Evidence heard in Public

Questions 4225 - 4303



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Oral Evidence

Taken before the Parliamentary Commission on Banking Standards

on Thursday 14 February 2013

Members present:

Mr Andrew Tyrie (Chair)

Mark Garnier

Lord Lawson of Blaby

Mr Andrew Love

Mr Pat McFadden

Lord McFall of Alcluith

John Thurso

Lord Turnbull

The Archbishop of Canterbury also attended as a Specialist Adviser with power to examine witnesses.

Examination of Witness

Witness: Eric Daniels, former Chief Executive, Lloyds Banking Group, examined.

Q4225 Chair: Mr Daniels, PPI developed on your watch, and of course it developed into a catastrophe. With hindsight, what would you do differently?

Eric Daniels: Let me give a bit of background in order to be able to answer the question.

Any time a customer receives a product that is not appropriate for them, or they do not receive a good, full-bodied explanation of how the product works, its terms and conditions and so on, that is simply wrong, that would be a mis-selling, and I am deeply regretful about those cases. However, I believe that the vast majority of the provision that has been made is related not to that, but rather to a difference in understanding between the industry and the regulator.

That difference in understanding comes from: what would constitute a reasonable sale at point of purchase, and were representations made in addition to the written contract that would have been critical for the customer? We found that we could not prove that those oral representations had been made, and then retrospectively the claims were allowed; that accounts for the great majority of the claims today. In those cases where there were mis-sold products-the customer did not understand what they were receiving, or it was not appropriate for them-that clearly is wrong, but that is not the majority, in my view.

Q4226 Chair: In the majority of cases you think the customer probably was informed, but the bank, at this time, cannot prove it. Is that what you are saying?

Eric Daniels: Yes, that’s correct. In the case of Lloyds, we had a script on the screen, which was shared with the customer, so when the customer applied for a loan, they were then asked whether they would like payment protection insurance; they were then walked through the terms and conditions around the product by the salesperson. We monitored that very carefully: we had supervisors, as part of their normal control routine, ensure that in fact the customer was walked through those screens, and they were pre-scripted. At the end of the process, the customer signs a document that says, "Yes, I want the product. Yes, I understand the terms and conditions," and they were written in plain English, so we believe that that constituted reasonable evidence that the sale was correct. However, the difference with the regulator was that in 2008, in the open standard, the FSA said that it was critical that oral representations were made in addition and they needed to be proved to have been made. If we could not prove it as an industry, that opened the door for a mis-selling case.

What we have found is that almost half the claims made against Lloyds were by people who had never had a personal loan with us; had never had PPI with us; were not, in fact, customers. Included in there were cases where customers had claimed against the insurance-in other words, they had become unemployed or had a life event and took compensation against the insurance policy-and then later reclaimed their premium. So it has a wide spectrum of cases.

Q4227 Chair: You are really saying that, in addition to a large number of cases of mis-selling, there have been a large number of cases of mis-regulation.

Eric Daniels: I would not term it as mis-regulation. I would term it as a difference between the industry and the regulator.

Q4228 Chair: [Laughter.] That’s a fine point of difference, isn’t it?

You said earlier one other thing that was interesting: that one needs to work out what would constitute a reasonable sale at the point of sale. What did you mean by that?

Eric Daniels: One of the fundamental things is that if we act at the time with what we believe is reasonable care and with as much care as we could have taken, and, in hindsight or with changes in standards, that is deemed to be inadequate, it hardly seems right that we should look retrospectively at that. If at the time of sale we believe that we made the appropriate judgment that can only later be proved faulty in hindsight-I would maintain that in many cases it is not faulty, but in those cases in which it is deemed to be faulty in hindsight-it should not look backward.

Q4229 Chair: You are not denying, though, that a large number of these PPI cases were mis-sold and that Lloyds made a lot of money out of it and that that was wrong?

Eric Daniels: Lloyds clearly had cases where the product did not fit the customer. For example, in 2005, what we did was conduct an internal review: what we wanted to do was to ensure that the customers who purchased were in fact able to claim under that-so in cases where they were of advanced age and reasonably could not claim under it, we took those all to one side. We found that about 1.6% of the sales probably were not good sales, so we promptly contacted the customers and refunded their money. What we have done is-

Q4230 Chair: Sorry, just to give us a feel, what proportion of sales have now been deemed to be mis-sales by the regulator?

Eric Daniels: I would guess somewhere around 200%, judging from the number of claims.

Q4231 Chair: [Laughter.] Okay. So you are saying that there is a lot, plus a few more.

Eric Daniels: Plus a few more.

Q4232 Chair: You would not deny, though, that even if the proportion of genuine mis-sales is disputed, those mis-sales occurred as a consequence of poor controls in Lloyds?

Eric Daniels: I would say that it is always possible to improve controls. It is something we strive to do over many, many years-in other words, this is not something that you can claim once and done; it needs constant attention. During my watch at Lloyds, we had, in addition to the annual product reviews, the quarterly reviews of each one of the divisions, the risk reports that went to the board and the risk committees that went to the management group, so we had substantial monitoring. We evolved our product and practice quite considerably. Every time, it seemed, that we looked at it, we found ways in which we could improve-the sales process, the documentation in simpler English, and the product itself so that we eliminated exclusion after exclusion in the product. In other words, when we finally ended-

Q4233 Chair: The question really was: were the controls okay or are you, in retrospect, saying that they were not okay?

Eric Daniels: We believe that the controls were actually pretty good. We went through, as you recall, three thematic reviews by the FSA. In addition, we went into an over-two-year investigation to see whether we should go into enforcement, which happily did not result in enforcement. So I believe that while the controls could continue to evolve and always should, they were certainly the best in class at the time.

Q4234 Chair: Although defective right across the industry.

Eric Daniels: I cannot speak for the rest of the industry, but I believe that in Lloyds they ensured that we had good outcomes, in terms of making sure that we met the customer need and we sold the product correctly. Now, I cannot obviously say that in every case; there are clearly cases where we did not meet that standard and those are highly regrettable. But we took every reasonable precaution to do so-

Q4235 Chair: And you are apologising for those?

Eric Daniels: I absolutely do.

Q4236 Lord McFall of Alcluith: Mr Daniels, you became CEO in 2003. Around the same time a new head of internal audit, Martyn Scrivens, and a new chief risk officer, Carol Sergeant, formerly at the FSA, were appointed; Carol Sergeant was also in charge of the compliance function. In effect, you put in a new control team. Why did you feel that was necessary?

Eric Daniels: Thank you for the question, Lord McFall. If you recall, at the time-in fact, I think we talked a bit about it in one of the Treasury Committee hearings-we completely revamped, as I was taking over, the Lloyds risk and control structure. We had hired KMPG-I believe it was KMPG-to help us to understand what best practice was, not only in the UK but across the globe. We came up with a three lines of defence structure, so what we were trying to do was to put accountability at each step in the organisation. The first line of defence was making sure that the manager on the spot carried out the functions correctly; the second line was making sure that we had an independent compliance function that would have oversight and make sure that the first line was in fact behaving properly; and the third line, finally, was the board and the audit committee.

We did not believe that we had people who were fit for purpose in the organisation when we put in that new structure, hence the hiring of Martyn Scrivens, who was a deeply experienced auditor, and Carol Sergeant, who had been one of the very senior regulators at the FSA and the Bank of England before then.

