UPDATE 1-HBOS caught out by funding market shutdown

Mon Nov 12, 2012 9:58am EST

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* Ex-risk director says 2008 short-selling threatened bank

By Matt Scuffham

LONDON, Nov 12 (Reuters) - HBOS was not prepared for a complete shutdown of wholesale funding markets that contributed to its near-collapse in the financial crisis and also misread the property market downturn, a former finance director of the UK bank said on Monday.

Phil Hodkinson, who was finance director between 2005 and 2006, told a parliamentary inquiry that HBOS had undertaken stress tests against various scenarios but was not prepared for the total closure of wholesale markets.

"We had stress-tested against what would happen if some wholesale markets were closed to banks. The event which did bring down the bank - that all wholesale markets would be closed to banks for some period of time - was not conceivable," he told the Parliamentary Commission on Banking Standards.

Wholesale markets, including money market funds and other investors that provide banks with cash, virtually dried up during the financial crisis causing big problems for the industry.

HBOS, more reliant on wholesale funding than rivals, had to be rescued in 2008 through a government-engineered takeover by Lloyds Banking Group. Weeks later, Lloyds had to ask for a government bailout in which Britain pumped in 20 billion pounds ($31.82 billion) to keep the enlarged bank afloat.

HBOS's downfall was also blamed on the overly aggressive growth of its corporate division. Britain's financial regulator has said the bank failed to rein in high risk loans at its Bank of Scotland unit even as rivals were scaling back.

Hodkinson told the commission there was no evidence in 2007 that HBOS's corporate division had been overly aggressive and blamed the bank's demise on the downturn in Britain's property market. As Britain's biggest mortgage lender, the bank was heavily exposed to falling house prices.

"From the information the board received it wasn't evident that the corporate division was pursuing aggressive growth. We hadn't foreseen that the UK property market, which was a third of our book, would suffer as much as it did," he said.

Peter Cummings, the head of corporate lending until 2008, in September was fined 500,000 pounds by Britain's Financial Services Authority for his part in the bank's troubles and banned for life from working in financial services.

The FSA said Cummings led a "culture of optimism" which affected the division's judgment about bad debts and did not properly monitor big loans properly. Hodkinson said he believed the bank would have benefited from having more directors with a corporate banking background.

Peter Hickman, HBOS's risk director between 2007 and 2008, told the commission that false market rumours which led to a slump in HBOS's shares in March 2008, had borne the "hallmarks of a deliberate attempt to undermine the share price" and "could have threatened the bank's existence."

Hodkinson and Hickman were appearing before the Parliamentary Commission on Banking Standards, set up in response to a number of scandals across the financial services industry.

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