18 May 2018 Interview
Central Banking: When you began the job of governor, what advice did your predecessor, Patrick Honohan, give you?
Governor Lane: Probably the most important thing was: “It’s up to you. Don’t feel bound by prior decisions if you want to move in different directions.” It was very nice to hear that. Beyond that, we were long-time collaborators, since the late nineties. So I absorbed my example from his period in office, rather than from any direct advice.
Central Banking: Was it important that you had policy experience, from the European Systemic Risk Board, but also had the perspective of being an academic economist?
Governor Lane: Running a central bank is a group effort. People bring different strengths and weaknesses, and it’s not the case that everybody should have a fixed background. But I would say probably, in the senior leadership of a central bank, it is important to have the perspective of an academic economist – just not necessarily as governor.
Central Banking: How important is transparency to the Central Bank of Ireland?
Governor Lane: There are two levels to that. One is what is necessary for effective policy – and there, transparency helps. Secondly, regardless of that, you have the fundamentals of democracy and accountability. That’s ethical, in my point of view, but it’s also the legal environment in which we work.
For the substance of policymaking to be effective, you have to explain why you are doing what you are doing. And then for the accountability of any public organisation, being transparent about numbers on salaries, expenses and procurement is necessary to reassure both the politicians and the wider public that things have been done correctly.
It’s also true that not everything can be shared. It’s fundamental that there’s a limit to the information sharing for financial supervision and in relation to the process by which policy is made. If you believed the minutes, or a transcript, would be published within a few weeks of the meeting, this would inhibit the free discussion that is necessary for good policymaking.
Central Banking: Is there anything you are planning to do further in terms of transparency, or have you reached your limits?
Governor Lane: We reversed the order here: unless there’s a very good reason not to, we put the information out there.
Central Banking: Do you believe the greater transparency of the Central Bank of Ireland over the last few years has been effective in winning public support – or, one might say, in winning back public support?
Governor Lane: I think that’s a reasonable context. Definitely the central bank was very reputationally damaged by the crisis. Ireland had an inquiry into the banking crisis [by a parliamentary commission, with the results published in 2016]. But even before that, the central bank under Patrick Honohan was attempting to make changes. Clearly, we could just declare policy, but I don’t think the level of public trust would be there for the public to say: “Well, OK, we trust the central bank, and if this is their policy, we accept it.”
When the default reaction of some parties is scepticism, you have to be able to go beyond just announcing a policy to explaining it. For example, with the macro-prudential measures, we release a lot of the research and data that we base our decisions on. In part, that’s a robustness check, so that someone in academia or a research position in a bank is enabled to say: “Actually, we think you misinterpret what’s going on here.” Especially in a small country, the central bank has to be proactive to do that.
Obviously, there are lots of Fed-watchers and ECB [European Central Bank]-watchers. In a small country, the community of academia and informed media might be quite small. Rather than individuals in those sectors having to fight to build a dataset or to gain access, then having as much transparency as possible builds up a more robust ecosystem around a central bank. It’s important that everyone else can be reassured not only that the central bank has decided this, but that the opportunity has been given to others to take a look and challenge that analysis.
Central Banking: How do other governors in small countries feel about that philosophy? Have any of them contacted you for advice?
Governor Lane: We do have a lot of interaction. The central bank, for various reasons, probably is receiving attention. For example, we have quite an extensive regime of macro-prudential measures. One of the basic underlying dynamics of what’s going on in many countries now, is that with the recovery it’s becoming increasingly clear it’s time to get macro-prudential measures. New Zealand was an important first mover for us, as a small country, and the Bank of England as well. As more and more countries get going, those that have yet to make the same journey or are less advanced are looking at us because we have extensive material out there and they can learn quite a lot.
Just last Friday there was [a meeting of] a group of European central banks that have twice-yearly macro-prudential sessions. Central banks can learn a lot from each other through the Eurosystem, mostly in relation to European policies. We also have a commitment that we are quite proactive in the Eurosystem committees and other fora to tell our story. So we are communicating not just domestically. We want to have a good relationship with our domestic public, but also with our peers. On one level, it’s built into our framework that we have a regular peer review, where we ask another central bank to “kick the tyres”. But, more generally, building a solid reputation with our peer group is important.
