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Wednesday, 11 February 2009


John McFall MP for Dunbarton East, Labour, Chairman of the House of Commons Treasury Select Committee: Hearings Tuesday and Wednesday 10th and 11th February 2009
Introduction by John A Morrison (
"The Thatcher Room in Portcullis House, Westminster; became the Court of the Star Chamber for British banking this week. One of the MPs actually wondered aloud what Henry the VIIIth might have done in these circumstances; “Off with his Head”. This was “The Spanish Inquisition”.
One crucial conclusion is that the letter to the Treasury Select Committee by one Paul Moore (an ex-Risk Manager of the parish); which letter being the basis for the resignation of Sir James Crosby from the FSA and much huffin' and puffin' at Prime Minister’s Question Time; is a chimera, a journalistic running up the flag pole. “Moore's letter is an effective distraction. It makes some good points, but ultimately it diverts attention from more truly serious matters,” (even if it has led to the resignation as deputy Chaiman of the FSA of James Crosby.)
Now we have that out of the way, Robert’s notes on the details of the conversations point to the substance of the issues debated and where we can learn lessons for the future;- Sir Fred actually nailed it early in the debate; the issue was Stress Testing and the inadequacy of historic accounting values in alerting a board as to what risk was likely to look like even 3-months ahead on alternate scenarios.
Lord Stevenson referred repeatedly to Basel II and to HBOS’ elaborate committee structure underpinning risk management but those of us who follow agile techniques understand completely that committees just obfuscate and create “delay worry and expense” to use the Edinburgh phrase.
Buying ABN Amro's investment banking business was a disaster for RBS, a pig in a poke (I thought someone was actually going to use that phrase) again mainly because RBS personnel had followed good old fashioned due diligence techniques of the “wee Scottish CA”! (including 18 board meetings when ABN AMRO was on the agenda). No consideration was given to exploring downside risk using quantitative techniques (to allow the board to examine the interdependence of a multivariate equation, which is what risk really is - not a topic which can be managed in committee). As a senior Scottish banker once remarked to one of his committees; “we are running a bank here, not a philosophy department!”
J.A.M. by Robert MCDowell:
With financial journalist Ian Fraser, I watched the Treasuring Select Committee questioning of 4 top bankers for 4 hours while being filmed and interviewed by BBC Scotland's Raymong Buchanen. Next day we were interviewed by South German television, Bayerische Rundfunk, and there will be an upcoming Channel 4 film too about HBOS.
First, to make it absolutely clear - to borrow the favourite politician's phrase - the banks did not collapse because of their simple hubris and belief in asset values forever rising; they failed because of the loss of confidence in the banks ability to refinance their wholesale funding and this resulted from complete failure at stress-testing of economic scenarios as legally required by the CRD (Basel II Pillar II) and inability to imbed the new Basel II risk culture fully and properly. This failure had typically a lot to do with the status of risk professionals and the inevitable clash between finance and risk and of risk and finance with structured products divisions. Above, there was a failure to integrate economics modeling and forecasting into risk management and business strategy, despite the undoubted resources available to the banks to do this well. This biggest failure may therefore have been the sidelining of economists by top bankers in favour of mathematical engineering as the intellectual basis for risk valuations.
Eric Daniels of Lloyds TSB as well as Andy Hornby ex-HBOS CEO and Fred Goodwin ex-CEO of RBS have each emphasised their problem was funding (liquidity risk) and not credit risk. Stephen Hester, Goodwin's replacement said RBS purchase of ABN AMRO's investment banking doubled the bank's exposure to structured products.
Treasury Committee Hearing
On 10 feb the 4 bankers questioned: Sir Fred Goodwin (FG) ex-CEO of RBS (nearly $3tn assets, 40 million customer accounts); his ex-Chairman Tom Killop (TK); Andy Hornby (AH) ex-CEO of HBOS (over $1tn assets, 22 million customer accounts) and his ex-Chaiman Lord Dennis Stevenson (DS).
The 4 bankers and the questions (Feb 10) put to them did give clues to what went wrong, but a coherent explanation did not emerge; this was clouded over by the interest to find how these men are personally guilty, despite this not being the purpose of the hearing or the motive of the Treasury Select Committee (TSC), but everyone knew this to be what the public & media wanted to know? The smoking gun that has now animated media comment is Paul Moore's letter to the TSC. He was the GRR (Head of Group Regulatory Risk at HBOS) 2002-05. What he says seems important.
But it is also a distraction. I know very well how typical it is of what happened to many risk managers, but I could tell over a dozen similar and more important stories. It does point to key governance matters addressed in the CRD (Basel II) legislation that were ignored by ignorant executives. But, what Moore has to say does not go to the real problem. (for discussion of the letter and how it exonerates Hornby and Stevenson see Note 2 below)
The other important points arising are:
- all said sorry to whomsoever, to everyone and anyone, but they passed the
- blame on to unexpected "wholesale crash of the wholesale markets" and
- FG emphasised the 2 weeks following Lehman Bros. collapse (15 Sept.)
