Not too Big to Fail, but Nothing Learned

Lessons go unlearned from the HBOS failure.

Do you remember the 2007-08 banking crash? In the build up to it, UK bankers made vast profits and their executives collected big bonuses. After the crash, taxpayers bailed them out, which led to increased government borrowing. We have all been suffering a never-ending programme of austerity ever since.

One of the biggest banks to fall was HBOS, which traded under the brands Halifax and Bank of Scotland. No ordinary bank, it had a market capitalisation of over £40 billion at its peak in 2007 and was the UK’s largest lender. However, the financial crisis exposed the bank. It had to be bailed out to the tune of £30 billion and almost 50,000 employees have lost their jobs.

The official investigation into what happened has taken seven years. The Bank of England published two reports at a cost of £7m. The first is a 407-page report on the demise of HBOS. The second is a 144-page assessment by Andrew Green QC on whether the decisions taken on enforcement by the former regulator, the Financial Services Authority (FSA), were reasonable.

The first report paints a picture of reckless risk-taking by the HBOS board, which despite warnings continued with its growth strategy. The report said that the HBOS board had a “flawed and unbalanced strategy and a business model with inherent vulnerabilities arising from an excessive focus on market share, asset growth, and short-term profitability.” Moreover, the description of the FSA’s supervisory approach is “highly unsatisfactory.”

The UK’s approach to punishing the bad behaviour in its banking industry that led to the financial crisis has been lacklustre at best. While Iceland has sent 26 financiers to prison for their misdemeanours, not one senior banker in the UK has gone on trial over the failure of a bank.

The Bank of England’s reports into HBOS took seven years to complete and cost £7m.

The reports call for investigations into as many as ten senior executives and possibly the barring of them from working for a financial company, though it may be too late to impose any fines. Any attempt to impose retribution after such a long delay is bound to be contested by HBOS executives. So expect long legal battles.

Overall, the reports are disappointing. They are more noticeable for their silence and lack of attention to systemic problems.

A system-wide problem

A major regulatory problem in the UK is the revolving door through which industry grandees become regulators and vice-versa. Are they defenders and promoters of industries or umpires and prosecutors? For example, James Crosby, HBOS' chief executive until 2006 became a non-executive director of the FSA in 2005, and from 2007-2009 was also its deputy chairman. The report is silent on such relationships.

The HBOS report cites regulatory failures but fails to note that the UK has a fragmented and ineffective regulatory structure. The report does not address how HBOS was audited, despite the bank’s auditors being the most important group of independent professionals to regularly examine the performance and accounts of HBOS.

Instead, it defers to the accounting regulator, the Financial Reporting Council (FRC), which has indicated it will look into the report. However, those of us hoping for a swift conclusion will likely be disappointed. As a recent example, car manufacturer MG Rover’s collapse in 2005 amid allegations of accounting misdemeanours did not conclude until 2015.

The report notes that HBOS had a remuneration committee consisting of non-executive directors, mostly directors of other companies. Executive pay linked to profit targets. This encouraged excessive risk-taking. It draws attention to sharp accounting practices, which boosted balance sheets and profits. At the same time, a non-executive audit committee poorly monitored risks. Despite the huge corporate governance failures, the report makes no recommendations about board structures or reward systems.

Therefore, despite the HBOS debacle and the banking crash little has changed. Banks remain devoted to maximising shareholder wealth even if that means taking excessive risks. Shareholders have only a short-term interest in banks as they constantly buy or sell shares to make short-term profits, and cannot invigilate mega corporations. HBOS employees and other stakeholders suffered, but there is no place for them on company boards.

Nothing has been done to protect and empower whistleblowers such as Paul Moore, HBOS’s chief regulatory risk officer, fired in 2004 after he warned the board of the bank’s risky sales strategy. Auditor files are still secret and they still do not owe a “duty of care” to any individual stakeholder, or even the regulator.

The publication of the HBOS report may enable politicians and regulators to draw a line under the affair, but the banking industry still needs major reform.

HBOS report does little to tackle systemic problems is republished with permission from The Conversation

The Conversation

See also: The Federal Reserve Could Redefine 'Too Big to Fail'