Q4237 Lord McFall of Alcluith: I note in a speech that Carol Sergeant made in October 2003 that she said, "The retail market place is confusing, indeed incomprehensible, to many consumers and continues to be a risky and dangerous place for firms which do not understand the social, political and economic context in which it operates." She also said that "effective delivery" of products "will include ensuring that the firm…has in place a process to identify the needs of the customers for whom they are designing, manufacturing and/or distributing products". She went on, "In designing their strategy, we would expect senior management to have regard to all stages of the product lifecycle. This would therefore include: product design; financial promotions; advice (including remuneration of advisers); information at the point of sale; treatment after the point of sale; and complaints." You praised Carol Sergeant when she left, saying that "She has established an outstanding risk leadership team and has implemented industry-leading risk-management standards and practices." So what happened to your organisation? Did it live up to the points that Carol Sergeant made in her speech in 2003, and was product design a board responsibility, so that you checked off exactly what was being sold to customers?

Eric Daniels: I had in fact forgotten that speech; thank you for reminding me of it, Lord McFall. I think it pretty clearly sets out what we in Lloyds wanted and what Carol’s mission was when she joined Lloyds. We wanted to be best in class. What we believed at the time and I continue to believe is that you cannot make profit your objective when you run an organisation. The profit is the result; the objective has got to be to serve your customers well over the longer term-that is the only way in which you can survive in a service business. What that necessarily meant is that our controls and standards had to be very, very high indeed.

When we design a product, we have the customer in mind. With PPI, which was invented long before I arrived on the scene-it has been around for a good long time-the original design of the product was to give peace of mind to the consumer. Most consumers in Britain are underinsured-I think that the estimates are about £3 trillion, by the Zurich Insurance company-so when a customer takes a loan, they are fearful that if they fall ill or there is a life event, they will not in fact be able to repay. This product was designed to give them peace of mind.

Around selling that product, we then put in and continued to improve a whole series of controls, both before the fact, through the training of our people and making sure that the screens were scripted, so that people had to walk through the disclosures; and after the fact-we called customers, first on a sample basis and then more frequently, to ensure not only in PPI but in other products, that the customers were in fact happy with the sale. What we found was that, as opposed to being bothered, customers were actually pleased that the bank cared enough to say, "Does your product work? Is it good for you? How was the process?" We started to institute that post-sale call more and more, which not only gave us a valuable input in responses to, "Was there a problem?" but also pleased the customer, because they thought we cared, which we did.

Q4238 Lord McFall of Alcluith: So product design was a board responsibility.

You will be aware of the case of Harrison v. Black Horse. The Harrisons took out a loan of £46,000 and were sold a single premium PPI policy costing £11,500, so the total they borrowed was £57,500. Three years later, in July 2006, £54,815 of this loan was still outstanding. To refinance it, the Harrisons took out a loan of £60,000, and were sold a single premium PPI policy costing £10,200, which meant that the total borrowed was £70,200. The bank earned a commission of 87% of the £10,200 premium, which is £8,887.49, but it did not disclose that fact to the Harrisons, as was said in the case. The PPI policy lasted five years, but the cost of it would be paid over the entire 23-year loan, so the monthly repayments were £444.10 for the loan and £75.50 for the PPI. This meant that the total cost of the PPI over the term of the loan was £20,636. The maximum benefits payable under the disability and unemployment elements of the insurance were £18,705.60-less than the total cost of the insurance over the 23-year loan.

Why did Lloyds design and sell such poor value PPI policies that paid the bank 87% commission? By the way, in a forum in which I was involved a number of years ago, Sir Win Bischoff said that it was as plain as the nose on your face that the market was not working if returns were 87%. What did the board do to ensure that there was appropriate product design? That was manifestly not the case here.

Eric Daniels: Can I give a bit of the context and then answer the question specifically? When we look at the profitability of an individual product, we look for, at the sale, what the return is on it. By way of clarification, PPI was never sold alone; it was always sold in conjunction with a loan. When we looked at the profitability at the management level and at the board level, we looked at the combined basket. What we found was that, in the case of personal lending-I think that the Harrisons were in fact in Black Horse Finance-

Q4239 Lord McFall of Alcluith: Can I just say this, because you mention Black Horse? In 2005, the Black Horse loans website said that "Full details of eligibility criteria and exclusions will be sent to you with your loan agreement." Why did you expect customers to apply for a loan including PPI before they had even seen the policy details? It seems to contradict what you said right at the beginning.

Eric Daniels: If I may, I will answer the previous question, and then come back to that one.

When we looked at profitability, we looked at the basket. What we found was that in personal lending, whether through Black Horse or the Lloyds branches, this was a very low return product. When looked at on a combined basis-PPI as well as the personal loan-the return was low; it was a sub-par return, lower than on most of our other products. We did not look at the individual profitability of pieces-the PPI piece, for example -but considered the whole. That is the first point.

The second point is that I am not sure that 87% is accurate, because I believe that it does not include the costs within it. I think it simply takes the-

Q4240 Lord McFall of Alcluith: The judgment in the court case said it was 87%. If you go back to it you will see that figure mentioned.

Eric Daniels: I do not doubt that, Lord McFall, but I think what they were doing was taking the gross premium from the customer less the premium that was paid to the insurance company-Prudential in this case, I think-and they did not deduct all the costs, never mind the risk of default, which should have been included in the calculations. That may have been the gross, but it was certainly not the net profitability.

Q4241 Lord McFall of Alcluith: I put it to you that you were selling loans and not making money out of them, and cross-subsidising them with PPI, which was a profitable product. Indeed, in her evidence to our Panel, Helen Weir made that very point-yes, it was cross-subsidisation. You were giving a loan, you were giving your staff extra points for securing a loan plus PPI, and the less profitable part-loans-were being more than supplemented by high-profit PPI. That is where we get the 87% commission.

Eric Daniels: There is no question that cross-subsidisation is a factor in the industry, but it is not unique to the banking industry. Tesco, for example, in a two-for-one sale, is clearly hoping that if it takes a loss on a carton of orange juice, you will buy bread and milk there as well. The luggage fee at an airline is clearly a way of managing the total pricing package. The combined return on a loan combined with PPI is still sub-par, and yes there is cross-subsidisation.

Q4242 Lord McFall of Alcluith: Almost immediately after you left Lloyds Banking Group, António Horta-Osório took up the job as CEO and Martyn Scrivens, for whom you said you have a high regard, was asked by the group executive committee to undertake a lesson learned on PPI. Did you ever ask Mr Scrivens to undertake such a review?

Eric Daniels: Yes. I asked not only Mr Scrivens, but Mrs Sargeant as well, and we had drains-ups, if you will, on many occasions. When you are subject to three thematic reviews, which we had between 2005 and 2008; when the investigation into whether we should go on to enforcement on this very subject lasted more than two years; when 173 new rules were promulgated by the FSA in 2005, and subsequently more and more one has to look deeply into the organisation and ask oneself, "Are we doing the right thing? Are there things we should be doing differently? We did ask ourselves those questions on many occasions.

Q4243 Lord McFall of Alcluith: I ask that because, in a submission to the group executive committee on Tuesday 12 April 2011-this is under António Horta-Osório; there is nothing under your stewardship that we can get from the minutes-Mr Scrivens mentioned "the desirability of conducting earlier in depth review of known problem situations like PPI", which indicates that a review was not undertaken. He also said "There was a clear case for greater and earlier analysis of current and back book exposures, particularly where there were known to be challenges" and there was "the need for improved accountability for back book products including greater senior ownership of significant historic issues". Do you agree with Mr Scrivens’s comments there?

Eric Daniels: I am not sure of the context of his comments, Lord McFall.

