Abstract
HBOS plc, a UK-based financial institution, initially appeared as a remarkable success story in the banking industry. 2001 marked a pivotal moment when Halifax and Bank of Scotland joined forces to create HBOS. For the subsequent six years, it achieved substantial double-digit profits, solidifying its position. In 2007, the bank’s market capitalization soared to an impressive £40 billion.
While HBOS garnered accolades from analysts and brokers for its apparent success, beneath the surface, its business model proved susceptible to economic fluctuations due to what was identified as a flawed strategy and inadequate risk management practices. These critical shortcomings left the bank ill-prepared to navigate the global financial crisis. In October 2008, HBOS faced a severe crisis and ultimately merged with Lloyds Banking Group.
This case delves into the intricacies of HBOS’s strategy, internal and external governance issues and the changing business environment. It serves as an invaluable tool for students seeking to comprehend the factors that led to the company’s downfall. Several pressing questions are raised, including the role of accounting improprieties, the effectiveness of the risk management system, internal governance and the inability of the board and auditors to foresee the impending challenges within the company.
Discussion Questions
How did HBOS attain its status as one of the largest banks in the UK?
What were the key factors that contributed to the failure of HBOS?
To what extent did the FSA play a role in the HBOS situation?
What insights can be gained from examining HBOS’s risk management framework?
In September 2012, Peter Cummings, the former head of the Corporate Division at HBOS plc, a prominent banking and insurance company, faced severe repercussions from the Financial Services Authority (FSA). He received a lifetime ban and a £500,000 fine for his involvement in the banking crisis and failure to exercise due skill, care and diligence in managing the division. Cummings was held responsible for overseeing bad loans amounting to £26 billion, which played a pivotal role in pushing HBOS to the brink of collapse.
HBOS, a subsidiary of the UK-based Bank of Scotland, also endured significant turmoil during the economic recession, eventually being acquired by Lloyds Banking Group. The bank grappled with a multitude of challenges, rendering its survival unsustainable. In its annual reports for the year ending 31 December 2007, HBOS boasted a profit before tax of £5.5 billion. Yet, just eight months later, the bank ceased to exist, marking the second-largest failure in British banking history. The bank’s 2008 accounts revealed an irrecoverable loss of £11 billion, including a staggering impairment charge of £12 billion, reflecting the write-off of worthless goodwill.
A confluence of macroeconomic factors, such as the 9/11 and dot-com crises, had a profound impact on the global and UK economies. The subprime crisis further compounded the challenges faced by HBOS, jeopardizing its very survival. In a desperate pursuit of revenue, HBOS had adopted a high-risk business model coupled with aggressive strategies that exposed the bank to severe adversities. Contributing to the derailment of the bank’s operations were financial irregularities and a lackadaisical attitude among auditors, regulators, the board and senior staff.
The decline of HBOS offers valuable lessons in business and bank management. The factors contributing to its significant downfall encompassed poor strategy, an inadequate business model, ineffective leadership, excessive greed, weak control systems, as well as organized crime, ineffective regulatory mechanisms and macroeconomic influences, among others.
Economic Turmoil and the Domino Effect
9/11 and Dot-com Crises
The dot-com bubble, also known as the Internet bubble, left a significant impact on the entire US economy. Dot-com companies infused immense confidence into investors and the markets from 1995 to 2000. Investors flocked to Internet-based startups, envisioning them as future tech giants. By the late 1990s, the hype surrounding these dot-com companies had reached a zenith, driving the equity markets predominantly.
Investors were captivated by the lofty promises made by dot-com companies. Traditional performance and predictability metrics like the P/E and debt–equity ratios were conveniently overlooked. New and enticing indicators such as brand building and rapid market share acquisition took precedence. Fueled by the success of early entrants like Cisco and Oracle, investors believed that these new-age businesses, the dot-com companies, would determine economic growth.
