THE OVERSEAS OPERATIONS OF THE STATE BANK
THE OVERSEAS OPERATIONS OF THE STATE BANK
TABLE OF CONTENTS
19.1 INTRODUCTION 19-5
19.1.1 GENERAL 19-5
19.1.2 SCOPE AND FORMAT OF THIS CHAPTER 19-6
19.2 DIRECTION SETTING AND PLANNING FOR OVERSEAS
19.2.1 BACKGROUND 19-7
19.2.2 THE STATE BANK ACT: THE PRINCIPLES OF BENEFIT TO SOUTH AUSTRALIANS AND THE STATE'S
19.2.3 LONDON OFFICE: THE MOVE TO LIMITED WHOLESALE OPERATIONS 19-10
19.2.4 LONDON OFFICE: THE INTERNATIONAL BANKING STRATEGY PAPER 19-11
19.2.5 1985-1990 STRATEGIC PLAN 19-13
19.2.6 1986-1991 STRATEGIC PLAN 19-15
19.2.7 HONG KONG OFFICE 19-17
19.2.8 OCTOBER 1986 JOINT BOARD/EXECUTIVE CONFERENCE 19-18
19.2.9 1987-1992 STRATEGIC PLAN 19-20
19.2.10 NEW YORK BRANCH 19-21
19.2.11 CAYMAN ISLANDS BRANCH 19-23
19.2.12 1988-1993 STRATEGIC PLAN 19-25
19.2.13 AUCKLAND BRANCH 19-25
19.2.14 1990-1994 STRATEGIC PLAN 19-32
19.2.15 THE BANK'S PROFIT PLANS 1985-1990 19-33
19.2.16 CONSIDERATION OF DIRECTION SETTING AND PLANNING FOR OVERSEAS OPERATIONS 19-36
19.2.17 CONCLUSIONS 19-43
19.3 GROWTH AND PERFORMANCE OF OVERSEAS BRANCHES
19.3.1 OVERVIEW OF OPERATIONS OF THE LONDON BRANCH 19-44
22.214.171.124 Principal Activities 19-44
126.96.36.199 Organisation Structure and Staffing 19-45
188.8.131.52 Prudential Control and Supervision 19-46
184.108.40.206 Business Plans and Financial Performance 19-46
220.127.116.11 Asset Quality 19-48
18.104.22.168 Observations on Operations and Performance of London Branch 19-49
19.3.2 OVERVIEW OF OPERATIONS OF THE HONG KONG OFFICE 19-49
22.214.171.124 Principal Activities 19-49
126.96.36.199 Organisation Structure and Staffing 19-50
188.8.131.52 Prudential Control and Supervision 19-50
184.108.40.206 Business Plans and Financial Performance 19-50
220.127.116.11 Asset Quality 19-51
18.104.22.168 Observations on Operations and Performance of Hong Kong Office 19-51
19.3.3 OVERVIEW OF OPERATIONS OF THE NEW YORK BRANCH 19-51
22.214.171.124 Principal Activities 19-51
126.96.36.199 Organisation Structure and Staffing 19-52
188.8.131.52 Prudential Control and Supervision 19-53
184.108.40.206 Business Plans and Financial Performance 19-54
220.127.116.11 Asset Quality 19-55
18.104.22.168 Observations on Operations and Performance of New York Branch 19-56
19.3.4 OVERVIEW OF OPERATIONS OF THE AUCKLAND BRANCH 19-56
22.214.171.124 Background 19-56
126.96.36.199 Principal Activities 19-56
188.8.131.52 Organisation Structure and Staffing 19-57
184.108.40.206 Prudential Control and Supervision 19-57
220.127.116.11 Business Plans and Financial Performance 19-58
18.104.22.168 Asset Quality 19-59
22.214.171.124 Observations on Operations and Performance of Auckland Branch 19-60
19.3.5 ASSET GROWTH IN THE BANK'S OVERSEAS OPERATIONS 19-60
19.3.6 NON-PERFORMING ASSETS 19-65
19.3.7 CONCLUSION ON OPERATIONS AND PERFORMANCE OF THE OVERSEAS BRANCHES 19-65
19.4 CONTROL AND SUPERVISION OF OVERSEAS OPERATIONS BY
THE BANK BOARD 19-67
19.4.1 INTRODUCTION 19-67
19.4.2 INFORMATION AVAILABLE TO THE BANK BOARD 19-68
19.4.3 DELEGATED LENDING AUTHORITIES 19-84
19.4.4 PRUDENTIAL EXPOSURE LIMITS 19-85
19.4.5 TREASURY LIMITS 19-88
19.4.6 BANK BOARD DISCUSSIONS CONCERNING OVERSEAS OPERATIONS 19-89
19.4.7 CONCLUSIONS 19-92
19.5 CONTROL AND SUPERVISION OF OVERSEAS OPERATIONS BY
19.5.1 GROUP MANAGING DIRECTOR 19-92
19.5.2 CHIEF GENERAL MANAGER, INTERNATIONAL BANKING 19-93
19.5.3 CHIEF MANAGER OF EACH BRANCH/OFFICE 19-101
19.5.4 CONCLUSIONS 19-101
19.6 INTERNAL CONTROLS AND THEIR REVIEW 19-101
19.6.1 INTERNAL POLICIES AND PROCEDURES 19-101
19.6.2 GROUP INTERNAL AUDIT 19-102
19.6.3 WHOLESALE CREDIT INSPECTION 19-104
19.6.4 EXTERNAL AUDIT 19-107
19.7 REGULATORY AUTHORITIES 19-108
19.8 SOME ISSUES RAISED BY REVIEWS OF OVERSEAS
19.8.1 LONDON BRANCH 19-120
19.8.2 HONG KONG OFFICE 19-128
19.8.3 NEW YORK BRANCH 19-129
19.8.4 AUCKLAND BRANCH 19-132
19.8.5 AUGUST 1990 REVIEW OF INTERNATIONAL BANKING OPERATIONS 19-133
19.9 CONCLUSIONS ON CONTROL AND SUPERVISION OF THE
OVERSEAS BRANCHES 19-134
19.10 GENERAL SUBMISSIONS OF THE NON-EXECUTIVE DIRECTORS
19.11 CONCLUSIONS ON THE BANK'S OVERSEAS OPERATIONS
19.12 REPORT IN ACCORDANCE WITH MY TERMS OF APPOINTMENT
19.12.1 TERMS OF APPOINTMENT A 19-142
19.12.2 TERM OF APPOINTMENT C 19-142
19.12.3 TERM OF APPOINTMENT D 19-143
This Chapter of the Report examines the overseas operations
of the Bank, and the growth and development of these operations over the period from July
1984 to February 1991.
This Chapter also specifically examines:
(a) the "Charter" of the Bank in accordance with
Section 15 of the State Bank of South Australia Act, 1983 as that "Charter"
applied to the Bank's establishment of overseas branches;
(b) the relationship between the overseas branches and Head
(c) the supervision and control of those branches by the
Bank Board and management; and
(d) the financial performance of the overseas branches,
including the levels of non-performing assets held by the overseas branches as at the end
of the period under review.
The State Bank of South Australia's involvement in overseas
markets dates from the time of the merger of the predecessor Banks in July 1984 when, as
part of the merger, it took control of a minor retail banking() operation
previously run by the Savings Bank of South Australia in London. In October 1985, the
London branch closed its retail banking activities, and started wholesale banking()
operations, refocussing primarily on treasury operations and corporate banking.
In 1987, the Bank developed overseas offices in Hong Kong,
and, in 1988, in New York. In December 1988, the Bank acquired Security Pacific Bank New
Zealand. This bank was renamed SBSA (NZ) Limited ("SBSA (NZ)") and formed the
basis for the Auckland branch of the Bank's operations.
Representative offices were subsequently opened in Chicago
and Los Angeles (United States) and in Christchurch and Wellington (New Zealand). By the
end of the period under review, the Bank also maintained an off-shore "asset booking
point" in the Cayman Islands for the New York operation and in Nassau to augment the
The preliminary investigation phase indicated that one of
the primary causes of the Bank's financial position and associated losses arose from its
lending activities both within Australia and Overseas. Overseas assets grew from $222.6M
at 31 December 1985() to $5,270.0M as at February 1991(), by which
time overseas assets represented 23.5 per cent of the Bank Group's total assets
($22,387.5M)() and 27.4 per cent of the Bank's Australian retail and wholesale
assets ($19,209.1M).() Overseas operations gave rise to a significant
proportion of the Bank's non-performing loans, especially London and Auckland branches.
Accordingly, investigation of matters relating to the Bank's overseas operations is
founded on Term of Appointment A. In addition, Terms of Appointment C and D have relevance
in relation to matters reported in this Chapter.
In analysing the Bank's overseas operations, it is
necessary to consider the statutory framework within which these activities took place and
Sections 15 and 19 of the State Bank of South Australia Act, 1983 ("the Act")
are relevant in this context. I am satisfied that the Act permitted the Bank to operate
overseas but subject to these activities satisfying the principles set out in Section 15
of the Act.
19.1.2 SCOPE AND FORMAT OF THIS CHAPTER
The examination of the overseas operations of the Bank
(a) London branch;
(b) Hong Kong office;
(c) New York branch; and
(d) Auckland branch.
These branches/offices represent the off-shore locations
where significant operations of the Bank took place. There are other off-shore entities,
namely, companies in the United States and Hong Kong, but these were established
principally for local regulatory purposes and their activities have been treated as part
of the main office operations in those particular locations. Certain aspects of the New
Zealand operations, other than those arising in the Auckland branch, are examined in other
Chapters of this Report.
Whilst Hong Kong office did not achieve "branch"
status during the period under review, where this Chapter refers to a "branch"
or "branches" the reference is to be taken to include Hong Kong office unless
the context indicates otherwise.
The information in this Chapter is presented in the
(a) Direction Setting and Planning for Overseas Operations;
(b) Operations and Performance of Overseas branches;
(c) Supervision and Control of Overseas Operations; and
In this Chapter any reference to the Bank Board is, unless
the contrary appears or is otherwise inconsistent with the context in which it appears, to
be construed as a reference to the Bank Board as constituted at the time of particular
acts or omissions as reported in the Chapter. Furthermore, any reference to "the
Non-Executive Directors" is a reference to the following former Non-Executive
Directors of the Bank: Mr R D E Bakewell, Mrs M V Byrne, Mr R E Hartley, Mr R P Searcy, Mr
K Smith, Mr L Barrett, Mr K J Hancock, Mr W F Nankivell, Mr A R Prowse, Mr D W Simmons and
Mr A G Summers.()
19.2 DIRECTION SETTING AND PLANNING FOR OVERSEAS OPERATIONS
As mentioned in the Introduction of this Chapter, when the
Savings Bank of South Australia merged with the State Bank of South Australia in July
1984, the new State Bank assumed control of a minor retail banking operation in London,
previously conducted by the Savings Bank of South Australia. This office continued to
operate as a retail banking office until October 1985, when London branch commenced full
wholesale banking operations, and discontinued its prior retail banking operations. From
this point on, the Bank's overseas assets grew rapidly until, by February 1991, they
reached $5,270.0M which, as noted above, was 23.5 per cent of the Bank Group's total
assets and 27.4 per cent of the Bank's Australian (ie on-shore) retail and wholesale
assets. The branches and representative offices established during the period July 1984 to
February 1991 are as stated in Section 19.1.1 above.
Whilst the Bank's strategic direction overseas was decided
by the Board on a "branch by branch" basis, it was also considered within the
general framework of a January 1985 Board Paper entitled "International Banking
Strategy" and the Bank's Strategic Plans and Profit Plans. "Strategic
Plans" were prepared annually and covered five year periods. The Strategic Plans were
presented to the Bank Board for approval around March of each year. Whilst these plans
dealt with the Bank's overseas operations, financial detail in relation to overseas
operations was generally limited to projections of total assets for off-shore operations,
and there was little detailed financial and strategic analysis by individual location.
The following table indicates the Strategic Plans()
that were prepared, the years covered by these Plans, and when the Strategic Plans were
considered by the Bank Board:
1985 - 1990
1986 - 1991
1987 - 1992
|23 April 1987
1988 - 1993
1990 - 1994
|10 May 1989
"Profit Plans" were prepared annually and covered
one year periods. The Profit Plans were presented to the Bank Board for approval around
June - July of each year. Whilst these Plans also dealt with the Bank's overseas
operations, in general, financial detail regarding overseas operations was limited to
projections of total assets and, again, there was little analysis by individual location.
Each of the Bank Board's decisions to open overseas branches, as well as the Bank's
Strategic Plans and Profit Plans as they relate to overseas operations, are considered
Strategic issues relating to the Bank's overseas operations
were also considered at a joint Board/Executive Conference held on 17 and 18 October 1986.
The strategic implications for the Bank's overseas operations arising from this conference
are considered in Section 19.2.8 below.
19.2.2 THE STATE BANK ACT: THE PRINCIPLES OF BENEFIT TO
SOUTH AUSTRALIANS AND THE STATE'S ECONOMY
The Act gives the Bank power to carry on its business
"within or outside the State" of South Australia.() The Bank also has
power to "establish branches and agencies within and outside the State."()
These powers reside in the Bank Board as the
"governing body" of the Bank() however, the Act imposes a number of
requirements for the Bank Board to observe in exercising its powers. In particular, the
Bank Board is required:
"... [in] its administration of the Bank's affairs
... [to] act with a view to promoting -
(a) the balanced development of the State's economy; and
(b) the maximum advantage to the people of the State,
and shall pay due regard to the importance both to the
State's economy and to the people of the State of the availability of housing loans."
It was, therefore, incumbent on the Bank Board in
considering the establishment of overseas branch operations to have regard to the
requirements of this Section. Accordingly, in considering any proposal to establish an
overseas branch operation, the Bank Board was required to consider the principles of the
balanced development of the South Australian economy; the maximum advantage to the people
of South Australia; and the importance to both the State's economy and to the people of
South Australia of the availability of housing loans.
The Act also imposes a separate but reciprocal obligation
on the Bank Board to "administer the Bank's affairs in accordance with accepted
principles of financial management and with a view to achieving a profit." ()
In my opinion, the notions of benefit to the people of
South Australia and the South Australian economy on the one hand, and the achievement of
profit on the other are not necessarily mutually exclusive. In my view the Act imposes, in
effect, a combined obligation that whatever the Board approves in the exercise of its
powers and authorities in achieving the principles of benefit to the people of South
Australia and the South Australian economy, must also be with a view to achieving a
profit. I observe that the Board must act with a view to promoting both the
balanced development of the State's economy and the maximum advantage to the people of the
State. I am of the opinion that, for example, in the case of the Bank's overseas
operations, the simple fact of the generation of a profit overseas is not of itself
sufficient to satisfy the provisions of Section 15.
As will appear in the following Sections of this Chapter, a
number of reasons for establishing overseas branches were advanced by management in Bank
Board Papers, Strategic Plans and Profit Plans. Accordingly, the following Sections of
this Chapter consider the strategic reasoning behind each decision to open an overseas
branch or representative office, within the context of Section 15 of the Act and of the
annual Strategic Plan and Profit Plan process. The general topic of Direction-Setting and
Planning for the Bank is considered in detail in Chapter 4 - "Direction-Setting
and Planning". This Chapter will focus on overseas operations but the issues
reported on in Chapter 4 - "Direction-Setting and Planning" concerning
the Strategic Planning process as such, should be borne in mind in considering these
19.2.3 LONDON OFFICE: THE MOVE TO LIMITED WHOLESALE
The Bank Board first considered the future of the London
office at a meeting held on 27 September 1984. This was in response to a paper prepared by
Mr D E Hosking (Chief Manager, International Banking).() This paper drew the
Board's attention to the losses being incurred by the London office's retail operations()
and stated that consideration was being given to the "development of a wholesale
operation under the direction and control of Corporate and International Banking
The Board Paper also recorded that an investigation was
being made into an off-shore banking association of State banks and that the London office
(a) introduce a new accounting facility; and
(b) engage in limited wholesale banking activities.
The rationale for this move was put in this way:
"Upon introduction of the new accounting facility,
it will be possible to raise foreign currency borrowings at competitive interest rates
through Adelaide and book them in London, without incurring Australian withholding tax.
This will place us in a fully competitive position to quote on foreign currency borrowings
for domestic corporates and provides the opportunity to purchase assets and participate in
risk proposals that can be placed directly on the books of London Office to produce fee
The Board, inter alia, resolved:
"Management be authorised to write asset/risk
business on the books of London Office up to £E20M in the following categories -
(1) A class companies, subject to approval for each
(2) A and B class country risks of either a sovereign or
statutory entity, to a total limit of £E20M under existing Credit Line approvals.
London Office assets be funded on a back-to-back
19.2.4 LONDON OFFICE: THE INTERNATIONAL BANKING STRATEGY
The Bank Board first considered a comprehensive report on
the strategic objectives of the Bank's international banking directions on 24 January
1985, when it had before it a paper entitled "International Banking Strategy"
prepared by Mr Hosking (Chief Manager, International Banking) and Mr S G Paddison
(Manager, Strategic Planning).() This paper had been "endorsed"
by the Executive Committee on 18 January 1985.()
The International Banking Strategy Paper noted that a "coherent
International operation based on the combined State Bank's initiative" ()
was "unlikely" and that it was "necessary for the Bank to
establish strategic directions for the development of its international banking
facilities". The principal strategic reason in favour of the paper's
recommendations was stated as:
"The key to the provision of competitive service is
the development of international representation giving us the ability to book transactions
on an overseas branch".
The paper went on to observe:
"The International Banking Division while existing
primarily to service the Bank's corporate customers must remain a cost effective operation
... Even with extensive marketing activity to accelerate the demand of South Australian
corporates for our services, we could not reach activity levels that would make the
projected offshore operations profitable on domestic business alone."
There is no indication in the paper that any assessment of
demand had in fact been made and this conclusion is reinforced by the paper's own
statement of a "strategic objective" being:
"To clarify the exact nature of existing South
Australian corporate demand for international banking services ... this survey should
include our existing S.A. corporate base as well as all subsidiary operations."
The Investigation was unable to find any evidence of such a
"survey" being conducted.() Mr Barrett gave evidence to the
Investigation that he had been told "that a survey had been made"
although he could not recall who told him this.()
Mr Barrett also gave evidence that there was active
discussion in the boardroom in relation to the International Banking Strategy paper to
determine what benefits to South Australia there might be from establishing a wholesale
banking operation in London. In relation to the rationale that the Bank would be servicing
the needs of South Australian customers, Mr Barrett gave the following evidence:
"Question: ... Was there any probing by the Board
as to the number, the identity of these particular customers that management was putting
forward were requiring to be serviced?
Mr Barrett: No, not in - not in detail. I think a few
names have been mentioned from time to time but I think - I think it is a difficult
situation. Which comes first -having the operation or having the customers to service? ...
Question: So you saw this was an opportunity to attract
further customers to the Bank?
Mr Barrett: Yes, that's right. Without the branch you
could - you - you couldn't get the customer.
Mr Barrett: ... I think there was an expectation we
would be able to attract customers once we established the operation."()
The paper went on to consider possible points of
representation for branches or representative offices as London, New York, Hong Kong,
Singapore and Tokyo. However, development of London was seen as the priority and the
upgrading of London office to a wholesale banking operation was recommended.
The paper stated that it was "proposed"
that other overseas representation be established "as soon as practicable after
our wholesale unit in London is trading" and that "initial attention must
focus on locations where most of our customers trade is conducted and where we can readily
access financial markets." It was recommended that investigation into the "establishment
of low cost representative offices in Hong Kong and New York commence within six months
with the aim of opening in most countries in 12 and 18 months respectively of London
The paper contained as a "secondary
"A small scale market research study be conducted
to identify demand from South Australian corporations for international finance services
and that this study provide the basis for a subsequent low key advertising campaign aimed
at increasing market awareness of the Bank's services in this area."
The Bank Board resolved:
"To develop the International Division by giving
priority to establishing a major offshore office in London capable of conducting a full
range of wholesale banking activities and, subject to State Government approval and the
concurrence of the Bank of England, the steps and timetable as set out in the paper be
taken to relocate and upgrade the existing London office operation." ()
19.2.5 1985-1990 STRATEGIC PLAN
The 1985-1990 Strategic Plan was considered by the Bank
Board on 28 March 1985(), some two months after the approval of the
establishment of full wholesale banking operations in London office pursuant to the
International Banking Strategy paper. This Plan reaffirmed the Bank's intention to develop
substantial off-shore representation. Total assets in the London office were projected to
grow from $38.0M as at June 1985 to $848.0M in June 1990, at which time, London would
represent almost 10 per cent of the total assets of the Group ($8,640.0M).
The main rationale for the overseas strategy was that there
were significant opportunities off-shore to build up business:
"A major part of the growth of International
Division will be based around the development of our offshore representation, starting
with London followed by New York and Hong Kong ... There is every reason to believe that business
opportunities for Corporate can be dramatically expanded once we have substantial London
representation. This business development will probably be focused around existing
Corporate clients but will also be supported by a continuing emphasis on correspondent
banking business."() [Emphasis Added]
The Plan also emphasised the need to ensure the
profitability of the business to be written. One of the key objectives identified was to:
"... acquire all business available from ...
overseas opportunities that:
- meet margin requirements;
- are within prudential, customer and industry limits;
- do not expose the Bank to risk of political
While Section 15 is not specifically referred to in the
Strategic Plan, the "Mission Statement" included the following matters
directly relevant to Section 15:
"To promote the balanced development of the State's
economy acting to the maximum advantage to the people of the State by:-
. maintaining our position as South Australia's leading
financial services organisation;
. providing market leadership in retail and corporate
. providing finance to any credit worthy individual,
business or community organisation.
To pay due regard to the importance both to the State's
economy and to the people of the State of the availability of housing loans consistent
with prudent banking practice.
To operate the Bank's affairs in accordance with:
. accepted principles of financial management;
. achieving a level of profit growth that would be
adequate to ensure the ongoing progress of the Bank."
The Plan does not indicate how the recommendations relating
to overseas expansion would achieve the principles enunciated in Section 15. It is
implicit, however, that profits from overseas operations would assist in "[ensuring]
the ongoing progress of the Bank".
The Bank Board resolved that the "objectives and
aims contained in the 1985 Strategy Plan be approved in principle".
19.2.6 1986-1991 STRATEGIC PLAN
The 1986-1991 Strategic Plan was presented to the Bank
Board on 27 March 1986.()
In this Strategic Plan, international expansion was a core
strategic focus. The rationale was extended from that indicated in the 1985-1990 Strategic
Plan and included:
(a) restricted growth opportunities in the domestic market,
particularly in South Australia;
(b) increased competition in Australian financial markets
following the entry of foreign banks; and
(c) the benefits of risk diversification.
The strategic thinking concerning overseas operations is
encapsulated in the following extract:
"The business of the Bank may be carried out within
or outside the State. However, until recently it had been limited almost exclusively to
the State's boundaries.
As a result of growing competition, the acquisition of
subsidiaries, and the emergence of new opportunities both interstate and overseas, the
Bank will seek to win more business outside South Australia. Selective geographic
expansion is a vital component of the Group's strategy." [Emphasis Added]
The Strategic Plan indicated that the Group's position in
1991 would include representation in London, Asia / Pacific, United States of America and
The Strategic Plan also contained five year balance sheet
targets which projected total London assets as at June 1991 as $853.0M and total other
overseas assets as $1,179.0M. This combined total of $2,032.0M represented some 16 per
cent of total projected Group assets of $12,988.0M.
As a point of comparison with the 1985-1990 Strategic Plan, this Strategic Plan projected a lower rate of
growth for the London branch with total assets as at June 1990 for London of $735.0M
(previously projected $848.0M). Other overseas branch's total assets were projected to
grow substantially to $983.0M, totalling $1,719.0M for all overseas branches. This
represented 20 per cent of projected total Group assets as at June 1990 of $8,640.0M.
This substantial increase in overseas assets is consistent
with the plan's strong emphasis on business growth. The Strategic Plan asserts that:
"The Bank will need to grow in order to:
. Meet the expectations of the shareholders, the Bank's
Board of Directors and Management, and the community,
. Remain competitive in terms of resources, size,
product and service range,
. Generate a growing stream of profits to satisfy both
the internal and external needs of the organisation." ()
The Plan noted that the Bank's traditional areas in South
Australia and the Northern Territory would be restricted in future due to, amongst other
things, the limited potential and limited growth of the South Australian economy and
population, the Bank's current high market share and the narrowing interest rate margin
environment. The Strategic Plan then propounds a rationale for overseas expansion in the
context of the principles set out in Section 15 of the Act, in the following manner:
"The Bank does not encounter a similar set of
restrictions in the Corporate/International area, where it has, in fact, greater growth
This strategy is based largely on strong
Corporate/International business growth and growth in Treasury operations gradually
throughout Australia and offshore. The objective is to achieve total assets of around $11
bn by June 1991. The proportion of wholesale assets will increase significantly. The
strategy will enable the State economy and the people of South Australia to receive
increased benefits as a result of the Bank's move outside S.A (Emphasis
The Bank Board Minutes relating to the 1986-1991 Strategic
Plan state: "The 1986-1991 Strategic Plan ... [was] discussed at
length." () There is no specific mention of any matters relating to
the overseas branches/offices. The Bank Board "endorsed" the Plan.
The Statement of the Bank's "Mission" in this
Strategic Plan was generally the same as that set out in the 1985-1990 Strategic Plan()
but was altered in relation to profitability to read as follows:
"To operate the Bank's affairs in accordance with:-
- Achieving a growing level of profitability to ensure
the ongoing competitiveness of the Bank." ()
19.2.7 HONG KONG OFFICE
The Bank Board approved the opening of the Bank's
representative office in Hong Kong on 26 June 1986.()
The Bank Board Paper() proposing the
establishment of the Hong Kong office noted that, prior to its preparation, a review of
the International Banking Strategy had been undertaken "to ensure that the Bank's
best interests as a whole are served by further development offshore".()
The paper examines the Bank's London operations in the following terms:
"In London the activities of the Bank's branch come
within the supervisory powers of the Bank of England. In exercising its powers the Bank of
England lays down certain guidelines relating to the nature and location of risk
pertaining to assets that the Branch takes onto its books.
These guidelines are established by the Bank of England
without any reference to or consideration of the nature and location of the Bank's assets
as a whole.
Consequently in order to comply with the requirements of
the Bank of England a situation has been reached where the Bank is being forced to be
prejudiced in selecting assets that London branch can hold and is being forced to forego
opportunities that would otherwise be attractive. Exposure to individual entities is
limited to 2% of London office's Balance Sheet and, in addition, the Bank of England
applies stringent controls upon the Bank's operations there ...
The Bank of England is inflexible.
An alternative `booking centre' is thus required which
will be free of the constraints currently inhibiting the growth of the Bank. This can be
overcome by having a presence in Hong Kong ..."
The rationale put forward in the paper, however, went
beyond merely overcoming the Bank's problems in achieving the growth objectives contained
in the 1986-1991 Strategic Plan. This paper's rationale also incorporated a particular
focus on Australia's position in the South-East Asian region, as indicated in the
". ... the Bank can immediately have an alternative
to booking assets through London Branch. There are no similar restrictions regarding
country limits as are advised to London by the Bank of England whilst other limits can be
overcome by arrangement with the Commissioner of Banking.
. the Hong Kong office must stand ready to offer its
corporate customers assistance and support with trade information and introductions
especially regarding China and for the region generally ... thus fulfilling the Bank's
obligations to at least one sector of the South Australian economy, as well as to the
Bank's shareholder ...
. valuable Capital Markets intelligence can be gained by
keeping in close contact with major participants in the Hong Kong market. More offers of
participations will be received and the Bank's name will become better known within this
. corporate lending opportunities should be produced
from close liaison with other Australian and New Zealand banks in Hong Kong ...
. Retail Banking can benefit from the involvement of the
Hong Kong Office in the Government's Business Migration Programme".
The paper also included a five year financial projection
for the office which showed that it would be profitable for the year ending June 1988
onwards. In addition, total assets for the Hong Kong office would grow from $215.0M as at
June 1987 to $444.0M as at June 1991.
19.2.8 OCTOBER 1986 JOINT BOARD/EXECUTIVE CONFERENCE
A joint Board/Executive Conference was held on 17 and 18
October 1986. Directors in attendance at this meeting were Mr Barrett, Mr Hancock, Mr
Bakewell, Mr Nankivell, Mr Searcy, Mr D W Simmons, Mr Smith, and Mr T M Clark. Fourteen
executives and a number of other Bank officers were also present.
