The Joint Committee met at 11 a.m. MEMBERS PRESENT: Deputy Chris Andrews,  | Senator Paul Coghlan,* | | Deputy Seán Barrett, | Senator Camillus Glynn,+ | | Deputy Joan Burton, | Senator John Hanafin, | | Deputy Terence Flanagan, | Senator Marc MacSharry, | | Deputy Brendan Kenneally, | Senator Feargal Quinn. | | Deputy Michael McGrath, | | | Deputy Kieran O’Donnell, | | | Deputy Noel Treacy,* | |
*In the absence of Deputy Frank Fahey and Senator Liam Twomey, respectively. +In the absence of Deputy John Hanafin, for part of meeting. In attendance: Deputies Arthur Morgan and Tom Sheahan. DEPUTY MICHAEL AHERN IN THE CHAIR. The joint committee met in private session until 11.17 a.m.  Banking Sector Issues: Discussion with Financial Regulator and Central Bank.
Chairman: The purpose of the meeting is to discuss the Credit Institutions (Financial Support) Act 2008 and the relationship between financial institutions and the regulatory and supervisory environment. Before we commence, I ask people to ensure that their mobile telephones are switched off. Members are reminded of the parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses, or an official either by name or in such a way as to make him or her identifiable. I draw witnesses’ attention to the fact that members of the committee have absolute privilege, but this same privilege does not apply to witnesses appearing before the committee. I welcome from the office of the Financial Regulator Mr. Jim Farrell, chairman, Ms Mary O’Dea, acting chief executive, and Mr. Con Horan, prudential director. I also welcome Mr. Dermot Quigley, a member of the Irish Financial Services Regulatory Authority. I call on Mr. Jim Farrell to make his presentation which will be followed by a question and answer session. Mr. Jim Farrell: I thank the Chairman and members of the joint committee for inviting us to meet them. As the Chairman said, I am accompanied by Mr. Dermot Quigley, a member of the authority, Ms Mary O’Dea, acting chief executive, and Mr. Con Horan, head of prudential regulation. The Financial Regulator’s key responsibilities are prudential regulation in financial institutions in Ireland and consumer protection. Today, I would like to cover three main areas with the joint committee. First, the system of financial regulation that is in place in Ireland and how the Financial Regulator carries out its prudential regulation role within the system. The second is the examination which is now under way in the Financial Regulator to determine the changes required to the system of regulation in the light of events over the past 18 months and, third, the new regulatory measures we have put in place in regard to the banks covered by the Government guarantee. The Financial Regulator’s responsibilities include the prudential regulation of the 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 co-operation 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 aligned 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 our principles-led supervision system, responsibility for the proper management and control of a financial services provider and the integrity of its systems rests with the board of directors and senior management. Prudent risk management, ethical behaviour and transparency in business dealings are key values expected of boards and senior management in regulated firms. I stress 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 the rules that apply under the law of the land. For example, under Basel II, 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 by 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 Irish Bank. 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 and, therefore, it is not possible to get into any specific detail on it with the committee today. However, I can assure the committee 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 to ensure that nothing of this sort can happen again, including, if necessary, requesting Government to introduce new legislation in this area. Furthermore, we will engage with the auditing profession on any changes that may be required. Apart from 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 to 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 assessments, we nevertheless took strong action on lending. Our steps included the following. In 2004, consumers were warned about the risk of debt, including warnings about re-financing personal debts into mortgages. In October 2005, new requirements for credit loss provisioning, including requirements for credit risk management, were introduced. In May 2006, increased capital requirements on high loan-to-value mortgages were introduced. In August 2006, we tackled aggressive lending by introducing consumer protections on affordability and suitability, and banned unsolicited credit offers. In June 2006, we introduced new liquidity requirements which came into effect in mid-2007. In January 2007, a stringent approach to property-related requirements under the capital requirements directive was introduced, with 150% risk weighting from the previously 100% weighting on exposures to speculative real estate and high capital requirements on residential investment properties. These measures 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 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 co-operation 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 significant increases 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 or the impact of global events outside the control of the local regulator. Notwithstanding this, the need to revisit and improve the regulatory system is 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 its implications 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 the banks covered by the Government guarantee scheme. The