Crisis result of property bubble and weak rules


REGLING-WATSON REPORT:IRELAND’S BANKING crisis resulted from a “plain vanilla property bubble” and “weak” bank governance and risk management, according to the preliminary report produced for the Government by Klaus Regling and Max Watson.

The two experts were also critical of the Government’s management of the economy, highlighting the raft of property-related tax breaks, the narrowing of the tax base and its failure to cool the economy by budgetary measures.

But they also concluded that Ireland’s membership of the euro zone helped the country to survive the global banking crisis that unfolded in 2008.

In their 45-page report, the two experts found that the banking crisis was caused by a simple over reliance on property lending, particularly to the commercial sector.

“Bank supervisors in Ireland were not called upon to deal with technically complex problems,” the report states. “Ireland’s banking exuberance indulged in few of the exotic constructs that caused problems elsewhere.

“The problems lay in plain vanilla property lending (especially to commercial real estate), facilitated by heavy non-deposit funding, and in governance weaknesses of an easily recognisable kind. The Watson/Regling report said this could be an area of “further investigation to see what degree of censure is warranted for the failures of supervision”.

The report found that credit risk controls failed to prevent “severe concentrations” in property lending and resulted in “high exposures to individual borrowers” and a “serious overdependence” on wholesale funding.

“It seems that internal procedures were overridden, sometimes systematically.”

It also notes that “incentives set for middle-level bank management and indeed loan officers” could have played a role in the property market overheating.

The two experts said there was a need to “probe more widely” the scope of band governance failings.

It highlights how joining the euro zone gave Irish banks access to cheap wholesale funding while increasing the competitive pressures on domestic banks as foreign-owned institutions targeted this country for growth.

But it also clearly states clearly that membership of the euro zone helped Ireland weather the global financial crisis.

“Funding problems for the banking sector would have become much bigger,” it says.

“Firms and households would have borrowed more in foreign currency and would have been exposed to balance sheet risks.

“Co-ordination problems for national central banks would have been significant.

“None of the interlocutors in Ireland and abroad . . . questioned that European Monetary Union membership for Ireland has been, on balance, highly beneficial.”

Mr Watson and Mr Regling also questioned the Government’s handling of the economy following Ireland’s entry into the euro.

The report states that wages increased by two or three times the euro area average from 1997 to 2008, while civil service employee numbers rose by 15.5 per cent from 2001 onwards.

It said repeated income tax cuts narrowed the tax base and made it “more fragile because the booming part of tax revenue turned out to be a transitional phenomenon”.

“Budgets that were strongly counter-cyclical could have helped to moderate the boom. . . but budgetary policy veered more toward spending money while revenues came in,” the report says.

“Ireland was also unusual in having tax deductibility for mortgages, and significant and distortive subsidies for commercial real estate development, yet no property tax.”