Q4244 Lord McFall of Alcluith: You have that in the submission the Commission sent to you-you have that.

Eric Daniels: They did. I am not aware of the context that he made that comment in. What I can tell you is that I met with Mr Scrivens on a monthly basis, sometimes more frequently, and Mr Scrivens appeared before the risk committee of the board on a monthly basis, so we had, I can assure you, more than adequate opportunity to exchange views.

Q4245 Lord McFall of Alcluith: Okay. You would say then that the minute, which you have seen, would indicate that Lloyds should have been doing something earlier in conducting in-depth reviews. That is what Mr Scrivens is saying. You would agree with that, because it is in black and white.

Eric Daniels: Again, I am not sure of the context.

Lord McFall of Alcluith: There you are-that’s it there.

Eric Daniels: That you. I have seen this, but I am not sure of the context in which he made the context.

Q4246 Lord McFall of Alcluith: Are you saying to us that words can mean different things? It is very obvious there from the sentence. It is very simple.

Eric Daniels: If the context is that we can always improve-in other words, that there is further room for improvement-I would heartily agree with that. If the context is that we were asleep at the time and did not entertain it, I would absolutely disagree, but I think the context is that there were more things that could be done, and I would agree with that.

Q4247 Lord McFall of Alcluith: Natalie Ceeney of the FOS told us in evidence that banks should have seen the signs as long ago as the early 2000s. That was about the time you became head of retail banking. Why did you not do as Ms Ceeney suggested you should have done and address PPI problems? There were indications from CAB from 1995. There were articles from Which? in 2002 about a protection racket. The Treasury Committee in 2003 asked the OFT to have an investigation into PPI, and it asked the FSA again in November 2005. Thematic reviews were taking place. It would seem as though the whole world knew about PPI and the consequences of PPI in terms of mis-selling and customers being ripped off, but the board of Lloyds did not know. There seemed to be a tin ear on the Lloyds board: while there was this cacophony of sound throughout the rest of society, you were just going to go on and make your profits.

Eric Daniels: As you suggest, there was a huge amount of public scrutiny as well as regulatory scrutiny. We talked about the thematic reviews, the investigations and so on. At all times, Lloyds worked with the regulators; the Ombudsman service, the OFT and the FSA all were involved; we certainly had constant communication with the CAB and others. So we were in constant dialogue. We had thought that with each one of the thematic reviews which resulted in new rules, which we implemented-we did more than simply implement the letter; I think we went to the spirit and wanted to ensure that we had best practice. At each stage, with each new input, we analysed, responded and tried to make sure that we were listening to the customer, exceeding the letter and living up to the spirit of the changes.

As I suggested, in 2005, we had 173 new rules that were asked for in ICOB. We implemented not only those, but in addition, our own internal pieces. With each thematic review came more changes, and we thought that, with our consistent and constant dialogue with the regulators, we were on the side of the angels. We had thought we were listening and responding. I would characterise our board and management as being responsible and responsive during this period, for the reasons that I mentioned.

Q4248 Lord McFall of Alcluith: I will take you on to the group executive minutes again. Peter Ayliffe took over your role in retail when you became CEO. According to the minutes of your executive committee on 14 November 2004, which you have, "Mr Ayliffe warned of the possibility of adverse publicity regarding the selling of credit protection insurance… The committee asked that balanced scorecards of relevant employees be reviewed in that regard"-in other words, the commission that employees got-but Mr Ayliffe was seemingly unable to report back on his finding, because, according to press articles at the time, you ousted him. He stepped down from the board less than two and a half months after bringing these PPI issues to your executive committee. Did you oust him?

Eric Daniels: Did I oust him? No, Peter left on a voluntary agreement. I have the highest respect for Mr Ayliffe. He went on to run Visa for Europe and in fact went on to an even better career. No, Peter was my selection for the role, to replace me, and certainly, he and I worked very closely together. The balanced scorecard that you mentioned was implemented by me when I first came into the retail bank, and then it was instituted across all of Lloyds TSB.

The balanced scorecard seeks to say that we are in business not simply to sell, but, rather to build for the longer term. The balanced scorecard has five elements to it: risk, development of people, service and customer advocacy, building relationships with customers, and then sales-so sales constitutes one of five. Within sales, we assign points for sales. Yes, PPI did have a role within that one-fifth portion of the balanced scorecard, but only a role, along with every other product-savings accounts, chequing accounts and so on.

Q4249 Lord McFall of Alcluith: What did Mr Ayliffe mean, then, by "adverse publicity"? Are you telling us that Mr Ayliffe was in the process of leaving when he presented this to the board? He left two and a half months later-it seems a very short time.

Eric Daniels: I do not recall when Peter and I had the conversation regarding his leaving, whether it was before or after, but I can assure you it had nothing to do with the conversation regarding PPI. We were all conscious that PPI had an interest in the public arena, but I would tell you also that, at that time, this was the least complained about product in the Ombudsman’s service. When we looked at all the complaints on a percentage basis, this was either the least, or near the least, complained about product. Customers got legitimate peace of mind for it-

Q4250 Lord McFall of Alcluith: Do you think that could be due to the fact that a lot of customers really did not know they were buying PPI, as FOS said to us in their evidence?

Eric Daniels: On the contrary, I believe it gave them peace of mind-

Q4251 Lord McFall of Alcluith: So FOS are wrong? You contradict them. You also contradict the view that you should have been looking at this in 2000.

Eric Daniels: I believe that customers did know what they were buying. I think they got good value; they believed they were getting good value. When we priced PPI, we purposely built the product so that it was the most generous in the marketplace-it was rated by Defaqto as a five-star product; it was given the top rating. When we priced it, we in fact priced it within the market, even though it was the most generous in terms of its payout and its benefits. We gave a very competitive price for a very valuable product, and I think that customers enjoyed that.

Q4252 Lord McFall of Alcluith: The minutes of your executive committee meeting on 2 November 2010 say that when the group’s interim management statement was released earlier in the day "initial market reaction…had been disappointing...Some commentators, wrongly, had interpreted the Group’s view of the outlook for the full year as less ‘bullish’. There was some evidence of profit take in and rebalancing of portfolios. There had been questioning about the Group’s PPI exposures," which you, Eric Daniels, "had…replied to robustly". Why did you think that, as late as 2010, when a super-injunction was going forward, there was still a robust case to be made for selling PPI?

Eric Daniels: We believed fundamentally that we were solving a customer need and adding legitimate value to the customer. They wanted insurance to give them peace of mind. We felt it was a good thing to provide that. We believed that we explained it and sold it well. We gave the simplest English that we could, and we provided the most robust set of benefits. We in fact paid out: 90% of the claims were compensated under the claims for policies. When someone became disabled or unable to repay the loan because of a life event, 90% of cases were successful.

Q4253 Lord McFall of Alcluith: So, to sum up what you have said to us, you were on the side of the angels. Despite the cacophony of adverse comments, you were doing the right thing. The regulator kept changing the rules, as Carol Sergeant said. It was a huge misunderstanding of the situation between yourself and the regulator. You hung out for judicial review because you wanted clarification. Therefore, everything that you did was always correct, and the bonus that you got for 2011-12, and are maybe going to get for 2012-13, is thoroughly deserved. Eric Daniels should be commended for PPI.

Eric Daniels: If I may, as I told Mr Tyrie, there were certainly cases where a customer did not receive an appropriate product or a reasonable explanation of the terms and conditions of that product. Those were clearly wrong, and I am deeply regretful for them. However, I do not believe that those are the majority of cases around the payments today. To clarify, I did not receive a bonus for 2011, 2012 or 2013, nor did I receive one for 2008 or 2009.