Tabled at this conference was a paper entitled "State
Bank Long Term Development Options". In relation to corporate and international
operations of the Bank, this paper notes that off-shore expansion:
"... represents an area of dynamic growth, but is
subject to possible Offshore Banking Unit legislation. The Bank could easily increase its
assets offshore to its limit of 20 per cent of the balance sheet (excluding New Zealand),
by which time a review of the exposure limit may be necessary. Expansion will be through
London Office and representation points in Asia, New Zealand and USA. Opportunities for
corporate business in New Zealand are extensive."
Of particular relevance to overseas operations was a paper
entitled "International Banking - Its Role in the Future". This paper described
the general thrust of the Bank's international banking development as having two main
"1. International Finance: support Bank objectives
for offshore growth within spread of risk and target profitability parameters.
2. Trade Finance: provide a full service trade finance
facility to profitably support South Australian trade requirements."
The paper identified as one of Management's priorities, the
management of off-shore exposure and stated:
"The Bank must also continue development of our
ability to assess International Bank/Corporate risk exposure".
The paper went on to note, in relation to asset growth,
that the Bank should:
"... continue to minimise risk by obtaining a wide
spread of assets in a range of different countries, banks and industries. All asset
development should be confined within conservative risk parameters with concentration on
sovereign, bank and AAA-AA corporate risk. Higher yielding direct corporate assets
should be acquired selectively to improve return on assets (emphasis added)."
As to off-shore points of representation, there was to be
concentration on London, Hong Kong (representative office to be established in November
1986), New Zealand and New York, with other representation being established given that "the
Bank has a requirement for a booking point to hold offshore assets on a tax effective
The paper, which was presented by Mr T L Mallett (Chief
Manager, International Banking), concluded by pointing to a number of significant
"Profitable growth opportunities for the
Bank ... diversification of political and economic risk across the international economy
... enhance our ability to fully serve South Australian trade requirements ... development
of technical expertise will be encouraged by Bank exposure to international financial
markets. This expertise will enable the Bank to compete more effectively in the Australian
financial market (emphasis added)."
19.2.9 1987-1992 STRATEGIC PLAN
The 1987-1992 Strategic Plan was considered by the Bank
Board at a meeting held on 23 April 1987.()
In this Strategic Plan, the focus was again placed on
growth in overseas operations. Attention was also given to profitability:
"Offshore representation will be a major element of
the Bank's growth strategy to 1992, with the primary criterion for establishment being
profit generation. In addition to being sources of profit, offshore offices will
contribute to the Bank's wholesale funding, trade finance and corporate lending
activities (emphasis added)." ()
In considering the State Bank Group's future position, the
Strategic Plan noted that corporate/wholesale assets in the corporate and international
areas would "by far exceed retail banking assets by 1992". Representation
was noted as London, Hong Kong, New Zealand, United States of America and "possibly
The rationale for the strategy was stated as:
"This will allow [the Bank] to further
service the needs of larger corporate clients, to spread risk and to gain access to
offshore capital markets and funding sources."
The five year summary balance sheet included in this
Strategic Plan projected total overseas offices assets as at June 1992 as $2,250.0M out of
a total group asset base of $13,887.0M.
In comparison to the 1986-1991 Strategic Plan, this
Strategic Plan projected a higher rate of growth for overseas offices with total assets as
at June 1990 of $1,862.0M (previously projected $1,718.0M). This represented 16 per cent
of projected total Group assets ($11,421.0M).
The Bank Board resolved to "approve" the
In this Strategic Plan, the Bank's "Mission
Statement" underwent yet another modification, but, on this occasion, in the context
of the Bank's overseas operations, the amendment was significant. The Strategic Plan
stated that the Bank's "Mission" to promote the balanced development of the
State's economy and acting to the maximum advantage to the people of this State, would be
achieved, in addition to the means stated in the previous Strategic Plans, by:
"... increasing operations in selected markets
outside South Australia, and achieving a growing level of profits from these
In addition, according to the Strategic Plan, the Bank's
affairs would be operated not only to achieve a growing level of profitability to ensure
the ongoing competitiveness of the Bank but also "to satisfy shareholder demands
for a reasonable return on their investment".
19.2.10 NEW YORK BRANCH
(a) The First Bank Board Paper: November 1987
On 26 November 1987 a paper was presented to the Bank Board()
proposing the establishment of a New York branch in line with the International Banking
Strategy presented in January 1985.() The benefits to the bank were noted in
the Bank Board Minutes as including:
". A New York presence offering direct access to
the world's largest lending market and enhanced opportunities to achieve growth goals for
. [the office would] support the Bank's own
foreign exchange activities and provision of basic customer service by establishing a
global foreign exchange network.
. Facilitation of an increasing number of opportunities
available to the Bank to support the U.S. activities of South Australian and Australian
. Complete a natural international network.
. Improved access to sources of US dollar wholesale
funds to support the funding of US dollar denominated assets.
. Provision of a contact and referral point for U.S.
investment in South Australia as well as serving customer investment requirements in the
The Board resolved to "establish a State licensed
office in New York with the prime object of engaging in corporate lending and customer
driven foreign exchange business". The Board also resolved to "establish
a managed branch in the Cayman Islands to be used as an offshore asset booking point."
() As with all of its overseas operations, the Bank funded its overseas
operations by borrowings off-shore. Neither the Board Paper nor the Board Minutes examine
this strategic move in light of Section 15(1) of the Act, however, the Report identifies
some indirect financial benefits (eg potential to reduce international wholesale cost of
funds). The paper recommending establishment of the New York branch, as presented to the
Bank Board, did not include any reference to a significant number of matters addressed in
the body of and in attachments to the corresponding Executive Committee paper. In
particular, paragraph 3.2 of the Executive Committee paper noted:
"The principal strategic objective referred to in
this paper involves credit risk diversification in U.S. markets and by its nature the New
York wholesale corporate market requires loan participations that are medium sized
(USD10-25M) ... the asset growth necessary to ensure successful achievement of strategic
objectives in the establishment of a New York operation is significant."
Furthermore, Attachment B to the Executive Committee paper
comprised the `New York Agency Business Strategy' which included the following:
"To achieve the returns necessary to justify
activity in this market, the Bank must be prepared to consider innovative and complex
transactions. Participation in complex structured finance transactions is central to the
profitability of most successful small foreign banks in the U.S."
In evidence to the Investigation, Mr Mallett, who presented
both Executive Committee and Board Papers, was unable to recall why the various deletions
from the Executive Committee paper were made in the corresponding Bank Board Paper.()
In my opinion, these were material matters that should have been communicated to the Board
for its consideration regarding the opening of the New York office.
(b) The Second Bank Board Paper: June 1988
On 23 June 1988, the Bank Board considered a further paper
relating to the establishment of a State licensed agency in New York.() This
paper pointed out that Mr R Sewell had been appointed Executive Vice President - United
States of America in March 1988, that suitable office premises had been located and that
all documentation necessary to lodge an application for a State licensed agency had been
prepared. The paper indicated that, in order to meet the target opening date of November
1988, it was necessary to lodge this application in early July 1988.
This paper annexed a five year financial projection for the
New York branch which showed a rapid growth in assets for this office rising to $1,500.0M
by the end of the fifth year of operation. In fact, New York branch's assets reached
$1,750.0M by June 1990.
The financial projection for New York branch showed a net
loss after tax of $0.726M as at the end of year one, but a cumulative profit after tax as
at the end of year two of $1.9M, rising to a cumulative profit after tax as at the end of
year five of $20.0M. The branch's actual outcome was a cumulative profit for the period
November 1988 to February 1991 of $4.9M.()
The recommendations contained in this paper were approved
and application in due course successfully made for the grant of a State licensed agency
in New York.
19.2.11 CAYMAN ISLANDS BRANCH
At the same time as the Bank Board approved the
establishment of a State licensed office in New York (namely, 26 November 1987), the Bank
Board also approved the establishment of a managed branch in the Cayman Islands to be used
as an "offshore booking point".
The Cayman Islands is made up of a group of three islands
in the Caribbean with the capital Georgetown situated on Grand Cayman, the largest of the
islands. The Cayman Islands are a British dependent territory and enjoy a substantial
measure of self government. In the banking sphere, the Cayman Islands are one of the most
popular off-shore financial centres with in excess of 500 banks and trust companies
The attractiveness to banks of the facilities available on
Cayman Islands include:
(a) relative freedom from controls on international banking
and trust activity;
(b) absence of exchange controls;
(c) absence of stringent regulation of liquidity ratios and
(d) profits may be retained off-shore and repatriated at
will with the possible advantage of legally reducing or postponing payment of taxes in the
home country of the parent; and
(e) interest can be paid without deduction of tax at
The November 1987 paper noted the following as the:
"... principal benefits of an offshore booking
. the lowered cost of funds resulting from the absence
of reserve requirements
. the ability to hold assets that have selling
restrictions in the U.K. and Australia
. the absence of taxation. ..."
In a paper presented to the Bank Board on 24 March 1988(),
management sought the Board's confirmation of their approval of the establishment of a
managed branch in the Cayman Islands. This paper, consistent with the November 1987 paper
proposing the establishment of the New York branch, stated that the Bank intended to
establish a Cayman Island office:
"... to fulfil the following requirements:
. a holding point for assets that have selling
restrictions in the UK and Australia
. the absence of taxation, to maximise return in South
. the absence of reserve and capital requirements. ..."
In Section 19.2.16 below, I consider evidence obtained from
the Directors of the Bank as to the inference that might be drawn from the Board Papers
that the Cayman Islands branch was being established to avoid prudential requirements in
relation to the Bank's operations.
The March 1988 paper included the following statement:
"... South Australian Treasury has given their
consent. The Reserve Bank of Australia is aware of our intentions ..."
In my opinion, this statement did not convey fully the
importance of the communications between the Bank and the Reserve Bank. This issue is
further dealt with in Chapter 15 - "The Relationship with the Reserve Bank of
Australia" of this Report.
19.2.12 1988-1993 STRATEGIC PLAN
The 1988-1993 Strategic Plan was considered by the Bank
Board on 24 March 1988.() In this Strategic Plan, the international emphasis
was less marked than in former Plans. The Bank planned to have an active presence in
Melbourne, Sydney, Perth, Wellington and New York as well as in London; and to establish
regional lending offices in Manchester, Bristol and Southampton (United Kingdom). The
Cayman Islands branch was to be "heavily used as a booking centre".()
The Bank Board resolved to "approve" the Strategic Plan.
The statement of the Bank's "Mission" underwent a
significant recasting in this Strategic Plan with the statement reverting to a virtual
restatement of the plain words of Section 15(1) and (2) without the embellishments which
had appeared in earlier strategic plans.
19.2.13 AUCKLAND BRANCH
(a) The April 1988 "Concept Paper"
The Bank effectively had been expanding into New Zealand
from 1984 by means of loans or facilities in favour of New Zealand companies. These loans
were managed out of Adelaide office, and, by 1988, the Bank had exposure of some $400.0M
in New Zealand. Mr Mallett, stated that the principal reason initially for establishment
of the Auckland branch was that "we should have people on the ground to manage
On 6 May 1988,() the Executive Committee
considered a "Concept Paper" in relation to a recommendation put forward by Mr
Mallett that the Bank establish a branch in New Zealand. This Concept Paper dealt with a
broad range of issues including: strategic objectives; "environment" (economy,
market, competition, threats and opportunities); forms of representation; and structure.
The following extracts from the Concept Paper are
indicative of the tenor of the paper in relation to the New Zealand economy:
"The Lange Labour Government's policies towards
restructuring the New Zealand economy ... are expected to result in a more competitive and
flexible economy and business sector by the early 1990s. In the interim, however, the
continuation of high interest rates relatively high inflation and an overvalued $NZ are
likely to keep overall economic activity flat.
The international debt is high in relation to Gross
Domestic Product and Exports but some stabilisation is expected as a consequence of public
asset sales. The public sector deficit is being wound back but remains high relative to
Gross Domestic Product, as does the public sector debt.
The evident confusion and disagreement within the
Government surrounding the tax and other changes announced in December  has
been criticised by business and caused a further fall in confidence already adversely
affected by the deteriorating state of the economy.
In 1988 and 1989 economic growth is expected by the
Reserve Bank of New Zealand to be slow or negative."
On 15 July 1988, a paper entitled `Establishment of New
Zealand Office' was presented to the Executive Committee for consideration for
recommendation to the Bank Board.() This paper not only sought to establish the
Auckland branch, but also recommended increasing the New Zealand country exposure limit to
a total of $1,500.0M. This paper contained none of the economic information included in
the May 1988 "Concept Paper".
(b) The First Bank Board Paper: July 1988
A paper entitled `Establishment of New Zealand Office',
dated 20 July 1988, was presented to the Bank Board by Mr Mallett on 28 July 1988.()
This paper sought the establishment of the Auckland branch with the "prime object
of engaging in direct corporate and commercial lending, money market and foreign exchange
business." This paper followed the lines of the July 1988 Executive Committee
paper in that it contained none of the economic information included in the May 1988
"Concept Paper". The Executive Committee paper stipulated that corporate lending
in New Zealand would continue to be the responsibility of head office. The Bank Board
Paper, however, altered this arrangement and proposed that the Auckland branch assume full
responsibility for New Zealand corporate lending as was the practice with London and New
York branches. In due course, head office's existing portfolio of New Zealand assets was
transferred to Auckland branch. This portfolio included a number of non-performing loans.
This issue is dealt with in Sections 126.96.36.199 and 188.8.131.52 below.
In relation to the strategic rationale for the proposal,
the Bank Board Paper observed:
"... principle (sic) objectives of the
establishment of a New Zealand branch are consistent with the International Banking
. improve the Bank's diversification of both geographic
and industry risk while broadening the range of customer services
. extend the Bank's international network
. expand opportunities for foreign investment in South
Australia (emphasis added)".
Of the various strategic objectives indicated in the Bank
Board Paper, commercial lending was highlighted as being the "charter" of
the "major thrust of the New Zealand office".
On 28 July 1988, the Bank Board approved the establishment
of the New Zealand office. At the same time, the Bank Board also approved the increase in
the New Zealand country exposure to a total of $1,500.0M comprised of $500.0M direct
exposure (eg loans made), $500.0M contingent exposure (eg undrawn credit lines) and
$500.0M money market exposure (ie Treasury dealings).()
In their submission to the Investigation, the Non-Executive
"Moves into New Zealand were also seen as
counter-cyclical, given that the likely outcome for the New Zealand economy in 1988 and
1989 was "slow or negative ... economic growth". The Board was aware of this."()
The investigation noted that Mr D Gobbett, the Bank's Chief
Economist, presented regular economic overviews to the Bank Board; these overviews,
however, did not specifically cover the New Zealand economy until February 1989.()
A number of Directors however asserted in evidence to the
Investigation that prior to the Board's approval to the establishment of the Auckland
branch, questions were asked of Mr Gobbett in relation to the New Zealand economy. This
evidence is not contradicted by the evidence of Mr Gobbett.()
An application, to the Reserve Bank of New Zealand, for
approval of the Bank's establishing a branch in Auckland was duly procured. Another event,
however, was to overtake this application.
(c) The Acquisition of Security Pacific
On 27 October 1988, Mr Mallett presented to the Bank Board()
a paper recommending that the Board authorise Mr Mallett to proceed with negotiations with
an unnamed "major international bank" (later identified as Security Pacific
Limited) for the purchase as a going concern of its New Zealand subsidiary. (This
subsidiary was later identified as Security Pacific Bank New Zealand Limited).()
The Bank Board Paper noted that:
"... purchase of [Security Pacific] will
enable State Bank to acquire personnel, premises, systems and (at our discretion) assets
of up to $NZ700.0M, creating a fully operational and immediately profitable New
Zealand branch, and accelerating our New Zealand business plan by approximately 3
The paper concluded by stating that:
"The proposal outlined ... represents an
outstanding opportunity for the Bank to acquire at no premium a fully operational,
profitable New Zealand branch (emphasis added)..."
As with the first Board Paper seeking establishment of a
New Zealand branch,() this paper was submitted to Board without any of the
economic information and views expressed in the Concept Paper of May 1988. In addition, at
the time that the Bank Board was first considering the proposal to establish a branch in
New Zealand (ie 28 July 1988), Mr J B Macky (General Manager, Group Information Systems),
was visiting New Zealand. In a memorandum to Mr Mallett, and copied to Mr Clark, dated 5
August 1988, Mr Macky reported on his findings of his New Zealand visit. Mr Macky's
"... the general impression is that many NZ'ers
believe the New Zealand economy is headed for a major disaster. There is an overall
pervading atmosphere of pessimism. The feeling is that Mr Douglas's policies are driving a
lot of previously highly protected firms out of business and generating high levels of
unemployment, without there being a clear direction from the government as to what is
going to take its place and how this replacement is going to be achieved.
Those that I spoke to, when asked if there was an
opportunity for another Bank to enter the market, all commented that they felt this would
be very difficult because of existing loyalties."
Mr Mallett acknowledged receipt of this memorandum stating "read
with interest". Given that commercial lending had been highlighted in the Bank
Board Paper of 20 July 1988 as the "major thrust" of the Auckland branch,
Mr Mallett's response to Mr Macky's memorandum, in my opinion, is cavalier to say the
Of even more concern is the fact that Mr Mallett and Mr
Clark did not see fit to present Mr Macky's report (or any summary of it), or any of the
economic information contained in the May 1988 "Concept Paper" to the Bank Board
when it was asked to consider the acquisition of Security Pacific. I regard this failure,
on the part of Mr Mallett and Mr Clark, as a dereliction of their duties to the Bank and
to the Bank Board.
In evidence to the Investigation, the author of the Bank
Board Paper, Mr Mallett, indicated that he saw no need to include information on the
economic situation in New Zealand in the paper:
"... New Zealand was going through a difficult
period. It was understood, recognised, publicly communicated in many forms by the Bank, by
myself, by the Managing Director. It wasn't something that Daryl Gobbett was telling us
was new, we knew it, but we were still prepared to establish in that market. It's a bit
like saying today in South Australia that the South Australian economy's got severe
problems. Big deal. We're still out there trying to write all the business we can. We know
it, we recognise it but we're still actively out there trying to build the Bank, build our
business ..." ()
I do not accept Mr Mallett's rationale as any answer to his
failure to present economic information to the Bank Board. It is simply a presumption on
his part as to what the Bank Board knew or did not know of the economic situation at the
time prevailing in New Zealand. The failure on the part of Mr Clark and Mr Mallett to
present economic information to the Bank Board in the Board Papers of 20 July 1988 and 27
October 1988, in my opinion, reflects, for reasons that are amplified hereunder, an
attitude on their part that the Bank Board would simply "rubber stamp" whatever
proposal was put forward to the Bank Board concerning overseas expansion of the Bank.
(d) The "Profitable New Zealand Branch"
The Bank Board Paper of 27 October 1988 advanced the
following as the reason for sale by Security Pacific:
"... the seller is currently undergoing a program
of rationalisation, on a global scale, in order to boost the price of its shares traded on
U.S. stock exchanges ... despite the New Zealand subsidiary's profitability and
consequent importance to the seller, it has no direct impact on the seller's global
strategic goals and objectives (emphasis added)."
This same paper, however, notes that Security Pacific
upgraded its prior merchant banking activities in New Zealand to a registered bank in
February 1988, only some 8 months prior to the date of the Bank Board's deliberations. The
question arises as to why there would be the sale of a profitable enterprise for no
premium. This is not in itself outside of the parameters of commercial practice, and not
necessarily unusual. Nonetheless, it would be expected that a reasonable business person
would seek some independent comfort that there was no underlying reason that should be
understood and/or examined.
On 27 October 1988, the Bank Board resolved() to
approve that Mr Mallett proceed with negotiations. On 8 November 1988, Mr Clark and
Mr Mallett signed, as Attorneys on behalf of the Bank, a Heads of Agreement with Security
Pacific Limited, in relation to the purchase of Security Pacific Bank New Zealand Ltd.
This agreement was expressed to be not intended to form a binding agreement, and was
subject to execution of a formal Sale Agreement which was duly executed on 6 December
On 24 November 1988, Mr Mallett presented a paper to the
Bank Board seeking confirmation of the acquisition of Security Pacific Bank New Zealand
Ltd at a "total net cost to the Bank of approximately $A1.1M, being the net
written down value of the fixed assets." () The paper went on to
"Budgets are currently being formulated to cover
the period between purchase date and June 30, 1988. It is expected that the New Zealand
operation will contribute $A1.0M during this time. It is predicted that within three years
the operation will increase its return on equity from 8% to 15%."
Although the Bank was given a period of three months by
Security Pacific to analyse its New Zealand subsidiary's receivables and then to purchase
only those assets which met the Bank's lending criteria,() the Bank took only
three weeks to review the portfolio.() The quality of the portfolio taken over
by the Bank from Security Pacific will be dealt with later in this Report.() At
least by May 1989 (ie less than six months from the date of the purchase of Security
Pacific), Mr Mallett was reporting, to Mr Clark, non-accrual loans totalling $16.0M
arising from the Security Pacific purchase.()
(e) Increase in the New Zealand "Country
The Bank Board Paper of 24 November 1988 not only sought
"confirmation" of the acquisition of Security Pacific, but also the Board's
approval to an amendment to the Bank's "country limit" in respect of New
In support of the proposal, the paper noted:
"In view of the close economic relationship in both
Commerce and Finance that is developing between the two countries, the level of sovereign
and political risk that would normally be taken into account when assessing country lines
is of only limited concern."
On 28 July 1988, when it approved the establishment of the
Auckland branch, the Bank Board had also approved the New Zealand "country
limit" exposure as a total of $1,500.0M comprising a maximum of each of
$500.0M direct exposure, $500.0M contingent exposure, and $500.0M money market exposure.
The proposal before the Board, on 24 November 1988, sought a maximum of all exposure (ie
any one or more of direct exposure, contingent exposure or money market exposure) to New
Zealand of 15 per cent of the Bank's total balance sheet. The attachment to the Bank Board
Paper indicated total Bank assets as at 30 October 1988, of $10,654.0M, giving an
immediate limit of $1,598.0M in respect of any one or more of these categories of
Given the Bank Board's previous approvals for country
limits of 20 per cent of the Bank's balance sheet for all other overseas operations, the
Bank Board's decision effectively permitted management, in accordance with delegated
lending authorities, to expose a total of 35 per cent of the Bank's balance sheet from
time to time in overseas operations.
On 24 November 1988, the Bank Board confirmed the
acquisition of Security Pacific New Zealand and approved the recommendation that 15 per
cent of the Bank's total assets be the "country limit" for New Zealand. The
Board Minutes of 24 November 1988 indicate that Mr Clark and Mr Mallett had visited
Security Pacific and that "the Board were advised that all had been impressed with
the standing of Security Pacific in the market place in New Zealand and the quality of
staff at Security Pacific". As noted in Sections 184.108.40.206 and 220.127.116.11 below, the
loan portfolio of Security Pacific gave rise in a short space of time to significant
19.2.14 1990-1994 STRATEGIC PLAN
The "1990-1994 Strategic Plan" was considered by
the Bank Board on 10 May 1989. This plan covered the period 1989 to 1994, notwithstanding
the year references in its title.
This Strategic Plan recognised the strategic limitations of
the South Australian market, but, with the Bank Board's approval of the opening of the
Auckland branch, proceeded to recognise Australia and New Zealand as the Bank's "main
region of ... operations". The principles enunciated in Section 15(1) of the Act
are, in this Strategic Plan, indirectly referred to in the statement of the "Group
Vision" in the following way:
"The Bank has, however, grown beyond the abilities
of the South Australian market to utilise fully its own and the subsidiary companies'
capacity to provide financial services. This excess capacity is used in interstate and
overseas markets to generate a greater return on South Australians' investment in their
This maximises the Bank's contribution to the State's
revenue to the benefit of the whole South Australian community.
We selectively seek offshore expansion, through our
representations in Great Britain, USA, New Zealand, Hong Kong and other areas."
Total group assets, in the Strategic Plan, were predicted
to grow from $18,046.0M in 1989-90 to $36,028.0M in 1993-94, corresponding Bank assets
growing from $15,215.0M to $30,396.0M. Total Treasury and International assets including
New Zealand were predicted to reach $12,800.0M by 1993-94 with locations overseas as
". New Zealand: Auckland, Wellington, Christchurch;
. USA: New York, Los Angeles, Chicago, Houston;
. Europe: London, Manchester;
. Asia: Hong Kong;
. Elsewhere as appropriate."
By the end of the period covered by this Report, the Bank
had established representation in all locations identified above, with the exception of
Manchester and Houston.
The Bank Board resolved to "approve" the
Strategic Plan. The Bank Board Minutes reflect, at least indirectly, the Bank Board's
thinking on the relevance of the Bank's overseas expansion to South Australians as
"The Strategic Plan highlighted the Bank's primary
commitment to South Australia, whilst utilising its own and subsidiary companies capacity
to provide financial services interstate and overseas to generate a greater return on
South Australians' investment in their Bank." ()
19.2.15 THE BANK'S PROFIT PLANS 1985-1990
During the period under review, the Bank produced annual
"Profit Plans". These plans were, in effect, annual budgets.
The profit plans for the years 1985-1990 are consistent
with the annual Strategic Plans in relation to the growth of overseas assets. These profit
plans also give an insight into the Bank's expectations as to the profitability of its
overseas operations during the period under review. As will be indicated later in this
Chapter, however, the actual financial outcomes for the overseas branches, having regard
to the level of non-performing assets reported by those branches as at February 1991,
indicates the extent to which these expectations were not fulfilled.
(b) 1985-1986 Profit Plan
The 1985-86 Profit Plan which was approved by the Bank
Board on 25 July 1985(), referred to the London book as a major source of
growth with London branch advances, increasing by $310.0M to $350.0M. This growth would be
funded solely in London.() The Plan states that:
"The main action plan on the international side is
simply to build up business. This can be partly achieved by using the existing corporate
base. Generally, there needs to be a greater awareness of the Bank's ability to handle the
full range of international transactions ... emphasis will be placed on development of
London Branch ..."
The budgeted profit for the overseas branches is not shown
in this Plan.
(c) 1986-1987 Profit Plan
The 1986-87 Profit Plan was approved by the Bank Board on
24 July 1986.() This Plan again refers to the London and Hong Kong offices as
being major components of asset growth for the Bank, with assets increasing by $475.0M to
"Expansion overseas is vital to the Groups asset
growth and funding. As such our program proposes the development of international business
in selected overseas markets."
The increase was to be funded entirely by the individual
overseas branches. This Plan noted that Management was seeking to achieve a break-even
point during 1986 in respect of its overseas operations.
(d) 1987-1988 Profit Plan
In presenting the 1987-88 Profit Plan to the Bank Board, on
23 July 1987, Mr Clark advised the Bank Board that "the emphasis this year will be
concentrated on profitability, accepting if necessary the possibility of some loss of
market share." ()
This Profit Plan stated that the Bank had dedicated
personnel to research the potential of establishing a New York branch "if the
feasibility prepared evidences profitable opportunities in that market".
The Plan predicted significant growth in overseas assets
with management budgeting for a growth in overseas assets of approximately 127 per cent in
the financial year from $750.0M to $1,700.0M "and with a profit lift of
approximately 100 per cent". In particular, London office assets alone were
predicted to reach $1,050.0M by June 1988.
The Bank Board approved the Profit Plan on 23 July 1987,
and the Bank Board Minutes record that:
"The Managing Director advised the Board that
offshore banking operations would be closely monitored to ensure that growth is achieved
in a controlled manner." ()
This undertaking by the Managing Director was vital
given the significant asset growth projected for the overseas operations.
(e) 1988-1989 Profit Plan
The 1988-89 Profit Plan, which was approved by the Bank
Board on 28 July 1988,() called for "continued growth in assets and
profitability within the [State Bank] Group".
In submitting this Profit Plan, Mr Clark noted that
establishment of the target profit of $97.3M for the Group ($65.8M for the Bank) had not
been easy and in fact, the first cut of the profit plan produced a profit of only $24.0M.
After various "cuts" and "reviews" the target profit was struck.
(f) 1989-1990 Profit Plan
The 1989-1990 Profit Plan was approved by the Bank Board on
27 July 1989.() This Plan noted that:
"Expansion of the Group's activities will occur
through selected market niches within Australia and continued careful expansion of
operations in the International arena."
(g) 1990-1991 Profit Plan
The 1990-91 Profit Plan was approved by the Bank Board on
23 August 1990.() In this Plan, the need to ensure that the off-shore
operations were profitable was emphasised:
"Our offshore operation must in its own right
generate financial advantage to the State of South Australia. To expand offshore the Bank
must fully recognise the commerciality of the decision that it is exporting its
Management, however, saw that the Bank's Government
Guarantee gave it a competitive edge:
"We pursue aggressive, controlled growth in major
financial centres using the strong competitive position provided by our Government
Guarantee and reputation as a high quality sovereign counterparty".
