Strategic risk management: The failure of HBOS and its regulators

Abstract

In a long awaited joint report into the failure of the UK bank, Halifax/Bank of Scotland (HBOS), the Prudential Regulatory Authority (PRA) and the Financial Conduct Authority (FCA) concluded that the bank had failed because the Board ‘placed inappropriate reliance on continuous growth without due regard to the risks involved [and …] The result was a flawed and unbalanced strategy and a business model with inherent vulnerabilities’ (see https://www.fca.org.uk/news/ publication-of-hbos-failure-review). This conclusion was not a surprise as, in 2004, the predecessor to the FCA reportedly told the Board of HBOS that their aggressive growth strategy was an ‘accident waiting to happen’ (see http://www.parliament.uk/business/committees/committees-a-z/ joint-select/professional-standards-in-the-banking-industry/news/an-accident-waiting-to-happenthe- failure-of-hbos/). In 2008 the accident happened and HBOS collapsed under a mountain of debt, requiring a government-backed takeover by Lloyds TSB bank and the injection of over £20bn of UK taxpayers’ support. Although HBOS did indulge in lending to some ‘sub-prime’ borrowers, this was not a major contributor to its failure; rather, to meet its growth targets, the bank had made some very risky loans to the corporate sector. Regulators concluded that this was just ‘bad banking’. Ultimately, while the initial impetus for the collapse was an inability to fund its assets, the bank failed because an economic downturn affected its corporate lending portfolio which had grown massively as a result of its misguided growth strategy. The UK parliamentary enquiry (see http://www.publications.parliament.uk/pa/jt201213/jtselect/jtpcbs/144/144vw.pdf) into the HBOS collapse labelled the bank’s strategy ‘incompetent and reckless’. This paper looks at the collapse of HBOS as an example of a failure of strategic risk management (SRM), in particular the failure of the board and senior management first to identify and then to mitigate the risks that were inherent in its chosen business strategy and that eventually brought a once-thriving bank to a very messy end. The paper also considers deficiencies in the regulation of HBOS’s strategy and makes recommendations that aim to improve the regulation of risks to the strategies of large banks.