new regulatory measures for the covered institutions are as follows. A number of actions have been taken by the authority since September last to deal with the evolving international financial market 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 established a new supervisory unit, the role of which 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 an 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 business models are sustainable. We have examined these plans and commenced a series of engagements with the institutions at the most senior level in order to determine the soundness of their 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 in place robust processes in respect of 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 this 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. We will be reporting to the Minister shortly on the levels of lending that the banks are applying in respect of this sector. The chief executive and chairman of each institution must report on a quarterly basis to the Financial Regulator — acting on behalf of the Minister for Finance — regarding overall compliance with the guarantee scheme. These are significant measures and they are necessary as a result of the changed environment in which we are operating. It is a priority for us to ensure that the institutions covered by the scheme are subject to the highest form of scrutiny. I wish to assure the committee that the Financial Regulator has already made changes to the way in which it goes about its business. We will continue to work closely with our colleagues in the Central Bank and Financial Services Authority of Ireland at board and executive level. This system, which includes common directors and high level working committees, provides a basis from which to move forward and ensure that the financial system operates to the highest standard. I will be glad to answer any questions members may wish to pose. Chairman: I thank Mr. Farrell for his comprehensive presentation, which brings to the fore the dilemma we face in the context of ensuring that while there should be regulation in place, we must see to it that we do not over-regulate. It is unfortunate that the individuals who caused many of the problems under discussion did not agree with the type of regulation being pursued by the Financial Regulator and the Central Bank and Financial Services Authority of Ireland and that they broke all rules. Mr. Farrell stated that more strict rules and examination procedures are being put in place, which is extremely important in the context of ensuring the credibility of our financial institutions. Deputy Kieran O’Donnell: I thank Mr. Farrell and his colleagues for coming before the committee this morning. Matters have moved on since the previous occasion on which we met. To put this issue in context and regardless of who considers it, the previous system of financial regulation imposed by the Financial Regulator has failed. A property bubble was allowed to develop in this country when a global downturn was taking place. In that context, the capital ratios relating to weighting and loans should have been introduced much sooner. The principles-led system adopted by the Financial Regulator did not work and was abused by the banks. Mr. Farrell stated that the Financial Regulator proposes to introduce new regulations going forward, but did not provide details in respect of these. The major issue with which we are faced at present relates to the two main banks, AIB and Bank of Ireland. The share prices of these two institutions continue to fall. I understand that the Financial Regulator issued a statement yesterday to the effect that the ban on the short selling of shares remains in place. The taking of short selling positions was referred to yesterday as one of the reasons for the share prices of banks falling. What is the Financial Regulator’s view on the matter? Is the Financial Regulator of the view that AIB and the Bank of Ireland are financially sound? What measures has it taken to ensure that they are financially sound? What advice has it provided to the Government in the context of ensuring that these banks will, in whatever form, be financially sound going forward? What is the Financial Regulator’s view with regard to Anglo Irish Bank being established as a repository into which toxic debt from the other banks might be placed? Mr. Farrell referred to small businesses. It is clear that, for whatever reason, the banks are not providing such businesses with funding. Liquidity has again become a major problem for the banks. What measures has the Financial Regulator suggested to the Minister for Finance might be introduced in order to ensure that the banks make available funding for small businesses? What steps might the Government take to ensure that this happens? When the Government guarantee scheme was introduced, the key aspect was that it would ensure that funds would flow to small businesses in order that they might deal with the difficulties they were experiencing, trade their way out of trouble and retain their employees. The Financial Regulator is currently engaged in investigating directors’ loans at Anglo Irish Bank and the other banks. What are the terms of reference that govern these investigations? Have the investigations at Anglo Irish Bank been extended to include the Quinn Group? What are the other issues under examination by the Financial Regulator? Has it informed the Government as to what should be done to ensure that AIB and Bank of Ireland remain in operation as sound institutions and prevent further falls in their share prices? Mr. Jim Farrell: The Deputy stated that the system of financial regulation has failed. As stated earlier, there are 13,000 regulated entities in Ireland. It is clear that there are