Total assets for the overseas operations (excluding United
Banking Group) were forecast to grow from $5,080.0M as at June 1990 to $5,885.0M as at
June 1991. There was to be growth in New Zealand (up $220.0M) and Hong Kong (up $480.0M -
following its proposed upgrading to branch status). There would be a reduction in London
assets (down $34.0M to $1,318.0M) but growth in New York (up $134.0M to $2,255.0M).
19.2.16 CONSIDERATION OF DIRECTION SETTING AND PLANNING
FOR OVERSEAS OPERATIONS
The Bank's strategic planning processes are discussed in
detail in Chapter 4 - "Direction-Setting and Planning" of this Report.
For the purposes of considering the direction setting and planning of the Bank in relation
to its overseas expansion, the starting point is Section 15 of the Act and the
identification of the way in which the development and growth of the Bank's overseas
operations satisfied the principles set out in that Section.
This second Section of this Chapter of the Report focused,
not only on the specific decisions to open off-shore branches, but also the Bank Board's
support for the strategy of overseas expansion via the approval of the more general
Strategic Plans and Profit Plans which recommended continued growth of these operations.
Whilst many and varied strategic reasons were advanced in
support of each of the decisions to upgrade London branch to wholesale banking operations
and to open Hong Kong office and New York and Auckland branches, the recurring theme is
that there was an opportunity identified by management and supported by the Board to grow
the Bank's balance sheet and to diversify the Bank's risk profiles in these new markets.
There was also a recognition that the South Australian market was saturated and that
profits were ready to be made off-shore.
Prior to the opening of London branch's wholesale banking
operations in October 1985, the Bank had no wholesale banking experience in off-shore
markets. The operations of London branch prior to October 1985 were minor retail banking
services; indeed they were described by Mr Mallett as a "mail redirection and
plant watering service". ()
Prior to the submission of papers recommending opening of
branches in New York and Auckland, Mr Mallett sent one of his senior staff members to
conduct an initial survey of opportunities available to the Bank. These preliminary
surveys were of limited scope as indicated by Mr Mallett in relation to the New York
"[The Bank's officer] went there to ... build up
the Bank's knowledge of data base, premises, registry requirement, all those type of
issues, talked to other banks that were there, and certainly gained an impression that
there were opportunities there and make us aware of things we need to consider ...".()
The Non-Executive Directors made extensive submissions to
the Investigation in relation to direction setting and planning for the Bank's overseas
operations. In particular, they submitted that "consideration of any proposal
before the Board was always tested against Section 15. That process was axiomatic."()
At the outset, the Non-Executive Directors pointed to
Government support for the Bank's expansion overseas and to the argument that the Second
Reading Speech to the State Bank of South Australia Act, 1983 gave a "mandate"
for such expansion. The involvement of the Government in relation to the Bank's operations
is not a matter to which I am required to direct attention by my Terms of Appointment.
Accordingly I do not propose to make any further observation in relation to the role of
Government. The Second Reading Speech did indicate the following as principles on which
the legislative framework for the new bank was based:
"1. That the Bank should conduct its affairs with a
view to promoting the balanced development of the State's economy and the maximum
advantage of the people of South Australia. Bearing in mind the traditional emphasis on
housing, the Bank shall also pay due regard to the importance, both to the State's economy
and to the people of the State, of the availability of housing loans.
2. That the Bank should operate in accordance with
accepted principles of financial management.
3. That the Bank should operate in conditions as
comparable as practicable with those in which its private sector counterparts operate.
4. That the Bank should be able to become an active,
innovative and effective participant in the South Australian economy and financial
markets, with the flexibility to adjust to the changes which are a feature of these
As the Second Reading Speech noted, the first two of the
above principles appear significantly in Section 15 of the Act. The Second Reading Speech
also noted that the third principle was reflected mainly in Section 6 (which confers on
the Bank the powers of a body corporate) and Section 22 (which provides that the Bank
shall make payments from any operating surplus to the General Revenue). The fourth
principle was said to be embodied in Section 19 of the Act (which confers on the Bank
power to carry on banking and other related business).
As noted above in this Chapter, various reasons were
advanced by management in support of the proposals submitted to the Bank Board for
approval of establishment of overseas branches.
In their Submission to the Investigation, the Non-Executive
"In the view of the Board, perhaps the key reason
for the Bank's overseas expansion was to ensure access to the international capital
markets to assist fund raising, both to the Bank and its customers. The Board also
recognised that to attract major Australian corporates as clients it was necessary to
"be seen as international" or, at least, have an international capacity. In
time, management would rely increasingly - and offer as justification time and again - the
need to follow its customers offshore and provide them with all of the services they
expected from their Bank. For the Board, this justification, while often repeated by
management, remained a secondary consideration.
As the International Banking Strategy paper of January
1985 envisaged, it was also intended that the overseas branches of the Bank pay their way
and this was one of the reasons why the Board accepted the principle of the Bank engaging
in some domestic business in offshore markets consistent with and subject to the
recommendations of management and their assurances that growth would be prudent and
In his evidence to the Investigation, Mr Clark denied that
he had, in particular, advanced as a reason justifying off-shore expansion the matter of
following existing customers off-shore. Mr Clark also gave evidence that of all the
various reasons advanced in support of overseas expansion, management did not present them
in any order of importance.()
Mr Clark did support the evidence of the Non-Executive
Directors as to the benefits of an off-shore branch in borrowing funds more
advantageously. Mr Clark acknowledged that whilst an off-shore branch was not necessary to
raise funds, he "believed that the presence offshore assisted in the raising of
those funds at the very best rates." ()
In relation to the proposal to establish the New York
branch, the Non-Executive Directors submitted:
"... a factor which was influential when
considering the opening of the New York branch was the continuous trading opportunities
allowed through the opening of an office (in) a different time zone."
One strategic objective which is consistent throughout the
various Bank Board Papers relating to overseas operations is the opportunity to make a
profit - by writing more business than was available within the South Australian market.
In evidence to the Investigation, Mr Mallett (Chief General Manager, Corporate and
International) emphasised that, as the manager responsible for the Bank's overseas
operations, he had clear instructions as to the priority of profitability:
"What I do recall though was a very firm
requirement of Tim Clark's ... that any offices of the bank opening outside of South
Australia had to be profitable within their own right within 12 months. Now, by
definition, the only way to do that was to write substantial business in the new market
that you're going into." ()
But the Bank's overseas expansion was not without risks, as
was appreciated by management:
"Just the whole exercise had risks, not just taking
on more risky business. Just simply by going into a brand new market has risks ... you can
gain competitive advantages for various reasons and you can take the business that no one
else wants. Well, let's assume you're smart enough that you're not doing that, you can
gain business by doing it cheaper than everyone else ..." ()
In evidence to the Investigation, Mr Mallett spoke of an
"unwritten rule" as to the need to have a branch overseas profitable within 12
"... The most important thing was profit because
under the rules which says unless you could have an office that broke even within 12
months, no matter what your reasons were you couldn't open the office any way and you were
not allowed to open beach heads. You are not allowed to open offices that were there for
flag flying. You weren't allowed to have a look at the market and try it out. You had to
go there and make money." ()
Mr Mallett's observations are borne out by the evidence to
the Royal Commission of Mr Barrett (Chairman until June 1989):
"Question: What do you say about New York, what was
your perception [of the reasons for going there]?
Mr Barrett: As it was presented to the Bank, this was to
service customers from our Australian home base.
Question: Were there many?
Mr Barrett: I don't know the detail, no, I don't think
there were many at that stage, but one principle the Bank had in mind was that any branch
had to be financially independent, so they would be expected to generate a bit of profit
on their own, they weren't to be a loss on the profit and loss account of the Bank, so
would expect them to be self supporting financially.
Question: When you say "self supporting",
wouldn't you expect a bit more than that, indeed wouldn't you expect something better than
a little profit, which is your word.
Mr Barrett: At least self supporting, yes, but starting
off in a small way, of course, and gradually building a base in which to make reasonable
Mr Bakewell's evidence to the Investigation() is
illuminating as to the approach taken by the Bank Board to the various proposals for
overseas expansion submitted to them:
"... I can't remember any director particularly
opposing the opening of the London - or with the increasing of the London development. As
far as America was concerned, the Bank was on the up. There was a certain amount of
enthusiasm. There was considerable discussion of where the office should be in America.
Some directors felt Chicago was more appropriate or even Los Angeles was more appropriate
than New York. I don't, frankly, remember any director opposing at that stage."
Mr Barrett gave evidence to the Royal Commission about the
"prestige" of the Bank being seen as an "international bank":
"Question: Was it ever put to the Board, or seen by
the Board as a matter of prestige, to have the State Bank flag waving or its emblem as
showing in as many parts of the world as possible.
Mr Barrett: Yes, I don't know about as many parts of the
world as possible, but we certainly saw benefits promoting South Australia, yes, promoting
Question: What, as an advertisement for the State.
Mr Barrett: Yes.
Question: Who was putting that point of view, in
Mr Barrett: Management, in particular.
Question: When you say Management, I suppose that really
means Mr Marcus Clark, does it.
Mr Barrett: And his Executive Committee, his Corporate
Banking people and Treasury people.
Question: ... Would it be fair to say that also, apart
from what I'll call any flag waving aspect in expansions interstate and overseas, the Bank
had a clear policy, supported by the Board, that it didn't want to be seen, didn't, in
fact want to be, what I'll call a small regional bank, it wanted to be something more than
Mr Barrett: Yes." ()
In his evidence to this Investigation, however, Mr Barrett
sought to explain his evidence to the Royal Commission on this matter:
"Mr Barrett: I think the word "prestige"
there was in promoting South Australia, putting South Australia on the map. Nothing more
than that. I think there was no great prestige in us having a branch there ipso facto, but
only a matter of promoting South Australia. A lot of people wouldn't know where South
In his evidence to the Royal Commission, Mr Clark agreed
with the proposition that in relation to the establishment of the New York branch, there
was "an element of keeping up with the Jones." ()
So far as the decision to open the
Auckland branch was concerned, certainly Mr Mallett, as the Chief General Manager
responsible for the international operations of the Bank was concerned, the position was
"Question: [The question is] whether it was
as you may have perceived it to be almost a rubber stamp?
Mr Mallett: A done deal. I mean, we already had major involvement in New Zealand. I
mean, this whole concept of someone telling us that the economy is stuffed. It's a bit
late when you've got half a billion dollars worth of lending there." ()
Whilst economic information on countries put forward as the
proposed target for overseas expansion was presented to Executive Committee in Executive
Committee papers, no such information was put forward to Bank Board in the corresponding
Bank Board Papers. In his evidence to the Investigation, Mr Mallett defended this
discrepancy in the case of New Zealand, on the basis that the state of the New Zealand
economy was understood by all.()
I do not accept this explanation by Mr Mallett, not least
for the reason that it begs the question why he saw fit to present the information to the
Executive Committee but not to the Bank Board. In discharging his duties to the Bank and
to the Bank Board it was not open to Mr Mallett to make any assumptions about the level of
knowledge about the New Zealand economy which the Bank Board may individually or
collectively have had. The Bank employed experienced and senior economists presumably so
that Management could obtain the benefit of their knowledge and experience. The inference
is open to be drawn from Management's failure to present to the Bank Board the economic
information which was presented in the "Concept Paper" of May 1988, that the
economic views expressed did not suit Management's arguments and because they could have
prompted the Board to probe Management on the wisdom of opening a branch in Auckland.
In Section 19.2.11 above, I referred to the proposal to
establish the Cayman Islands branch. As noted in that Section, each of the papers
submitted to the Board made it clear that the Bank was seeking to benefit from "the
absence of reserve requirements". In their submission to the Investigation, the
Non-Executive Directors said:
"At no time was it suggested to Mr Simmons, or any
other Board member that the State Bank's activities in New York escaped the net of either
Federal or State regulators."()
The Non-Executive Directors further said:
"As far as the Board were concerned, New York State
Banking Regulations - and the scrutiny of all relevant regulators - applied to the New
York operations of the State Bank in the same way as they applied to any other bank with
an office in New York. Although transactions were to be booked through the Cayman Islands,
the Board was assured by management that this procedure was lawful, normal and utilised by
many domestic Australian and other international banks carrying on business in the United
The above submissions were supported by evidence given by a
number of the Directors as to their understanding of the phrase "absence of
reserve requirements". The effect of the evidence of the Directors was that they
did not understand the phrase to suggest that the Bank would, by adoption of the Cayman
Islands branch as an off-shore booking centre, avoid the prudential scrutiny of the New
York State banking authorities.
Nevertheless in excess of 95 per cent of the assets managed
by New York branch were actually booked through the Cayman Islands and thus were not
subjected to prudential supervision or any other form of scrutiny by the New York State
banking regulators. In particular, the New York State banking department's Prime Asset
Ratio ("liquidity") was therefore determined on some 5 per cent of the
total corporate book under management of the New York branch.
New York branch was, in fact, subject to one review by the
New York State Banking department, and this review covered a balance sheet of some $US
30.0M. At the same time, assets in excess of $US 700.0M sat off-shore (at least
notionally) in the Cayman Islands.
On the basis of the matters reported above, and for the
reasons indicated, I am of the opinion that the direction setting and planning process
adopted by the Bank in relation to its overseas operations was appropriate. I emphasise
that this conclusion relates to the "process" whereby the Bank Board
approved specific proposals for the establishment of overseas branches in the broader
context of an annual five year "look ahead" broad strategic analysis, and
annual Profit Plans.
I am satisfied that the Bank Board did have regard to the
Bank's "Charter" as set out in Section 15 of the Act, albeit that Section
15 of the Act was not specifically referred to in Bank Board Papers or Bank Board Minutes
in relation to the proposals to establish off-shore branches. I am also satisfied that the
Bank Board believed that the various reasons advanced by management from time to time in
the specific Bank Board Papers, the Strategic Plans, and the Profit Plans, had a
sufficient connection with the Bank's Charter such as to satisfy it. In this Chapter I do
not propose to express a view as to whether I, personally, if I were in the place of the
Bank Board, would see the reasons advanced by management as satisfying the Bank's Charter.
Such a process, I suspect, could suffer too severely from the benefit of hindsight.
I am, however, of the opinion, that the Bank Board and
management were significantly influenced by the arguments time and again advanced in the
various Bank Board Papers, Strategic Plans, and Profit Plans, that off-shore expansion
provided to the Bank the opportunity to grow its asset base and, in particular, its
corporate banking asset base. In my view the drive for growth was apparent in the January
1985 International Banking Strategy Paper and the 1985 Strategic Plan. Whatever doubts any
person may have entertained about the Bank's focus on asset growth overseas was clearly
dispelled in the Bank Board Paper proposing the establishment of the Hong Kong office. In
my view, the focus was deliberately to avoid the prudential requirements and growth
restrictions imposed by the Bank of England. This was no secret. This was the plain and
primary rationale for the establishment of the Hong Kong office as proposed in the June
1986 Bank Board Paper.
The evidence of the Non-Executive Directors, on the one
hand, and Mr Clark and Mr Mallett, on the other, in relation to the reasons for the Bank's
off-shore expansion is, in many respects irreconcilably conflicting. I am not in a
position to reconcile those conflicts. Whatever may have passed between the Bank Board and
management in relation to the rationale for overseas expansion, the plain fact of the
matter is that asset growth with emphasis on corporate banking asset growth, was apparent
on the face of the Bank Board Papers, the Strategic Plans, and the Profit Plans as the
ostensible reason for the moves proposed.
But asset growth was not advocated simply for asset
growth's sake. I am satisfied that asset growth off-shore did give the Bank a measure of
risk diversification at least geographically. I am of the opinion, however, that the
driving force behind asset growth was the opportunity to make profits and this again is
clear on the face of the Bank Board Papers, the Strategic Plans, and the Profit Plans as
In the next Section of this Report I analyse the Bank's
off-shore asset growth and the profitability of the bank's overseas operations.
19.3 GROWTH AND PERFORMANCE OF OVERSEAS BRANCHES
19.3.1 OVERVIEW OF OPERATIONS OF THE LONDON BRANCH
18.104.22.168 Principal Activities
From July 1984 to September 1985, London branch operated
essentially as a "paying -receiving centre" (), which was not
operating profitably and was, in fact, expected to produce a $0.2M loss for the year ended
30 June 1985.()
In August 1985, Mr Mallett was sent to London to assist in
establishing the administrative procedures for the branch upon its commencement of
wholesale banking operations.()
From October 1985, London branch provided corporate
finance, and became an active dealer with the professional financial markets. London
assets were funded by the London branch's own borrowings. Its treasury operations
comprised both trading activities and risk management activities. London branch's treasury
activities ceased in November 1990, whilst its risk management operations continued
London branch's corporate finance activities focused
predominantly on exposure to the United Kingdom property market.() From the
beginning, the corporate finance portfolio carried a weighting in favour of property
exposure with 30 per cent exposure to property being set by Head office. As will be noted
in Section 19.7 below, the London branch's exposure to property was a matter of
significant concern to both the Bank of England and the Reserve Bank of Australia; that
concern was expressed on numerous occasions to Mr Clark, Mr Mallett and other Bank
In late 1990, London branch moved into the area of
"asset based lending" and away from real property secured loans. "Asset
base lending" was the description applied to corporate lending secured against
business assets and business cash flow.
22.214.171.124 Organisation Structure and Staffing
In the period since 1985, the London branch has had four
(a) Mr R Wright (appointed April 1985);
(b) Mr M Wilcox (appointed April 1988);
(c) Mr T Lynn Todd (appointed September 1989); and
(d) Mr P Russo (appointed November 1990 - on secondment
from New York).
Up until late 1990, London branch was responsible directly
to the Chief General Manager, Corporate and International (previously Treasury and
International) who was located in Adelaide. From November 1990, London branch reported to
the Executive Vice President, United States of America.
In line with the Bank's restructure of its Treasury
operations, from November 1990, London Treasury became part of Global Treasury reporting
to the Group Treasurer in Adelaide.
126.96.36.199 Prudential Control and Supervision
The London operations are supervised by the Bank of
England. The Reserve Bank of Australia also monitors the London operations by way of its
regular meetings and correspondence with the Bank.
From the time of establishment of the London branch,
regular meetings and correspondence occurred with the Bank of England. There were also
periodic meetings and correspondence with the Reserve Bank of Australia involving senior
management in Adelaide.
The matter of communication to the Bank Board of
management's dealings with the Reserve Bank of Australia is dealt with in detail in
Chapter 15 - "The Relationship with the Reserve Bank of Australia" of
this Report. Specific issues raised by the Bank of England and the Reserve Bank of
Australia in relation to London branch are dealt with in Section 19.7 below.
188.8.131.52 Business Plans and Financial Performance
In June 1985, projections were produced for London branch
to June 1990.() The following table() compares 1985 forecasts of
total assets with actual total assets and forecasted profits with budget and actual profit
London branch's reported loss of GBP 12.773M resulted
essentially from specific provisions of GBP 12.865M being bought to book for the seven
month period ended February 1991. Of this figure, specific provisions of GBP 4.064M were
raised in February 1991 alone, as against a budget for specific provisioning for that
month of GBP 0.064M.()
Briefing notes prepared for the London Strategic Planning
Conference in April 1989, set targets over five years to double corporate assets and
triple profits. Of particular note was the target for property exposure of GBP 170.0M in
June 1990 out of total advances outstanding of GBP 400.0M (ie 42.5 per cent). This
contradicts the policy stated in a letter dated 29 August 1990 from Mr Mallett to the Bank
of England that "exposure to Property Risks including contingent liability
exposure, at any time [is] not to exceed 30 per cent of "risk
assets"".() There is no evidence that this latter target was
incorporated into the Bank's 1990-1994 Strategic Plan.()
According to the management accounts for the year ended
June 1989, net profit after tax and provisions was GBP 1.196M compared with a budget of
GBP 0.599M. The positive variance over budget comprised:
+ GBP 1.2M;
- GBP 1.0M;
+ GBP 0.4M
The increase in net income related primarily to profits
from trading/arbitrage whilst the provision arose in respect of one loan.
Management accounts for the year ended June 1990, showed a
net profit, after tax and provisions, of GBP 0.233M compared with a budget of GBP 0.733M.
The negative variance against budget comprised:
Some text in between here.
+ GBP 3.0M;
- GBP 4.0M;
+ GBP 0.5M
The increase in net income related primarily to profits
from trading/arbitrage (GBP 1.5M) and net interest income (GBP 1.2M).
184.108.40.206 Asset Quality
By 31 March 1991, the exposure of London branch by industry
was as follows:
Whilst the exposure to property exceeds the maximum level
noted in the letter to the Bank of England dated 29 August 1990 the significant factor in
the portfolio carrying a 40 per cent property exposure was a loan of GBP 46.8M which the
Bank had made on the basis of the exposure being "sold down," but was unable to
do so. The high property exposure in the portfolio also came about because of distortions
caused by London branch ceasing new corporate lending in December 1989. A memo dated 15
January 1991 from Mr Mallett to Mr Paddison, Director, Banking states:
"This business [corporate lending] has for
all intents and purposes ceased. We are now managing the portfolio and while its overall
quality is not as high as I would have liked, it is standing up with one or two exceptions
to the current UK recession".
This memorandum went on to note the proposed strategy for
reducing London branch's property exposure:
"Our current exposure to property is GBP 190
million or 34% of our earning assets. It is our intention to reduce this level to 29% by
30 June 1991 or earlier if such is possible and I have advised the Bank of England
accordingly. For prudential purposes, it is further proposed to limit property to 20% of
Corporate commitments, however, this is not possible in the short term".
By the end of February 1991, London branch's portfolio
included eight non-performing accounts, with a total risk exposure of $125.0M. According
to the report to the Bank Board on non-productive items as at 28 February 1991, the worst
case risk/loss prognosis for London branch was a loss of $60.0M against which a specific
provision of $25.0M was then held.
This Report indicated that there were four accounts within
London branch designated "Problem Dimension 1 Accounts" totalling $84.2M. The
report defined a "Problem Dimension 1 Account" as an account:
"...of significant concern. A high level of
management input/account workout is required to limit our potential loss".
220.127.116.11 Observations on Operations and Performance of
On the basis of all the evidence available, I am satisfied
that whilst the Bank devoted substantial assets to the operations of the London branch,
the performance of that branch over the period under review indicates that it was not
profitable. As at February 1991, London branch held significant non-performing assets.
The Group Operating Review for February 1991 listed
"gross assets" for London branch at $1,487.0M. Non-performing assets reported
for the same period at $125.0M represented some 8.4 per cent of the London branch's
The London branch's financial result for the period ended
February 1991 was reported, in the Group Operating Review for that month, as a negative
3.23 per cent return on assets as against budgeted return on assets of 0.43 per cent.
19.3.2 OVERVIEW OF OPERATIONS OF THE HONG KONG OFFICE
18.104.22.168 Principal Activities
The Bank officially opened its representative office in
Hong Kong in April 1987.
The main activities of the office have been a low level of
lending for corporate and sovereign borrowers in the Asia/Pacific region, and the
provision of off-shore property finance, chiefly in Australia and New Zealand, for
corporate and private banking clients. In September 1990, the office was granted authority
to take up a restricted banking licence, but this had not been taken up as at February
1991. The application for the licence was to enable the office to diversify its operations
by providing deposit-taking facilities.
The policy of the office has been to target major corporate
names in the Asian region for short to medium term funding, for use in their own
operations. In addition, through the arrangement of mortgage finance to Asian investors
purchasing real estate in Australia, the United Kingdom, and the United States of America,
the office developed a private client list of around 200 Asian investors.
With respect to Treasury operations, due to the
non-activation of the restricted banking licence, the Treasury activity in the office was
limited to the distribution of commercial paper on behalf of Head Office.
By February 1991, the office had gross assets of $102.0M.()
22.214.171.124 Organisation Structure and Staffing
From the inception of that Office, the Director of Asian
Operations in Hong Kong has been Mr I R Johnston.
The office acts as a representative office for State Bank
of South Australia, and has a direct reporting line responsibility to Corporate and
International division in Adelaide.
A limited company registered in Hong Kong was established
in July 1987, by the name SBSA Asia Limited ("SBSA Asia"). This company is a 100
per cent owned subsidiary of State Bank of South Australia. The company was established
because the representative office was not a legal entity under local law and was not
permitted to own property or undertake fee-based services of a non-banking nature.
126.96.36.199 Prudential Control and Supervision
The operations of the Hong Kong office are regulated by the
Hong Kong Commissioner of Banking.
188.8.131.52 Business Plans and Financial Performance
A business plan was drawn up in March 1990 by Ms M Yeung,
Manager, Corporate Lending. The plan only covered corporate lending, and included an
overview of the office's current strengths and weaknesses in this area, together with an
analysis of potential opportunities and threats. It also considered market positioning,
prospects for corporate lending and staffing levels. A business plan for the Treasury unit
for 1990-91 was prepared in September 1990, covering the proposed development of the
As mentioned previously, there are two aspects to the
Bank's operations in Hong Kong:
(a) the representative office; and
(b) SBSA Asia.
Total assets in this company increased from HKD 3.4M in
June 1987 to HKD 48.8M in June 1988 to HKD 109.8M in June 1990.
The Hong Kong office report for January 1991 indicated
portfolio levels of HKD 439.0M ($A 72.0M), for corporate lending and HKD 352.0M
($A 58.0M) for off-shore property finance. This compares with a balance of HKD 182.0M
for off-shore property finance in March 1990.
At the same time, total outstandings of short-term
commercial paper distributed by Hong Kong was the equivalent of $A 62.0M.
For the period ended February 1991, the Group Operating
Review for that month reported that the Hong Kong office had achieved a net contribution
to profits of $0.392M (as against a budgeted loss of $0.073M) which was a 0.58 per cent
return on assets of $102.0M.
184.108.40.206 Asset Quality
Hong Kong operations have not been subject to the credit
problems that have arisen in other business divisions of the Group. The February 1991
Report to the Bank Board on Non-Productive items showed one non-accrual account of $0.5M
with a nil provision against this amount. Worst case loss prognosis was $0.2M. This item
has only been noted on non-accrual reports in 1991. The one item reported was classified
as a "Problem Dimension 1 Account".
220.127.116.11 Observations on Operations and Performance of
Hong Kong Office
The operations of the Hong Kong office have not contributed
to the Bank's financial position as at February 1991.
19.3.3 OVERVIEW OF OPERATIONS OF THE NEW YORK BRANCH
18.104.22.168 Principal Activities
The New York branch was established in November 1988. This
branch has the capacity to provide full wholesale banking services, although it
concentrates largely on corporate lending. It also engages in Treasury operations.
The primary role of New York Treasury is to raise funds to
support the corporate lending activities. This is achieved via an active commercial paper
program and interbank loans and deposits. In January 1990, New York Treasury established a
trading function which included limited trading in futures and FRAs (forward rate
agreements), but this activity ceased in 1990-91. In September 1990, the commercial paper
program totalled $US 1,000.0M and was a provider of short-dated funds to Head Office.
A significant proportion of New York branch's lending
activities involved a type of financing described by the Bank as "Highly Leveraged
Transactions". In August 1990, the Internal Audit department reported that more than
40 per cent of New York branch's outstanding corporate commitment was made up of Highly
Leveraged Transactions. These transactions are loans, where, after the loan is made, the
borrower's debt to equity ratio equals or exceeds 3:1. In its report, the Internal Audit
department noted that such transactions "generally carry a negative net worth [and]
involve a high level of risk". As at 30 April 1990, Internal Audit department
was reporting that the Bank had a total commitment of $US 260.1M to highly leveraged
transactions of which $US 190.8M had already been drawn down.
In this same report, the Internal Audit department noted
that the branch was involved in Mezzanine Financing which was noted as a "form of
structured financing" [which] is unsecured [and] are attractive because they
bring high returns". In the period December 1989 to May 1990, the New York branch
had approved three Mezzanine Financing deals with a total commitment of $US 30.0M.
22.214.171.124 Organisation Structure and Staffing
The Executive Vice-President, Mr Sewell, took up his
appointment with the Bank in March 1988 to commence planning of the new office, prior to
opening in November 1988. He reported directly to the Chief General Manager, Corporate and
International (formerly Treasury and International) and at February 1991 continued to hold
In 1990, the New York branch was separated into five
functional areas each reporting to the Executive Vice-President, United States of America.
