Thank you Chairman and members of the Committee for the invitation to meet with you today. I am accompanied by Dermot Quigley, Authority Member, Mary O’Dea, Acting Chief Executive of the Financial Regulator, and Con Horan, Prudential Director.
The Financial Regulator’s key responsibilities are prudential regulation of financial institutions in Ireland and consumer protection.
Today, I would like to cover three main areas with you:
- the system of financial regulation that is in place in Ireland and how the Financial Regulator carries out its prudential regulation role within this system.
- the examination now underway at the Financial Regulator to determine the changes required to the system of financial regulation in the light of the events of the past 18 months, and,
- the new regulatory measures that we have put in place in relation to the banks covered by the Government Guarantee Scheme.
The system of financial regulation
The Financial Regulator’s responsibilities include the prudential regulation of individual financial institutions and consumer protection. Some 13,000 entities varying from investment intermediaries and funds to banks are regulated by the Financial Regulator. Developments in international financial markets over the past 18 months, and particularly in recent months, have rightly focused attention on systems of regulation employed both here and in other jurisdictions and on the issues of global cooperation between regulators.
When the Financial Regulator was established in 2003 all the key stakeholders in the economy were consulted to determine the most appropriate system of supervision. A principles-led supervision system was agreed with the key stakeholders and was set out in our strategic plans each year. This approach was aimed at protecting consumers while facilitating competition and innovation among financial services providers required in a growing economy. This system was in line with the principles outlined in the Government’s “Better Regulation” approach and was considered a cost effective approach to regulation. It was well regarded internationally, indeed a number of reports from bodies such as the IMF and the OECD recognised this explicitly.
Under a principles-led supervision system, responsibility for the proper management and control of a financial services provider and the integrity of its systems rests with its board of directors and senior management. Prudent risk management, ethical behaviour, transparency in business dealings are key values expected of boards and senior management in regulated firms.
I want to stress here today that the principles-led supervision system that was applied to the 48 banks we regulate is not a “rules-free” environment where regulated firms can do as they wish. In addition to the principles set out by the Financial Regulator, there is a vast number of rules that apply to the banking industry. These range from rules and requirements put in place by the Financial Regulator, including capital requirements and weekly liquidity reporting, and the Consumer Protection Code, to rules applied under EU Directives and, of course, the rules that apply under the law of the land.
For example under Basel 2 – the EU Capital Requirements Directive – there are hundreds of detailed rules with which banks must comply.
In operating the principles-led supervision system, the Financial Regulator has relied on appropriate management and controls in firms, ethical behaviour and true and fair reporting by firms and their auditors, as well as on-site inspections and supervision actions by the regulator.
It is clear that in the case of Anglo Irish Bank, this did not happen. The Authority takes an extremely serious view of the issues around directors’ loans that have emerged at Anglo. We are currently carrying out a comprehensive investigation into these matters. We have been in contact with the Office of the Director of Corporate Enforcement so it is not possible to get into any specific detail on it with you today. However, I can assure you that the Authority is committed to fully investigating all aspects of this and completing such investigations without delay and taking whatever actions are appropriate.
We are also engaged in a parallel investigation into all other covered institutions regarding directors’ loans and we expect to complete our work in this area within a matter of weeks.
We are committed to putting in place measures to try and ensure nothing of this sort can happen again, including, if necessary requesting Government to introduce new legislation in this area if necessary. Furthermore, we will engage with the auditing profession with regard to any changes that may be required.
Apart from the controls over Directors loans, it is clear that key areas such as risk management, compliance and general control processes in banks need to be re-examined in light of recent market turmoil. Liquidity management and risk concentration are also areas that need particular attention.
In carrying out its functions the Regulator is informed by the assessments of both international and domestic economic developments. It is instructive to read the forecasts made over the past 12 – 24 months. While they varied in their assessments, it is fair to say that almost without exception, the severity and rapidity of the downturn, both in Ireland and internationally, far exceeded their forecasts. Against the background of these positive economic assessments, and an expected soft landing in the property market, we nevertheless took strong action on lending. Our steps included:
Consumers were warned about risks of debt, including warnings about refinancing personal debts into mortgages.
New requirements for credit loss provisioning, including requirements for credit risk management were introduced.
