UK: The Truth Is Out There

Last Updated: 2 March 2016
Article by Peter Swabey

Conflicting explanations around the collapse of HBOS

The failure of HBOS in October 2008 has been attributed to a variety of reasons: some technical; some relating to global economic conditions; some alleging fraud or criminality; some blaming poor governance; and some simply screaming 'conspiracy'. The publication of the combined PRA and FCA report in December 2015 into the failure may mean we begin to see the root causes emerging from the fog of conflicting explanations.

We have also seen an independent review by Andrew Green QC into the actions of the (then) regulator, the Financial Services Authority (FSA), and a further independent review commissioned by the Parliamentary Treasury Select Committee, into whether the PRA and FCA report has been properly carried out. Conspiracy theories abound and we may yet see a further report into whether this review was properly carried out.

Proper assessment

One of the challenges for those engaged in the report or either of the reviews has been that plenty of views, of greater or lesser evidential worth, have already been expressed and so there is relatively little that is new to be said. However, a proper assessment of what went wrong is important. Although it might have been more effective to undertake this nearer to the event, the distance from it lends detachment which may not have been possible in the immediate aftermath. The report itself notes, 'The story of the failure of HBOS is important both to provide a record of an event which required a major contribution by the public purse, and because it is a story of the failure of a bank that did not undertake complicated activity or so-called racy investment banking. HBOS was at root a simple bank that nonetheless managed to create a big problem'.

The report looks, in essence, at the period from January 2005 to October 2008 and concludes that 'both the strategy and operation of HBOS, and its supervision by the FSA, were creatures of the time'. This was a phase of 'almost uninterrupted economic growth over a long period and the rapid development of financial markets'. This, in turn, created an atmosphere in which a fundamentally 'flawed business model that placed inappropriate reliance on continuous growth without due regard to the risks involved' appeared sustainable.

The board and the executive team were found to have failed to set an appropriate strategy or to have effectively managed the risks associated with their chosen strategy. This was in terms of 'the credit risk on the assets side of its balance sheet, and on the liabilities side in respect of the vulnerability of its funding.'

Mitigating strategies

So far, so culpable. However, as the report goes on to note 'the paradox of the story is that at the time, and indeed up until quite near to its failure, HBOS was widely regarded as a success story. The 2001 merger of Halifax and Bank of Scotland had yielded double-digit profit growth in all but one of the years up to end-2006 and analysts' and brokers' views were positive at least until early 2007. But, by this time, the seeds of the firm's destruction had already been sown as a flawed strategy led to a business model that was excessively vulnerable to an economic downturn and a dislocation in wholesale funding markets.' The criticism of management and the FSA is not that they failed to foresee this eventuality, but that they failed to consider appropriate mitigating strategies or actions should this eventuality arise. The report makes six main recommendations. Companies should ensure that:

  • The responsibilities of boards and senior management explicitly include a focus on the safety, security and ongoing viability of the business
  • Boards are comprised of individuals with an appropriately diverse mix of background and experience and sufficient independence of mind to enable them to provide rigorous challenge to executives on major business issues 
  • There is a culture which encourages compliance with the principles underpinning legislation and regulation and encourages open and thoughtful discussion of issues with regulators.

Regulators should ensure that:

  • They are able and willing to take action where they believe that their statutory objectives are under threat, regardless of contextual issues
  • They have the necessary knowledge and experience to engage effectively with complex international businesses and the relevant overseas regulatory authorities
  • They have adequate processes in place to address any actual or perceived conflicts of interest.

Materially flawed

The review of the FSA's regulatory performance is quite damning. Mr Green concludes that 'the scope of the FSA's enforcement investigations in relation to the failure of HBOS was not reasonable. The decision-making process adopted by the FSA was materially flawed; and the FSA should have conducted an investigation, or series of investigations, wider in scope than merely into the conduct of Mr Cummings [Chief Executive Officer of the Corporate Division and the only individual censured over the HBOS failure] and the Corporate Division'. One of the central criticisms made of the FSA is the failure to keep proper minutes of some meetings.

The further review is similarly scathing of processes at the FSA and, again, of its failure to keep adequate records to explain the regulatory decisions made about HBOS at the time. It also makes a number of adverse observations on the quality of the initial scope and drafting of the PRA/FCA report, although accepting the limitations of the information available to the reporting team. Importantly, it asserts that 'records, and in particular board and committee meeting minutes, were frequently not sufficiently full to provide a definitive record of what happened, and in some cases are missing altogether. One consequence of this is that there has probably had to be greater circumspection around some of the conclusions reached than might otherwise have been the case'. This demonstrates the critical importance of well-crafted minutes to an understanding of business.

Danger of hindsight

Yet after three reports, we still do not have a definitive assessment of what went wrong at HBOS and how we can make sure that it does not happen again. There was probably complacency and hubris at the top of HBOS. The advantage of a prompt investigation would have been that those who were guilty of misbehaviour might have been punished, whereas now many of them are, largely, retired. The advantage of delay is that of detachment, but it comes with a risk of hindsight.
As noted above, between 2001 and 2006 HBOS was widely regarded as a success story and by the time this ceased to be the case, and it began to appear as though the golden egg-laying goose was unwell, it was already too far down the strategic path that led to ruin.

Even if management had foreseen an economic downturn and a dislocation in wholesale funding markets, they may have not been able to, in reality, develop successful mitigating strategies or actions.

Hindsight is a wonderful thing and it is easy for politicians, regulators, journalists and other commentators to argue that HBOS collapsed owing to poor management. Would they have argued this at the time? Was the failure of HBOS a failure of management, a failure of governance, an economic 'perfect storm' or simply the catastrophic failure of a market model that no-one believed ever could fail?

As Douglas Adams wrote, 'The major difference between a thing that might go wrong and a thing that cannot possibly go wrong is that when a thing that cannot possibly go wrong goes wrong it usually turns out to be impossible to get at or repair.'

Peter Swabey is Policy and Research Director at ICSA: The Governance Institute

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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