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THE DAY of reckoning for Scotland's once proud and swaggering bankers came on Monday, October 13. This was the day that the prime minister announced his £37 billion rescue of the sector, the part-nationalisations of the Royal Bank of Scotland and HBOS, and the departures of their chief executives.

During a series of meetings with Alistair Darling and Treasury officials over the preceding weekend, the erstwhile "titans" of Scottish finance, Sir Fred Goodwin and Andy Hornby, had been told in no uncertain terms that there was no more room for shilly-shallying and that they must properly recapitalise the institutions that they had led to the brink of the abyss.

The only area where they were given any choice was whether they wished to source the massive capital injections that were needed from the UK government or seek them elsewhere, perhaps from Middle Eastern sovereign wealth funds.

This chain of events had been set in motion by the collapse of American investment bank Lehman Brothers on September 14, spreading a mood of extreme nervousness, bordering on panic and even terror, throughout the global financial markets. For the first time there had been a genuine and justifiable fear that a leading UK institution could fail. Speaking on BBC's Panorama programme last week, Sir John Gieve, the deputy chairman of Bank of England, admitted that by October 10: "RBS quite honestly was the leading candidate."

Insiders say that Goodwin and Hornby had still been in denial until that point, having made out as recently as seven months previously that all was fine with their banks and the debt-fuelled party could continue.

Some investors even believe that RBS chief executive Goodwin may have misled the market by being bullish about his bank's prospects between December 2007 and February 2008, and are threatening a class action against the former board as a result.

They point to the fact that Goodwin claimed that the bank's exposure to sub-prime mortgages in the US was lower than some analysts were expecting and denying any need for "no plans for any inorganic capital raisings or anything of the sort". He then presented a much bleaker picture and announced a £12bn rights issue a few weeks later, by which time many investors had persuaded people to buy shares. As the Sunday Herald has previously reported, both RBS and HBOS also deeply angered the Bank of England governor Mervyn King when they totemically sought to increase shareholder dividends and executive pay.

Rather than extending an early apology for the damage they had wrought on centuries-old institutions and indeed on the wider UK and Scottish economies, Goodwin and Hornby initially kept their counsel. It was only when asked to apologise by a shareholder at a meeting in the General Assembly Hall of the Church of Scotland that Goodwin finally said sorry on November 20. Hornby apologised for the "anxiety" caused by the bank's collapse at an HBOS shareholder meeting in the NEC, Birmingham on December 12, but both had seemed to be talking through gritted teeth and for many, they had not gone nearly far enough.

Alan Steel, chairman of Linlithgow-based Alan Steel Asset Management, says the people that ran these banks were at the very least incompetent and the non-executive directors "deeply culpable".

He says: "If they were in the US, these guys might be facing very long jail sentences. They were perfectly happy to spend billions of other people's money in their quest for scale. Yet, having destroyed both these banks, they walked away with handsome cumulative bonuses. They don't seem to give a damn about the trail of destruction that they have left in their wake or that millions of people have had their life savings destroyed."

For both banks, the rot arguably set in around 2000 to 2001. As the dust was settling on the dotcom crash, interest rates had become unsustainably low and the banks suddenly felt the risks normally associated with lending had been banished through things like derivatives and securitisation. The rivalry between the two banks may also have been aggravated after their intense battle over English bank NatWest, won by RBS.

"I think they were far too competitive with each other," says Steel. "They seem to have become obsessed with the idea of beating each other to be number one. It led to a self-destructive mania about how big they could get and Hornby and Goodwin started to believe they could walk on water."

The obsession with market share - in almost every financial market in which the bank operated, including private equity and UK mortgages - led to sales-driven cultures in which salesmen were handsomely rewarded but the people tasked with growing the deposit base were paid a comparative pittance.

In a growth-obsessed culture, corners inevitably get cut and the moral compass of some employees gets demagnetised. Banking fundamentals such as checking that a customer has the ability to repay the loan become less critical when loans are anyway going to be parcelled up, securitised, and tossed into a wider financial sea.

The biggest error made by HBOS was probably to believe its own self-serving hype that UK house prices were on a permanent upwards trajectory - even though so much evidence was already pointing to the contrary. The problem almost seemed to become delusional when the bank paid top dollar for equity stakes in Scottish housebuilders like Tulloch and Miller Group long after the UK property bubble had burst.

