Seven years ago the mega-bank HBOS, a merger of Halifax and Bank of Scotland, ran out of money after a huge and rapid expansion in risky lending.
It was bailed out at a cost of £20.5 billion to the UK taxpayer in one of the greatest banking disasters in British history.
Yesterday the Bank of England released a 400 page report, partially written by independent barrister Andrew Green QC, in to the reasons for the failure. It tells three main stories.
Another investigation is needed
The report says another investigation in to how HBOS was run at the time should be conducted.
This is hardly a surprise – only one former HBOS senior executive, corporate lending head Pete Cummings, was ever sanctioned, receiving a fine and partial ban in 2012.
It is highly likely the Bank of England will investigate some of the bank’s other senior executives in the New Year.
The failure of the regulator
The report blames the Financial Services Authority (FSA) for failing to intervene in the activities of HBOS, despite identifying a considerable build-up of risk.
The FSA’s inquiry carried out in 2012 is criticised for being too narrow.
Why HBOS collapsed
But the most interesting story is the one of the wider reasons for the failure of the bank.
The foreword states that “prolonged economic growth and the appearance of financial stability created a prevailing view that the prudential regulation of the financial firms should be ‘light touch’, thus limiting the challenge provided to firms including HBOS.”
In other words: a case of group-think on a grand scale across government, domestic and international regulators and the boards of banks whose profits were growing at an enormous rate. When everyone is making a lot of money, it’s very hard to take away the punchbowl.
What does the report recommend?
The report notes that the government and Bank of England have taken steps to try and prevent a re-occurrence.
Banks are now subject to more rigorous requirements about how much money they hold, are tested against how they would fare in the event of a crisis and must be transparent about how they would close down without costing the taxpayer.
A new ‘Senior Managers regime and Conduct regime’ has been introduced to try and improve the governance and accountability of top bankers – although its powers have been watered down by the recent Bank of England bill.
These are all welcome developments, but would they actually prevent another ‘group-think’ scenario emerging? The recommendations here don’t go far enough.
The report states that banks themselves must do more to ensure their boards are independent and powerful enough to challenge senior managers if they believe there is risk building up – but will boards ever be truly independent enough to do so?
And it notes that regulators now have statutory powers to intervene ‘where the risks to their objectives are high, for example to require a bank to change its business model‘ – but will regulators be prepared to do this when the economy has been growing for a number of years, as during the last crisis?
Finally, the report argues that to regulate large international banking firms effectively, more must be done to understand different regulatory regimes and how they interact.
What’s missing?
The UK banking system is still dominated by one particular type of bank: very large, national or international shareholder-owned private limited companies with a preference for lending against land or housing (collateralised debt) and requiring high quarterly profits. Exactly the type of bank HBOS was.
As shown in the figure above, this is not a normal banking ecosystem.
In other countries, including some of our major economic competitors, there is a greater diversity of types of banks and business models. Many countries have large international shareholder banks but also smaller regional banks focussed on supporting smaller, local firms.
These ‘stakeholder banks’ are owned by the members (cooperatives) or held in public trust (savings banks). They aim to support their customers and the regions where they lend rather than deliver double digit returns to their shareholders.
Academic research shows that stakeholder banks maintained their lending during the 2007-08 crisis in contrast to shareholder banks. It was the shift towards meeting the needs of shareholders over stakeholders that led banks into increasingly risky activities such as mortgage securitisation.
The biggest question raised by the failure of HBOS is whether it makes sense to leave banking – that is the creation and allocation of new money and credit in the economy – to institutions primarily driven by the need for short-term growth and returns for their investors.
It remains to be seen whether the beefed up regulators will use their new powers to change banks’ models.
So far, we’ve only seen a return to business as normal, with George Osborne desperate to sell off shares in Lloyds TSB and RBS in order to ‘return banks to the private sector where they belong’. Changes to the Bank levy have supported larger banks over smaller competitors and the ringfence between retail and investment banking has been weakened.
To prevent another HBOS what we ultimately need is not just tougher regulation of a banking system that we know is dysfunctional: we need different types of bank.
— source neweconomics.org