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BACKGROUND INFORMATION
One upon a time (more than 300 years ago), the island of Great Britain had three kingdoms:
Scotland in the north and England and Wales in the south.
In 1707, Scotland united with England and Wales, creating the kingdom of Great Britain.1
Prior to the Global Financial Crisis, Scotland had two major banks, both based in Edinburgh
(the capital of Scotland)
• The Bank of Scotland (BOS) which was established in 1695.
• The Royal Bank of Scotland (RBS), which was established in 1727.
In the 1990s, both Scottish banks decided to expand by competing with the larger banks
which were "south of the border" (i.e. in England).
The Bank of Scotland took over an English Bank called Halifax and the merged entity became
HBOS (=Halifax + BOS). HBOS later expanded into Ireland and Australia (it owned Bankwest,
which is based in Western Australia). HBOS also became involved in structured finance
operations, via a subsidiary called Grampian. HBOS became the fifth largest bank in the
United Kingdom.
RBS took over a large English bank called NatWest and the merger was quite successful,
leading to an increase in profitability. RBS then made several more acquisitions, in the USA
and several other countries. In the United States, RBS bought a bank called Citizen’s, and
also an operation involving structured finance which was based in Greenwich. By the end of
2007, RBS became the largest bank in the world (measured by assets).
Both banks appeared to be very successful during the period from 2000 to 2007. Their
profitability and their share prices increased.
However, both banks suffered catastrophic problems during the Global Financial Crisis –
especially after the collapse of Lehman Brothers in mid‐September 2008. The graphs on the
next page show the share prices of HBOS and RBS.
1 Much later, Great Britain joined up with Northern Ireland, and together these countries form the
United Kingdom.
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In September 2008, a few days after Lehman collapsed, HBOS needed to be rescued. The
government agreed to allow another bank, Lloyds, to take over HBOS. (It took a while to
organise this, so the takeover was not completed until January 2009).
On October 7, 2008, three weeks after the collapse of Lehman, the chairman of RBS rang up
the Chancellor of the British government and said that he thought RBS bank would be
insolvent within a few hours, unless the government rescued them.
These banks were both “Too Big to Fail”: the failure of either bank would have had
devastating consequences for the British economy. So the government did intervene,
providing both liquidity and capital to both banks (and a few other smaller banks as well)
• Liquidity. In October 2008 both banks had to bo
ow billions of dollars from the Bank
of England to meet liquidity needs. (In the reports, this is called “Emergency Liquidity
Assistance”). HBOS bo
owed £25 billion and RBS bo
owed £29 billion plus $25
illion in US dollars. This was done secretly because no one wanted the general
public to realise the severity of the problems at these banks.
• Capital. Both banks desperately needed additional capital, which was provided by
the UK government. The banks raised capital by issuing new shares, which were then
purchased by the government.
For HBOS, the government provided several billion dollars in capital in October 2008. The
government also a
anged for a stronger bank (Lloyds) to take over HBOS in January 2009.
However this turned out to be a bad deal for Lloyds, because Lloyds soon discovered that
HBOS’s losses were even larger than expected. As a result, Lloyds itself needed to obtain
more capital from the government. The total amount provided to cover HBOS’s losses was
above £20 billion. After the bailout, the UK government owned 43% of Lloyds.
It would be fair to say that these cases indicate some serious flaws in the management and
egulation of British banks.
The British regulators were the FSA and the Bank of England.
• The Financial Services Authority (FSA) which was responsible for prudential
supervision. The FSA’s role was roughly equivalent to the Australian APRA.
• The Bank of England was the central bank which was responsible for financial
stability. The Bank of England’s role is roughly equivalent to the Reserve Bank of
Australia.
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The FSA was severely criticised for failing to prevent the enormous losses caused by the
failures of HBOS and RBS. The FSA was abolished in 2012 and replaced with two new
egulators (the Financial Conduct Authority and the Prudential Regulation Authority)
Your task:
Write an essay (2000 words) to answer the following questions:
Q1. Why did HBOS fail? Your answer should include a description of
o Weaknesses in the management of lending (credit risk)
o Weaknesses in the management of liquidity risk (funding)
o Weaknesses in the Board of Directors and Risk Management Controls
Q2. Why did the FSA fail to prevent this failure?