In addition to this optimism, certain regulatory developments in the United States, such as the Taxpayer Relief Act of 1997 (which lowered capital gains tax and encouraged speculative investments) and the Telecommunications Act of 1996 (promising new technologies and profit opportunities), further bolstered the optimistic outlook on the dot-com market. With support from investors and regulators, as well as the enthusiasm of entrepreneurs and Internet-savvy individuals, the dot-com sector ballooned into a massive bubble. Between 1995 and 2000, the Nasdaq Composite stock market index surged 400%, capturing everyone’s fascination. Many individuals even left their jobs to pursue day trading full-time.
However, in March 2000, Japan faced a severe recession, leading to the technology stock meltdown and the brink of bankruptcy for many startup firms. Confidence waned, and investors began withdrawing their money. The year 2000, despite being the turn of the millennium, brought challenges for the dot-com sector, and additional adverse developments, such as accounting scandals (e.g. Enron and Tyco) and anti-trust cases (e.g. Microsoft), further eroded investor confidence and led to share price declines. By November 2000, most Internet stocks had lost 75% of their value, wiping off approximately $1.755 trillion from the market. This crash had adverse effects on the UK banking system, including HBOS.
As the economy grappled with the aftermath of the dot-com bubble burst, the 11 September 2001 terrorist attacks on the World Trade Center plunged it into even deeper adversities. The attacks severely affected the US economy, resulting in an estimated cost of around $3.3 trillion (Amadeo, 2018). By 2003, the Federal Reserve lowered its benchmark rate to 1%, marking a 45-year low and the lowest viable level.
Subprime Crisis
By 2007, the US economy and the global financial landscape were heading towards another looming disaster. The US housing sector had experienced a significant boom in the early 2000s. By June 2004, housing prices were soaring, prompting the then-chairman of the US Federal Reserve, Alan Greenspan, to take action. To cool the overheated housing market, Greenspan initiated a series of interest rate hikes.
Between June and December 2004, the Fed raised the Fed funds rate six times, reaching 2.25%. With two more rate increases, by December 2005, the rate had climbed to 4.25%. This course of interest rate hikes continued under Ben Bernanke, Greenspan’s successor. After four additional rate increases, by June 2006, the rate had peaked at 5.25%.
However, the real estate sector, known for its cyclical nature, began to decline in 2006. A double jinx of high interest rates and declining housing prices rendered it unfeasible for homeowners to sustain their mortgage payments. This situation led to widespread defaults on housing loans and other subprime loans across the United States. The subprime crisis inflicted a staggering $22 trillion blow on the US economy, with inevitable repercussions felt in other countries, including the UK. The ripple effect disrupted international interbank liquidity, affecting the UK and global financial systems.
HBOS High-risk Business Model
Halifax Building Society, established in 1853, was founded with a central mission to bring mutual benefits to the local workforce. Its model involved individuals with surplus funds investing in Halifax, while borrowers accessed loans to finance home purchases. By 1993, Halifax had become the largest building society in the UK. In 1997, it transitioned into a public limited company and secured its place on the FTSE index.
In 2001, the Bank of Scotland merged with Halifax, forming HBOS plc (HBOS), a UK-based public limited company. Following the merger, the bank faced immediate pressure to perform and deliver results. The trio of Peter Cummings, a long-serving senior executive with Halifax; James Crosby, chief executive; and Lord Stevenson, the chairman, devised a high-risk business model and executed an aggressive lending strategy. Their focus was primarily on growth and optimism, often at the expense of prudence and sound judgement. Their strategy revolved around four key targets:
Achieving a 20% return on equity Pursuing aggressive growth targets Securing a market share of 15–20% in key markets Maintaining tight cost control (Andrew Green, 2015)
While the bank had clearly defined ambitious targets, it failed to conduct sufficient due diligence in identifying and quantifying the underlying risks. It disregarded effective risk-centric measures that would have supervised and constrained asset growth. The bank approved an excessive number of large loans to a limited number of borrowers, making recovery seem nearly impossible. According to the FSA, ‘the bank was overly optimistic about bad debts and did not take “reasonable care” to control its affairs’.
HBOS’s high-risk strategy provided significant support to entrepreneurs experimenting with various business ventures. By the end of 2005, the Corporate Division’s top thirty exposures represented 15% (£19.2 billion) of its portfolio, which increased to 21% (£30.9 billion) by 2008. Out of the top thirty exposures, fourteen exceeded £1 billion. These decisions were radical, the risk stance was hazardous and the strategy was fragile. It was clearly a bubble on the brink of bursting.