Q4254 Lord Turnbull: We have spent a lot of time on this, so just a couple of quick questions. On Mr Ayliffe’s comment to the group executive committee, was this concern relayed to the board at any point?

Eric Daniels: I do not know whether this specific minute was relayed to the board, but I can assure you that the board received an annual product review, where we would have looked comprehensively at each one of the products that we sell and the controls around that product, as well as the aptness for customers and so on. The board would have seen PPI, certainly during that year. I do not know whether they had sight of that comment specifically.

Q4255 Lord Turnbull: You commented on the ratio of claims to gross premium. You are right to point out that that is not the whole story. There is another comparison to make, which is that 15% compared with motor, home and other insurance is extraordinarily low. Was that not a warning sign that the pricing of this product was not correct?

Eric Daniels: Again, we looked at the profitability of the basket. One could not buy a PPI product without purchasing a loan, so when we looked at the profitability of the basket-I believe that Mrs Weir walked you through the mechanics of that-in fact what we found was that this was a pretty low-return product.

Q4256 Lord Turnbull: I think one of the results of this is that you have a cross-subsidy, and you are being asked to make restitution for the mis-selling part, but you are unable to go back to the customer and say, "Let’s go back right to the beginning, as though this thing had never existed, and say ‘Can we have our subsidy back?’"

The banks, I think, are paying back vastly more than they ever gained in the first place by hanging on to this product. It seems to have been a calamitous misjudgment that that risk was not spotted. They did not spot the fact that if they lost this case, they would be paying back the gross revenues from the mis-selling but would never be able to get back the other side of the cross-subsidy. So the irony with the provisions you are making is that the Government have put huge amounts of money into Lloyds, and through that misjudgment, billions of that capital are being sucked out and undoing the good work of putting the capital in, as a result of pursuing this case six years after Mr Ayliffe first identified it as a problem.

Eric Daniels: I’m not quite sure whether there is a question there.

Q4257 Lord Turnbull: Do you think that banks are now having to repay vastly more than the total benefit they got from the package?

Eric Daniels: I clearly agree that the payouts are the compensation against this. It far exceeded any estimate by the regulator or the industry.

Q4258 Lord Turnbull: That was a risk that I think could have been anticipated.

Eric Daniels: I believe that one of the reasons why the industry decided to go to judicial review is that this was a precedent where one could look backward and say that, retrospectively, the burden of proof was on the bank or the industry to demonstrate that oral representations were made at the time, rather than the evidence being in the written documentation. When the industry-the individual banks-could not prove that, that laid the groundwork for the claims to come. As I suggested, many of the claims were from non-customers or customers who already had compensation under the insurance policy, so this has taken on proportions that I think no one anticipated.

Q4259 Lord Turnbull: I think the bogus claims are largely irrelevant, because your successors are not making provisions on them. All this £5.7 billion is for the claims that are either genuine mis-selling or the cases where you could not prove that you sold properly. So I do not think that the bogus claims are relevant to the amount of provisions you are having to make.

Eric Daniels: To clarify: I have heard that, at least in some institutions, a fair number of bogus claims were in fact paid out because the number of claims was so overwhelming that staff could not analyse whether or not a claim was bogus in the time frame prescribed by the ombudsman service. So, to avoid penalty and further opprobrium from the ombudsman service, claims were paid out wholesale. A fair number of claims were paid out that were not legitimate. I do not know whether that practice continues, but I have heard that, in the early days especially, it was common.

Lord Turnbull: I think that we have taken this as far as we can go.

Q4260 Chair: To clarify one point: do you agree that there are perils to cross-selling where one of the products-the most profitable of the two-subsequently turns out to have been mis-sold, leaving it very difficult for a bank to recoup the subsidy element in the other product that initiated the cross-selling?

Eric Daniels: When you have cross-subsidies, there are risks involved, there is no question about it; I would agree with your point. It happens across not only the banking industry but other industries as well. The issue becomes: how does one back down from something that has been an industry practice for a number of years without first mover disadvantage? There is no question but that the rate on credit cards and personal lending was far below the economic value of those products, but the industry got itself into a position where advertising low APRs and the expectation of low APRs became the norm.

Q4261 Chair: Given the risks that come with first mover disadvantage, as you have just put it, does that not point to a case in principle for regulation to bear down on cross-selling?

Eric Daniels: Certainly there are risks to cross-subsidisation. Cross-selling; in order to for me to respond to that, I would like to define that better. The clearer the regulations can be, so that we do not have cases where we look backward, as we are looking with PPI, the healthier for the industry.

Chair: That is very helpful.

Q4262 Mr Love: In response to an earlier question, you mentioned that you believed that a lot of the claims were not legitimate. You said, in an even earlier answer, that the majority of claims were not genuine. Can you give us a better idea of why you think that? What proportion of claims do you think are not genuine?

Eric Daniels: We have the outright bogus claims, where they come in in template form from people who never had a loan or were never customers of Lloyds. I think we can put that 50%, hopefully, to one side.

Q4263 Mr Love: So 50% are completely illegitimate?

Eric Daniels: Yes. I would believe so, because they were never customers and never took the product.

Of the people who took the product and who were in fact customers, there comes the difference in interpretation with the regulator. We would maintain that we upheld the standards of the time. We had written documentation that the customer had understood what they were receiving and that it was a separate sale from the loan, and the terms and conditions were written in plain English. Those were deemed not to be sufficient by the regulator, who demanded evidence of certain oral representations made at the time. When the industry could not fulfil that evidential hurdle, the groundwork was laid for mis-selling.

Mr Love: I want to come on to the selling process in a second. According to the latest estimates, Lloyds will have to return about £5.3 billion in claims. You were not there for quite a lot of that time, when the claims were built up, but based on your experience while you were there as the managing director, what proportion of that £5.3 billion do you think is illegitimate in some way?

Eric Daniels: I do not have access to that information.

Q4264 Mr Love: But you would say that it was over a majority?

Eric Daniels: I would say that the majority of the claims stem from the difference in interpretation, not from legitimate-sorry, that was a poor choice of words-not from genuine mis-selling, where a customer did not receive an appropriate product without an appropriate explanation. In other words, I believe that in the great majority of cases, customers did receive a good sales process, a product that fit them and good value from that product.

Q4265 Mr Love: Can I pick up on the point made by the Chairman about a good sales process? Is it the reality, because of the cross-subsidy, that it was critical that your staff-indeed, the staff of all banks selling PPI-sold PPI along with the loan, otherwise it was a non-economical sale, because the loans were priced at a level that had to be sold along with PPI? We have discovered, in one of the Panels we have been holding, that sales staff were incentivised to ensure that they sold PPI. Wasn’t all of that coming together? Did that not mean that there was massive mis-selling, that people were not properly informed and that staff were under enormous management pressure and incentive pressures to get the sales to include PPI?

Eric Daniels: If I can give you a little bit of background and context to answer that question, the average salary of a person who works in the branch selling this product is around £20,000 a year. The average bonus is around 10% to 15%. Lloyds is not an investment bank; we do not pay phone-number bonuses. We believe that outsize bonuses can distort behaviour, so we adopted a pay policy that we thought would encourage the right behaviours without providing distortions that would incentivise aberrant behaviour. Our compensation design was as I described. In addition to that, we did not have a specific requirement around cross-selling of a PPI product or any other product. What we did in terms of setting targets for a branch-

Q4266 Mr Love: Can I stop you there? We have received evidence to suggest that selling a loan was remunerated far less than selling a loan alongside PPI. Would you confirm that in Lloyds’ case?

