by Perman, Ray
From its lofty perch on The Mound, Bank of Scotland contemplated these changes by its upstart rival – a stripling yet to reach its 270th birthday, whereas the Bank was preparing for its tercentenary. The older guard thought some of the changes flashy, dangerous and bound to end in tears. Younger managers looked on in awe and realised their revolution had not gone far enough.
6
The most boring bank in Britain
In 1988 Bruce Pattullo had split the top job at the Bank in two. He took the new title of Chief Executive, concentrating on growing the group by acquisition. His old title, Treasurer, which went back to the early days of the Bank, was now effectively managing director of the domestic banking and finance operation, and he gave it to his brightest lieutenant, Peter Burt.
Burt, like Pattullo, was middle-class, having been educated at Merchiston, one of the more academic Scottish public schools, and St Andrews, smallest, oldest and most exclusive of the Scottish Universities. After graduating he had taken an MBA degree at the prestigious US Wharton business school and started his career with Hewlett Packard, one of the new breed of successful computer companies where the management style could not be more different from that of Scottish banking. Hewlett Packard had open-plan offices and its shirt-sleeved employees called each other by Christian names no matter how junior or senior. Even the founders were known as Bill and Dave. Chains of command were short and hierarchy was not important. Innovation and experimentation were encouraged and so was teamwork. Returning to Edinburgh, Burt had worked briefly for a high-tech spin-out company and then for the merchant bank Edward Bates, putting together financial deals for the North Sea oil industry.
Bates had collapsed in the secondary banking crisis in the 1975, throwing Burt and his colleagues out of work. He was unemployed for three months – not a long period by today’s standards – but he had recently married and had his first child and he felt the anxiety of uncertainty and repeated rejection acutely. I wrote about him during the 1990s and played down the episode in my article, for which he rebuked me. The experience had marked him and it was not something he wanted to hide.
In his search for a new job he had been interviewed by Bruce Pattullo, then running the Bank of Scotland Finance Company, who had not had a vacancy, but had been impressed enough to send Burt up to The Mound, where he had been hired in the new ‘Special Duties’ department of the International Division. It was a period when the Bank of England was restricting sterling lending so Bank of Scotland was exploring ways to lend in foreign currencies. The Bank’s reputation in the oil industry was growing and Burt worked on some of the major North Sea field financings. Through ability and hard work he had worked his way up, becoming a divisional general manager in 1983 and general manager leading the international department two years later. His brain and drive made him the obvious successor to Pattullo.
Like his boss, Burt was a tennis player, but his sporting enthusiasm lay elsewhere. He was an exceptional amateur golfer and drove himself as hard on the tee as he did at work. An interviewer once asked him why he played golf and got a rhetorical question in reply: ‘Why did I turn to banking?’ The interviewer concluded: ‘Despite him putting golf on the same level as banking, you get the impression that one is a passion and the other a job that enables him to follow his love. In golf, he says, ‘You are competing against yourself, nobody else – and every so often you hit a perfect shot and there is no reason, other than human frailty, why you shouldn’t do it every time.’1 Human frailty was not something Peter Burt allowed to hold him back in banking any more than in golf. His annus mirabilis came in 1993 when he achieved two personal goals – getting the Bank’s cost/income ratio below 50 per cent and taking the amateur record at the championship Muirfield golf course with a round of 69, which stood for many years.
He had a sharp mind and a quick wit which could sometimes wound, not always intentionally. For some this made him difficult to work with. One non-executive director remembers that although Burt was never a bully, his rigorous reasoning could intimidate subordinates into not standing up to him or putting counter arguments in case a flaw was found in them. Burt was an admirer of the Hewlett Packard style of ‘management by walking around’, but his own style was not exactly pedestrian. David Jenkins, the Bank’s Economist recalled seeing him running down the first floor corridor at the Bank’s international division, tripping at the top of the stairs and falling head-over-heels right to the bottom, where, to the amazement of those watching, he sprang up and continued running to his next appointment. Jenkins was one person who was not intimidated by Burt’s intellect, but admired and liked him. The two men became close colleagues and Jenkins used his sense of humour to turn Burt’s barbs aside and tell him home truths if the occasion demanded. When Jenkins retired (and, sadly, died shortly afterwards), his counsel was missed.
In 1990 Tom (now Sir Tom) Risk retired and Bruce Pattullo took his place as Governor, but continued as Group Chief Executive. While Peter Burt ran the domestic banking business, Pattullo tried to find acquisitions to expand the Bank abroad. It had opened a New York branch and had long had a representative office in the Texas oil capital of Houston. Gradually it opened small offices in other large US cities, but it hankered after a slice of the huge American domestic banking market. With over 15,000 registered banks, there was no shortage of opportunities, but America had been a graveyard for British banks. One by one the Big Four London banks had bought US subsidiaries, only to fail to make them profitable and be forced to dispose of them at a loss. Even with this history, Pattullo was keen to buy a US bank, but his Scottish caution kept getting in the way.
