COMMITTEE OF PUBLIC ACCOUNTS debate - Thursday, 13 May 2010

Special Report No. 72 of the Comptroller and Auditor General: Financial Regulator

Mr. John Buckley (An tArd Reachtaire Cúntas agus Ciste) called and examined.

Mr. Matthew Elderfield (Financial Regulator) called and examined.

Chairman

We are dealing with Special Report 72 of the Comptroller and Auditor General: Financial Regulator, Responding to the Financial Market Crisis.

Before we commence I remind members of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the House, or an official by name or in such a way as to make him or her identifiable. Members are reminded also of the provisions within Standing Order 158 that the committee shall refrain from inquiring into the merits of a policy or policies of the Government or of a Minister, or the merits of the objectives of such policy or policies.

I welcome Mr. Matthew Elderfield, Financial Regulator, Office of Financial Regulation, and invite him to introduce his officials.

Mr. Matthew Elderfield

I thank the Chairman and members of the committee for inviting me to discuss the special report. I am accompanied by two colleagues, Mr. Patrick Brady, our newly-appointed assistant director general for risk and policy, and Mr. Brendan Sheridan, our newly-appointed assistant director general for consumer protection.

Chairman

I thank Mr. Elderfield. In welcoming Mr. Elderfield to the Committee of Public Accounts I would like on my own behalf and on behalf of the committee to congratulate him on his appointment. It is a very onerous task. He has taken on a task that is vital to our future well-being as we need a good, healthy and competitive banking system. It is clear from his early words and actions to date that he intends to oversee a system of effective regulation. The role of this committee is to examine the value for money report of the Comptroller and Auditor General and in that regard we are essentially examining how effective our regulatory system is in doing its job.

In his report, the Comptroller and Auditor General has looked at the Financial Regulator's systems and processes and how he evaluates risk in our financial systems. The committee will now examine the steps that are being taken by the Financial Regulator in seeking to get institutions to manage the risk, based on the information he has taken from the regulated bodies. We will also examine the resources he needs to fulfil his mandate as well as the powers he has to bring regulated bodies into line. We have seen where the principle-based light touch regulation has led us and we will question today how the new regime of rules-based regulation will work in practice and how it will prevent situations arising and ensure that the banks and insurance companies are kept well away from the emergency department or, in the case of some banks, their reliance on life support. Our primary concern is that things that should have been done, especially in terms of over-exposure of banks to the building industry and the reliance of banks on bond markets to fund their lending, were not done and we will seek assurances that such events will not recur under the new system. I invite Mr. Buckley to make his opening statement.

Mr. John Buckley

The primary purpose of this special report was to identify the measures taken or proposed by the Financial Regulator to respond to shortcomings in regulation that come to light as the financial market crisis unfolded during 2008 and 2009. A second aim was to draw together the results of international reports on the reasons for the crisis and, in particular, into what aspects of regulatory practice might have contributed to the problems.

Two previous special reports have dealt with regulation of financial services providers by the Central Bank and the regulator. I will briefly put the latest findings in the context of the earlier work. First, however, I want to refer briefly to the scope of the mandate I have to examine and report on the work of the regulator.

The Central Bank Act 1997, as amended, provides for the Comptroller and Auditor General to carry out examinations of the efficiency of the regulator and of the systems, procedures and practices used by the regulator to evaluate the effectiveness of its operations. Consequently, the primary focus of any review by my office is on the efficiency of the regulator's processes. Prudential judgments are a matter for the regulator alone and do not come within the scope of my audits.

The first examination carried out by the office was reported in 1999. It looked at the Central Bank's approach to regulation of credit and investment institutions, which was the extent of the regulatory remit at that time. The report on the examination concluded that: the frequency of on-site prudential inspection appeared low, and target levels of inspection were not being achieved; the Central Bank had adopted a light-touch approach to prudential supervision with limited on-site inspection activity combined with review meetings with the management of the institutions; the Central Bank did not base its prudential supervision work on a formal risk-based approach — we recommended that such a system be developed; and we also concluded that, if a formal risk assessment were to be instituted, the prudential risk profile of services providers in the various sectors could potentially be used to gauge the stability of the overall sector.

Following completion of that report and of an inquiry into deposit interest retention tax administration, which was completed around the same time, there was an in-depth review of the role of financial regulation and its structures. That resulted in the establishment of the Financial Regulator in its current form and it brought together responsibility for most financial regulation into a single agency. This included functions of the then Department of Enterprise, Trade and Employment. The Office of the Director of Consumer Affairs and the regulator then commenced operations in May 2003. A second examination was undertaken having allowed a period for the new institution to settle in. It was intended as a follow-up to see if the recommendations of the earlier report had been implemented.

The report on this examination was published in May 2007. The main findings on prudential supervision of financial services providers were as follows. While the regulator had developed a formal risk-assessment model, there remained scope for its enhancement. A shortcoming was that the model by then in use had been developed to assess the risk of one service provider relative to another, and it did not try to assess the absolute risk attaching to the institutions in question. From a resources viewpoint the model operated to allocate available resources for supervision work in each financial sector, rather than to inform decision making about what the optimum level of resources that might be needed for supervision work. In short, supervision was still resource driven but with priority going to those institutions that were assessed as relatively more risky. The model would not necessarily therefore detect alterations in the overall risk within a sector. The report also repeated the concern about the frequency and intensity of on-site inspection work. It was found that the frequency of visits to financial services providers remained low. As a result of this work we recommended that the regulator should arrange for an independent review of the adequacy of its prudential processes, including the target frequency and duration of inspections, the resource levels applied, the checks carried out on-site and the follow-up processes. We also suggested that this work be carried out by means of peer review and that the inspection process should be benchmarked against those of other EU regulators with similar mandates. We noted that the regulator had, up to then, used administrative penalty powers provided in 2004 in a limited way.

The latest report, which is before the committee today, sought to examine how much progress had been made since 2007, to explore how the regulator had responded to the turbulent events of 2008 and how he was changing or planning to change the processes in the light of experience. I will now outline some of the key findings of the latest examination. In response to the recommendation in the 2007 special report, the Financial Regulator had commissioned consultants to carry out a review of the adequacy of its prudential inspection process as part of a general business process review. This found that the level of resources devoted to banking and insurance supervision was lower than that of other international financial regulators reviewed.

By way of a response to the financial crisis, a significant intensification had occurred in how those credit institutions that had availed of the State guarantee for banking liabilities were being regulated, including additional reporting requirements, increased on-site presence by regulation staff and attendance at key meetings. The regulator noted that a key factor in implementing a more intensive supervisory approach generally was the recruitment of additional staff and supervisory personnel. The regulator has committed to developing and extending the current risk model as a priority but he stressed that the ultimate design of the model will need to be aligned with developments in the international regulatory framework.

Arising from an internal inquiry into its response to information about the handling of directors' loans at Anglo Irish Bank, the regulator identified a need to improve internal information management processes and for greater disclosure by financial services institutions of directors' loans. Overall, the regulator has acknowledged that, in retrospect, the actions it took were insufficient and were not taken early enough. It stated that it took what it then considered to be proportionate actions to mitigate the risks in the system but that this was not enough as the scale and rapidity of the crisis greatly exceeded forecasts.

Domestically, the Government has begun the process of introducing legislation to address the structure of the Irish regulatory system. In advance of the proposed restructuring, the regulator has begun a process of intensifying supervision, speeding up information flows and addressing internal communications. A number of international studies of the financial markets crisis indicate that Ireland was not alone in having shortcomings in its regulation of financial institutions. Similar deficiencies have been encountered elsewhere in the EU and farther afield. The EU is proceeding with plans to create separate EU-wide institutions that will monitor systemic risk and introduce more co-ordination of national regulators. Considerable work remains to ensure that future shocks can be effectively addressed by "fit for purpose" crisis management that is characterised at international level by co-ordination rather than competition, and that ensure effective regulation of cross-border financial services provision.

Following on from those findings, and cognisant of the need to strengthen further the regulatory framework, I made a number of suggestions in the report including the following. At the level of systems, procedures and practices employed by the regulator, I suggested it would be appropriate to consider placing a greater emphasis on testing of transactions and balances in the course of inspection work. I do not suggest that in this respect statistically representative samples are necessary, rather that a number of large or randomly selected transactions be reviewed from to time to test that the relevant controls have operated. My overall view in this respect is that risk-based systems can only function optimally when they are informed by feedback from the review of actual transactions in conjunction with top down analysis of the sustainability of the business models and associated strategies operated by the individual institutions.

Recognising that good internal regulation is in the interest of financial institutions, I suggested that consideration be given to the provision of an annual positive assurance by their auditors in regard to the functioning of the internal corporate governance regime in each institution, including the risk management function and that this could benefit the institution and strengthen public assurance. To make regulation more accountable, I suggested that consideration might be given to requiring that the regulator give an annual statement relating to supervisory matters to Dáil Éireann.

Chairman

I invite Mr. Elderfield to make his opening statement.

Mr. Matthew Elderfield

I thank the committee for inviting me here today to discuss the special report of the Comptroller and Auditor General on the response of the Financial Regulator to the financial market crisis. Special report 72 was published shortly after I arrived in Ireland to take up the position of head of financial regulation. It set out the background to the financial crisis and the actions taken by the Financial Regulator. We have studied the Comptroller and Auditor General's report and have paid particular attention to the issues it raised, as I will outline in more detail later.