The areas were:
(b) Corporate Banking;
(c) Corporate Finance;
(d) Operations; and
(e) Corporate branches (located in Chicago and Los
Following the establishment in November 1990 of Global
Treasury, the New York Treasurer formally began reporting to the Group Treasurer Adelaide
in March 1991. An agreement was established between Global Treasury and New York for the
New York office to continue to provide administrative support services for the New York
Since the opening of the New York branch, the Bank has
established the following wholly owned subsidiaries in the State of Delaware, United
States of America:
(a) SBSA Delaware Inc, was established to enable the
issuance of commercial paper in the United States of America.() The company is
guaranteed by State Bank of South Australia.
(b) SBSA Holdings Inc, was established to hold warrants
which can be received through lending facilities and is currently inactive.()
As noted above, the Cayman Islands branch acted as an
off-shore booking point for assets, and the vast majority of transactions originating from
the New York office (about 95 per cent) have been made through the Cayman Islands, but for
management reporting purposes, all transactions were shown as part of the New York office.
All transactions were managed by New York office.
There were also representative offices in Chicago()
and Los Angeles.()
126.96.36.199 Prudential Control and Supervision
The New York branch is supervised in the United States by
the State of New York Banking department. At 30 September 1989, the department made an
examination of the operations of the branch; however, as noted earlier in this Chapter,
the scope of the examination was limited to the accounting records that reflect the New
York operations only. The department did not inspect the records relating to the off-shore
banking unit in the Cayman Islands through which the vast majority of transactions for the
New York office are booked.
188.8.131.52 Business Plans and Financial Performance
In June 1988, a paper was submitted to the Executive
Committee() relating to the establishment of the New York branch then targeted
for November 1988. This paper contained a relatively detailed business strategy. The
objective for the corporate lending side of the business was stated as:
"To selectively acquire U.S. corporate assets to
diversify the credit profile of bank risk assets. To achieve a minimum average return on
loan assets of 1.0% p.a. at a credit risk acceptable to the Bank."
The paper submitted to the Bank Board seeking its final
approval to the establishment of a State licensed agency in New York() did not
attach a business strategy. This Bank Board Paper stated the New York branch's
"mission" in the following way:
"The New York Office focus over the planned period
will be directed towards achieving the Bank's required strategic target as well as ROA
objectives of 1% after tax, while maintaining prudent balance sheet qualitative and growth
Other key initiatives included:
(a) Focusing initially on the East Coast, and then the Mid
West and West Coast markets;
(b) Treasury operations to focus on capital markets; and
(c) Growth intended to be focused on the corporate market.
The growth of New York branch assets was spectacular as a
comparison of projected total assets() with actual total assets indicates:
By February 1991, total assets amounted to $2,149.3M(),
an 81 per cent increase on the June 1990 figure.
Profitability of New York branch was also quickly
established ahead of initial projections after absorbing initial start up costs; with the
branch reporting a profit of $US 0.2M for the period from establishment to 30 June 1989.
In December 1988, Mr Sewell submitted a progress report to Mr Mallett which included
projected profits for the New York branch. The following table compares December 1988
projected profits for the New York branch with actual outcomes:
1989 - 1990
1990 - 1991
|3.1 (February 1991)
In the February 1991 Group Operating Review, management
reported a net contribution by New York branch to profits of $3.159M as against a budget
of $2.692M. This represented a 0.22 per cent return on gross assets of $2,149.3M. The
reported gross assets for New York were far in excess of the budgeted gross assets for
that branch for the same period of $1,547.2M. The actual profit outcome to February 1991
allowed for loan loss provisions of $US 4.6M.
The eight months' result to February 1991 was above budget
by $US 0.4M. The excess was achieved from:
+ $US 1.5M;
- $US 0.5M;
- $US 0.5M;
- $US 0.1M
184.108.40.206 Asset Quality
By the end of February 1991, New York branch was reporting
non-productive loans with a total risk exposure of $41.0M and a worst case loss prognosis
of $15.0M against which specific provisions of $13.0M were held.() Of these
non-productive loans, one account of $11.2M was classified a "Problem Dimension 1
220.127.116.11 Observations on Operations and Performance of
New York Branch
The highlight of the Bank's experience in New York, is the
spectacular growth in assets of the branch particularly in the eight month period July
1990 - February 1991 when the branch increased its assets by 81 per cent.
19.3.4 OVERVIEW OF OPERATIONS OF THE AUCKLAND BRANCH
When the Bank acquired Security Pacific Bank New Zealand
Limited in late 1988 its business and staff were taken up in establishing the Auckland
branch. The name of Security Pacific Bank New Zealand Limited was changed to SBSA (NZ)
Limited. In December 1988, the Bank's Auckland branch received Reserve Bank of New Zealand
authorisation to commence banking operations.
18.104.22.168 Principal Activities
The branch provided wholesale banking services including
corporate banking and Treasury activities, structured into three distinct areas: Treasury,
Administration, and Corporate Banking. The main activity of the Auckland branch was the
corporate loan book.
The New Zealand Treasury Section was responsible for
providing the New Zealand branch funding requirements, interest rate risk management,
currency risk management and liquidity requirements. Trading and arbitrage activities were
also undertaken. Treasury was also responsible for managing and providing United Banking
Group's liquidity requirements.
Over a period of some 12 months from the time of its
establishment, the operations of the Auckland branch were significantly restructured. In
January 1989, the branch assumed responsibility for the New Zealand country risk assets
that originated in Australia. In June 1990, the branch also assumed responsibility for the
on-balance sheet operations of Southstate Corporate Finance Limited. This company, a
subsidiary of Beneficial Finance Corporation Limited, was principally involved in the
Commercial Loan area. In December 1990, the branch took over the remaining Beneficial
Finance assets in New Zealand.
After the Bank's acquisition of United Building Society,
the branch was again restructured to undertake all of the Bank's wholesale and commercial
banking operations in New Zealand, whilst the United Bank (as the United Building Society
became) undertook the Bank's retail banking operations in New Zealand.
22.214.171.124 Organisation Structure and Staffing
The Chief Manager in Auckland in 1989 and 1990 was Mr D
Hammond, who was directly responsible to the Chief General Manager, Corporate and
International. The Sections reporting to the Chief Manager were:
(a) Corporate and Commercial Banking;
(c) Operations; and
(d) Retail Operations (subsequent to United Bank
The Senior Manager, Auckland Treasury reported directly to
the Group Treasurer, Adelaide, following the establishment of Global Treasury in November
SBSA (NZ) Limited (the name to which Security Pacific Bank
New Zealand Limited was changed) is a wholly-owned subsidiary of SBSA (NZ) Branch Holdings
Limited which itself is a wholly owned subsidiary of the Bank. SBSA (NZ) Limited had four
wholly owned subsidiaries as at 30 June 1990:
(a) SBSA (NZ) Investments Limited;
(b) SBSA Mortgage Investments Limited;
(c) Lontas Holdings Limited; and
(d) Taybrook Holdings Limited.
SBSA (NZ) Limited is registered in Auckland and has as a
branch in Nassau which, as in the case of the Bank's Cayman Islands branch, operates as an
off-shore booking point for assets. This Nassau branch was acquired as part of the
purchase of Security Pacific Bank New Zealand Limited.
126.96.36.199 Prudential Control and Supervision
The Auckland branch is an "overseas person" under
the terms of the (New Zealand) Overseas Investment Act, 1973 and the Overseas Regulations
1985. Accordingly, the branch required approval from the Overseas Investment Commission to
carry on business in New Zealand. This consent was granted in December 1988. With this
consent the branch is permitted to undertake merchant banking activities, and to operate a
registered bank, which includes authority to engage in foreign exchange dealing. The
operations of the branch in respect of the registered bank are also covered by the Reserve
Bank of New Zealand Act, 1989 and the Banking Act, 1982 (New Zealand).
188.8.131.52 Business Plans and Financial Performance
A number of business plans for the Auckland branch were
prepared. In the initial paper on the establishment of the branch, presented to the Bank
Board in July 1988,() strategic objectives were set out, and a five year
financial projection was appended. Following the acquisition of Security Pacific Bank New
Zealand in December 1988, however, these projections were no longer applicable.
A detailed financial plan was then set out, in January
1989, for the period from acquisition to June 1989. This plan also took into consideration
the transfer of $146.0M of New Zealand based assets from Head Office Corporate Banking
division in January 1989. A further financial plan for the year to June 1990 was prepared
in May 1989.
The transfer of the portfolio of New Zealand based assets
from Corporate Banking division in Adelaide to Auckland branch resulted in a situation
where the carrying costs for the non-performing portion of the portfolio would outweigh
the net revenue earned from the balance of the portfolio. The significant problems created
by this situation led to Mr Hammond (Chief Manager, New Zealand) making the following
observations in a memorandum dated 1 May 1989 to Mr Mallett:
"The Corporate portfolio could hardly be described
(i) certain NZ country risk assets were extracted prior
to transfer. There can be little logic in the "balanced portfolio" argument
following this process;
(ii) the gross cost of carry for the
non-performing portion of the portfolio will greatly outweigh the net revenue
earned from the balance of the portfolio.
It was agreed between us that the NZ results would be
measured on a zero free capital base assumption. The effect of the corporate transfer will
be a significant negative gearing on NZ country risk. This situation will need to be
carefully handled with the Reserve Bank authorities in both countries."
On 3 May 1989, Mr Mallett referred this issue to the
Managing Director, Mr Clark, in the following way:
"With the advent of some very depressing news in
regard to the potential payout of secured debtors of Equiticorp Holdings, and the decision
made to transfer the entire Corporate Banking portfolio to New Zealand without account of
its credit quality or level of non-accrual loans, has resulted in an unsustainable
position for New Zealand Office in regard to both requirement for specific provisions and
the cost of non-accrual loans.
[The] level of non-accrual loans on a new operation
would effectively mean New Zealand will operate in an unprofitable manner for several
Further detail of the specific provisions required in
relation to the transferred portfolio is reported below. As at 30 June 1990, SBSA (NZ)
Limited had total assets of $NZ 2,000.0M and shareholders' funds of $NZ 27.0M.()
The branch's asset growth was significant, given that, as at June 1989, total assets
amounted to $NZ 1,000.0M, comprising essentially the assets gained upon acquisition (at
net asset value in December 1988) of Security Pacific Bank (NZ) Limited amounting to
$NZ 700.0M ($NZ 500.0M in corporate loans and $NZ 200.0M in liquid assets) and
the further $NZ 146.0M in corporate loans transferred from Head Office in January
The branch recorded the following losses for the periods
Year ended 30
Year ended 30
ended February 1991
As noted above, the main item affecting the profit and loss
account for SBSA (NZ) in 1989 and 1990 was the level of bad and doubtful debt provisions.
184.108.40.206 Asset Quality
A number of loans brought into the books of the Auckland
branch from different sources have required provisions. In the memorandum noted above from
Mr Mallett to the Group Managing Director, dated 3 May 1989, it was reported that at that
time non-accrual loans, amounting to $50.0M, had arisen from these sources (Security
Pacific - two loans totalling $16.0M; Corporate Banking Adelaide - five loans totalling
$34.0M). These items have required specific provisioning: Security Pacific -$7.5M and
Corporate Banking Adelaide - $6.8M.
By February 1991, Auckland branch's non-productive loans
had risen to $119.0M with a total risk exposure (including non-productive equity plus
interest uncollected or foregone) of $160.M and with specific provisions of $47.0M. Two
loans give rise to half of the provisions:
(a) loan ex Security Pacific - provision of $10.7M against
a loan of $11.4M; and
(b) loan ex Corporate Banking Adelaide - $12.7M provision
against a loan of $14.1M.
The February 1991 report to the Bank Board on
non-productive items listed 15 accounts totalling $72.0M as "Problem Dimension 1
220.127.116.11 Observations on Operations and Performance of
It is difficult to analyse the underlying profitability of
the Auckland branch because of the changes in the loan book. Above all, the assets
acquired or transferred into the branch have in a number of instances given rise to the
losses. At the same time, in addition to the provisions required, these losses have given
rise to funding costs within Auckland branch.
19.3.5 ASSET GROWTH IN THE BANK'S OVERSEAS OPERATIONS
The asset growth in respect of the Bank's overseas
branches during the period under review is, in my opinion, the most striking feature of
the Bank's overseas operations. The Operating Reviews presented to the Bank Board clearly
indicated the asset growth in relation to all of the Bank's overseas operations which,
until the second half of 1990, continually outstripped budget and planning projections.
In the table shown in Section 18.104.22.168 above, I compare
actual total assets with projected total assets forecast in June 1985 in respect of the
London branch. As noted in Section 19.2.10 above, New York branch's assets reached
$1,750.0M by June 1990 as against a five year asset projection, in June 1988, of
In the table below, I indicate the growth in income earning
assets in respect of the Bank's overseas operations between June 1985 and December 1988.
Income Earning Assets - Overseas Operations
As is seen from the above table, by December 1987 the
Bank's overseas assets level-off at around the $1,000.0M mark, and continue at around this
figure until December 1988 by which time total off-shore assets are $1,207.9M. As from
December 1988, however, the growth in the Bank's overseas assets is significant, as
indicated in the following table:
Income Earning Assets - Overseas Operations
After September 1990, the Bank's total assets overseas fall
away to $6,459.9M as at December 1990 and $5,270.3M as at February 1991.()
The above asset figures represent the Bank's on-balance
sheet asset growth. The growth in the Bank's off-balance sheet assets, in particular its
contingent liabilities, was equally significant over the period under review.
As reported to the Bank Board in the Operating Reviews, the
Bank's off-balance sheet contingent liabilities included the following items:
(b) Letters of Credit;
(c) Bill Endorsements;
(d) Foreign exchange transactions;
(e) Interest rate swaps;
(f) Cross currency interest rate swaps;
(g) Contingent swaps; and
(h) Interest rate futures.
The following table indicates the growth in the Bank's
off-balance sheet "Total Contingent Liabilities" during the period under review.
Off-balance Sheet Business - Total Contingent Liabilities
The following table indicates, in a summary form, the
profit/loss results for each branch (excluding Hong Kong):()
Whilst the above table indicates the profit/loss result for
each branch (excluding Hong Kong) expressed in straight GBP/$US/$NZ figures, the
investigation had regard to the profitability of the overseas branches expressed as a
return on average earning assets as indicated in the 1988, 1989 and 1990 Profit Plans.
The 1988 Profit Plan noted that average income earning
assets for International division would grow from $1,059.0M (1987-1988) to $1,687.0M
(1988-1989) and on the latter figure the division would contribute $1.7M to the Bank's
Profit and Loss Account. This contribution represented an average earning on assets of 0.1
per cent.() As the Bank Board had noted that the Bank Group's return on
assets target for 1988-1989 was 0.81 per cent(), it is apparent, given the
approval of the Profit Plan, that the Bank Board was content for the International
division to achieve a return on average earning assets of one eighth of that expected for
the Bank Group as a whole. Indeed, the Profit Plan itself noted that the 1988-1989 return
on asset projection was a 72.06 per cent reduction on the previous year's return on assets
of 0.57 per cent.
However, even the projected return for the International
division of one eighth of that expected for the Bank Group as a whole, as recorded in the
1989-1990 Profit Plan, was not achieved by a significant degree. As recorded in the
1989-1990 Profit Plan, the actual outcome for 1988-1989 was $0.2M, a return on average
earning assets of 0.01 per cent.
In the 1989-1990 Profit Plan, net profit for the off-shore
offices was forecast to be $8.9M, compared to an actual $0.2M in 1988-1989.()
As indicated in the 1989-1990 Profit Plan, this represented a staggering turnaround of
3,704.7 per cent. How precisely this turnaround in profitability was to be achieved is not
explained in the 1989-1990 Profit Plan, although the statement of the Group Strategy does
note that one of the strategic objectives to be pursued through 1989-1990 included:
"... achieve outstanding group performance and
balanced business growth through better penetration of the South Australian market,
interstate expansion and selective offshore business development (emphasis
This Profit Plan failed to offer any explanation for
overseas operations' failure in the previous year to achieve anything more than one-tenth
of the projected return on assets, which itself was approximately one-fifth of the prior
year's() actual return on assets.()
In addition, the Profit Plan failed to explain the basis
upon which maintaining overseas operations could be justified with a return of assets of
0.01 per cent for 1988-1989 as against Bank Group actual return on assets of 0.71 per cent
in 1987-1988 and 0.72 per cent for 1988-1989.
As recorded in the 1990-1991 Profit Plan, the actual
outcome for 1989-1990 in relation to the overseas operations was a loss of $6.396M. The
Bank recorded, not the projected 3,704.7 per cent profit increase, but rather an actual
2,821.7 per cent loss against the recorded prior year's profit figure.
The 1990-1991 Profit Plan forecast a profit of $2.74M for
the overseas branches, as against a loss of $6.396M for the financial year 1989-1990.()
The 1989-1990 result was a substantial reversal of fortunes for the Bank which had, as
noted above, forecast a net profit for the overseas branches of $8.9M.
Once again, there is no explanation in this Profit Plan:
(a) for the disastrous loss figure for the year 1989-1990,
as against the previously projected substantial profit;
(b) in support of the continuation of overseas operations,
given the negative return on assets for the year 1989-1990; and
(c) of how the Bank would turn a substantial loss into a
projected substantial profit given that, in the previous year, the Bank had turned a
projected substantial profit into an actual substantial loss.
In their Submission to the Investigation, in respect of the
approval of the Profit Plans for the year ended 1989, 1990 and 1991, the Non-Executive
"... it was in just this very period that a number
of Board members began to have serious doubts about the wisdom of the Bank's offshore
activities and the justifications which it had hitherto received from management."()
The Investigation heard extensive evidence from the
Non-Executive Directors in relation to this matter, but even if these "serious
doubts" were entertained at the time of the approval of the various Profit Plans,
a matter, on which I am not persuaded from the evidence of the Non-Executive Directors, I
am of the view that the Non-Executive Directors should not have approved the Profit Plans
in relation to the Bank's overseas operations until such time as management had prepared
and presented a detailed and substantiated review of these operations demonstrating, to
their satisfaction the benefit to South Australia of the maintenance of these operations,
and their future ability to achieve a profit. In my opinion, the Bank Board should not
have simply relied upon assurances or justifications proffered by management, without the
Bank Board positively satisfying itself that these assurances and justifications were well
founded in fact and were proven to be consistent with the Bank's Charter under Section 15.
19.3.6 NON-PERFORMING ASSETS
By February 1991, London, New York, Hong Kong and Auckland
were responsible for a total risk exposure to non-performing assets of $325.5M with a
total worst case loss prognosis of $141.4M against which total specific provisions of
$84.9M were held.() This total risk exposure represented 23.2 per cent of the
Bank's total risk exposure ($1,400.3M) as reported to the Bank Board in the February 1991
Non-Productive Asset Review. At the same time the Bank's total overseas assets ($5,270.0M)()
represented 27.4 per cent of the Bank's total income earning assets ($19,209.0M).()
So far as concerns the proportion of non-productive assets
of the overseas branches to the Bank's overall non-productive situation, from the figures
stated above, it can be seen that the overseas branches' reported non-productive asset
situation is not disproportionate to that of the Bank's operations in Australia. With
respect to the London branch, from the evidence and for the reasons stated in this
Chapter, I am of the opinion that its non-productive asset position has arisen
substantially out of an exposure to the United Kingdom property market in respect of which
the London branch's portfolio had a deliberate bias.
19.3.7 CONCLUSION ON OPERATIONS AND PERFORMANCE OF THE
In Section 19.2.17 above, I expressed a view that the bank
deliberately pursued an aggressive asset growth strategy in relation to its overseas
operations principally in order to access what the Bank perceived to be "profitable
The Bank's asset growth was apparent on the face of the
Operating Reviews and the Profit Plans presented to the Bank Board. The growth in assets
of the off-shore branches (well in excess of originally projected and/or budgeted asset
growth figures) was similarly apparent.
I am of the opinion, that at least by July 1988 the Bank
Board was on notice that the Bank's overseas branches were then operating at a level of
profitability significantly below that applicable to the Bank's overall operations.
This was apparent from the Operating Reviews, from the Profit Plans, and from the December
1987 Bank Board Paper reviewing London branch performance.()
The Non-Executive Directors gave evidence that they
accepted management's statement that the overseas operations were still "in start-up
phase" and therefore were not expected to be profitable. I am of the opinion,
however, that the Bank Board could not have failed to see the correlation between the
overseas branches' significantly inferior profitability at a time of over-budget asset
growth. Whatever above-budget profits for the overseas branches may have been reported to
the Bank Board in the Operating Reviews, in my opinion, such profit figures were achieved
only by the Bank is pursuing an aggressive asset growth strategy in its overseas branches.
In my opinion, as at June 1988, the circumstances of the
Bank's overseas operations called for immediate and definite action by the Board. In
particular, I am of the view that the circumstances called for the Bank Board to direct
management to conduct a full review of the justification for maintaining the Bank's
overseas operations, and for a report on that review to be presented to the Bank Board in
order for the Bank Board to determine whether or not the Bank should continue its overseas
In their Submission to the Investigation, the Non-Executive
Directors, in the context of the Bank Board's response to the significant lack of
profitability of the overseas branches, posed the following "rhetorical
"What more can Non-Executive Directors do but
demand that management readdress the rationale for an aspect of the business about which
the Board has developed concerns, independently of any expressions of concern from
In so far as this "rhetorical question"
may be seen as suggesting that the Bank Board, in the face of its own concerns, should
simply ask questions of management and uncritically accept the "assurances"
given, then I do not accept this. Indeed, as noted below in Section 19.4.2 (b), the
Minutes of a December 1987 Bank Board meeting indicated that the Bank Board was prepared
to close down one specifically unprofitable aspect of the London branch's operations
identified in the Bank Board Paper presented on that occasion.
In Section 19.8.5 below, I refer to evidence given by Mr
Hartley and other Non-Executive Directors concerning an assertion that the Bank Board
called for a full review of the Bank's overseas operations at around November 1989.
Even if I accepted this assertion on behalf of the
Non-Executive Directors I am still of the view that action on the part of the Bank Board
was called for at least in July 1988. In my opinion this action, should at the very least,
(a) a directive to management to conduct a full review of
the Bank's overseas operations;
(b) the presentation to the Bank Board of a reasoned and
substantiated report justifying the continuance of overseas operations, specifying
profitability, and strategic goals, to be achieved by indicated deadlines;
(c) the establishing of a review mechanism for the Bank's
achievement of those goals; and
(d) the modification, or closing down, of those operations
if performance and strategic goals were not achieved.
In my view, this is the answer to the "rhetorical
question" posed to the Investigation by the Non-Executive Directors.
In the next Sections of this Chapter, I consider aspects of
control and supervision of the overseas operations of the Bank by the Bank Board and
19.4 CONTROL AND SUPERVISION OF OVERSEAS OPERATIONS BY THE BANK
In my opinion, in order to adequately supervise and control
the development and operations of the Bank's overseas branches, the Bank Board needed to
ensure that appropriate levels of authority and systems of supervision and control were
established, and were periodically reviewed, and so were relevant and effective. By
approving the establishment of the branches and significant changes in their operations,
the Bank Board would have been able to ensure that their development was in accordance
with the Strategic Plans and Profit Plans approved by it.
Whilst routine supervision was conducted by the branch
Chief Manager in each overseas location, the Chief Managers were subject to the
supervision of the Chief General Manager, International Banking, by way of monitoring of
the performance of each branch. In addition, loan commitments above certain levels
required approval at Head Office by the Chief General Manager, International Banking, the
Lending Credit Committee or, in respect of the most substantial transactions, the Bank
Board itself, where the amount involved was outside the delegated lending authority of
Regular reports were made to senior management and the Bank
Board on matters such as: office performance (monthly), balance sheet composition and size
(monthly), and, in particular, asset quality. One particularly important source of
information on problems and concerns arising in relation to the overseas operations were
meetings and correspondence with the regulatory authorities, both in Australia and
overseas. Issues raised by these authorities should have been promptly and fully
communicated to the Bank Board by management so that the Bank Board could take whatever
action it considered to be appropriate. As will be reported below(), Management
failed to report, promptly and fully, on prudential consultations with the regulatory
As well as the process of direct supervision and control,
assessment of the branches' operations should have been provided by functions independent
of line management, eg Internal Audit and Credit Inspection.
19.4.2 INFORMATION AVAILABLE TO THE BANK BOARD
(a) Monthly Operating Reviews
Throughout the period under review, the Bank Board received
information of varying degrees of coverage and detail in relation to the overseas branches
in Monthly Operating Reviews and Quarterly Operating Reviews.
The overseas branches' performance against budget, and the
Bank's off-shore exposure limit summary, were consistent features of the International
Banking Section of the Operating Reviews. From time to time, operational matters
concerning individual overseas branches were included, but, overall, the level of
information on the operations of the overseas branches, apart from their performance
against budget, was limited.
Set out hereunder is an indication of the level of
information provided in the International Banking Section to the Bank Board in a sample of
(i) March 1986
The Review noted that London branch had achieved
profitability on a monthly basis for the first time in March 1986, but that year-to-date
losses were 14 per cent worse than budget.
(ii) August 1986
The Review noted that London branch had recorded a profit
in excess of budget and that London branch's total balance sheet size exceeded budget by
44 per cent.
(iii) May 1987
This Review contained no commentary.
(iv) December 1987
The commentary on overseas operations noted that the
"interest margin" for the half year was ahead of budget, as was "actual fee
(v) May 1988
This Review was in the same form as the review for May 1987
ie there was no commentary.
(vi) June 1988
This Review contained a quarterly performance summary in
relation to International Banking. The commentary on off-shore operations noted that a
separate report on London branch's results for March 1988 had been forwarded to the
Executive Committee; that total income for the year ended June 1988 was 21.2 per cent
below budget; and that expenditure for the year ended 30 June 1988 was 7.2 per cent below
(vii) February 1989
The level of information in this Review was substantially
increased to include an international operating result by branch. The Review included a
summary of transactional volumes for assets offered, approvals obtained and business
booked for each of the branches. General comments on the performance of Hong Kong, New
York and London branches were included.
(viii) June 1989
This Review contained the same areas of coverage as those
contained in the February 1989 Review. The commentary, in relation to London branch,
identified a number of extraordinary items that were said to significantly reduce the
branch's reported profit, namely, the reversal of income in relation to a swap
transaction, and a specific provision of GBP 1.0M in relation to one particular account.
(ix) September 1989
This Review contained a commentary on the profit
performance of each branch, together with profit and loss statements, management returns,
reports on risk weighted assets, and a selection of key performance indicators.
(x) December 1990
This Review contained the same coverage and level of detail
as that in the September 1989 review. This report noted that International Banking,
including New Zealand operations, showed a management return loss for the six months to 31
December 1990 of $30.029M which was $30.817M below budget.
Up until February 1987, Operating Reviews contained a
schedule of loan increases, approvals accepted/not accepted/declined for the London branch
. This schedule provided information on the identity of the borrower, and the total value
of the facility, together with a comment generally identifying whether or not the item was
a corporate syndication, or a corporate advance. In addition, Operating Reviews, up until
February 1987 included a London branch Balance Sheet. The London branch Balance Sheet, as
at 28 February 1987, indicated that out of total assets of $729.0M, corporate advances and
syndications totalled $263.2M.
Information relevant to the Bank's overseas operations was
also included in the general financial information sections of the Operating Reviews. In
particular, the growth in income earning assets in relation to the Bank's overseas
branches was indicated. As an example of the information available, the December 1987
Quarterly Operating Review indicated the growth in income earning assets for the London
branch office from June 1985 ($36.1M) to December 1987 ($1,037.2M).
It is apparent, from the examination of the
International Banking Section of the Monthly Operating Reviews that, overall, the coverage
of information was limited to financial analysis with virtually no reference to
operational issues. In particular, there was no analysis of the nature of lending activity
and exposure within portfolios to particular industries, for example, London branch's
(b) Occasional Detailed Analyses of the Performance of
From time to time, the Bank Board requested additional
information about the performance of the overseas branches/offices. The following papers
were presented to the Bank Board in accordance with such requests:
(i) August 1987
Paper on the Bank's operations in foreign exchange and
money markets, including a description of the London branch Treasury operations. This
paper stated the following:
"The background is some concern about foreign
exchange and money market management in London and the potential generally for companies
to experience problems in managing their foreign exchange and money market business. Also,
it needs to be recognised that the Bank is now a major player in markets which have been
- increased volatility in interest rates and exchange
- growing concern by central banks and supervisory
authorities about the adequacy of banks' prudential controls for managing risks; and
- the development of increasingly sophisticated and
complex financial technologies e.g. swaps, futures, etc."
The paper went on to note that:
"The risks in foreign exchange can be tightly
controlled if good internal prudential controls are in place and all dealing is managed
and warranted within these limits."