Eric Daniels: There were more points assigned when you sold more; there is no question about that. What we did was we had a certain number of points targeted per branch, and it was up to the branch to figure out what was appropriate for the customers in their area. Clearly, if you have an area that is populated by, for example, older people, they will have more savings needs and much fewer borrowing needs. You would fulfil the points by trying to attract in savings deposits, current accounts and so on. If you are dealing in a much younger, inner-city demographic, there will be much higher need for borrowing, so you would fulfil your points that way. We did not have a prescriptive definition of, "You must sell three widgets or two cookies," or whatever. A certain number of points were assigned to a branch, and the branch was able to parse how they wanted to sell.

Q4267Mr Love: You mentioned the difference in view between the banks and the regulator. Wasn’t the regulator bringing in at this time treating customers fairly? They looked at the sales process that banks were undertaking where there were incentives to cross-sell and there was enormous management pressure to ensure that the sale included PPI because it was much more profitable a result. Wasn’t it reasonable for the FSA-the regulator-to conclude that the sales process was not treating customers fairly?

Eric Daniels: I believe that Lloyds always tried to instil the highest standards and to embrace treating the customer fairly as a principle. Fundamentally, what we believe-what we believed for many, many years, and certainly the reason why I joined Lloyds-is that building long-term customer relationships is the only way we can run a business. Violating a customer’s trust, treating them unfairly and mis-selling are all antithetical to building a business that we believe is worth while. We took extraordinary steps to make sure that we trained our people well and that we had good compliance monitoring. When I hired Carol Sergeant to help us become state of the art in terms of managing risk and compliance, she staffed up considerably to ensure that we were doing the right thing. I cannot imagine anyone in the management of Lloyds saying that they wished, for the sake of a short-term gain, to put in jeopardy longer-term relationships.

Q4268 Mr McFadden: I am slightly confused, Mr Daniels, by the logic behind this. You have said you were meeting a customer need in that the UK population was, as a whole, underinsured. You have also said that this was a cross-subsidisation product, which was necessary to render sales of the primary product-the loan or credit card-economic. There seems to me to be a contradiction between those two statements. They cannot both be true.

Eric Daniels: I am not sure I see the contradiction, if you would be kind enough to explain.

Q4269 Mr McFadden: What was driving this-customer need or cross-subsidisation? These are two different things.

Eric Daniels: Let me try to address that. I am not sure I get it, but let me try to wander around for a bit and perhaps I can hit the point. Households are generally very underinsured in the UK, to a point where I think it is something that should be much more in the national consciousness. When customers take out a loan, there is a concern that if they were to become unemployed or they were to have a life event that would prevent them from working-illness, death and so on-there would be that loan still to repay. So by giving them payment protection insurance, you are giving them piece of mind, so that when they purchase the car or new washing machine or whatever, they know that they have some certainty that they will be taken care of if there were a life event. That, I absolutely stand by.

The pricing of the package, as I suggested, was not a very high return, but it is very clear that personal lending, when looked at in isolation, did not give an economic return, because the APRs were so low. The PPIs did give a higher return, but the combined basket was still very low, and we looked at it on a combined basis.

Q4270 Mr McFadden: You have a lot of experience in insurance in your life. You ran the Travelers insurance business. You know your insurance market inside out. Is it not the case that the profitability on this product was significantly higher than on other insurance policies, such as car insurance or something like that, because the claim rates were so low?

Eric Daniels: I think that we are looking perhaps at a point in time and looking at it in a fairly partial fashion. One of the things that I would remind you of is that we were living in a particularly benign period, when the economy was in robust good health and unemployment was very low, so the number of claims tended to be lower. When you look over an entire cycle, and you look at the higher unemployment, for example, that we are experiencing now, you would see the returns on that product come down quite a bit.

Q4271 Mr McFadden: Do you accept my basic premise that the profitability-leaving aside the cross-subsidy element-on PPI relative to other insurance policies was significantly higher than, say, car insurance?

Eric Daniels: Than property and casualty insurance? Yes. Life insurance, almost by definition, has different pricing dynamics. So it is very much two completely different markets: property and casualty-general insurance as we call it in the UK-versus life insurance. They are very different.

Q4272 Mr McFadden: You also talked about the retail side, where you said that cross-subsidisation exists. It does, but it is usually on an ongoing basis. For example, if I buy a new razor, it does not cost me very much, but I know that they are going to get me on the razorblades. You can buy a printer now for £20 or £30, but they are going to get you on the cost of the ink. Was not the problem here that you only had one shot at cross-subsidisation? It had to be done at the point the customer signed up for the credit card or bought the loan or whatever it was. Did that not add to the pressures on your front-line staff to sell what Andy Love and John McFall have been talking about? This had to be done at a particular moment in time. The whole business model was based around that and that produced what I would argue were bad incentives from a customer’s point of view.

Eric Daniels: Thank you for the examples on cross-subsidisation and so on. I had not thought about those, so I will add those to the repertoire. To address your point, we wanted to ensure that we did not have incentives that would lead to aberrant behaviours and that we put in substantial processes to train our people well. We think we arrived at a compensation system that incentivised the right behaviour but without providing an incentive to go over the top. We had substantial monitoring, so that, as I mentioned before, we could electronically monitor how long a salesperson stayed on a particular screen, such as, in the case that we are discussing, the PPI terms and conditions screen. If they just flashed through it, that would set off an alarm bell. Likewise, we would look to see whether there was a particular seller or branch that was selling above what a reasonable expectation would be-twice or three times the norm. That would set off an alarm bell and we would immediately investigate. We took substantial steps to ensure that the process was well designed so that it would serve the customer well, but then we also took great pains to monitor that process to ensure that it was working correctly.

Q4273 Mr McFadden: I am still slightly confused, because your whole argument has been that this was cross-subsidisation-that PPI was really profitable on its own, but not that profitable when you put it in a basket with the product with which it was associated. Let us take that at face value. If the only way of making the loan or the credit card work financially was to sell PPI with it, that completely runs against the grain of, "You can’t rush through the screen, and you can’t be selling too many more than the other branch," and so on. Those arguments are pulling in different directions. Either this product was necessary in order to make the primary credit product viable financially or it wasn’t.

Eric Daniels: I do understand your point. I think the key was to ensure that this product was sold correctly. Yes, it helped improve the basket-there is no question about that-but it had to be done correctly. In other words, just because it is more profitable, that does not mean we were unmindful that it can be mis-sold. We therefore took great pains to ensure that the eligibility was right, the explanation was clear and we measured and monitored to ensure good sales.

Q4274 Mr McFadden: So you were effectively saying to your staff, "In order to make that loan viable, we need to sell PPI, but not too much"?

Eric Daniels: No, we would never tell staff that because we did not push profitability down to the branch level. That was not how we operated. What we said was, "We will ask you to look at a balanced scorecard"-the five elements I talked about earlier-"within which there is a sales component." There is no question but that every business needs to sell. It was up to the branch to determine how they sold-whether it was deposits or loans, and what their mix was. We did not push that down, and we certainly did not push PPI or incentivise people to a level where they would do the wrong thing.

Q4275 Mr McFadden: Is not the problem with this kind of business model reflected in the whole thing about interest rate swaps to small businesses, which I believe were also being sold during your tenure? What you have here is another product that is associated with a primary credit product where there is a one-shot chance of bringing the two together, and here we are with potentially another mis-selling scandal where the business model of bringing two things together in a high-pressure way at a single point of sale is leading to great customer anger.