The mounting pressure on the bank to generate income drove it towards riskier avenues. All bank divisions escalated their risk profiles in pursuit of higher income. HBOS’s aggressive strategy substantially increased its exposure to high-risk commercial property (refer to Exhibit 1).
Over the two years from 2005 to 2007, annual impairment losses recognized in the HBOS Group’s income statement ranged from £1.7 billion to £2.1 billion. In 2007, due to underperformance in retail mortgage lending, corporate loans grew by 22%, and international division loans grew by 38%. The global economic downturn posed challenges for income generation. The bank’s exposure to the real estate sector and impairment in the subprime sector did not yield favourable results for HBOS (refer to Exhibit 2).
In September 2007, HBOS introduced its contingency funding plan, which committed to providing support to Grampian, a special-purpose vehicle, if it faced difficulties. This plan covered assets totalling £18.6 billion. Between 2008 and 2011, these markets became the source of approximately £14.5 billion in impaired loans for HBOS.
The shockwaves hit investors and the market when HBOS released its December 2007 pre-close trading statement. A more detailed 2007 results report followed on 27 February 2008. These reports revealed the bank’s exposure to its debt securities portfolio, totalling £81 billion, which included asset-backed securities of £41.9 billion and Alt-A assets (a classification of mortgages with a risk profile between prime and subprime) accounting for £7 billion. Consequently, HBOS’s shares plunged 23% in the week following the preliminary results announcement.
This chain reaction affected the bank’s liabilities, which began deteriorating. Investor sentiment turned bearish towards HBOS, and they moved from maturing long-term funding to short-dated instruments. By the end of 2008, HBOS had witnessed a significant increase in losses on its lending portfolios, with impairment losses reaching a staggering £13.5 billion.
The board failed to curb the bank’s risky endeavours, especially as the retail vertical underperformed. To compensate for the retail arm’s underperformance, the organization set ambitious targets in the corporate arm without fully assessing the looming challenges posed by its aggressive business model and high-risk strategies.
In April 2008, HBOS sought to strengthen its capital ratios and restore investor confidence by raising £4 billion of capital through a rights issue. This move aimed to conform to Basel II norms, mitigate regulatory capital volatility and address market value erosion (refer to Exhibit 3 and 4).
However, HBOS’s overexposure to the commercial real estate sector and growing concerns among shareholders, investors and analysts about the group’s business model and aggressiveness led to a disappointing response to the rights issue. Only 8.29% of the rights issue was subscribed to, leaving the underwriters to take the remaining shares. Unfortunately, this decision proved too little and too late to restore investors’ confidence, as HBOS’s share price had plummeted by 60% by July 2008.
By the end of 2001, the bank’s loans stood at approximately £55 billion, which ballooned to £123 billion by the end of 2008. During 2001, HBOS had a loan-to-deposit ratio of 143%, which had surged to 198% by the end of 2008 due to the bank’s aggressive strategy and high-risk model. The bank’s funding needs, which were around £61 billion in 2001, had grown to £213 billion by 2008.
While other banks were also impacted by the global economic downturn, HBOS suffered more severely. The Parliamentary Commission on Banking Standards (2013) characterized the bank’s funding position as ‘untenable’ and ‘unsustainable’, describing HBOS as ‘structurally illiquid’.
Cummings was widely seen as the primary factor behind the bank’s near-bankrupt state. As an aggressive dealmaker, he played a pivotal role in exposing HBOS to cyclical and vulnerable sectors such as house building and commercial property. His bold and risky deals had the unfortunate consequence of pushing the bank into a perilous position with unrecoverable losses looming on the horizon. The loans sanctioned by Cummings had greatly expedited the bank’s decline, resulting in approximately £7 billion in impairment charges on the bank’s loan book.
Financial Irregularities at HBOS
A plethora of financial irregularities marred HBOS. Allegations arose that both HBOS and Lloyds had intentionally misled the Financial Conduct Authority (FCA), with these irregularities dating back to as early as October 2008.
