The Fourth Report of the Parliamentary Commission on Banking Standards "'An accident waiting to happen': the Failure of HBOS" makes surprisingly interesting reading for insurers. (The Report, published on 5 April 2013, is available here.) Perhaps the most striking findings are these:
- Between 2002 and 2004, the FSA identified, and drew HBOS' attention to, most of the risks that would eventually cause HBOS to collapse. However, the FSA didn't follow-up on some issues, and it "closed-off" others as if they'd been "resolved" when that was clearly not the case;
- In late 2004, the FSA switched its attention from HBOS' prudential risks towards the implementation of Basel II. In 2004, Basel II was seen in much the same way as Solvency II is seen today: it used the most up-to-date modelling and risk management techniques to enable banks to calculate their capital requirements; and to identify, manage and monitor the risks inherent in their businesses. Banks were therefore much less likely to collapse and cause loss to consumers. Basel II was also regarded as appropriately risk sensitive and conservative, and its implementation was seen as essential if we wanted to reduce the risks inherent in the banking system. Like Solvency II, Basel II also relied on what was effectively a standard formula and a regulator approved internal model. Banks with approved internal models were given "advanced status", their regulatory capital requirements were thought to be more closely matched to the risks inherent in their businesses, and their regulatory capital requirements were invariably lower as a result;
- Even so, Basel II was "immensely complex and immensely resource demanding". HBOS' staff devoted "tens of thousands of hours" to securing HBOS' advanced status, and that was a "huge distraction".
Now, of course, Basel II is regarded as a failure, and "a complete waste of time", and HBOS and a number of other banks have long since collapsed.The parallels between these findings and today's environment are as easy to over-state as they are plain to see. Basel II and the FSA's apparent failures did not cause HBOS' collapse, even if they partially allowed it to happen. Even so:
- The FSA is said to have failed to follow up on some key issues because HBOS pushed back so hard when they were raised. And the FSA's Board is said to have decided not to pursue national liquidity requirements "following push back from the industry". This is why the PRA now insists (apparently at the behest of the Parliamentary Commission) that firms must not respond to regulatory concerns as if they're part of an ongoing negotiation with their regulator (see my earlier blog on this point which is here);
- Many of the flaws apparent in Basel II are also apparent in Solvency II. For example, Solvency II has been widely criticised as too complex to consistently to deliver on its objectives, whilst the development of internal models and the search for regulatory approval is widely regarded as complex, expensive and a huge distraction - even by firms that are actively pursuing (and may feel compelled to secure) internal model approval because of the "advanced status" and lower capital requirements that should deliver.
This can only make sense in business and regulatory terms if you think "it's different this time". But as Sir John Templeton pointed out - those are the four most expensive words in the English language. They're also very rarely proved to be right.