The paper went on to make the following specific reference
to controls in relation to London branch's foreign exchange and money market activities:
"... recent problems in London have been management
problems rather than poor or inadequate controls. Essentially the controls/limits were not
fully monitored and adhered to." ()
In my opinion, the above extracts from the Board Paper
were a significant and timely reminder to the Bank Board of the vital importance of strong
supervision, direction, and control, of banking operations conducted in remote locations,
in particular, operations involving complex high risk activities in the Treasury area.
This warning was clearly applicable to all operations conducted in London branch and any
other overseas branch.
The Board Minutes note the Bank Board's approval of certain
staff changes and title changes to senior executives.
(ii) December 1987
Paper on London branch operations. This paper "London
Office-Report" () was presented in response to an undertaking, given
at the November 1987 Bank Board meeting, to provide a report on London branch's
performance with particular emphasis on its foreign exchange activity.
The report noted that:
"Adverse foreign exchange activity, eg losses and
non budget performance have set the branch back GBP 640,000."
The paper went on to note a number of staff changes made in
the London branch's Treasury area and stated:
"Despite good intentions, communications between
Adelaide and London dealing rooms have not been as good as necessary in a volatile market.
Efforts continue to improve this area."
In relation to the December 1987 paper, the Bank Board
Minutes record that "in an endeavour to improve London Office profitability"
a senior Treasury officer from Adelaide would spend a minimum of two months in London
branch early in 1988 "to take operations into a permanent profit position or take
the Bank out of inter-bank market making activity until such time as the Bank could
re-enter it with assured profitability".
(iii) August 1990
Paper on "International Banking division" which
provided details of the financial results and balance sheet structure, International
Banking objectives, and details of off-shore operations.
The Bank Board Minutes of 26 July 1990 record an unnamed
director's "concern" as to "the failure of Management to present
a report on [overseas] operations." () On this occasion, a
"specific report outlining a fundamental review of international operations"
was to be presented at the next Board meeting, and the requested report was presented to
the Bank Board at its meeting on 23 August 1990.
The Board Minutes indicate the Bank Board's "concern
... that there were a number of non-financial reasons which were given to support the
banking operations at offshore offices. It was considered that the Bank should review its
offshore operations more in line with financial returns rather than
non-financial." () The Minutes also record that Mr Mallett
advised the Board "that the two major reasons for international operations were
that the International Banking division was profitable and that it also enabled risk
diversification for the Bank."
The circumstances surrounding the Bank Board's request for
this paper are dealt with further in Section 19.8.5 below.
(iv) September 1990
Overview of New York branch. This review contained no
mention of the involvement of the New York branch in highly-leveraged loan transactions
(described to the Investigation as loans to corporate bodies with gearing ratios at or in
excess of 3:1)(), or Mezzanine (subordinated) Financing. This latter form of
financing is potentially higher risk than the majority component of the portfolio which is
"senior" or non-subordinated debt. This report states that no loss of principal
or interest was expected on the only non-accrual loan in the portfolio. Nevertheless as
noted above, New York branch, by February 1991, was reporting a total non-productive loan
risk exposure of $41.0M, a worst case loss of $15.0M, against which specific provisions of
$13.0M were held.
The Board Minutes indicate that the Bank Board was advised
by Management that "the general thrust of the United States activities had now
been modified with internal restrictions being placed on real estate and other areas
directly affected by the decline in the economy or consumer confidence. Growth was
projected towards portfolio management for the coming year, rather than asset building and
that this would further assist the group in the overall risk management." ()
(v) May - October 1990
The minutes for the Bank Board meeting held on 26 April
1990 indicate that "a more detailed report on the UK property market would be
provided for the next meeting". The report, dated 4 May 1990, contains the
following observations on the Bank of England's concerns with the United Kingdom Property
"The Bank of England has been quoted as saying
"we do not see property as a major supervisory risk", however, it is well known
that they have made noises indicating they are worried about the U.K. banks levels of
exposure to the property market (currently around GBP 32 billion) and it has been
confirmed that the Bank of England has been monitoring banks property exposure quite
closely. Whilst the Bank of England is urging prudence it also points out that 1990 is
not following the pattern of the early 1970s since "the distribution of lending is
very different". It goes on to say the risk is spread across a wide range of banks
with London branches of strongly capitalised foreign banks making up a significant
proportion; rather than concentrated amongst the fringe banks as in the 70s. Risks are
also being covered or laid off in other parts of the financial markets (ie indemnity
insurance) (Emphasis added)."
Mr Mallett was aware of the Bank of England's concerns and
of the Bank Board's request for information. He was under an obligation to ensure that
this report was submitted to the Bank Board but failed to discharge this obligation. This
failure deprived the Bank Board of the opportunity to assess the report and, as it saw
fit, to give appropriate directions to Management to ensure that adequate controls were in
place in relation to the Bank's risk exposure in this market.
The Bank Board Minutes of 25 October 1990 record that "an
updated report on London Branch would be provided for directors at the next meeting".
The Bank Board Minutes do not record any such report being presented at the Bank Board
meetings on 14 November 1990 or 22 November 1990.
(c) Reviews by the Group Managing Director, presented on
a Periodic Basis
During most of the period under review, the Group Managing
Director made an oral presentation to the Bank Board at its monthly meetings. As from
April 1990, these reviews were presented in the form of a Board Paper. In addition, Mr
Mallett generally attended during the Bank Board's deliberations on matters relating to
the overseas branches.
As recorded in the Bank Board Minutes or in the Bank Board
Papers, the Group Managing Director's reviews occasionally included information about the
overseas operations, but the amount of information given regarding these operations was
minimal. For example, the Group Managing Director's review of September 1990, contains
four paragraphs referring to:
(i) the change in reporting lines for London branch;
(ii) the reaction of the London Chief Manager to this
(iii) a request for an external review of the London
Treasury operations; and
(iv) the Credit Inspection Unit visit to London.
There was no mention of the other branches.()
In my view, is was incumbent on Mr Clark to provide
regular and detailed reports on the Bank's overseas operations in order to enable the Bank
Board to fully appreciate the risk profiles existing in the operations conducted by the
overseas branches, and to determine for itself whether or not the Bank Board should give
appropriate directions to Management in order to protect the interests of the Bank. He
failed to do so.
(d) Quarterly Reports from Group Internal Audit
These reports were first made in respect of the September
quarter in 1989; but as was noted in the June 1990 report, "due to previous
limitation of Internal Audit staff, there was very little coverage of International
Banking. With the new staff being in place now, a full program is being launched." ()
The issue of Internal Audit coverage is considered further below. The Internal Audit
quarterly reports did, however, provide an outline of the audits of the overseas branches
and the findings of those audits. The major points raised related to weaknesses of
controls and procedures. It was also noted in the reports that the Bank's control systems
improved over the period.
(e) Listings of Non-Productive Loans
The Bank Board received details of the Bank's
non-productive loans. In 1989, these reports were presented on a quarterly or six-monthly
basis, and did not separately identify those loans that related to the overseas
operations. From 1990 onwards, the reports were presented monthly and separately
identified loans by business area and office. From August 1990 onwards, however, the Board
Minutes indicate that the Bank Board was becoming more interested in the Bank's
non-productive loans with specific requests for more information about the status of these
loans being made in August 1990 (), September 1990() and January
1991.() Board Minutes, in relation to the August 1990 meeting, indicate the
Bank Board's noting the tabled listing of the Bank's non-productive loans as "one
of the most important papers upon which they needed to focus attention".
The Investigation observed that, in general, there is
little specific comment by the Bank Board Minuted on non-productive loans.
(f) Special Presentation to Bank Board by Mr Mallett
During October and November 1988, Mr Mallett made a formal
presentation to Mr Searcy, Mr Nankivell, Mr D W Simmons, Mr Summers, Mrs Byrne, Mr
Barrett, Mr Bakewell, and Mr Clark, and provided to each of these directors formal
material in a booklet entitled "Treasury and International Division". An
invitation to attend one of these presentations was extended to Mr Hartley but, he was
unable to attend. Mr Mallett made these presentations, on a one-on-one or one-on-two
basis, on several occasions over this period, and, in each instance, the director or
directors concerned had an opportunity to ask questions in relation to the Bank's overseas
The booklet presented to directors contained information in
relation to the following matters:
(i) names and position designations of senior officers in
Treasury and International division;
(ii) Treasury department organisational structure, dealing
room staff, and functions and principal objectives;
(iii) New York branch personnel, principal objectives, five
year financial projection, and strategic development plan;
(iv) London branch personnel, principal objectives, five
year financial projections and strategic development plan; and
(v) Hong Kong office personnel, principal objectives, and
strategic development plan.
The principal objectives of London branch were stated to
"To provide services in the United Kingdom
supportive to the activities of the Bank's operations in Australia, particularly to the
Bank's International Treasury and Corporate Banking activities.
To establish a viable and profitable business base in
the United Kingdom (Emphasis Added) ..."
The strategic development plan for the London branch stated
"... London Office will position itself within the
U.K. market as a comprehensive wholesale banking operation ...
Marketing will be targeted towards corporate business
which is underserviced by the U.K. clearing banks.
The core activity of the U.K. operations will
continue to be corporate lending (Emphasis Added)."
Most significantly, the presented booklet suggested that
corporate lending exposure to property would be limited to 20 per cent of total assets,
whereas in fact Management's policy was for a 30 per cent limit. As noted above in Section
19.2.4, the International Banking Strategy paper of January 1985 pointed out that the Bank
of England required industry and similar risk concentration exposures to be appropriately
spread with no more than 20-25 per cent of branch assets to any particular region or
industry. Mr Mallett should not have presented this booklet to directors containing as
it did a statement which, to his knowledge, was wrong.()
So far as New York branch was concerned, the booklet stated
that the principal objectives of the New York branch included the following:
"To engage in corporate lending and customer driven
foreign exchange business.
To establish a U.S. domestic Commercial Paper Program
according to U.S.$ funding needs.
To establish a profitable business base in the United
The strategic development plan for New York branch stated
"... The New York Office will access the following
. direct corporate lending markets in Australia and the
. syndicated corporate lending markets in the U.S.A.
. inter-bank/corporate money market
. credit enhancement;
. trade finance (at a later date)".
As noted in Section 19.5.2(c) below, from the time of the
November 1987 Executive Committee paper proposing the establishment of the New York
branch, Mr Mallett contemplated the involvement of that branch in Highly Leveraged
Transactions. In my view, it was misleading for this Section of the booklet, dealing as
it did with the business strategy proposed for New York branch, to omit a reference to
that branch's involvement in Highly Leveraged Transactions.
On this matter, as well as that referred to above
regarding property exposure in the United Kingdom, Mr Mallett was in error in presenting a
document to directors that was, in my opinion, seriously misleading.
Notwithstanding, the deficiencies in the booklet as
presented to directors, the document did, in a general sense, indicate the nature of the
activities conducted in the overseas branches, and it was clearly open to the Board
collectively, and directors individually, if so minded, to make further inquiry into and
obtain further detail in relation to, the operations then being conducted in the overseas
branches, as well as activities proposed to be conducted in those branches.
(g) Directors' Visits to Overseas Branches
During the period under review, certain directors were
regular visitors to the Bank's overseas branches. The Non-Executive Directors gave
evidence that, with the exception of Mr D W Simmons' visit, as Chairman, to New Zealand
(with Mr Bakewell as Deputy Chairman) in March 1990, Mr D W Simmons' visit to London and
New York in October 1990, and Mr Searcy's visit to London in mid 1989 (with management),
none of the Directors' overseas visits was funded by the Bank.
The Bank Board Minutes contain the following references to
directors reporting to the Bank Board on their overseas visits:
(i) 22 October 1987
The minutes note that Mr D W Simmons and Mr Bakewell
visited London branch and had met approximately 20 staff members, that morale was "exceptionally
high" and that Mr D W Simmons and Mr Bakewell were "impressed with the
staff in London Office".
(ii) 26 May 1988
The minutes note that Mr Bakewell visited London branch and
Mr Bakewell "advised that the appointment of Mr Murray Wilcox had had a positive
effect and that the office appeared to be running smoothly".
(iii) 29 August 1988
The minutes record Mr Bakewell's visit to Hong Kong office
and his meeting with the Manager, Mr Johnston.
(iv) 27 October 1988
The minutes record Mr Bakewell's visit to London branch,
who reported that he had "found that morale was still high".
(v) 23 February 1989
The minutes record Mr Bakewell's visit to Hong Kong office.
The minutes also record Mr Summers' visit to London branch,
who reported that "in his opinion, the premises should be upgraded".
(vi) 25 May 1989
The minutes record that Mr Bakewell "briefly
reported on his recent visits to London, New Zealand and Hong Kong offices".
(vii) 22 June 1989
The minutes record Mr Barrett's "recent promotional
visit to New Zealand".
(viii) 26 October 1989
The minutes record the visit to London branch by Mr D W
Simmons and Mr Bakewell, and that Mr Bakewell "advised directors of the high level
of morale that was present amongst staff".
(ix) 22 February 1990
The minutes record Mr Bakewell's visit to Hong Kong office
and that he "commented favourably on the branch's current operation".
(x) 22 March 1990
The minutes record Mr D W Simmons' and Mr Bakewell's "most
successful visit to New Zealand [which] had provided an opportunity to meet key
staff in the New Zealand operation as well as enabling discussions to be held with the
Bank's auditors and solicitors in New Zealand and also the Governor of the Reserve
The minutes also record the Chairman's (Mr D W Simmons')
observations on the surplus of commercial property in Auckland, the extent of non-accrual
loans in Auckland arising from transactions which were undertaken prior to a full branch
office being established, the current flatness of the New Zealand economy, and the need
for the Group operations to be more cohesive.
(xi) 26 April 1990
The minutes record Mr Bakewell's visit to London and Hong
(xii) 12 September 1990
The minutes record that a report was given in relation to
the visit to New Zealand by Mr Hartley and Mr Prowse.
(xiii) 25 October 1990
The minutes record Mr D W Simmons' visit to London branch
and his concern "that Treasury operations were exposing the London portfolio to
foreign currency exchange risk".
The minutes also record Mr Bakewell's visit to New Zealand.
(xiv) 14 November 1990
The minutes record Mr D W Simmons' visit to London branch
"That he had recently met with the external
auditors of London and that they had expressed concern over operations. In addition, he
advised that the Bank of England and the Reserve Bank of Australia had commented that the
portfolio in London had a high level of exposure to the property market."
Whilst the above list indicates Directors' visits to
overseas branches as recorded in the Bank Board Minutes, the submission of the
Non-Executive Directors points out that Mr D W Simmons and Mr Bakewell visited the London
and New York offices in October 1990; Mr D W Simmons visited New Zealand between 13 and 15
August 1990 to inspect the operations of the United Building Society; and Mr Hartley
visited London in December 1990.() In addition, Mr Smith gave evidence of his
visits to the London branch throughout 1986 whilst he occupied the position of the
Director of State Development, and Mr Barrett gave evidence that he visited London for the
opening of the London branch in October 1985, and personally called on the Bank of England
and the Reserve Bank of Australia representative in London.()
(h) The Bank Board's Interstate and Off-Shore Advisers
The idea of appointing "advisers" to assist the
Bank Board was initially raised by the Group Managing Director in July 1989. The Bank
Board Minutes for the Bank Board's meeting on 27 July 1989() record that the
purpose for appointing advisers was "to assist local branches and provide input to
the Bank's Board on operations interstate". The Bank Board resolved to approve
that the Bank seek out advisers in Sydney, Brisbane, Melbourne, Perth and Auckland.
At the Bank Board meeting of 26 April 1990, Mr Clark
foreshadowed that a paper would be presented to the next meeting of the Bank Board
recommending appointments of advisers to the Bank's offices in Brisbane, Perth, Auckland,
London and New York.
The Bank Board Minutes record that:
"Collectively, this group would be in a position to
provide independent advice to the Board as required."
This matter was further considered by the Bank Board at its
meeting on 24 May 1990, the minutes for which note() that:
"Since [July 1989] the Sydney office had
developed an excellent relationship with Mr Studdy [a director of Beneficial Finance]
which highlighted the significant advantages which were to be derived from the employment
of interstate advisers. The position also enabled directors to have a formal contact with
an adviser in each of the interstate and international offices ..."
The Bank Board resolved that Mr Clark approach a number of
named individuals with a view to appointing them as advisers to the Bank Board. The only
named persons to be approached were potential advisers in Victoria, Western Australia, New
Zealand and Queensland. The Bank Board Minutes do not record at either this, or any
subsequent meeting, that the Bank Board pressed Management to approach individuals to
accept the position of adviser for the London, New York or Hong Kong branches, and
Management did not bring this matter back before the Bank Board.
In my opinion, Mr Clark should have brought this issue
back to the Bank Board, given his knowledge, in particular, of the Bank's property
exposure in the London branch, and the concerns of the Bank of England and the Reserve
Bank in relation to that exposure. In the same context he was aware of the high risk
lending activity of the New York branch.()
(i) The Bank Board's Requests For "Quarterly
At its meeting on 26 November 1987, in relation to the
proposal to establish a New York branch, apart from approving in principle the
establishment of New York operations, the Bank Board also requested quarterly reports from
March 1988 onwards, as well as a report in June 1988 "where a critical path
decision would need to be made whether to continue development of New York Office."
The Investigation did not identify any specific "Quarterly Reports" being
presented to the Bank Board as directed.
At its meeting on 29 August 1988, directors requested "details
of the Bank's overseas operations."() The minutes go on to note that:
"It was agreed that [a report] would be
provided to Board on a quarterly basis with the first reports being provided to the
October Board meeting."
An examination of the Bank Board Minutes indicates that the
requested report was not tabled at the October 1988 Bank Board meeting, nor at any time
On 21 December 1989, the Bank Board noted the recent
appointment of Mr Lynn Todd as Chief Manager of London branch, and that "a
quarterly report would be provided to the Board detailing performance achieved".
The Bank Board Minutes do not record any such quarterly report being presented to the Bank
In evidence to the Investigation, Mr Clark expressed his
belief that such requests were satisfied by the Quarterly Operating Reviews which contain
more information than the Monthly Operating Reviews.()
19.4.3 DELEGATED LENDING AUTHORITIES
All delegated lending authorities required the approval of
the Bank Board. In January 1986, London branch's initial delegated authority level was set
at GBP 0.5M.() By September 1990, the Bank's delegated lending authorities had
reached the following levels:()
||London branch Credit Committee
||New York branch Credit Committee
||Auckland branch Credit Committee
||Chief General Manager,
||Leading Credit Committee
There were no separate delegated lending authorities
identified by the Investigation for the Hong Kong office.
The January 1986 delegation to London branch specified the
following terms so far as concerned relevant security to be taken and review of the
"Security: Any facility to be approved under this
delegation is to be secured by first class tangible security, with valuation margins,
following those laid down in the Bank's standing instructions.
Review: Facilities approved are to be reviewed on an
annual basis, or more regularly should there be any evidence of deterioration in the
safety of the Lending. It is also a requirements (sic) that any deterioration in lending
be promptly reported to Head Office." ()
The paper seeking approval for the delegated lending
authority for London branch() did not identify the persons to comprise the
London branch Lending Committee by name nor did it indicate their qualifications and
experience. The paper justified its recommendation on the basis that the delegated
authority be approved "in order that lending propositions may be dealt with in an
efficient and prompt manner".
In October 1988, the Bank Board approved a delegated
lending authority of up to $US 2.0M for New York branch. The Bank Board approved the
establishment of a New York office Credit Committee whose delegation permitted it to make
secured or unsecured loans for a maximum term of five years on the basis of the following
reasons put forward by Management:
"With the recent appointment of Vice President,
Corporate, and Vice President, Administration and Operations, New York Office will have
the capacity to pursue the wholesale lending market. Corporates targeted operate in a
diverse range of industries with turnover in excess of USD 50.0M. It is considered that
the level of experience and qualifications held by senior management justifies the level
of delegated authority sought.
... Approval of the detailed delegated lending authority
is recommended based on the quality and scope of business opportunities available, and the
experience and qualification of New York Office staff within their geographic area."
Whilst the paper recommending the approval of the delegated
lending authority for New York branch referred to the individuals to comprise the New York
office Credit Committee by name, the paper did not set out any of their qualifications and
In May 1989, the Bank Board approved a delegated lending
authority of up to $NZ 3.0M for Auckland branch. The Bank Board approved the establishment
of an Auckland branch Credit Committee, whose delegated lending authority permitted
secured or unsecured lending for a maximum term of five years. Without advising the Bank
Board as to the personalities involved nor their qualifications and experience, the
proposal was supported on the basis that:
"Approval of the detailed delegated lending
authority is recommended based on the experience and qualifications of Auckland Office
staff within their geographic area."
19.4.4 PRUDENTIAL EXPOSURE LIMITS
From time to time, the Bank set maximum exposure limits
(both actual and contingent) on any particular account. In July 1985, this limit was 20
per cent of the Bank's "capital base"(), limited to $33.0M, with
exposure to a "group" of related accounts being required to be included within
the maximum $33.0M exposure, unless specific Board approval was held. Under this policy,
higher levels of exposure , could be submitted to the Bank Board for approval in
particular cases. The policy also noted that the Bank Board would consider proposals to
take on corporate risk outside approved guidelines on the basis that the risk could be
sold down to place exposure within prudential guidelines within a period of six months.
The Bank also maintained prudential policies limiting
off-shore exposure. In December 1985, the Bank's policy on off-shore exposure was as
(a) off-shore assets limited to 20 per cent of the Bank's
(b) contingent off-shore exposure limited to 20 per cent of
the Bank's "risk assets"(); and
(c) within these broad parameters, off-shore assets not to
exceed $600.0M while contingent exposure not to exceed $500.0M.
In December 1985, the Bank Board approved New Zealand
country exposures not being recorded in the total of the Bank's off-shore exposures. The
Bank Board's approval limited New Zealand assets to 5 per cent of the Bank's total assets,
and New Zealand contingent exposure to 5 per cent of the Bank's total risk assets. The
Bank Board's approval was required for New Zealand assets to exceed $200.0M, and for
contingent exposure to exceed $100.0M.()
In June 1986, the Executive Committee considered a
recommendation for increases in the Bank's off-shore exposure limits. The Executive
Committee paper noted that the "Bank has recently been able to take advantage of
opportunities for rapid growth offshore." () The factors
affecting this growth were stated to include the "increased use of swap-based
transactions in international debt and capital markets." () The
paper, therefore, for the first time, proposed a separate set of off-shore swap exposure
limits. Swap transactions, under which the respective parties "swap" interest
rate or exchange rate risk, was said to be entered into by the Bank:
"... almost exclusively as interbank transactions.
Under the circumstances the counter party to the transaction is a bank subject to
supervision and prudential control by the relevant bank regulating authorities." ()
It was also noted in the paper that:
"The Bank is involved in the swap market with a
broad range of currencies, interest rate structures and counter parties. The Bank
undertakes swap contracts in both directions, ie, from fixed rate to floating rate,
floating rate to fixed rate, and both for the forward purchase and forward sale of a range
of currencies." ()
Accordingly the following off-shore exposure limits were
recommended to the Executive Committee:
(a) increase total off-shore direct exposure limits from
$600.0M to 20 per cent of Bank total assets at any time (on the then current balance sheet
size this limit was $1,000.0M);
(b) increase off-shore contingent exposure limits to 20 per
cent of Bank total assets;
(c) create a separate set of off-shore Swap exposure
limits, with assessed limits being restricted to 20 per cent of Bank total assets; and
(d) increase New Zealand country exposure limits to:
(i) direct - 5 per cent of total Bank assets;
(ii) contingent - 5 per cent of total Bank assets; and
(iii) swap - 5 per cent of total Bank assets.
These limits were approved by the Bank Board on 24 July
From time to time over the period under review, the
Executive Committee and the Bank Board considered and approved adjustments to these
prudential exposure limits. In relation to Auckland branch, the Bank Board made
substantial alterations to the New Zealand country exposure which is dealt with in Section
In my opinion, the Bank Board should have ensured that
at all times prudential limits for industry exposure within the London branch corporate
loan portfolio were in place. These limits should have been approved by the Bank Board on
the basis of a reasoned and substantiated recommendation from management, and such limits,
once established, should have been regularly reviewed and reassessed for relevance and
effectiveness. Management failed to submit recommendations for industry exposure limits
for the London branch to the Bank Board. Notwithstanding this, however, I am of the
opinion, that the Bank Board should have directed management to consider and recommend
appropriate limits. In evidence to the Investigation, Mr Mallett said that the "emphasis
in London was quite deliberately on property." () Mr Mallett
explained that the "emphasis" of the London branch on property arose as "the
first chief manager [of the London branch] went in and recognised what he believed
was an opportunity for the Bank in the property market".() This cannot
be described as an acceptable explanation.
In due course a 30 per cent maximum exposure to property in
the London branch was established by management.() So far as concerned
operations in New York, Hong Kong and Auckland, there is no evidence of the Bank Board
approving limits for industry exposure within portfolios for these branches.
In my opinion, the Bank Board's failure to ensure that
prudential limits for industry exposure were established, within the portfolios in respect
of the overseas branches, is an example of the Bank Board's failure to deal appropriately
with the management and prudential issues arising from maintaining remote branches. By
1988, these branches, theoretically, could represent an exposure of 35 per cent of the
Bank's total assets. In my opinion, the Bank Board's inaction in this regard left it open
to Management to act without Board direction in relation to prudential issues concerning
industry exposure within portfolios. As is noted in Section 22.214.171.124 above, the Bank's
exposure to property was the substantial factor in the recording of significant
non-performing assets by London branch in the February 1991 Report to the Bank Board on
19.4.5 TREASURY LIMITS
The Bank Board approved policies relating to Treasury
dealing limits during the period under review as follows:
(a) October 1985 - limits approved for London branch for:
open foreign exchange positions, mismatched forward foreign exchange positions, and money
market mismatch positions;()
(b) January 1989 - limits approved for all overseas
branches. The limits applied to open foreign exchange positions, money market mismatch
positions, and open swap positions;() and
(c) August 1989 - increased limits approved for all
overseas branches. The limits applied to open foreign exchange positions, money market
mismatch positions, and open swap positions.()
The Investigation noted that the information provided to
the Board for money market limits was brief. The paper presented in August 1989
illustrates the point, the following being submitted to the Bank Board:
"MONEY MARKET - Adelaide, London, New York, New
Equivalent 91 day mismatch of AUD 750m (Adelaide), USD
300m (New York Office), USD 300m (London Office), and USD 300m (New Zealand office),
restricting future losses on a 0.5% adverse rate movement to AUD 935,000/USD 375,000.
Long Futures - for London Office - 100 Long Futures
contracts maximum position. Stop loss level GBP 25,000 or its equivalent when positions
are to be immediately cut."
It is doubtful that a Board presented with this limited
information could make a reliable and/or informed decision on this matter. Given that the
London Treasury was operating in the areas of FRA arbitrage and spread trading futures
positions, more detailed information regarding limits would, in my opinion, have been
necessary for informed approval by the Bank Board.
19.4.6 BANK BOARD DISCUSSIONS CONCERNING OVERSEAS
A review of the Board Minutes and supporting papers
indicated that, in general, the level of information concerning the overseas branches
provided to the Bank Board was unduly limited. This is surprising, given the extent of the
rapid growth in the overseas operations over the period, and the development of Treasury
operations in these locations.
In their evidence to the Investigation, the Non-Executive
Directors said that the matter of overseas operations was a consistent and regular topic
of discussion. The fact that some discussion in relation to overseas operations occurred
at most, if not all, Board meetings is not contradicted by the evidence of Mr Clark.
However, at least until the second half of 1990, with the exception of one occasion on 24
March 1988, the Bank Board's Minutes do not record details of discussions specifically on
overseas branches. I accept the submission of the Non-Executive Directors that the Bank
Board's Minutes did not, and were not intended to record all discussions taking place in
the board room. I am therefore prepared to accept the evidence of the Non-Executive
Directors notwithstanding the silence of the Minutes except as indicated below.
The following items are extracted from the Bank Board
Minutes which record Bank Board discussions on overseas operations issues.
(a) Supervision of Overseas Operations
Expressions of concern by the Bank Board about control and
supervision related exclusively to the London branch:
(i) Bank Board discussion 24 March 1988:
"Directors considered that part of the reason for
the Bank failing to recognise and act on management problems in London Office earlier was
the fact that there was limited contact with management of London Office. It was agreed
that in future all managers of overseas operations would come to Adelaide for meetings
with Bank management at least twice annually." ()
(ii) Group Managing Director's Overview - 27 September
"Management continues to be uneasy about London ...
I have briefed our London auditors, Peat Marwick McLintock to do a full overview of our
London Treasury operation and when this is completed I have asked Robin Sewell to use it
as a guide to operate our London Treasury on a much lower risk basis.
