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HBOS: The bank that fell over

Updated Wednesday, 29th October 2008

What happened? Explore the events that led up to the collapse of two giant names in banking.

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Of all the UK casualties of the ‘Credit Crunch’, HBOS (Halifax Bank of Scotland) is to date the biggest and most significant. The planned takeover of HBOS by Lloyds TSB, announced to stunned financial markets on Tuesday 16th September, marks the demise of two giants that have dominated the UK financial sector for centuries. The Bank of Scotland was formed in 1695 and was the first commercial bank in the UK. The Halifax Permanent Benefit Building and Investment Society was founded in 1853. Prior to its demutualisation and conversion to banking status in 1997 the Halifax was, by some distance, the largest building society in the country. Bank Of Scotland New Uberior House Creative commons image Icon Richard Milnes under CC-BY-NC-ND licence under Creative-Commons license The Bank Of Scotland's corporate HQ

We are too close to these amazing developments to understand exactly how the Bank of Scotland and the Halifax, united by the merger to form HBOS in 2001, found themselves being forced into a rescue by Lloyds TSB – a rescue that the Prime Minister himself took a central role in instigating.

Much has been made in the media that HBOS was a victim of ‘short selling’ by City traders. This practice which involves selling stocks that are not currently owned with the view of buying them back in the future at a lower price is a common trading strategy. The view held by some commentators is that aggressive short selling of HBOS’s shares drove down the share price to the point where public perception was that the bank was in trouble. With the Government and the Financial Services Authority  not wanting a repeat of a ‘run on the bank’ that we saw with Northern Rock in 2007, with savers queuing to get their cash out, the authorities acted swiftly to end HBOS's independent existence.

By placing it in the ownership of Lloyds TSB, the hope was that some semblance of confidence in the banking system would be restored. Given the size of HBOS – at £681 billion of assets it is seven times larger than the Northern Rock was when its problems surfaced in September 2007 – the Government simply could not contemplate a nationalised solution to the problem. Given the perceived impact on HBOS’s share price of the alleged short-selling the Government and the FSA also moved quickly to outlaw the short selling of the shares of other financial institutions.

Was HBOS a victim of short selling or rather an institution that weakened itself through its impaired business strategy?

But was HBOS a victim of short selling or rather an institution that weakened itself through its impaired business strategy? Many observers have pointed to HBOS’s growing reliance in recent years on wholesale funding from the world’s capital markets which made it, like Northern Rock, vulnerable to the illiquid conditions we have seen in the wholesale markets since the emergence of the US sub-prime mortgage crisis in summer 2007. Additionally HBOS was active in enlarging its share of the UK mortgage market just at the point that house prices peaked. The subsequent marked fall in prices has left HBOS vulnerable to bad debts as borrowers with negative equity default. There have also major losses in treasury assets – investments in asset-backed and other securities which have fallen in value in the wake of the sub-prime collapse.

Given the business backcloth it was perhaps hardly surprising that the process of raising more capital by the £4 billion ‘rights’ issue of new shares in HBOS was troubled with many investors refusing to take up their rights to further shares. This also was a factor which placed doubts in the minds of investors about the worth of HBOS’s stock - doubts that became reinforced by the reduction in dividends being paid out.

So was the reality that it was investors - particularly the fund managers - who brought on HBOS’s demise simply by dumping an increasingly unattractive stock? This seems more plausible than simply blaming the bank’s demise on ‘short sellers’.

Whatever the cause the outcome and consequences of the takeover by Lloyd TSB are huge in more senses than one. The bank will be a colossus in the retail financial market with 142,000 employees and a 28% market share - in fact if it had not been for the crisis conditions competition law would not have allowed the takeover to take place. The risk of such dominance is that Lloyds TSB will now have greater power to set the prevailing levels of mortgage and savings rates in the UK.

A further consequence is that there will be substantial job cuts given the overlaps between the two banks - for example in the branch networks and in the ‘back-office’ processing businesses.

For Scotland the blow is potentially substantial - both economically and to the country’s self confidence since, with the Royal Bank of Scotland, the Bank of Scotland dominated the Scottish banking industry. Lloyds TSB has, though, pledged to keep jobs in Scotland, retain the use of HBOS’s headquarters in Edinburgh and continue to print Bank of Scotland bank notes.

Additionally the disappearance of the Halifax - predating by just a few days the rescue of the Bradford & Bingley - represents the failure of the demutualised building society business model. All those societies that converted to banks amidst much heralded plans to grow their businesses and explore new avenues for making money have now, within a handful of years, lost their independent existences.

HBOS building Creative commons image Icon by JohnConnell, some rights reserved under Creative-Commons license HBOS offices At the time of writing, however, the approval for the takeover by the shareholders of Lloyds TSB has still to take place. In the light of the further collapse of the share price of banks globally in late September and October, and the move by the UK government to recapitalise the banks, a renegotiation of the original terms of the takeover inevitably had to take place. Under the revised terms made public on 13th October HBOS shareholders will receive 0.605 Lloyds TSB shares for each HBOS share. Additionally up to £17 billion of capital may be invested in the combined institution by the Government.

The amount of State finance will be determined by the shortfall in the demand by existing shareholders for further shares in the banks offered to them via forthcoming ‘rights’ issues. Given the distinct possibility that a substantial proportion of HBOS could end up being owned by the Government - making Lloyds TSB itself partially nationalised if it absorbs HBOS - there remains the risk that Lloyds TSB’s shareholders may not have an appetite for the takeover.

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