Hubris: How HBOS Wrecked the Best Bank in Britain (6 page)

Very few people were recruited from other professions and if they were it was generally acknowledged that their careers would be limited. Unless you had ‘passed money over the
counter’ you could not reach the top. Time-served bankers filled every post, in personnel (not yet called HR), in the management of computer departments (not yet called IT) and in marketing.
This led to an in-bred, conservative
culture, but also to an immensely strong sense of shared values. Talent and hard work were no guarantee that you would rise. After the
merger of Bank of Scotland and British Linen Bank it was agreed that promotions would be in turns, one from each bank, rather than on merit.
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It was a paternalistic world. Margaret Taylor
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remembers the Bank as being ‘a very sleepy sector and was seen as full of dusty old
men and dusty old offices, and actually was. The sector was entirely different to what it is now, banks didn’t really have to go out looking for custom at that time, people came to them, and
there wasn’t the same competitiveness. The old idea that if you work in a bank you’re well looked after and you’ve got a job for life and a cheap mortgage still
prevailed.’

Staff were expected to open accounts with the Bank and use them to conduct all their financial affairs. David Jenkins, who joined from academic life as the Bank’s Economist in 1976, was
shocked to be told that not only must he move his own account to Bank of Scotland, but his wife must do so too. This was partly so that the Bank could keep an eye on its staff and know if any of
them were getting into financial difficulties which might affect their work, but it was also a big source of business. ‘Staff Branch’ was very profitable.

Systems within the banks were still mostly paper-based at the start of the 1970s. Bank of Scotland had bought its first IBM computer in the 1950s, but it performed only very basic accounting
tasks and ‘cashing up’ at the end of each day was still the method by which branch managers knew how much business they had done.

They had no idea whether their branch was profitable or not, because they were not told its costs and it is doubtful whether Head Office knew which branches made surpluses and which did not, let
alone which products made money and which lost it (not that banks spoke of ‘products’ in those days). The Chief Accountant (not actually a qualified accountant, but a banker who had
done his Institute exams and come up through the ranks) was the guardian of the balance sheet. His was the responsibility for making sure that the Bank was always solvent. The profitability of the
Bank was a secondary consideration: as long as it earned a profit and could pay a dividend that was enough. No one in the management thought much about the share price and shareholders
(‘proprietors’ in the Bank’s seventeenth-century terminology) seldom complained. Banks were expected to be solid, not to grow.

In England newly affluent workers were opening chequebook current accounts, which paid no interest and incurred charges. But canny Scots clung to their deposit accounts
and the Scottish banks were slow to move them. Frequent bank mergers had left branches dotted along High Streets, often within a few hundred yards of each other, so it was no hardship for a
Scottish bank customer to pop into a branch every time he needed to withdraw cash to pay a bill, rather than use a cheque. In the meantime his balance earned interest and he paid no bank charges.
No wonder the profitability of the Scottish banks lagged behind their southern neighbours.

Scottish banks were austere institutions. The Institute of Bankers did not teach ethics (it does now), but a strict ethical code was implicit in the Presbyterian character of each of the banks.
Lines were imaginary, but everyone knew where they were and once crossed there was no way back. If you were asked to leave the bank, your career in banking was over. Discipline was maintained by
the bank inspection department, which scrutinised lending applications down to very small amounts and made unannounced visits to branches. Gavin Masterton, who later became the Bank’s
Treasurer, remembered his time in the department: ‘Bowler hats were mandatory and you had six white collars delivered every Saturday. Not too many people in Dunfermline wore bowler hats, so I
had to smuggle mine across the River [Forth] to Edinburgh every day.’
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The relationship was not quite that of the KGB to the Soviet Union, but the sudden arrival of the bank inspectors, typically wearing black overcoats and bowlers, could induce anxiety in a branch
manager. The story is told of the inspectors arriving in a northern town, checking into the station hotel during the evening and having dinner and a few drinks before retiring, so that they were
less than fully alert on the doorstep of the branch the following morning when the manager arrived to open up. After spending the day in the vault, counting money and matching totals against the
ledgers, they summoned the manager to his own office for the verdict. All the sums were correct, everything balanced, but the inspectors never liked to leave without finding at least one fault:
‘You have a large amount of Royal Bank notes in your safe,’ they challenged. ‘Well of course,’ replied the puzzled manager, ‘this is the Royal Bank. The Bank of
Scotland branch is on the opposite corner.’ Despite this momentary lapse, the inspection department grew very powerful in the Bank,
exercising sway over promotions as
well as over lending. If the inspectors remembered a bad debt they thought could have been avoided, it might hold back your career.