Bank of Scotland had good contacts in Texas through its work in the oil industry. The dramatic rise in oil prices following the Middle East war had prompted a massive boom in the state, particularly in property. But a rapid plunge in the price in 1986 brought about a collapse in the market and Texas banks, which had over-extended themselves, failed at a rate unprecedented in US history. In all, 506 commercial banks went bust, including seven of the ten largest banks in Texas. The job of cleaning up the mess fell to the Federal Deposit Insurance Corporation, which restructured banks, injected new funds into those which were salvageable and offered them for sale. Bank of Scotland joined two auctions, the first in 1987 for First City Bancorp and again two years later for 20 banks, part of the Dallas-based MCorp. Either deal could have transformed the fortunes of the Bank, but it was unsuccessful in both. Pattullo later regretted his caution: ‘The Presbyterian instinct means that you don’t pay top dollar at the table.’
The Bank did take a minority stake in a Greek banking venture, but sold it again a couple of years later when it disapproved of the way the management were stretching their mandate. It also entered into a joint venture with a German department store group to offer credit cards, but it found Europe difficult and the US too expensive. It turned to the other side of the world. New Zealand was a small country like Scotland, spoke English and had a similar legal and financial system. In 1987 the Bank took a stake in Countrywide Building Society, taking full control in 1992. The country’s financial markets were deregulating and the Bank applied its skills and balance sheet to grow the business.
It was a modest and cautious purchase, but Pattullo felt emboldened by the experience to go further. Two years later he splashed out £437 million to buy Bankwest from the Government of Western Australia, which had rescued the bank in the late 1980s. Such a bold move was out of character and the stock market reacted badly, marking down Bank of Scotland shares. But Pattullo had thought it through and six months later sold 49 per cent of the new subsidiary on the Australian stock market.
The year 1995 saw Bruce Pattullo receive his knighthood and the Bank celebrate its tercentenary. The Financial Times Lex column marked the occasion by calling the company ‘the most boring bank in Britain’ which had made dullness a virtue. ‘The business’s steadiness helps explain 300 years of consistent profitability and more recently how the Bank has
outperformed the sector by nearly 100 per cent since 1980.’2
Pattullo, in a piece published at the time, gave his own view of the Bank’s longevity and recipe for success: ‘The culture in any corporation is important and can help a bank to ride out the [trade] cycle. I would also argue strongly – and my friends in the City of London would be disappointed if I resisted the temptation to make the point – that not having one’s headquarters within the Square Mile makes it slightly easier to resist some of the herd instinct and cyclical pressures to over-extend advances and rashly build up new directions . . . Bank of Scotland’s Tercentenary in 1995 reminds us that our canny forebears must have resisted temptation many times over those 300 years.’
Then in a passage which emphasised the Bank’s distinctive culture, where the institution was more important than the individual, he added: ‘Mistakes are more likely to occur in corporate life, especially in a bank, where one individual is anxious to achieve too much in too short a space of time. There is no substitute for good old-fashioned common sense.’3
The following year saw the Bank again produce record profits and a return on equity of an unheard-of 36 per cent, but the market punished it for allowing its cost/income ratio to rise over 50 per cent again – although it was still the lowest of any UK bank. Pattullo was unrepentant and upbeat. The Bank had been investing in its computer systems, refurbishing its branches and boosting its finance house subsidiary. He stated, ‘The point is you must not fall in love with having a low cost/income ratio if there are investment opportunities and income streams to be generated, otherwise you inhibit growth for the future.’4 Lex found his bullishness hard to take, asking: ‘Is Bruce Pattullo losing his grip?’ and pointing to the unaccustomed optimism of the legendarily bearish Pattullo and dour Peter Burt. It quoted an unsettled stockbroker as saying: ‘We are all used to emerging from our conversations with them plunged in gloom.’ There was no gloom for the next five years as the Bank rode the boom in the UK economy and increased its profits by an average of 20 per cent a year.
If there was an outward show of optimism, it was masking deeper concerns. Despite Bruce Pattullo’s exhortation to his managers to pull in the deposits, they could not keep up with the Bank’s success in lending. In 1978 it had been able to fund over 90 per cent of its lending from retail deposits – the savings of its customers – and a large proportion of these were in current accounts, which did not pay interest. By 1985 the amount of lending covered by branch deposits had fallen to less than half.5 This trend had serious implications, but it would not be easy to reverse.
The Bank’s deep roots in Scotland and its branches in every town and city meant that it was a natural home for the savings of thrifty Scots. Its expansion, however, had been fastest in the south of England where it did not have a branch on every high street and was not a known and trusted brand. The success of non branch-based savings products like the Money Market Cheque Account and HOBS, which had a savings account facility, could pull in amounts in thousands or even tens of thousands per customer, but lending, whether it was in mortgages or corporate loans, was in much larger sums. Competition for savings was also much fiercer than it had been 20 years before. The deregulation of building societies in 1986 had spurred a number of the larger organisations to follow aggressive expansion policies, which included competing strongly with the banks for deposits.