Rob Wright has just returned from some weeks in London
doing a hindsight review of all corporate loans. His full report is being compiled at
present but verbally he has advised me that their loan portfolio is in good shape." ()
The assertion concerning the London branch loan portfolio
is inconsistent with the reported non-productive loan risk exposure in February 1991 of
$125.0M, by which date some $6.5M of income was uncollected or foregone.
(iii) Bank Board discussion 27 September 1990:
"Directors expressed their concern with London
Office. Mr Prowse questioned whether the arrangement of Mr Lynn Todd reporting to Mr Robin
Sewell would create any problems. The Group Managing Director advised that he had
discussed in detail the situation with Mr Todd and, to date, he had accepted it.
The Chairman was also concerned as he noted in his
recent visit to London that Treasury operations were exposing the London portfolio to
foreign currency exchange risk."
Matters relating to Treasury operations in the London
branch are dealt with in more detail in Chapter 7 - "Treasury and the Management
of Assets and Liabilities at the State Bank" of the Report.
(iv) Bank Board discussion 14 November 1990:
"The Chairman advised that he had recently met with
the External Auditors of London and that they had expressed concern over operations. In
addition, he advised that the Bank of England and the Reserve Bank of Australia had
commented that the portfolio in London had a high level of exposure to the property
Mr Hartley stated that London's over-exposure to the
property market suggested that supervision from Adelaide was inappropriate and this, in
turn, reflected on International Division management. Mr Hartley questioned what effect
the perceived errors in judgement by International management would have on other managers
in the organisation.
Directors were assured that Mr Mallett was competent and
his new reporting capacity to Director, Banking would ensure that he received adequate
guidance and direction. Further, Mr Mallett's performance would be closely
(b) Management Reporting
Bank Board discussion 26 July 1990:
In this discussion, the Bank Board directed management to
present the paper on the operations of the International Banking division, which is
reported on in Sections 19.4.2 (b) above.
(c) Overseas Strategy
(i) The report requested by the Bank Board on 26 July 1990
was tabled on 23 August 1990. As noted in Section 19.4.2 (b) above, the Bank Board was
concerned about the strategic justifications indicated in the Paper.
(ii) Bank Board discussion 27 September 1990:
"Mr Prowse questioned how much of New York's
business operations were directly generated by South Australian entities. Mr Sewell
advised that the operations in New York were not dependent upon business being referred
from South Australia." ()
Mr Sewell's statement is reinforced by the tabled Board
Paper which notes that the Bank at that time "banks 2 South Australian
My general conclusions with respect to control and
supervision of the Bank's Overseas Operations by the Bank Board are included in Section
19.5 CONTROL AND SUPERVISION OF OVERSEAS OPERATIONS BY MANAGEMENT
19.5.1 GROUP MANAGING DIRECTOR
The day to day management of overseas operations was the
responsibility of Mr Mallett from February 1986. However, Mr Clark played a critical role
as the interface between Management and the Board. Mr Clark, together with Mr Mallett,
shares responsibility for failing to present the required level of information to the
Board in support of proposals for the establishment, and the operations, of the overseas
Whilst the overseas branches reported directly to Mr
Mallett and his department, rather than directly to Mr Clark, Mr Mallett regularly briefed
Mr Clark on matters relating to the overseas branches. As noted below, Mr Clark was
directly involved in negotiations with the Bank of England in relation to the London
branch, and in discussions with the Reserve Bank of Australia concerning the Bank's
From his regular discussions with the regulatory
authorities, Mr Clark was well aware of their concerns in relation to the London branch's
Corporate Banking portfolio exposure to property.() Notwithstanding this,
however, Mr Clark did not ensure that loan proposals going forward to the Bank Board
(which by nature of the delegated lending authorities were the largest loans, for example,
by September 1990, over $25.0M) contained a statement as to the London branch's then
exposure to property, and the effect on that exposure of the loan proposal submitted for
approval.() With his knowledge of the concerns of the regulatory authorities,
Mr Clark should have ensured that the Board was fully informed of the London branch's
exposure to property as a relevant factor in considering whether or not to approve the
19.5.2 CHIEF GENERAL MANAGER, INTERNATIONAL BANKING
Up until December 1985, International Banking was under the
management control and supervision of Mr Hosking and Mr P E Byrnes. In December 1985,
after the death of Mr Hosking, Mr Mallett was appointed Acting Chief Manager,
International, and was formally appointed Chief Manager, International Banking, in
February 1986. In this position, he was responsible for the entire operations of the Bank
outside of Australia and reported directly to Mr Byrnes.
In May 1987, Mr Mallett was appointed Chief Manager,
Treasury and International, with his portfolio responsibilities being expanded to include
the Australian Treasury Operations and the Overseas Treasury Operations. In this position,
Mr Mallett reported directly to Mr G S Ottaway. In March 1988, Mr Mallett was appointed
General Manager, Treasury and International, and reported directly to Mr Clark. In July
1989, Mr Mallett was appointed Chief General Manager, International Banking, and from
January 1991 to the end of the period under review, was Chief General Manager, Corporate
and International Banking.
At the time of his appointment as Chief General Manager,
International Banking, in July 1989, Mr Mallett maintained responsibility for the overseas
branch Treasury Operations; the Australian Treasury Operations became the responsibility
of Mr Paddison, then Chief General Manager, Australian Banking.
Each branch was in daily communication with Head Office,
and Mr Mallett visited each branch semi-annually, and also met on a regular basis
with the Bank of England as the prudential regulator of London branch, and with the
Reserve Bank of Australia in relation to the Bank's overseas operations. In addition to
the operational aspects of supervision, Mr Mallett was responsible for the appointment of
senior staff in the off-shore locations.
As noted above, the delegated lending authority for the
Chief General Manager, International Banking, had, by September 1990, reached $16.0M. This
delegation was by far the highest lending discretion vested in an individual - the next
highest delegation to an individual was $5.0M.() This delegation placed Mr
Mallett in a position to significantly affect the Bank's financial performance and asset
quality. In addition, Mr Mallett received regular and detailed financial information on
the overseas branches. The branches reported their financial positions on a weekly basis
to Head Office and prepared a full financial analysis on a monthly basis, detailing profit
and loss account and balance sheet.
In my opinion, in light of the above factors, Mr Mallett
had a specific obligation to ensure the highest levels of control and supervision of these
distant branches. He also had an obligation to keep the Bank Board informed of matters
affecting the overseas branches which would enable the Bank Board to give prudential
directions to Management in respect of the overseas branches, in particular, directions
regarding their operations in particular markets or in particular types of lending.
(b) Mr Mallett's Approach to Control and Supervision of
the Overseas Branches
In his evidence to the Investigation, Mr Mallett
highlighted the difficulties in adequately supervising and controlling distant branch
operations, in particular, the extreme difficulties in adequately monitoring a particular
branch's (and therefore the Bank's) actual non-performing asset position, and whether or
not that position was a result of a "one-off" event, or was part of, or
indicative of, a trend.
Up until May 1990, Mr Mallett did not believe that the
London branch's property exposure was going to be a "concern" nor did
management of the London branch.() Information concerning the Bank's exposure
to property and its non-performing asset situation, was flowing from London branch to head
office but this process was susceptible to time lag, and, most importantly, to the level
of the accuracy and reliability of the assessment made by the Account Manager as to
whether the account was such as to lead to a potential loss by the Bank.
Management in Adelaide head office was in reality, totally
dependent upon account managers in the London branch (and in other overseas branches), as
indeed within their own head office, to take an independent view of the risk of the asset,
and to objectively report on it to Management. Clearly inherent in this approach is the
risk that an account manager will not fully and objectively report on an account which may
have developed into one exposing the Bank to risk, as this may have been seen to adversely
reflect upon the particular officer's own performance, including that officers' initial
assessment of the credit risk applicable to a particular loan proposal.
The following extract from Mr Mallett's evidence()
succinctly states the very real and substantial exposure taken by the Bank in adopting a
"hands-off" approach to control and supervision in its overseas branches:
"The entire bank, whatever its business was, was
totally dependent upon the account manager recognising the problem, communicating it then
to his manager, his manager then taking the whole picture and communicating it up the line
and in London the situation is worse of course because it's 10,000 miles away, and whereas
in Adelaide you may have a feeling that something in Adelaide is going ... wrong, you
don't rely even, you may not be totally dependent upon your account manager telling you
In London you're totally dependent on the people over
there and you're asking me why was the process in hindsight, and I have to agree, slow and
it is simply because, I believe, human nature, reluctance to recognise that something you
did has gone wrong and having recognised it's gone wrong, the problem compounds because
you then rely on other people to tell you how much has gone wrong and you take the initial
stab in the dark and there is so much uncertainty and ... other issues that may or may not
come to play but the figures ... [are] only relevant at a moment in time."
With his understanding of this most fundamental issue
arising in relation to control and supervision of the Bank's overseas branches, it was, in
my opinion, incumbent on Mr Mallett to ensure that the highest level of relevant internal
control systems were in place, at all times, in order to protect the Bank's interests.
As is noted in other Sections of this Chapter, there was
no on-site audit conducted of the London branch for some three and a half years after its
establishment. There was no credit inspection function independent of Management in the
London branch for some four and a half years after the Branch's commencement of wholesale
banking operations. In addition, delegated lending authorities did not restrict lending
activities in relation to industry exposures within portfolios. Essential Management
information stopped at Mr Mallett's desk that, in my opinion, should have been
communicated to the Bank Board.
(c) Information Flow to the Bank Board
As noted earlier in this Chapter, there were substantial
discrepancies in the level of information submitted to the Bank Board in support of the
recommendations for establishing the various overseas branches when compared to the
corresponding Executive Committee paper. This was particularly so in the case of the
proposals put forward to the Bank Board recommending the establishment of the Auckland
The Investigation also identified a number of reports on
operational matters concerning the overseas branches where information presented to the
Bank Board omitted matters that were material and that had been provided to the Executive
Committee. The following is an illustration of such a matter. A number of papers
submitted to the Bank Board concerning the New York branch omitted any reference to the
type of corporate lending undertaken or proposed to be undertaken, by the New York branch.
New York branch was, over the period from its establishment to the end of the period under
review, actively involved in "Highly Leveraged Transactions" (as noted above,
these are corporate loans to a borrower with a debt to equity ratio of 3:1 or higher) and,
to a much lesser extent, Mezzanine Finance (subordinated lending).
In November 1987, the Executive Committee paper seeking
that Committee's endorsement to the proposal to establish the New York branch(),in
so far as this paper considers the proposed nature of corporate finance activities, made
the following observation:
"To achieve the returns necessary to justify
activity in this market, the Bank must be prepared to consider innovative and complex
transactions. Participation in complex structured transactions is central to the
profitability of most successful small foreign banks in the U.S."
In evidence to the Investigation, Mr Mallett as the
presenter of this paper, confirmed that this paragraph was referring to Highly Leveraged
Transactions.() This reference was omitted from the corresponding Bank Board
Paper. I regard this as a material omission, in that the Bank Board was not advised of
matters that were significant in relation to prudential management of the Bank's risks in
the New York branch.
The June 1988 paper to Executive Committee on the
establishment of the New York branch() made it clear that the complexity of the
financing arrangements proposed for New York branch had significant implications for the
required level of staffing skills to adequately protect the Bank's position in these
"To enter this market successfully, the Bank must
develop or acquire the skills to assess complex corporate transactions. Head office must
also develop the skills and experience to support this business."
This reference was omitted from the corresponding Bank
Board Paper.() I regard this omission, also, as material, as it deprived the
Bank Board of the opportunity to assess the risk profile of the New York branch to give
appropriate directions to Management for prudential management of those risks.
In December 1989, Mr Mallett presented a paper to the
Executive Committee() concerning the formation of a United States subsidiary to
assist the New York branch with respect to corporate finance activities. This paper
referred to the proposed areas of activity, and included a specific reference to the
proposed involvement of the New York branch in "Mezzanine Finance".
All reference to the proposed areas of activity for New
York branch were omitted from the corresponding Bank Board Paper.() I regard
this, also, as a material omission, which deprived the Board of the opportunity to
discharge its obligations as to prudential management of the Bank's risk profile in the
New York branch. The Investigation put these discrepancies to Mr Mallett, who in
evidence, expressed the view that such matters were not "relevant" ()
as the Bank was involved in similar transactions (albeit, not known by these particular
labels) in Australia.
The following extract of Mr Mallett's evidence clearly
indicates his view that matters that fell within Management's delegated authority were
matters for Management, and not the Bank Board.
Mr Mallett: "... we were doing mezzanine debt in
Australia. Debt is debt and has a higher risk profile. ... but I don't remember going to
the Board at any stage and saying, "hey, in Australia," or "hey, in New
York, we are doing second tier financing".
Question: You didn't see a need to draw it to their
Mr Mallett: That was Management's responsibility. I
don't see that was a Board responsibility at all. Just for the record, if the Board
delegated me a discretion, it was a total discretion. That's been my banking experience.
If the Board said: you can approve $5m, $10m, that's it.
Mr Mallett: I certainly didn't ever go the Board and
say: Do you realise, as Board of Directors - or Credit Committee or whatever it was, and
say, you know, that in New York we'd done a mezzanine debt, a debt that has a greater risk
than senior debt for that particular company ... Maybe I'm not the most experienced person
dealing with a Board, but there were some things that I didn't think were the Board's -
interest to the Board. I mean, the Board was running a bank, and running a bank we lend
Mr Mallett: ... so far as I'm concerned the activities
of management within discretions were Management's responsibility, not the Board. I
wouldn't have gone to the Board and - equity, yes, but not mezzanine.
Question: So the type of lending, if it was within
discretion, was a matter for Management?
Mr Mallett: Absolutely. Management ought to be
accountable for some things."()
Yet, notwithstanding Mr Mallett's views, Management was not
unanimous in its appreciation of high risk lending being carried on in New York office,
particularly mezzanine finance arrangements which carried spreads of some 8 per cent.
On 14 May 1990, the Executive Vice President, United States
of America, in a memorandum to Mr Mallett, raised as a "strategic initiative" a
mezzanine financing arrangement with a United States company which was active in this
On 24 May 1990, Mr Mallett replied as follows:
"Thank you for this background. My response is a
bit late seen (sic) as though I have already approved two transactions ... I would have to
make comment that there will be a lot of heartache from various parts of the organisation
in regard to the risk profile of some of these transactions. Obviously it is my belief
that the risk profile is understood and boxed but other peoples' opinions tend to be
influenced by more traditional lending structures ... It is not an area that we should
look to grow too quickly. I would really like to see some track records established in
some of our existing transactions and the profits banked. It has, however, as you have
mentioned, if well managed and properly evaluated, very attractive revenue streams to the
In evidence to the Investigation, Mr Mallett said that his
reference to "heartache" was to certain members of the Executive and
Lending Credit Committee.()
Whilst Mr Mallett may be technically correct in his view
of delegated authorities so far as the performance of those delegated authorities is
concerned, his failure to draw the Board's attention to the nature of the corporate
finance activities of the New York office, in view of the fact that the Executive was not
unanimous as to the desirability of engaging in this particular form of lending, deprived
the Bank Board of the opportunity of deciding for itself whether such lending activity was
in the interests of the Bank, and if so, what prudential controls and limitations ought to
be imposed in relation to these activities. Morover, Mr Mallett's withholding of the
information sits uneasily with his description of the difficulties of exercising effective
control over the off-shore branches.
The above is but one of a number of situations noted in
this Chapter where the Bank Board was not informed of information from which it could, in
discharging its functions, have set in place prudential controls and limitations.
(d) The Lack of Significance to Mr Mallett of the Bank
as a "Government Bank"
One matter of particular significance in respect of which
Mr Mallett gave evidence was his views as to whether or not the Bank's position as a bank
carrying a Government Guarantee required him, as the Chief General Manager in charge of
the Bank's overseas operations,to adopt a higher level of attention to internal control
systems in order to protect the interests of the people of South Australia as the ultimate
"underwriters" of the Bank's liabilities. So far as he was concerned, Mr Mallett
did not see anything "special" because of the Bank's status as a
Government guaranteed State Bank:
"... Would I have treated [control and
supervision of the overseas branches] any differently because it was the State Bank of
South Australia? My answer is no. I mean, consistently, it's only in recent times that I'm
fully coming to grips with the fact that this is a government bank. I really came into
this organisation with no experience of anything other than private banking and for many
years it was as though we were a private bank, a board and a Managing Director, or General
Manager, whoever, so, no, I didn't treat, I didn't run, did not assume that we had to do
anything more special because we were a state bank." ()
(e) Loan Proposals Submitted to the Bank Board
As is noted in Section 19.7 below, Mr Mallett was in
regular contact with the Bank of England and attended prudential consultations with the
Bank of England and the Reserve Bank of Australia.() In his evidence to the
Investigation, Mr Mallett stated that:
"Every time London [branch] did a credit
paper, they would always put down their industry exposure." ()
A review by the Investigation of a selection of property
secured loan proposals presented to the Bank Board identified only one occasion on which
London branch's exposure to property was shown.() This proposal was presented
to the Bank Board in March 1990, and indicated London branch's then exposure to property
as 27.5 per cent of total London branch risk assets, with a forecast increase to 29.2 per
cent having regard to "recent approvals" and on the basis that the
proposal then before the Bank Board was approved.
In my view, having regard to Mr Mallett's knowledge as
to the concerns of the regulatory authorities concerning London branch's exposure to
property, it was incumbent upon him to ensure that, in all cases, this information was
drawn to the attention of the Bank Board. This would have enabled the Bank Board to fully
assess the risks involved in the loan proposal. These risks would include not only the
risks inherent in the particular loan proposed, but also the risk arising from
"portfolio exposure" to one particular "industry". I am of the view,
that Mr Mallett failed in his duty to the Bank Board, and to the Bank, in not presenting
information relating to London branch property exposure.
At the same time, however, in my opinion, the Bank Board
should have required Management to present information to the Bank Board on risk
concentration and the implications for the Bank's risk profiles in the London branch in
relation to its property exposure.
19.5.3 CHIEF MANAGER OF EACH BRANCH/OFFICE
The Chief Manager in each overseas office had
responsibility for the daily operations of that office. The extent of responsibilities
varied from office to office, depending on the level and range of activities within the
office concerned. These matters are discussed above in Section 19.3 of this Chapter.
My general conclusion with respect to control and
supervision of the Bank's overseas operations by Management are included in Section 19.9
19.6 INTERNAL CONTROLS AND THEIR REVIEW
19.6.1 INTERNAL POLICIES AND PROCEDURES
In my opinion, the nature of the operations of the overseas
branches would, as a matter of prudential financial management, require the following
policies and procedures manuals:
(a) Corporate Banking - covering the preparation of loan
proposals, the loan approval process (including approval limits), security exposure
monitoring (counter-party, industry, country), loan management, and loan administration();
(b) Treasury - covering dealing procedures, exposure
monitoring, and operations procedures;
(d) Reporting; and
(e) General - covering budgets, business plans, strategic
The manuals that have been made available to the
Investigation dealt with some, but not all, of these areas.
(i) Office Policy (1985);
(ii) Procedures Manual (1988); and
(iii) Asset Based Financing Operations Manual (1990).
(b) New York
(i) Reporting and Procedures (1988);
(ii) Operating Procedures/Accounting (undated);
(iii) Loan Administration - Operational Procedures
(iv) Treasury Operations (1991)
(i) Procedures Policy (1989);
(ii) Banking Division Manual (1990); and
(ii) Treasury Manual (Security Pacific NZ, 1987).
(i) International Finance Policy (1990);
(ii) International Finance Procedures (undated);
(iii) International Banking (1987);
(iv) Policy/Procedures - Treasury (1989);
(v) Corporate Banking: Accounting, Policies and Procedures
(vi) Group Credit Manual (1991);
(vii) Commercial Lending (1985); and
(viii) Global Treasury (1991).
The off-shore branches/offices had individual policies and
procedures manuals as well as those applied to the Bank as a whole. As will be noted later
in this Chapter of the Report, in some cases, individual offices either did not maintain
specific procedures manuals (eg Hong Kong - Lending) or did not keep the manuals
up-to-date (eg London).
19.6.2 GROUP INTERNAL AUDIT
On-site Internal audits of the overseas branches were first
performed in May 1989, when London branch was audited, after having operated in wholesale
banking since October 1985. The audits of overseas branches that were performed, and which
had relevance to matters occurring during the period under review were as follows:
(commenced wholesale banking
operations October 1985):
Kong (established April 1987):
York (established November 1988):
Audit of New
(established December 1988):
The Bank's failure to secure early on-site internal audit
review of internal control systems in the overseas branches is reported in detail in
Chapter 23 - "Internal Audit of the State Bank". So far as concerns this
Section of this Chapter, I am of the view that the significant delay in securing
adequate and effective on-site inspection by Internal Audit department of the overseas
branches' internal control systems is a serious failure on the part of the Bank Board, Mr
Clark, and Mr Mallett, to discharge their obligation for the prudential management of the
So far as concerns New York branch, the very nature of the
lending activity conducted by that branch, and the growth in assets reported in respect of
that branch imposed a particular obligation on the Bank Board, Mr Clark and Mr Mallett.
The Board and the two executives concerned had a responsibility to ensure that there was a
regular review, independent of Management, of the internal control systems in place to
manage the Bank's risks. Any such review would assess the effectiveness and relevance of
the internal control systems, and recommend new or improved systems.
I regard the delays in securing on-site internal audit
reviews of the London branch and the Auckland branch as a significant failure by the Bank
Board and management to adequately discharge their respective responsibilities.
As appears above, Auckland branch inherited its most
substantial non-productive assets from either Security Pacific or Corporate Banking, Head
Office. Notwithstanding this, ongoing management of the Bank's exposure required
maintenance of effective and relevant internal control systems, and these should have been
reviewed earlier than 19 months after establishment of the branch.
So far as London branch is concerned, the absence of
effective internal audit review is a most significant failure of the Bank on the part of
the Bank Board, Mr Clark, and Mr Mallett, to protect the interests of the Bank. For the
reasons indicated in Chapter 23 - "Internal Audit of the State Bank", I
do not regard it as appropriate or justifiable that the Bank Board, Mr Clark, and Mr
Mallett seek to rely upon the activities of the external auditors. The failure to
secure even the most rudimentary on-site internal audit review of internal control systems
for three and a half years after the establishment of the London branch is, in my opinion,
a failure on the part of the Bank Board, Mr Clark and Mr Mallett of their respective
duties to protect the interests of the Bank.
19.6.3 WHOLESALE CREDIT INSPECTION
A memo dated 16 February 1990 from Mr Mallett to the
Director, Australian Banking, proposed the establishment of a Wholesale Banking Credit
Inspection Team with responsibility for reviewing the loan activities of International
Banking, Corporate Banking and Business Banking. The Wholesale Credit Inspection Section
was then established in 1990 and consisted of one person, Mr Wright, who performed the
inspections. Reports were produced for London branch (August 1990) and for Hong Kong
office (January 1991):
The report on the London branch was based on a review of
all accounts on the lending portfolio and concluded that:
"... to the best of my assessment, there are no
problem or potential problem loans on London's books which London Office has not already
identified and is reporting upon together with appropriate action plans in place".
This report noted that, in 18 cases, annual reviews of
loans had not been carried out in a timely manner, but that accounts due for review were
being closely monitored by London management on a formal basis.
The executive summary noted that:
"The present state of the UK property market causes
some concern and has resulted in a small number of property loan borrowers defaulting.
However, all are subject to strong management control and various strategies are in the
course of negotiation which are expected to enable London Office to manage these accounts
out of trouble over a period without (on present indications) possibility of loss".
As noted earlier, this conclusion is contradicted by the
February 1991 Non-Productive Assets Report() to the Bank Board only some 6
months later, as well as the findings of an Internal Audit report of May 1991()
which expressed serious concerns about the quality of the London branch loan portfolio. Mr
Wright has given evidence on this matter, that satisfies me that the change in
circumstances in the London portfolio is not attributable to a lack of care on his part in
carrying out this inspection.
(b) Hong Kong
The report on the Hong Kong office portfolio concluded that
there were "no problem loans" but "two exposures do require close
Given that London branch had been engaged in wholesale
banking activities since September 1985, and that New York office in particular had been
involved in high risk corporate lending from November 1988, the question naturally arises
as to why it was not until February 1990 that the proposal for the establishment of a
Wholesale Credit Inspection Unit was put forward. This question is partially answered in
the paper itself:
"We have to date, deliberately chosen not to
introduce a credit inspection procedure for the wholesale side of the Bank. This has
centred around several issues, one being the dynamic growth of the business and our
concentration on this area rather than a review of the credit implications and, that with
little delegation of authority, arguably credit review could only question senior
management's decision ... It is a common practice in all major banks globally, to have
a delegated lending inspection team who, operating under appropriate policy guidelines,
review on an annual basis, all lending activity." [Emphasis Added]
In evidence to the Investigation, Mr Mallett explained that
the principal reason for the delay in the establishment of a wholesale credit inspection
unit was that most of the lending was "new lending" and wholesale credit
inspection review was not therefore required:
"Mr Mallett: ... As far as I was concerned with
international the majority of my lending was new lending but it had only been done in the
past 18 months, ... the dramatic growth in New York, that was my [catalyst] for
Even though London branch's lending activities had been in
place for some four and a half years by that time, Mr Mallett did not see that as a
"Mr Mallett: [London book] didn't worry me
Question: It was New York that concerned you?
Mr Mallett: Yes.
Question: And why was it New York that concerned you and
Mr Mallett: Because New York had a different style of
book. It had grown quickly ... It was predominantly lending of a more complex analytical
Mr Mallett: ... The catalyst in my mind was New York
growing book, a growing balance sheet, a more complex lending. London, as we said earlier,
was bread and butter lending. It was very simple banking ... So I wasn't that concerned
about having it reviewed. I mean, there wasn't any urgency to get a review, bearing in
mind that it was looked at every six months by the external auditors and the reporting
accountants. They reviewed our loan portfolio ..."
In his evidence to the Royal Commission, Mr Clark made the
following observations in relation to the failure to introduce a credit inspection
procedure for the wholesale side of the Bank.
"Question: ... Were you aware of that type of
comment being uttered by middle management.
Mr Marcus Clark: That paper is addressed to me.
Question: And is it correct that there had been a
deliberate decision not to introduce a credit inspection procedure of the wholesale side
of the Bank.
Mr Marcus Clark: Yes, that was true at that stage.
Question: Whose decision was that.
Mr Marcus Clark: Mr Mallett's, because we did have a
different method of credit processing and approval in New York and London to that in
The external auditors of London branch did carry out an
audit of that branch for the purposes of its reports to the Bank of England, and also
reported on internal systems and controls. The Investigation did not sight any evidence
that the external auditors of London branch were charged with the responsibility of
assessing, from a credit perspective, the London corporate book, and reporting on that
book to Management and the Bank Board in a way designed to assist the Bank Board to set
prudential limits and controls in respect of that branch's activities. Any purported
reliance on the external auditor to discharge this role was, in my opinion, misplaced.
19.6.4 EXTERNAL AUDIT
As all overseas operations were consolidated into the
Bank's financial statements, all were, to this extent, subject to external audit.
The Auckland branch operations were conducted as part of
SBSA (NZ) and so were the subject of a specific statutory external audit. The other
overseas operations, however, were conducted through branches, so
"branch-specific" statutory audits were not required.
In 1990, KPMG Peat Marwick McLintock, the London branch
external auditors, reported to management on certain matters arising from limited audit
procedures of London branch as part of the Bank's statutory audit. In October 1990, that
firm reviewed Treasury Operations in the London branch to determine the cause of a GBP
0.5M loss, and, in March 1991, KPMG Peat Marwick McLintock investigated the events
surrounding the identification of an unexpected deferred charge of GBP 0.4M in the
balance sheet of the London branch, which had occurred during the period under review.
In addition to this work, the external auditors in London
prepared regular reports to the Bank of England on the branch's prudential returns, and on
its reporting and internal control systems. The role of the external auditors in relation
to London branch is dealt with in detail in Chapter 23 - "Internal Audit of the
In January 1991, KPMG Peat Marwick performed limited audit
procedures in the New York office as part of the Bank's statutory audit.
Matters relating to the performance by the external
auditors of their responsibilities as such in relation to the Bank, will be dealt with in
detail in a subsequent report.
19.7 REGULATORY AUTHORITIES
This Section of the Report deals with communications
between the Bank and the regulatory authorities, the Reserve Bank of Australia and the
Bank of England. As discussed in Chapter 15 - "The Relationship with the Reserve
Bank of Australia" of this Report, the Bank was not legally subject to the
Reserve Bank's supervisory jurisdiction. It was, however, subject to the jurisdiction of
the Bank of England with respect to the activities in the United Kingdom. The focus of
this Section is on those communications that relate to the Bank's overseas operations.