- both banks admitted to growing too fast (but only in hindsight)
- none of the 4 bankers had banking qualifications (only high-level experience)
- all claimed to have sufficient banking expertise around them
- AH and FG both claimed to preside over a collegiate collective of experts
- with regular involvement with FSA that approved their strategies
- questions as to how it was they claimed solid performance up to and including 16 Sept. got no admission of having made false or misleading statements to shareholders and markets, or of market abuse!
- DS came close to saying they'd used gloss to calm the markets, but stopped himself
- Jim Cousins MP asked TK if he'd consulted legal advice on criminality; answer: no!
- Cousins said UK banks had lost £120bn in securitised assets & got no clear answers!
(This was from page 16 of BoE Stability Review - see link below)
- no clear answer to why UK taxpayers are supporting non-UK loans (e.g.Citizens Bank owned by RBS, the 6th largest in the USA)?
(Note that only 15% of RBS loans are to UK borrowers, and several £billions of Bradford & Bingley assets are GMAC US mortgages and US car loans. Hence £tens of billions of UK Government funds are supporting US loanbooks.) Halifax Bank of Scotland HBOS - over £600 billions of assets Lord Dennis Stevenson ex-Chairman (DS) Andy Hornby (AH)
- AH blamed funding but agreed the bank's takeover was a commercial decision!
(implication is then that it should have been referred to Competition Comission!)
- AH said he felt no personal blame (clearly minded to blame the Crosby inheritance, even if he was 7 years responsible for retail on the Crosby board before becoming CEO for the last 2 years)?
- he also blamed bonuses rewarding wrong kind of behaviour, and
- failure of risk systems in "banks all round the world"
(Failure of markets are a systemic and global matter, but there is no excuse for inadequate or failing risk management systems given the years of renewing regulations and accounting standards other than foot-dragging or incompetence. The failures of banks are shared not only collectively but individually, especially in the case of those banks who found themselves exceptionally exposed to the largest 'funding gaps' which is clear sign of irresponsible and excessive growth in risk exposures, of seeking to grab maket share when others were behaving more prudently!) - because of the Paul Moore issue, AH was able to shift blame to James Crosby!
- he said takeover (by Lloyds TSB at a small fraction of book value and after 90% share price collapse) was good for shareholders, employees and the bank's continuation (possible interpretation: little or no analysis was attepted on how the bank could survive independently, especially when Government and Bank of England intervention measures became stronger and more comprehensive?)
- DS said no other bank offered to buy the group, which was
- no answer to what if bank could've stayed independent? even if meant becoming temporarily nationalised?
- he said his bank's scenario stress-testing was totally inadequate and said this was serious! (This is like an 757 pasenger aircraft pilot admitting to flying blind in fog without a properly functioning instrument panel!)
- he was only the one to mention Basel II, but said little further of substance about it
- he admitted over-exposure to property developers, but
- he mitigated this by saying the bank decided to stand by its long term customers
- on governance they claimed to have excellent non-execs and
- that every risk cmte had a non-exec to report to (trashing Moore on that point)
- that means bank risks were considered in disaggregated ways, not holistically!
- Crosby sacked head of risk who whistleblew in '05, replaced by a sales-banker!
- FSA approved and KPMG investigated (so Crosby has paper defences on this!) Royal Bank of Scotland RBS - over £2 trillions assets (most of its outside UK) Tom Killop ex-Chairman (TK) Fred Goodwin ex-CEO (FG)
- Cmte assumption was bank's failure was20buying ABN AMRO
- but the reasons for buying it were not elicited (e.g. to get hold of more ABS)
- questioned on 27 takeovers, FG said most asset growth was actually organic!
(This can be challenged e.g. most profits coming from derivatives & struct. products?)
- the scale of US sub-prime exposures of Citizens and Greenwich not elicited
- FG said Greenwich only intermediated and Citizens did not do sub-prime loans
- asked about sufficient capital for Greenwich, FG fudged his answers
- asked about Greenwich's leading role in structured product markets in US, ditto
(can of worms, 85% of loans ex-UK according to HoC Banking Bill debate same day!)
- TK couldn't say what % of £20bn write-off was ABN AMRO or what the rest is?
- but later admitted the £10bn cost of ABN AMRO purchase was totally lost!
- FG said blaming him would not explain anything.
- he also said his integrity should not be doubted.
- he, remarkably, couldn't be clear on value of, & loss from, ABN AMRO
- he tried to say this investment could "still come good"?
