The UK Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) has published the Review into the failure of HBOS Group. The Review concludes that ultimate responsibility for the failure of HBOS rests with the Board and senior management. They failed to set an appropriate strategy for the firm’s business and failed to challenge a flawed business model which placed inappropriate reliance on continuous growth without due regard to risks involved. In addition, flaws in the FSA’s supervisory approach meant it did not appreciate the full extent of the risks HBOS was running and was not in a position to intervene before it was too late.
This review was originally started by the former regulator, the Financial Services Authority (FSA). Its purpose is to analyse the causes of the firm’s failure, and to draw out lessons for the future, for both the industry and the regulatory system as a whole.
On 1 October 2008 HBOS was approaching a point at which it was no longer able to meet its liabilities as they fell due and so sought Emergency Liquidity Assistance from the Bank of England. This report seeks to explain why HBOS failed, the role that HBOS Board and senior management played in the failure and the FSA’s supervision of HBOS.
The main period covered by the FCA/PRA Report (the Review Period) is from January 2005 to the point of failure, though it draws on earlier materials going back to the creation of HBOS in 2001, and some materials from after the point of failure where these provide useful context to help the explanation of failure. The Report draws on the records of the firm, the FSA as supervisor of HBOS, interviews with the main individuals involved, and other relevant outside sources. Documentary evidence has been combined with interviews, so that individuals could give theirown account of events, and supplemented by representations received from a number of parties.
The paradox of the story is that at the time, and indeed up until quite near to its failure, HBOS was widely regarded as a success story. The 2001 merger of Halifax and Bank of Scotland had yielded double-digit profit growth in all but one of the years up to end-2006 and analysts’ and brokers’ views were positive at least until early 2007. But, by this time, the seeds of the firm’s destruction had already been sown as a flawed strategy led to a business model that was excessively vulnerable to an economic downturn and a dislocation in wholesale funding markets.
The failure of HBOS can ultimately be explained by a combination of factors:
- Its Board failed to instil a culture within the firm that balanced risk and return appropriately,and lacked sufficient experience and knowledge of banking.
- The result was 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.
- This approach permitted the firm’s executive management to pursue rapid and uncontrolled growth of the Group’s balance sheet, and led to an over-exposure to highly cyclical commercial real estate (CRE) at the peak of the economic cycle, lower quality lending, sizable exposures to entrepreneurs, increased leverage, and high and increasing reliance on wholesale funding. The risks involved were either not identified or, where identified, not fully understood by the firm.
- There was a failure by the Board and control functions to challenge effectively executive management in pursuing this course or to ensure adequate mitigating actions.
- HBOS’s underlying balance sheet weaknesses made the Group extremely vulnerable to market shocks and ultimately failure as the crisis of the financial system intensified.
- There was an extended period of inflows of capital to developed economies, resulting in low yields, declining awareness of risk and asset price bubbles, in which market discipline – investors, analysts, rating agencies and other third parties – failed to constrain firms from undertaking risky strategies.
- An overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure. HBOS was one such bank.
Ultimate responsibility for the failure of HBOS rests with its Board. However, another striking feature of HBOS’s failure is how the FSA did not appreciate the full extent of the risks HBOS was running and did not take sufficient steps to intervene before it was too late.
The FSA Board and executive management failed to ensure that adequate resources were devoted to the supervision of large systemically important firms such as HBOS. This gave rise to:
- a risk assessment process that was too reactive, with inadequate consideration of strategic
- insufficient focus on the core prudential risk areas of asset quality and liquidity in a benign economic outlook; and
- too much trust being placed in the competence and capabilities of firms’ senior management and control functions, with insufficient testing and challenge by the FSA.
Andrew Bailey, Deputy Governor of the Bank of England, CEO of the PRA and Accountable Executive for the HBOS Review said “The story of the failure of HBOS is important both to provide a record of an event which required a major contribution by the public purse, and because it is a story of the failure of a bank that did not undertake complicated activity or so-called racy investment banking. HBOS was at root a simple bank that nonetheless managed to create a big problem.”
Sir Brian Pomeroy, Senior Independent Director at the Financial Conduct Authority and Chairman of the HBOS Review Steering Committee said:
“The review into HBOS has involved a dedicated team sourcing and considering a huge amount of material including reviewing around a quarter of a million documents and interviews with 80 key individuals. I am hugely thankful for the painstaking work the team have done to compile a comprehensive report. While much has already been written about the failure of HBOS, I believe this to be the definitive account and to be a thorough, fair and balanced view of what occurred.”
As part of the Review, Andrew Green QC was asked to provide an independent assessment of whether the decisions taken on enforcement by the former regulator, the FSA, were reasonable. The PRA and FCA are therefore also today publishing Andrew Green QC’s report into the FSA’s enforcement actions following the failure of HBOS
In his report, Andrew Green QC recommends that the PRA and FCA should now consider whether any former senior managers of HBOS should be the subject of an enforcement investigation with a view to prohibition proceedings.
The PRA and FCA will conclude a review as to whether further enforcement action should be taken as early as possible next year.
