26 November 2015
Bonkers Bankers
by M J Horast
If bankers were a racial minority, a religious grouping or of unusual sexual determination, the Chartered Banker Institute (bankers, not understanding the proper use of the apostrophe, seem to have simply abandoned the expected ‘s) would be protesting in the strongest possible terms about the portrayal of bankers in the media, and the offensive and scurrilous remarks made about them by politicians, commentators, journalists and even that most glorious example of everyman, the man on the Clapham omnibus. Bankers bear the blame for all the bad things that have happened in the financial world, not to say in housing, arms dealing, drug distribution, and every other activity that is either illegal or grossly expensive.
The public view is that bankers are a greedy grasping bunch of rogues, and further titillation is endlessly stoked by media coverage of cases of bankers who rig markets, earn preposterous bonuses in return for doing very little, and throw dwarves around the office to relieve boredom after lunch, as per the “Wolf of Wall Street”.
“Jail is too good for ‘em” would seem to be the view of that chap on his way to Clapham, and every other non-banker. Now the cries to do something to punish these dastardly financial wizards seem likely to be renewed as the latest bonk buster – no, sorry, bank buster – report hits the nation: that of the enquiry into the collapse of Halifax Bank of Scotland (“HBOS”).
Like most major enquiries these days, this one has been running late, caused by the need to show persons mentioned in the report what is proposed to be said about them. (One wonders if this practice might soon spread to court judgments, with judges having to show the defendant that they intend to call him “a villain of the most appalling type” or whatever.) It was set up by the Prudential Regulation Authority and the Financial Conduct Authority to enquire in to the causes, actions and lessons to be learned from the collapse of HBOS, including the failure of the Financial Services Authority, the then regulator, now closed down. The enquiry was led by Andrew Green, a barrister with expertise in financial matters.
This is the second enquiry – the first enquiry sort of shrugged helplessly and blamed most of the bank’s troubles on Peter Cummings, who was head of the bank’s property lending department but not a member of the bank’s board. Mr Cummings was fined £500,000 and told he could not work in financial services again. He was apparently outraged by this verdict, but decided to keep his head down and retire.
It is a sad end to two distinguished histories. Bank of Scotland was one of Britain’s oldest banks, effectively Scotland’s central bank, and for over three hundred years had a reputation for prudence, if not for downright conservatism. In May 2001, a minnow in a world increasingly of banking sharks, struggling as a small lending bank to find a remunerative business model, it merged with Halifax Bank, formerly the largest building society in the UK, which had demutualised not long before. Halifax was a similar type of institution – conservative, suspicious of the City and running a careful deposit-taking and residential mortgage lending business. It had an exceptionally strong balance sheet because of all those deposits, but a weakening lending business. It seemed the perfect merger. Bank of Scotland could make much bigger loans and Halifax could more profitably deploy the deposits from its branch network. Bank of Scotland’s main activity had long been commercial property lending. It naturally began to push into that in a much bigger way. Its timing seemed immaculate. The commercial property market was undergoing a long run of growth and HBOS not only captured an increasingly large share of lending, it introduced various new “products” to appeal to potential borrowers.
These new products had one thing in common – they involved lending at much higher levels of gearing on property. In fact it became possible to borrow almost all the money for a commercial property purchase from HBOS – the borrower needed to have hardly any money of his own in the deal, but still got most of the profit – and, usually, was not on the line for any losses. This was understandably popular with property companies, who had longer memories of the risks of the property cycle than the bank, it seems. So the bank and its profits grew at a rapid rate until early 2008, when the property market suddenly went into a rapid collapse.
That extent of the failure of the bank, of the Regulator’s apparent lack of any insight or inkling as to what was going on, and who exactly did what in this descent from prudence to disaster by way of gross largesse, are the subject of the report. (What is not in the report is the second act of this cross between high opera and low farce – the disastrous political solution hastily cobbled together by Gordon Brown, Old Prudence himself, which dragged Lloyds Bank into the melee and effectively bankrupted it as well. That must wait for another day – probably a long way off as no such enquiry has been instituted.)
But the report is fascinating indeed and fingers the senior management of HBOS, principally the chairman, Lord Stevenson, the first chief executive James Crosby and his successor Andy Hornby. Also singled out are Mr Cummings, again, Lindsay Mackay, the head of HBOS’s Treasury (which funded the obligations of the bank) and various non-executive directors of the bank.
Most of these are distinguished business people, who rose to their positions through toil and experience; many of them have achieved success in new roles since the collapse of the bank. Stevenson might almost be described as a new renaissance man, having achieved distinction in the arts, in business and in sociology. Hornby and Crosby both achieved high office exceptionally young, Hornby in food retailing, Crosby in insurance. But the reader may notice a theme here. None of them were bankers. And banking is a business which is a bit different to many businesses. Most businesses want to sell things. Make a reliable product cheaply enough, and sell it at more than cost, the profits are made. Banking has a subtle difference – at least in the lending business which is where the greatest risks are – the profit is only truly made when the bank gets its product back, unimpaired and in full. But the bank does not book its profits at the end – it does that year on year as interest and fees are paid, after a cursory examination of continuing viability of the underlying transaction.
What is more, banks have to keep their books balanced in complex ways – but reduced to a simple formula; the funding obligations need to match the lending obligations. It is no use making five year loans funded by three month deposits. If depositors get nervous or greedy they can take their money away, leaving the bank with a need to fund its book in what may be a much more expensive way. On a typical commercial interest margin of less than 2%, that can bring instant disaster to the bank.
HBOS managed to get both of these banking equations wrong at the same time – it had very highly geared debt to the property market (that’s another thing best not to do, pile all your banking eggs in one basket), and it was lending long against a short term deposit profile.
What seems to have been going on was that the business heads were under great pressure to produce more and more profits, and were doing it in the ways that bankers do – taking more risks, whilst the board that was effectively driving that strategy did not understand the risks. The end was inevitable. And the non-executives, also ornaments to other professions, mostly also did not understanding what was going on, so could not counsel and warn and question.
Certainly a number of senior executives and directors are deserving of censure. Intelligent and gifted as they doubtless are, they did not understand the business for which they were responsible. The shareholders have every reason to feel disgruntled at the failure of those who should safeguard their interests, and at the consequent loss of their investment. But were those directors and senior managers criminal? Most certainly not, surely. They had no criminal intent. Far from it, they did not seek to enrich themselves, they did not look to convert shareholders wealth to their own use. They certainly had no intention of bringing down the banking system.
Banking is about taking risks to encourage enterprise; measured, controlled, closely managed, properly rewarded risks. A modern economy needs ways of converting the deposits of the non-enterprising to use by wealth creating entrepreneurs. Lending banks are the catalyst through which that is done. If we prosecute bankers, make them too constrained and nervous to do their jobs properly, create public pariahs of them, the loss will fall on all of us.
What we need is adult consideration of risk taking, of supervision, of how a failing bank might be laid to rest. Sadly, this report does very little of that, but simply bangs a populist drum of revenge and exculpation. It will not help us rebuild our banking system. That is a waste of an opportunity.
(Mr Horast is a banker in the City of London)
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