It is important to acknowledge that weaknesses in regulation contributed to the financial crisis in Ireland, as outlined in the Financial Regulator's analysis of the financial crisis published in its 2008 annual report. It was caught off guard by the force and severity of the crisis. In response to accelerating credit growth, steps had been taken in 2005 and 2006 to slow bank lending in Ireland but, with the benefit of hindsight, these measures were insufficient given the severity of the problems that have emerged. With hindsight, it is now clear that stronger measures should have been taken and these should have been taken much earlier. Regulation in Ireland was not robust enough to prevent the asset bubble and the Financial Regulator's reliance on some boards and management to meet their corporate governance responsibilities was misplaced.

Although international pressures contributed to the timing intensity and depth of the Irish banking crisis, the underlying cause of the problem was domestic and classic — too much commercial property and mortgage lending, financed by heavy foreign borrowing by banks, which led to an unsustainable housing price and construction boom. This occurred against a background of low interest rates and protracted expansion in output, employment and population especially from the mid-1990s.

The devastating impact of the financial crisis on Ireland's economy, finances and citizens is clear. The Government decided to establish a commission of investigation into the crisis with the first phase involving commissioning two independent preliminary reports into the regulatory and banking aspects of the crisis to be carried out by the Governor of the Central Bank, Mr. Patrick Honohan, and Mr. Klaus Regling and Mr. Max Watson, respectively. These independent reports are imminent and their findings will help the Government and the Oireachtas as they prepare the terms of reference for the second stage of the investigation.

However, it is not necessary to wait until this investigation is fully completed to begin a fundamental overhaul of the regulatory model for financial services in Ireland. That work was already under way when I arrived here in January, led by my predecessor, Mary O'Dea, as acting chief executive of the Financial Regulator. Today, I wish to comment on three main areas. First, I will outline briefly the changes we have made and are making in the supervision of financial institutions. Second, I will comment on the main regulatory issues raised by the Comptroller and Auditor General in the special report, which he just summarised. Then, I will set out some important changes we are publishing today in the area of related party lending, which was one of the topics mentioned by the Comptroller and Auditor General.

I will start with the changes we have been making to how regulated financial services firms are supervised. The first phase of improving the supervisory system, introduced by my predecessor, Mary O'Dea, involved changing to a more intensive approach to the regulation of banks, with particular focus on monitoring liquidity and solvency issues and monitoring banks' compliance with the Government guarantee scheme. New codes relating to mortgage arrears and business lending to small and medium enterprises, SMEs, were introduced. The reporting obligations of regulated firms were increased so that the Financial Regulator could obtain more comprehensive information on a more timely basis. Supervisory staff were placed on site in the banks so they could attend regular meetings with senior executives, including those responsible for compliance, internal audit, risk management and credit, and could attend certain board, board committee and other management meetings on a sample basis to assess corporate governance in action.

Internal supervisory procedures at the Financial Regulator were also strengthened with the introduction of "challenge meetings", where examination teams produce a monthly supervisory report and engage with management and the senior executives on serious prudential issues. Policies for escalation and information sharing were also introduced to improve internal communications. A number of investigations were also initiated into issues at Anglo Irish Bank and in this regard we are supporting the Garda and the Director of Corporate Enforcement. This more intensive approach to supervision included reassigning staff from other areas and the recruitment of specialists.

This was a very important first phase in changing the system of financial regulation in Ireland and paved the way for the second phase we are now entering. We are now developing an assertive risk-based system of regulation underpinned by the credible threat of enforcement. This involves calibrating the intensity of our regulatory standards and day-to-day supervisory approach to the risk profile of the firms and sectors we supervise. We will concentrate our efforts and resources where the greatest risks lie. It means we will insist that the biggest and riskiest firms manage themselves better and that firms and their management are questioned and probed by their supervisor and held more accountable for their actions. We will focus on risk mitigation and challenge, assessing business risk, not just controls and rules, and developing and using the risk model to systematically assess firms and set the supervisory agenda.

While many of the required changes in regulation are occurring at European level, there is also a need to improve the domestic regulatory framework in several areas. In this regard, the Central Bank Reform Bill will, when enacted, provide us with new statutory powers to ensure that those responsible for managing financial service providers continue to be fit to do so. A new enforcement division will be resourced at a level sufficient to apply a credible threat of action where that is necessary. The entire approach to enforcement, including the current administrative sanctions procedures, will be reviewed at an early stage and we therefore plan to consult on our enforcement strategy later this year.

It is clear that to operate such a supervision system effectively a significant increase in front-line regulatory staff will be required. It was clear when I arrived here that the level and skill mix of supervision staffing at the Financial Regulator was inadequate to implement a risk-based model of supervision. This model requires significantly more intensive supervision of high risk firms at this critical time in financial markets. Our supervision model also needs to take on major new tasks such as the supervision of large complex groups, new risk assessment and enforcement capabilities, the implementation of new EU directives and regulations and the unwinding of delegations from the Irish Stock Exchange.

In addition to adding more resources we are working to improve our internal processes and procedures to ensure we are operating effectively and efficiently. We must upgrade our information technology and have recently appointed a chief information officer who will spearhead this important development process. More resources means additional costs, and, as we move towards a full-funding model, we are examining our fee structure. We plan to re-tune this structure to ensure that the appropriate proportion of the increased costs of regulation will be borne by the entities that require the highest levels of supervision. The cost of regulation will undoubtedly rise, but judged in the context of the huge cost of a financial crisis, the increase in the cost of regulation must be seen as a price worth paying.

It is important to be clear today that these are major changes and they will not happen overnight. This is a multi-year and multi-faceted project, not a quick fix. We have to recruit and train staff, put in place information technology systems, develop risk assessment models and develop and implement our enforcement capability. It will take some time to fully develop our new system of regulation, but we have started the process. Even with all these changes, we can never guarantee a zero failure rate. However, regulated firms are already very clear that the bar has been set high and they need to adjust to the new world of financial regulation in Ireland.

I will now turn to the four major issues the Comptroller and Auditor General raised in Special Report No. 72. He said that consideration should be given to requiring that the Financial Regulator make an annual statement about supervisory matters. This measure, as well some other accountability measures, is included in the Central Bank Reform Bill 2010. Under this legislation the Financial Regulator will be required to produce an annual performance statement comprising a regulatory performance plan for the current year and a review of regulatory performance for the preceding year. In addition, the Bill provides for other accountability measures, including a requirement to arrange, at least every four years, an international peer review of our regulatory performance.

The Comptroller and Auditor General also suggested that the auditors of financial institutions should provide annual positive assurance about the functioning of the internal corporate governance regime in each institution, including the risk management function. We broadly welcome this suggestion. While its implementation will require considerable further work by accounting bodies, a strengthening of audit review and assurance would be a helpful improvement in the regulatory framework. However, this needs careful consideration. Ireland must be wary of the Sarbanes-Oxley experience. It is important to be cautious about new measures which could significantly increase costs, especially if the standards being audited are too vague or extensive. We have, however, recently published a consultation paper on corporate governance which sets out a standard that could be assessed and we will develop other standards. In addition, it is not clear if the auditor report is to be made to the Financial Regulator or to the public: the latter could raise liability concerns that would have to be addressed by the accountancy bodies. Nevertheless, we feel this suggestion merits further consideration and would be prepared to contribute to an initiative in this area from the appropriate accounting regulatory authorities.

The third major issue raised in the report referred to the Financial Regulator's systems, procedures and practices. The Comptroller and Auditor General suggested that the Financial Regulator should consider incorporating a greater emphasis on testing of transactions and balances into its inspection work to improve on-the-ground evidence, and that this be balanced with a top-down analysis of the sustainability of the business models and associated strategies of individual institutions. We are in the process of enhancing our supervisory approach and engagement with financial institutions. We strongly agree about the importance of the top-down analysis and analysing the business models and strategies of individual institutions to add value to the supervisory process.

Greater emphasis in inspection work on testing the implementation and application of policies, procedures and practices could add value but we have concerns about the cost/benefit implications of this approach. Given the sheer scale of each individual bank's transactions and the limited resources available to us, even after the increase in resources I have outlined, it is unlikely that it would be possible to test a "statistically significant" sample of transactions. I noted that in his opening comments the Comptroller and Auditor General mentioned that he was not necessarily aiming for that. Spot checks can be helpful and we can perhaps talk about that. Nevertheless, we will consider how best to meet this recommendation as part of the development of our risk and supervisory models. The fourth major suggestion from the Comptroller and Auditor General was that the Central Bank, the Financial Regulator and the Department of Finance carry out a review of the lessons learned from the financial crisis for future policy formation. This suggestion was made prior to the Government decision to establish the commission of investigation that is currently underway, and I think it is clear that the investigation is the appropriate place for such a review.

I would also like to briefly address some recommendations made by this committee in its annual report last year, following on from a previous special report prepared by the Comptroller and Auditor General. The committee recommended that financial regulation should be based on a thorough assessment of the risks associated with individual financial institutions, taking account of sector-level risk. We fully agree with this recommendation and will be taking it into account in the development of our risk model. The committee's recommendation that the Financial Regulator should report publicly each year on the extent to which it achieves its supervision targets is now covered by the Central Bank Reform Bill, which will require us to produce the annual performance statement that I have already mentioned.

