The not-so-pure retail bank

I've decided I don't like Lloyds Banking Group*. It presents itself as this pure retail bank that would never behave in such a dastardly manner as the universal banks with their greedy rapacious investment banking arms. But the reality is far different.

LBG has just been fined a total of £218m jointly by the FCA and American regulators for rigging benchmark rates including Libor. That is the crime for which the Barclays' chief Bob Diamond lost his job. But we're all used to hearing about Libor fines now: LBG is the seventh bank to be fined (and there are more to come). The seven banks fined so far, with the amounts, are as follows (chart courtesy of the Wall Street Journal):


OK, so LBG's fine doesn't look that bad, does it? It's the smallest fine of any of the big banks. But in this case the size of the total fine is not a good indicator of the seriousness of the offence. To find out what is really going on, we need to break it down.

The fine is made up of three components - £105m from the FCA, $105m from the US's CTFC and a further $86m from the US Department of Justice. The American fines are substantially lower than those imposed on other banks, reflecting LBG's lower level of overseas activity. But the FCA's fine is considerably higher than that imposed on any other British bank for benchmark rate rigging: at £105m (after 30% discount for "pleading guilty") it is the same as that issued to Rabobank. Only UBS has been fined more by the FCA for benchmark rate rigging.

Why is the FCA's fine so high? The clue lies in this letter to the Chairman of LBG from the Governor of the Bank of England:
The Financial Conduct Authority has made the Bank aware of enforcement action which it is taking against Lloyds Bank plc and Bank of Scotland plc (the Firms) in relation to manipulation of LIBOR and of submissions to the BBA GBP Repo Rate (the Repo Rate) during the period from January 2009 to June 2009. In respect of the manipulation of the Repo Rate, we understand that the motive was to reduce fees payable to the Bank under the Special Liquidity Scheme (SLS), for which the level of fees was dependent on the Repo Rate.

Such manipulation is highly reprehensible, clearly unlawful and may amount to criminal conduct on the part of the individuals involved. It reduced not only the amount of fees payable by the Firms but also the fees payable by other firms using the SLS. The Bank's calculations show that the total reduction in fees received by the Bank may have been as high as £7.76 million. 
So LBG was not only rigging Libor, it was rigging another rate too - the Repo Rate, used to price the cost of borrowing under the Special Liquidity Scheme during the financial crisis.

The Special Liquidity Scheme was put in place by the Bank of England to support distressed banks struggling to obtain market funding - of which HBOS was a prime example. Indeed according to Jill Treanor in the Guardian, LBG was one of the largest beneficiaries of this scheme. It enabled banks to exchange illiquid mortgage assets at the Bank of England for highly liquid UK Treasury bills, which these banks could then use as quality collateral against which to obtain funding in the repo markets. Banks were charged fees for this service in order to bring the cost of such borrowing close to commercial (unsecured) norms. The size of the fee was determined by the spread between 3-month Libor and the 3-month Repo Rate, subject to a 20 bps minimum: a narrower spread meant a lower payment, and vice versa.  

Clearly failing to understand that the SLS was preserving their jobs, traders routinely overstated the Repo Rate to narrow the spread to Libor and therefore reduce the fees payable to the Bank of England. The Guardian trenchantly describes this as "biting the hand that feeds them". This example of an interchange between two traders (quoted by the FCA in the Final Notice) shows how the scam worked:

Lloyds Trader A: The only thing is, I like it, we try and push it, we put
a higher rate when obviously we…

BoS Manager A: Well do you want me to put 102 for the 3’s?

Lloyds Trader A: Yeah do 102. It is just that we try and give a higher rate when we do the SLS obviously, so therefore we get a bit better yield on the book, are you with me?

And it is this, not the rigging of Libor, that explains the high fine. Two-thirds of the fine is for defrauding the Bank of England, and by extension (since the Bank is wholly owned by Her Majesty's Government) taxpayers. In addition, LBG has had to refund the £7.76m the Bank of England says it should have received. Furthermore, as the Governor's letter indicates, criminal prosecutions of the individuals involved may follow: the Serious Fraud Office says its investigation is "ongoing". No other British bank has openly defrauded taxpayers in this way. Not even RBS. So much for the wonderful retail bank culture. LBG is toxic through and through.

And that extends into Libor rigging. The FCA speaks of a "poor culture" on the money market desks responsible for obtaining short-term funding for lending (as retail banks, neither Lloyds TSB nor HBOS relied on trading for income, and nor does the enlarged LBG). We now know why they rigged the Repo Rate. But why did they manipulate Libor?

In the case of HBOS, the answer is clear. HBOS deliberately gave low submissions to the Libor panel in the last few weeks before its failure, in order to make itself look better than it actually was. This remark from a senior manager at HBOS (quoted in the CTFC's press release) is telling:
As a bank we are extremely careful about the rates we pay in different markets for different types of funds as paying too much risks not only causing a re-pricing of all short term borrowing but, more importantly in this climate,may give the impression of HBOS being a desperate borrower and so lead to a general withdrawal of wholesale lines...
HBOS certainly wasn't the only bank doing this at the time. Indeed as markets froze and real funding rates headed for the skies, it is likely that all Libor submissions were understated at this time. HBOS's behaviour is reprehensible, but understandable.