Central Banking: You’ve had some public criticism recently on the handling of tracker mortgage mis-selling. Do you think that the central bank has dealt with the problem correctly? Was it alert early enough to the dangers of tracking mortgage selling?
Governor Lane: That’s a multi-layered question. The central bank was quite aware of the tracker mortgage problem early on – it was very obvious. Basically, especially in the summer and autumn of 2008, the funding costs of banks totally changed. So they more or less withdrew tracker products in 2008. Most people who had trackers, they still had them because they were cheap. Remember: in 2006 and 2007, the ECB was raising rates.
Various banks said: “If you would like a fixed rate, you can fix for a couple of years.” Where most of this arose from was that the wording of these contracts assumed the world was stable. So when the two- or three-year fixes were over, the customer would have to make a new decision. Essentially, a lot of this goes back to badly drafted contracts or banks not really fully taking the customers’ perspective about what was the appropriate rate when the fix expired. So, in 2008, 2009, 2010, the central bank issued warnings saying banks have to be careful in communication with their customers, they could not mislead them. And also in 2006, we brought in a consumer protection code that goes beyond the narrow mortgage contract, and says you have to put customers first.
From that perspective, what’s happening now is basically a major victory for the consumer protection role of the central bank. The redress and compensation flowing to customers is mostly not about violating contracts. It’s mostly about the wider questions of: “Did you put the customer first? Was all the information as transparent as it should be? Was it reasonable for the customer to read the small print of footnote 29 in terms and conditions?”
In the autumn of 2017, there was a period of uncertainty because, in terms of leading to a final finish line, in terms of the banks accepting that these were the number of cases that needed redressing, that was not concluded. This goes back to the trust issue. We were saying: “This is happening – it’s on its way through the process here.” The political system was, I think, nervous, until they saw what the outcome was. Whereas now we have 30,000-plus customers receiving significant compensation, there’s a greater awareness that this indeed would not have happened without the central bank.
We all have to learn lessons from it. The counterfactual where we trigger this kind of universal exam [of tracker mortgages] at an earlier point is a reasonable question, and we have to revisit it. But, in terms of the overall process here, it’s showing the power of a central bank in delivering consumer protection that goes beyond just contract violations to the wider responsibility that financial service providers should put their customers first.
Central Banking: Does the Central Bank of Ireland face any particular problems that prevent it from being able to recruit and retain staff?
Governor Lane: If you go back to when I took over at the end of 2015, we were in the high 1,400s in staff numbers. At the end of this year, it’s going to be nearly 1,900, so this is in the context of a very big increase in staffing. So there are two questions. One is the speed at which these new positions are being filled. We are below our desired staffing number. But is there really a recruitment issue if you successfully increase staffing by that much? Number two is maybe many people in the political system think of the central bank as like the civil service, where turnover is pretty low. When the reality is, the kind of people we attract – especially in supervision – are the people that financial services firms want. So the turnover rates are higher, but I’m pretty sure they’re comparable to – if not far less than – the New York and London numbers.
What ideally we would like is to instantly create a bank of experienced supervisors, but they just don’t exist. We also value people going to Frankfurt, taking multi-year leave to work for the Single Supervisory Mechanism, as it makes them better supervisors. From 2014 to 2016, when the SSM was getting going, there was a wave of people like that. But they’re not permanent exiles – they can come back.
What is realistic and feasible? It is a persistent challenge. It’s fair to say our salary levels have to be kept broadly comparable to the public sector. It would be politically unsustainable to say central bankers are special when the hospitals have procurement issues for senior medics and so on. Obviously, if we decided to ignore public sector pay restrictions, we could more easily fill some positions. It’s unusual for the Irish public sector, which is why it attracts some political commentary. But in the context of being able to grow quite a bit, in the context of the norm for financial regulation being different from other parts of the public sector, I’m not overly worried about it. We cannot offer the whole staff pay increases outside of the public-sector baseline. At the point of hiring, we’re free to pay higher salaries. So it’s not the case we’re restricted. If we really want to fill a particular vacancy, we can pay what we feel we need to do that. So there’s a degree of flexibility there that isn’t there for the wider public sector.
Central Banking: Is there sufficient flexibility for you to be able to build up a rather large supervisory machine?
