Why did HBOS make risky loans?

A BBC News investigation has uncovered reckless lending at HBOS Corporate and some irregular loans at its 'high risk' unit in a regional office.

MPs will debate HBOS next week

Financial journalist Ian Fraser hears from former insiders about the inadequate safeguards which left the bank open to huge losses.

Soon after it was formed from the merger of Halifax and Bank of Scotland in 2001, HBOS embarked on rapid growth strategy and adopted a "pile em high and sell em cheap" approach to the banking market.

The Edinburgh-based bank was determined to rapidly win market share from the "Big Four", Barclays, HSBC, Lloyds and NatWest/RBS, banks that some members of HBOS's top brass regarded as stuffy and conservative.

The Bank of Scotland was already considered to be an aggressive player in the corporate market, before its merger with Halifax.

It had what was seen as an "atypical" approach to credit approvals and the provision made for bad debts (the amount set aside to cover corporate customers who go bust), and the loans which have to be written off.

'Too risky'

Following the Halifax merger, salesmanship predominated and executives were incentivised to expand the loan book without, it now seems, the normal checks and balances. Employees responsible for growing deposits and risk management were alleged to have been treated as second class citizens.

The merged banks risk management and credit checking processes struggled to keep pace with its rapid growth.

One former relationship manager said: "They didn't have their risk management infrastructure in place at all. They behaved in a very reckless fashion. Nothing was done properly."

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Some of the worst excesses seem to have occurred in the area of impaired and high-risk assets, bad debts and provisioning.

"The bank had an ad hoc approach to this whole area," said one ex-relationship manager.

For example, Bank of Scotland Corporate, HBOS's corporate lending arm, had a policy of continuing to lend to companies which other banks would have recognised as insolvent and put into administration.

On some occasions, it is claimed the bank was told by appointed advisers that a corporate customer was technically bankrupt and should have been put into administration with the bad debt taken as a loss on the bank's bottom line. But the bank still kept the businesses afloat.

Bigger bonuses

This enabled the bank to book the customers interest payments as profit and to limit losses associated with writedowns and bad debts.

The larger loan book enabled the bank's former board of directors to boost their pay packets, since the continued interest payments could be booked as profits, which translated into a stronger share price and bigger bonuses for executives.

Even though a system of credit committees was established within the bank's corporate lending arm following the Halifax merger, sources claim it was largely ineffectual.

Those with knowledge of the bank say its corporate lending team became a self-policing fiefdom under former chief executives Sir James Crosby and Andy Hornby.

HBOS may also have believed that it was managing risks by syndicating and selling down debt.

"The head of Corporate at the bank, was also chairman of the credit risk committee of corporate," said the bank's former head of group regulatory risk, Paul Moore.

'No safeguards'

This meant he was essentially signing off his own loans.

One turnaround consultant said: "HBOS was widely known in the market to be doing this [keeping insolvent corporate customers afloat]. It was a very short-termist approach. They were showing no interest in the capital."

"Sometimes the 'high risk' department would gamble on a loan coming good, and would continue to lend, when the prudent thing to have done would have been to have recognised the loss, and shut down the business [put it into administration] so you had no more exposure," said one former relationship manager at Bank of Scotland Corporate.

Other banks such as Barclays have a separate credit team which is not involved in either sales or relationships. However at BoS there was no such separation of the powers.

Sir Peter Burt, who stepped down as HBOS's executive deputy chairman in early 2003, said: "If that is true, then there was a complete failure of corporate governance. The chairman of a credit committee should never be the individual who is sponsoring the proposal. The danger is the chairman would be parti pris."

Sir Peter added: "Without proper checks and balances there can be no control over lending."

'Reckless lending'

Others have suggested that the bank's bonus system definitely had the effect of encouraging reckless lending.

One former insider has said that he thinks the reporting structure in HBOS, and particularly its lack of a separate credit team, may have enabled some in its 'high risk' team to keep the corporate board in the dark about their exposure to individual companies.

Already £11.5bn of taxpayers' money has been injected into HBOS to shore up its capital position, without which the bank would have gone bust last October.

The problem of reckless lending at BoS Corporate first became apparent last year. Much more will be needed as the bank's bad debts come home to roost in the coming months and years.

Bank of Scotland would not be interviewed about its lending and credit management systems at the time, but in a statement told the BBC it deals in a sensitive and fair way with all of its corporate banking customers, including those experiencing difficulties.

"We simply cannot comment on individual circumstances. However, we strongly believe that we have acted throughout in a fair and responsible way".