Opening Statement by Chairman - Joint Oireachtas Committee on Economic Regulations

Introduction

Thank you Chairman and members of the Committee for the invitation to meet with you today. I am joined by my colleagues, Authority members, Dermot Quigley and John Dunne, Chief Executive, Patrick Neary, Consumer Director, Mary O’Dea and Prudential Director, Con Horan.

Before I begin, as you know, on Friday last, the Authority issued a statement accepting, with regret, the decision of Patrick Neary to retire as Chief Executive. I would like to take this opportunity to thank Patrick, on behalf of the Authority, for the contribution he has made over the years. We have appointed Consumer Director, Mary O’Dea, as acting Chief Executive. I myself will assume enhanced executive responsibilities until the appointment of a new Chief Executive.

Today, I would like to cover three main issues in this opening statement.

• As you are aware on Friday last the committee established by the Authority to undertake an urgent review of directors’ loans at Anglo Irish Bank delivered its report. I will discuss the Report with you.
• I will update you, since we last appeared before this Committee in October, on some of the new regulatory measures that we have put in place, in particular in relation to the banks covered by the Government Guarantee Scheme.
• I will detail some of the issues that the Authority is now examining in relation to the system of financial regulation here and the lessons that are emerging from the events of the past 18 months.

At the outset I would like to assure you that the Authority has already made changes to the way it goes about its business and is fully committed to taking the necessary steps, working with our colleagues in the Central Bank and in cooperation with Government, to ensure that the Irish financial system operates to the highest of standards.

Anglo Irish Bank

As you know, the Authority first became aware on 17 December last of issues that had emerged around directors’ loans in Anglo Irish Bank. We appointed a committee, comprising of Authority members who are here with us today, Dermot Quigley and John Dunne, to examine the regulatory response. It is important to point out that this was a review of our own internal practices and processes in relation to this issue. A separate investigation into the matter of directors’ loans itself is ongoing and it is not possible, therefore, to discuss that particular investigation here today.

The Committee worked over the Christmas and New Year period and completed its work within the three-week deadline we had set. It delivered its report to the Authority on Friday last, 9 January and the Authority accepted the findings and recommendations of the report. I should explain that the Authority was legally advised that it may not publish the Committee’s report. However, in the interests of transparency and in the public interest, we published a summary of its findings on the day.

The essential task of the Committee was to look within the Financial Regulator organization at two issues: when the information about these loans was obtained by the organization, and how the information was communicated and followed up by way of response.

In summary, in relation to dealing with the issue of directors’ loans in Anglo Irish Bank, the Committee concluded that there was a breakdown in terms of internal communications and process and in the regulatory follow-up and response of the organization. This resulted in a failure to take appropriate and timely actions in relation to what was a serious matter and to escalate the matter to the Authority.

In relation to the particular issue of whether this matter had been mentioned to the Prudential Director and Chief Executive after a wider meeting had concluded in January 2008, the Committee was impressed with the coherence, clarity and belief in their stated recollections of the people concerned and their integrity. Nevertheless, the evidence presented to the Committee on this issue could not be reconciled by the Committee. There is no suggestion from any party that any communication – verbal or written - on this issue was made to either the Prudential Director or Chief Executive in the period (subsequent to January) to December 2008.

The Committee noted that it had been greatly impressed by the quality, dedication, commitment and strong work ethic as well as the integrity of the officials with whom they engaged. The Committee also noted the pressures that the staff had faced since the onset of the crisis in the global financial system in August 2007 and noted issues with staffing requirements. Following on from this, the adequacy of existing resources would need to be kept under review particularly where modification of the approach to regulation and more intensive supervision would require more staff.

The Committee observed that the system of regulation that operated in Ireland was highly regarded internationally. However, the events of 2007 and 2008 in the financial environment globally pointed to serious inadequacies in systems of regulation operating across the world. Ireland is no exception and a much more intensive type of regulation has been introduced here under the Government Guarantee Scheme and this position is developing all the time.

The Authority noted and accepted the recommendations of the Committee and is committed to implementing them in full. These are:

• The review of our strategic regulatory approach in the light of developments in 2007 and 2008, to which the Authority is already committed, will be advanced as quickly as possible. The review should ensure that the organization meets its statutory mandate and responds to the changed regulatory environment and to EU and international developments in financial regulation.
• The staffing requirements for the organization are being reviewed on the basis of both the strategy review and also of the outcome of the work being undertaken by external consultants for the Authority, specifically the Business Process Review and Benchmarking against comparator financial regulators and other similar businesses, which is expected to be concluded shortly.
• Any changes recommended by these consultants in the organizational structure and reporting lines within the Financial Regulator will be examined and, if considered appropriate, acted upon by the Authority as a matter of urgency.
• While no process can eliminate the need for the exercise of good judgement by officials, existing internal communication and escalation procedures and procedural manuals are being reviewed taking into account the lessons to be learned from the report and the ongoing separate review of directors’ loans initiated by the Authority.
• Filing and document management and tracking arrangements are being improved.
• The review instigated by the Authority to determine the treatment of directors’ loans in all institutions covered by the Government Guarantee Scheme will be completed at an early date.
• Loans to directors will be examined in greater detail, especially to ensure that loans to any business in which a director has a major interest (defined as 10 per cent or more of the shares or voting rights) are being included in returns to the Financial Regulator.
• Arrangements will be made to ensure more effective monitoring of prudential returns, including those for loans to directors, with on-line submission and built-in data validation and checking processes.