Governor Lane: The facts speak for themselves. Even in the middle of the crisis, the central bank was growing, even though the private sector was pretty dead. So, at that point, there may have been refugees – the kind of people who joined the central bank as the best feasible option, but whose heart was elsewhere. But, at this point, what we want are people joining the central bank because they value making a difference. Central banks and financial regulators can offer very good careers, whether long-term or temporary. The pay is decent – it’s less than some parts of the private sector, but no-one can say we’re paid badly. The trade-off is that, number one, you’re doing socially valuable work – and it’s very important to emphasise that, that you’re making a difference to society. And, number two, we try to create a very nice workplace – we have family-friendly policies and so on. If you ask the same question of the regulator here in London or at the New York Fed, you’ll see high turnover rates because it’s just the inevitability of living in a financial centre.
Central Banking: You and other senior members of the Central Bank of Ireland have consistently warned that the Irish economy will be badly affected by a ‘hard Brexit’. How likely do you think that outcome is?
Governor Lane: I don’t think it’s very likely. But I find that consideration kind of irrelevant. I don’t run the central bank – and we don’t want financial firms running their businesses – on the basis of what we or they predict, because we or they could be wrong. So the question is: are we making plans that are resilient to the ‘hard Brexit’ scenario? Even if you don’t think it’s likely, you have to prepare for it. I do think it’s increasingly unlikely: the momentum is there towards some kind of solution. But it’s a tail risk that has to be prepared for by financial firms and by the Irish public policy system.
Central Banking: You have also consistently warned that the central bank is not prepared to accept ‘brass-plate operations’, with corporations moving from London to Dublin more or less in name only. Has this been a particularly popular stance?
Governor Lane: Broadly speaking, I think so. Our strategy from the word go has been to be exactly in line with the EU27. This is the uniform view of the EU27, all the supervisory authorities, the ECB. For regulation, the SSM is a single voice. And that voice is saying it’s perfectly OK to have deep levels of integration between the different parts of the firm. So having risk transfer within a firm is perfectly fine. But that cannot be to a degree where the EU entity ends up being an empty shell. The principle here is: EU regulators have to be able to be effective. You can’t effectively do much with an empty shell. You have to have a corporate structure where the local executives have autonomy over their entity. It’s not an acceptable answer for the local chief executive to say: “Sorry about that, but group headquarters have made that decision – I can’t do anything about it.” What it comes down to is, if we decide we want the local entity to raise capital, raise the equity or reduce risk taking, those requirements can be delivered. That’s the fundamental principle.
Central Banking: Has that single voice among the European regulators always held true since the UK’s Brexit referendum? The Irish finance ministry was not happy about how Luxembourg was handling the possible movement of insurers out of London, and said there was an attempt at regulatory arbitrage.
Governor Lane: I’m not going to comment in particular about any particular country episode. But what I think is generally true is that any kind of variation is in the distant past. As the weeks and months have gone by, more and more institutional frameworks have been developed to make sure that essentially very much the same outlook has been implemented everywhere. Maybe in the first weeks and months straight after the referendum vote, all the architecture was not in place, but it is now.
Central Banking: Ireland is one of the biggest centres of shadow banking in the world. How are you addressing risks in this area?
Governor Lane: Let me rephrase that. Ireland is definitely one of the biggest centres for market-based finance. The time has passed for shadow banking to be a colloquial phrase for all of market-based finance. A lot has been done to take it out of the shadows. But, absolutely, we have a huge amount of investment funds, money market funds and special purpose vehicles [SPVs]: that’s absolutely true. A big part of transparency for us is taking all that out of the shadows. A couple of years ago we got new information-gathering powers, so we’re able to understand more about what’s going on. We contributed a chapter in the Banque de France’s April 2018 Financial Stability Review explaining market-based finance in Ireland.
One important point is that a lot of it is not euro-denominated. We have a lot of dollar-denominated money market funds, with also a fair amount of sterling. It’s part of Ireland being a global financial centre. The number of SPVs is partly because Ireland played a really large role in aircraft leasing, by historical accident. People often want to run their aircraft leasing out of Ireland, and run their financial transactions through a SPV.
It’s also the case that firms – say, for example, Russia – issue debt out of Ireland. There might be many investors unwilling to lend directly to a Russian enterprise. Having their legal protections by issuing debt out of an SPV in Dublin – which, in turn, may on-loan back to Russia – is, kind of, one role for an international financial centre.
