HBOS’s Corporate division lost control, didn’t know what it was doing, continued with flawed strategy as competitors exited and markets worsened
The Financial Services Authority has today publicly censured Bank of Scotland plc (part of HBOS) for failings within its Corporate division between January 2006 and December 2008. The FSA press release is here and the Final Notice is here.
Between those dates, the Corporate division ran an integrated finance practice that focused on high-risk, sub-investment grade lending – largely to individual, often high-profile property entrepreneurs. (Being christened “Fat Bloke Finance” as a result.) Naturally it all ended in disaster, with the Corporate division’s activities contributing to the demise of HBOS, its takeover by Lloyds and the taxpayer bailout.
The Corporate division’s failings are summarised in the FSA press release:
“Between January 2006 and March 2008, Bank of Scotland’s Corporate Division pursued an aggressive growth strategy that focused on high-risk, sub-investment grade lending. Over the period, the division’s transactions increased in size, complexity and risk. Its portfolio was high risk with highly concentrated exposures to property and to significant large borrowers.
This strategy was highly vulnerable to a downturn in the economic cycle, yet the Corporate Division continued with the strategy even as markets began to worsen in 2007. Rather than re-evaluating its business as conditions worsened, the division set out to increase its market share as other lenders started to pull out of the market. In addition, its internal culture was focused on revenue rather than assessing the level of risk in transactions.
Bank of Scotland did not have systems and controls that were appropriate to the high level of risks that its Corporate Division was taking on, and there were serious deficiencies in:
•Bank of Scotland’s control framework which provided insufficient challenge to the Corporate Division’s strategy;
•the framework for managing credit risk across the portfolio;
•the distribution framework which did not operate effectively in reducing the risks in the portfolio; and
•the process for identifying and managing transactions that showed signs of stress.
From April 2008, as it became apparent that high value transactions were demonstrating signs of stress, it should have been apparent to Bank of Scotland that a more prudent approach was needed to mitigate risk, yet it was slow to move such transactions to its High Risk area within its Corporate Division. There was a significant risk that this would have an impact on the firm’s capital requirements. It also meant the full extent of the stress within the corporate portfolio was not visible to the Group’s Board or auditors. In addition, while the firm’s auditors agreed that the overall level of the firm’s provisioning was acceptable, in relation to the Corporate Division provisions were consistently made at the optimistic rather than prudent end of the acceptable range, despite warnings from the divisional risk function and Bank of Scotland’s auditors.”
Enforcement action against individuals?
The FSA press release strongly hints that enforcement action against individuals involved in this debacle is taking place:
“This announcement marks the conclusion of the enforcement action against the firm, but other enforcement proceedings in connection to the failure of HBOS are ongoing and remain subject to the legal processes prescribed by the Financial Services and Markets Act 2000 (FSMA).
The FSA has publicly committed to produce a public interest report into the causes of the failure of HBOS. To carry out work on an HBOS report at this time would risk legally prejudicing the outcome of ongoing enforcement action. Therefore, it is our intention that the review and analysis work to produce such a report will commence at the conclusion of the enforcement proceedings connected to this matter. The start date for this will be determined by the progress of the enforcement action.”
So no doubt there is more to follow.
UPDATE 14 March 2012: In an interview in today’s Times, Lord Turner, Chairman of the FSA, says that Bank of Scotland’s fine for this misconduct would have been in the range of £50 million to £100 million. No fine was levied due to the taxpayer bailout of Lloyds Banking Group (which now owns HBOS) – a fine would have in effect penalised the taxpayer.
UPDATE 14 September 2012: Cummings goings: former head of HBOS Corporate division fined and banned by the FSA for “culture of optimism”
Friendly Corporate PSL
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