OPINION:THE GOVERNMENT plans to reorganise the Central Bank and Financial Regulator for the second time in seven years. The last reorganisation changed the existing one pillar into two pillars. The present proposal is to change the structure back again to one pillar. It does not seem as if much thought has gone into this, writes MICHAEL CASEY
What does not seem to have been considered is the original McDowell committee proposal of hiving off the Financial Regulator completely.
In any event, the culture of an institution is far more important than the organisational set-up.
The promise of more staff and resources for financial regulation is not well founded either. Before and during the existing twin pillar era, regulatory staff numbers were increased by about 30 per cent. Did that help to prevent the banking catastrophe that occurred within five years of the restructuring and expansion? Sadly, it did not.
There is no point in throwing bodies at the problem, especially in the middle of a fiscal crisis. More importantly, how can something be fixed when it is not known what went wrong?
The most critical reform of regulation would be to establish clear rules and to impose serious penalties for breaches of the rules.
Suppose, for example, that Anglo Irish Bank had been seriously fined for going beyond a certain level of concentration in its loan book, and suppose there were mandatory dismissals at the top for breaching such important rules. Would we then need many regulators for supervisory purposes?
No, we would not. If the penalties are tough enough, the executives and boards of banks will behave themselves.
There is no need to waste taxpayers’ money by employing more regulators. Just make the rules tough and clear and the penalties tougher and clearer. It is actually quite a simple matter and it can be done cost-effectively.
Before any reform of financial regulation, we need to know exactly why and how it failed. There are many questions about the failure to regulate Anglo Irish Bank (to take but one example) that need to be answered. It must have been known by the Financial Regulator that this bank was incurring risks that were off the chart. This must have been known for several years. Yet nothing was done. Why?
As far back as 2003, the Financial Regulator reported on the outcomes of its on-site inspections. In general it concluded that there was inadequate status given to risk management committees in those institutions which had been inspected.
There were even cases of inaccurate computation of capital adequacy, and there were cases of procedures manuals being out of date. Other serious deficiencies were noted. Clearly, alarm bells had to be ringing, especially in the middle of a property boom.
It was also widely known from international experience that by far the greatest risks were associated with commercial property lending, rather than lending for house purchase. Who was the biggest player in this market segment, and who was growing its business at an incredibly fast rate? Anglo.
Most of the other banks were trying to keep up with Anglo, to protect market share, and this caused a classic race to the bottom in terms of asset quality.
But back to Anglo: it is not clear how many on-site inspections were conducted with Anglo, but there would probably have been two a year, each one lasting a week or more. We do not know whether any of these inspections were “themed”: ie, focused on specific issues, or indeed whether they were scheduled or unscheduled.
We do know that the Financial Regulator received comprehensive data on Anglo’s balance sheet each and every month. Therefore, they would have been aware of the huge concentration on commercial property in its loan book.
Moreover, they would also have been aware of the extraordinary degree of concentration within the loan book, such as outstanding loans of some €500 million to each of fifteen property developers. (How Anglo was allowed to get into this bizarre situation in the first place is a question for another day.)
Concentration is the opposite of diversification. The fact is that Anglo had almost all its eggs in one basket – commercial property.
Even a slight wobble in the property market was guaranteed to cause problems. Because of Anglo’s dependence on foreign borrowing (instead of deposits), the Financial Regulator would also have been aware of the possibility of reputational risk internationally.
The fact of the matter is that Anglo stuck out like a sore thumb. It was the proverbial accident waiting to happen. No one knew this better than the regulators who dealt with Anglo – well-trained accountants – who must have escalated their concerns up to the authority and indeed to the board of the Central Bank. Why was nothing done?
Conspiracy theorists might suggest that political instructions were given to “let the hare sit” and that the taxpayer would ultimately come to the rescue. There are other variations on this theme.
It is more likely that the Financial Regulator at the highest level was in a quandary. If, for example, Anglo was instructed not to accept new deposits or borrowings and/or to curtail its lending, the news might have leaked out. This could have caused a run on the bank.
In this event, the regulator would be accused of causing the crisis and might even be sued by Anglo.
When banking problems are allowed to build up they reach a tipping point beyond which the solution becomes extremely difficult. There is no clear endgame. This is why prevention is infinitely better than cure.
If even some of this is correct, then we must ask the next question. What exactly is the point of financial regulation if the regulators can’t or won’t take action? Why provide more resources to a function which cannot act as it is supposed to?
The good news is that we can get answers to these questions because there must be a paper trail. The regulators who examined Anglo over the years would have prepared reports and sent them all the way up the line. The authority would have recorded its views in the minutes of its meetings. Government ministers would probably have been in the loop since they appointed the members of the authority.
The Government as a whole should have complete access to these documents. If the regulatory function is to be reorganised and given more resources, then we should at least know whether it can ever work!
In my view it can only work if there are tough rules and penalties in place. But in that case there would be less need for regulators.
The public should also have access to these documents. Why? Because the Financial Regulator and the Central Bank are public bodies, and, unfortunately, we, the public, now also own Anglo Irish Bank.
Michael Casey is a former chief economist with the Central Bank and a former member of the board of the International Monetary Fund