Latest Central Bank move on banking oversight will help reduce risk

The legendary Warren Buffett once described some shadow banking activities as "financial weapons of mass destruction". By that he meant they pose a huge threat to the global financial system, as these investment structures operate outside the traditional banking system and, unlike the latter, are not subject to close regulatory oversight.

One favoured investment structure is the special purpose vehicle (SPV), which major financial institutions set up in order to contain risk, by keeping certain assets off their balance sheets. The Central Bank now wants to improve its oversight of the SPV sector, which has developed an increasingly large presence in Ireland. The bank will do so by extending quarterly reporting requirements to this, and to other such investment vehicles.

Ireland has become a favoured jurisdiction for locating SPVs. The country is seen as offering a favourable tax regime, having a large number of double taxation agreements, and providing a developed corporate legal system. Another attraction has been light-touch regulatory oversight of these SPVs. Central Bank economists last month reviewed the sector, recognised that latter feature, and also expressed their concern at how so little was known about what so many of these Irish registered entities did.

They noted that a lack of information about the activities of SPVs, which are opaque and largely unaccountable, made it “difficult to assess fully the financial stability implications of activities within the sector”.

One harsh lesson learned from the global financial crisis was the failure of light touch financial regulation of domestic banks, which has cost Irish taxpayers heavily. At that time, Ireland also faced some criticism from Germany for its lax regulation of Depfa bank, based in the IFSC, which had it not been rescued by another German bank, Hypoverein, could have meant an additional bill for the taxpayer. The Central Bank has been right to increase its regulatory oversight of SPVs, which pay little tax, and potentially pose, as Mr Buffet recognises, major risks to international financial stability.