terms-it is a slight simplification-if you are in the business, your ultimate aim is to make profits for the bank and so on, whereas, in a risk management function you are monitoring the business of other people and trying to make sure that they are not taking on too much risk.

Jo Dawson: I have a broader view of what running a business is. Yes, you are looking to make profits, but in a sustainable way. That means making sure that you have an effective risk management framework, otherwise it is not sustainable.

BQ215 David Quest: Of course, but the particular purpose of having a separate risk function is to put a check or a brake on what people in the rest of the business are doing. The question I started with is, given that you were coming to a risk management function for the first time, do you think that the relatively short time you were in the position gave you long enough to get to grips with what was a new job?

Jo Dawson: Goodness, no. I was on a learning curve and would have continued to learn if I had still been doing it today.

BQ216 David Quest: You made the point in your statement that, particularly in relation to corporate lending, you had assistance from a partner in Ernst and Young? Presumably that was because your background was largely in retail.

Jo Dawson: Retail and commercial. In recognition of the fact that I did not have both market and high-end corporate experience in any way, this regulatory risk partner-who had just stepped away from Ernst and Young-was recruited alongside me so that I had a functional expert.

BQ217 David Quest: I am sure you would not have taken the job if you did not feel able to do it. However with hindsight and knowing what we know now about what happened in the corporate division, would it have been better-obviously it would have been-for group risk functions of this nature to be taken by someone who has a more extensive career in risk management; indeed someone who has exposure to corporate functions as well? Is there a danger of a weakness-not just with hindsight-of not having exposure to corporate?

Jo Dawson: There are a couple of points. First, if I had come under the HBOS operating philosophy and the federal model-even if I or any of my successors had been through-and-through corporate bankers-that would not have changed the nature of the role in that it was not an authority, it was an influence. I am not saying I agree with that, but that is what it was. Secondly, you would want much greater longevity in role to build experience in a risk role; there shouldn’t be moving across.

BQ218 David Quest: Do you think you were able to influence corporate?

Jo Dawson: Yes. Not fully and absolutely. In terms of the key priorities that were on our agenda at the time these were the completion-as you have heard-of the risk mitigation programme from the previous ARROW, which included the corporate credit sanctioning process. This was changed and implemented in February 2005 and the FSA informed and signed off on it. The Basel work was a huge thing standing before us and nobody had got their heads round how we would do it. So the influence was in terms of getting a group-wide structured programme around that, being clear about the requirements, where we still had work to do in each division and what it was, and trying to direct that work, report back and liaise with the FSA. That was a key area. Did we make as much progress in that in relation to corporate as I or others would have liked? No.

BQ219 David Quest: Could I pick up on the FSA? As you said, it was initially the ARROW report in which some fairly serious concerns were expressed by the FSA about corporate lending and controls. As I understand it, that is one of the things that you were responding to, or were looking at while you were group risk director?

Jo Dawson: My recollection is that it was around the credit sanctioning process, which was out of line with the market.

BQ220 David Quest: What do you understand was the outcome with the FSA? Were the FSA eventually satisfied with the way the bank had addressed its concerns?

Jo Dawson: It would be fair to say that part of my role as group risk director was being the key interface between the FSA and the business. There were close and continuous meetings with everybody-other divisional chief executives and elsewhere. Once or twice a month I met the FSA, and progress in corporate and concerns around corporate were mentioned at every single meeting.

BQ221 David Quest: Is the impression that so far as the FSA was concerned, this was an ongoing concern, an ongoing project, or was it that they thought you had addressed it?

Jo Dawson: In respect of the short term-the specific around the credit-sanctioning model-I think they felt, "Okay, done." But there was not a close relationship between corporate and them. They had a sense that…I cannot really speak for what they had a sense of. I had a sense from the things they said that the relationship was not strong with corporate and they felt more had to be done, and therefore they were encouraging me to push harder.

BQ222 David Quest: Can you give us an idea of what they wanted done?