In contravention of the FCA’s business principles, HBOS failed to adhere to Principle 3, which stated that ‘a firm must take reasonable care to organize and control its affairs responsibly and effectively, with adequate risk management systems’. Additionally, it violated Principle 9, which required that ‘a firm must take reasonable care to ensure the suitability of its advice and discretionary decisions for any customer who is entitled to rely upon its judgment’. Tracey McDermott, the FCA’s acting director of enforcement, expressed how the conduct of Bank of Scotland (HBOS) not only incurred massive costs for the firm but also led to losses for shareholders, taxpayers and the economy (Principles for Business, FCA Handbook, 2018).
The bank not only adopted an aggressive stance but also kept regulators and shareholders in the dark by providing misinformation. Lord Stevenson had described the bank as ‘highly conservative’ and ‘as secure a position as it could be’ in filings to the regulator (The Guardian, 2012). Alongside the aggressive strategy, it became evident that the quality of the loans was subpar, underscoring a lack of scrutiny and ineffective audit controls within the bank. The bank’s overexposure to riskier sectors, such as property and construction (amounting to £25 billion by 2011), pushed it to an unrecoverable state.
As described by the parliamentary committee, its ‘wildly ambitious growth strategy’ brought particular pain through its international portfolios in Australia and Ireland, contributing significantly to the bank’s woes. HBOS was disproportionately exposed to the Commercial Real Estate (CRE) sector, which was considered highly cyclical. By the end of 2007, HBOS’s exposure to the CRE sector represented 75%–80% of its sundry loans. This overexposure reflected a lack of prudence on the part of HBOS’s board. By the end of 2007, the Corporate Division’s portfolio was exposed to the CRE sector to the tune of £76 billion, further burdened by approximately £12 billion of Irish portfolio and £6 billion of Australian portfolio from the International Division.
The committee pointed out that, ultimately, the ‘strategy for aggressive, asset-led growth’ was what led to HBOS’s downfall. The fault also lay with the board and control systems, which failed to challenge the decisions and actions of executive management in a timely manner. In addition to the overexposure to cyclical sectors and poor credit quality, HBOS’s loans were characterized by an extended period of capital inflows to developed economies, leading to low yields and asset price bubbles. Lord Nigel Turnbull, who chaired the committee that wrote the report for listed companies on their internal controls and code of conduct, remarked, ‘This is a story of a retail and commercial bank, rather than an investment bank, brought down by ill-judged lending, poor risk control, and inadequate liquidity. Its strategy was flawed from the start’.
Analysts reasoned that the downfall resulted from ‘a combination of significant structured credit exposures, concentration in UK property, and funding pressures [that] placed HBOS in the eye of a perfect storm’. As of mid-2008, HBOS had lost its sustainability and strength to stand on its own. The options were either to shut down or be acquired by a larger organization. The UK government intervened to facilitate the acquisition of HBOS by Lloyds Banking Group (Lloyds).
Lloyds Acquisition
To facilitate the acquisition of HBOS, Lloyds was compelled to increase its provision for bad debts, raising it from £3.3 billion in December 2008 to £7 billion in February 2009. This move exposed Lloyds to substantial risks, leading to legal action by over 6,000 Lloyds shareholders in 2009. They sued Lloyds and its key personnel for the losses incurred due to the acquisition.
Lloyds faced severe criticism and opposition for defending a bank fraught with numerous issues, including a flawed strategy, an imperfect business model, troubled assets and financial irregularities. The unapologetic stance of Lloyds’s top executives amidst investor losses drew considerable backlash.
Allegations suggested that Lloyds was aware of financial irregularities even before the UK government proposed the acquisition of HBOS (Ford, 2018). The irregularities, initially estimated at £800 million during the merger, were later reduced to £245 million in the financial statements (Shipton, 2018). There were claims that the audit firm KPMG might have been involved in irregularities within HBOS’s books. Lloyds was accused of downplaying the risks associated with the HBOS takeover and concealing critical information from shareholders, including HBOS’s risk status and solvency (Peston, 2011).