Central Banking: So are you confident of the risks now that you have brought a lot of market-based lending measures out of the shadows?
Governor Lane: Yes. We can see from our research it basically has very little interaction with the Irish banking system or with the Irish economy. We could just ignore that, because we know the financial risks are elsewhere. But part of being a good global citizen is by contributing on this – it helps regulators and investors elsewhere understand the linkages. If regulators or investors are in the UK or the US or elsewhere, the end of the road in terms of what they see might be in Ireland. But then we can say: “Well, actually that fund is in fact a dollar fund, so you have an exposure to dollars, and that fund might be a kind of offshoot of something else.” We do a lot of this work for the international public good, rather than for domestic reasons.
Central Banking: Are there any benefits to Ireland having this amount of the market-based finance sector based in the country?
Governor Lane: That goes back to the question of whether there are any benefits from financial intermediation. The intermediation in Ireland creates jobs for lawyers, accountants and back office. It’s not a choice variable for us as to whether or not those firms are in Dublin or not. We live with the reality.
Central Banking: You say there’s no financial risk to Ireland from these funds. Is there not a reputational risk?
Governor Lane: That implies there’s some kind of choice here – as in, we could decide, as the central bank. Now, the wider state system, the government, could change that. The Irish legal framework is friendly to those funds. If the wider system decided that they didn’t want to have that business, then they could write laws that kind of make it unfriendly. But as a central bank, that’s not part of our world.
Central Banking: You chaired the European Systemic Risk Board task force that wrote a report on a new safer asset class: sovereign bond-backed securities. You said in the report foreword that if the eurozone changes the way sovereign bonds were treated in a way that reflects credit or concentration risk, then the demand for these securities could be substantially enhanced. What changes do you think the eurozone’s political leaders should be making to the treatment of sovereign risk?
Governor Lane: In the report, we acknowledge that link, but we didn’t get into evaluating the pros and cons of those issues. We were clearly focused on the analytics of sovereign-bond backed securities. My personal view is probably that if the decision is made to have a reform, the most important move is concentration risk, to promote diversification. What that means is, in principle, with enough reallocation, it’s not necessarily a case your bank can hold less sovereign debt, it’s just the home bias would be managed. Whether credit risk rates are additionally needed, or a hybrid model where if you want to violate a concentration restriction you have to attach risk rates – maybe there’s virtue in that. But, again, all those details are fundamentally for the people who write legislation to worry about.
Central Banking: How important do you think it is for the EU to introduce a unified deposit insurance scheme?
Governor Lane: I think it is desirable to do it, and clearly it’s all about detail. Most of the time, it doesn’t matter. But when it does matter, it really matters. So I do think they’d be better to finish it. The European banking union will be demonstrably more complete with it. You also have to recognise reality. It is all about managing hypothetical run risk. Now we have much better capitalised banks, better provision for existing NPLs [non-performing loans], and ‘bail-in-able’ debt being raised. The empirical probability of all that being burnt through, and you get to actually invoking deposit insurance, at least for a large bank, is not that high. So this is why the paradox of that is: if the predicted losses from doing that are basically invisible, then why not?
Central Banking: If a genie gave you the power to implement one reform to Europe’s financial architecture, what would it be?
Governor Lane: To eliminate the connection between the national sovereign and the national banks, so we have a true European banking system. If the genie could do that, it would be very helpful. If there were agreement among European governments that banking troubles are collective troubles, and they will be sorted collectively – as opposed to, say, Ireland having to deal with its banks and so on.
Central Banking: ECB president Mario Draghi said after the last meeting of the ECB’s governing council that policymakers were beginning to worry that the governments of major economies are moving away from the intellectual co-operation that’s been the norm since 1945. Have you seen any sign of that?
Governor Lane: What we’re seeing in the world, the main identified issue, is the degree of commitment of the West to multilateralism. That remains open to question. That’s really the fundamental issue. Obviously, there’s been some news on steel tariffs. That gives some signals. The question is whether that’s tactical and minor, or the preface to something more general.
Central Banking: What do you think the next de facto chief economist of the European Central Bank should be thinking about, when he or she is appointed after Peter Praet leaves?
