News & Articles

The Definition of Insanity

4th March 2009
Lee Werrell

Let's rebuild the banking world, based on the old one.

Rebuilding public confidence in the banking system is "critical" murmur all the world leaders, specifically those who are hardest hit by the financial crisis, strangely enough the G8 members, but that is surely a coincidence, isn´t it?

City speak is often referred to when a long sentence is used to describe an outcome that would not always fit a closed question. For example, is the bank failing? The answer may typically be that a huge number of great successes have been experienced across the diverse and highly profitable sectors of the markets that the bank deals in and this has provided the opportunity to revise the methodology applied in such circumstances to enable re-evaluation of investment strategy to provide the best possible outcome for our customers and stakeholders alike.

Now obviously people don´t want to be thrown into panic and the market would certainly negatively respond to a simple yes, but when this diatribe is repeatedly used, people normally get suspicious and start asking more clarifying and quantifying questions, don´t they?

The recent HBOS debacle has raised some interesting points that would indicate that warning signs had been overlooked to a certain degree by all concerned.

HBOS whistleblower Paul Moore was investigated by KPMG in 2004 which then brings into value and effectiveness of such an investigation and the adoption of the process it was made under.

Back in late 2002, over 6 years ago, the FSA conducted an ARROW assessment of the new HBOS to which identified "a need to strengthen the control infrastructure within the group." Following this, PwC undertook a Section 166 report (under FSMA Section 23) where it was stated that this "revealed a need for improvements in the HBOS risk management environment."

A further ARROW assessment was conducted in late 2004 and noted that "the group risk functions still needed to enhance their ability to influence the business". In mid 2006, the FSA conducted an interim assessment and found that there were "still control issues" and also noted that the growth strategy "posed risks to the whole group and that these risks must be managed and mitigated".

This would suggest that nothing was done at the time to address the concerns of the regulators or even a skilled person report from an established and respected firm. How many times do you get to be tested, found lacking, and still continue without any further counselling or supervision? Had HBOS been a financial adviser, the T&C regime would be accompanying every sale with them.

Perhaps criticism at this level may be unfair, as in response to the FSA comments, in 2004 HBOS decided to upgrade its risk function and dismissed Mr Moore, replacing him with Jo Dawson, seemingly with a strong sales background, an appointment independently reviewed by KPMG and her appointment subsequently approved by the FSA.

Now as the damning words of the FSA were published in December 2004, it would seem strange to appoint someone with no background in compliance to a position of head of risk? Or was it so strange? In this instance it could be construed as strange as in November 2003 the FSA had stated "the balance of experience amongst senior management could lead to a culture which is overly sales focussed and gives inadequate priority to risk".

The definition of insanity then surely has to be: Doing the same thing but expecting a different result.

If that was not enough, Mr Moore has alleged that in, 2004 after a boom in sales, he repeatedly called for a review of concerns that retail savers may have been pushed into corporate bond funds (CBF) without understanding the additional risk and revision of the selling practices.

In new written evidence submitted to the Treasury select committee He says that his calls were ignored by Jo Dawson, who then ran the sales force, until the FSA specifically requested the bank to look into CBF sales.

Mr Moore says:

"As the yields went down on standard deposit accounts, many customers were switched into corporate bond funds and [the Group Regulatory Risk department] and I were not confident that customers who were switched out of deposit accounts into CBFs would really understand the additional risks they were taking on and we wanted to ensure they did. "What was clear was that the advisers were strongly targeted to sell CBFs to deposit account customers whose deposits matured and the margin HBOS made on CBFs was very much higher than on deposit accounts." He adds: "This obviously increased the incentive to sell them."

This would be a very common sense request in any normal organisation for the risk and compliance function to make. This is a potential Key Risk Indicator that requires investigation and explanation. It may not be a significant risk at all but surely better to catch it while it is small, before it brings down what effectively could be a house of cards?

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Lee Werrell FInstSMM MSI is the Owner and Principal Consultant of CEI Compliance Limited, a Compliance Consultancy. CEI provide a broad range of expertise having worked with governance, risk and compliance functions for a number of years.