Confidential letters revealed that regulators feared the potential evaporation of funding for other banks if sensitive and damaging information about HBOS’s discrepancies were made public. This raised suspicions of a coordinated effort involving regulators, auditors, Lloyds and HBOS to ensure the acquisition’s success.
Between 2006 and 2007, HBOS received £25.4 billion in emergency liquidity support from the government. Notably, there was no mention of this capital injection in Lloyds’ acquisition circular. Former BBC reporter Alice Beer claimed that information had been deliberately withheld to secure the merger, with government officials, Lloyds’s chairman, HBOS directors, the FSA and the bank allegedly aware of the situation. Ordinary individuals, however, were left in the dark about the risks their savings faced in this questionable deal.
Despite the controversy, Lloyds maintained its position on the acquisition, asserting it would ultimately benefit shareholders. The bank’s spokesperson emphasized their belief in the acquisition’s potential long-term benefits and their commitment to vigorously defending the group’s stance in case of legal action.
Lloyds’s shareholders organized a protest under the banner of Lloyds Action Now (LAN) to seek compensation for the losses incurred due to the merger of Lloyds TSB Bank with HBOS. This group voiced its protest by highlighting that various parties, including Lloyds’s directors and advisors, the government, the FSA and the Bank of England, were fully aware of HBOS’s effective bankruptcy before the merger but proceeded with it, nonetheless.
According to LAN, approximately 800,000 individual shareholders suffered financial losses due to bad loans stemming from the merger. Lloyds’s chief executive, Eric Daniels, acknowledged that Lloyds’s shareholders were not consulted before the deal was finalized.
Loose Ends
KPMG
KPMG faced allegations regarding its role in inadequately reporting on HBOS’s risk position. Several senior management and board members at HBOS claimed that KPMG’s reports indicated that the bank’s impairment provisions were within an ‘acceptable range’ (Warmoll, 2015). Shareholders were disappointed that KPMG did not conduct more rigorous and sincere auditing as the official auditor of HBOS and did not make a correct assessment of impairments.
During the review period (2006–2007), KPMG independently assessed loans in the ‘bad book’, which included high-risk loans not yet classified as impaired. However, KPMG did not directly review loans in the ‘good book’ to verify the authenticity and validity of these loans (Dixon, 2017). Additionally, it was alleged that the Corporate Division did not fairly categorize its loans based on their distress levels.
In 2006, KPMG’s year-end report on the Corporate Division’s risk control practices described the investment portfolio as conservative. The report portrayed KPMG’s auditing as comprehensive, sufficient and fair. KPMG’s report concluded that HBOS’s corporate provisions complied with general IFRS standards, and no concerning issues needed to be reported to the group.
However, KPMG’s interim report in 2007 presented contrasting observations compared to its previous report, which many shareholders viewed as a phased approach to revealing the facts. The report indicated a significant deterioration in several key credit quality indicators, such as increased impaired loans and reduced provisioning to impaired assets. Despite these concerning findings, KPMG did not clearly communicate the hard facts and stated that ‘management believes there is sufficient security coverage or enterprise value in the Impaired-With-Loss book’. In its February 2008 report to the Corporate Risk Control Committee, KPMG reiterated that the asset quality should not be seen as indicative of HBOS’s underlying credit quality but rather related to the adjustments required for Basel II norms.
In its 2008 year-end report, KPMG cautioned that HBOS’s credit provisions were overly aggressive compared to its recent history, and most of its impairment provisions had fallen outside the expected range.
KPMG faced criticism from various quarters and was closely scrutinized for its delayed identification of the troubled situation at HBOS. In 2016, approximately eight years after the crisis, the Financial Reporting Council (FRC) initiated an investigation into KPMG. However, by the end of 2017, KPMG was cleared of the charges. The FRC’s observations concluded that ‘the firm’s audit of HBOS’s 2007 results did not fall significantly short of the standards reasonably to be expected’. The report further stated that KPMG’s assessment of HBOS’s health in 2008 was within reasonable limits. After a fifteen-month investigation, the FRC determined that it was beyond KPMG’s control to anticipate the extreme market conditions and make accurate assessments.