- he said his leverage (funding gap) was medium rank (absolutely not)
- all knew HBOS was highest, higher than RBS (and both above others)
- he excused funding gap/ leverage as being so much less than that of hedge funds
- FG said he'd raised £24bn Jan-Aug '08 (+£12bn rights) - (but this is far too little!)
- TK&FG admitted reserve capital ratio was too low at time of ABN AMRO deal
(half of the minimum - so what did FG think he was buying in ABN AMRO, a solution to his reserve capital problem? - not asked? In fact, the deal meant doubling RBS exposure to structured product assets, including especially toxic CDO2 and unique CDOs, roughly in my guesstimation from about $90bn to $200bn!)
- TK&FG were not quizzed re. too little capital for the bank's general growth
(I suspect RBS tried to take some kind of advantage of Basel II not yet being firm law in USA?)
- ironically TK admitted that ABN AMRO's sale of Bank LaSalle greatly improved the deal for RBS (yet at the time the opposite was vehemently stated, and the sale was an attempt by ABN AMRO to fend off the RBS-led consortium bid. RBS FG showed zero compunction about offending the Dutch Regulator DNB, whose Chairman Nout Wellinck was also Chairman of the BIS BCBS author of Basel II, which indicated disrespect for regulatory laws and prudential standards, and not least for serious matters of a national concern; he and his board clearly believed global banks like RBS to be above national concerns and thereby also above matters such as customer loyalty including corporate clients. ABN AMRO shareholders are also to blame, however, for holding out for €3bn more and in cash in a €68bn responsible and sensitive 'merger' bid by Barclays that would not have meant the dangerous break-up of ABN-AMRO!)
- motives for buying ABN AMRO were questioned but not as to precise reasons?
- FG attempted to describe securitisation tranches & that banks surprisingly latterly sold even the highest risk equity tranches (in trying to explain why fundamental high-rated values had been traduced by market panic - but his line on this was cut short! It was clear, however, that FG did not accept market prices and did not understand the economics behind of market prices! His mentality is that of a book-value accountant only! He was cut off - not today's issue - & anyway he can't teach the Trsy Cmte anything on this that they do not already know a lot about.)
- FG nevertheless extolled the rating of ABS and CDOs as triple-A and double-A! (He might have gone on to state that defaults rates gave no warning until it was too late, but that is precisely the point of scenario stress-testing, because shocks are sudden and unexpected and have to be accounted for nevertheless. This was not a California earth-quake, but what there is past experience for even if it means going back 80 years). - he only admitted to first doubting values after March '08 when Bear Stearns failed!
(after 6 months of ratings downgrades had already been coming thick & fast and half of all CDOs defaulted and much ABS collateral had been sold at 80% discount to face!)
- he was shocked by rapidity of market collapse (This shows the worst economics naivete given that the solid average period for market and economic collapses are sub-1 year and recoveryies are 5-6 years i.e. FG had no cyclical awareness, which is a primary concern of all regulators, to ensure all board members personally understand this and to determine if they are professionally competent to accept regulatory fiduciary responsibilities!), and not just because of government shareholdings, but as an international legal reposibility. OUR FINDINGS:
- I suspect that in 2007, FG focused far too much on ABN AMRO & lost the plot on everything else going on. TK said the board had 18 meetings after April that year that discussed ABN AMRO, more than one a fortnight. This is far more than normal, hence most of the meetings may have only discussed ABN AMRO. This will be checked by the Trsy Cmte. TK offered the Trsy Cmte list of all the meeting agendas. That should be taken up to see whether the Credit Crunch was given at least equal consideration at this time!
- There was not enough searching detail on both banks 'funding gaps' (RBS £168bn, HBOS £193bn, each greater than several other important banks combined). This is the most important aspect of the iceberg that is 'the credit crunch'. This is probably obvious to the Trsy Cmte that both banks had striven to grow too fast using off-balance sheet securitisations, but that the 2004-2007 timing of their assets growth had the result of a ballooning of refunding requirements in 2008/2009 just when the wholesale markets closed down (some say entirely aftr Lehman Brothers failed on 15 Sept. and AIG was nationalised i.e. both banks grossly failed to adequately understand their liquidity risk - basic concerns of properly trained bankers, which these 4 guys are not! (see NOTE 1 below)
- Media comment and some of the Trsy Cmte comments focused on the obviously absurd expectation among the banks that property values would always rise. That was not the big problem! The really important (irresponsible) assumption was that wholesale interbank funding (to fill the funding gap) would always be available, and even when property values would fall and markets go through whatever corrections! The bankers mistakenly assumed the credit crunch would be a temporary blip, not prolonged! This again shows indifferent or careless ignorance of 'credit cycle' economics.