At RBS, the biggest strategic errors included overpaying for the Dutch bank ABN Amro in October 2007 and making a headlong expansion into derivatives and so-called "toxic assets" based on subprime mortgages at the worst possible time in the cycle. A third error was to maintain very low reserves of Tier One capital (a measure of financial strength and the vital reserve set aside to cover losses).

Goodwin, however, swept the naysayers aside, confident in his own genius. His management style has been described as "so brutal that you didn't dare to disagree with him". One former senior executive says he came to loathe the regular Monday morning top executive meetings because, he says, you always knew that somebody would get a bollocking, even if it was undeserved.

If this is not bad enough, there was another stonking "elephant in the room" for the boards of both banks, their auditors, their investors and most financial journalists: neither HBOS nor RBS had a deposit base of sufficient scale to finance their headlong rush for growth. Instead they seemed entirely comfortable with the notion of throwing in their lot with the future health of the wholesale funding market. Given these had seized up after the 9/11 terror attacks, it was a risky strategy. When these markets completely seized up as they did after the collapse of Lehman Brothers, both banks were effectively scuppered.

But as long as the profits kept rolling in and the shares continued to defy gravity, few raised any concerns. Many Scots seem to have bought into the idea that the economic party would last forever, and would proudly parrot the line that their country was now home to two of the largest banks in Europe. Nor were politicians particularly eager to root out the culture of recklessness and greed that overran the banking system and by extension the society it served. Indeed it suited the politicians, who rather liked the chimera of wealth that a massive housing bubble can create. How else were they going to prop up post-industrial economies?

Then there was the Financial Services Authority (FSA), the main City regulator, which seemed happy to give the bankers the benefit of the doubt on funding.

"As far as I'm concerned the UK regulators have been utterly useless," says Steel. "The guys at the top of the FSA should get the bullet. There are 3500 of them at Canary Wharf just farting about. They make the lives of people like us very difficult but what they've let through at the top of banking and finance has been extraordinary. They haven't got a clue about the real world." Liz Watson, leader of the One Voice Action Group, believes the FSA has been turning a "Nelsonian blind eye" to malpractice across the UK banking sector and has not been doing enough for victims.

When the bankers' party came to an end on October 13, the collective suspension of disbelief could endure no longer. Goodwin and Hornby were shown to have feet of clay and the transformation from hero to villain happened more or less overnight. As Scotland seeks to pick up the pieces, a lot of soul searching is still going to be required and not just from the main protagonists.

THE BURSTING BUBBLE

THE wall of cheap credit that banks lavished on the UK property sector between 2001 and 2007, combined with their customers' proclivity to borrow, caused huge distortions in the housing market.

Bubbles expanded in both the residential and commercial sectors of the market, further fuelled by a tide of speculative and buy-to-let investment. As valuations stretched to breaking point, the International Monetary Fund warned that UK property prices were some 30% higher than was sustainable.

Artificially cheap and easy credit could only mask these realities for so long, and valuations went into freefall. According to the most reliable estimates, house prices have fallen by between 12% and 15%, while commercial property is down a whopping 40%.

Whole swathes of the housing, commercial property and construction industries went to the brink. Some 20,000 construction industry jobs have been lost in Scotland at firms such as Miller, Cala and Stewart Milne, and Michael Levack, chief executive of the Scottish Building Federation, fears that the lost skills mean Scotland will struggle to build the "inspirational projects of the future".

Related areas, including professional firms specialising in property have also been very hard hit. Already, Edinburgh estate agent Stewart Saunders has gone bust, and other firms are either laying off staff or reassessing their futures.

Banks that previously were willing to lavish credit on the property sector have, perhaps unsurprisingly, been taking a much dimmer view. Not only has the supply of new loans become a trickle, but existing borrowers are having their rates of interest hiked up at renegotiation time. And despite the government rhetoric, the banks advanced 61% less money into new mortgage lending in November 2008 than they did November 2007.

The credit squeeze and falling prices also made life tougher in commercial property, with Glasgow-based developer Elphinstone forced, for example, to scrap plans for Scotland's tallest building - a £120 million, 40-storey tower at Charing Cross. Highmore Homes, formerly part of the Kenmore Group, and the luxury developer Gregor Shore have both entered administration. The new mood of cautious conservatism among banks risks pushing scores of others over the edge or forcing them to cut back drastically to avoid breaching covenants.