Governor Lane: What’s important about the way Europe works and one of the virtues of a monetary union, is that there’s a deep talent pool among the staff. The Eurosystem committees, and the members of the governing council – whether they’re executive board members or national governors – rely heavily on the analysis of and recommendations of staff. The emphasis on the contribution of individual members of the board is overplayed. We see the same commentary with the transition at the Fed. Governors come and go. Making sure that your system has excellent staff: that’s what’s important.
Central Banking: The governor of the Slovenian central bank recently announced that he was leaving office, after he had been persistently criticised by the country’s government in connection with the bail-in that he’d organised several years back. Do you have any comment on that?
Governor Lane: I don’t want to comment about any particular country. But the more general observation is clearly that the political spotlight is far harder on central banks now. It is not particularly to do with monetary policy, but to do with whenever you have to take a step in terms of resolving a bank. There will be losers. As more and more bail-ins happen, especially when the banks are failing or likely to fail, the forward-looking decision about the conditions under which a bank is likely to fail requires judgement. What that means is, any central banker – whether at a national central bank or the SSM – has to be rigorous in making his or her case. It’s tough, and this is why you have to have the courage to be willing to take those decisions. It also provides yet another reason why the SSM is such a good idea. Having the insulation from national political pressure, having European decision-makers, is vital. This Slovenian case was pre-SSM. Whereas now, with the SSM, the reassurance that the whole European system is behind that decision [to bail in], that there’s no domestic component to it, is vitally important.
Central Banking: Policymakers were wrong in their view that the financial system was safe pre-crisis. Is there anything that you worry that economists and policymakers are missing now?
Governor Lane: There are two parts. One is: what can we expect from regulated firms? We’ve moved a long way with that. There was excessive optimism in the 2000s that there would be a soft landing, especially in a time of a lack of credibility of many countries with large imbalances. Now that we’ve seen one severe case of downside risk being realised, we know it’s important to have much better capitalised banks. All that is good, but secondly, we also require central banks to be effective in a crisis situation. The ECB – initially with liquidity policies, and then with monetary policy through the quantitative easing programme – has demonstrated that it is fully committed to delivering. Broadly speaking, everything boils down to resilience. Really, it’s a question of not relying on prediction. We may all hope that the next recession will be shallow and far away, but we have to run the system on a more resilient basis.
Central Banking: There has been pushback from Italy on what should be happening at the European level for addressing NPLs. The Italians are saying it’ll take some time to work through the system. Yet others are saying Europe just needs to crack on, address this issue and put it behind them. What’s your view?
Governor Lane: There’s truth on both sides, and the real answer is: number one, there is a policy dimension that what makes sense to an individual bank may be collectively inefficient. This is why a push from regulators is a good idea. Number two, it does have to be bank-specific, because every bank is different in terms of its loan book and its circumstances. That’s exactly what the SSM has done in its guidelines. The interchange between the SSM and the European Parliament was more about communicating that properly: [explaining that] these are not legal requirements, they are flexible guidelines. It’s true that also macro-wise, there’s a clear pathway: push too fast to sell off NPLs, you get ‘fire sales’; too slow, you get ‘extend and pretend’.
In 2017, all the data showed we were in a recovery. It’s now easier to calculate what a reasonable value is on these NPLs. In the Irish case, if in 2012 they had decided to resolve all the NPLs, the kind of prices at which you would have renegotiated housing loans was far less than you would now, because of the recovery in the market. So waiting for a recovery can make sense. But once the recovery is there, you do need to move rather clearly. The exact timeline has to be very specific to each bank’s portfolio and each market. Ireland – where NPLs are mainly property-related – is perhaps easier than Italy, where you may have to work with a specific firm more.
Even in Italy the NPLs are coming down because of the recovery. But it still needs a bit of a regulatory slog to interact with each bank and make sure it’s happening. I would say the key ingredient is sufficient capital – you need to make provisions. We did that in Ireland in an expensive way, through the public recapitalisation of the banks. It did have the virtue that capital has not been a constraint in Ireland. When banks have needed to write off bad loans or make provisions, they were able to do so. And that’s an ongoing challenge – it’s not over yet in Ireland. But sufficient capital is helpful.
This interview took place at Central Banking’s London offices on March 27, 2018