The committee recommended that supervision regimes for each sector should be benchmarked against international good practice and subject to periodic independent evaluation. We agree with the committee on this too. In 2009, Mazars completed such an analysis of the Financial Regulator, which we have now made available on our website. The Central Bank Reform Bill 2010, which was published recently, requires us to undergo a review of our performance by our peers, or a suitability qualified person, at least once every four years.

The committee also recommended that the Financial Regulator should change the culture in the provision of financial services to give greater consumer protection by imposing fines where we find that vulnerable customers were sold an inappropriate product or service. Consumer protection is a high priority for me. The Financial Regulator is adamant that regulated firms must meet the requirements of the statutory consumer protection code, which requires them to treat consumers fairly. Firms need to be aware of their responsibilities. We are building up our enforcement capabilities to ensure that we have a credible deterrent in place.

Mr. Bernard Sheridan, who is here with me today, has recently been appointed assistant director general for consumer protection, and he will lead our initiatives in this important area. With his team, he is examining how best to achieve this change as part of our consumer protection strategy. We are carrying out a review of our consumer protection code and the minimum competency requirements, which have been in place since 2007.

I would like to take just a few minutes to tell the committee about a new initiative we are announcing today. We are launching a consultation paper to bring in new rules to cover related party lending. One of the lessons we have learned from the banking crisis is the need to have clear and enforceable rules in the area of lending by banks and bank officers to related or connected persons or individuals. In the case of a bank, a related party would be a director, a shadow director or a senior manager as well as persons connected to these individuals. Related party lending also covers lending to significant shareholders or to entities in which the credit institution has a significant shareholding.

Lending to related parties is a form of lending that has a special potential to give rise to conflicts of interest and abuse. This is particularly the case where large sums are concerned. Unfortunately, Ireland has witnessed some of this lending at irresponsible levels and, in one notorious case, in a manner that was apparently designed to avoid detection.

We want to take action to protect against abuses in this area and to address conflicts of interest. We intend to impose a statutory code of practice concerning lending by banks and building societies to related parties that aims to ensure that such lending is on an arm's length basis and subject to appropriate and effective management oversight and limits. In addition, we will introduce a requirement for periodic reporting to us to monitor compliance with the code.

Loans to bank directors and senior management have been the subject of abuse and excess, if not outright subterfuge. Our proposals establish better checks and balances, tougher limits and clearer reporting to clean up these practices.

This latest consultation paper is part of a wider strategy to update the domestic regulatory framework applying to credit institutions. Just recently we issued a consultation paper on corporate governance requirements for credit institutions and insurance companies. We will issue further requirements, including remuneration statements and a revised fitness and probity framework, in the coming months. We will also consider the need for additional requirements in respect of internal governance and risk management as international initiatives in these areas are published.

The programme of change required to improve Irish financial regulation is a multi-faceted and multi-year project. There is an enormous task ahead of us: increasing resources; improving skill levels; enhancing powers; implementing a risk model; building an enforcement capability; making domestic rules to fill the gaps on corporate governance; directors loans and credit risk management; implementing complex international rules on bank capital and liquidity; insurance solvency and funds regulation; tackling the problems of mortgage arrears and mis-selling; fundamentally re-engineering our processes; and investing in IT, to name just the top ten obvious categories.

We need to accomplish this while doing the day job of processing transactions, doing on-site assessments of firms, and engaging in supervisory fire-fighting at a time of continuing uncertainty in the financial markets. It is important that the members of this committee and the public are under no illusion about the scale of the task before us. This is going to take time and there will be bumps in the road ahead. However, the process of change has started and the Governor, my team and I, are determined to make progress on this to-do list over the years to come.

I want to thank members of the Committee of Public Accounts for inviting me here today. I look forward to answering their questions.

Chairman

Thank you, Mr. Elderfield. Can we publish your statement?

Mr. Matthew Elderfield

Yes.

Deputy Deirdre Clune

I thank Mr. Elderfield for his opening statement and wish him well in his new position. I am sure he regrets leaving the sunshine behind in Bermuda. As he said, there will be enough bumps along the way.

Deputy Jim O’Keeffe

There is more financial heat here.

Deputy Deirdre Clune

Before we turn to the special report, may I ask Mr. Elderfield about the Quinn Insurance issue? I do not know how far he can go on that, but there is a lot of concern about it because many people are facing redundancy towards the end of this month. Respecting the fact that Mr. Elderfield has a job of work to do, can I ask him about the issue? He issued a directive for Quinn Insurance to cease trading in the UK a short period before he appointed the administrators. I have not examined it, but I am told that Quinn Insurance was profitable in the UK in the first quarter of 2010. I understand it lost money last year but compared to its competitors it was doing better than others. Could Mr. Elderfield comment on that, as well as on the liquidity levels? If I am correct, it required 150% in Ireland, while it was 125% in the UK. The point is therefore that UK customers who were purchasing products from Quinn Insurance would have been in a safe position vis-à-vis the competitors there.

Mr. Matthew Elderfield

I would be glad to cover both the UK business and the solvency position, so let me take them in that order. For the UK business, we felt we needed to issue the direction to prevent Quinn Insurance from conducting further UK business because it was loss-making. It made a significant loss last year of €44 million. Our concern would be that to allow it to keep writing loss-making business would have added to the solvency hole and made the situation worse. It is one thing if it is a healthy company with a solvency margin, and it is deciding to write some unprofitable business as some sort of a loss leader, but when we knew there was a significant solvency hole — I will talk about that later — we had a great concern that we should not add to the size of the hole. It should be borne in mind that adding to the size of the hole adds to the exposure of the compensation scheme and adds to the potential bill that policy-holders in other companies, that have nothing to do with Quinn Insurance, might have to pay to do that. Therefore, we thought it was important to take that action.

We also knew that there had been concerns for some time — expressed to us and to the FSA — about the pricing model in the UK, and whether the pricing was done at unsustainable levels. I suspect that if we had not acted to direct Quinn Insurance to stop taking business in the UK, the FSA would probably have done so anyway.

We made clear to the administrators that if we are presented with new business plans that had proper analysis of the risks, we would be willing to reopen parts of the business. There is probably a misunderstanding about earnings and profitability. The two of us could set up an insurance company, we could offer prices at half the current market rate, everybody would flood into our business, we would have a lot of earnings, we could pay ourselves big bonuses, but when the claims had to be paid at the end of the day we would not have enough reserves in our back pocket in order to be able to do that. That is why solvency is so important — I will come back to that.

In terms of the UK business, this is how it has unfolded. With the Chairman's permission, I will talk through the chronology a little because there has been some confusion as to what happened and when. The administrators tabled a plan to us on 8 April, setting out a plan to reopen some of the UK businesses. That analysis they gave to us was proposing significantly curtailed and scaled back UK activity, reducing perhaps by 60% the current business plan, because they shared our analysis that the pricing was off and there were problems with the profitability of that business.

However, that plan, on 8 April, stated that the way they were going to make changes would be to change the pricing levels in the UK, but they did not give us any details of the pricing and they did not give us any actuarial analysis. One of the problems is that Quinn Insurance did not have an in-house actuary to help it with pricing. Basically, we asked the administrators to come back with more analysis to be able to show us that the pricing levels are justified. They did that with the provisional car licence information. We asked for some more information for the full licences and over a couple of stages, we allowed them to reintroduce that business.

At each stage it was important we talked to the FSA as well because it had a view on this, and it took a couple of days for that. We are now at the stage where the motor business is being reopened, but on a much curtailed scaled-back and more realistically priced level, and yesterday we received proposals for the commercial business.

The commercial business had very significant losses. It is going to be a much more finely balanced judgment about whether to open aspects of that business. Indeed, the administrators are not planning to open the full scale of it.

In terms of solvency, if I could come on to that, — apologies for taking a while on the answer——

Deputy Deirdre Clune

It is clear, and worth putting on the record here.

Mr. Matthew Elderfield

——but it is important to reveal the full picture. The standard we have is 150% of the Solvency I Directive. Let us be clear, that 150% test applies to all regulated insurance companies. Whether we have a different insolvency rule than the UK, Bermuda or Switzerland, the fact is our responsibility is to apply it equally across all of the Irish companies. We cannot say, "You are operating in the UK so you get a lower standard than the rest of the Irish companies", and vary it. It is one size fits all. It it is a regulated company, that is the way it works.

We have made the decisions on all of the motor business, and the commercial business has just been tabled to us recently. Significant changes and scaling back has been proposed. We are working on that. That will take a little more time than with the motor business because of the significant size of losses and the complexity of the business.

I should add that I am very sympathetic about the employment situation. I have met the employees twice and have heard the very serious implications that the changes to the business are having. Whatever happens on the commercial business will be at the margin of the level of staffing changes. The administrators found a company that had serious problems and they have had to make some changes as a result.

The next immediate step is to look at the commercial business lines. What is beyond that is what is best for the future of the company, Quinn Insurance — to put it up for sale. The administrators are looking at selling business lines. The main focus of attention is what is the best option for the company. When a potential buyer is identified by the administrator and Quinn Group, then the ball will come back into our court to give approval to that.

I do not want to spend all the time available here on Quinn. I can explain what our criteria will be, if the committee wants to get into that, or we can move on to another subject.

Deputy Deirdre Clune

The future of the company is of major concern, particularly in the areas where there is such a high level of employment. Yesterday I read in a newspaper report that Anglo Irish Bank is looking to an international partner that might submit to purchase Quinn. What would be Mr. Elderfield's views on that from a regulatory point of view?