The one positive is that as commercial property prices fall, rental yields do tend to rise. And if yields rise to 8% or more, then the market is going to become increasingly attractive, especially to bargain hunters from overseas. However, Dan Macdonald, chief executive of Macdonald Estates, believes that if such buyers do emerge, it will only be because the UK's commercial property market is effectively bust. "Britain looks like a bargain store - a pawn shop - for prime investment property," he says.

BANKING NEW FACES

The unparalleled events of 2008 mean total change at the top of what is left of Scottish banking. Susan Rice will be queen of the new Lloyds Banking Group Scotland, and will need to focus on integrating the operations of HBOS with those of Lloyds TSB. Her appointment as managing director came as a modest surprise given that Scotland also houses Archie Kane, chairman of the Association of British Insurers, who also sits on the main Lloyds board. Some had thought that one heavyweight in Scotland would have been all we could have expected.

A popular figure, Rice will need to use all her diplomacy given the widespread opposition to the deal north of the Border, and the fact that she is likely to oversee branch rationalisation and probably the loss of up to 7000 of the merged banks' 24,000 Scottish jobs.

Over at RBS, Stephen Hester formally succeeded Sir Fred Goodwin as chief executive on November 21, just weeks after the government bail-out. The fact that Hester was chief operating officer of mortgage bank Abbey - before later becoming chief executive of British Land - gives an indication of the government's more modest future ambitions for its recently acquired majority shareholding.

Hester has already expressed a desire to "shrink and sell RBS's weaker operations" and rebuild the group around businesses that have growth potential and clear competitive advantage. Speaking last month, he said: "I'm full of vim and vigour. I'm very confident in telling you RBS will embrace change."

2008 FLASHBACK: WIND EVERYWHERE...BUT NOT A DROP OF POWER

ALEX Salmond's ambition to turn Scotland into the Saudi Arabia of renewable energy might be often quoted, but it didn't stop his government from rejecting planning permission for what would have been Europe's largest wind farm on the isle of Lewis.

Lewis Wind Power, a consortium including British Energy and Amec, wanted to build 181 turbines in an £512 million project that would have produced 651MW of power and created 400 jobs in the Highlands and the Western Isles.

Yet the government delighted environmental campaigners in January when it declined the application, citing environmental concerns.

The decision to refuse the project raised oft-cited concerns with the planning system.

Many in Scottish business feel new projects can become strangled by red tape, sometimes taking as long as seven years to get to the building stage.

There was, therefore, relief all round in July when first minister Alex Salmond green-lighted a 152-turbine project in South Lanarkshire.

The announcement for the Scottish and Southern Energy Clyde wind farm near Abington meant Scotland will become home to the top two of the three largest onshore wind farms in Europe.

The 548MW project, which is expected to power 320,000 homes, will be second largest, bigger even than the Scottish Power Whitelee project near Glasgow (Whitelee is currently Europe's second-largest, generating 322MW).

The announcement meant that a total of 4.5GW of renewable energy has been approved in Scotland to date. This means the SNP government is very close to its target of generating 31% of energy demand from renewables by 2011. With offshore wind also to get seriously under way next year, if anyone can raise funding, the Scottish government is also confident it will meet its key target of 50% of electricity from renewables by 2020.

2008 FLASHBACK: TOURISM TARGETS DRIFT

FOR Scottish tourism, 2008 was the year that the target of 50% growth by 2015 was watered down into no more than an aspiration.

The 50% goal was first set in 2006 by the public-private partnership Tourism Framework for Change. It was seen as the minimum growth required for Scotland to keep up with global tourism rates.

Yet as the economic outlook worsened throughout 2008, meeting the target seemed less and less likely.

Barbara Clark, head of communications at VisitScotland admitted as much in July, when she announced the target would be reviewed "in the light of the worsening economic situation".

Iain Herbert, chief executive of the Scottish Tourism Forum, went further, saying in July: "I don't think the target can be met at the current rate of progress."

Only the Scottish government insisted it was still "perfectly reasonable".

Although much was made of the weakness of the pound and the effect this would have in encouraging holidaymakers to stay in the UK, few would argue that it was a good year for the tourist industry. In September, for example, it was revealed that visitor numbers to Scotland's top attractions - including Stirling Castle and Linlithgow Palace - had fallen by 10% over the year.

More trouble followed when it was announced that VisitScotland.com - the public-private partnership that provided the key portal for tourism bookings - was to be taken into public ownership amid mounting debts.

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