- In none of their replies did the bankers refer to risks by their proper name e.g. liquidity risk or market risk or credit risk etc. Neither did they refer to "economics", not even when asked about qualities needed on their boards did they think to mention 'economists'! (This is a widespread penemonen where bankers fear to have economists on board, preferring mathematicians and accountants only)
- The MPs failed to question is any of the bankers if they understood economics? In fact, the biggest excuse they are hiding behind is the 'black swan' get-out-of-jail free card of "we faced totally unexpected shocks from circumstances beyond our control that hit all banks not just us" etc. What is really clear, however, is that the banks were the 'black swans', and only from the neck up, the South American variety? - DS's point about the failure of his bank's stress-testing should have been put to RBS also, and was almost, then not? The Trsy Cmte thought better of going there as soon as TK (a Pharma maths expert with a lot of boardroom banking experience) indicated he was ready to explain in exhaustive opaque detail just how complex the analysis of all this is including all the ways of doing risk stress-testing. (Given how Pharma companies do this he would have explained monte-carlo analysis which is actually almost wholly irrelevant to medium and long term risk economics.)
- But, the Trsy Cmte could have asked what importance and resource did they commit to this and did it fail in RBS, and as DS said it failed in HBOS? What analyses did they do is only marginally less important than what were the results?
- And in this context the Trsy Cmte could have asked the 4 bankers for their understanding of how their banks managed their funding gaps and the scale of these? But, it was clear from the start that this is precisely where the 4 expected questions to go to and were prepared with answers about the worldwide collapse of wholesale money markets, of interbank lending following first Bear Stearns and later Lehman brothers collapse, such as when FG tried to talk about CDS and monoline insureres, and blame it all on a general loss of confidence in banks.
- A key question, however, would have been, did any of the 4 directors ever see any analyses showing how their respective banks capital reserve could be 100% or 200% wiped out, and when they say no, ask why not, and then ask is it because they did not understand the vital importance and fragility of their capital reserves that taxpayers money has had to be committed, and that is really why their banks shares crashed?
- Another question should have been to ask the bankers if their past vows to protect shareholder value was mere rhetoric?
- Was it not so that when wholesale funding became expensive they refused to pay the price and fooled themselves that this problem was temporary?
- And when it was not temporary they resorted to Bank of England and Government support?
- Had they sacrificed £150bn of shareholder value for the sake of saving 200-300bp on top of LIBOR (falling) on interbank funding costing i.e. to save a mere £6bn?
The question of UK Financial Stability (systemic risk)
The 4 bankers interviewed on Tuesday were not asked about this aspect, although it was the reason (officially)for the takeover of HBOS by Lloyds TSB and for pumping government capitalisation funding and guarantees into the banks (in return for certain conditions such as maintaining 2007 lending levels - to which Hester, new RBS CEO reported on 11 Feb, his bank had increased retail lending by 10%?
They were asked about the warnings given by the Bank of England (stability reports) and why they had not heeded these warnings? FG said they had heeded these warnings. But this matter needed more enquiry as this answer was of doubtful quality. What did the bankers recall of those warnings, what precisely the warnings told them, and how did they comply with them? What did they understand of their responsibility in the economy and to the wholefinancial system?
Just as one of the media highlighted findings from this hearing is that none of the 4have qualifications as professionally trained bankers (despite TK saying new directors get taken through an exhaustive induction process and that there were many sessions to learn about risk) the fact is that equally important is what did they know or understand about economics? What we have are 4 bankers who like many others were helicoptered into 'boardroom banking' without thorough experience of the work by rank and file bankers in the engine room. Similar accusations may be levelled at engineers and mathematicians helicoptered into structured finance and derivatives and allowed to play with $billions involving traditional banking assets without understanding the reality of these; they are nor mere numbers games! Hester (on the 11 Feb)for RBS admitted to over $500 billions of derivatives exposure NET, which raised McFall's eyebrows as high as they can ever go! This number will be more forensically examined!
Except in this one case, Hester, even alongside Varley and Daniels, came across extremely well as one of the most astute bankers to have as yet appeared before the Trsry Cmte, and he a government appointee, ex of Credit Suisse and British Land!
Wednesday's hearing with Abbey (Santander), RBS, Barclays, HSBC UK, and Standard Chartered.
Questioning began with how much public funding support the banks had received. All said they were not allowed to say how much they obtained via the Bank of England's SLS. (Though we know the total to be £185bn from £285bn of asset backed collateral). On bonus-culture all said this was under severe review. John Varley (CEO Barclays) interestingly referred to Basel II counter-cyclical awareness by banks suggesting that economic cyclical understanding was weak among the banks! (At Treasury Questions on Feb 13, the ministers stated that stress-testing is central to diuscussions with the banks and central to the G20 London Conference in April when improvements to global financial regulation will be progressed. These issues go to the heart of matters that John Morrison and I have advised and publicly argued for years concerning Basel II Pillar II. It should be noted that the Trsy Cmte's questioning of the big 4 auditing firms elicited that they have no legal or fiduciary responsibility and may lack expertise or resource to audit the risk models and stress-testing and Pillar III statements of the banks. Beyond how these aspects are now part of IFRS7, the auditors when qualifying or appending notes to accounts are not expected to encompass these matters when deeming the solvency of the banks for the next 12 months after the accounts are signed off. The Trsy Cmte is determined to address this important topic! By doing so the implications will be international and the Trsy Cmte is conscious of EU liaison on these issues.)
