How to do a banking inquiryThursday 25 April 2013 16.11 By Sean Whelan
By Sean Whelan, Economics Correspondent
So it looks like Matthew Elderfield is off to Lloyds Bank in London.
There is certainly a big job to be done in repairing the regulatory side there, if the recent UK Houses of Parliament report into its Halifax – Bank of Scotland (HBOS) unit is anything to go by.
Entitled “An accident waiting to happen”, the report doesn’t hold back in its conclusions, describing HBOS growth strategy as “a manual for failed banking” (the title of the concluding chapter).
It also draws the conclusion that “prudential supervisors cannot rely on financial markets to do their work for them”.
And most stark of all, for an Irish reader, is the committee’s conclusion of its investigation of the groups Irish operations that “the losses at HBOS were relatively greater than those of the other major Irish banking groups”.
Apart from Anglo Irish, naturally. More of this later.
But first, a note on the HOW of this report. One of the reason we are told that the there has been no open inquiry into the bank failures here, that results in a report that names names in the way the UK reports do, is that the public voted down a constitutional amendment that was considered necessary to allow Oireachtas committees to investigate.
One of the big objections from many quarters was that most TDs are not trained in cross examination –because they are not barristers – so they would be incapable (according to the wig-wearing classes) of conducting a proper investigation.
And even if they found information, they wouldn’t have the smarts to understand it.
Exactly the same criticisms could be levelled at British (or indeed any other democratically-elected-by-a-broad-franchise) parliamentarians.
So what did the Brits do? They went and hired some barristers to conduct the investigation. And some banking experts to crunch the numbers and supply expert analysis and truth control. Simple.
The report notes that there were “a number of unusual features in the way we have carried out our work”.
It appointed Counsel – David Quest and Rory Philips QC and three other colleagues from their Chambers – the first use of Counsel by a committee of this kind.
The committee staff gathered a much larger amount of paper than would be usual for such a committee, including confidential correspondence between HBOS and its regulator, the FSA.
It established a panel to undertake the initial phase of the investigation, holding eight meetings over the course of a month and hearing from 16 witnesses including HBOS staff, directors and regulators – a broader level of inquiry than normally available to parliamentary committees.
Two of the hearings were anonymous – one of them was an FSA staffer below director level.
The Panel was led by Lord Turnbull – a former Cabinet Secretary and head of the Treasury (and one time private secretary to the Prime Minster, Margaret Thatcher).
He is also a director of some big league UK companies, including Prudential and British Land.
Finally the committee “deployed some high quality bank analysts as staff to assess the evidence on what happened and to provide advice”.
Once the Panel completed its work, all the full committee had to do was hear evidence from three people – Sir James Crosby, Chief executive of HBOS from its creation to 2006 – Andy Hornby, its second and last CEO, and Lord Stevenson of Coddenham, chairman of HBOS throughout its short existence.
Counsel also took a lead role in the examination of those witnesses.
The resulting report is a short-ish (100 page), sharp shocker.
It is presented as a case study, separate but complimentary to a longer forthcoming report on all the UK banking failures. It also sets out instructions for the regulator, the FSA, to follow in compiling its own report on what happened at HBOS.
Is there any reason why the Oireachtas cannot follow this model to perform a similar exercise on AIB or PTSB or Bank of Ireland?
Anyway, back to the conclusions of the report on HBOS Ireland.
Throughout the 1990s Bank of Scotland had grown on the back of asset-led expansion, funded increasingly from wholesale market funding rather than a deposit base, which takes time to grow.
It used this model to expand in England, and then in Ireland.
Then at the start of the new century, it merged with former building society Halifax. That gave it assets of £275 billion at the end of 2001, making it bigger than Lloyds and three quarters the size of Barclays and RBS.
A return on equity target set by CEO Crosby of 20% by 2004 (from a then 17%) required a very rapid expansion of assets, which had to be financed by wholesale funding.
The report states “the fastest growth took place in Ireland, where HBOS aspired to become “the number one business bank during 2005”, with the overall strategic goal of becoming “the fourth largest full service Irish bank by 2009”.
The committee says the Irish unit followed the same route as the UK bank, concentrating on property and construction.
“As in the UK, loan growth continued in 2008, in Ireland at a rate of 8 percent which Colin Matthew (CEO International Division) attributed to the draw-down of existing facilities, the inability to sell down and the residential property pipeline”.
It goes on in paragraph 36:
“In Ireland, estimated impairments between 2008 and 2011 totalled £10.9 billion (€13 bn), equivalent to 36% of the loan book at the end of 2008… All leading Irish banks incurred significant impairments as a result of the Irish recession. However, the losses at HBOS as a proportion of loans were greater than those of all but one of the major Irish banking groups”.
The Committee lists impairments at the end of 2011 as Anglo Irish 48.3%, HBOS 35.5%, AIB 22.1%, Danske 17.9%, Ulster 17.5%, BoI 9.4%, KBC 6.7% and ILP 6.1%.
Sir James Crosby and Andy Hornby, the two former CEO’s defended their Irish strategy, leading the Committee to conclude “the repeated reference in evidence to us by former senior executives to the problems of the Irish economy suggests almost wilful blindness to the weakness of the portfolio flowing from their own strategy”.
Colin Matthew said that with the benefit of hindsight the “principal weakness” in the approach the (international) Division followed was that “the expansion plans were wrongly timed”, but he defended other aspects of the Division’s strategy.
The Committee concluded that “the evidence from those two countries (the other was Australia, where HBOS lost £3.5/€4.2 billion in a growing economy) clearly suggests that HBOS had significantly worse asset quality than other banks”.
It says “the risk function in HBOS was a cardinal area of weakness in the bank. The degradation of the risk function was an important factor in explaining why the high-risk activities of the Corporate, International and Treasury Divisions were not properly analysed or checked at the highest levels within the bank.”
In paragraph 65 it states baldly “The weakness of group risk in HBOS were a matter of design, not accident. Responsibility for this lies with Sir James Crosby, who as chief executive until 2005 was responsible for that design, and Andy Hornby, who failed to address the matter, and particularly with Lord Stevenson as Chairman throughout the period in question”.
British taxpayers, who bailed out Lloyds HBOS to the tune of £20.5 billion (€24.3 bn), have been given a clear account of why they have had to pay for this bank, and who was to blame.
We know the how, why and who of the failure of one of the key banks in the Irish bank fiasco. Irish taxpayers are entitled to the same level of clarity on the banks they have had to bailout.
The HBOS report shows exactly how this can be done.