Mr. Matthew Elderfield

The best way to describe it is to ask what are the hurdles that any transaction must clear in order to satisfy us. I would say there are some hurdles that anybody would have to satisfy and there are some additional ones if it is an Anglo Irish Bank transaction.

The first hurdle is does it solve the solvency position. Most obviously, is the €700 million gap filled one way or the other? That involves somebody writing a cheque to put that cash in.

The second issue that must be solved is the governance arrangements. There has been a governance failure — how the board did not know about the subsidiaries with the guarantees — and there is a systems and controls problem. There has to be a better governance structure. Somebody has got to make a proposal that satisfies us on that, strengthening the management team and the control framework. Those tests have to be met — solvency, governance, management, controls. Then, for the acquirer, there is a fitness and probity test. Are we happy about who is going to acquire it?

With Anglo Irish Bank questions arise about the bank's own prudential position because it is a State-owned challenged bank. Then there are questions about expertise on whether it is appropriate for a bank with an awful lot on its plate to be running an insurance company. If it can solve for solvency, solve for governance, solve for management, solve for controls, solve for its own prudential situation and find a structure at the end of the day which means that the insurance company lives to be well-managed with people who are expert in this, then it is possible that an Anglo Irish Bank transaction could be successful. Frankly, I would say there are more hurdles to jump than for a straight transaction with another insurance company.

Deputy Deirdre Clune

I thank Mr. Elderfield for that response. I appreciate him answering those questions which were not on the agenda today.

If I may, in the time allocated to me, turn to the special report. It looks back at what went wrong. We are seeking to ensure that this will not happen again and that the appropriate structures will be put in place.

Professor Patrick Honohan stated that balance sheet growth in excess of 20% should have been a trigger. In eight out of nine years, Anglo Irish Bank had an annual balance sheet growth of 36%. In addition, foreign-owned operators in the Irish banking sector were pushing aggressive growth levels and there was a high increase in the loan-to-value ratio and an overexposure to the property sector. The previous regulator has acknowledged that insufficient action was taken in respect of these matters and that such action was not taken soon enough. Does Mr. Elderfield agree with that assertion?

Mr. Matthew Elderfield

Yes.

Deputy Deirdre Clune

What will Mr. Elderfield be doing to ensure that there is no recurrence of excessive growth rates, overexposure to particular sectors and so on?

Mr. Matthew Elderfield

I have tended to categorise the sources of failure into three broad areas, namely, weak rules, poor resources and the wrong attitude. In some instances, the rules were international. I refer, for example, to those laid down by the Basel committee on banking supervision. With hindsight, the quality and quantity of capital was inadequate in the context of the risks banks were taking in many jurisdictions. There was a big gap in respect of funding. The banks were borrowing wholesale funds overseas in order to lend into the domestic credit boom. There were no international standards in respect of funding and that allowed poor practices to continue.

It is important to acknowledge that there were also home-grown elements. There were gaps in the rules governing the domestic market which need to be considered. We are, for example, trying to plug the gap in respect of corporate governance and we issued a consultation paper in that regard. As stated earlier, we are also endeavouring to deal with the issue of related party lending. The difficult truth is that it was not particularly CDO squared or cubed securitisations, which were complicated to either consider or value, that gave rise to trouble here, it was more traditional commercial property and mortgage lending that caused the problems. There is definitely a need to carry out some fine tuning in respect of the rule book in this regard.

On concentration limits and hard exposures, we must consider how lending could simply exceed the internal limits the banks had imposed or whatever lending limits the regulator should have insisted upon. That is an area in respect of which we can introduce some improvements.

The resources levels that obtained were much too low. The position has improved in recent times but we have quite a way to go in this regard. Prior to the crisis, two of the largest banks had two supervisors between them. They did not each have two supervisors. What does that mean? Part of one's work as a supervisor is to deal with regulatory transactions, change of control and new directors. These people are probably continually on the receiving end of a deluge of paper relating to accounts, etc. It is necessary to have an adequate number of staff in order that one can set the agenda oneself and pick and choose one's areas of focus. One wants to take it to the banks and be a proactive supervisor. Operating at the level I have outlined, the two supervisors in question were hopelessly outgunned.

Would it be possible for Mr. Sheridan to indicate the number of new staff that were brought on board?

Mr. Bernard Sheridan

As previously outlined, a team of two to three people were tasked with covering a number of institutions. Under the current regime, a team of five people is dedicated to the larger institutions. We hope to expand that in the next six to 12 months in order that there will be up to eight or nine people on each team per institution. In addition to the teams that are dedicated to the institutions, we have teams which look across the institutions in order to monitor standards across those institutions.

As part of the new, intrusive model, we decided we needed to carry out on-site inspections in order that we might discover what is happening within the banks. One of the key benefits of this is that we are now attending, as observers, internal meetings, including board meetings, of the credit institutions. We can actually see governance in operation and are not relying purely on examining the reports we receive. We can see how the institutions operate and the challenges in place between executives and non-executives. We revert to institutions in circumstances where we are unhappy with their performance. We have sought that changes be made in the internal functions and workings of committees within the institutions. We have also increased the reporting requirements relating to the institutions, particularly in respect of credit and lending.

All of this means that we have a much better understanding of the internal governance and workings of the institutions and their risk appetites. We have more up-to-date information regarding the direction in which the institutions are heading. The sooner we know this, the sooner we can react to it.

Deputy Deirdre Clune

What about the comment that there was no sense that they were ever going to receive a visit from the regulator to conduct an inspection? Does the regulator now engage in on-site inspections? Does he have targets in this regard?

Mr. Bernard Sheridan

Our approach to the covered institutions was that we considered we needed to be there much more regularly rather than making regular inspections. We try to have people on site most of the time. We have them on site two to three days a week monitoring the institutions and carrying out inspection work.

Mr. Matthew Elderfield

Our approach needs to re-engineered. The impression I have is that we did deep dive audits of specific items in a firm's accounts, but we did not do them frequently in the past. I would like to see a couple of things for the risk model, including, first, a better categorisation of firms based on their impact and size. Obviously, the big domestic covered institutions are systemically important. How many big IFSC banks are in that category? How many big insurance companies are in it? What is our level of supervisory engagement? We should set a minimum standard of engagement. Should there be an on-site assessment once every three years, two years or 18 months? Some may be mademore frequently, but one wants a minimum level of engagement and flowing from this one wants to decide how many people are on one's team. As Mr. Sheridan mentioned, we are up to five or six per team, but we would like to get up to eight or so.

Rather than just looking at one issue, I would like to see them looking systematically at a range of issues. Therefore, one would score a firm on governance, management, credit risk, market risk, operational risk, liquidity, reserving and underwriting. In that away, one would have a view of the firm from A to Z, a soup to nuts assessment. One could then be more proactive as a supervisor. It would also be better for the firm because it would have a clearer understanding of our priorities. We could say, "We think you do well on consumer interaction and your reserving is fine, but we think your underwriting standards are poor." We could then set the agenda for the firm. We have a way to go before we get there. We have to identify what is our minimum number, but to get through all of the insurance firms and banks once every two or three years, we will have to have the staff to do this. We still have some work to do to get the model and resources in place in order that on-site inspectors cover their territory in a reasonable cycle of time.

Deputy Deirdre Clune

On the basis of Mr. Elderfield's reports, the issues of staffing levels and the qualify of staff are important. He requested staff from the Department of Finance. What has been the response?

Mr. Matthew Elderfield

The staffing level last year was 371. We requested 154 staff to bring the total up to about 520. That request is with the Minister. We are going through the statutory consultation process with the consumer and industry panels before he gets to back to us. I do not want to prejudice his decision, but I note he made a statement during the announcement of the merger of the Financial Regulator and the Central Bank that significant resources would be needed. Beyond this, we will need additional resources, say, through 2012 to meet the rest of our plan.

I will mention a few other areas in which we are short on resources. On the banking side, two institutions were way off what was needed. The position is getting better with five or six staff per team. For the biggest banks which are much more complicated than the Irish banks, the FSA has 25 people on each team. There is a dedicated risk analytics unit which has modelling capability and can unpack a balance sheet. There is a huge gap in that regard. That also applies to our insurance division. We have big substantive insurance companies which use Ireland as the hub for their activities across Europe. We need to have staff for this. There is to be a major change in insurance — the solvency II directive — which will open the door for the use of internal models and a technical assessment of the models needed. Therefore, we will need more actuaries. That gives the Deputy a perspective. It is not just about banks; it is also about insurance.

What about enforcement? While we have a small enforcement team of good guys who are professional lawyers, we do not have dedicated investigation staff. If one is a supervisor of one of the banking or insurance teams and one comes across something, one has an invidious choice to make between stopping day-to-day supervision and suspending on-site inspections to pursue the enforcement case or putting the case aside because one needs to maintain supervision. The best practice model is that one should have a dedicated investigation team, to which one can hand these cases and which can plough through them, especially if one wants to take enforcement action against individuals because they will fight tooth and nail since they will be banned from the industry. We have to develop an enforcement capability almost from scratch.

On policy capability, we have a few good policy people dotted around the place. There is a massive policy agenda from the G20 financial stability board, the insurance regulator, the banking regulator and the securities regulator. There is also a huge list of directives, including capital directives, the funds directive and the solvency II directive. There is a massive policy agenda which forms part of the post-mortem resulting from the financial crisis and we need to have staff to pursue it. If one does not try to influence the upstream in Brussels, Ireland will be on the receiving end of something that will be cooked up elsewhere that could impact on its industry.

