Memo to the banking inquiry: please answer the following questions
OPINION:THE PROPOSALS about structuring the financial investigation seem to me to be unwieldy and lacking in transparency. But the methodology probably is not all that important as long as the major questions are answered fully and honestly within a reasonable timeframe. The financial institutions will have to answer the following questions, truthfully and in considerable detail. Internal memos and minutes of meetings should in all cases be made available.
1Why did boards and senior management not worry about excessive growth of credit, especially for commercial and residential property? What kinds of discussions took place between boards and management on portfolio diversification and “value at risk”? How many of these individuals understand how risk is measured? Do they believe that current systems for calculating bad-debt provisions are adequate?
2What, if any, warnings were given by internal auditors, risk managers and credit committees? What responses were made by senior management to these committees.
3To what extent were the bonuses and incentives geared to growing the balance-sheet at the expense of quality? Loan officers, for example, might have received bonuses for a high volume of business booked, but did not suffer any sanction when these loans went bad.
4What discussions took place on the question of banks depending more on borrowed funds than on deposits?
5How did bank’s internal stress tests compare with those submitted to the Financial Regulator? To what extent did all of these tests err on the side of optimism?
6Between 2004 and 2008 what policy discussions were held between the banks and Financial Regulator on the issue of burgeoning property-related lending?
7What systems were in place for valuing property provided as collateral?
8Why did it take so long for senior executives to admit to problems, such as the need for recapitalisation?
9What steps were taken over the last five to 10 years to develop skills in relation to derivative financial products?
10What does the Competition Authority make of two big institutions colluding to window-dress year-end accounts? Are there other examples of collusion?
11Why did the board of the Central Bank lobby so hard for the twin-pillar approach, instead of accepting a greenfield Financial Regulator? Why did they succeed?
12Has corporate hospitality led to a form of “regulatory capture”? Details of corporate hospitality should be provided, as well as the number of regulator staff who join the boards of financial institutions.
13How many on-site inspections were carried out by the regulator on the main property-lending banks each year between 1995 and 2008? What were the main issues investigated? What kind of advice was given to each institution?
14What was the attitude of the regulator to Anglo Irish Bank and Irish Nationwide Building Society 10, seven and three years ago?
15The degree of concentration on property-related lending in these two institutions reached extraordinary levels in 2007/8. Did the regulator discuss this with the Financial Stability unit of the Central Bank? Were concerns relayed to the board of the bank and the authority of the regulator? Did the members of these boards pass on the concerns to the politicians who appointed them, or to any other politicians? What were the responses? (If the response at political level was to take no action, then Pat Neary would be exonerated.)
16Did the Financial Regulator decide not to take any action and if so, why?
This is the most fundamental question and it is important to explore it further. In its mission statement the regulator is strangely silent on the question of intervening in a troubled financial institution. It could be argued that the failure to intervene is due to bureaucratic inertia. The regulators wait and wait and hope the problem will disappear. The point then comes when the troubled institution hits the wall and it is too late. We then go suddenly from the possibility of preventative action to the need for damage limitation – which as we have seen in Ireland is extraordinarily complex and costly.
One reason for inertia could be the fear of litigation. If bureaucrats do intervene before a crash then word might leak out and cause a run on the troubled institution. The latter could then sue the regulator for taking “peremptory” or excessive action and damaging its business.
What is intriguing is the possibility that the Financial Regulator does not have an endgame. Is it conceivable that regulators never have any intention of intervening? This is the fundamental question that must be pinned down by the investigation because it raises profound issues about what regulation is all about.
In Ireland, the main institutions did hit the wall and the Government, advised by the Department of Finance and EU Commission and ECB, provided huge deposit guarantees, followed by recapitalisations (and the promise of more) and a bad bank (Nama) to take the bad assets off the books of the banks. The main questions that must be addressed here are:
- Were all three approaches necessary?
- Why was Anglo not allowed fail?
- Why was temporary nationalisation not considered, or a greater degree of risk-sharing?
- Why is the Nama business plan so optimistic? It is essential to stress-test this plan by feeding in less favourable assumptions.
- Under what conditions will Nama get the banks lending again?
No doubt there are other questions which should be answered and the list presented here should be regarded as the bare minimum.
The people who took bad decisions should be named since this is part of the process of reforming the system. It is unlikely, however, that many people will be named – because of our Houdini-like capacity to unshackle ourselves of responsibility. It is also worth remembering that our system of political appointees allows senior politicians pull the strings without the public knowing.
Michael Casey is a former chief economist at the Central Bank and a member of the board of the International Monetary Fund