Initially, a chronological analysis of the consultations is presented, at the end of which
I present my conclusions on this particular topic. In some instances, to assist the
reader, I present observations in the course of presenting the chronology.
Regular meetings were held by management with both the
Reserve Bank of Australia and the Bank of England. Annual "Prudential
Consultations" were held between the Bank and the Reserve Bank of Australia. As
appears below, not all matters raised by the regulatory authorities in these Prudential
Consultations were reported to the Bank Board, and, in most instances, there are
substantial contradictions between the Reserve Bank of Australia's record of a particular
meeting, and the Bank's record of the same meeting.
(a) 1985 Consultations
On 23 October 1985, Mr Clark, Mr K S Matthews, Mr Byrnes,
Mr Ottaway, and Mr C W Guille, on behalf of the Bank, attended a Prudential Consultation
with the Reserve Bank of Australia. The Reserve Bank's record of this meeting noted that
the Reserve Bank observed that, during the course of this consultation, the Bank's "aims
for its London operations seemed quite ambitious" and that, in response,
the Bank said that it felt "comfortable with their plans for London and did not
believe that they were ambitious or unwise."
At its meeting on 24 October 1985, the Bank Board was
advised that the Prudential Consultation had taken place. In relation to the matters
raised by the Reserve Bank of Australia concerning the London branch, the minutes simply
"Discussions centred on prudential arrangements in
place by the Bank to prevent business risk." ()
(b) 1986 Consultations
The Prudential Consultation with the Reserve Bank of
Australia held on 12 September 1986 was attended by Mr Clark, Mr Matthews, Mr G T Hazel
(General Manager, Treasury and Capital Markets division), and Mr D C Masters (Chief
Manager, Corporate Banking).
In this meeting, Mr Clark commented on the Bank Group's
significant expansion over the previous year and the Reserve Bank of Australia's minutes
record the following:
"Mr Marcus Clark responded that the group had
expanded by 56 per cent in the past year and that this rate of growth was too fast; he
suggested that growth exceeding 30 per cent could lead to indigestion." ()
Mr Clark was recorded as identifying London branch as a
significant contributor to the Group's growth.
The Investigation was unable to locate any written report
on this Prudential Consultation to the Bank Board or notes of an oral presentation of the
(c) 1987 Consultations
The operations of the London branch, in particular its
internal control systems and head office's supervision, direction and control, over London
branch, was raised again by the Reserve Bank of Australia at a Prudential Consultation
held on 15 October 1987.() This consultation was attended by Mr Clark, Mr
Ottaway (at that time General Manager, Corporate and International Banking), and other
executives of the Bank. Mr Mallett was not in attendance. At this meeting, Mr Clark
referred to recent "problems" in London "due mainly to losses on forex
operations" and "loss of some key staff".()
The Investigation was unable to locate any report on the
proceedings of this Prudential Consultation to the Bank Board either written or oral.
(d) 1988 Consultations
On 12 May 1988, Mr Matthews and Mr Copley attended an ad
hoc meeting with the Reserve Bank of Australia. During the course of this meeting, the
Reserve Bank of Australia again expressed its concern as to supervision, direction, and
control, of the Bank's overseas operations.()
The Prudential Consultation between the Reserve Bank of
Australia and the Bank on 15 November 1988, which was attended by Mr Matthews, Mr Ottaway,
Mr Copley and Mr Mallett, on behalf of the Bank, addressed a number of significant issues
in relation to the Bank's overseas operations.()
The Reserve Bank of Australia's minutes of this Prudential
Consultation record the following matters relevant to the Bank's overseas operations:
"Mr Kelleher [Reserve Bank] drew Mr
Matthews' [the Bank] attention to a number of aspects of the bank's operations
that were causing us some concern. These included ... offshore expansion of activities
(including the Bank's recent establishment of operations in New York and now its proposed
New Zealand branch). Mr Kelleher noted that the underlying rate of growth of the Bank may
be too fast and we were concerned to ensure that the bank's management systems could
properly monitor and control risks associated with this level of business.
Mr Kelleher drew attention to the Bank of England's
concerns about the level of the UK branch's investment in property. Mr Mallett was
[surprised] by this statement as the bank had heard no unfavourable comment from the B
of E and as far as he was aware that institution was quite happy with SBSA's level of
property lending." [Emphasis Added]
This account of the proceedings is totally at odds with
the report of the meeting to the Bank Board, prepared by Mr Matthews, which states:
"Reserve Bank commented that they were satisfied
with our offshore arrangements and advised that they had not had any adverse comments from
regulatory authorities in the various areas." ()
Mr Matthews' report was tabled at the meeting of the Bank
Board on 24 November 1988 and the Bank Board Minutes record the following in relation to
"The Reserve Bank were satisfied with the Bank's
offshore arrangements and advised that they had not had any adverse comments from
regulatory authorities in the various areas." ()
(e) 1989 Consultations
On 16 November 1989, the Prudential Consultation with the
Reserve Bank of Australia was attended by Mr Matthews, Mr Copley, Mr Guille, and, for part
of the meeting, by Mr Mallett, Mr Paddison and Mr Gobbett (Chief Economist) on behalf of
The Reserve Bank's minutes of this Prudential Consultation
record that during the course of this meeting, the Reserve Bank of Australia observed that
the Bank's New Zealand activities had expanded rapidly and that it "would have to
doubt the wisdom of that expansion ..." and that in reply, Mr Matthews said that:
"... SBSA was not unique in seeking to build up its
assets in NZ, with all of the majors currently building assets there ... Assets had, of
course, been built recently through the Security Pacific acquisition, which SBSA saw as
simply too good a deal to let pass." ()
The Reserve Bank of Australia also expressed its concern to
the Bank as to the growth in the Bank's overseas operations generally:
"Mr Kelleher [Reserve Bank] said that it was
difficult to ignore the significant growth in the bank's overseas operations during the
past year. He added that, from our perspective, we had some difficulty in understanding
the Bank's strategy for being offshore, given the extra risks involved and finer returns
relative to business in Australia." () [Emphasis Added]
As is noted below, this issue was reported to the Bank
The Reserve Bank minutes record the following response by
Mr Mallett on behalf of the Bank:
"In response to Mr Kelleher's noting of high level
of property exposure [Mr Mallett] agreed that this is the case but pointed out that
in five years' presence in market, no losses/defaults encountered. Have had long
discussions with B of E in relation to the branch's property exposures and believe B of E
are comfortable with position." ()
I do not regard the statement attributed to Mr Mallett
concerning "defaults" in relation to property lending activities in the London
branches as correct. Mr Mallett was aware from the Lending Credit Committee review of
potential bad debts as at 28 June 1989 of a default in respect of a property secured loan
in London branch. Furthermore, I do not accept the statement attributed to Mr Mallett as
regards the Bank of England. In evidence to the Investigation, Mr Mallett conceded that he
was aware, at least by 1988, that the Bank of England was concerned with the Bank's
exposure to the United Kingdom property market.()
The proceedings of the Prudential Consultation held on 16
November 1989, were reported to the Bank Board in a paper presented by Mr Matthews dated
17 November 1989. This Board Paper stated:
"As far as State Bank Group operations were
concerned, the Reserve Bank did not raise any matters of serious concern. However, it was
apparent that the Reserve Bank is expecting some slowing in the growth of the group
consisted (sic) with minimising risk in difficult times."
Attached to this Board Paper was a file note of the
proceedings of the Prudential Consultation which contained no reference to the Reserve
Bank's expression of concern as to the high level of property exposure in the London
branch. This file note did, however, refer to the Reserve Bank's views concerning the
importance of supervision, direction, and control, of the Bank's overseas operations, in
the following terms:
"... At all times (and for all banks) it was
important to closely monitor and understand the risks in the businesses of offshore
The Bank Board Minutes() do not indicate that
the Bank Board directed management to present a report on the "risks"
inherent in the business of the off-shore branches.
On 29 November 1989, the Reserve Bank of Australia's New
York representative attended a Prudential Consultation with Mr Sewell, the head of the
Bank's New York operations. The Reserve Bank's minutes of this meeting record that during
the course of this consultation, the Reserve Bank sounded a warning concerning the New
York branch's spectacular growth in assets:
"We drew out the great risks that exist in rapid
development of lending business, and the need to be sure that the pace of growth does not
exceed the capacity of systems, management resources, and experience in the markets and
lending business being developed ... The striking growth in lending which has been
achieved in the initial year must be a cause for some reservations." ()
The Investigation could find no evidence of any record of
this meeting being presented to the Bank Board.
(f) 1990 Consultations
The 1990 Prudential Consultation was held on 29 August 1990
with Mr Clark, Mr Mallett, and other senior officers in attendance.
The Reserve Bank of Australia's record of this meeting in
relation to the Bank's overseas operations concentrates principally on concerns with
respect to supervision, direction, and control, in relation to the United Banking Group.
The London branch's exposure to property was, however, again discussed. The minutes of the
Reserve Bank of Australia record the following responses by Mr Mallett on behalf of the
"The London property portfolio, which has rated a
special mention at recent meetings with SBSA both here and in London, has been built up
over 5 years and is well secured. The Bank is involved in no development projects. Mr
Mallett said that the Bank could not foresee any problems unless property values fell by
30/40 per cent. Mr Austin [Reserve Bank] remarked that such falls might not be
uncommon in a shakeout."
On 27 September 1990, the proceedings of the Prudential
Consultation were reported to the Bank Board in a paper prepared by Mr Guille.()
Neither the Bank Board Paper, nor its attached diary note, make any reference to the
Reserve Bank of Australia's, now many times repeated, reference to concerns about the
London branch's property exposure.
The Bank's growth in its overseas operations was the
subject of particular attention during the course of the 29 August 1990 Prudential
Consultation. This matter was reported to the Bank Board in the following extract from the
diary note attached to the Board Paper:
"Mr Austin [Reserve Bank] recalled that at
the last consultation, the RBA had expressed concern at the rapid growth of the State Bank
Group and queried asset quality, management resources, overseas operations and controls
over subsidiaries. In the intervening period, assets had grown over 40 per cent, asset
quality had deteriorated and Beneficial had emerged as a problem. In addition, Mr Austin
said the RBA had considerable difficulty understanding why the latest profit plan
anticipated further strong growth, particularly overseas ...".
The Bank Board Minutes record that the paper was "noted"
"Mr Guille advised that feedback from the Reserve
Bank was generally positive and that the Reserve Bank's understanding of our business was
most helpful. There was some areas of concern, particularly in relation to Beneficial
Finance, which would continue on the agenda for regular discussions."
Having regard to all the evidence stated in this
Chapter, I am of the opinion that this record in the Bank Board Minutes was misleading as
to the nature of the matters dealt with during the Prudential Consultation.
On 6 November 1990, the Bank met with representatives of
the Bank of England and the Reserve Bank of Australia in Adelaide. This meeting was
attended by Mr Clark and other executives on behalf of the Bank. At this meeting, the
matter of the London branch's exposure to the United Kingdom property market was yet again
a topic of discussion. The Reserve Bank of Australia's minutes of this meeting record
"[Mr Clark] noted that Mr Anderson [Bank of
England] had cautioned him every year about property." ()
The Bank's own record of the meeting with the Bank of
England on 6 November 1990 notes:
"We were aware the London book was unbalanced in
terms of its property exposures, and the situation would be corrected." ()
The Investigation sighted no evidence of any report of this
meeting being presented to the Bank Board.
On 21 November 1990, Mr Clark and other senior executives
of the Bank again met with the Reserve Bank of Australia, and yet again the London
branch's exposure to property was a topic of discussion.() The diary note made
by the Bank observed:
"The RBA was told that we were restructuring our
loan books in New York and London. In London our exposure to property was being reduced
along with a general scaling down of operations." ()
This diary note was presented to the Bank Board at its
meeting on 22 November 1990. The minutes of this meeting contain no reference to the Board
being advised that the matter of London branch's exposure to property had been the subject
of repeated expressions of concern by the Reserve Bank of Australia and the Bank of
(g) 1991 Consultations
On 9 January 1991, Mr Mallett met with the Bank of England
with the matter of the London branch's property exposure again being discussed. Mr
Mallett's diary note of this meeting contains the following record:
"[Mr J Anderson (Deputy Head of Banking Supervision
division), Bank of England] emphasised that their concern in regard to the Banking
systems exposure to property in the UK was now being fully justified. In regard to our own
activity, they would like to see the exposure reduced to within 30% of our balance sheet. [Mr Mallett]
responded that the 30% level was a bank policy and its current breach related to [a
property] transaction which had been transacted outside of Board approvals ... It was
agreed that [the Bank] would move to sell down the [property transaction]
exposure and other property exposure that was necessary to achieve these levels." ()
On Mr Mallett's return to Adelaide, he wrote to the Bank of
England advising that, following a review of the London branch:
"... we will endeavour to bring back the level of
property commitments in relationship to total income earning assets to 30% or less by 30th
June 1991. This reduction includes a sell-down of the [property transaction facility
referred to above]." ()
(h) Other Significant Issues Raised
Apart from the recurring expressions of concern by the
regulatory authorities as to the growth of the Bank's balance sheet, and London branch's
exposure to the United Kingdom property market, there were other significant issues which
were raised by the Reserve Bank and the Bank of England from time to time as follows:
(i) Control and Supervision of the London Branch
This issue was raised at the Bank's meeting with the Bank
of England and the Reserve Bank, on 6 November 1990, in Adelaide. Mr Guille's file note
"Mr Clark said that as far as London
operations were concerned, steps were being taken which would see some major changes in
focus and organisational reporting." ()
This issue was raised again at a meeting with the Reserve
Bank of Australia held on 14 January 1991; Mr Paddison and Mr S C Targett attended on
behalf of the Bank. The Bank's record of this meeting reads:
"Les Austin [Chief Officer, Bank Supervision,
Reserve Bank of Australia] also stressed that the RBA [Reserve Bank] were keen
for Head Office to take an active role in the supervision of London Treasury." ()
At a meeting between the Bank of England and Bank Director,
Mr Bakewell, held on 11 April 1991, the Bank of England expressed its concerns about the
administration and control of the London branch during the period under review in the
following terms, noted in Mr Bakewell's Trip Notes:
"[The Bank of England was] of the view that the
administration and control of the London activities of the SBSA had been at the best lax
... we [SBSA] seemed to have taken positions which other more mature overseas banks
had declined and [the Bank of England] put this down to our [the Bank] desire
to make the "entity a profit centre"."
(ii) The Performance of the London Branch
At the Bank's meeting with the Bank of England and the
Reserve Bank of Australia on 6 November 1990, in Adelaide, the Bank of England presented
statistics comparing the Bank's London branch's performance with that of 66 other overseas
banks under its supervision. The London branch's return on assets, operating expenses as a
proportion of total assets, and bad debt expense as a proportion of average receivables,
were all considerably worse than the average for the 66 other overseas banks.()
As I observed earlier in my commentary on the 1990
consultations with the regulatory authorities, the Investigation sighted no evidence of
a report on proceedings of this meeting being presented to the Bank Board. This clearly
was information which should have been presented to the Bank Board by Mr Clark in order to
enable the Bank Board to consider the continuation of the Bank's London branch operations.
(iii) The Size of the London Branch Loan Portfolio
At a meeting with the Reserve Bank of Australia in London
on 22 November 1989, the Reserve Bank of Australia commented on the London branch's
balance sheet "footings" (ie total assets). The Reserve Bank's minutes of this
meeting record that they were advised by the Chief Manager, London branch, Mr Wilcox,
"... future growth will be dependent on the
opportunities available but that the  budget permitted footings to increase
to GBP 600 million if the opportunity arose." ()
The Bank of England's concern about the size of the London
branch's loan portfolio was again covered at a meeting attended by the then Chief Manager,
London branch, Mr Lynn Todd on 19 May 1990. The Bank's record of this meeting reads:
"[Mr C Mann queried] the increased corporate loan
book compared to a year ago and we were able to confirm that we were within our budget
(i) Observations on Consultations Between the Bank and
Having regard to the matters detailed above, I am
satisfied that there was a substantial flow of information to Mr Clark, Mr Mallett, and
other Bank executives in Adelaide, regarding the concerns of both the Bank of England and
the Reserve Bank in relation to the Bank's overseas operations generally. This was
particularly so in relation to the growth in the Bank's overseas assets, and the level of
property exposure in the London branch.
The expressions of concern by the regulatory authorities in
relation to the level of exposure in the London branch to property was first recorded as
being raised in the Reserve Bank of Australia's Prudential Consultations in November 1988,
and repeated regularly thereafter.
On the evidence described in this Chapter, I am of the
opinion, that neither Mr Clark, Mr Mallett, Mr Matthews nor Mr Guille fully and adequately
related to the Bank Board the expressions of concern by the regulatory authorities as to
the growth in the Bank's overseas assets, and as to the London branch's level of property
exposure. Accordingly, the Bank Board was denied the opportunity of assessing the Bank's
overseas risk profile and of setting appropriate prudential controls in place in order to
protect the interests of the Bank.
Of significant concern is the fact that Management adopted
a deliberate bias in the portfolio of the London branch in favour of property exposure,
and that this continued without amendment until very late in 1990, notwithstanding the
clearly expressed concerns of the Reserve Bank of Australia and the Bank of England. In
my view, it is a serious omission, on the part of both Mr Clark and Mr Mallett, to have
failed to specifically bring to the Bank Board's attention the fact that the London
branch's portfolio was deliberately biased in favour of property in spite of the expressed
concerns of the prudential regulators.
In so far as Mr Matthews and Mr Guille recorded meetings
with the regulatory authorities, and reported upon these to the Bank Board, on the basis
of the evidence, I am satisfied that the records so made and the reports so presented,
failed to fully and accurately report the nature of the discussions held with the
The reports which were presented to the Bank Board,
however, in my opinion, contained sufficient warning signals to the Bank Board to put it
on notice that it was required to obtain further information from Management concerning
the Bank's overseas operations, in particular, the London branch. In addition, the Bank
Board should have been on notice as to the prudential supervision and control issues
arising in respect of the Bank's operations, having regard to what was reported to the
Bank Board in relation to the prudential consultation held on 16 November 1989. The Bank
Board should have demanded from Management a greater level of detail in order for it to
properly discharge its responsibilities to the Bank.
So far as concerns other matters raised by the prudential
regulators, as noted above, I regard the fact that the prudential regulators found it
necessary to draw the Managing Director's attention to concerns about the control and
supervision of the London branch as indicative of a serious deterioration in such control
and supervision which put at risk the Bank's assets. Both Mr Clark and Mr Mallett must
bear responsibility for this situation.
I also regard the information relayed by the Bank of
England to Bank Management on 6 November 1990 as consistent with its statement to Mr
Bakewell that the Bank took positions in the United Kingdom which "other more
mature overseas banks had declined". There is no evidence of the Bank of
England's statistical information provided at the meeting on 6 November 1990 being
presented to the Bank Board. In my view, it was incumbent on Mr Clark to present this
information to the Bank Board in order for it to determine for itself whether, on
profitability grounds, the continuation of the London branch operations was justified.()
19.8 SOME ISSUES RAISED BY REVIEWS OF OVERSEAS OPERATIONS
19.8.1 LONDON BRANCH
Various reviews of London branch by both internal and
external parties gave rise to a number of consistently recurring issues. The following
Section of this Chapter reviews the particular areas of concern regarding the Bank's
overseas operations, and the occasions on which these matters were raised at various
levels within the Bank management.
(a) Internal Control Systems - Treasury and Operations
The internal control systems within the London branch were
reviewed during the period by a number of parties independent of management:
(i) Bank Group Internal Audit;
(ii) KPMG Peat Marwick McLintock; and
(iii) Bank Wholesale Credit Inspection.
The most significant of the concerns raised by these
(i) Internal Audit Report - May 1989
This report noted that in the New Products area there was a
lack of segregation of duties. There were also no written procedures in this area. In
addition, there were no back-up computer facilities available. Management controls within
Treasury were reported as of a "good standard" and within Corporate Section as
of a "high standard" with management controls within Accounting Section being
described as "adequate".
The Internal Audit department report for the year ended 30
June 1989, which was "noted" by the Bank Board at its meeting on 24 August 1989,
"An audit was conducted on London Office for the
first time, in April/May 1989. Recommendations were made for improving internal controls
within the new products area and accounting standards. Overall, the London Office controls
were adequate and performing satisfactorily."
I regard the report to Board as accurately reflecting the
findings of the report on the audit of London branch.
(ii) External Audit (KPMG Peat Marwick McLintock)
Management Letter - Audit 30 June 1990
This management letter noted that the following matters,
inter alia, "required a high level of attention":
. Limits on off-balance sheet activity were monitored by
the dealers themselves;
. The branch's risk management systems were not able to
produce reports of interest rate gap exposures;
. There was a need for closer supervision of the prudential
reporting process; and
. Accounting entries relating to accruals for FRA deals not
There is no evidence that either this Letter to Management
or a summary of its findings was presented to the Bank Board.
(iii) Internal Audit report: Treasury Operations -
Internal Audit stated in this report that it had "formed
the opinion that the level of internal controls are less than satisfactory" for
the following reasons:
. Inadequate segregation of duties between Treasury
Operations and the Accounting Function;
. No formal written policy outlining procedures for the
management of gap exposures nor an adequate computer system in place to report gap
. Limits monitoring by Credit Control does not include all
Treasury products, and limits monitoring of off-balance sheet products was performed by
Treasury dealing personnel;
. No system was in place to manage adequately swap
commitments. The monitoring of positions and the recording of deals were not segregated
from dealing activities; and
. The policy and procedures manual (produced June 1988) did
not reflect current London branch business.
The main effect of the above weaknesses in the internal
control environment was to undermine the level of control that London branch management
could achieve. The segregation of duties within the Treasury area is of great importance
to ensure that accounting and management reporting systems function correctly. Without
this control, there is the possibility that the Bank could be exposed to market risks
because of the inaccuracy or inadequacy of management information.
There was the major risk of dealers incurring an exposure
that could result in an unacceptable level of risk and possibly loss.
A summary of the findings of the Internal Audit Report on
London Treasury Operations was presented in the Internal Audit department Quarterly Report
to September 1990. The audit of London branch Treasury Operations was graded Satisfactory
Minus, and the following was indicated to the Bank Board:
"Major concerns identified include no formal
written policy outlining procedures for the Management of Gap exposures or an adequate
system in place to report Gap exposures, inadequate limits monitoring, no system in place
to adequately manage London's AUD $9B worth of Swap commitments and a General Ledger
accounting system which does not meet London's accounting requirements. London Management
are taking steps to address these deficiencies."
This report was presented to the Audit Committee on 20
November 1990, which directed that future Quarterly Internal Audit Reports include
Management's response to problems highlighted, and steps being taken to resolve these
issues. The minutes do not record any substantive comment by the Audit Committee on the
(b) Internal Control Systems - Credit
The points raised by the various reviews related to the
delays in the annual review of loan accounts and the insufficient detail provided in
(i) External Audit Management letter - Audit 30 June
This Management letter noted that there was a need to
produce "more orderly credit files [to] reduce the risk of unexpected
credit problems ... Reporting of credit excesses to Head Officer intra-month in addition
to month end would improve the "early warning system"."
There is no evidence that either this Letter to Management
or a summary of its findings, was presented to the Bank Board.
(ii) Internal Audit report: Corporate Banking - July
In this report, Internal Audit concluded as a result of
their work, that the effectiveness of internal controls in a number of the areas examined
was found to be unsatisfactory. The main findings of the report were:
. The Branch was entering into transactions for financing
leases which had not been accounted for in the Bank's records and monthly financial
reports to Head Office. The leases identified amounted to GBP 1.0M; and
. In a number of cases, annual reviews of loan accounts
were overdue. "Overall, a pattern of delaying annual reviews was observed."
The findings of this audit review were reported to the Bank
Board in the Internal Audit department's Quarterly Report to the Bank Board for the
quarter ended September 1990. The audit of London branch Corporate Banking Section
Internal Controls was graded Unsatisfactory with the following observations being made:
"London office has committed facilities
approximately totalling AUD $1B. Audit examined the portfolio controls, accounting
controls and administrative procedures. We are of the opinion that the effectiveness of
these controls in the areas examined were not of a satisfactory level.
Audit concerns included controls in internal accounting
and reporting, segregation of duties, administration controls and lack of Group policies
There were particular concerns with a number of overdue
reviews, incorrect accounting for lease financing involving approximately AUD 4M and
collection of overdue receivables with outstandings over AUD $1M, which were distorting
profit and loss figures. London office have addressed the issues raised by Audit and are
taking corrective action."
As noted above, this Quarterly Report was presented to the
Audit Committee, but the relevant minutes record no comments on these substantive
findings. I would expect that concerns of the Committee would be recorded for the purpose
of making clear to the Bank Management matters that should be the subject of attention.
(iii) Internal Audit report: Corporate Banking - May
In this report, Internal Audit expressed its "concern
that credit papers examined did not always address satisfactorily all issues such as
security position, projected cash flow analysis, and construction of transactions".
The main effect of the above control weaknesses is to
reduce the effectiveness of the credit approval process. In particular, inadequate
evaluation of credit issues and delays in reviewing credit files could give rise to loan
losses. Without the proper functioning of these procedures, the assets of the Bank could
not be properly controlled.
(c) Asset Quality
(i) Credit Inspection report by Mr Wright (Chief
Manager, Credit Inspection) - August 1990
As noted above, Mr Wright, Chief Manager, Credit
Inspection, presented his report on his credit inspection of the London branch in August
1990 at which time he formed the opinion that the London branch Corporate Banking
portfolio did not raise issues for concern. As indicated in 19.6.3 (a) above I am
satisfied, having heard his evidence that he discharged his responsibilities properly in
carrying out this review.
(ii) Internal Audit report: Corporate Banking - May 1991
In this report, Internal Audit expressed its:
"... opinion that the quality of assets examined is
unsatisfactory and reflects both the financial performance of accounts sampled and the
amounts of specific provisions required. It is a further reflection of the poor economic
climate in the United Kingdom and the depressed real estate market, given that over 40% of
assets are directly associated with the property market."
This analysis by Internal Audit department more closely
reflects the London branch non-productive loans position as reported in the February 1991
report on non-productive loans to the Bank Board.
(d) Procedures Documentation
The main point raised in the various reviews was that
procedures manuals were not kept up-to-date:
(i) External audit management letter - Audit 30 June
This Management letter noted that procedures, controls, and
accounting policies, for off-balance sheet instruments were not formally documented.
(ii) Internal Audit report: Corporate Banking - July
In this report, Internal Audit observed:
"The current manual on Corporate Banking operations
needed to be updated."
(iii) Internal Audit report: Treasury Operations -
Internal Audit reported:
"Existing Policies and Procedures Manual must be
updated and maintained to reflect the business perf [sic] by [London
Staff in overseas locations must be able to refer to
procedures manuals that provide guidance in all aspects of the Bank's operations. Without
procedures manuals that are kept up-to-date, management in Head Office cannot ensure that
authorised procedures are being followed. As a result, control over the operations of the
London branch could not be properly exercised.
(e) Position Limits and Monitoring
A review was performed in October 1990 by London branch's
external auditors, KPMG Peat Marwick McLintock, at the request of Mr Clark to determine
the cause of a GBP 0.5M loss that arose in London Treasury in the first week of August
1990. It was discovered that the losses arose from spread trading futures positions. The
external auditors concluded that:
"None of these spread positions have breached
limits because there are no specific limits for spread trading ... It would appear that
the management of SBSA in Adelaide are insufficiently aware of the potential of the London
Treasury to make losses as well as profits."
The external auditors recommended that:
"London and Adelaide immediately discuss and agree
upon a clearly defined limit for interest rate risk, and that daily reporting of exposures
against this limit arising from off-balance sheet positions is instituted."
The report indicates that no specific limits were in place
for this complex part of the Treasury operations. It is of paramount importance that
limits for such transactions be in place and that they are approved by the Bank Board. The
Bank Board should have been aware of these unusual types of transactions so that it could
exercise proper control over the activities of the off-shore Treasury departments.
(f) Prudential Reporting
Annual audits were performed by KPMG Peat Marwick McLintock
of the statistical returns to the Bank of England. In 1988, 1989, and 1990, the auditors
concluded that the returns were correct in all material aspects, except for some errors
which were not noted as material.
The auditors also produced reports in September 1989 and
September 1990, of reviews of London branch's accounting and other records, and of the
internal control systems. The reports concluded that the records and control systems were
established and maintained in accordance with the Bank of England guidelines, with the
(i) Credit risk: The 1989 report stated: "the
branch currently informs Head Office only of excesses over credit limits existing at the
month-end, rather than of excesses (if any) which existed during the month." The
1990 report noted that this was corrected.