With regard to markets, there is a need to transfer certain functions from the Stock Exchange. We will also need staff up for that purpose. It is the provision of resources that worries me the most. Will we be able to get the resources we need to complete that long to do list which I mentioned at the end of my opening statement?

Deputy Deirdre Clune

Mr. Elderfield will need 154 people. I thank him for his replies.

Chairman

In 2006 a World Bank survey showed that the regulator had responded that he was under-resourced, there was a huge turnover of staff and that inexperienced staff were dealing with the high flyers in the banks. It will, therefore, be a case of history repeating itself if Mr. Elderfield does not get the resources he requires. It is significant that, at a time when Anglo Irish Bank was acting like a drug pusher and fuelling the craze in the property market, this survey showed the regulator was concerned about the quality of his staff.

Fitch Ratings also compiled a report. I am not sure whether the OECD report in 2006 was the same as the World Bank survey, but did anybody question Mr. Neary and those around him when he made the following statement on "Prime Time" in October 2008: "By any standards, the Irish banks are so well capitalised compared to any bank anywhere across Europe that I am confident that they can absorb any loan or any impairment that emerges in the ordinary course of business over the foreseeable future"? Mr. Elderfield's challenge is to put right what was so grievously wrong, but, at the same time, we have a responsibility to ask the hard questions about how people like Mr. Neary could make such a statement at a time when he was not equipped and in a position to come to that conclusion. Have the former regulator and those around him been asked how he was able to stand over that statement? Do those who were around him remain within the structure of the Office of the Financial Regulator?

Mr. Matthew Elderfield

On the Chairman's question about resources, it is an ongoing worry.

In reply to Deputy Clune, I mentioned our ability to hit our recruitment targets. We are gearing up aggressively to bring in hired staff. Frankly, the employment market is favourable to us. We have talked to the professional services firms about a professional secondment programme and they have responded fantastically. That will bring a quick infusion of resources. We have an ongoing recruitment campaign and are also bringing in risk advisers. We are trying to bring in some senior "grey hairs" with board experience or experience in a commercial environment to give us advice. The risk is that our staff will be poached when the market heats up, at which stage we will have to be prepared to look at pay levels. It is right and proper that we are affected by the public sector pay constraints. All of us have taken a hit, but at some point in the future we will have to make sure we will not lose our good staff because of it.

On the historical question, I will make a few comments. Obviously, I was not around at the time and do not know what information he had available to him to make that statement. I know the Governor, Dr. Patrick Honohan, is conducting a review of the performance of the Financial Regulator and will comment on that. He is due to present his report to the Minister for Finance at the end of this month. It is clear there were institutional failures and accountability for that rested with Mr. Neary. On the banking side, we have made some public statements about the bank's lost positions and have done significant rigorous analytical work on that. I would be happy to talk about that if the members would like me to, but in terms of judgments on the past, it is probably better to wait for Dr. Honohan's report at the beginning of June.

Chairman

Was the financial stability committee a committee within the office of the Financial Regulator?

Mr. Matthew Elderfield

No, the financial stability committee is fully merged in the Central Bank. The performance of the Central Bank and the activity of the financial stability committee will be covered by Dr. Honohan also. We have made some immediate changes to the committee and Dr. Honohan now chairs it. We are trying to use it as a mechanism to better plug in the Financial Regulator and the Central Bank together to work more effectively. This is an area that still needs more work to improve. One of the major conclusions from many of the third party reports mentioned by the Comptroller and Auditor General was the need for better macro prudential supervision. We are not just looking at individual firms, but trying to take the overall view of what the firms, in aggregate, are doing to the economy or stability risks. Therefore, having better metrics, like asset growth, and having a better heat map on financial stability risks will be important. The key element however is that it should not be just an analytical exercise. It is fine to analyse risks, but what will be done about them and what levers can be pulled to mitigate those risks? That debate applies to financial stability as much as it does to micro prudential regulation and more work is needed in this area over time.

I was interested in the speech the regulator gave to the third annual global financial services centres' conference. Before looking again at what has happened, I would like to look forward, because in every crisis there are opportunities. Mr. Elderfield said in his speech that the imminent changes in regulatory standards provided opportunities for the IFSC, that Ireland was well positioned to gain from those changes in insurance regulation and that he also thought this was the case in fund regulation. What are Mr. Elderfield's views on the opportunities we have?

Mr. Matthew Elderfield

By way of context, there is something interesting going on in financial regulation outside of banking. In banking, international standards are set by the Basel committee and these standards apply to everybody. What is happening in insurance and funds regulation is that the pace is being set by the European Union, because the international standard setters do not have binding rules. We have two directives, solvency II, for insurance and the investment fund managers directive for funds, which contain provisions termed equivalence provisions. They provide that any other jurisdiction wishing to have its companies do business into the EU, must match EU standards. This is a method for exporting European rules. This is a challenge to other jurisdictions such as Bermuda — where I came from — the United States and Switzerland, to match the EU rules. If they do not match the EU rules, their companies will not be permitted to come into the EU. This triggers a debate in a lot of corporate boardrooms. I have spoken to these guys and I have been at their board meetings. They have to decide where they want to be positioned, whether they want to stay outside the EU and hope to get equivalence and perhaps not have full rights of access or whether it would be better to set up a base in the EU. Many of these companies are making that decision to come all the way or at least to have a plan B to set up some operations here. In the insurance world, some overseas companies are relocating, re-domiciling their activities here, to either use this country as their base or their plan B. Because of that insurance directive, a company can use its capital more effectively and to have a single hub and branch out, so a lot of companies are centralising their operations. I refer to Zurich and Aviva as two examples. This moving in of non-EU companies is one opportunity and centralisation is another.

It is interesting that the same applies with regard to the funds directive. There is much that is unpalatable in the funds directive. There is the concept of strict liability that could be damaging to some companies. Some of the provisions are close to protectionist. A similar dynamic exists whereby it will export its rules, therefore, offshore centres and offshore funds might decide they would rather be based in the EU and they might move across. The post-mortem on the financial crisis is leading to this re-regulation. Changes in the levels of regulation allow opportunities for people to think about how they want to organise themselves. I think Ireland is quite well positioned for that. However, we will have to see how it pans out and we will have to be nimble in our choices as we implement the directives. I think there are opportunities on the insurance side and on the funds side.

Deputy Darragh O’Brien

I refer to the Comptroller and Auditor General's report and what the Chairman said earlier. This committee has reported on the Financial Regulator. The former regulator, Mr. Neary, came before this committee. At the time, a number of colleagues and I questioned the inspection rate and the level of on-site inspection. It was not made clear at the time and I was never told that Mr. Neary or the Financial Regulator were ever refused additional staff at that time.

Mr. Elderfield referred in his opening statement to the skills mix. It seemed to have been obvious to Mr. Elderfield quite early on that the skills mix was not available within the Financial Regulator with regard to oversight of the banks and insurance companies. I will not refer specifically to the banks. How obvious was this? How long did it take Mr. Elderfield, who came in January, to realise there was a problem with regard to the skills mix?

Mr. Matthew Elderfield

When I was looking at the job last autumn I ran some rudimentary ratios of number of firms to number of staff. I raised my eyebrows when I was doing the interview. I explained there was a problem and that significant extra resources would be needed but I agreed to examine the situation. I knew there was an issue about resources. When I was appointed I did a walk-around in each department. I asked staff members about their duties and asked how many firms they were responsible for and whether staff ever visited those firms. For instance, a staff member might be the only supervisor for a firm or might be supervising 15, 20 or 40 firms. I want to be careful what I say about the skills set in the organisation. I have some very bright staff members. We have hired some good people with technical skills.

No.

Deputy Seán Fleming

They are going to represent much of Mr. Elderfield's staff activity.

Deputy Seán Fleming

I am a little worried given that Mr. Elderfield said that 14,897 organisations are being regulated by the Financial Regulator. If one was being flippant, one could say it is similar to the taxation system; it is a case of self-regulation and one might get caught in an audit. It will be very difficult for Mr. Elderfield's office to physically examine those reports on a quarterly basis for each of those approximately 14,000 organisations. I suspect that what was happening is that someone had a spreadsheet and he or she ticked the box when the report was received at the end of the quarter. Once the report was received it was put on a shelf or in the basement. Once the report was in, it was in.

Mr. Elderfield referred to risk assessment. He will probably carry out a detailed analysis based on the risk assessment. It is probable to assume that many of the approximately 14,000 institutions will not be subject to any real examination each year anyway. What is Mr. Elderfield's intention in that regard?

Mr. Matthew Elderfield

That is absolutely right. I will ask Mr. Brady to help me out. Being a risk-based supervisor means we will have different levels of intensity of supervision depending on the size. What we need to do is take that population of 15,000 and sort it into categories such as "highest impact firms", "systemically risky", "big banks", "big insurance companies". At the other end of the spectrum there will be small companies, retail intermediaries, some small credit unions. We need to man-mark the ones at the top. For example, seven, eight or ten against one. At the other end of the spectrum we will probably have a portfolio basis and it will be more reactive. If we were to man-mark each of the 14,000, that would involve a great number of staff. However, all regulators do that. We did it in Bermuda and in the FSA, and it was done in BaFin in Germany. The United States does so also. The key point is deciding on the cut-off point and the engagement model for each threshold. At the top level, one is saying one will carry out on-site investigations every two or three years, for example. At the bottom level, one is not pretending to cover everybody every two or three years. It could be a case of doing spot checks, involving a sample of 10%, 5% or 2%. What one definitely needs is a system that tries to give one red flags and market intelligence regarding regulatory returns. That is another thing on the to-do list I mentioned at the outset.

