Co-operative Bank Chairman was out of his depth

Paul Flowers’ evidence in person to the House of Commons Treasury Select Committee was one of the most depressing events I can recall.  After months in which the...

Paul Flowers’ evidence in person to the House of Commons Treasury Select Committee was one of the most depressing events I can recall.  After months in which the co-operative movement gradually realised the scale of the crisis overpowering The Co-operative Bank, this was a new nadir. 

I like Paul and have met him twice — once when he took me to lunch in Manchester and once when I interviewed him and then took him to lunch. It was the fact that I like Paul that made the live events on my computer screen much more depressing.  Paul, I’m very sorry to say, revealed himself to be severely out of his depth as chairman of the Bank.  It started very badly when chair Andrew Tyrie asked Paul for the size of the Bank’s asset based.  Paul suggested it was £3bn. A very large figure, but many times’ smaller than the actual figure of £47bn.

By this time I was — possibly literally — hanging my head in my hands. Even as a financial journalist who looks at the Bank’s accounts probably twice a year, I knew Paul’s figure was hopelessly wrong. So did Tyrie. Paul’s credibility was destroyed from the beginning of his appearance.

In truth, matters generally improved from that point on. Except for one horribly telling exchange near the end of the session. In December 2012 the Bank’s executives had been told by Lloyds – as potential sellers of the 630 branches under Project Verde – that the emerging capital hole in the Bank cast serious doubts about whether the deal could go ahead.  One would have thought this would generate severe anxiety within the Bank and there would need to be an urgent rethink on strategy.

Yet it seems – according to Flowers’ evidence – that he and presumably the rest of the board were not advised of this for three weeks, until the next board meeting.  Moreover, to the MPs’ clear astonishment, Paul did not go berserk at this lack of communication, nor, it seems, did the board even express surprise or disappointment at the lack of information.  The clear impression was given that the board was asleep on the job.

It is possible that the Treasury Select Committee will suggest in its report on Project Verde that it believes Paul was not a ‘fit and proper person’ to chair a bank, as the regulatory requirement puts it.  Committee members gave a clear steer during Paul’s evidence session that this was very much in their minds.

The MPs were clearly unhappy about another aspect of the evidence both of Flowers and previously of Peter Marks.  They expressed surprise – of which we can expect to hear more – that the two of them were not better acquainted with various government and Parliamentary reports on the banking sector.

One of the reasons why this evidence session was so depressing was that, as Paul emphasised in his evidence, he was appointed as an expert in corporate governance.  Yet those watching – and the MPs – were left with the clear impression that the Bank’s corporate governance was weak and there was ineffective control of the Bank’s executives.  Indeed, it is strange that the Bank ended up with a chairman who had previously, Paul told the committee, indicated that he was short of confidence in the chief executive.  That itself is an indication of a corporate governance crisis.

In the aftermath of the global financial crisis, a lot of us were too cocky in proclaiming the mutual model as one that was more fit for purpose than shareholder owned banks.  True, it was the shareholder owned banks that caused the crisis.  But it has proven to be the mutuals that have been least able to withstand it, not least because they are unable to improve their capital positions when regulators increased their capital requirements.

Two factors were in particular stated to be strengths of the co-operative and mutual sector.  One was its conservative operating model.  The Co-operative Bank has had to confess, in the full glare of the Treasury Select Committee, that it was not at all conservative in its growth strategy.  And, of course, the demutualised building societies had previously also not been conservative (very much using the word with a small ‘c’) in moving to become PLCs.  Nor has either the Britannia nor the West Bromwich building societies been sufficiently conservative in its lending policies.

The other proclaimed virtue of the mutual model had been its use of lay directors.  Many of us comforted ourselves that lay people, who were more objective than the professionals who had been sucked into wicked ways, were able to provide common sense governance.  However, the fear must now be that the lay members of the Bank’s board were too trusting of the professionals and insufficiently rigorous in their interrogation of the advice they were given and too permissive of communications lapses.

It will be the whole of the mutual sector that will suffer for what is emerging at the Treasury Select Committee.  This is perverse given that it was shareholder owned banks that nearly destroyed the capitalist system.  (And I do not believe that last sentence is an overstatement.)  The solutions being imposed by regulators are disproportionately impacting on the mutual sector.

By coincidence, I had to miss the end of Paul Flowers’ live evidence session in order to receive a personal briefing on the future of my local building society, the City of Derry.  (I declare an interest here, as I am a member and saver in the society.)  It is to be swallowed up by the tenth largest society, the Belfast based Progressive.

The actions and demands of the regulator are a major factor in the demise of another independent local building society.  In the case of the City of Derry, I am assured its capital position is strong and this is not a reason for the ‘merger’.  (It is actually a nil cost acquisition, but it is being termed a merger.) 

But it is the cost of the required contribution to the Financial Services Compensation Scheme that is a key consideration, which has driven down margins (along with the low interest rate environment).  The FSCS contributions are based on the value of savings, not on the risk profile of the financial institution.  This has effectively provided a subsidy to risk-taking banks from low risk building societies.

Meanwhile, the regulator requires the City of Derry to increase other revenue costs, by engaging a finance director and it was expected to require the society to use a much larger (and much more expensive) firm of accountants.  It is, says the directors of the society, a one size fits all approach by regulators which is hitting small building societies – and which is likely in the future to hit credit unions, too. 

It should be added that other factors the City of Derry society took into account have been the need to invest in new IT systems and to provide for succession planning at an institution where the managing director is moving towards the end of his career.  (Ironically, succession planning seems to have been a major area of failure at The Co-operative Bank and Group, where senior executives arguably held position for too short a time, with each bringing in a major change of strategy.)

If I am unable to seek relief from the depressing national scene at a local level, nor can we do so internationally.  For decades, the Mondragon confederation of co-operatives has been held up as an exemplar of a self-help structure, where each independent co-operative is supported through tough times by fellow federation members.  Well, we have to rethink that line.

Fagor is one of Mondragon’s largest co-operative businesses.  In a horrifying parallel to The Co-operative Bank’s trauma, Fagor has had to turn to hedge funds and private equity in an attempt to avoid bankruptcy and protect around 5,600 jobs.  Fagor needs a new capital injection after several years of losses, caused by the collapse of the Spanish economy.  Other Mondragon co-operatives, it would seem, do not have enough capital reserves to rescue Fagor.

It is time to hear some good news about the co-operative and mutual sector.  Personally, I don’t have any.

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