(ii) Interest rate risk: The 1989 report stated: "the
branch relies on certain information supplied by the dealers to monitor its daily interest
rate position without any current independent check ... The branch has entered into
transactions (for example [Forward Rate Agreement] arbitrage) which are considered
to be broadly hedged ... but currently there are no independent checks to ensure that the
transactions are in fact hedged and are not exposed to interest and foreign exchange risk."
The 1990 report noted that "the branch remains unable to report interest rate gap
exposures. Limits on off-balance sheet products are monitored only by the treasury dealers
but should also be checked independently."
In the absence of properly functioning control systems, the
Bank Board and senior Management at Head Office could not properly control the operations
of London branch. In particular, without satisfactory management information systems for
reporting Treasury exposures, the Bank could incur risks that it is not aware of, and so,
would not be able to manage those exposures properly. As a result, the Bank could incur
losses which could have been prevented by adequate control systems.
In addition to the above concerns raised over the period,
in a report prepared by KPMG Peat Marwick McLintock, in March 1991, at the request of Mr
Russo (acting manager of the London branch), the external auditors were asked to carry out
a brief investigation into the events surrounding the identification of an unexpected
deferred charge in the balance sheet of the branch, for the financial year 1990-1991, of
some GBP 0.4M. The deferred charge arose in relation to Forward Rate Agreement arbitrage,
and the identification of the reasons for this item was made difficult by the complicated
nature of the arbitrage.
In June 1990, a shortfall of GBP 0.4M was identified on the
deferred balance of the arbitrage transactions. Rather than recognise this charge in
1989-90, London branch (in consultation with Head Office) decided to defer the charge to
"The situation was brought to the attention of the
newly appointed Head of Finance and Operations, Neil Kelly, who consulted with the Head of
Credit and Development, Abe Rawat. They concluded that to report an unexpected reduction
in profits of this order would be disastrous ... The branch had committed to Head Office
its profit for the year and branch staff had the impression that the bank's results
worldwide were under pressure."
The report goes on to note that the failure to record the
amount was queried by Mr Copley's office but that:
" ... the Chief Manager at the time (Murray Wilcox)
eventually agreed the branch's desired approach with Head Office."
The external auditor's report concludes that:
"At a minimum, the events surrounding the
£400,000 `problem' could be characterised as aggressive accounting practice, together
with lax bookkeeping and financial management. At worst, they could be viewed as a
deliberate attempt to shift unexpected losses from one year to the next in a manner which
would not be detected and which, through incompetence, came to light in any event".
The main effect of this item was to increase the Bank's
reported profit for the year ended June 1990.
19.8.2 HONG KONG OFFICE
(a) Internal Control Systems
A preliminary audit review performed by Internal Audit in
August 1990 raised a number of matters, notably:
(i) payments made on behalf of individuals were not
(ii) there was inadequate information on a loss from an
(iii) in certain instances, verification of customer
information appeared inadequate;
(iv) there was no cost recovery in respect of legal work
performed on syndicated loans; and
(v) there was no Policies and Procedures Manual for
The use of a formal Manual for lending policies and
procedures is considered essential to ensure that the systems authorised by the Bank Board
and senior management are followed. Without such a manual, the credit approval process may
not be complied with, or loans may not be properly maintained, and, as a result, the Bank
may incur losses.
In December 1990, a credit inspection of the Hong Kong
office was carried out by Mr Wright, Chief Manager, Credit Inspection. The inspection
revealed the following weaknesses in corporate lending procedures:
(i) credit reviews of loan facilities were not always
conducted in a timely manner; and
(ii) financial analysis and comment in review submissions
was not undertaken in sufficient depth to ensure that borrowers' performance and position
had been fully and critically reviewed.
One additional point that was noted was there was little
depth of experience in the corporate lending area.
(b) Asset Quality
The December 1990 credit inspection made the following
points about asset quality:
(i) Corporate loans
A complete inspection of the loan portfolio (17 accounts)
was performed. The conclusion reached as a result of this work was that although there
were no problem loans found in the portfolio, two loans required close attention.
(ii) Property Loans
It was noted that no loans in this category were in default
at inspection date, nor was there any need for provisioning.
19.8.3 NEW YORK BRANCH
(a) Internal Control Systems - Commitments Register
Internal Audit report: Corporate Banking - August 1990
(i) The audit identified mezzanine debt (ie subordinated
debt) and other facilities to the value of $34.0M approved as at March 1990 which were not
reflected in the Bank's commitment records before the examination of the records on 6 June
(ii) Inadequate information on the commitments register.
The purpose of recording these amounts at the proper time
is to enable the Bank to readily ascertain its financial exposure generally, or to
individual borrowers or groups of borrowers.
It is also important from a Treasury Management point of
view, as the funding requirements of these commitments should be made known at the
earliest possible time.
The findings of the Internal Audit department's review of
New York office's Corporate Banking Section were reported in the Internal Audit
department's Quarterly Report for the quarter ended September 1990, which was presented to
the Audit Committee. The audit was reported with an Unsatisfactory grading.
(b) Internal Control Systems - Annual Reviews of Loan
Internal Audit report: Corporate Banking - August 1990
Reviews of certain accounts overdue and facilities extended
without authority. Total facilities identified with overdue reviews were $US 80.2M
comprising mainly Highly Leveraged Transactions each of $US 10.0M or more.
By not performing credit reviews on time, the Bank may be
exposed to loan losses arising from loan problems that could have been identified earlier,
when more appropriate corrective action could have been instigated.
(c) Internal Control Systems - Limits for Loan Exposures
Internal Audit report: Corporate Banking - August 1990
The report contained the following observations on
guidelines and limits for highly leveraged transactions or mezzanine debt finance:
"No guidelines or limitations are in place defining
how far the Bank will pursue with this type of financing [highly leveraged
transactions]. In view of the high level of risk associated with HLT's, Audit
identified the need to set limitations on the level and distribution of these transactions
i.e. limiting them across industries and limiting them as a % of the total loan
(d) Segregation of Duties
Internal Audit report: Corporate Banking - August 1990
(i) The Credit approval Section was not independent of the
Lending Section; and
(ii) Loans Administration was performing its own accounting
Segregation of duties within the Lending Section is of
paramount importance to ensure that credit approval procedures are strictly adhered to,
and that loan maintenance and accounting systems function correctly. Without such
procedures, the assets of the Bank were not properly safeguarded.
The Internal Audit report described the potential risk in
these circumstances in the following way:
"This is a major breakdown in internal control and
gives powers to change records and still balance the books."
(e) Credit Gradings
Internal Audit report: Corporate Banking - August 1990
No grading system for credit quality and "no set
criteria for deciding on irregular accounts".
A grading system for loans enables management to accurately
assess the asset quality of the loan portfolio, and to identify problem loans promptly so
corrective action can be taken. At the same time, on the basis of the gradings, management
can evaluate whether provisions are required and, if so, at what level provisions should
(f) Asset Quality
Internal Audit report: Corporate Banking - June 1991
The quality of assets from the files examined was
considered to be unsatisfactory. In particular, Internal Audit were concerned with a
number of accounts that had little or no equity, and that had a negative cash flow
position. Recommendations were made for some accounts to be downgraded.
(g) Budget Process
Internal Audit report: Corporate Banking - August 1990
Unrealistic budgets were considerably lower than actual
It was important that realistic budgets are set so that
senior management and the Bank Board could properly evaluate the performance of the New
York office, and then properly assess the management of the operation and determine the
most appropriate level and content of future business in that office.
KPMG Peat Marwick New York office performed limited audit
procedures in January 1991, and a report was issued to their Adelaide office, a copy of
this being received in Mr Mallett's office on 11 February 1991. The auditors expressed
concern in relation to four non-accrual loans:
"SBSA has not recognised losses on these loans.
Based on our analysis, we believe that it is probable that losses will be incurred on all
of the above loans. SBSA has taken the position that losses will not be recognised until
such losses can be quantified due to the uncertainty of the workout terms. We believe that
it would be prudent for reserves to be established specifically for these loans at the
branch level or allocated at the Head Office".
The establishment of prudent reserves would enable senior
management and the Bank Board to assess fully the financial position of the New York
office, and to make decisions regarding that office on the basis of appropriate
information. It would also ensure that the Bank did not misstate its financial position.
This report makes the following observation in relation to
the general level of loan loss provisions maintained by the Bank in relation to its New
"... Peat Marwick noted that SBSA plans to achieve
a reserve for loan losses equal to 1% of outstanding loans over the next two years. Since
we have not performed an evaluation of the adequacy of the loan loss reserve, we cannot
determine whether 1% of this portfolio is adequate. However, we note that all of the top
100 US banks had reserves in excess of 1% at December 31, 1989, and that the economic and
business environment has substantially worsened since that date in the US. In addition, we
note that SBSA has had significant loan growth since June 30, 1990 [approximately
$200.0M]. Such growth is unusual, as many US banks have downsized during this
19.8.4 AUCKLAND BRANCH
(a) Internal Control Systems
The only reviews by parties independent of management of
the operations of the Auckland branch were those performed by Group Internal Audit. The
main concerns raised by these reviews were:
(i) Internal Audit Report: Information Systems - June
. SBSA (NZ) was deficient in its systems documentation, and
was too heavily dependent on one Information Systems member of staff;
. The branch was not receiving details of published Head
Office Information System policies and procedures; and
. The Information Systems Strategic plan prepared in March
1989, had not been approved or accepted by management at the time of the report.
(ii) Internal Audit Report: Treasury - March 1991
The branch's policies and procedures were established in
1989 and did not fully reflect the current business undertaken by New Zealand Treasury.
Without up-to-date policies and procedures manuals, the
Bank Board and senior management could not ensure that the internal control systems
addressed all risks and exposures incurred. In particular, if the policies and procedures
in place were not wholly appropriate for the Auckland branch's current business, some new
areas of business may not have been adequately covered by guidelines and limits.
19.8.5 AUGUST 1990 REVIEW OF INTERNATIONAL BANKING
Mr Hartley gave evidence to the Investigation that around
the end of 1989 he expressed concerns about the Bank's involvement in overseas operations,
and called for a full review to be presented to the Bank Board. This was probably at the
November 1989 Board Meeting. However, in his evidence to the Investigation, Mr Clark
denied that any such direction was given until at least mid-1990.
Mr Hartley in his evidence which has some support from
other Non-Executive directors, said:
"... We were not getting a proper return on the
funds tied up. Just simple arithmetic showed me that, so I demanded - I raised this,
didn't get anywhere, so I demanded a formal written paper from management to justify in a
formal way for discussion at a future meeting and given proper space on the agenda, to
justify what we were doing with this increasing exposure in London. ... I waited for this
paper and it didn't materialise. I asked maybe three months later, 'Where's my paper on
international?'. 'It's coming, it's coming'. I waited another 3 months - 'It's coming -
it's coming'. Then I rang Trevor Mallett directly myself, having got nowhere with Marcus
Clark, and he didn't know anything about it, so I wrote to him to put it on record and I
have a - I think that might be in - yes, it is. It's in the papers you've got. I then got
to giving him the history of why I was concerned and when I first expressed my concerns.
He then produced a paper which I thought was a very shallow document which didn't address
the issues at all."()
This is yet another instance which I have had occasion
to consider in the course of this Investigation, when there has been a difference of
opinion or recollection between the Board and management as to whether directions were
given or requirements were implemented. It highlights the absence of proper procedures for
communication between the Board and management or alternatively the resistance of
management to keep the Board informed adequately and properly on important areas of the
19.9 CONCLUSIONS ON CONTROL AND SUPERVISION OF THE OVERSEAS
Given the growth in assets and lack of profitability of the
overseas branches, in my opinion, the Bank Board received relatively little information in
its regular reports about the performance of the overseas branches, especially on an
individual location basis. The Chief General Manager, International Banking, however,
maintained regular correspondence and communication with each of the branches and received
detailed financial and other returns from the overseas branches. Management (including the
Managing Director) had, or had the ability to access, a substantial volume of information
concerning the overseas branches, but the level of information provided to the Bank Board
was, in my opinion, influenced by Mr T L Mallett's attitude towards informing the Board on
matters that fell within his discretion.
In view of the rapid growth in the Bank's international
operations over the period, and the level of risk involved for the Bank in operating
overseas, Mr T M Clark and Mr T L Mallett should have provided regular detailed reports on
an individual branch basis, to the Bank Board. This is emphasised by the fact that
London Treasury was using advanced Treasury techniques, such as FRA arbitrage, and New
York office was involved in Highly Leveraged Transactions and Mezzanine Financing.
Effective control and supervision by the Bank Board of
the Bank's overseas operations was made more difficult by the "quality" of the
information that was provided by management to the Directors. In the report on the New
York branch, presented, to the Bank Board in September 1990, no mention was made of Highly
Leveraged Transactions or Mezzanine Finance, and the report stated that no loss of
principle or interest was expected on non-accrual loans. There was no mention of the
substantial provisions that were to be required within six months of the report.
Similarly, the Credit Inspection report of London branch,
in August 1990, concluded that all problem and potential problem loans had been
In addition to the above mentioned matters, in my
opinion, the Bank Board was not adequately informed, for most of the period under review,
of concerns raised by the regulatory authorities. Indeed, the information provided to the
Bank Board in November 1988 substantially conflicts with the record made by the Reserve
Bank of Australia of that meeting.
In their submission to the Investigation, the Non-Executive
Directors had this to say about the provision of information to the Bank Board:
"In regard to the volume of information received by
the Bank Board, it should always be borne in mind that by virtue of the Group Operating
Reviews, the Group and Managing Director's monthly overview (from April 1990) and
individual Board papers in respect of specific loan proposals, the Board believed that it
was being kept abreast of developments. In addition - and perhaps more importantly -the
Board received reports each month from Mr Mallett, during which time Board members would
pose questions to Mr Mallett about overseas operations generally. In the absence of any
indication of major problems with either the international loan portfolio, the Bank's
international banking strategy or expressions of concern on the part of any of the
regulatory authorities, the Board was entitled to assume that the Bank's overseas
operations were being managed properly."()
Evidence was given by a number of the Non-Executive
Directors in support of the above submission.
In relation to the inherent problems in supervision and
control of "distant branch operations", the Non-Executive Directors made
the following submission to the Investigation:
"The problems which Mr Mallett has since identified
to the Auditor-General's Inquiry() in respect of the supervision and
control of "distant branch operations" were never communicated to the Board, be
it by Mr Mallett, Mr Marcus Clark or any other member of management. To the contrary, in
response to frequent questions as to the capacity of management to cope with growth in the
overseas operations, the Board was constantly assured ... that the Bank had the capacity
and the resources to cope with that growth, even in "distant branch operations"."
There is nothing in the evidence given by Mr T M Clark and
Mr T L Mallett to suggest that either of them at any stage advised the Board that
management was otherwise than in control of the situation in relation to the overseas
branches. Nevertheless the question squarely arises whether the Bank Board should have
adopted a proactive approach to the matter of control and supervision of the overseas
branches, and should have probed management more actively in relation to reports on those
operations given the level of information provided to the Bank Board on those operations.
Notwithstanding the submission and the evidence of the
Non-Executive Directors, I am of the opinion that the Bank Board, in light of the
overseas branches' asset growth accompanied with profitability at a level substantially
below that of the rest of the Bank Group, should not have simply been content to rely on
management's "assurances," but should have called for written detailed
reports on the operations of the overseas branches and the relevance and effectiveness of
internal control systems. I refer to Section 19.3.8 above, and to my answer to the
Non-Executive Directors' "rhetorical question" there noted.
The fact is that over the period under review the Bank
Board did receive some written reports which, in my opinion, should have elicited from the
Bank Board a response far more searching and definite than simply seeking and being
content to rely on "assurances" from management.
The Bank Board submitted that it had "regard, at
all times, to its responsibilities under Section 15."() If that
is so, then the Bank Board could not have failed to appreciate that rapidly increasing
assets with poor profitability raised such serious doubts about the maintenance of the
Bank's overseas operations that more positive action than simply asking management and
being given "assurances" was called for. I am satisfied that it was only
towards the end of 1989 that the Bank Board took action to require management to produce a
written comprehensive review of the performance of and justification for overseas
operations. In my opinion, such a written comprehensive review was called for, given the
circumstances of the Bank's overseas operations, at least on an annual basis from the end
1986 onwards, and most certainly from 1988 onwards in light of the significant
profitability problems revealed in the 1988 Profit Plan in relation to the Bank's overseas
operations. In my opinion, it was not good enough for the Board to rely upon a "question
and answer" process with management. The Bank Board should have conducted any
question and answer process at least against the background of a detailed review of the
Bank's overseas operations at the level of some detailed information as that contained in
the August 1990 paper presented to the Bank Board, or better.
19.10 GENERAL SUBMISSIONS OF THE NON-EXECUTIVE DIRECTORS
The Non-Executive Directors made detailed and lengthy
submissions to the Investigation in relation to the Bank's overseas operations. In this
Chapter, where appropriate, I have drawn attention to specific matters submitted on behalf
of the Non-Executive Directors. However, I believe it is now appropriate to present those
submissions of the Non-Executive Directors which seek to draw together the various
contentions and explanations which they saw as relevant to the subject matter of this
The Non-Executive Directors submitted that it was necessary
"... have regard to the limited opportunities which
a Board of Non-Executive Directors has to go beyond what management tells them, both in
terms of recommendations in respect of which Board approval is sought or the information
made available to the Board from time to time about the performance of the Bank's
... A Board of Non-Executive Directors cannot involve
itself in the day to day operations of the Company and ... is reliant upon management to
keep it abreast of matters about which it should be aware. In this, the Board must proceed
on the assumption that management is acting honestly, with integrity and highlighting all
matters about which a Board is entitled to know. These are very fundamental assumptions.
It is submitted that a Board of Non-Executive Directors,
meeting once or twice a month and with no independent resources - and no reasons to go
behind management's assurances - cannot possibly be expected to do what management itself
is retained to do.
... There were never any matters about which the Board
could be said to have been put on notice of the need to test the quality or reliability of
management's representations to the Board."()
I do not accept that there was "never any matters"
about which the Board could be said to have been put on notice. In this Chapter there is
reference to matters on which the Board was on notice that were deficiencies concerning
the management of the overseas operations of the Bank. In my opinion, the Board failed
to respond to these deficiencies, and in this respect, did not adequately or properly
supervise, direct and control the affairs and transactions of the Bank.
I will further deal with these broad submissions in the
next Section of this Chapter in which I express my conclusions on the Bank's overseas
19.11 CONCLUSIONS ON THE BANK'S OVERSEAS OPERATIONS
The State Bank of South Australia is a bank which enjoys a
privilege not available to proprietary based banks, namely, the privilege of a sovereign
credit risk rating. This arises because of the specific Government Guarantee contained in
The marketing and financial advantages to the Bank of its
sovereign credit risk rating was certainly not lost on the Bank Board and Management in
their endeavours to expand the Bank's operations overseas on a major scale.()
I am satisfied that the Bank Board accepted Management's
assessment that the South Australian market was saturated and that there were significant
opportunities for growth, and therefore profit, overseas. In this regard, the sovereign
credit risk rating of the Bank gave the Bank a significant pricing advantage, both in
respect of its liabilities (funds raised) and in respect of its assets (pricing advantages
in respect of offering credit enhancements which were themselves able to carry the
sovereign credit risk rating).
In my view, with the benefit of the sovereign credit risk
rating and the Government Guarantee, came an obligation for a level of attention and
performance by the Bank Board consistent with its obligations under the State Bank of
South Australia Act, 1983 and in particular, Section 15.
At a practical level, the Board of a proprietary based bank
answer to the bank's shareholders - investors who have a financial interest in the
profitability and general financial well-being of the entity, and who can act via their
votes to remove a board that fails to perform or to protect their interests as
The Bank regarded the State Government as its shareholder.
The State Government did, of course, guarantee the Bank's liabilities. The Bank's own
Internal Audit department succinctly stated the effect of the guarantee in its report on a
particular corporate banking account as follows:
"A Government Guarantee is merely an assurance that
in the event of financial crisis, the buck does not stop until it reaches the taxpayer who
will be forced to come to the rescue." ()
The Bank Board had a duty under Section 15(2) of the Act to
"administer the affairs of the Bank in accordance with accepted principles of
financial management ...". In addition, the Bank Board's actions in respect of
the overseas operations of the Bank were required to be considered in the context of the
requirement that the Bank Board act with a view to securing a benefit to South Australians
and the South Australian economy and with a view to achieving a profit.
Not only was the Bank Board required to act within the
constraints imposed by virtue of the Government Guarantee, and the specific requirements
of Section 15 of the Act, but, in this matter of international banking, the Bank had
minimal experience prior to its establishment in July 1984. The predecessor merging banks
were banks whose operations were predominantly based in South Australia, and the Savings
Bank of South Australia's London retail branch was of marginal consequence.
The legal and fiduciary obligations placed on the Bank
Board, together with the recognition of the Bank's lack of experience on the international
scene, imposed on the Bank Board an onus to carefully consider the reasons for, and the
control of, the Bank's overseas expansion. Particular emphasis should have been placed
upon the control and supervision of the off-shore branches, the quality of assets, the
profitability of the off-shore branches, and their ongoing strategic relevance to the
In my opinion, the Bank Board was motivated to establish
the Bank as a participant in the international banking arena. The 1988 Strategic Plan
referred to the Bank positioning itself as:
"... the dominant bank in SA, a regional bank in
Australia and a niche player in the global market." ()
Notwithstanding whatever "prestige" there
may have been in the State Bank of South Australia being seen as a "niche player
in the global market", I am satisfied that the apparent and overriding
consideration was the perceived profitable growth opportunities in overseas markets. By
June 1988, however, in my opinion, the Bank Board should have called for a thorough
review of the Bank's overseas operations, and if appropriate on the basis of marginal
strategic relevance and substandard profitability, should have seriously considered the
withdrawal of the Bank from those operations.
But the Bank Board did not do this. The Bank's
operations continued to grow, and grow rapidly, and to diversify into new areas.
I do acknowledge, however, that, expressed in simple
percentage terms (that is, overseas assets to total bank assets, and overseas total risk
exposure to bank total risk exposure), the non performing asset situation of overseas
operations was not disproportionate to the figures produced by the Bank overall in its
non-performing asset review as at the end of February 1991. At this time, overseas assets
represented 27.4 per cent of the Bank's total income earning assets and the overseas
branches' total risk exposure to non-performing assets represented 23.2 per cent of the
Bank's total risk exposure to non-performing assets. Be that as it may, such
considerations cannot be regarded as resolving the problems presented by the off-shore
There was no shortage of information produced out of the
overseas branches and forwarded to head office. Nonetheless, the level of information
provided by Management to the Board in the Monthly Operating Reviews and in other ad-hoc
reviews was unjustifiably limited. I am satisfied that, particularly so far as Mr T L
Mallett is concerned, during his time as the head of the Bank's international operations,
the level of information submitted to the Board was constrained by his view that matters
that fell within Management's delegated authority were matters for Management and required
only sketchy reporting to the Bank Board. Whilst Mr T L Mallett is no doubt correct in his
view that he was at liberty to act as was appropriate within the ambit of his delegated
authorities, that ambit did not represent the limits of his responsibility to the Board.
The driver of a motor vehicle may stay within the speed limit, but still drive with
culpable negligence. The broader situation is that it was his responsibility to deal with
the fact that the Bank's overseas operations were exposing the Bank to new and greater
risk profiles. The failure to adequately inform the Board of these matters deprived the
Bank Board of the opportunity of setting appropriate prudential standards for these
An issue of significance noted in the course of this
Investigation was the contrast between the information flow to the Bank Board, and the
information flow to Management and the Executive Committee, with respect to the Bank's
overseas operations during the period under review.
It is to be expected that the Executive Committee would
receive the benefit of a far greater level of information than the Bank Board.
Nonetheless, the Board must be advised of all material issues, and, on the evidence
available to me, and for the reasons stated in this Chapter, I am of the opinion, that the
Board was not kept aware of material issues. By way of example, the Executive Committee
paper proposing the establishment of New York branch contained the proposed New York
branch's business strategy, the corresponding Bank Board Paper was simply limited to
financial projections and a relatively superficial rationale in support of the proposal.
As is stated in this Chapter, the New York office was required to consider complex and
innovative transactions as a basis for its profitability.
I am also of the opinion that, for the reasons indicated
above in this Chapter, Mr T M Clark and Mr T L Mallett presented papers to the Bank Board
which did not fully and accurately convey information concerning the Bank's overseas
operations, and which omitted information that was material for the Bank Board's
deliberations. In addition, I am of the opinion that in relation to reporting on the
matters of consultations with the Reserve Bank of Australia, Mr K S Matthews and Mr C W
Guille prepared and/or presented papers to the Bank Board which did not fully and
accurately convey information concerning those consultations.
I conclude from all the information available that the
editing from Board Papers of information contained in the corresponding Executive
Committee papers was not carried out by Management for any improper purpose, but reflected
Management's view as to what was appropriate information for the Bank Board to have regard
to in performing its, ie the Bank Board's, duties. The Bank's Management had a strong
sense of management's prerogative in those areas where it had delegated authority. In the
day to day operations of the Bank this was a defensible position for management to take.
It was not, in my opinion, defensible when wider issues of policy were involved and the
nature and extent of risks were not adequately made known to the Board. Here the Executive
Committee made serious errors of judgement.
The Investigation does note with concern, however, the
significant discrepancies in the Bank's management reporting of discussions with the
regulatory authorities in relation to the Bank's overseas operations when compared to the
records maintained by the regulatory authorities themselves. The matter of Management's
reporting to the Bank Board of discussions with the Reserve Bank of Australia is dealt
with in more detail in Chapter 15 - "The Relationship with the Reserve Bank of
Australia" of this Report.
The weakness of the Bank's control and supervision of its
overseas branches was, in my opinion, exacerbated by the late introduction of Internal
Audit department reviews and credit inspections. Clearly, so far as management of overseas
operations was concerned, "control" was not a priority. As Mr T L Mallett's
February 1990 memorandum notes, attention had been concentrated on the dynamic growth of
the business rather than the credit implications of this growth.
In my opinion, Management's pre-occupation with growth
of the overseas operations at the expense of attention to prudential controls and ongoing
credit assessment was a predominant cause of in the profit and asset quality outcomes
reported in February 1991.
19.12 REPORT IN ACCORDANCE WITH MY TERMS OF APPOINTMENT
19.12.1 TERMS OF APPOINTMENT A
I have investigated and inquired into matters relating to
the overseas operations of the Bank as directed in my Terms of Appointment A. For the
reasons indicated in this Chapter, I hereby report that, in my opinion:
(a) The matters and events reported on in this Chapter in
relation to the conduct of operations in and by the overseas branches of the Bank which
gave rise to non-productive assets as at February 1991, together with other matters
examined in this Report caused the financial position of the Bank as reported on the
(b) The processes reported on in this Chapter in relation
to the overseas branches of the Bank led the Bank to engage in operations which have
resulted in material losses or in the Bank holding significant assets which are
non-performing and were not appropriate.
(c) The procedures, policies and practices adopted by the
Bank in the management of significant assets which are non-performing, as reported on in
this Chapter, were not adequate.
(d) In relation to the overseas operations of the Bank,
adequate or proper procedures did not exist for the identification of non-performing
assets or assets in respect of which a provision for loss should be made.
19.12.2 TERM OF APPOINTMENT C
I have also, as directed by my Term of Appointment C,
investigated and inquired into matters relating to the supervision, direction, and
control, of the overseas operations of the Bank.
For the reasons indicated in this Chapter, I hereby report
that, in my opinion the operations, affairs, and transactions, of the Bank with reference
to its overseas operations were not adequately or properly supervised, directed and
controlled by the Board of Directors of the Bank, the Chief Executive Officer (Mr T M
Clark) and Mr T L Mallett.
19.12.3 TERM OF APPOINTMENT D
I have further, as directed by my Term of Appointment D,
investigated and inquired into whether the information and reports given by the Chief
Executive Officer (Mr T M Clark) and other officers of the Bank to the Bank Board were, in
all the circumstances, timely, reliable and adequate and sufficient to enable the Board to
discharge adequately its functions under the Act. For the reasons indicated in this
Chapter, I am of the opinion that:
(a) the information and reports given by the Chief
Executive Officer (Mr T M Clark) and Mr T L Mallett, to the Bank Board were not, under all
the circumstances, timely, reliable and adequate, and were not sufficient to enable the
Board to discharge adequately its functions under the Act; and
(b) the reports noted in this Chapter in relation to
consultations with the Reserve Bank of Australia given by Mr K S Matthews and Mr C W
Guille were not, under all the circumstances, reliable and accurate, and were not
sufficient to enable the Board to discharge adequately its functions under the Act.