If some of the smaller organisations cannot manage electronic filing, how can they offer consumer protection? Does Mr. Elderfield understand where I am coming from?

Bearing in mind that Mr. Elderfield has worked abroad, my last point is on Ireland's reputation in regard to the International Financial Services Centre. We obviously want everything done to ensure it is enhanced. When the Financial Regulator's regime is completed, will the standing of the centre change? Some will say there was very light regulation in that companies could come in and almost be set up there within an afternoon under the pro forma arrangements in place. Should new organisations have to go through a more rigorous process than has been suggested was in operation in some cases in the past? The rigour of the process reflects on the good reputation of the centre, which is a major source of employment and funding for the Exchequer.

Mr. Matthew Elderfield

Deputy Jim O’Keeffe

Mr. Elderfield was very blunt in his assessment of the cause of the problem in his opening statement, where he referred to international factors contributing to the intensity and depth of the banking crisis here. Significantly, he said that the underlying cause of the problem was domestic and classic. We seem to have been living in some type of cloud cuckoo land. Were our heads totally in the sand as regards the situation? Were there not clear signs in the bank practices of the time, where essentially, they were borrowing short and lending long? They were borrowing on the bond markets from an ever-lowering deposit base. Then in 2007 the Irish banks had the lowest deposit to credit ratio within the European Union, at 60%. Simultaneously, the real estate sector was engaged in most of the lending and in 2007 accounted for 57% of total lending by the banks. Why was that not foreseen?

When the Secretary General of the Department of Finance was before the committee last week, I was horrified to hear that he accepted the position that there was a lack of expertise in the Department. Was there also a lack of expertise in risk analysis in the Office of the Financial Regulator? That led to a situation where we were fed a mantra that the fundamentals were sound. If I heard it once, I heard it 1,000 times. Was that the real cause of the problem?

Mr. Matthew Elderfield

There is much in what the Deputy said. I will start with the point about the domestic environment versus the international environment. There were contributors from both sides. It is wrong to say this is just an international crisis, as there were domestic factors. I tried to explain as regards the nature of lending that it was not about securitisation and that it was not very complicated, which is a cause for concern. However, other regulators had a poor track record also. The FSA had its problems and there has been a great number of bank failures in the United States. Plenty of the blame can be shared by regulators around the globe, not just here.

Deputy Jim O’Keeffe

In relative terms, it seems we have been hit harder than most.

Mr. Matthew Elderfield

Yes, we have because of the small size of the economy and the severity of the failures. That is a very fair point.

Somebody spoke about principles and rules. There was a mantra about the efficient markets hypothesis, which is that the markets are efficient and self-correct and that regulators must stand at the margins and should only intervene when there is a clear and compelling case to do so. The idea is that there should be deference shown to the markets and those who operate within them because they know best and things will sort themselves out. That thesis has been exploded comprehensively. That philosophy represented the conventional wisdom among academics, economists and in popular culture and it led to bias against intervening and having proper regulation. However, that has changed and it is now more important to be seen to be challenging and intervening in financial regulation.

Markets have an irrational element. There are bubbles which have irrational reasons behind them. Incentive systems can exacerbate irrationality, a factor which must be taken into account. This overlaid everything and caused many regulators in different jurisdictions to sit on the sidelines, rather than jumping in and taking action early enough. As the Deputy pointed out, these problems were exacerbated by a lack of expertise. While the complexity of the lending was not at the high end, commercial property lending expertise is a particular skills set and the number of supervisors was simply outgunned. There is a certain transaction flown for supervisors who need to look at financial returns, change controls and processes in a given firm. If that is everything they are doing, the firm is setting the pace and they will not have enough space to look at the big picture. This can be done with expertise, experience and resources. We had a philosophical predisposition not to act; we did not have the right resources and the right rules to underpin matters.

The Deputy spoke about the loan-to-deposit ratio and the funding problems experienced. The Irish banks are very heavily exposed to borrowing in overseas capital markets and then lending here. There were no international funding rules. We looked at the Basle rules a few times, but we did not bring them in and got bogged down. The European Union looked at directives, but when I started working in the early 1990s, they did not get off the ground. A fundamental reason banks fail stems from the funding side, but there was no international standard. However, multiple causes contributed to the failure.

Deputy Jim O’Keeffe

Is there a danger that the pendulum will swing the other way? Is there a danger that we will become so over-regulated that the market will be stifled? How are we best advised to find the right balance?

Mr. Matthew Elderfield

That is the danger I mentioned to Deputy Fleming. I hope we have the right philosophical approach, which is to be risk based. For the most systemically important institutions which get us into trouble and leave us writing massive cheques, we have to be tough with regulation. However, we should not let that standard dictate the rules for every sector. It will ultimately boil down to a matter of judgment on a case-by-case basis.

We have a corporate governance policy which we pitched at the banks and insurance companies but not at the funds and captive companies. When we bring forward fitness and probity standards, we will have to have a different approach to funds, as well as to the big banks. It will have to be calibrated according to the role played inside each institution. It will be a matter of fine tuning our standards. Mr. Brady has been working on the solvency II rules; it is a very complicated directive. For companies at the top end of the spectrum such as Zurich, Aviva, Quinn and the like, we need a much more rigorous approach to supervision than to the captive insurers which are self-insured. We have already told them that we will take a proportionate approach to certain parts of the rules. We have to have our philosophical approach right which should be risk based, but it will be a matter of judgment, judgment after judgment, to get the balance right.

Deputy Róisín Shortall

I welcome Mr. Elderfield and his colleagues. His appointment in this grim scenario provides grounds for optimism, which is to be welcomed.

The main purpose of the special report was to establish what had gone wrong in the area of regulation. It is our job to examine that issue, but it is also our job to establish accountability for what went wrong. We will be seeking to speak to others who were involved at the time.

It would be helpful if Mr. Elderfield told us what he found out at the beginning and where he was going in terms of staff. He spoke about the skills mix. What is the ultimate staff complement towards which he is aiming? What skills mix is he aiming to have? Where are the weaknesses in the relevant professional qualifications of staff?

Mr. Matthew Elderfield

We have about 371 staff and are trying to get to a figure of about 520 in 2010. It will be a challenge to recruit that many staff, not because there are no opportunities in the market to do so, but because there is much to digest and we want to make sure we will have quality control in order that we hire good people. The board has agreed that we are probably aiming for a figure of around 700 at the end of the day, but we are not committed specifically to having that number. We want to engage in more benchmarking of our resource levels. After we bring forward the risk model, to provide for the categorisation of high, medium and low risk, we want to figure out what is the appropriate level of resources for the top tier. The Comptroller and Auditor General made the good point that risk-based supervision can be used just to re-divide the current pool of resources, but what he was saying in the report was that we need to decide the appropriate minimum level of resources in terms of the size and impact of the firms. We need to figure out how many we want to put in the top tier — obviously the large banks, but where is the cut-off for insurers, security firms and the rest? What is the minimum engagement model? The model would be a metric of how frequently we want comprehensive on-site engagement — that is, in a two-year or three-year cycle. What about interim contact with the regulated firm in the form of prudential meetings or discussions about strategy, consumer relations and so on? Based on that, we can calculate the required level of resources, and we will benchmark this in terms of other regulators by asking what BaFin, Luxembourg, Bermuda or the FSA do.

There are some other moving pieces. We are taking on new responsibilities from the Irish Stock Exchange in terms of reviewing prospectuses. We are also building up our policy and enforcement capabilities. Thus, we certainly need the extra 150 staff this year. Whether there will be another 100, 150 or 200 on top of that, we will work out later in the year when the risk model is articulated.

The range of skills is broad. I would like some more staff with front office or commercial experience. One way of doing that is by appointing so-called risk advisers. My idea is to have a small panel of six or seven people with board level and commercial experience who would work part-time for us on a consultancy basis and of whom the staff could ask advice. They could sit on risk panels. When we are doing reviews of risk assessments we want to have a peer challenge process in which the supervisor must explain and show he or she has dealt with all the risks, and he or she is challenged. To have somebody with some grey hairs who can ask tough questions will be useful.

There are some areas of technical experience in which we need staff, of which credit risk is an obvious one. The Irish banks are not so complicated in terms of the types of activity they undertake; it is mainly a question of credit risk. We must be ready for that. On the insurance side, we need more quantitative modelling ability; this is a quite technical skill that we need to develop. We also need people with a good understanding of policy; Europe is growing, and the European supervisory agencies, ESAs, are starting to dictate the sense of rules. As one member mentioned, it is important to have people who are good drafters and good at policy. That will be part of the mix. This is quite a long list and we have quite a bit to do.

Deputy Róisín Shortall

Is it the intention, when the office has a full complement of staff, that the costs involved be shared equally between the State and the clients, or the industry?

Mr. Matthew Elderfield

Around the time the Central Bank Reform Bill is passed, the Department of Finance will launch a consultation about moving from a 50% to a 100% cost allocation. Costs are going to rise; financial regulation has previously been done on the cheap, and Ireland is paying the price for that in billions of euro. That must be addressed. Resources will go up and the levy will go up, so the cost increases will be significant.

