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How HSBC’s Errors and Lack of Oversight Hit Reputation As World’s Best-run Bank

“Our executive directors have a combined 178 years of service – a track record almost without parallel in the industry. I believe there is no better management team in banking and it is no coincidence that HSBC has remained profitable throughout the financial crisis.”

 

So said Stephen Green in HSBC’s 2009 annual report, his last as executive chairman before he was made a peer and joined the government as trade minister. His boast was designed to make colleagues’ controversial pay packages easier for shareholders to swallow – investment banking chief Stuart Gulliver had been awarded a 9m pounds bonus.

 

In 2009 the claim that HBSC was a cut above other big banks was credible. It had not been rescued by taxpayers and was able easily to tap its shareholders for 12.5bn pounds of fresh capital. It also seemed free of scandals, a point Green made often. Competitors had “profoundly damaged the industry’s reputation”, he declared. HSBC was “strong, steadfast, sustainable” – the words displayed in large type on the cover of that year’s annual report.

 

In the event, 22% of shareholders refused to back the pay report – a chunky protest. But Green’s claim that he was leading the best-managed major bank in the world would soon sound ridiculous.

 

“HSBC has made mistakes in the past, and for them I am very sorry,” his successor Douglas Flint, the former long-serving finance director, told shareholders in July 2012: “Candidly, in particular areas we fell short of the standards that I, my colleagues, our regulators, customers, and investors expect.”

 

A grovel was the only position Flint could adopt. US officials had uncovered money-laundering and sanctions-busting at HSBC on a colossal scale. The bank’s culture was “pervasively polluted”, said a senior US Department of Justice official. The confessions have kept coming, including this week’s acknowledgement of past control and compliance failures at the Swiss private bank.

 

Gulliver, who became chief executive in 2011, argues that HSBC is a fundamentally different bank after his root-and-branch restructuring programme. Maybe it is. About 24,000 people – about 10% of the workforce – work in risk and compliance roles these days, Gulliver revealed last year. But what happened to the cautious, conservative HSBC of old? Why did HSBC require a complete overhaul almost immediately after Green departed saying all was well?

 

The generous interpretation is that HSBC fell prey to common corporate failings such as over-expansion. Gulliver has encouraged this idea by talking of how HSBC was run in a “federated” way. An alternative view is that the highly-paid directors simply failed to police their expanded empire.

 

Most of the woes can be traced to businesses bought during a massive acquisition spree after 1999, when Sir John Bond was chairman. HSBC, concentrated at the time in the UK, Hong Kong, and other parts of Asia, wanted to operate globally. The tagline “the world’s local bank” was adopted. A tower in Canary Wharf in London, with an executive suite on the 41st floor, was commissioned as the new headquarters. The pace of expansion was astonishing. In 1998 the bank had 25m customers; by 2003 it had 110m.

 

The first unit to turn sour was Household, a Chicago-based sub-prime lender, bought for 9bn pounds in 2003, a time when the term “sub prime” required explanation. Household was lending to people who couldn’t get credit from mainstream lenders. Risky lending can carry high profit margins if the interest rate is high enough. But Household had been dogged by accusations of predatory practices and its share price was sliding. Bond spied an opportunity.

 

HSBC’s bigger balance sheet and reputation would reduce Household’s funding costs, fuelling growth. “This is a perfectly logical move, positioning HSBC on what has been the main engine of American economic growth [the US consumer],” he said

 

Others were not convinced. Household seemed a long way from HSBC’s Scottish Presbyterian roots. One HSBC executive at the time was astonished. Teams had examined Household’s operation when the two companies were in a branding dispute in the UK, where Household traded as HFC and complained about HSBC’s rebranding of Midland Bank.

 

“In the US, it just seemed to be operating from small offices at the back of Greyhound bus stations,” he says. “Not our thing at all.” American sceptics called HSBC the Highly Suspect British Company.