Jo Dawson: This was quite a long time ago. I have a recollection of one key area. Clearly, the exposure within corporate to the commercial property market was an area of concern, not necessarily about how much we had but about the concentration between HBOS and Scotland and RBS, which I think had 40% of the market. That was a cause for concern. They were keen to understand and press for stress tests to really push on that point. There was a little bit of a philosophical difference, so within the Bank of Scotland-I do not know whether my former colleagues spoke about this-commercial property was seen as a key area of expertise, such that in the 1990s recession, when there had been a previous collapse, the Bank of Scotland corporate, as it was then, prided itself on the fact that it had stuck by its clients. It had lent through the cycle; it had taken equity stakes where necessary and at the end of it that was a much more financially successful strategy than that of those other lenders who had dumped assets at the time. There was a really strong belief in Bank of Scotland corporate that they had far greater expertise and understanding in this market than others, so I think they were less open to challenge, whether internally or from the FSA.

BQ223 Chair: We get to a point in December 2003 or January 2004 when you get a pretty stiff letter from the FSA basically saying, "You are expanding very rapidly and your risk management function is not keeping pace with it." I think that was more or less what they were saying. Then a section 166 is put in hand and I think your predecessor was probably working on that. Then somehow or other, this 166 seems to take the pressure off and they expressed themselves as reasonably satisfied, but there was nevertheless still some work to do.

By the time we get to 2006, there is another engagement with the FSA, by which time the FSA, in the note attached to your submission, said this was business as usual-that is, as they often say, that there were things you needed to improve, but not that there were major danger signals. Why do you think it was that, having expressed themselves so forcefully around the turn of the year ’03-’04, a couple of years later they were pretty much not giving you a clean bill of health but not treating you as in special measures, so to speak?

Jo Dawson: It is all hypothesis from my point of view, so let me advance. I never saw-

BQ224 Chair: You say it is hypothesis from your point of view. By this stage-by the conclusion-you were partly in this job for part of this period, and after that job you then became a board member.

Jo Dawson: Yes. Sorry. What I am saying is that I cannot speak for what their motives were.

I never saw the original letter. I was doing a business role. I did not see the letter in 2003-whenever that came out-that increased the ICR. I was very much aware of it. I do not think I was aware that the ICR had been increased. I think that was kept quite within a tight community-I presume it would have been regarded as price-sensitive-but I was aware from Andy Hornby, who ran the retail business then, in our divisional board meetings that, as you say, we absolutely had had strong feedback from the FSA that we had lots to do. It was with gusto that the particular areas affecting retail, which I was in at that stage, were really developed.

As to what happened in the interim, I think we did follow through on the FSA. Whatever the RMP was then-the RMP that I inherited on the eve of taking on the group risk director role-all those issues were followed through and completed. In terms of the regulator or the supervisor laying out, "Here’s your to-do list", we got on with it and did the to-do list, with the exception of the ongoing work on Basel. I guess from its perspective, that it saw willingness. I do not remember the PwC section 166 skilled persons-

BQ225 Chair: It was before your time.

Jo Dawson: I would hope that the FSA saw us addressing the issues it was raising with gusto to their satisfaction, and that that gave it comfort and confidence that we were taking this seriously.

BQ226 Chair: You said in your note, with commendable candour: "With the benefit of hindsight, I now believe that for a federal model to work requires stronger central functions". Of what was being agreed between the company and the FSA in 2006, you are saying, looking back, "We should have gone on further and strengthened this risk structure more than it was being strengthened at the time."

Jo Dawson: The point I made was not in reference to any FSA change in stance, but just the difficulties I had, and I think my successors had and maybe my predecessors as well, in terms of effecting the degree of change. It is a personal view. You will undoubtedly hear from both the chief executives I worked for, who will explain why they felt that actually the federal model was very important.

BQ227 Chair: There is an interesting sentence: "The relationship between Group Risk and the Corporate division (led by George Mitchell…) was probably the most challenging of these." This is a very interesting choice of language. Were you getting the sense that they were resisting you, in your new role, trying to get into their little fiefdom?

Jo Dawson: It was not personal at all. Going back to the comment I made to Mr Quest, Bank of Scotland Corporate had a long and proud history and felt it was expert, and I am not sure it was felt that the group central functions were as expert in being able to offer advice.

BQ228 David Quest: Is the impression you had that they felt they had weathered the last crisis?

Jo Dawson: Not just weathered-came through quite strongly.

