OPINION:THE EVENTS of the last three months have shaken confidence in Irish banking and the regulatory framework that governs it. Everyone in the financial services industry is angry and disappointed that the behaviour of a small number of senior executives has done so much damage to Ireland's reputation. A well-informed and thoughtful debate is required to fix a system so obviously broken.
The Taoiseach’s announcement on Saturday evening that the Government intends to establish a Central Banking Commission with international expertise and greater involvement from the Central Bank is a start. But unless it is accompanied by a thorough rethink about our attitude to regulation and additional resources, it is unlikely to represent a complete solution.
Most importantly, there needs to be a clear recognition that our financial services industry is complex and heterogeneous. Ireland’s international banking, insurance, and fund administration businesses present fundamentally different regulatory issues to our domestic banks, and require a tailored approach with international credibility.
There is a view among some media and political commentators that our regulatory system failed because the International Financial Services Centre sought light-touch regulation. This is simply wrong. More importantly, the lazy analysis that leads to this conclusion masks a more fundamental problem. The truth is that the quality and quantity of financial regulation in Ireland are the same as in any western market economy. Unfortunately, it has not always been applied and enforced as comprehensively as it should. Second, far from encouraging this situation, the IFSC has consistently argued for greater resources and expertise within the Financial Regulator. Also, the financial services industry has warned the Financial Regulator about the risks of increasingly complex financial markets for many years.
It is important to note that the vast majority of financial regulation in Ireland is derived from EU law, and is exactly the same as in any other EU state. However, our enforcement and supervisory structures represent something of a regulatory solo-run, as they were devised 10 years ago as a response to very specific problems in the domestic banking sector that came to light at that time.
Over the last decade there has been a wholesale restructuring of our system to provide a greater level of consumer protection. This included the creation of an Irish Financial Services Regulatory Authority, semi-detached from the Central Bank, with a dual mandate to secure sound financial markets and protect consumer interests, and with a complex governance structure that involves two separate but overlapping boards.
No other country has tried to fuse prudential supervision and consumer protection within one organisation regulating everything from global banking giants to small credit unions. The events of the last few months, and the Taoiseach’s announcement on Saturday, would suggest that this experiment has come to an end.
Whatever form the new commission takes, it must recognise that its success will depend on securing cutting-edge expertise from around the globe and focusing clearly on the sectors with the greatest systemic risk. It must also resist the temptation to spend years rewriting regulatory standards at the expense of enforcing the ones that currently exist.
Despite the widely held view that “principles-based” regulation is a second-rate system, this is not the case. Most importantly, in the current crisis there is little to suggest that “rules-based” systems performed any better. As many countries have discovered, specific rules are not enough to effectively regulate complex financial markets.
Despite a heavily prescriptive rules-based system, the US was where the sub-prime mess started. Similarly, the German financial system has struggled to deal with the collapse of its Landesbanks, and countries as diverse as Belgium and Hungary are grappling with banking problems as complex as ours.
The introduction of high-level principles in Ireland over the last few years was intended to promote a stronger compliance culture within firms and place a greater importance on the substance of their behaviour, rather than whether it was strictly legal. But its success always depended on the availability of sophisticated and experienced regulators, because irrespective of the regulatory style a country adopts its effectiveness depends on the quality of the people supervising it.
The IFSC has consistently argued for greater resources and expertise within the Financial Regulator’s office. The Financial Regulator’s Consultative Industry Panel is the key forum for industry to raise concerns and make suggestions. For several years the industry panel has warned about an emerging knowledge gap in that organisation.
The panel has recommended, on a number of occasions, a range of measures including the appointment of more personnel to focus on risk monitoring, and a greater level of expertise in complex financial products and markets. The panel and various industry groups also warned the Financial Regulator’s office about the increasingly complex nature of international financial services. The industry also highlighted the lack of financial services experience on the board of the Financial Regulator, and the need for a dedicated unit to anticipate the regulatory hazards caused by financial innovation.
Cynics might find it hard to believe that the financial services industry wants more regulators and supervision but, for most firms, financial regulation is akin to airport security – despite the cost and inconvenience, it is essential to keep them safe. At the heart of the relationship between consumers and banks, insurance companies and fund managers, is the peace of mind that comes from knowing that the company you are dealing with is properly regulated.
Any question mark over the quality of Irish regulation and our international reputation is fatal to the success of our industry – which is why Financial Services Ireland has consistently argued for additional resources in the regulator’s office and for international best practice to be at the heart of its work. We don’t, and never did want a pro-business regulator – just one that is businesslike.
There is a broader lesson to be learned. Our current system was the result of looking in the rear view mirror 10 years ago and trying to fix problems of the past, rather than looking to the challenges of the future. We cannot afford to do the same thing again. The problems in some of our domestic banks are extremely worrying, but we should remember we are not alone in this regard, and a real solution will only be found by looking at how other jurisdictions are tackling similar problems. There is an entirely new financial system taking shape and we need to prepare for it.
Globally, governments and financial regulators are trying to work out what went wrong and how to prevent it happening again. Last week a high-level group made recommendations to the European Commission on the future of financial regulation, and it is widely expected that the commission will act on many of those recommendations. Similar exercises are under way in the US and the UK.
If we are serious about restoring our international reputation, we must have a regulatory structure that reflects the best of this international thinking, is outward looking and is policed by the brightest and the best.
We look forward to seeing the details of the Government’s plan.
Brendan Kelly is director of Financial Services Ireland, the group within Ibec that represents the international financial services sector