 

The doubters were right. By 2006 Household’s bad debts were soaring and the business imploded in the sub-prime crash that followed. In 2008 HSBC reported a $15.5bn loss in North America, including a $10.6bn impairment charge for Household’s consumer finance operation. The loan book was put into run-off, meaning it was closed to new business. In effect, HSBC wrote off its investment in Household six years after buying it.

 

Bond had departed in 2006 and Green, who had been his chief executive and so was also associated with the deal, stated the obvious: “With the benefit of hindsight, this is an acquisition we wish we had not undertaken.”

 

The next disaster would shake HSBC to its core. In 2002 HSBC had bought a Mexican bank called Grupo Financiero Bital. Mexico, with large clothing and agricultural export industries, appeared a promising prospect for a bank chasing global trade flows.

 

What followed in 2012 was the devastating US Senate committee report that prompted the humiliating apology. Money-laundering in South America and Iranian sanctions-busting brought a fine of $1.9bn and a five-year deferred prosecution agreement with the US Department of Justice.

 

The detail of the prosecutors’ allegations destroyed HSBC’s reputation for having strong audit systems. Mexican and Colombian drug cartels exploited HSBC’s lax controls to launder at least $881m through HSBC. The gangs even designed cash boxes to fit the dimensions of the tellers’ windows. HSBC failed to act despite being warned of suspicious payments.

 

“HSBC is being held accountable for stunning failures of oversight – and worse – that led the bank to permit narcotics traffickers and others to launder hundreds of millions of dollars through HSBC subsidiaries and to facilitate hundreds of millions more in transactions with sanctioned countries,” said assistant attorney general Lanny Breuer.

 

In the case of Iran, the Senate investigation said HSBC in London coached an Iranian bank on how to get payments through the US without inspection and bypass legal restrictions.

 

During the Senate hearing David Bagley, HSBC’s head of compliance, resigned on the spot and revealed the limits of his job. Bagley said his role was merely to set policies and escalate problems that were reported to him.

 

The Mexican tale has a parallel in the Swiss case. Once again, HSBC seems to have left a local unit to do its own thing. The Swiss private bank was formed from the 1999 purchases of two banks from Edmond Safra, a billionaire banker who died in a fire later the same year.

 

“The business acquired was not fully integrated into HSBC, allowing different cultures and standards to persist,” said the bank’s statement this week. “With hindsight, it’s clear that too many small and high risk accounts were maintained and the business was stretched over more than 150 geographical markets.”

 

The problem with this statement – and with the plea that HSBC was run “in a more federated way than it is today” – is twofold. First, even a novice knows that private banks in Switzerland and Monaco carry higher reputational risks. Second, HSBC claimed at the time to have got a grip on its purchases. In the 2000 annual report, Bond said “the integration of the former Republic and Safra businesses went smoothly during 2000.”

 

HSBC has also fallen into holes that have caught other banks. Last year it paid 216m pounds in the UK and $275m in the US to settle for rigging foreign exchange markets. There was also a $550m settlement of allegations that it mis-sold mortgage-backed securities in the US. In the UK mis-selling of payment protection insurance has cost 2.5bn pounds.

 

But it is Household in the US, Mexico and now Switzerland that have most damaged its reputation. The Hong Kong-end of HSBC has kept the show relatively stable – albeit the share price stands only at the same level as in 1998. But how did a bank that was so convinced of its superior management talent and values make so many major mistakes?

 

The long-departed executive who was sceptical of the Household deal regards the “too federated” argument as glib. “Head office was always able to stick its nose in if it wanted to, and often did. Hong Kong was the only part that was generally left alone.

 

“In my day, the reputation of the bank was sacrosanct. If somebody tried something untoward, we drove them into the ground. That was how we operated. It is very sad what has happened because it is always the people lower down the organisation who pay when things go wrong and management tries to get profits back up.”

 

By contrast, Green, chief executive and then chairman from 2003 to 2010, left with a pension pot worth 19m pounds.

 

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  • 18 Feb, 2015
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