But both HBOS and Lloyds TSB also allowed their traders to manipulate Libor submissions to suit their trading positions. We perhaps might expect traders in investment banks to behave like this, and management to turn a blind eye - after all, their profits depend it. That's why investment banks need watertight controls around Libor submissions and the like, and why the absence of those controls is a sackable offence for executive management, as Bob Diamond discovered. But why on earth would retail banks allow their traders - whose job is funding and hedging, not market making - to behave like this?

It's clear from the traders' messages that traders were manipulating Libor submissions to suit their own positions, not to benefit the bank as a whole. And the traders' messages indicate that they knew perfectly well that what they were doing was market manipulation, but they thought they could get away with it - after all, everyone was doing it. But they were more like naughty children than adults - the Famous Five with swear words. I am reminded of the password for Harry Potter's map - "I solemnly swear that I am up to no good".

But this doesn't excuse senior management, any more than parents are excused for turning a blind eye to their children playing truant and causing mayhem in the local park. It was the job of executive management to set and enforce the standards of behaviour across the bank. And it seems they manifestly failed to do so. The FCA suggests that this was a sin of omission rather than commission:
The Authority does not conclude that either Lloyds Bank or Bank of Scotland as firms engaged in deliberate misconduct. Nevertheless, the improper actions of many Lloyds Bank and Bank of Scotland employees involved in the misconduct were at least reckless and frequently deliberate. The Firms, because of a poor culture on their Money Market Desks and weak systems and controls, failed to prevent the deliberate, reckless and frequently blatant actions of a number of their employees.
Nor is this the first such sin. LBG/HBOS has previously been fined SIX times for conduct offences, all but one since the financial crisis. Here's the FCA's list:
  • In September 2003, the Authority imposed a penalty of £1.9 million on Lloyds TSB Bank plc (now known as Lloyds Bank plc) for systems and controls breaches in relation to its conduct in selling high income bonds between October 2000 and July 2001
  • In May 2011, the Authority imposed a penalty of £5 million (£3.5 million after the 30% discount for settling at stage 1) on Bank of Scotland for breaches of Principle 3 and Principle 6 between July 2007 and October 2009 relating to its handling of complaints relating to retail investments
  • In March 2012, the Authority imposed a public censure on Bank of Scotland for breaches of Principle 3 between January 2006 and December 2008 relating to the management and control of its corporate lending. 
  •  In October 2012, the Authority imposed a penalty of £6 million (£4.2 million after the 30% discount for settling at stage 1) on Bank of Scotland plc for breaches of Principle 3 in relation to incorrect mortgage terms and conditions that it gave to standard variable rate customers
  • In February 2013, the Authority imposed a penalty of £6,164,327 (£4,315,000 after the 30% discount for settling at stage 1) on Lloyds TSB Bank plc, Lloyds TSB Scotland plc and Bank of Scotland plc for breaches of Principle 3 (and DISP 1.4.1R(5)) between May 2011 and March 2012 relating to their failures to pay redress promptly to PPI complainants
  • In December 2013, the Authority imposed a penalty of £35,048,500 (£28,038,800 after the 20% discount for settling at stage 2) on Lloyds TSB Bank plc and Bank of Scotland plc for their breaches of Principle 3 between 1 January 2010 and 31 March 2012 relating to serious failings in the systems and controls governing the financial incentives that they gave to sales staff.
And the FCA adds, in relation to this latest censure:
The failure of the Firms to establish and maintain adequate systems and controls in the above cases is not wholly similar to this case and, with the exception of the March 2012 Final Notice, the cases do not relate to the wholesale banking businesses of the Firms. However, all six previous matters highlight the inadequacies of the Firms (both members of Lloyds Banking Group plc) in implementing adequate systems and controls for their different business areas. 
In short, this is yet another example of long-standing management failure at LBG and HBOS. This latest censure of course relates to behaviour from 2006-2009, and the executive team then in place has long since departed. The SFO's criminal investigation may extend to them, but as the FCA concludes that the offences were individual rather than systemic it seems unlikely that any of the former executive team will face prosecution in this case.

But the last two fines were for serious failures of customer service that happened on the watch of the CURRENT team. The last was so sickening that I felt it warranted the Board's resignation. Why are they still in place, I want to know?

Related reading:

Final Notice, Lloyds and Bank of Scotland - Financial Conduct Authority

Governor's letter to Lord Blackwell - Bank of England

Response to Governor's letter from Lord Blackwell - Lloyds Banking Group

Of obseen Libor manipulation - FT Alphaville (rubbery jubbery)

*I should declare here that I do have a personal grievance with LBG. Obviously I'm not going to disclose details, as it is a personal financial matter, but suffice it to say that I experienced a level of customer "service" that was so bad I reported them to the Financial Ombudsman.


  1. Are large banks manageable?

    1. Luke - no. For discussion why see here:

    2. Salmonandmisosoupbreakfast30 July 2014 at 13:33

      I'm surprised that those authors submitted the paper for publication. It reads like a "quick thoughts" blog post. At some point in the paper, they should have introduced SOME rigor.

    3. Your comment is highly disrespectful. I'm not prepared to argue on a blog comments section but a few things you should note: (1) it was written in 2012 against the backdrop of many pointless corporate governance initiatives in the UK and Europe when everyone was calling for tougher regs in both policy-making and academic circles - publication was delayed beyond the authors' control; (2) the law journal it was published in is not an empirical journal - the article was a normative discussion of why corporate governance reform is likely not to work; (3) the article was reviewed by Prof Charles Goodhart - if you want to argue with him on the article's merits, be my guest.


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