Another factor was that British households were saving less. Unsurprisingly the proportion of incomes which went into savings fell during the recession of the early 1990s, but worryingly for the bankers even in the relatively good economic position of the late 1990s the savings ratio was dropping rapidly – from nearly 12 per cent of household incomes in 1995 to less than six per cent five years later.
The effect on Bank of Scotland was to make it much more reliant on the wholesale money market, where banks and other financial companies and institutions lent and borrowed on a daily basis. Banks would forecast how much money they would need to meet their obligations and lend out any surplus to other banks for days, weeks or even months. Other institutions, such as pension funds and investment managers might lend for longer periods, months or years. Brokers were also active in the market, lending and borrowing on behalf of a wide range of clients from financial institutions, to governments, local authorities and other public agencies, private corporations and wealthy individuals. By the mid-1990s the ability to trade electronically had made this market wide and deep – hundreds of banks and other financial companies were active across the world, trading in many currencies as well as government and corporate bonds and ‘derivatives’ such as futures contracts and more esoteric products. The market functioned 24 hours a day and was continually liquid with untold billions (in whatever major currency you liked to name) moving hourly.
To borrow in this market you needed to be ‘a name’, meaning that you were known and trusted. Your standing determined how willing others were to lend to you and what interest rate they would charge. The Bank, with its high capital ratios and its reputation for prudence, would have no difficulty in raising the finance it needed.
But the wholesale market was capricious. Interest rates could vary widely and the perception that a bank was becoming dependent on it could affect both its credit rating and its share price. Analysts began to ask questions about the Bank’s strategy and whether it could sustain the remarkable record it had achieved in increasing its lending. The question mark over how the Bank would fund itself in the future became a weakness and in the minds of Pattullo, Burt and the board it made the Bank vulnerable to takeover and the possibility of losing its independence just as it was celebrating its 300th birthday.
These fears were heightened by the shock decision by Standard Life in May 1996 to sell the one-third stake in the Bank it had acquired a decade previously from Barclays. Up to this point the Bank had been able to ignore the threat of takeover, confident that its close relationship with the life assurer would protect it. The two companies were twin pillars of the Edinburgh establishment and had representatives on each other’s boards. Any potential acquirer of the Bank would have to deal with Standard Life and it was tacitly assumed that nothing would be done to jeopardise the independence of Scotland’s largest company.
But times were changing and the ‘squalid Scottish stitch-up’ which Tom Risk had been able to pull off ten years before was no longer possible. Local loyalties and the necessity of avoiding embarrassment in the New Club, the exclusive gentlemen’s club overlooking Edinburgh Castle in Princes Street, cut no ice with the professional fund managers running Standard Life’s equity portfolio. The insurance company had done well out of its Bank of Scotland shares, but it represented a disproportionate element of its equity holdings and if the Bank’s performance in the future faltered, the shareholding could drag down the fund’s return. The announcement came without warning and immediately promoted speculation that the shares might be sold to a potential predator, such as one of the London Big Four or a foreign bank wanting to enter the UK market. The Financial Times Lex column declared that the decision had ‘put Bank of Scotland into play’6 and the share price jumped on speculation of a possible future bid.
The decision caused uproar in Scotland and spilled over from the business world to the political. The day after Standard Life’s announcement Bruce Pattullo met Michael Forsyth, Secretary of State for Scotland in the Conservative government, who issued a statement emphasising the importance of the Bank to the Scottish economy and saying that he hoped there would not be a hostile bid. Alex Salmond, leader of the Scottish National Party, called on the Government to refer any future bid to the Monopolies and Mergers Commission. Pattullo was embarrassed and angry that he had not been given prior warning and to show his displeasure at the way the announcement had been made, he immediately quit the board of Standard Life, delivering his resignation letter in person to their offices. He said he had been affronted at the way the news had been allowed to become public and he owed it to the 18,000 employees o
f the Bank to show where his loyalties lay.
The speculation continued in the Scottish newspapers for a month until Standard Life placed its shares in the stock market, selling them in small lots to many different buyers rather than as a lump to a single purchaser.
There was relief on The Mound, but it did not answer the underlying problem of what to do about the increasing reliance on wholesale funding. The Bank commissioned the management consultancy McKinsey to report on its strategic options, but it confirmed what was already feared. If it carried on growing at the rate it had been, increased reliance on the inter-bank market – and therefore increased vulnerability – was inevitable. The alternative of putting the brakes on growth could have the same effect: the share price would fall, making the Bank an easier target. The only answer was to get access to a new, large source of deposits and do it quickly.
In 1997 the Bank signed an agreement with the supermarket chain Sainsbury’s to create Sainsbury’s Bank, which offered savings products devised and operated by the Bank, but branded and sold by the supermarket to its customers. There were no branches, customers used the telephone (and later the internet) to access their accounts and carry out transactions. It was the first such venture in the UK and within months it brought in several hundred million pounds in deposits which Bank of Scotland effectively lent to itself – useful, but not nearly enough.