BRITAIN'S High Street banks were warned by the Government's financial watchdog more than six years ago about their lending practices, leaving them highly vulnerable to a collapse in property prices.
Scotland on Sunday has learned that the Financial Services Authority issued a red flag letter to all the major retail banks in November, 2002.
The banks – including RBS, Lloyds and the former HBOS, all of which have since been part-nationalised –
were told they must carry out urgent internal checks on whether they had enough capital to back up their loans in the event of a crash.
The FSA letter is understood to have warned them that they would be exposed by either a fall in property prices or an increase in interest rates.
Taxpayers have now spent £37bn underwriting the banks contacted by the FSA, after they were forced to ask for a bail-out or face collapse.
The FSA is facing growing criticism from opposition parties that it failed to follow through on its warnings.
They also say the Labour Government is to blame for putting pressure on the FSA to lay off the banks in the good times.
A stream of evidence is now coming forward to show that warnings about the banks were not heeded. Earlier this month, former HBOS risk adviser Paul Moore revealed that he had warned that the bank was "going too fast", had a "cultural indisposition to challenge" and was a serious risk to "financial stability and consumer protection". He claimed that as a result, he was fired by former HBOS chief executive Sir James Crosby.
Crosby was also the FSA's deputy chairman at the time. The FSA carried out internal reviews of HBOS but stopped short of enforcing change..
HBOS was among the banks written to by the FSA in 2002 when the body took the unusual step of writing to them all. The letter is understood to have flagged up a fall in property prices as being the biggest concern facing them.
The letter ordered all the banks to carry out so-called 'stress tests' to check the quality of their mortgage books, to see whether they would be able to cope with a sudden collapse in property prices or marked increases in unemployment. It appears that no further stringent action was taken.
Scotland on Sunday has also discovered correspondence between the FSA and the then Prime Minister Tony Blair, after Blair accused the body of being too heavy-handed in its regulatory practices.
In a 2005 letter replying to Blair, the then chief executive Sir Callum McCarthy wrote: "We make extensive use of advisory letters ("Dear CEO" letters) warning companies of problems which our contact with regulated firms has identified, so that direct intervention and enforcement action can be avoided."
He added: "The thrust of our work is to make the markets work effectively and avoid the need for regulatory interventions."
With regard to HBOS, the FSA has now revealed that, after making its concerns clear in 2002, it then carried out a full risk assessment of the bank. It concluded, in 2004, that "the risk profile of the group had improved and that the group had made good progress in addressing the risks highlighted".
Two weeks ago, the new Lloyds Banking group declared losses of £10bn, almost all due to risky corporate loans made by the former HBOS bank.
Lib Dem shadow chancellor Vince Cable said
: "It's about having more effective supervision of the banks. You can have intelligent regulation that isn't obstructive."
He added: "One of the lessons coming out of this, which they (the FSA) themselves have acknowledged, they're going to need high quality people."