Eric Daniels (CEO Lloyds Banking Group) said taking over HBOS was for systemic stability reasons, without which the bank would not have needed government funding support, but that the takeover would prove good commercial value for Lloyds. Daniels said 5,000 man-days of due diligence was done on HBOS purchase, including advisory firms and law firms! (At a reputed cost of £130m, reliably reported elsewhere, perhaps he had meant to say 'man-months' including weekends?)
On the question of governance, Hester said non-execs should deliver strong constructive challenge to the executive. On whether splitting traditional banking and investment banking should be separated given their different cultures, Varley said it is important to have investment banking experience on boards and in banks, especially the most esoteric parts of it as part of the challenge. The implications here, which I believe is totally valid, is that it will not be possible for the banks to return to traditional banking only where loans and deposits are equal. This does not mean, however, that reviing Glass-Steagal is not a practical option. In the present circumstances, however, when Morgan Stanley and Goldman Sachs have both turned themselves into 'banks' to be eligible for central bank support, and given that banks have immense problems that would impact economic growth if they had to reduce their funding gaps quickly and subsequently only grow at roughly the pace of growth of cash deposits i.e. a purist 'transmission mechanism'? Therefore, some hybrid combination of safeguards are required. And, furthermore, some aspects of these will have to extend to 'investment banks' and the 'shadow banking' sector.
The Treasury Select Committee questioning has focused more on retail banking than on investment banking, more on what the public understand such as credit risk matters, less on market risk in both cash markets and derivatives markets. The banks were not asked about bringing 'over-the-counter' money and credit markets 'on-exchange' or about their 'own-book' portfolio trading in the markets, or about swapping assets between 'banking book' and 'trading book'. The auditors were not asked about this either. But these are issues that the Trsry Cmte is concerned about including 'fair value' etc. The bankers were asked about 'bad bank' and insurance options for dealing with toxic assets and did not give definitive opinions. At Treasury Questions (13 Feb) The Chancellor indicated he was waiting on the details of the US measures recently announced. His team also reported that all EU countries are now delivering proportionally the same re-capitalisation funding and fiscal responses as had been led by the UK (and the USA). (But, we still lack a clear statement as to the precise scale of this along the lines that we have calculated at reported here and elsewhere i.e. one times banks capital reserves plus 8% ratio to GDP fiscal impulse, with the banks tasked to recover another one times capital reserves while maintaining lending levels of 2007, but with changed composition.)
NOTE 1: UK Banks Funding
Pages 8 & 9 show total UK banks' funding gap over not much over $700bn. Page 29 graphic shows c.£240bn of banks' bonds maturing in 2008/09/10 but a ctually approx.£800bn of refinancing is required in next 2 years! In fact, RBS needs £266bn, HBOS £156bn within a year, Barclays £176bn, Lloyds £96bn = nearly £700bn! UK banks got £185bn from Bank of England SLS, £50bn from UK Gov funding, £51bn rights issues, £250bn Gov. Guarantees = £536bn leaving residual raising required of about £194bn this year and £70bn next year (possibly most from Bank of England's new liquidity window, "son of SLS") less whatever has been borrowed via ECB liquidity funds.
Tuesday afternoon also saw the House of Commons (less than 20 MPs) debating Lords amendments to The Banking Bill which authorises working capital funding for the banks in which Government has a systemic interest. The main issue appears to be that HM Treasury does not want to report to Parliament quarterly but on a 6 months basis (first report next October) about working capital money given to the banks (including what the banks claim from Gov. guarantees) and not to name he actual institutions supported, and with the deemable right not to make any report at all!
Hence. we might not know directly from Government what of the £264bn still required by banks and £250bn guarantees is used, not until some indeterminate time after next October, with broad totals only by that time, though not necessarily so.
At Treasury Questions, the Chancellor was asked when the Acting Chairman of the UKFI would be permanently replaced? This is in process. The failures of the FSA were also raised. Essentially the answer was that notifications of problems in the banks were not notified to the Treasury until the crisis was obvious to all! What this confirms is that the FSA has treated its supervision as too confidential and the lack of liaison with the Bank of England (which has systemic risk responsibility) means that individual bank details pertaining to systemic problems could not be discussed even by the Bank of England with the Treasury! What has also not yet been asked is the regulatory status of the bank holdings of UKFI. These are by law now outside of regulatory law - unless the FSA can continue to supervise at Government behest and or focus on banking licenses and bancassurance subsidiaries belonging to holding companies that are nationalised? The legal precdent in EU law is established by the nationalisation of Anglo-Irish Bank.
