With the FSA (Financial Services Authority) report on what went wrong at HBOS (Halifax Bank of Scotland) before the bank had to be rescued by the UK Government and Lloyds TSB clearly showing that the issue was one of governance, there has never been a time when the need to change the culture of the banks has been clearer or more urgent.
The FSA report demonstrates that the corporate lending division of HBOS had a far riskier book than any of the other UK banks. HBOS continued to win deals in both the commercial and retail property markets in the UK, Ireland and Australia at lower margins and higher risks at a time when all the other banks were reducing their exposure to the sector or no longer pursuing new business. HBOS proudly proclaimed their success and growth in the market, not recognising that they alone were doing this. It doesn't appear to have crossed the minds of the executive that they were winning business that no one else wanted, or at least no one wanted at the rates that HBOS were offering. When the Head of the division proposed a growth of 10-12% in commercial lending not only was this not challenged he was told by the CEO of HBOS that this needed to be increased to 22%.
How could this situation have arisen?
The CEO of HBOS, Andy Hornby, had arrived at HBOS triumphantly from ASDA, part of the Walmart Group. With no background in Financial Services but having graduated top of his course at Harvard and having had a successful career with the strategy consultancy, Boston Consulting Group prior to ASDA, he was seen as the person who would shake up the sleepy financial services industry. He surrounded himself with people who agreed with his position. Those who didn't agree with him got short shrift. Benny Higgins (currently CEO of Tesco Financial Services), had joined from RBS, where he had had a very successful career, to lead the HBOS retail banking business. He left after only a very short while when he fell out with Andy Hornby over strategy.
What this meant was that no one was there to challenge the strategy and the decisions that the CEO of HBOS was taking. Not dissimilar to the situation that was described in the recent report on what went wrong with the corporate governance at RBSG under the leadership of Fred Goodwin.
It is undoubtedly for this reason that the FSA is asking for a change at the Co-operative if they wish to push ahead with the acquisition of the Verde branches from Lloyds Banking Group. The FSA are insisting that the board of the Co-op must have much more experience of Financial Services and be able to challenge the executive leadership of Co-operative Financial Services. This could be such a significant challenge for the Co-op to make them question whether they will continue to pursue the deal. Finding people who the FSA will approve to run or sit on the board of a bank is increasingly difficult. It took Tesco over two and half years to get approval to set up their bank. The FSA has an increasingly large backlog of people to be approved to work in senior roles for banks and it now takes months to get approvals for an individual, even if that individual has already been approved for a similar role at the bank or a rival bank. Such a delay in being able to pushed forward with Verde could make the deal so unattractive to the Co-op that they walk away from it. However given what went on at HBOS and RBSG it is not difficult to understand why the FSA is pushing for this.
The culture of banks where the CEO's and other executives' words are final and unchallengeable is not something new and has always been dangerous.
A recent example of this is the fine raised on RBSG for complaints. The fine was not for the poor service that RBSG was giving its customers but for the fact that the complaints received were modifed by staff before being submitted to the Banking Ombudsman. The reason given being that the staff were afraid of the consequences for their careers of the complaints being upheld. What does this say about the culture at RBSG today, many years after Fred Goodwin left?
A further example that illustrates why the culture needs to change is that of the misselling of PPI (Payment Protection Insurance). It was known throughout the banking industry that both personal loans and mortgages were being sold at prices below cost and subsidised by the excessively high margins on PPI policies, which were very hard to claim on. Yet because it was so profitable no one spoke out and the number of PPI policies that were sold grew exponentially. Why did no one speak out? Surely the hierarchical, command and control culture of the banks has to be key to this along with the pursuit of short term profits at the cost of the customer.
The £8.75m fine imposed on Coutts, owned by RBSG, for not putting in adequate measures to ensure that the money-laundering wasn't taking place or that they were doing business with PEPS (Politically Exposed Persons). One of the reasons cited by the FSA for this behaviour was that staff were incentivised to add additional customers and balances with no measure about the quality of the balances or the customers, is yet more evidence for the need for a fundamental shift in the culture enforced by alignment of incentives with the values that the banks should be upholding.
Without a fundamental change to the culture of banks, where both independent, experienced voices are listended to and encouraged to challenge the exexcutive of banks and with CEOs and senior executives who encourage their staff to challenge their thinking without fear of reprisals then another HBOS, PPI misselling or the latest misselling of derivatives to SMEs is inevitable.