BQ229 David Quest: Came through and profited from that.

Jo Dawson: And they did, and that is the truth.

BQ230 David Quest: And they thought they had nothing to learn from you, or from the FSA for that matter? What was your impression?

Jo Dawson: I do not think that it was as strong as "they had nothing to learn" from anyone, but they were very clear at the time about what they were doing and that they felt it was right.

BQ231 David Quest: As it happened, your time as group risk director straddled the end of George Mitchell and the start of Peter Cummings. Was the position the same under both heads of division, in terms of the challenging nature of the relationship?

Jo Dawson: There was a wide expectation-you will ask Dan Watkins and I am sure he will respond-that that relationship would be easier under Peter. In fact, Peter declared himself to be much more willing to embrace the group, the way that the group was set up and the challenges ahead over Basel.

BQ232 David Quest: You say at paragraph 70 that the ability to challenge effectively depended on the quality of relationships. That is a weakness in the set-up, is it not, if your ability to challenge depends on the quality of the relationship?

Jo Dawson: Yes, I believe so. I think relationships are really important even if you have authority though.

BQ233 David Quest: Yes, but the point I think you were making is that because your role was only an advisory one without power or authority, you were necessarily dependent on the quality of the relationship.

Jo Dawson: Yes.

BQ234 David Quest: And that, as I say, is a structural weakness, is it not?

Jo Dawson: Yes.

BQ235 David Quest: In general terms, was there a sense that there was too much autonomy of the divisions from the group, particularly the corporate division?

Jo Dawson: From whom?

BQ236 David Quest: The distinction between the individual divisions and the group management. Was there a sense that there was too much autonomy enjoyed by individual divisions?

Jo Dawson: Obviously, through my whole time at HBOS I only had these 14 months when I was in a group role.

BQ237 David Quest: Yes, but then you were on board, so you can also look at this question from the perspective of someone who was on board and therefore having ultimate supervisory responsibility for the divisions.

Jo Dawson: Sure. I don’t think the board felt that that was a weakness.

BQ238 David Quest: You refer in paragraph 70 to the challenge process for the divisions. Who, apart from you-you have already explained that your role is advisory oversight-would have been challenging the risk management of the individual divisions?

Jo Dawson: The ultimate challenge at an executive level of any of the divisional chief executives in the divisions was obviously the group CEO, supported by the group CFO. They would meet quarterly, if not more frequently, would have formal quarterly meetings with the divisional chief executive to go through plans, business performance, whatever. There was quite a strange question which talked about "disciplining", which is a strange word to use, but in terms of my authority as group risk director, if I did not feel I was getting any traction, or felt that I needed more traction, my route was to escalate through to the group chief executive.

BQ239 David Quest: Did you ever do that?

Jo Dawson: Yes.

BQ240 David Quest: In relation to what?

Jo Dawson: In relation to just getting traction, getting commitment.

BQ241 David Quest: Specifically in relation to corporate?

Jo Dawson: Yes.

BQ242 David Quest: When was that?

Jo Dawson: I don’t remember. It was an ongoing challenge throughout the year that I was there.

BQ243 David Quest: Right. The other point you make in your submission about corporate is in paragraph 50 where you talk about management information. This is actually a point that you make about the board, but it may also apply in relation to your position as group risk director.

You say: "The quality of management information varied considerably between the divisions. It was recognised that there was a lack of reliable management information and data in the Corporate division which impeded progress on Basel II…Improving this data was a key priority for the Corporate division during the period 2005-2008 although it is fair to say that progress was slower than desired." What I understand from this is that you have got a three-year period up to the end of the bank when you are not getting satisfactory management information at board level from corporate.

Jo Dawson: Whether it is satisfactory, I think the nature of what I meant here-this relates to the FSA Bank of Scotland final notice-is that a large part of Basel development is the development of models, and those require data. Within retail, we had 20 years-plus of mortgage data going back through various recessions. You input the data to define a probability of default. In corporate, particularly in a number of the newer business areas, they had not been going for any length of time. Therefore, there was no historic data of how joint ventures fared in the last recession, for example, because those did not exist so the data did not exist.