Bankers lent on the basis of a few simple rules, mostly based on the experience learned from crises past. For example, there was the liquidity rule:

‘Lend short and borrow long’,

a lesson which might have gone back all the way to the Bank’s early struggles against the Darien Company and the Royal Bank. A run on the bank was every senior
banker’s ultimate nightmare, so this rule was designed to make sure you could get your money back from those you lent to before you had to repay those from whom you borrowed it. This rule
propelled banks to look for personal deposits (now known as retail deposits) because individuals were likely to be saving for long-term aims – to pay the deposit on a house, to buy a car, to
pay for a daughter’s wedding or a son’s education, or just against a ‘rainy day’. Having thousands of small depositors also had the advantage that it was very unlikely they
would all want their money back at the same time. It was this rule which also deterred banks from offering mortgages. They did not like having their funds tied up for 25 years and preferred to
leave this market to the building societies.

Then there was the lending rule:

‘Look at the borrower, not the asset’.

The test a manager applied was whether the borrower had sufficient income to repay the loan, even if things went wrong. The value of the asset being purchased which might provide security, was
secondary because a factory, or a company, or a machine tool was worth much less to a bank which had to repossess it and try to sell it again, than to the businessman who had originally bought it.
This test equally applied to individual borrowers when car loans and hire purchase began to be introduced. It meant, in the words of one senior banker, that a Scottish bank manager looked deep into
your soul and only when he was convinced that you did not need the money would he agree to lend it to you. A supplicant could quite often be sent away empty-handed with the manager telling him it
was for his own good, but it also meant that the bad debts of Scottish banks were low.

This was not only the result of careful appraisal before an advance was granted. If things did go wrong, Scottish banks were reluctant to call in a loan and write off a
debt, particularly if that meant plunging a borrower into bankruptcy. They were prepared to accept reduced or deferred payments until such times as the borrower was in better financial shape. In
this they were helped by an accounting regime which was much more lax than it is today. Loans did not have to be publicly branded as ‘non-performing’ or marked down if interest payments
were not being met and they could be hidden away in a suspense account until such time as the loan was repaid or the bank finally had to admit that the money had to be written off.

Supervision of the banking system was the responsibility of the Governor of the Bank of England, a figure held in such awe that it was said that the raising of his eyebrows was enough to deter
behaviour of which he did not approve. Mergers of banks had to be agreed by the Governor, who would not sanction hostile takeovers or a bank being acquired by a non-bank company or a foreign bank
not under British jurisdiction. Scrutiny of the solvency of individual banks was delegated to deputy governors and other senior officials, but their authority was also absolute. One Scottish
executive complained to a Bank of England Deputy Governor that one of his rival banks was almost certainly bust. ‘It is bust when I say it is, laddie, and not before,’ was the
reply.

The primary concern of the Bank of England was to preserve the integrity of the banking system, which ultimately meant protecting depositors from loss, should a bank get into difficulties. Its
authority and competence were severely tested early in the 1970s when a sudden drop in property prices following a long, unsustainable boom precipitated around 30 small banking companies into
bankruptcy. These ‘secondary banks’, as they were known, had broken both fundamental rules of banking. They had borrowed short to grant long-term mortgages on homes and commercial
properties and when the market plunged they were unable to get their money back. They had also been fooled by a period during which property prices had risen dramatically into believing that the
value of the assets against which they had lent could not go down. When interest rates were suddenly increased to 13 per cent, borrowers could not afford their massively increased interest charges
and property prices plunged.

