Banking inquiry should look at support given to regulator and learn the lessons

Opinion: Failure to challenge those who appear to be performing well financially seems to be a recurring issue

Tue, Nov 12, 2013, 00:01

To be of value, Ireland’s banking inquiry will need to determine and act upon the weaknesses in its corporate governance system that allowed the underlying causes of the banking collapse to form in the first place.

The main factors that led the banking system to spin out of control and plunge Ireland into the economic depression from which it is still struggling to emerge were not unique to Ireland.

The banks had ill-conceived lending policies, which enabled them to earn large fees and profits over a short period of time. This apparently profitable lending enabled them to raise more funds in the international market, which allowed them to lend even more and earn greater fees, which, in turn, meant they could raise even more money – and so on.

The increased profitability led to big financial rewards for the banks’ management, thus causing them to take a reckless approach to the lending rules imposed upon them both internally and externally.

The banks became too big and treated the regulator as a barrier to their business as opposed to an entity that was supposed to govern it. Auditors had their eyes dazzled by the lucrative advisory fees their firms could earn from a bank’s success. The last thing an audit partner would want was to stop the lucrative consulting work flow by challenging decisions.

These underlying factors were replicated globally, particularly the conflicts between institutions, regulators and auditors. The inquiry should focus on the issues relevant to the governance structure in place in Ireland, where it broke down, and what remedial steps should be implemented.

There is no doubt that governance issues were compounded by the Irish business community being so small. But this was not unique to Ireland. The conflicts associated with a small community were similar in Iceland.

The inquiry therefore needs to focus on understanding the difficulties that the regulator had in managing the financial institutions as they grew both in size, global reach and product diversity.

It needs to examine both the resourcing and funding that the regulators had available to act effectively and it needs to look carefully at the adequacy of the sanctions and punishments that were available to be used against those within regulated entities who provided false or misleading disclosures to the regulators, both knowingly and recklessly.

Relationships with auditors
The inquiry needs to look at the relationships between the banks and their auditors, and the auditors and the regulators. It needs to examine whether too few firms were acting for too many clients.

Was there a conflict between the work that the auditors were doing for the regulator at one institution and the audit work it was conducting for a similar regulated entity elsewhere? It needs to examine the level of consulting fees being earned additionally by the audit firms and determine whether this had an undue influence over their judgment.

Most of all any inquiry will need to make decisive conclusions and recommendations which must be implemented.

Nearly 20 years ago, I sat in a darkened room, affectionately known as “the bunker”, at a leading London City law firm. My task was to document in simple terms, for a group of leading barristers and litigation lawyers, how the trades undertaken by Nick Leeson had bust Barings Bank.

What we produced was a step-by-step guide to a day in the life of the trading activities of Leeson – how he executed his futures and options trades, how they were accounted for, how they were funded and why no one found out that each day he was hiding an ever-increasing loss that was being funded by the bank.

What purported to be a complex trading operation was broken down into a series of pictures showing a relatively simple process. The exercise demonstrated that even for someone relatively inexperienced in the supposedly complex word of banking, as we can probably expect any Oireachtas committee to be, it was not a particularly difficult task to drill down and understand what Leeson was really up to.

Three themes emerged:
n A lack of adequate supervision
n A hesitation in challenging or questioning a star trader as to how he was making his money
n A failure in audit checks

Following the collapse of Barings, numerous inquiries were conducted, including substantial reports prepared for the Bank of England and the Monetary Authority of Singapore. Arthur Andersen prepared the report for the Bank of England, Price Waterhouse for the Monetary Authority of Singapore.

Financial collapses
Twenty years on, Arthur Andersen has dissolved following the uncovering of a serious accounting fraud at Enron, one of its largest clients, and Price Waterhouse has merged with the auditors of Barings Singapore (Coopers and Lybrand). Numerous inquiries have taken place into regulation following further financial collapses around the world, yet similar patterns continue to emerge.

My colleagues and I have investigated five banking collapses across Europe, The Middle East and Asia following the most recent financial collapse. In each investigation there have been three recurring motifs:
n No one sought to fully understand how the banks were operating
n Dominant shareholders or owners were not challenged
n There were failures in audit checks

As we finally look forward to an economic upturn, the Oireachtas inquiry needs to ensure more than anything that in 20 years’ time we are not still discussing audit failings and regulatory weaknesses in the financial sector.

Richard Abbey is a partner in the specialist financial investigations firm Tyrian. He has more than 20 years’ experience of conducting forensic accounting investigations across a wide range of sectors

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