On the other part, in terms of the credit sanctioning data, the difficulty seemed to be that a lot of it was held on paper and not on systems that were readily accessible, and therefore bringing that together. During the year, Peter Cummings continued to push really hard and made a lot of progress, and Dan Watkins will be able to speak more clearly about that. In terms of manually going through files and inputting data into systems so that they could be used, that was the challenge. The risk ratings and all those things came off those systems.

BQ244 David Quest: Let us just talk briefly about the FSA final notice, which presumably you have read. There are some very serious criticisms of corporate. Do you recognise those criticisms? Do you agree with them?

Jo Dawson: In answer to the first question, the FSA notice goes through the list of failings, and I was asked whether I believe that that was a broadly sensible assessment, which I do. I think it is also noteworthy that the FSA in its final notice quotes that the tone and content of internal documentation, business plan and otherwise, coming from corporate was at odds with what was actually happening.

BQ245 David Quest: It does. Just to be specific about that, the FSA make their general point in paragraph 2.2 that "Corporate pursued an aggressive growth strategy, with a specific focus on high-risk, sub-investment grade lending." Just looking at that statement, is that something that came as a surprise to you when you read it, or were you aware that that was a strategy that was being followed?

Jo Dawson: I would say from a board perspective, those words would never have been used at the board to describe what was being done.

BQ246 David Quest: No, I am sure that they would not be. The FSA then go on to describe the strategy in more detail. The focus on high-risk, sub-investment grade lending-is that something that was familiar to you, or did it come as a surprise?

Jo Dawson: I think-this is with hindsight and recollection-the typical nature of the counterparties that corporate were dealing with was, from recollection, likely to lead to being sub-investment grades. These were a lot of entrepreneurs as opposed to-they were not lending to BP or BT. They had relationships with a lot of entrepreneurs. When the large exposures reports were taken to board, that was the reason for the explanation in terms of the investment grade and ratings.

On high risk, the equity risk and the risk capital, in terms of the joint venture, and indeed the equity stakes in the integrated finance area, were obviously higher risk. I think everybody understood that.

BQ247 David Quest: Then at paragraph 2.5 there is a reference to "portfolio...highly concentrated in its exposure to property...and...to significant large borrowers." That was not something that was unknown to the board.

Jo Dawson: No.

BQ248 David Quest: If I may say, the impression that might be taken from the way that you deal with it in your statement is that someone will want to see whether this is right. In effect, you seem to be saying that corporate was misrepresented to the board in what it was actually doing.

Jo Dawson: That corporate was exposed to commercial property-that was a key area that it was doing in integrated finance, and therefore putting in equity elements. The nature of the counterparties it dealt with were different from a FTSE 100. All that was known to the board.

What I probably had in mind when I wrote that was that, notwithstanding all of that, there were various strands where oral assurances were given to the board that corporate were not doing, which is in line with what the FSA say in terms of the business plan. They were not doing anything-other competitors were being far more aggressive and adopting covenant-lite approaches.

BQ249 David Quest: You refer to that in paragraph 88 of your statement: "Whilst I was a Board director...I took comfort from reassurances provided by the Corporate division CEO, Peter Cummings, to the Board that the division was adopting a cautious approach". Is that really what the board thought about corporate-that it was adopting a cautious approach?

Jo Dawson: I think the quotation provided in my response to (5), if you read through the corporate business plans and the submissions, they would generally talk about a conservative approach to risk management being very selective and looking to sell down.

BQ250 David Quest: Is that what you thought the approach was-a cautious and conservative approach?

Jo Dawson: Within the parameters of the type of business it was writing. Relative to others writing equity risk, they were more cautious. Relative to others doing mezzanine debt or whatever, they were adopting a cautious approach. It was not just going for everything. The strategy was clear. I do not wish to mislead. The board was aware that corporate was a very different animal to other lenders in the market.

BQ251 Chair: If you had people who mixed with bankers in the forum in which bankers meet, that surely was not the reputation of HBOS corporate. HBOS corporate were the people you went to if you had some adventurous proposition and you wanted a very quick decision. Wasn’t that its reputation? On this idea that HBOS corporate was more cautious than other lenders, I would be surprised if that was really what your peers thought about you-not you personally, but HBOS corporate. They thought the opposite.

