ANALYSIS:Banks lobbied hard for the removal of the sort of regulation that might have helped mitigate the scandalous behaviour that is now emerging around Anglo Irish
THE REVELATION that a subsidiary of Irish Life and Permanent made a huge temporary deposit of €7 billion in Anglo Irish Bank at the end of its financial year raises further serious questions about governance and regulation.
Anglo had been losing deposits and seems to have classified the €7 billion injection under “customer deposits” which would, of course, have made its balance sheet look considerably stronger.
While the jury is still out, it seems fairly clear that this back-to-back transaction was designed to window-dress the accounts of Anglo – on the eve of an investor roadshow.
At the time, the Financial Regulator was encouraging banks to lend to each other and so improve liquidity, but it is doubtful if the regulator would have accepted the classification of such funds as customer deposits.
It is a grave matter for four reasons.
It would mean that Anglo was misleading existing shareholders, credit-rating agencies and potential new investors.
Second, it would indicate that other banks, apart from Anglo, ie counterparty banks and their subsidiaries, were aware of the window-dressing. If those institutions were prepared to help out a rival bank in this way, what might they not be capable of doing themselves?
Third, it would suggest there is a degree of collusion between banks which might come as a surprise to the Competition Authority.
Fourth, it would indicate that banks had no regard for, or fear of, the Financial Regulator and, indeed, treated that body with contempt. One wonders how honest they were with the Minister in the negotiations leading up to the recapitalisation plan announced on Wednesday.
We did put manners on the banks some 15 years ago. At that time, there were quite strict regulations imposed on banks by the Central Bank for economic reasons rather than prudential ones. They included a primary liquidity ratio, a secondary ratio to ensure the banks bought certain amounts of Irish government bonds, a matrix of maximum interest rates which could be charged, and “corsets” which limited the margins banks could impose on their customers.
There was also a period when the banks had to limit their credit growth to a certain percentage every year, and they were obliged to allocate a proportion of that credit to productive business activities.
These regulations were designed primarily to help the economy and they were supervised by the economics side of the Central Bank and not by the Financial Regulator.
These (economic rather than prudential) regulations gave rise to serious lobbying by the banks, and gradually they were abolished on the (unproven) grounds that there was adequate competition among banks.
There may also have been a political push to this process of deregulation. It is clear that banks have always been part of the establishment of this country and have always maintained a close relationship with political parties. Since Anglo lent to many of the property developers, it had a natural affinity with the present Government.
How did Anglo’s internal auditors view this in-and-out transaction – and, indeed, other dubious transactions involving directors’ loans and lending for share purchase?
What of the external auditors? It is interesting to remind ourselves that auditors are so-called because, originally, they simply listened to the chief executive’s account of the business and then signed off. Perhaps this relaxed auditing tradition lives on despite the huge fees which are charged.
Auditors and accountants use a peculiar language in which the words “right” and “wrong” do not appear. If something smells to high heaven it may be said to be “irregular”, and if it is downright fraudulent it is said to be “irregular and material”.
We now know to our cost that principles-based regulation was far too lightweight for our banking system. It is probably unfair to blame the Financial Regulator entirely for this.
The Government decided, after considerable lobbying, to let that function remain in the Central Bank and it appointed most of the members of the authority which oversaw the function. None of these political appointees had any experience of financial regulation.
Partly because of our Boston connection, there was also a spirit of laissez-faire in the air, and the development of the International Financial Services Centre added to that free-booting philosophy. The Irish promoters of the centre were always careful not to irritate the institutions located there, and regulation became as light as a feather landing on a snowflake.
Financial regulation cannot prevent an institution going bad. It can only reduce the probability of this happening. It is virtually impossible for a group of public officials to keep on top of fast-moving financial innovation.
It is as important to assess the probity of bankers as it is to examine loan books and capital ratios. This aspect of personal “fitness and properness”, however, is a legal minefield.
Nevertheless, the Financial Regulator should have done more given that an ounce of prevention is worth a megaton of cure.
The flamboyant growth of Anglo Irish Bank was noted in dispatches several years ago. The rate of growth was such that questions should have been asked about the quality of the balance sheet against the background of a rapidly inflating property market.
Sometimes the rate of progression can be too fast. It was also well-known that Anglo was highly exposed to property, especially commercial property. In short, Anglo stood apart from most other institutions in terms of risk.
Like the other banks, Anglo was repeatedly stress-tested. The responses to these tests seemed to satisfy the regulator. But it must surely have been suspected that, since the questionnaires were filled in by the banks themselves, they would tend to be self-serving.
Five or six years ago, the Financial Regulator and the Central Bank began to develop contingency plans for possible banking crises. Officials were sent to countries like Sweden, to engage in war-games, ie exercises for coping with simulated crises. This was important work, and it is paying some dividends now. However, a cynic might ask whether it might not have been better to have put as much effort into preventing crises from happening in the first place.
It is probably going too far to suggest that the regulator has been “captured” by the banking industry but the degree of closeness is greater than it should be. The practice whereby former central bankers and regulators join the boards of entities they once regulated is highly questionable and should be stopped as a first step towards reform.
We should have some sympathy for the Minister for Finance who inherited a crisis caused by others, including some of his colleagues. The recapitalisation plan he announced yesterday has a number of good provisions. The reference to a “short, sharp” due diligence is worrying, however, given the amount of taxpayers’ money involved. Even so, the €7 billion may not be enough though it is probably not too far short of the mark. Toxic assets may have to be dealt with in a more direct manner later.
It will be very difficult to monitor the situation to see if the banks live up to their agreements regarding house repossessions and lending to small and medium businesses. If they fail to comply in any respect, there should be instant dismissals at senior level.
We have all learnt the hard way that trusting in banks is foolish.
Michael Casey is a former chief economist at the Central Bank and a member of the board of the International Monetary Fund