NOTE 2 Moore's letter to Treasury Committee
Moore writes that in Nov. 2003: the FSA had assessed key parts of the Group as posing high or medium-high risks to the achievement of its statutory objectives of maintaining market confidence and protecting consumers; the risk posed by the HBOS Group to the FSA's four regulatory objectives is higher than it was perceived" and, about Halifax (retail): "There has been evidence that development of the control function in Retail Division has not kept pace with the increasingly sales driven operation. There is a risk that the balance of experience amongst senior management could lead to a culture which is overly sales focused and gives inadequate priority to risk issues." Moore does not say what risk issues are referred to? These appear to me to be FSA Arrow comments and all board directors read those. The Boards also have to sign off formal reports to the FSA setting out the banks risk accounting and risk management framework etc. Moore warned in 2005 that the bank was growing its retail business too fast. He complained to his boss, the CFO, of mistreatment by others in group finance. He wanted to question the retail "operating and strategic plans" to the board? And it seems this was objected to by others in Finance on the usual grounds of being probabilistic (stochastic) and just guesswork (forecasting) as reflected in, "the sentiment that constantly questions the competence and intentions of GRR carrying out its formal accountabilities for oversight plus the ever present need to be able to prove beyond reasonable doubt as if we were operating in a formal judicial environment" when the strategy had most likely been financially okayed, but a formal doubt to the board meant an underling going over the head of the CFO, Mike Ellis, who may have considered this a bid for GRR promotion to the board (something Moore's successor acheived).
Moore writes, "I was obliged to raise numerous issues of actual or potential breach of FSA regulations and had to challenge unacceptable practices and the conduct of others in fulfilling their obligations under the Principles for Approved Persons including very senior executives." I understand this well. I'm sure he did the above. Everyone in his position had to be doing that, being irritating (otherwise called 'a challenge'), some lacked guts or confidence to do so. Can we presume that of his successor?
Dennis Stevenson said there had been an external enquiry (by PwC) validating the bank's risk governance. DS also shifted the problem in line with Moore's letter to the James Crosby period and DS with Andy Hornby said they had cut back from 2006 on and even reduced the bank's mortgage maket share latterly. (In 2008, that is true, in a 50% smaller market, HBOS share of new business went from 20% to 8% and Lloyds TSB from 8% to 20%!). Both Stevenson and Hornby said they had begun in 2006 to cut back in assets growth but in hindsight should have cut back more. This helped them to shift the blame (from Moore on risk governance issues) onto James Crosby, who according to Moore's letter personally sacked him and it was this bypassing of HR processes that got him an out-of-court settlement i.e. his sacking was improper, but a settlement does not prove his allegations?
This helps Hornby to get out from under the accusation that he wanted to keep pushing sales growth in mortgages when Crosby wanted to cut back and - as an earlier story in the media had it - that was why Crosby had to go when the board backed Hornby's strategy. Stevenson and Hornby may have agreed this would be their tactic since both backed the line that they had been cutting back on growth, had held the composition of assets steady and slowed or stopped new lending e.g. sticking with long term customers only in property and construction. Hornby also said his bank's funding gap was inherited from Crosby! The resignation of Crosby on Wednesday helps to sustain this proposition. So we have here a testable claim by Stevenson and Hornby that they were not responsible for over-ambitious (foolish or irresponsible) retail sales growth or for the funding gap? I think this is disengenuous at best.
The Treasury Committee questions did not focus enough on funding, liquidity risk, and nothing on systemic risks to UK banking. The questions gnawed at bonuses, banking qualifications, risk reporting access to non-exec directors, and governance, to get to the issues raised by Paul Moore's letter. My impression is that this much of this line of questioning had not been deeply considered and displaced other questions arising out of the longer term work of the Treasury Committee. The blaming of Crosby was picked up as an issue by Conservative ministers and clearly he had to resign not least to retain confidence in the Treasury Committee as well as the Government and the FSA.
When Moore writes, "My team and I experienced threatening behaviours by executives when carrying out its legitimate role, in overseeing their compliance with FSA regulations". This is frankly sadly normal and what good risk managers know to expect to deal with. Moore does not refer to funding risk. He also blames his own dept. by writing: "Actually, the responsibilities for getting into the current position are held all around the organisation and not just in Retail... and I include Group Risk functions in this. What would be absolutely fatal would be if there was ever a perception - explicit or implicit - that different parts of GF&R took different views." He is indicating here the gulf within Group Finance & Risk and by threatening something 'absolutely fatal' sounds like proposing to make differing views known - perhaps to the FSA - and/or insisting Finance has no choice but must agree with Risk?