Jo Dawson: One, to clarify, I am not saying that the strategy was cautious, but we were told that the assessment of counterparties to advance that strategy was more cautious.

BQ252 Chair: That is the one thing that turned out to be manifestly untrue.

Jo Dawson: In any business, it is about risk optimisation in terms of whether the risks and rewards were balanced and whether the risk framework was balancing those risks and rewards. An interesting little anecdote is that we had an annual management conference every year with the top 500 or so coming.

In 2006, I think, Sir Philip Green came as the guest speaker and spoke very positively and strongly about corporate. Speed of response was one factor. He was very positive about corporate’s understanding of business. The top 500 or 600 people in the group heard from one of the group’s key clients.

Apart from here in group risk, I was heavily absorbed in running my businesses, so I did not bump into corporate bankers every day in the marketplace-quite the contrary. One certainly heard things along the lines of what you are saying. I had no ability at that time to discern whether people were jealous or whether it was real. I raised similar concerns with both the chief executive and the chairman, just repeating back the things I was hearing.

BQ253 Chair: So you were hearing similar things to what I was suggesting.

Jo Dawson: It was not an everyday conversation, but yes. The response in both those conversations was that they were comfortable with what was being done and it was just competitive mudslinging.

BQ254 Chair: There is one intriguing paragraph in your submission about the length of time of board meetings. Were they very brisk? Did you get the impression that people were not given enough time to raise their doubts, and that the chair and the CEO were always pressing on? Was that the style?

Jo Dawson: For a group of the scale and the complexity of all the different businesses, we as a board met for two hours a month. Obviously, the group audit committee, the divisional risk committees and the divisional audit committees met separately to that. As an executive committee we met once a month. An interesting comparison for me, as the person who went into the Lloyds banking group and sat on the executive committee following the acquisition, is that we had executive committees every week.

BQ255 Chair: And how long did a typical meeting last?

Jo Dawson: The executive committees lasted most of the day, once a week.

BQ256 Chair: How long did a board meeting last at Lloyds?

Jo Dawson: I was not on the board, but I got the impression from agendas and papers that it was over half a day.

BQ257 Chair: Two hours does not sound much to me for a £40 billion company.

Jo Dawson: And some of the information, it was not that there was a mislead in terms of a paucity of information-actually, sometimes quite the contrary. I am sure that all of us have sat on boards-

BQ258 Chair: Yes, it’s about the time made available to discuss it or, in a sense, the extent to which people were invited to ask questions. That is interesting. Thank you.

BQ259 David Quest: You describe it as a sort of federal system, I think. To what extent were the board concerned to probe what divisions other than your own division were doing? To what extent were you on the board probing what corporate was doing, challenging what corporate was doing?

Jo Dawson: I would say that the level of probing or challenging, whether from executive or non-executive directors, was quite low.

BQ260 David Quest: Quite low. You have a slightly extraordinary situation in corporate, because you have a division, first, which is carrying out a high-risk strategy,; second, where the relationship at a group-risk level was challenging, you said; third, where you have ongoing queries by the FSA following on from the ARROW report; fourth, where you have, as you said, a lack of historical management data about credit sanctions; and fifth-a subsidiary point-where you have got a kind of general perception in the market that this is a higher-risk enterprise. Putting those things together rather suggests that there should have been some rather more robust challenge, doesn’t it?

Jo Dawson: With the benefit of hindsight and the points you make, absolutely.

BQ261 Chair: If you had gone regularly to exco awaydays or board awaydays, almost from the start of the company’s existence the weakness of wholesale funding would have been identified, yet the impression is that it is identified but no one actually says, "Well, in order to deal with this gap in funding we should slow lending." They press on and somehow hope that they will manage to get through. Then when the crash came, of course, they were caught with a very, very large wholesale funding requirement. So a strategic weakness is identified on several occasions, but is insufficiently addressed, it seems to me.