issues with regard to the banks and we are not pretending that the position is otherwise. There is no form of regulation that would contend with the downturn that has taken place internationally and domestically. It would not be realistic to have in place a form of regulation that would have catered for the events that have transpired. Breaches of corporate governance occurred at one bank in particular. We have made our views on what happened in that regard very clear. The Deputy can rest assured that we will get to the bottom of what occurred. This will take some time. If one wishes to do a thorough job, it takes a while to do so. Deputy Kieran O’Donnell: With respect, it took almost a year for this matter to emerge. The Financial Regulator was aware of what was taking place. Mr. Farrell is going over old ground. The fact is that the system failed. As regards the various measures the Financial Regulator introduced from 2004 onwards, the dogs in the street knew there was a problem with the housing market. The IMF, the ESRI and various other commentators raised this issue. Why was a more severe form of stress testing not introduced? Why were weightings not attached to loans? Banks were allowed to operate unchecked. Young people were given 100% mortgages they could not afford. The facts do not stack up to support the statement that the Financial Regulator was doing a good job. We represent the people and the financial system and the regulator have failed the customer, bank shareholders and Ireland Inc over the past number of years. The key issue is everything in the presentation refers to the future. Proper regulation is needed now and it must be ensured that a sound financial system is in place, to which the two main banks are critical. They are sound but, based on their share price, the markets do not believe that to be the case. Regulation is about providing confidence and certainty and the regulator is not doing so. Mr. Jim Farrell: The regulator has made changes. I fully agree what has happened in Irish banking, as has happened in virtually all western economies—— Deputy Kieran O’Donnell: Not in the same severe form. The downturn is not the same. Mr. Jim Farrell: I am not here to make excuses. In the European Economic Area, 17 countries have had to resort to government guarantees while 14 have had to resort to equity injections from government. That does not make what has happened in Ireland right and I am not present to paint over what has happened. I have been chairman of this organisation since last May and we are making a great deal of headway now. People in the Financial Regulator’s office were regulating in an environment that was totally different from what we have today. The Deputy can say we should have taken more pre-emptive action. Action was taken in the context of the environment at the time. With hindsight, more severe ratios could have been applied but nobody forecasted the contraction in the economy of between 4% and 5% this year. If somebody said that 12 months ago, they would have been laughed out of court. Deputy Kieran O’Donnell: I did not refer to that. Chairman: The purpose of the meeting is to discuss the Bill and the relationship between financial institutions and the regulatory environment. I ask everyone to concentrate on this aspect. Deputy Kieran O’Donnell: Will Mr. Farrell address my question regarding AIB and Bank of Ireland? Mr. Jim Farrell: The head of prudential regulation is present and I will ask him to take this question. Mr. Con Horan: Since the end of the last year, the major action taken was that the Financial Regulator carried out an investigation using PricewaterhouseCoopers to examine the banks covered by the legislation. That report analysed, particularly from the perspective of large property development, the situation in each of the banks. Banks are going through their audits at the moment but the view from that was that the banks were able to absorb the losses in their portfolios. They have confirmed to the market that there will be losses in their portfolios but they have the capacity to absorb them. On our behalf, PwC also stress tested the portfolios beyond the losses forecast by the banks in a number of different scenarios and, in all known scenarios, the regulatory capital levels would be maintained by the banks between 2009 and 2011. That gave us reassurance regarding the two institutions referred to by the Deputy. Deputy Kieran O’Donnell: Their share prices are falling. Mr. Con Horan: The Deputy is correct and the dramatic movements of the past few days reflect events in global markets. Since last Friday, Bank of America and Citibank have come out with very bad news, which spread into the UK market where we saw significant falls in the share price of Barclays Bank and it appears the international markets have become nervous of banking again in an even more severe way. There is an international trend in banking, particularly over the past week or so, because of events in Ireland and more generally internationally in the banking system. Deputy Kieran O’Donnell: With regard to AIB, the Financial Regulator is commissioning reports such as that by PwC, which should be made public, but we have a problem. What is the regulator doing to provide further confidence to the international markets that our two main banks are financially sound? That is the key question. What Mr. Horan outlined regarding the PwC report is clearly not working. Mr. Con Horan: Measures have been taken at Government level, in which we have played a part in dealing with the Department of Finance and others. The Government guarantee scheme introduced at the end of September was a significant development and it certainly helped Irish banks in managing their liquidity in a tough period towards the end of