FSA
Criticism was directed at the FSA for its handling of the HBOS crisis. Many believed that the FSA fell short of establishing sufficient safety and soundness standards. Ineffectiveness in global prudence standards and regulations concerning capital adequacy and liquidity were seen as contributing factors to the bank’s downfall.
The FSA was faulted for not taking a proactive role in warning the bank about its lending exposure and credit quality. The FSA and the board were criticized for inadequate oversight of the bank’s aggressive strategies (Chu, 2015). A parliamentary committee led by Turnbull raised concerns about the risk assessment process at HBOS, highlighting its insufficient attention to strategic and business model–related risks. Critical aspects like asset quality and liquidity received minimal consideration from both the board and the control systems at the bank and FSA.
Andrew Tyrie, chairman of the Parliamentary Commission on Banking Standards, described this as a case study of how not to manage a bank and regulate it. He emphasized the lack of a sound culture and strategy at HBOS, leading to reckless lending policies and weak risk management, ultimately resulting in a financial crisis.
This situation highlighted an overreliance on the competence of the executive team, coupled with insufficient scrutiny and challenge from the board and FSA. Before the review period, the FSA had identified several key risks that would later contribute to the firm’s failure. However, the FSA failed to implement measures that could have mitigated these identified risks, revealing shortcomings in its supervision approach. There were also allegations that FSA supervisors lacked adequate training to review a firm’s stress test.
Governance
The Prudential Regulation Authority (PRA) and FCA, which published a report on the failure of HBOS, concluded that the primary reason for HBOS’s collapse was the senior management’s failure to develop an appropriate business strategy and a heavy reliance on continuous growth.
The board of non-executive directors (NEDs) had limited banking experience, with only one of the twelve NEDs possessing a background in banking. This lack of expertise within the board hindered its ability to provide the necessary support to the executive management. Additionally, the executive management team lacked sufficient banking experience, and the NEDs were not adequately informed about banking, regulatory and governance mechanisms. Experts suggested that a board with a deeper understanding of banking intricacies might have benefited HBOS.
In most organizations, the board played a crucial role in strategy approval. However, at HBOS, the board had a limited role in strategic planning, with much of it falling to the CEO. Due to their lack of banking experience, board members struggled to comprehend the risks of running a bank and how to manage them.
Internal controls and risk management practices were considered insufficient, with a weak risk culture prevailing throughout the organization. The absence of a risk committee within the board and the low priority given to risk management were highlighted issues.
Experts argued that the chairman of the board should have overseen the board’s performance to ensure its proper functioning. Simultaneously, the bank’s executive leadership primarily came from retail and insurance backgrounds, and the board, with its limited knowledge of banking, relied heavily on the leadership. According to Oliver Parry, senior corporate governance adviser at the Institute of Directors, ‘HBOS may have been swept up in a global financial crash, but the regulators are clear that a lack of expert oversight from the HBOS board made it “inherently vulnerable”’.
Reading Incident
Amid the systemic and organizational challenges facing HBOS, an unexpected development at its Reading 1 branch sent shockwaves through the bank. On 3 October 2010, Lyndon Scourfield, a former HBOS director, was arrested on corruption charges, along with his wife, Jacquie Scourfield; Tony Cartwright; and David Mills. The scandal revolved around Scourfield’s misuse of his position to direct companies to Quayside Corporate Services (QCS), a company controlled by Mills. He influenced small enterprises to seek turnaround services from QCS.
Scourfield, as the head of the bank’s Impaired Assets Division, conspired with partners like David Mills and Michael Bancroft, the owners of Quayside Consultants. Scourfield was expected to introduce business owners to QCS as part of their agreement. However, QCS lacked credibility and qualifications for these services, employing staff with criminal backgrounds, primarily in embezzlement. An article by Tommy Kelly in Daily Mail said, ‘Reading was behaving like the “Mafia”, they would then use threats and extortion to seize control of the businesses, plundering bank accounts and pocketing massive new loans granted in their name’.
Between 2002 and 2007, small business owners labelled as weak and high-risk were transferred to HBOS’s corporate division in Reading despite having a good repayment history. QCS saw these owners as potential clients and proposed additional financing against their wishes. Scourfield facilitated these additional funds by leveraging his influence and circumventing internal checks.