This is a severe problem that is common to all banks. Finance and Risk are different cultures and cannot be happily integrated and must perforce be challenging each other and become rivals for board attention. But, no questions were asked by the Trsry Cmte about risk accounting and finance accounting differences and where in understanding the issues between these two should might triangulate the problem. The 4 directors gave a clear message that the problem was wholesale funding (the 'funding gap") but this aspect was not pursued directly!
Moore's letter focuses on the sales culture in retail, "...exactly what level of sales growth is achievable... without putting customers and colleagues at risk" which is curious phrasing, but could go straight to AH as being to blame as he was in charge of retail, or a risk appetite question or one risk diversification, of capital reserves, or of liquidity? Was Moore aware of the bank's ABS, covered bonds and MTN programs? Behind the retail sales strategy was a very aggressive off-balance-sheet funding plan, which knew precisely the enormous funding gap and intended to make it bigger! (I have copies of these strategies & sales piches to board and counterparties.)
That information was witheld from the board is also typical. Similarly, future funding plans and much else were probably withheld from the GRR. Moore writes, "I was strongly reprimanded by the CFO for tabling at a Group Audit Committee meeting the full version of a critical report by my department making it clear that the systems and controls, risk management and compliance were inadequate in the Halifax to control its over-eager sales culture. Mysteriously, this had been left out of the papers." This might have concerned basic regulations concerning the sales pitch, cooling-off period, insurance cover, third party agents fees and suchlike matters, not the most obvious causes of the credit crunch? I don't know - the answer is not obvious from Moore's letter.
Moore's points imply severe criticism of the CFO Mike Ellis and also of Hornby in charge of Retail. but Moore redirects his criticism at Crosby! If the CFO was wrong, was he protecting his own accounts or Hornby, for applying ASDA discount pricing in place of prudential risk-pricing? Whatever the case, Moore's letter greatly helps Hornby and Stevenson by ending strongly, saying it was all Crosby's fault; the aggressive sales strategy was his alone!
Stevenson and Hornby appear to go along with this. DS offered the Committee the PwC Report. Will a between-the-lines interpretation of this support putting the blame onto Crosby! Hornby must be most thankful for Moore's letter! I expect the Treasury Cmte will support Moore's recommendation for "Regular formal independent audit of risk management, compliance and internal audit functions to keep them honest" Yet, that is what the FSA is already supposed to be doing and as Moore indicates has been doing? But, the FSA is due for more criticism and Moore provides a useful constructive form for this by saying the FSA needs more expert, much better paid people - I agree. Moore's letter is an effective distraction. It makes some good points, but ultimately it diverts attention from more truly serious matters.



from the BBC
The Financial Services Authority (FSA), the City watchdog, has said it raised concerns about the way HBOS was being run as far back as 2002. It said it looked at the risks before and after a sacked HBOS risk manager warned about the bank's business model.
Prime Minister Gordon Brown said the Treasury was not made aware of the FSA's communications with HBOS. "There were probably 20 or 30similar discussions going on with other institutions at the time," he said.
Paul Moore says he was sacked in 2005 for blowing the whistle on the risks being taken by HBOS. But the regulator said it had investigated the way the bank was being run in 2002 as part of its usual operations. Sir James Crosby, the former head of HBOS, stepped down as FSA deputy chairman on Wednesday, although he maintained that Mr Moore's allegations had no merit.
The prime minister was asked about Sir James when he appeared before the chairmen of all the House of Commons' committees on Thursday.
Gordon Brown says the whistleblower's allegations were fully investigated. "The Treasury would not normally be told of these interactions between a bank and the FSA," he said. He also stressed that Sir James' appointment had been recommended by a panel, which included the chairman of the FSA and one of its non-executive directors, who would have known if there had been serious concerns about him. The FSA said that in the light of the allegations it was taking the unusual step of issuing a statement about its regulation of HBOS, which was bailed out with taxpayers' money last year. In the statement, the FSA stressed:
• It first carried out a full risk assessment of HBOS in 2002, which found the bank needed to strengthen control infrastructure within the group
• After another full risk assessment in December 2004, the FSA found that progress had been made, but HBOS still needed to improve its group risk functions and ability to influence the business
• In June 2006, the FSA wrote to HBOS with a further risk assessment, making it clear there were still control issues and the "growth strategy of the group posed risks to the whole group and that these risks needed to be managed and mitigated"
• It also said it backed the findings of an inquiry conducted at the time Mr Moore made the allegations, which found his concerns were unfounded.