Increased capital requirements for high LTV mortgages:
Tackled aggressive lending by introducing consumer protections of affordability and suitability and banning unsolicited credit offers;
Introduced new liquidity requirements which came into effect in mid – 2007
Stringent approach to property related requirements under the Capital Requirements Directive was introduced – 150% risk weighting (previously 100%) on exposure to speculative real estate and high capital requirements on residential investment properties.
These were measures that recognised concerns that were being expressed at that time about problems in the property market. Such measures were not taken elsewhere in countries with similar growth in property prices. Indeed it was argued that the fact that we only had the power to impose the requirements on our domestic banks put them at a competitive disadvantage to those other foreign banks operating here.
In the changed environment in which we operate, there is now much debate here and abroad about how banking regulation should be structured for the future. This is a complex debate and will embrace issues such as principles versus rules, market transparency, accounting changes and the extent of cooperation between regulators in different jurisdictions.
The current debate seems to be focused on changing the current principles-based supervision system to a more intensive, rules-based system. This would involve detailed prescriptive rules to cover virtually every aspect of the business of banking and would require a huge increase in resources to implement, with associated costs. However, as we know from the Enron experience in the US, a rules-based system would not necessarily guarantee the required regulatory outcomes. Indeed no system of regulation will guarantee a problem free environment.
Any system of regulation will be greatly challenged by:
- unethical or dishonest behaviour
- collusion to conceal information
- the impact of global events outside the control of the local regulator.
Notwithstanding this, the need to revisit and improve the regulatory system is very clear against the background of both the international crisis, the severity of which no banking regulator, central bank or government anywhere was able to foresee – and the domestic economic downturn and the implications of this for our financial system. The Authority is now examining this as a matter of urgency, including:
- an assessment of the effectiveness of our regulatory approach in the context of EU and international developments;
- whether a differentiated approach is needed for different financial sectors or institutions;
- our risk appetite, including an evaluation of our risk rating system, and,
- our inspection framework.
It is clear that a more intensive form of regulation is now required. We have already begun to put this in place in relation to the banks covered by the Government guarantee scheme.
New regulatory measures for covered institutions:
A number of actions have been taken by the Authorities here since last September to deal with the evolving international financial markets crisis and its impact on our own system and institutions.
For our part, under the legislation introducing the Government Guarantee Scheme, the Financial Regulator has a number of specific new responsibilities, which we must carry out in consultation with the Minister for Finance. These are to impose conditions regulating the commercial conduct of a covered institution’s business, having regard to capital ratios, market share and balance sheet growth, in order to minimise any potential competitive distortion that may otherwise arise and to avoid any abuse of the guarantee.
To meet these responsibilities, we set up a new supervisory unit whose role is to define, impose and monitor conditions and targets under the Government Guarantee Scheme. Our involvement with the institutions covered by the Scheme is intensive, including on-site presence and increased interaction with their boards. We are closely monitoring corporate governance, Credit, Liquidity Management, Audit and Risk.
We have requested and received detailed business plans from the institutions. These plans focus on the need to reduce the risk profile of the institutions and to outline how their models are sustainable. We have examined these plans and have commenced a series of engagements with the institutions at the most senior level in order to determine the soundness of the plans.
The key areas we are addressing are:
- the performance of existing loans,
- ensuring that the institutions are making progress in achieving the targets set in their business plans,
- ensuring that the institutions have a robust process for credit risk management,
- actively monitoring compliance with liquidity requirements, and,
- assessing the ability of the institutions to fund their business without undue reliance on ECB operations.
We are also reviewing the governance structures of the institutions to ensure that there are proper systems of internal control.
As part of that process, we are working with the banks on clarifying for the Minister for Finance their plans to grow lending to small and medium sized enterprises in this economy. We will be reporting to the Minister on the levels of lending that the banks are applying to this sector.
The Chief Executive and Chairman of each institution must report quarterly to the Financial Regulator, on behalf of the Minister for Finance, regarding the institution’s overall compliance with the Scheme.
These are very significant measures. They are necessary because of the changed environment we are in. It is a priority for us to ensure that the covered institutions are subject to the highest form of scrutiny.
In summary, I would like to assure you that the Authority has already made changes to the way it goes about its business. We will continue to work closely with our colleagues in the Central Bank both at Board level and executive level. This system, which includes common directors and high-level working committees, provides a basis from which to move ahead towards ensuring that the Irish financial system operates to the highest standards.
Thank you. We would be glad to answer any questions you may have.