[Silverbacks may have a tough slog with this one, but it doesn’t last long. The key point is this: the apparent “winner” is often the ultimate loser. Think of it in terms of territorial battle amongst rival Silverback troops. The chest-thumping leader of the battle charge may be so weakened by the costly victory that he is too weak too satisfy the needs of the harem. Now do you get it? Me? I’m just sitting back here munching on leaves and bananas, saving my strength for the next round. Who needs all this business jargon? Oo-oo says it all. SB SM]
https://www.johnkay.com/2015/11/25/hbos-report-yields-three-important-lessons-for-all-businesses
HBOS report yields three important lessons for all businesses
The FCA and PRA have finally published their report into HBOS, the bank formed from the merger of Halifax with Bank of Scotland, more than seven years after its collapse. The 600 pages contain much detail on events and personalities. But there are general lessons for all businesses. Avoid the diversifier’s fallacy. Beware the winner’s curse. Fear adverse selection.
The diversifier’s fallacy is a generalisation of the widely observed Peter Principle; individuals rise within an organisation until they are given a job they are not competent to do. Companies diversify until they are engaged in businesses in which they have a competitive disadvantage relative to incumbents. This seems particularly common among financial companies. Most of the institutions that suffered in the crisis – most strikingly at troubled insurer AIG – were crippled by losses in areas distant from their principal business.
HBOS enjoyed market leading positions in UK mortgage lending and retail banking within Scotland. But these markets did not offer sufficient growth to meet the aspirations of HBOS executives. Since these expectations could not be met by things the bank knew how to do well, they were fulfilled by increasing market share in businesses the bank did not know how to do well: corporate banking in the UK and retail banking in Ireland and Australia.
While mortgage losses increased after the 2008 crisis, the core lending activity of Halifax remained not only viable but profitable. While the problems that became a crisis in October 2008 manifested themselves as a crisis of liquidity born of over dependence on wholesale funding, the underlying issue was one of solvency. Losses from diversification into corporate banking and international operations proved more than sufficient to wipe out shareholders equity.
When similar individuals or businesses are contenders for an object whose true value is uncertain, the winner will usually be the bidder who offers to pay too much. First observed in auctions of offshore oil blocks, the winner’s curse explains why mobile phone licence auctions raised so much more than governments expected (despite, in some cases, sophisticated designs aimed at mitigating the problem).
HBOS’s rival, RBS, experienced the curse when it outbid Barclays for ABN-Amro, a contest whose outcome was likely to bankrupt whichever bank became the ‘winner’. What the corporate banking division of HBOS described as ‘innovative lending’ was lending on more aggressive terms than any other bank would offer The same principle underpinned expansion in Western Australia, a far away country of which Edinburgh knew nothing, and in Ireland, a market already crowded with foolish lenders.
In Ireland, the winner’s curse was aggravated by adverse selection: when HBOS rolled out a new branch network after 2005, the borrowers who came through its doors inevitably included many whom better established banks had turned away. In credit markets, you can earn profits by doing better credit assessment than your rivals, or gain sales by doing worse credit assessment than your rivals. HBOS chose the latter route.
Much is made – and rightly – of the failures of risk control in HBOS. But the underlying issue is more fundamental. The sustainable rate of profitable growth in any business is determined by the strength of its competitive advantage and the scope of the application of that advantage. It is always a mistake to set growth targets to meet the expectations of ambitious executives or equity market analysts, as so many companies do, rather than to derive them from a realistic assessment of the competitive position of the business. The result is to drive the organisation towards the diversifiers fallacy, the winner’s curse, and adverse selection. For HBOS, that approach meant that strategy and risk control would inevitably come into conflict, and strategy would win. Until everyone, and everything, lost.
John Kay was a director of Halifax from 1991-2000.
[Here’s how AI described the image it created for today’s feature:]
Create a highly detailed, high-resolution image depicting a powerful Silverback gorilla in a lush green forest setting, symbolizing the “Winner’s Curse” as it stands tall, chest-thumping in apparent victory. The background should be filled with dense foliage, vibrant leaves, and scattered bananas, emphasizing the concept of strength versus hidden weakness. Use natural lighting to create a soft, yet dramatic atmosphere, highlighting the gorilla’s muscular form and expression of both triumph and solitude. The image should be in sharp focus to capture every detail of the Silverback’s fur and the intricate textures of the environment, delivering a striking visual representation of the blog post’s themes.