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Saturday, 6 April 2013

Crap bank, crap management, crap regulation.

I have posted about HBOS before, but it is good to know that the Parliamentary Committee on whatever pretty much agrees with my assessment of HBOS.  The bank didn't fail because of some unfortunate event in the markets.  It failed because it was run by a bunch of people who were either insufferably over-confident (Stevenson) or knew nothing about lending (Hornby and Crosby).

As I pointed out before neither Hornby nor Crosby had any background in lending money so how they ever got to run a bank that was basically dependent on lending and making a margin in that business is a complete mystery.

I did my credit training at an American bank famed for its credit courses and although I spent most of my career putting deals together without lending money the principles still stick in my mind.  First of all, banking is a very simple business. You lend money at a margin and you take in deposits at a cost.  Whereas some of your loans might go bad, all of your deposits will have to be repaid if you stay in business, so to be profitable in the long term you have to make damn sure that your losses on your loans don't wipe out the slender margins that you make on your lending business.

To put it in perspective, for every loan that goes bad you need 50, 100 or maybe 500 good loans in order to cover the losses that you make on the bad loan. And that means that you have to take a conservative risk position, lend carefully and be damn sure that you are going to get your money back.  Which makes most corporate lending pretty dull.

HBOS had a different mindset.  Attract retail deposits with TV adverts and then put the money raised out to borrowers to generate the cash flow to pay the retail deposits.  Almost arse about face, but if you were a retail manager at ASDA like Hornby you probably didn't realise that you were thinking the wrong way.  Fact is any bank can raise deposits and the retail end of banking is pretty straight forward.  All people want is somewhere to bank their pay and some pretty straightforward services to pay bills.  A bit of interest is noice, but there isn't a lot more that you can do.

Lending on the other hand is a different matter, and requires some skill and judgement, qualities that HBOS lacked in abundance.  Surely at some point you would have thought that the numskulls in charge of the bank would have sat down and wondered why the experienced banks at JPMorgan and Citi, Barclays and HSBC, SocGen and Deutsche didn't just copy their business model of lending more against less security than any other bank.  The answer, as the other banks knew and HBOS eventually found out, is that if you keep lending against nothing more than fresh air, eventually the whole house of cards crashes to the floor. Which it did.

So I have no qualms about the HBOS senior management all being kicked out of the City, but the bigger question that deserves more of an airing, is why hasn't the same level of punishment been given to the senior management of the FSA?  As often noted here, the FSA promoted a culture of box ticking to handle customer enquiries, money luaundering etc, but it failed abjectly in its supervision of banks.  In the case of HBOS, it failed to ask about the quality of the assets, the amounts lent against commercial property, and about the amount of residual risk taken on its books.

It is all right to write operating leases with large residual values on aircraft if you have a vast number of used aircraft salesmen and management who understand the risk like ILFC, but if you are just a bank based in Yorkshire, you are not only a fool for taking such risks.  You deserve to be shot, and so does your regulator.

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