New regulatory measures

In terms of our regulatory approach, I would like to detail for you some of the new measures we have put in place, particularly in relation to the institutions covered by the Government guarantee, since we last appeared before this Committee in October.

The legislation underpinning the Government guarantee Scheme has a number of objectives. These include the need to maintain financial stability in the best interests of the public and the economy of the State; to safeguard the financial system and economy of the State from the threat caused by the unprecedented turmoil in the international financial markets; to provide lasting systemic stability in the banking system; and to minimize the potential cost to the Exchequer and taxpayers.

Under the 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 minimize any potential competitive distortion that may otherwise arise and to avoid any abuse of the guarantee. In particular the Financial Regulator, in consultation with the Minister, has responsibility to monitor and review the expansion of the activities of covered institutions benefiting from the guarantee in order to ensure that their aggregate growth in balance sheet volume is not excessive.

In order to meet these responsibilities, we have established a new supervisory unit whose role is to define, impose and monitor conditions and targets under the Government guarantee Scheme. Our interaction with the institutions covered by the Scheme is intensive, including a permanent on-site presence. The level of interaction with the boards has increased. We are implementing a closer monitoring of internal committees, such as Credit, Audit, and Risk, which will include our attendance at committee meetings. We are monitoring liquidity and funding on a daily basis and we will ensure that there will be a strict adherence by institutions to agreed action 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 out 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.

We have requested and received detailed business plans from the institutions. These plans focus on the need to reduce the risk profile of the institution 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.

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 oversight 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.

System of financial regulation

The developments in the financial markets of the past 18 months have rightly brought a focus on to the system of regulation. This is the case not only in Ireland, but internationally.

There are different and competing regulatory and supervisory models internationally. For example, more prescriptive rules-based models versus more principles-led models aimed at delivering the required regulatory outcomes. In light of the changed financial services environment in which we operate, there is much debate here and abroad about how regulation should be structured for the future.

For our own part, the Authority is embarking immediately on a review of the system that operates here. Since the establishment of the Financial Regulator in 2003, and in consultation with, and with the agreement of, all the key stakeholders in this economy, a system of principles-led supervision was adopted. This system was well regarded internationally, indeed a number of reports from bodies such as the IMF and the OECD recognized this explicitly. However, the need to revisit this is very clear against the background of both the international crisis – which no regulator, central bank or government anywhere was able to foresee – and the domestic economic downturn and the implications of this for our financial system.

A more intensive form of regulation is required. As I have detailed for you earlier, we have already begun to put this in place in relation to the covered institutions. Among the areas that the Authority will now examine as a matter of urgency are:

• 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;
• our risk appetite, including an evaluation of our risk rating system;
• our inspection framework; and
• the adequacy of the information supplied by financial services providers under the current reporting structures.

More intensive supervision requires not only more resources, but also an efficient and effective deployment of those resources. This will also be a priority for the Authority over the coming period.

We will also need to examine the roles of oversight of the stability of the overall financial system and day-to-day supervision of individual institutions. It is very clear, internationally, that the interaction between these two areas is of critical importance. We will need to do this in conjunction with the Central Bank.

On a European level, the ECOFIN last year called for the introduction of a European dimension into the mandates of national supervisory authorities while on a more global scale, the G20 member states agreed to enhance co-operation and to work together to restore global growth.

It is clear that standards of regulation internationally have been found to be inadequate to deal with the unprecedented turmoil that emerged over the last period. There is an acceptance that change is required. We fully accept that substantial change to regulation is required here.

We will, of course, be informed by the international factors, but ultimately we must have a system of regulation that, above all else, ensures financial institutions in our jurisdiction operate to the highest standards and, if they don’t, that there must be serious repercussions. The behaviour of people operating at the top of our financial institutions must be fully appropriate to their responsible positions. Some of the behaviour we have witnessed of late is totally unacceptable.

The financial system internationally has suffered a loss of confidence among its customers and investors. It is vitally important, for the good of this economy, that there is a high level of confidence in our own financial system. We want to assure the Committee today that we are fully committed to playing our part by making whatever changes are necessary to achieve this. Our work in this regard is already underway.

Thank you for your time, we are now happy to take any questions the Committee may have.