Jo Dawson: A few comments there. Absolutely, back to 2004, or 2003-04, that was probably the first time I became aware of the question of funding: it was recognised as a strategic weakness. And then you go through a process of saying, "So what’s the risk?" The risk is, you know, the market dries up. Well, which market? The risk mitigation is to diversify the markets in order to reduce your reliance on any one market, because the likelihood of what we actually saw happening-of all markets closing up-I don’t think that has ever happened before for the extended period it did. So diversification, and extending the maturity profile, both of which happened over that period, were both risk mitigants-they were risk management activities, designed to mitigate the risk of having a large wholesale funding requirement. At the same time, one seeks to, as I heard Colin say, drive the customer deposit raising activity, but sort of the key issue-and pretty much all western banks, building societies, whatever, would have a wholesale funding requirement-is that we have a structural gap historically in the UK between savings ratios and, thinking about the retail business, house price inflation. Everybody had wholesale funding. For us, it was about diversifying, extending and lengthening the maturity profile. It was not the case that nothing was done, if I understood you rightly. It was not ignored and put away. There was a constant focus on that within the divisions.

I was not in retail for the period, but I know there was always a focus on raising retail savings, even though, if you think back to 2006, wholesale funding was plentiful and cheap. That was where private equity people made a fortune with the liquidity in the market. The prospect of that drying up-I don’t think it was ignored; it was managed. But even if at the end of 2008 we had had half the wholesale funding requirement that we did, the markets still would have closed. We still would have been reliant on the Bank of England and Government support to keep us going. I don’t know if that answers the question. The only other alternative, which I guess was the implication of your question, is to reduce your assets.

BQ262 Chair: Or slow the asset growth.

Jo Dawson: Yes. The selling-down in corporate had always been, but in 2007 when the markets closed, corporate growth was huge. The sell-down activity didn’t happen and, de facto, we had larger growth there. From the end of 2007, when Dan and I took over the retail side, we made a strategic decision, which was approved by board and which we announced, to move away from the net share targets that had previously been in place in the mortgage market, because we didn’t think that was a sensible thing to do. It was not leading to good-quality business; there was an awful lot of churn; it was not profitable-it didn’t make sense. It was the wrong metric to be managing the business by. That obviously reduced a funding requirement there. There was activity, as well as trying, as Colin said, new markets in terms of US funding and in Australia.

BQ263 David Quest: Of course you are right to say that all western banks were reliant to some extent on wholesale funding. The point seems to be that it was recognised that HBOS was, first, more reliant on wholesale funding than its competitors, and secondly, over-reliant on wholesale funding. What is striking, as one goes through the minutes over time, is a constant recognition that something needs to be done about wholesale funding.

Jo Dawson: That it was more reliant than others? Than some others, but not all others, as a percentage. That it was over-reliant? That is a judgment. That was never raised, for instance, by the FSA as a key risk to the business. I was not ever aware of that being in a specific stress test or whatever. Extending the maturity profile, diversifying the sources of it, trying to drive customer deposits, slowing the asset growth-those things were happening. I guess the only place they were not happening was in the international division.

BQ264 David Quest: I used the word "over-reliant" not as my own characterisation; that was the way Mr Hornby described it in one of the executive committee meetings.

Jo Dawson: Absolutely with the benefit of hindsight, clearly.

BQ265 David Quest: That is how he described it at the time, in June 2006, I think. I don’t know whether you were at that meeting-yes, you were. If you have document B3, you will see that it was one of the executive committee awaydays and you were present at that meeting, which was chaired by Mr Hornby. On the second page there is a list of strategic weaknesses in the group, and the third bullet point is over-reliance on wholesale funding. That point seems to be very important; it is picked up again in Mr. Hodkinson’s presentation. If you look at the next page of that document, there is a reference to funding: "funding that was not yet a constraint, but which could become a constraint by the end of the Plan period-as much of the Group’s funding capacity was utilised simply to renew and replace existing levels of funding.".

What is striking-and you get similar comments at other meetings-is that it seems to be that there was, from a relatively early stage, a recognition that something needed to be done about funding. From what I understand from your evidence, what was done about it was to try to find alternative sources of funding rather than to reduce the need for funding.

Jo Dawson: Diversify the sources, mitigate the risks of any single market being closed, and extend maturity profiles, so that we could withstand more. If you read the next sentence under that bit there, in Phil’s section, it says that it "was not yet a constraint, but…could become a constraint by the end of the Plan"-so five years out, this could be a risk in terms of that. "The sources of funding needed to continue to expand." Phil as group CFO was not saying that we needed to cut back on asset-

BQ266 David Quest: No, no one ever did say that. Of course, finding alternative sources of funding is a risk mitigant, but it does not eliminate risk.