Banking expert Peter Hahn from Cass Business School said the affair showed the FSA was not strong enough. "I think the FSA up until today has largely been a toothless tiger," he told the BBC.
Vince Cable and George Osborne discuss Gordon Brown's problems
"I think the regulators took it as too procedural - they didn't wave the red flags high enough."


The Financial Services Authority's (FSA) unusual statement about its dealings with HBOS has given an insight into the chronology of its interaction with the bank.
Here is a timeline, covering the FSA's activities, the movements of Sir James Crosby and the troubles at HBOS.
September 2001: HBOS is formed from the merger of Halifax and Bank of Scotland, with James Crosby at its head.
Late 2002: The FSA conducts a full risk assessment of HBOS, known as an Arrow assessment. It identifies the need to "strengthen the control infrastructure within the group". It also commissions a report from PricewaterhouseCoopers on the HBOS risk management framework.
8 November 2004: HBOS head of group regulatory risk, Paul Moore, is made redundant from HBOS as part of the bank's restructuring plans. He complains to the FSA about HBOS and about the suitability of the new appointee as the group risk director.
KPMG is commissioned to investigate the claims and decides that it "did not believe that the evidence reviewed suggested that the candidate was not fit and proper".
Mr Moore sues for unfair dismissal and says he received substantial damages but is subject to a gagging order.
December 2004: Having conducted another risk assessment of HBOS, the FSA concludes that "the risk profile of the group had improved and that the group had made good progress", but it adds that "the group risk functions still needed to enhance their ability to influence the business".
29 June 2006: The FSA writes to HBOS with another Arrow assessment saying that "the growth strategy of the group posed risks to the whole group and that these risks must be managed and mitigated".
June 2006: James Crosby's knighthood is announced in the birthday honours list.
July 2006: James Crosby steps down from his job at HBOS.
December 2007: Sir James Crosby is appointed to the role of deputy chairman of the FSA.
July 2008: Having raised £4bn through a rights issue, only 8% of which is taken up by existing shareholders, HBOS reveals that its six-month profits have fallen 72%.
17 September 2008: Lloyds TSB announces it is to take over HBOS. The deal follows a run on HBOS shares.
13 October 2008: As part of government plans to recapitalise the banks, Lloyds TSB and HBOS receive £17bn of public money between them.
30 October 2008: Paul Moore speaks to the BBC Money Programme of his concerns "as to whether or not the business was under control".
10 February 2009: Paul Moore's allegations are put to former bank bosses appearing before MPs on the Commons Treasury Committee.
11 February 2009: Sir James Crosby resigns from the FSA, although he maintains that Mr Moore's allegations do not have any merit.


Sir James Crosby's statement in full:
In the light of recent media coverage I have decided to issue a short statement.
Just over three years ago I resigned my position as CEO of HBOS.
Towards the end of my time as CEO of HBOS, as part of a wider restructuring of group functions the Risk Function was elevated to report direct to the CEO.
As part of this I asked one of our risk managers, Paul Moore, to leave HBOS.
At the time he made a series of allegations.
These were independently and extensively investigated on behalf of the Board, the results of which they shared with the FSA. That investigation concluded that Mr Moore's allegations had no merit.
Last autumn (on a BBC programme) and again yesterday at the Treasury Select Committee he repeated substantially the same allegations. HBOS has reiterated its view that his allegations have no merit.
Questions have also been raised about my independence from government.
During the last two years I have devoted considerable time to producing two reports for the Government; the first on identity assurance and ID cards (published last March) and the second on mortgage finance (published last November).
I am confident that anyone who either worked with me on the reports or indeed anyone who has read them will conclude that they are the work of someone who is genuinely independent of government. In addition I want to emphasize that I have absolutely no political connections or affiliations.
I am full of admiration for my colleagues at the FSA and the work they are doing under extreme pressure.
As a non-executive director I have an absolute responsibility to ensure that I do not make their task any more difficult.
Therefore, whilst I am totally confident that there is no substance to any of the allegations, I nonetheless feel that the right course of action for the FSA is for me to resign from the FSA Board which I do with immediate effect.

Risk Rapper said...

Corporations need to become disenthralled of their cleverness. Many believe that major investments in applied intelligence create a culture of insularity that hedges all risks and protects every business move. This allows corporate executives to hide behind a wall of opaqueness. They buy the best and brightest minds from our esteemed business schools convinced that this treasure of intellectual capital will protect them. They believe the digital blips of risk models to be sparkling Rosetta Stones containing the secrets that unlock the mysteries of effective risk management. The codified results of these algorithmic exercises are revered as holy Dead Sea Scrolls that offers the protection of an supernatural mojo. This is the thinking of a bankrupt brain trust.

Excerpt from Risk Rap post; We Must Disenthrall Ourselves,


Risk Rapper