There are a couple of issues that are still up in the air. One is that, as we have just talked about, we have not quite landed on the exact final destination. Second, what about timing? How quickly do we move to a 100% cost allocation? Do we give people time and do we vary it by sector, maybe treating those who are under more competitive pressure differently? We could allow the risk-based approach to feed into our fees, so that if a firm is in the high-impact category and using the largest proportion of regulatory resources, its fees can be calibrated to be higher. I would like to see that done.

I cannot remember who asked a question about manual processing — it may have been Deputy Fleming — but we do need to work on efficiencies. We need to make careful judgments about where the resources are added in terms of adding cost to the industry. The funds industry is very cost-sensitive, for example, so we must be cautious about that.

What are the potential implications for competitiveness? The frank reality is that the costs of regulation are going up in all the jurisdictions that are competitive with Ireland. In Bermuda the big insurers' fees have gone from 20,000 to 450,000 Bermuda dollars. I mentioned that we regulate 320 insurance companies. Our cost of regulation for them is €5.6 million. The same amount — €5.6 million — is paid by perhaps three insurers in the United Kingdom to the FSA, but we are regulating 300 for the same amount. The reality is that the cost of regulation has increased globally because of the financial crisis, and it will need to happen here, although there are some judgments to be made about where the cost will land.

It is important to have a sense of perspective. The cost of the banking failure has been tens of billions of euro. An ounce of prevention is worth a pound of cure.

Deputy Róisín Shortall

Given the general acceptance that the previous regime was less than robust in the way it carried out its responsibilities and that most of the staff from that regime remain, how is Mr. Elderfield addressing this cultural issue to ensure the organisation is more vigorous? When recruiting staff, are there safeguards against conflicts of interest?

Mr. Matthew Elderfield

That is an excellent question. The hardest thing will be to change the culture, which will take a while. With regard to the question about safeguards, we can have checks in the employment process.

The senior management team must explain what we want and model it to the staff. If the staff raise something which requires an assertive response, we must not take the feet out from underneath them but back their judgment for the most part. In addition, it is important to establish processes. Some of the people coming in will be inexperienced and will not have the necessary skills. We want the processes to be in place so that big decisions are escalated to the right people. What do I mean by that? We run an escalation process weekly with a risk committee using an escalation template. That is a way for me and my senior staff, as supervisors, to see the flow of activity. All the heads of function are there, so it is a crucible of challenge. Anyone can pitch in and ask whether we have thought about this or that angle. That is helpful and breeds the desired culture.

When the risk model is built, I would like to have the peer challenge sessions I mentioned earlier, in which a person's peers in the office of the regulator, along with risk advisers, are brought in to challenge his or her assessment of a firm. Part of it is modelling — that is, walking the walk — part of it is talking the talk, and part of it is building processes so that the regulator is forced to go along with them. In addition, along with the peer challenge, staff are required to have a mitigation plan at the end of the risk assessment. If one identifies a risk, one cannot stop there and put the file away, but must decide what is to be done about it. One might decide it is a low risk and one can live with it; or it could be a medium risk in a small firm, in which case it is up to the firm. However, for the bigger risks in the bigger firms, we must have a system and a process that requires one to set out one's mitigation plan in the form of milestones and targets for the firm before one can put the file away. To establish those processes will take some time. That is Mr. Brady's key challenge. He will be heading our risk and policy area.

Deputy Róisín Shortall

One of the recommendations in the report of the Comptroller and Auditor General was about the role of auditors and the need to sign off on adherence to guidelines and so on. This is an issue that arises frequently at this committee. Sometimes, when we examine organisations, we find that the rules or guidelines were in place, but no named individual was responsible for signing off on them. Mr. Elderfield says that he accepts, in general terms, the proposal that auditors should have to sign off on such things. Would that arrangement require legislation, in his view?

Mr. Matthew Elderfield

That is a good question. It depends on how the proposal is pitched. I was not quite sure what the nature of the recommendation was. It talks about public assurance and if that required the auditor to send something to us privately, it might be possible under the legislation although I would have to check. If it is required for them to make a public assurance, my guess is that legislation would be required for that. Part of the question pertains to exactly how this will be done, that is whether it will be sent just to us or whether it is to be published. Before rushing to legislation, some consultation with the accounting bodies will be required and they will need to start to roll it out. I see the value in having someone audit the compliance statement for corporate governance. I also can see value in getting the risk management standards. Indeed, because of the difficulty that we both acknowledged about conducting transaction testing across the entire piece, because one cannot do it for a statistically significant sample, the front line of defence must be the firm and the auditors.

Deputy Róisín Shortall

Okay. I am simply quoting from its documentation. It states "HomeBond Insurance Services Ltd is regulated by the Financial Regulator." While I do not mean to put the witnesses on the spot, perhaps they could check out this issue as to whether——

Mr. Patrick Brady

Absolutely. For clarity, I am well aware that HomeBond Insurance Services Limited is regulated as an insurance intermediary. I was trying to clarify for the Deputy that it does not provide the insurance cover. They acquire the insurance cover from a third party insurer.

Deputy Róisín Shortall

Yes, I know. Allianz plc does it at present, although it did not always do so. I refer to the Financial Regulator establishing whether the cover provided is adequate to ensure consumer protection. What is Mr. Elderfield's position in this regard?

I also asked about setting maximum mortgage levels for consumers in terms of the percentage of a mortgage made available by a financial institution and about the income to mortgage ratio. Does the regulator set these?

Mr. Matthew Elderfield

I do not believe we have ever prescribed them. The banks have retrenched in terms of the maximums they are providing. Had we information on a particular bank that was providing excessive lending, we would take action on a bank-specific level, but the regulator does not prescribe a cap.

Deputy Róisín Shortall

Does any agency set limits?

Mr. Matthew Elderfield

I do not believe so. There are debates on high loan-to-value ratios. The UK's Financial Services Authority, FSA, has gone into that space, but I am unaware of any regulator, at least none of those for which I have worked, that has set income multiple restrictions. An individualistic assessment of capacity to pay tends to be the better way. If one is a regulator, it makes sense to have metrics and information to monitor credit standards. We have published surveys of credit standards conducted through the European Central Bank, ECB, that show how lending decisions move over time.

Deputy Edward O’Keeffe

I welcome our guests. Mr. Elderfield has made much play about corporate governance. The two key sub-committees of any board are remuneration and internal audit. Mr. Elderfield has also stated that he must increase his staffing levels substantially. This makes it appear as though the internal audit side has fallen down.

My first point will be on the audit and remuneration committees. It is usually the lambs who are on those committees and I understand that there is rarely any reporting back. What influence does the regulator have and can he insist on reporting back? These sub-committees usually meet and report to their boards approximately three or four times per annum. This also occurs in other areas of the private sector, but has auditing in the banks failed if the regulator needs such a high level of staff to police the financial institutions? Why is the banks' auditing insufficient for investigations by the regulator? Given the level of staff, it is obvious that the regulator will be conducting another audit.

Mr. Matthew Elderfield

All parties involved in the financial crisis have lessons to learn and I am sure some searching questions are to be asked about the audit profession. A regulator tends to prefer multiple lines of defence. The first line should be the company, namely, making the front office and commercial staff aware of risk and the consequences of their decisions. One then wants the company to have a control framework in place, that is, internal audit staff, governance arrangements, a risk management unit and a compliance unit. These comprise another line of defence.

While one also wants external auditors in place, the regulator is still necessary. As a regulator, we can provide a different and fresh perspective. We are not necessarily carrying out pure systems and controls checks. We do not have the same role as an auditor. We should be examining risk in the round. For example, an area for supervisors is that of challenging business risks and business models. We have discussed a recent example of problems with pricing insurance. We could discuss banks getting too involved in the securitisation business. It is highly unlikely that an internal audit would pick up the latter. An internal audit checks whether all of one's controls have been met, so it is on the control side of the ledger. While we are interested in that, we care about the business risks. Having a challenge in this respect is important.

What I have outlined is best practice internationally. In the US, the UK, France and Germany, there are multiple lines of defence. One wants auditors and the regulator to do their jobs.

Deputy Edward O’Keeffe

Mr. Elderfield is seeking a higher level of solvency in the insurance and, possibly, banking industries than is the EU norm. Will he elaborate on why he wants levels that are higher than the EU norm?

Mr. Matthew Elderfield

For both banks and insurers.

Deputy Edward O’Keeffe

Yes.

Mr. Matthew Elderfield

In light of the recapitalisation of the banks, we were trying to address a number of challenges. First, we know that the banks are exposed to many losses in their NAMA and non-NAMA portfolios. We wanted the process to identify and flush those out so that the banks would be forced to face up to their problems now. This was an important goal.

Second, we wanted to be able to examine the banks' stress positions. A formal requirement to stress test against a capital level is not in the EU directives, but it is best practice internationally. The UK's FSA had a stress test requirement of 4% core tier 1. The American regulators — the Federal Deposit Insurance Corporation, FDIC, the Office of the Comptroller of the Currency, OCC, etc. — also had a stress requirement.

Third, we know that Basel III will be just around the corner. Since the EU will have tougher requirements, we believed it important to get the banks as far along the path to Basel III as we could so that the distance they had left to get there could be travelled under their own steam. If one only modestly recapitalised the banks, there would be a large gap between that and what they need to do under basel III and the market would claim they would need to revert to the taxpayer. There would be great uncertainty about the banks' prospects and the impact on the Government.