Eric Daniels: I do not believe that. I do not have access to recent statistics, but I can tell you that, during my tenure, we did not sell an awful lot of interest rate swaps, although we did sell some. The origin of swaps and the customer need behind it is very straightforward: if you are a manufacturer in the midlands and you are exporting to BMW in Germany, for example, you will receive euros at a future time when you export and you do not know what the exchange rate between pounds and euros will be. In the meantime, you have to pay your suppliers and employees in pounds, so naturally, when you receive an order from Germany, you will want to lock in a rate so that you have better predictability, and you would write a swap around that.

Likewise on interest rates, when you borrow at a variable rate of interest and are fearful that inflation and interest rates may go up, you want to have a stream of constant payments, so that you can better plan your business. That is the derivation of the swaps.

Q4276 Mr McFadden: I understand that. I am driving at the point of sale and cross-subsidisation. I understand the logic behind an interest rate swap, but if we do not learn the lessons from PPI, we could, with other products, be continually bringing two products together that are economically viable only if one of the products is sold at the same point of sale as the primary product. I think that is going to happen over and over again.

Eric Daniels: I understand the risk. As with most things, if misused they can represent an unanticipated risk. In the case of interest rate swaps, when a customer decides to borrow and they want to convert that borrowing from variable to fixed, I am not sure why you would tell them, "No, I won’t do that" if they are requesting it. It gives the customer better certainty around their repayment schedule. I understand that there is always capacity for abuse or misuse-I think we should be absolutely vigilant to ensure that does not happen-but I am not sure that separating, as you seem to be suggesting, is the answer.

Mr McFadden: I will stop there.

Q4277 Mark Garnier: Can I pick up one point that Mr McFadden raised about the pricing of the PPI product, and about the fact that it was an incredibly profitable product? You went on to say that there was a benign economic environment at the time, and that subsequently, all things being equal, it would have come down. Is it not the case that your actuaries who designed the pricing of this would have looked into what the current economic situations were?

Eric Daniels: I am sorry, I did not catch that.

Mark Garnier: The actuaries who price the premiums on any insurance product will be looking at a whole range of factors. Getting something like an 82% return on an insurance product is a very, very high return. We know that cars crash, we know that people lose their jobs and all that kind of stuff. To get such a high return-to try to expect that much out of an insurance product-is quite racy for an actuary, surely.

Eric Daniels: Again, I think there are three things that perhaps should be thought about. First, yes, the actuaries look at the profitability over a cycle-no question. I think you are looking at a point in time when the economy was particularly benign. I do not think that the actuaries thought they would ever get a return anything like that. We just happened to look at it at a point in time.

Q4278 Mark Garnier: On that point, given that we were at a particular point in the cycle, have you seen what the predictions were for the profitability over an entire cycle, notwithstanding the fact that it has now become a subject of mis-selling?

Eric Daniels: I do not recall what the profitability was. Again, we tended-

Q4279 Mark Garnier: It is an important question though; would you agree?

Eric Daniels: I would understand your point and your interest. We did not look at it that way; we looked at the basket. At a management level, we looked at, "What is the profitability of the basket?" You could not buy a PPI policy without purchasing a loan, so we looked at that entire basket. The second point I would make is that I think the 87% that was quoted was looking at the gross premium and the premium paid to the insurer, and then saying what the difference was. It does not take into account the risk of default, nor does it take into account the actual sales cost and administration cost, which would bring that number down quite a bit. That would be the second thing that I would point out.

The third thing that I would point out is that our products are priced based on market and competition, so what we sought to do was give best value by giving a very robust product. It was, again, rated as a five-star, best-in-class product by Defaqto, an independent entity, and yet we charged about middle of the market for it. This is something where we thought we were giving very good value to the customer. The customer could shop around for the cost of a loan with PPI at Barclays, RBS or whoever, and could compare their payments and effective costs. We think that we would have compared favourably.

Q4280 Mark Garnier: Can I move on to interest rate hedging products, which Mr McFadden started alluding to? Presumably you would have been selling this type of product to the big corporations. It would have been your big, commercial, corporate customers, wouldn’t it? I would not suggest that you name a particular customer, but, for example, if you were banking for an oil exploration company, you would absolutely be looking at these interest rate hedging products to help them mitigate their risk in terms of interest rates, wouldn’t you?

Eric Daniels: I can assure you that any oil exploration company that I know of will have CFOs far sharper than the average tool in the box. They will tell us exactly what they want. No matter how much you try, you will not convince that CFO or series of experts to buy anything they do not want to buy, I can assure you.

Q4281 Mark Garnier: And indeed they would have been seeking to get a deal like this anyway, because they have to hedge all their exposure on currencies, commodities and interest rates and all the rest of it.

Eric Daniels: Especially the ones that deal in multiple jurisdictions. Their whole ethos is around hedging and ensuring that they have predictability.

Q4282 Mark Garnier: Absolutely. As a commercial banker to these organisations that would come to you, would you arrange those interest rate hedging products on their behalf? Would you act as a broker for those? Would they necessarily go and find other people to do them, so they do them separately? I am talking about the very big ones.

Eric Daniels: Most companies, at the time they take the loan, will take the swap with the loan, if they are going to take it at all. Many don’t. They either want the certainty or they don’t. At future times, they may decide to go naked for some period and then subsequently decide to take a hedge. That happens as well.

Q4283 Mark Garnier: But on these big commercial loans, you would not necessarily, as a bank lending, say, £50 million, or part of a syndicated loan lending £500 million or so, make it a condition of the loan that they would have a thing with you.

Eric Daniels: One cannot make it a condition of the loan. That would be a tied sale and that is absolutely prohibited.

Q4284 Mark Garnier: That is very interesting. Thank you. That is not what we have heard necessarily from any other banks, but it is an interesting point. My interest is that, as you know, there is the developing scandal with interest rate hedging products that have been sold to smaller businesses. I think in the region of 40,000 of those businesses have put in a claim for this. We asked António Horta-Osório when he came in how many Lloyds had done. It seemed to be a fairly small number. At the time, he said it was only 60, but there may be more than that, and they are looking into it. It is entirely possible that Lloyds are not necessarily that involved in this.

To a certain extent, I am asking you philosophical questions about your views, rather than necessarily what Lloyds would have done. It is useful to have your point of view in this as a senior banker. We have discussed the fact that the people who started off buying these products are highly sophisticated treasurers within big organisations, but would you not agree that the people who are being sold these, within the 40,000, if you like, are completely at the other end of the scale? They are mom-and-pop organisations that simply will not have the expertise to understand that type of product.

Eric Daniels: Clearly, there is a huge range within the corporate space. As you get down to mom-and-pop shops, it would be a fair assessment to say that those need extra care, in terms of ensuring that customers understand what they are buying, what the purpose is and whether it suits them. A corporate treasurer needs no instruction, but when a mom and pop take out the loan and are thinking about a swap, yes, they need extra time and attention. There is no question.

Q4285 Mark Garnier: Yet the average relationship manager in a high street branch, doing a commercial loan, would not have the expertise to be able to provide that advice, would they?

Eric Daniels: I think what often happens when a relationship manager has a customer who desires a loan, and they believe that a swap might be appropriate, is that they call in an expert. I am not sure that they sell it themselves. In many cases, especially for large corporates, the same relationship manager usually would not sell the swap. It would be sold by somebody who was an expert in the product.

