Changes to services regulation here need to be closely co-ordinated with global responses – and they must bring about changes in operating practice, writes FRANK DILLON

REFORM OF the regulation of financial institutions was high on the agenda of governments in the US, Europe and Ireland last week. The unveiling of plans here for a new Central Bank of Ireland Commission, while admittedly short on detail, ended months of speculation about what structures will be put in place to reform the regulatory mess in this area and has been broadly welcomed by financial industry sources.

It is generally accepted that reform of the financial services industry needs to take place at three levels. Firstly, institutions need to reform their structures and practices, especially in relation to how they manage risk.

Secondly, there needs to be a powerful, well-resourced national regulatory framework, and thirdly, there needs to be an international element to co-ordinate global responses. As one observer put it: “If the crisis of last year illustrated anything, it’s that you need something big enough to gets its arms around problems that have global dimensions.”

At EU level, much of the work going on is as a result of the report of the de Larosière group that was established to look at how to organise the regulation of financial institutions and markets in the EU. Its brief extends to how to strengthen European co-operation on financial stability oversight, early warning and crisis mechanisms, and how EU supervisors should co-operate globally.

Among its recommendations are urgent reform of the Basle 2 capital requirements to create capital buffers amongst other things – in other words putting capital aside during good years to cope with the bad one – and strict regulation of so-called parallel banking systems such as hedge funds that present systemic risks to the financial services market.

It also proposed the creation of a systemic risk council under the supervision of the European Central Bank to gather information on all macroprudential risks in the EU – a proposal endorsed by EU leaders at a summit last week.

Ray Kinsella, professor of banking at UCD Smurfit School, thinks a global response is necessary. “We need a global regulator to co-ordinate efforts across continents in real time. There’s no point in governments arranging conferences for two weeks down the line to deal with immediate systemic threats.”

Kinsella suggests that such a body could be built around the Bank for International Settlements, a forum in which central bankers meet that also provides liquidity to central banks when needed. Three essential elements needed are a mandate, sufficient resources and the instruments to do the job properly, he says.

But there is growing recognition that financial institutions need to play their own part.

“Regulation is a necessary but not in itself sufficient condition for ensuring that banks don’t collapse,” Kinsella observes.

The financial services industry has a vested interest in reform to create a healthier, more stable operating model, both for itself and for the wider economy.

Governance is the key word in boardrooms today, notes Garvan O’Neill of PricewaterhouseCoopers. He says there is now a much more heightened – albeit belated – focus on the issue of controlling risk. The boards of some heavyweight global financial institutions have admitted that they did not even know that they were exposed to subprime lending through the complex instruments they had invested in – a practice no one wants to repeat, he says.

Some observers believe there are still massive losses on the balance sheets of European banks, but have not yet been recognised. The ECB warned last week that euro zone banks might have to take another €204 billion in writedowns by the end of 2010, mainly to cover risky loans.

One of the hottest jobs in banking from now on, O’Neill says, will be the post of chief risk officer. “This needs to be a very senior person, independent and with clout that can articulate risk factors clearly and highlight when risk is moving outside the agreed parameters. They need to be sitting in the main boardroom, not operating at a sub-committee level, and their remuneration should not be tied to the banks’ short-term performance in such a way as to lead to a conflict of interest.”

The days of bank directorships being handed out to retired “worthies” from the business community, who have no particular experience or insights into financial services-related issues, should now be over and there should be no room for “nodding dogs”, he adds.

Moreover, risk needs to permeate every level of the organisation. Staff processing mortgage-related paperwork, for example, need to be aware that failure to sign off on certain documents could affect the institution’s lien on the asset.

David Sherriff, chief operating officer of Microgen, a UK-based financial services technology firm with a global client base in the industry, says the new environment will involve an infinitely more complex data management and reporting landscape.

“The new regulatory model must require banks to better manage data and provide a clear, consistent view of financials and liquidity across the entire business, for all financial products and activities,” he says.

“This is no short order – banks manage massive amounts of data at very high speed every second, and they tend to be complex widespread, global organisations – so the regulatory model also must provide guidance for how to make that sort of system of reporting happen.”

For this to work, Sherriff agrees there must be buy-in from the institutions whose bottom lines and daily operations will be affected by regulatory change. Regulators must make room at the table for bank executives and industry bodies so that regulatory outcomes reflect the collective input of the industry.

Pat Farrell, chief executive of the Irish Bankers’ Federation, says the industry is at one with government in wanting a better regulatory system and says he looks forward to progress in this area over the coming weeks and months. The proposed new system, with an increased emphasis on prudential rather than consumer affairs regulation – notwithstanding its own importance – is one he welcomes.

Farrell notes that regulation assumes a greater importance here because of the IFSC. The Irish regulator has a very big mandate because of it and the complexity of some of its operations has to be matched by the skills and expertise of the regulator, he says.

Ironically, one of the positive byproducts of the fallout of jobs in the financial services sector is that increasingly talented people are now available to fill regulatory posts, talent that would not have been available during the boom.

Some in the industry believe this talent could help Ireland to quickly overcome its tarnished image and become a model for financial services regulation.

One way or another, however, the landscape is changing irrevocably. As Sherriff puts it: “Regulatory changes may be painful in the short term, but ultimately will bring tremendous benefit to the industry and, just as importantly, will help to rebuild the public’s trust.”