the year. That lent a great deal of support to the banks. Clearly, the recapitalisation scheme is also designed to give further confidence to international investors that Irish banks are recapitalising themselves to the levels demanded by the market. We work with Government and other parties to assist in putting these programmes together. Mr. Jim Farrell: We do not control stock markets but the question was rightly asked about what we are doing to ensure confidence. I assure the Deputy that the regulator is completely satisfied with the solvency and liquidity position of the two Irish banks. Beyond that, the markets must make their judgments. There is not much difference between the share price drop experienced by Royal Bank of Scotland and Barclays as a percentage versus what has happened in Ireland. It is probably a little more dramatic over the past few days. We are in a global market storm and Irish banks operate in an open economy where they are exposed to the whims of foreign investors. When capital takes fright, it tends to go to the centres. Ireland is a small country and it has taken firm steps to assure foreign investors, including at government level. As a regulator, we have done what we can to ensure the solvency and liquidity of the banks. The market must make up its mind as to the value of the banks. That is where we are coming from. Deputy Joan Burton: I welcome the delegation. I understood our invitation extended to Mr. Neary and I understood from newspapers reports that he would not retire until 31 January. If so, why was he unable to attend? Mr. Neary appeared before the committee on many occasions and a number of members, including myself, questioned him. Many of us suggested there was something very wrong with the bubble in the property market and it would end badly. Journalists, economists and other commentators strongly suggested the same over the past two and a half to three years. On every occasion, Mr. Neary assured us that through his stress testing and so on there were no difficulties and everything was right. We are owed an explanation as to why Mr. Neary is not here. Is he still employed with the authority, has his contract expired or has he been retired? I understand approximately 300 to 400 people are employed in IFSRA. Perhaps the delegation will tell us the number of people employed in IFSRA and the cost in that regard, which I understand is funded by the taxpayer and the banks. As far as I am aware, the bulk of the cost is met by the financial institutions. In addition, how many people are employed in the Central Bank? This information will help to put some context on our discussion. I want to ask some specific questions in regard to recent events. One of the issues facing us in respect of the covered institutions and the authority is the restoration to Ireland of some level of reputation. Our reputation has been shredded by recent events, principally the events concerning Anglo Irish Bank, in so far as they have been disclosed. What exactly is the regulator doing in regard to the warehousing for eight years of Mr. FitzPatrick’s loans? The internal auditor may have been aware of these loans. I am not sure whether the Chairman agrees with me but it appears to me that loans of the magnitude taken out by Mr. FitzPatrick must have been known to the bank’s credit committee, loans committee, senior executives and, I assume, the board, if operating as a board of a financial institution. It would seem to me that at least 30 or, perhaps, 40 or 50 people must have been aware of the arrangements in relation to Mr. FitzPatrick. These arrangements were made with another covered institution, Irish Nationwide Building Society, the deposits of which the taxpayer is also guaranteeing. The biggest risk to a bank, in terms of fraud, is not a clerk with a gambling habit who may steal petty cash but people at the top who are crooked and may steal from depositors and shareholders. This is identified in all auditing literature as the first risk. The first risk is the movement of information on and off balance sheets so that at year end information is concealed. This is what appears to have happened in respect of Mr. FitzPatrick unless his ownership of those loans was disguised by reference to names and so on. In a bank of the size concerned — we are told of loans totalling €87 million or €120 million — the identity of that debtor must have been known, even if disguised in some way by numbers or nominee accounts, to the key people in the loan committee, credit committee and to key executives. Anglo Irish Bank dealt in large sums but had only a relatively small number of clients. Perhaps the delegation will outline why this practice was not spotted and what is being done in terms of investigation of the matter, including whether the fraud squad and the Criminal Assets Bureau have been consulted. We know IFSRA has consulted on the matter with the Office of the Director of Corporate Enforcement. There is a common understanding in company accounting. Various provisions in company law, including various sections of the old Companies Act from the 1960s, require a director to give a true and honest account in respect of transactions with companies and of their loan accounts. It is common for directors to make representations to the auditors in respect of transactions with a company. This is routine in every company. Did this system fail and, if so, is that not a clear breach of company law? I have seen references to this being a sad item but not illegal, which I do not understand based on my knowledge of company law. Many Anglo Irish Bank shareholders are pensioners who have been significantly impoverished by what has happened. Chairman: The Deputy cannot continue indefinitely. That matter has been dealt with already. |