Q4286 Mark Garnier: But here is the interesting clash of cultures that possibly gets to the root of this. It is one thing to have a relationship manager dealing with a small business, or even a micro business in a high street in Kidderminster, where there is a certain amount of empathy between that relationship manager and the business manager. When you suddenly introduce a third element-a hardened derivatives or interest rate swap expert-you have a very different type of culture. Wouldn’t you agree?

Eric Daniels: I would agree that the people who are product specialists are not looking at the relationship broadly. That is the job of the relationship manager. So yes, there is a different point of view.

Q4287 Mark Garnier: Indeed, somebody who is used to dealing with a large oil company and helping them with their interest rate products simply would not comprehend the lack of understanding that somebody who runs a small development company in the midlands would have. You are inevitably going to have that problem, aren’t you?

Eric Daniels: If I may clarify, Mr Garnier, in most organisations, and certainly in Lloyds, SMEs are dealt with by a completely different set of people than the corporates-in other words, there is a recognition that individuals are different from SMEs, and SMEs are different from corporates-even mid-corps. The products that need to be sold to SMEs tend to be more of a packaged nature, simply because you cannot have the same tailoring-it is just cost-ineffective-and their needs are not as complex those of a major corporation. The SME units tend to have dedicated people, different products and a different sales process. I agree with you that if we had a derivatives trader speaking to a mom and pop shop, that would not be a desirable mix, either from a cost point of view, or an understanding the customer point of view.

Mark Garnier: And yet it seems that that has happened. I am not necessarily suggesting that it happened at Lloyds, but it is a general complaint. I have a couple more questions, if I may, Chairman.

Chair: Have you really? Why don’t you fire a double-barrelled shot?

Eric Daniels: If you could aim elsewhere, that would be helpful.

Q4288 Mark Garnier: Let me ask just one more question on this issue. The point about this interest rate-hedging product is that, when you come down to the mom and pop business, which is clearly not sophisticated, there is, as we have already seen, a cross-selling problem with PPI. You would agree with that. You have a cross-pollination of culture from one side of a bank-for example, a bank with a large investment bank. You have very low returns on loans-in fact, you had zero returns on loans-because of the competitive nature out there. You therefore have to sell something with the loan to package it up, so you end up with this PPI problem. Isn’t it inevitable that banks will turn around and say, "What else can we do? We have got this packaged product with the PPI. Let’s look for another packaged product with an interest rate-hedging product," because they happen to be within the organisations? Ultimately, does that whole thing not lead to a problem of not treating your customers fairly? You cannot reconcile that with the FSA’s treating customers fairly regime.

Eric Daniels: I understand the concern. I understand also that there is always the capacity for mis-selling when you have relationship selling and cross-selling. That is a point where we should all be very concerned, and certainly within Lloyds during my administration we were highly concerned about that possibility. There is a natural conflict, and I think the only way you can manage it is to be extremely vigilant.

We believe that the average household-although each household will be different depending on economic circumstances, family size and so on-has about seven fundamental financial needs: the need for savings, the need to transact through a credit card, the need for a personal loan to purchase a white good or a car, the need for a mortgage, and so on. You can count up to 15, like Wells Fargo does, but there are seven essential needs, and we try as an organisation to fulfil as many of those needs as possible, because thicker customer relationships mean that you have a strength of relationship that is much more valuable than a transactional relationship. For a customer that comes and goes, you basically pay an acquisition cost every time you have sell that customer something. We want to get to the position of trusted adviser, so that when the customer has a new need-"Gee, the house is too small. I think I need to take out a mortgage to buy another house."-they think of Lloyds first.

Clearly, what we would like to do is to satisfy as many of those customer needs and build as robust a relationship as possible. What we have to always do is to ensure that at each sale and at each interaction we are doing the right thing for the customer, giving them the right product-one that fits-and explaining it well. That is how we build long-term relationships. Customers, hopefully, will trust us and will think of us first when they have their next need. To ensure that we were doing just that-I talked earlier about this, so I will not repeat-we put in all of the training, monitoring and measuring devices I mentioned. We believed that fundamentally building those relationships was core to our existence.

Q4289 Mark Garnier: My last question is on a slightly different subject and will lead into John Thurso’s questions. Prior to the crisis-and, in fact, afterwards-I was the chairman of an investment committee where we held Lloyds Bank shares. We met our investment advisers on a fairly regular basis. Prior to the crisis, the criticism of Lloyds was that it was not a very exciting bank compared with the share price performance of some of the other banks, which were doing very well in terms of investment. Lloyds was pretty dull, it has to be said. Clearly, during the crisis, you collectively made a decision to do something different, which I think is the subject of John Thurso’s questioning. What I am particularly interested in is whether, during that time leading up to the crisis, when everything was seen to be tickety-boo, you were coming under any undue pressure from shareholders to leverage up your balance sheet in order to become more racy.

Eric Daniels: It is hard to characterise shareholders, because shareholders come in all varieties, from the people who attend AGMs with one share and have a very decided point of view-we have all seen those-to the rather large pension funds that hold a particular stock simply because they almost have to, because they have to replicate the FTSE. So you have that wide variety. Were there some shareholders that would have liked us to leverage the balance sheet? Absolutely. We could have improved returns substantially by doing more off-balance sheet lending, more CDOs, and more special purpose vehicles and so on. There was always some factor, some group of holders, that would encourage that. By and large, what we determined as a management team and as a board was that those were not for us: we were not an investment bank and we were not going to deal in the sophisticated or very racy end. We were building a bank that would serve its customers extremely well over the longer term, and that is how we would choose to compete. We were not up for foreign ventures or for racy balance sheet management.

Q4290 Lord McFall of Alcluith: Regarding stolen debit and credit cards, under the Consumer Credit Act 1974, consumer liability is limited to £50 before notification, and thereafter, when it is notified, there is no charge to the individual. I think that that is correct. If that is the case, why, in your deal with Sentinel, were you charging people £20 per year and why does the Lloyds TSB website state that there is cover against fraudulent use of your cards up to £1,500 for the 24 hours before you report the loss-it is only £50 under the Consumer Credit Act-and up to £75,000 thereafter, for which there is no liability. Why did you enter into an agreement that would let Sentinel take £20 off people? It is good money after bad by the looks of things.

Eric Daniels: Unfortunately, I am not conversant with that. If you like, I can look up the product and write to you.

Q4291 Lord McFall of Alcluith: It was on your website for three years.

Eric Daniels: I am sorry; I am not in a position to answer that.

Q4292 John Thurso: I want to ask you about a completely different subject. It seems to me that you have a unique perspective on some of the areas we are looking at around corporate governance and culture. First, as you previously described, you were running Lloyds in a prudent and conservative way with a clear set of objectives and a fairly well understood strategy. Of course, then you took over HBOS, which we now know to have been one of the most aggressive in terms of lending and was possibly the biggest example of bad lending; it has been the subject of a Panel inquiry. You have seen from the inside, after that event, what HBOS was like, and I wanted to ask you about the culture. What are your observations, having had that opportunity to look into HBOS, on the culture of board level corporate governance? As a good banker, with a good record, what were your thoughts on looking at that, and what were the things that you decided needed to be put right?

Eric Daniels: Culture is very hard to define and even harder to cause to happen. You move towards it over time and you try to have a strong set of principles that guide people’s behaviours, and that eventually leads to the desirable culture.

There are many ways to attack it, or to build a culture. I like the British system of having a separate chairman and chief executive, which is unlike the American system. I think that that leads to better governance and builds stronger culture. Boards, if they were not before, are now much more aware of their responsibilities to ensure that they are well informed and that they are a balanced board, not simply looking for growth but asking at what cost the growth and ensuring that it is within acceptable risks. There has been a fair amount of culture change over the last years.

