1.29 In requesting this Report, the Minister for Finance noted that the Government considers it essential ―to thoroughly examine the conduct of the banking sector in recent years in order to arrive at a fuller understanding of the root causes of the systemic failures that led to the need for extraordinary support from the State to the domestic banking system‖. The specific terms of reference ask that the Report have regard to ―the respective statutory powers, roles and responsibilities of the Central Bank and the Financial Regulator as well as consider the international social and macroeconomic policy environment which provided the context for the recent crisis in the banking sector.‖
1.30 Apart from the role of the CBFSAI, banking practice and Government policy both clearly played a central role in contributing to the crisis:
i) there is prima facie evidence of a comprehensive failure of bank management and direction to maintain safe and sound banking practices, instead incurring huge external liabilities in order to support a credit-fuelled property market and construction frenzy, and
ii) macroeconomic and budgetary policies contributed significantly to the economic overheating, relying to a clearly unsustainable extent on the
construction sector and other transient sources for Government revenue (and encouraging the property boom via various incentives geared at the construction sector). This helped create a climate of public opinion which was led to believe that the party could last forever. A less accommodating and procyclical policy would have greatly reduced the need for preventive action from the CBFSAI.
1.31 As regards the CBFSAI, the root causes appear to have been threefold:
i) a regulatory approach which was and was perceived to be excessively deferential and accommodating; insufficiently challenging and not persistent enough. This meant not moving decisively and effectively enough against banks with governance issues. It also meant that corrective regulatory intervention for the system as a whole was delayed and timid. This was in an environment which placed undue emphasis on fears of upsetting the competitive position of domestic banks and on encouraging the Irish financial services industry even at the expense of prudential considerations.
ii) an under-resourced approach to bank supervision that, by relying on good governance and risk-management procedures, neglected quantitative assessment and the need to ensure sufficient capital to absorb the growing property-related risks.
iii) an unwillingness by the CBFSAI to take on board sufficiently the real risk of a looming problem and act with sufficient decision and force to head it off in time. ―Rocking the boat‖ and swimming against the tide of public opinion would have required a particularly strong sense of the independent role of a central bank in being prepared to ―spoil the party‖
and withstand possible strong adverse public reaction.
1.32 There are undoubtedly many other factors which may have militated against the effectiveness of the CBFSAI during this period. These include: aspects relating to the quantity and skill mix of the staffing of the bank regulation function; an unduly hierarchical CBFSAI culture discouraging challenge; management process problems;
difficulties, related to the rather unwieldy organisational structure, in ensuring coordination between economist and regulator sides of the house; and weaknesses in preparing for a crisis. These factors may have contributed to the crisis but were not fundamental. Nor was the failure of Lehman Brothers decisive.
1.33 One additional element deserving of consideration is the suggestion by some commentators that the fact that some banking personages were politically well connected might have been a key factor in discouraging aggressive supervisory intervention. None of the persons interviewed during the investigation agreed with this proposition, with several noting (rightly) that it was quite predictable that senior
banking figures would have political contacts. While it is easy to imagine that senior management or CBFSAI Board or Authority Members might have instinctively and almost unconsciously shied away from aggressive action to restrain politically connected bankers and developers during a runaway property boom, no evidence has been presented suggesting that this was the case.12 Furthermore, although the climate of regulatory deference might have been unconsciously reinforced by social interaction – modest though it might have been13 – organised by regulated institutions, there is no evidence or hint of corrupt regulatory forbearance.
1.34 The question can legitimately be asked as to how much difference more resolute action by the CBFSAI would have made. At the micro-prudential level, a cap on property-related lending would have curbed the worst excesses, as would have increased, accompanied by a more aggressive stance on governance in the case of one or more specific institutions. At the systemic level, a far greater increase in capital requirements on risky loans, if implemented several years earlier, would have made a major difference. A ceiling or penalty on very high loan-to-deposit ratios for banks would also have been effective. To buttress these measures, the CBFSAI should have contained a much stronger message in FSRs and in accompanying public statements in order to lay out clearly the very serious risks posed to financial stability by an unsustainable housing boom and a vastly overheated economy.
1.35 The terms of reference for this Report request that it highlight key specific areas that it considers appropriate for subsequent examination by the statutory Commission of Investigation. Without ranging too widely, let us mention that as far as the organisation and conduct of the financial sector is concerned, the management and operations of the credit institutions themselves have not been studied in full detail for this Report.
12In the case of Anglo Irish Bank, management was seen by at least FR staff as perhaps ―slick and buccaneering‖ but not as presenting a large or imminent risk. Although it became quite clear to top FR decision-makers that senior Anglo figures were well-liked in political circles, and it cannot be excluded that this played a part in their subsequent continuation in office for some months after September, there was, until very late in the day, no perceived need to take regulatory action against them. The central management figure in INBS was seen as an overly dominating figure that needed to be surrounded by a stronger governance structure. While it was understood by all that he was politically well-connected, the failure to resolve the issue is not attributed by anyone involved to his having a privileged status. While unconscious factors may have been at work, FR management and directors agree that there is no evidence of political representations being made on his behalf aimed at influencing regulatory decisions.
13 Receipt of gifts or entertainment by CBFSAI staff has long been subject to a detailed Code of Ethics and Behaviour, including reporting requirements. Inspection of the register recording benefits received indicates that these have been of modest value.
Furthermore, the operations of mortgage intermediaries and audit and accounting bodies in the period prior to the crisis might also be worthy of examination.
1.36 This Report does not attempt to discuss certain matters that came to public attention after the guarantee was announced and which are the subject of separate inquiries, namely the director loans issue, the so-called Quinn-Anglo CFD affair and its ramifications, and the question of a back-to-back deposit arrangement. Awareness of these matters (all of them relating to Anglo Irish Bank) has, however, coloured the conclusions of the Report.
1.37 Although the Directors and officials of the CBFSAI differed in many detailed respects in their knowledge and understanding of the emerging situation, they do not appear to have realised – or at least could not bring themselves to acknowledge – before mid-2007 at the very earliest, not only how close the system was to the edge, but also the extent to which the task of pulling it back from the edge fell to the CBFSAI. Some also still feel that, without the external shocks of September 2008, the system would have survived without imposing a cost to the Government. The Report does not share this view.
1.38 Steps have been taken since the onset of the crisis to correct the main issues identified relating to the Central Bank and the Financial Regulator. New legislation has been prepared, and the organisation will shortly publish its strategic plan defining how it is strengthening and reforming its operations, procedures and overall approach.