OPINION:The scandal at Irish Life Permanent and Anglo Irish Bank threatens the entire future of Ireland's banking system, writes JUSTIN O' BRIEN
THE DECISION by three directors of Irish Life Permanent to step down caps an extraordinary week for corporate Ireland. What makes the resignations even more remarkable is that the chairman of the ILP board, Gillian Bowler, claimed the problem was not the transaction which led to their departure but the manner in which it was done.
The only motivation, she claimed, was to follow “a policy objective of both the Central Bank and the Financial Regulator that Irish financial institutions would work to support each other in the face of an unprecedented threat to the stability of the Irish financial system arising from the international credit crisis”.
The finance director, Peter Fitzpatrick, and head of treasury, David Gantly, have departed to salve the board’s “strong disapproval of and disappointment with some of the specific measures used to support Anglo Irish Bank during 2008 and the fact that the board itself was not informed of the specific manner in which such support had been afforded”.
In the early hours of yesterday, the board initially refused an offer by the chief executive, Denis Casey, to resign with his colleagues. But he insisted later in the day, “having reflected on the situation with his wife and family overnight” and so the board relented. Bowler, accepting Casey’s resignation with the “utmost regret”, said it had been prompted by his “dedication and loyalty to the company”.
The board changes followed the intervention of Minister for Finance Brian Lenihan, who had publicly called on the board of ILP to “face up to its responsibilities” after an emergency meeting with senior executives. It is hard to know who has less credibility: the Minister, who had failed to even read a report he had commissioned into the risks posed by Anglo Irish Bank; or the chairman and now outgoing chief executive of ILP who were not informed of unilateral decisions that have irretrievably marred the reputation of the State’s largest single mortgage and insurance provider.
The board statement describes Fitzpatrick and Gantly as men of “utmost integrity” and professionalism. It would appear they were victims of a misguided belief that supporting a corporate neighbour trumped any concern that the transaction seriously misled the investing public.
The controversy centres on a series of circular transactions in March and September, which were characterised as deposits rather than bank loans. The effect was to flatter the books of Anglo Irish Bank, which was haemorrhaging customer deposits in both March and by late September was at risk of immediate failure.
The explanation provided by both Anglo Irish and ILP lacks sufficient detail. We still do not know who made the decision and why. Furthermore, it is unclear whether the representatives at Irish Life Assurance (the ILP subsidiary used to effect the transaction) knew the purpose and, if not, why not?
The fact that neither the Financial Regulator nor the Department of Finance appear to have questioned the March transactions may have provided support for a misguided belief that saving corporate Ireland was more important than transparency and accountability.
The conceit is staggering and demonstrates a complete lack of understanding of international regulatory developments either within ILP or within the Financial Regulator, a member of the International Organisation of Securities Commissions. In short, the political and regulatory elite has lost all credibility in either identifying the problem or fashioning a coherent response.
The structured finance scandals involving Enron and other major US corporations at the turn of the millennium centred on precisely these kinds of mechanisms. The Sarbanes Oxley Act (2002) was introduced to curb such excesses and reduce the possibility that ignorance of the effect of a transaction could be used as a defence. It would appear that ignorance remains the defence of choice in the Irish context.
Moreover, the apparently critical report into the stability of the Irish financial sector has not been released. It is a matter of extreme urgency that this is done if the lack of international confidence in the probity of corporate Ireland is to be arrested.
The Minister may lack the financial literacy to read the document in full. He may have the full support of Brian Cowen. Loyalty always tends to trump pragmatism in Fianna Fáil.
The international markets will be less forgiving. The Minister for Finance’s position is now untenable. Unless this is recognised the short-term consequence could be catastrophic. Confidence can return only if there is transparency and accountability. Reliance on the impaired judgment of a Minister for Finance who lacks awareness of the enormity of his ignorance will not be tolerated.
It is important to be clear. What we are talking about here is not the fate of an individual bank but the future of the Irish banking industry. Unless the confusion over policy is cleared up, it is highly unlikely that international investors will risk capital on Irish institutions. Indeed, why should they?
In the Irish context, the evidence to date suggests that there was misplaced trust in the efficacy of internal controls, the strength of independent directors to hold management to account, the attestation provided by external auditors, legal due diligence, the assurances of those providing corporate advisory services, including inherently conflicted rating agencies and, ultimately, the robustness of the overarching regulatory system.
In times of crisis, there is always a retreat to quality. Across the world, capital flight is intensifying. Bank of Ireland and Allied Irish Banks, which each required a €3 billion capitalisation this week, remain dangerously exposed as a consequence of excessive bets on the commercial and residential property markets here and particularly in the United Kingdom, where late entry and desire to boost market share trumped prudence.
Ireland will find that it has to rely on itself for some time to come. This requires both a recognition that mistakes were made and a determination to change cultural attitudes.
Effective capital markets depend on confidence in the integrity of financial institutions, the regulatory apparatus and, ultimately, trust between market participants and financial intermediaries. Self-evidently, trust, like solvency, is now in very short supply, and confidence has evaporated. Resolution requires the provision of a functioning legal and regulatory framework that is informed by the interaction of rules, principles and norms.
The guiding principles of financial regulation should centre on five core components. The regulation must be transparent, accountable, proportionate, consistent and targeted. Irish financial regulation displays none of these features as a series of scandals in recent years amply demonstrates. An architecture was introduced that privileged innovation over security. In the process, it undermined crucial determinants of social life and community. Ireland was not alone in following this track. It did, however, take financial engineering to dangerous levels.
The former chief executive of Commonwealth Bank of Australia, David Murray, has reflected that “everybody got carried away by the concept of a ‘millionaires factory’ which was not culturally good . . . A lot of investment banking is that type of deal structuring, which is not very constructive. It produces over-engineered stuff that is the first to break when anything goes wrong.”
In order to avoid a repetition of past failure, it is necessary to combine assertive prosecution with informal approaches to guide behavioural change. The necessary first step is to articulate a common standard of corporate accountability. Benchmarking absolute and relative performance against this standard makes self-regulation more credible and effective. It reduces the space and justification for contestation between differing conceptions of compliance.
It is now clear that short-term financial incentives provide an insufficient support. As the chairman of the House of Representatives, Barney Frank, admonished bankers in Washington this week: “Why do you have to be bribed to align your interests with your employers?”
In Ireland, it appears that self-interest is cloaked with the promotion of economic nationalism. Such folly has brought the banking sector to its knees.
Justin O’Brien is professor of corporate governance at the Centre for Applied Philosophy and Public Ethics in Canberra and author of Engineering a Financial Bloodbath, to be published in April