John Thurso: Let me help you, because I can feel the Chairman’s desire to get this over with fairly quickly.

Chair: Not yet.

Q4293 John Thurso: You have given some very good general observations, ones that anyone could come to, but I am really asking you about your unique perspective of running one company with one culture and taking over another company with a completely different culture-as we now know, it was a lending culture that was completely at odds with your own. Clearly, when you take over a company like that, you have a plan of action to deal with it and you have people who go to look at it, so I am asking you about your thoughts about that particular business and the lessons that you might offer us that we might look out for in the future.

Eric Daniels: Thank you for the clarification. I was not confident that I knew in which direction you wanted to head, so thank you for that. I guess that my observation would be that HBOS had a desire to grow rapidly and they were seemingly able to pull off growth within acceptable risk parameters-seemingly. The board took great comfort that the audits seemed to be coming in well; the regulators seemed to be quiescent and did not seem to have issues until fairly close to the end.

I think it was a question of having an ambitious set of growth goals without having some of the experience and moderating influences in many of the cases. For example, in Lloyds, I hired Carol Sergeant and I brought in Martyn Scrivens, deeply experienced people, in order to help us build that culture, whereas in HBOS it was viewed more as a rotational set of assignments to round out people. So rather than getting experts, they would bring in people as development experiences. There was a much different approach.

Q4294 John Thurso: Can I draw from that the conclusion that best practice would be to get experts who truly believe in what they are doing in that risk and compliance area and stick to it, rather than whizzing generalists through so that they get basic knowledge and come out again? Is that the lesson?

Eric Daniels: That would certainly be one. It is critical that if anyone is to run a bank in a senior position, they ought to serve some time in a risk position, but hopefully that happens much earlier in their career, rather than at the most senior level where it is really a policy decision or a policy position. I do not believe that you can put talented amateurs in some of these positions, no matter how smart the individuals are. You really need deep professionalism, especially in today’s environment: the sophistication of financial products and the ways in which things can go wrong are that much greater than in the good old days.

Q4295 John Thurso: A follow-on question: if that is a view that we were to come to, should the regulators then be judged on whether or not, in looking at a bank, the test you have just set is being passed by the people in those jobs?

Eric Daniels: I believe that regulators should look at the adequacy of the risk staff and that they should ensure that those staff are really fit for purpose, especially in a fast-growing environment. When you try for rapid growth, the strains that are put on an organisation make the risks rise geometrically.

Q4296 John Thurso: Moving on from that, was there anything else that you observed in the way in which the board conducted itself that immediately made you say, "I wouldn’t have done it like that. Let’s get that changed, fast"?

Eric Daniels: Again, the issues were mostly related to wanting to experience rapid growth without having the appropriate checks and balances and controls in place. That was really the major observation.

Q4297 John Thurso: That is management culture. HBOS is often thought to have had a particularly aggressive sales culture on the shop front, as it were. Was that something that you observed?

Eric Daniels: An aggressive sales culture? Yes. Absolutely.

Q4298 John Thurso: Was that something, post the acquisition, Lloyd’s were looking to deal with in any way? What did you do?

Eric Daniels: What we said, very publicly, after the takeover of HBOS was that we wanted to put in Lloyd’s standards and Lloyd’s governance. There were many things that HBOS did well-the building of brand, the enthusiasm of employees and so on-but what we wanted and what we held dear were the risk controls and standards at Lloyd’s; we wanted that put across the entire combined organisation. With staffing, over a period of about a year, in transition, the Lloyd’s people took the great majority of the senior positions, and that was in part to make sure that we had Lloyd’s standards.

Q4299 John Thurso: Did the sheer scale of the bad lending in HBOS come as a shock to you?

Eric Daniels: I have to be a little bit careful, because there are legal cases pending.

Chair: You are subject to parliamentary privilege here so you can spill all the beans.

Eric Daniels: Would that parliamentary privilege, as robust as it is, protect me against class-action lawsuits in the US? I am not sure you would be willing to make that representation, as it might be a mis-sell, Mr Tyrie. I do want to be a little careful, because there are lawsuits pending.

I think we did a very good job in our diligence in HBOS; we understood it well and we understood the nature of the loans. What was somewhat unpredictable was that the economy was far worse than anyone had predicted. We did our stress scenarios and looked very carefully at how we thought the business would perform, but I do not think that anyone really would have called the financial crisis that we all live through.

Q4300 John Thurso: That is very interesting. I think it is absolutely a given, bearing in mind the timelines-we are talking 2008-that the sheer depth of what was coming was probably not foreseen. Equally, a lot of commentators might say that the sheer poverty of the quality of the lending decisions that had been made within HBOS, irrespective of economic conditions, in many aspects would be regarded as bad banking, particularly in the corporate property sector. Bear in mind that they were still lending: when the music had stopped and the punch bowl had been taken away, they were out there trying to hire a band. If you look at that, it really was a pretty classic case of bad banking. I was just wondering whether this all came as a bit of a shock and surprise when you took the lid off the pot and saw what was in it.

Mr Love: Did you sack the band?

John Thurso: Steady on. I do my metaphors to death, not you.

Eric Daniels: Again, we did a very thorough job in terms of our diligence. We understood what we thought were the strengths and weaknesses of HBOS at the time. We also thought that, despite this being a difficult deal, it would serve the shareholders well over time.

Q4301 John Thurso: When do you think that point will be? I am not asking you to make good because you are not even there. This is not a profit forecast, or advice for anyone to go and buy the shares. I was just wondering at what point that vision that you clearly had of the bigger Lloyds delivering value for shareholders-bearing in mind that we are some of the biggest shareholders-will be realised.

Eric Daniels: I am not privy to inside information, so I would find it very difficult to call. What I would say is that I believe that the share price has performed very well over the recent past. I believe that the provisioning that has characterised much of the past two years is in large part behind us, so that hopefully means very good news in terms of what the bottom-line earnings will look like.

Q4302 Chair: You have given us a number of reasons why, in your view, we should qualify some of the criticisms that have been made of the banks over PPI, but I think that you would have to agree that the malpractice we have seen in banking recently has been absolutely appalling-very bad in many areas. You have extensive experience of both US and UK banking. Do you think that we or the Americans have the bigger problem?

Eric Daniels: I want to be a little thoughtful here. I have not given this as much thought as I probably would have to to give you a textured answer. I think that by and large the British banking system is one that serves its customers well. If we look at the penetration rates of products, the uptake of financial services products in the UK is pretty good by any international standard. I know that we could all have major disagreements about pricing, but in every study that I have seen the UK consumer has great access not only to product, but to pricing-in every case, I think, the UK is best quartile pricing. The UK customer is well served, but there is always room for improvement. I am not sure that the American model is that much better or different.

Q4303 Chair: I was not really asking you whether that market is more competitive than this one. I was asking you whether the scope to get ripped off in the States as a retail customer is greater or less than in the UK.

Eric Daniels: I beg your pardon I was trying to answer in a fuller fashion about how customers are served. The chances of getting ripped off? I am not sure that I see that much difference. The consumer protection in the States looks very similar to the UK. There are differences and it is always worth exploring those differences, but, fundamentally, I am not sure whether there is that much difference.

Chair: Thank you very much for giving evidence today, Mr Daniels. It was both thoughtful and well balanced. It has been extremely interesting, and we are grateful to you.

Prepared 18th February 2013