Under the guise of a turnaround expert, QCS siphoned off large sums from these companies as consulting fees. Scourfield received substantial financial benefits, luxury items and even trips to Barbados and Cannes, while Mills and Cartwright stripped assets from many small businesses, leaving them with no choice but bankruptcy.
There were suspicions that the organized crime in the Reading branch was not unknown to other stakeholders. Customers had voiced concerns in 2007, and it even became a topic of debate in the British Parliament in 2010.
Paul and Nikki Turner, owners of Zenith, a publishing company, were among the victims of the Reading fraud. They reported the fraud, but their pleas were ignored for years, resulting in their company’s closure. Nikki said, ‘They defrauded us, denied for ten years that the fraud had happened, ignored the debt from the fraud and tried to evict us 22 times to cover up the fraud’. She added, ‘Other victims have gone through terrible things also. They have lost their businesses and homes’.
It was also alleged that Lloyds had knowledge of the scandal and the financial repercussions of the same on HBOS (Withers, 2017). When Sally Masterton, one of the employees of the high-risk division in HBOS, attempted to blow the whistle about the scandal, Lloyds allegedly tried to silence her. Masterton’s observations claimed that certain HBOS employees had orchestrated a fraud and concealed the facts related to the fraud. Masterton produced the report later in 2013, which stated that Lloyds had gathered evidence of HBOS’s financial status and the fraud that had taken place in the Reading branch of the bank. The report criticized Lloyds’s lackadaisical attitude towards Reading fraud and held it responsible for the sinking and suffering of many of its corporate clients.
The report had accused Lloyds of failing to conduct an adequate investigation into the Reading fraud. However, in the interest of the bank and the stakeholders involved, Lloyds kept quiet about the issue and conducted the takeover silently. Lloyds had explicitly claimed innocence about the fraud at Reading and the criminality of the executives at the branch. According to Anthony Stansfeld, police and crime commissioner at Thames Valley police, Lloyds ensured that Masterton quit her job. Stansfeld said, ‘I find it extraordinary that the bank saw fit to remove the employee who wrote the report and who at the time assisting the police in the investigation of the massive HBOS fraud’. He further said, ‘I have to suspect that it was because of the assistance given to the police that this happened’. 2 The bank, however, downplayed her departure as a decision prompted by her personal reasons and nothing related to official reasons.
In 2010, investigations began, revealing gross violations and misconduct at the Reading branch. Lloyds retaliated by labelling Masterton’s claims as unsubstantiated allegations with inadequate supporting evidence. The scam cost many hard-working middle-class business owners their livelihoods, homes, pensions and savings and even resulted in broken marriages. Jurors estimated the fraud’s worth at £245 million, but victims and police sources suggested the cost to small firms affected was up to £1 billion.
In January 2017, Scourfield was sentenced to 11 years and 3 months in prison, Mills received a 15-year sentence and Cartwright was sentenced to 3.5 years. During sentencing, Judge Martin Beddoe described the case as an ‘utterly corrupt senior bank manager letting rapaciously greedy people get their hands on vast amounts of bank money and their tentacles into ordinary and honest businesses’. 3
Footnotes
Declaration of Conflicting Interests
The authors declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.
Funding
The authors received no financial support for the research, authorship and/or publication of this article.
Appendix
Comparison of HBOS’s Basel I and Basel II Measures as of December 2007.
| Basel I | Basel II | |
| Tier 1 capital resources (£ billion) | 24.4 | 23.8 |
| Total capital resources (£ billion) | 36.7 | 33.9 |
| Risk weighted assets (RWAs, £ billion) | 330.8 | 309.2 |
| Tier 1 ratio | 7.40% | 7.70% |
| Total capital ratio | 11.10% | 11.00% |
| FSA capital guidance (ICR/ICG, %) | 9% | 8.70% |
| Minimum capital requirement (8% of RWAs, £ billion) | 26.5 | 24.7 |
| Surplus over minimum requirement (£ billion) | 10.2 | 9.2 |
| FSA guidance (ICR/ICG, £ billion) | 29.8 | 26.8 |
| Surplus over guidance (£ billion) | 6.9 | 7.1 |