Jo Dawson: No, of course it doesn’t.

BQ267 David Quest: No. In terms of stress tests there were done, do I take it that there was no stress test that considered the possibility that there might be-

Jo Dawson: A total closing of every single market for an extended period of time globally? No. Individual markets, impact of single name, name-specific events, impact of a closure of certain markets’ securitisation or such-and-such, or US markets? All of those, yes. Everything. There was definitely a period for which markets were closed to everybody, and then there was an extended period when maybe some banks could get some funding at some cost. It is linked to the confidence thing. Was it a lack of confidence in us that-

BQ268 David Quest: I was going to ask you about that in my final point about funding, because there is a correlation between the availability of funding and the market’s confidence in your asset position. What I suggest ended up being a particular problem for HBOS was that the serious impairments in its loan book not only went to its balance sheet, but also meant that such funding as was available was not going to be directed at HBOS.

Jo Dawson: It is a point I think that, from recollection, the FSA made in their report on RBS-raising the question of to what extent confidence to lend by wholesale counterparties was influenced or not influenced by perceptions of the risk profile of that organisation. In their report they said it was impossible to say-in the case of RBS.

BQ269 David Quest: Was that potential correlation a point that was ever considered by the board, or was it just assumed that there would always be wholesale funding available?

Jo Dawson: We clearly did not always consider that there would be everything we needed to continue to perform and for people to have confidence. At the end of the day, markets are all about confidence, so we needed to continue to have that.

BQ270 David Quest: I have one final issue: the treasury losses. As you probably know, there was a very large loss booked in treasury of some £3.6 billion in 2008, caused by mark-to-market losses on securities. In paragraph 92 of your statement, you say that you were "completely unaware" of the strategy that had led to the bank building up a structured credit and ABS portfolio "until it started to emerge as an issue in 2008". Shouldn’t the board have been aware of that?

Jo Dawson: As I understand it, these assets were held in liquidity and banking book portfolios. Treasury was charged with holding assets to certain mandates in terms of external ratings; if these assets met those external rating parameters, it was complying with the instructions that we, as a board, had given it. The credit rating on those assets went from AAA to unrateable within a period-and as that unfurled, therefore the mark-to-market and then no broker quotes, because there was no activity. At the time of acquisition, however, I do not think that I would have been aware of it as a strategy, because it would have been a business-as-usual activity of assets that met the liquidity requirements in the liquidity portfolio. We would have looked at a treasury liquidity paper, perhaps, that would have said, "We intend to hold all these assets and such." To be honest-I think this was part of the challenge in 2008 when it started-I probably would not have known what an alt-A security was at that time. I knew that treasury were the experts in that and they were telling us that these are securities that are AAA-rated externally.

BQ271 David Quest: So as far as you were concerned on the board, treasury was given a mandate to invest at a particular credit rating.

Jo Dawson: Yes.

BQ272 David Quest: Then it was for treasury to sort that out itself.

Jo Dawson: I am not sure whether there was any check or balance on that from anyone. I presume that audit or group finance within the funding and liquidity of the group capital committee would have-

BQ273 David Quest: But it wasn’t a board issue.

Jo Dawson: Clearly, setting the mandate is the board issue.

BQ274 David Quest: Once the mandate had been set.

Jo Dawson: I think you would want to know, as a board, if it was not being complied with.

BQ275 Chair: So it was not a decision to invest consciously in risky assets; it was that, rather suddenly, assets that you thought were not risky turned out to be risky.

Jo Dawson: Yes. Not just us, the whole market did not think in terms of rating agencies.

BQ276 David Quest: These were all mandated by reference to credit agency ratings.

Jo Dawson: Yes.

Chair: That has been very helpful. We are piecing together a jigsaw, and I think you have filled in some of the pieces for us. We are very interested in the risk function, how it developed over time and whether it ever really caught up with the degree of risk that the company was taking, but we will take some further evidence on that from former colleagues. Thank you very much for your contribution.