What concerned the Bank of England was that not only were the
individuals and companies which had deposited money with the secondary banks at risk, but so were large
banks, including National Westminster, which had lent to them. It stepped in to support the large banks and oversee an orderly wind-up of the secondary companies. Depositors were safeguarded and
the system survived, but at a cost – and not only to the Bank of England. To ensure that the lesson was well-learned by the rest of the banking system, commercial banks were compelled to meet
part of the cost. The Scottish banks felt aggrieved since the problem was mostly confined to London and the South-east, but nevertheless had to pay up. Bank of Scotland’s share amounted to
£31 million.
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They had also had to meet the cost of mopping up after a more domestic failure a short time before, when the Scottish
Co-operative Bank collapsed.

Regulation and supervision was largely voluntary and relied on all the players understanding the unwritten rules and respecting the authority of the Bank of England. It worked when the
participants were confined to the narrow old boys’ clubs of London and Edinburgh but became stretched when the game began to be played over a wider field. The effectiveness of the
Governors’ eyebrows was tested at the end of the decade when in response to an agreed bid for the Royal Bank of Scotland by Standard Chartered, a British bank headquartered in London, but
with its main activities in the Far East and in Africa, a rival counter bid was made. This came from the Hongkong & Shanghai Banking Corporation (HSBC), which although technically a British
bank, was headquartered in Hong Kong, then a British colony. It did not have the support of the Royal Bank board and the Bank of England Governor made clear his displeasure – and was ignored.
HSBC went ahead with its bid and looked likely to win until the Government referred both bids to the Monopolies Commission. Both were eventually blocked on the grounds that a bid would damage the
‘regional interest’ of Scotland, but it was widely believed that the real reason was to preserve the authority of the Bank of England.

The 1970s were not an easy time to make money in banking. The British economy lurched from boom to bust under the Conservative government of Edward Heath, the Labour governments of Harold Wilson
and James Callaghan and Mrs Margaret Thatcher’s first Conservative administration. Inflation rocketed reaching 22 per cent in 1975, interest rates were high and the Labour Chancellor was
forced to seek a loan from the International Monetary Fund (IMF). Ministers changed policies often. Heath placed restraints on lending, then removed them. Thatcher taxed
deposits and abolished exchange controls. Economic growth was sluggish and companies found it hard to move forward.

The high rate of inflation took its toll on bank costs, which were predominantly wages and salaries. High interest rates gave the banks the opportunity to widen their margins, but high costs and
a poor economic outlook did not encourage customers to borrow. In 1978 Bank of Scotland reported a pre-tax profit of £16.7 million, the same in money terms as it had achieved five years
earlier. When inflation was taken into account the Bank was going backwards rather than forwards, a conclusion confirmed by the fact that its rivals, the Royal Bank and Clydesdale Bank were
achieving much higher returns on their equity.
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The 1970s was a decade dominated by oil. In 1973 came the first ‘Oil Shock’ when Arab oil-producing countries imposed an embargo on supplies in protest at US support for Israel in
the Yom Kippur War. When supplies were resumed, prices were increased dramatically, sending growth rates in Western countries plunging. Further effects took a while to materialise, but in the
meantime Burmah Oil, a Scottish-based international oil company, got into trouble and had to be rescued and restructured. Bank of Scotland lost the account, which had been one of its biggest.

Not all the news was negative. In the early part of the decade oil was discovered in the North Sea, bringing dozens of oil companies to Scotland, and in their wake more than 30 international
banks looking to finance new developments. The London banks, seeing their international competitors getting near to the action, tore up the century-old ‘Gentlemen’s Agreement’ and
opened offices in Edinburgh and Aberdeen. This was initially treated with dismay by those in the headquarters on The Mound who saw only the downside.