Recommended Sources:
Some useful source material will be provided on iLearn, in a folder labelled Sources for HBOS
Assignment. These sources include
An Accident Waiting to Happen: The Failure of HBOS. The House of Commons
Parliamentary Commission on Banking Standards, (2013),
https:
publications.parliament.uk/pa/jt201213/jtselect/jtpcbs/144/144.pdf
Hu
is: How HBOS wrecked the Best Bank in Britain, by Ray Perman. Perman is a
journalist so this is well written and easy to understand. You don’t have to read all of
the historical information going back to 1695! The most relevant chapters for your
eport are Chapters 14, 17, and 18, and these are available on iLearn. If you want to
ead more, the entire book is available in electronic form via the University li
ary,
via the Proquest ebook li
ary (Just search for “HUBRIS HOW HBOS WRECKED” on
the li
ary’s Multisearch).
The Failure of HBOS plc. A report by the Financial Conduct Authority (FCA) and the
Prudential Regulation Authority (November 2015) https:
www.bankofengland.co.uk/-
media
oe/files/prudential-regulation/publication/hbos-complete-report. This is a very
long detailed report, it has a lot more information than you need to write your essay
– but the executive summary is only about 30 pages.
Final Notice from the Financial Services Authority to Bank of Scotland plc, dated 9
March 2012, https:
www.fca.org.uk/publication/final-notices
ankofscotlandplc.pdf This
is a critique of the bank’s risk management standards, written by the regulator. It
tends to get a bit technical.
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You might also find it useful to look up information on Factiva. Factiva is an electronic
database which is available via the Macquarie University Li
ary. It has articles from a very
wide range of sources, including most of the major newspapers and from financial news
services. It is very helpful for studying financial history and keeping up to date with
developments in financial markets. We will provide a
ief video to show you how to look
up information on Factiva.
In order to find academic research papers, you can look on Google Scholar. Most of the
papers listed on Google Scholar have been published in peer-reviewed academic journals –
so they are likely to be more accurate than other information available on the internet.
Most of these papers will also be available (for free!) via the University li
ary’s website
(using Multisearch).
Referencing
You should ALWAYS give your references – the Uni has an academic honesty policy which
equires this. If you do not cite your references, then you may face disciplinary action and
you will certainly lose marks.
There are several different referencing styles. You may use Harvard Referencing – a guide is
available at http:
www.citethisforme.com/harvard-referencing. If you wish to use a
different form of referencing, that’s fine, as long as you provide all the same information
specified in the Harvard Referencing System. (Most referencing systems provide the same
information, but it is just presented in a different order and format).
Wikipedia and Investopedia
Wikipedia and Investopedia often have good summaries of the facts, and may also give you
some references for further reading. So these sources are not bad starting points. However
if you simply summarise a Wikipedia article you are unlikely to get good marks. You are
likely to get higher marks for your reports if you do some additional reading and thinking.
You should be aware that sometimes Wikipedia may NOT always be reliable. This is
especially likely to be a risk in controversial cases and/or where the people involved in the
case try to change the Wikipedia entries to make themselves look better (I’ll point out some
examples of this during the term). So it is a good idea to check other independent sources.
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Marking Criteria
Your report will be assessed on
(a) your demonstrated understanding of the issues and
(c) your ability to communicate clearly.
Lending Does the student show a good understanding of the reasons
for HBOS’s enormous losses?
5 marks
Liquidity Does the student show a good understanding of the reasons
for HBOS’s liquidity problems?
3 marks
Board of
Directors / Risk
Controls
Does the student show a good understanding of the
weaknesses in HBOS’s board of directors and risk
management controls?
2 marks
Regulation Does the student show a good understanding of the reasons
why the FSA failed to prevent the failure of HBOS?
3 marks
Presentation Is the information presented clearly? Does the report have
headings and diagrams or graphs (where appropriate)?
Does the report have a logical structure? Is the report
presented in the student’s own words, or is there an
excessive reliance on cutting and pasting? Has the student
provided references for all sources of information?
2 marks
Total 15 marks
Warning against a Cut-and-Paste approach
Note that if you simply copy sections from any source (i.e. cut-and-paste), you have not
demonstrated much understanding – it simply demonstrates your ability to cut and paste
(which is a useful skill but not what we are looking for here!). So please express the ideas in
your own words. You will not get