Mr. Matthew Elderfield

We have supervisory responsibility for those entities, many of which operate as subsidiaries here. We have direct regulation of them. One of the issues we need to consider is the capital requirements we must impose at a solo level. When we issued a statement on bank recapitalisation, our so-called prudential capital assessment review, PCAR, approach on 30 March, we noted that we needed to do more work to think about how this applied to those banks.

We must also consider the consumer protection agenda for those banks. The code of mortgage arrears applies to those firms. Some of these sub-prime lenders have poor practices in their treatment of mortgage arrears. We recently commented on that and people can look forward to action on that as part of the mortgage arrears review.

Deputy Edward O’Keeffe

Smart Mortgages is the bank that comes to mind when I consider constituents and clients.

What regulation applies to deposits? The stones on the road knew that Anglo Irish Bank was going downhill as far back as five years ago. I sat on the Joint Committee on Finance and the Public Service for two terms and we said this at meetings but we got no answers. Now Anglo Irish Bank is paying over the top for deposits, paying in excess of what the market is returning. They are upsetting other bank structures. This morning we learned AIB is not receiving sufficient deposits because it is not paying the price. The market is governed by what the lender pays in — that is how the market works. What control does Mr. Elderfield have over Anglo Irish Bank in respect of this crisis?

Mr. Matthew Elderfield

Regarding deposit rates, it would be rare for a regulator to mandate deposit rates and set caps. It would send odd signals to the market if we were to act in that way. We have had representations from people to think about that but I am not aware of other regulators who have done so.

Deputy Edward O’Keeffe

If I am paying more for money than I receive when lending it, I am incurring massive loss. That is what is going on. Mr. Elderfield is charged with responsibility for regulating.

Mr. Matthew Elderfield

There is a difference between saying we should intervene in the market and mandating maximum deposit rates. It is a fair point to say that the liquidity positions of the banks and their funding is a major challenge. The recapitalisation work we have done helps to address the capital position but the other major issue that must be worked on over a number of years is the funding. As mentioned by a Deputy who has now left, the loan to deposit ratios of Irish banks and all banks around the world went out of sync and the amount of lending compared to deposits was inappropriately calibrated. It will take a while before the funding position is normalised. We must deal with the transition from the guarantee, the ECB exit strategy and Basel III with the concept of net stable funding ratios. It will be a three to five-year project before we can do this. Rates for deposits are part of the equation, as is improving banks' capital positions so they can fund more effectively on the interbank market and issue more term deposits. These must be addressed within the timeframe of three to five years.

Deputy Edward O’Keeffe

Mr. Elderfield should forgive my ignorance. If the bank is paying more to depositors than it is getting through lending, is the bank walking into a crisis? It will destroy its capital base.

Deputy Thomas P. Broughan

It is trying to pretend it is still alive.

Deputy Edward O’Keeffe

I thank Deputy Broughan for helping me. There must be a role for a regulator in that area. Anglo Irish Bank has been one of the great crises in the banking profession in this country. It led the other banks into the difficulties they are now in because they followed like sheep. We are where we are. The crisis was not brought about by everything else but an issue exists. That bank is like a hangman and more action must be taken in that area to sort out that organisation.

Mr. Matthew Elderfield

Chairman

Thank you.

Deputy Thomas P. Broughan

I welcome the regulator and his colleagues. My first questions relate to what Deputy Edward O'Keeffe raised, although of course I totally disagree with him. Taking into consideration the past 20 or 30 years, is Irish banking different? The Chairman mentioned the DIRT scandal, which this committee investigated and spent a long time, perhaps a year, in intensive daily investigation on television. Allied Irish Banks more or less collapsed in the 1980s. We had the collapse of our largest insurance company, related to AIB. We had the Ansbacher scandal where a prominent businessman, who was close to the Taoiseach, organised from his office a major bank; he ran a large bank from a little office. We had huge overcharging scandals. We had the disaster at NIB and the ongoing scandal of endowment mortgages whereby people were sold products in a criminal way which left them at a significant loss. One or two people have taken court cases on this. I understand approximately 90,000 families were trapped in the endowment mortgage scam. One could go on and on with scandal after scandal.

Deputy Edward O'Keeffe referred to 2003. Whatever regulation we had prior to that failed abysmally, but after 2003 not alone was there no improvement but subsequently it almost bankrupted the country.

When I returned to this committee in 2007 I asked for a report on the regulator. The then regulator, Mr. Neary, came before the committee on Thursday, 22 May 2008 and I will provide some quotes from his lengthy contribution.

Five years on from our establishment, we believe that the regulatory structure we have put in place is working very well. Our approach to regulating more than 13,000 [that is the figure he put it at] financial services firms is grounded in a set of principles accompanied by robust fitness and probity standards, where we place a duty on the boards and management of entities to manage their business in a responsible and prudent manner, within standards set out in Irish and EU law.

One could read out all of his contribution at a comedy club. It is wonderful.

We have spent much of the past five years developing and embedding our regulatory approach. We aim to be proportionate and to allow time for industry to manage and embed change. [Mr. Elderfield said something similar to this today.]...To the greatest extent possible, our regulatory regime must reflect the reality that we operate in a global marketplace....We take a risk-based supervisory approach guided by the nature of the risks inherent in the business of each financial service provider we regulate. We target our resources on those businesses and activities with the higher and more complex risk profiles....We are committed to continuous examination and upgrading of our own processes and procedures. Following wide consultation, we implemented a stakeholder protocol last July.

Mr. Neary then told us about his wonderful strategic plan. It is unbelievable rubbish. Two years ago, this committee was told a pack of lies by Mr. Elderfield's predecessor. We were utterly misled. Deputy O'Brien and I attended that meeting and Deputy Kenneally chaired it. We tried to raise numerous issues with the then regulator and we got what we call "plamás" — basically bullshit — about a fantastic system for our banks that simply did not exist. We were told lies and there are implications for the entire role of the committee and for the Comptroller and Auditor General in the way this happened. Is Ireland different or do we have a very bad banking structure?

By the way, my colleague, Deputy Rabbitte who made a fine speech on the Bill before the House and was one of the prominent movers, with the late Deputy Jim Mitchell, in uncovering the incredible DIRT scandal has continued to pose the question of whether it was the architecture or the culture that was wrong. Deputy Shortall referred to the culture. Is it that we had a terrible bank culture which consisted of insiders making massive profits for themselves while robbing consumers? Is it the case that when we joined the euro which gave us access to shedloads of money, we simply gave it out to developers and others who have now almost bankrupted the State? In the middle of all this, we were given a fairytale by Mr. Elderfield's direct predecessor, Mr. Patrick Neary. I would like to hear Mr. Elderfield's comments on these two points.

Mr. Matthew Elderfield

I fear other countries have their litanies of failures also. The United States and the United Kingdom have also had problems with mis-selling to consumers and there have been past bank failures. When I was at the FSA, I worked on the mortgage endowment team to try to sort out the situation where a large section of the population was trapped with underperforming endowments because of poor stock market performance and banks were not handling their complaints efficiently. It took a lot of pressure to come to a resolution. Each country, unfortunately, has had its problems.

He was referring to the Stock Exchange, another of the regulator's responsibilities, when he said it was a laughing stock.

Mr. Matthew Elderfield

Fine. That is a good example of the powers and resources problem. There are gaps in powers, resources and attitudes. In powers, there are gaps in fitness and probity on which we are working to try to get them through in this session of the Dáil and then for a second Bill later on. We may also be able to look at a higher level of fines. There is a cap of €5 million for fines which is not a deterrent for the most significant problems.

Regarding enforcement, I do not know if the Deputy was present when I mentioned this point before. We have a very small enforcement team. It does not really have an investigative capability which means we have not invested in the resources for that. If one wants to take action against individuals the problem is that it can be a very drawn out process. They fight all the way because they will be banned from the industry. Therefore, we need to invest more in that.

In terms of getting money back for customers, one of the areas in which I have asked the team to accelerate their work is on overcharging. A couple of overcharging issues came to a head just after I arrived and it is clear there is a backlog sent in to us concerning companies that have not yet dealt with their customers. We have written to all those companies and set them a deadline by which they must communicate and do restitution. We did that under powers, basically saying, "If you don't do this we are willing to take enforcement action against you". In the consumer protection code review that Mr. Sheridan is leading over the summer we will look again at the overcharging approach and see if we can make it sharper. I anticipate that if the firms do not pull up their socks in terms of their practices on overcharging there will be more enforcement cases in that space.

Deputy Brendan Kenneally

I have only a couple of questions because I wish to avoid going over old ground although my first question touches on some points Mr. Elderfield was asked about and has partly answered. Does the regulator have enough powers, or does Mr. Elderfield think he will have enough powers when the Central Bank Bill becomes law? It finished Second Stage in the Dáil last night. Are there enough sanctions? Mr. Elderfield said there was a gap in the sanctions. Will that gap remain when this legislation comes into force?

I have a question on directors' loans. In reply to Deputy Broughan, Mr. Elderfield said that under the code directors would no longer now get these on more favourable terms. Is there any monetary cap on the value of the loans that can be given out to directors, or does he intend to introduce any such cap so that there cannot be a situation that pertained in certain institutions which offered enormous and totally out of control loans? Can the regulator control that in some way?

Mr. Elderfield also mentioned that his office would go out on site. In his contribution he stated "Given the sheer scale of each individual bank's transactions and the limited resources available to us we believe it is unlikely it would be possible to test a statistically significant sample of transactions". I agree with that but might there be a facility to dovetail more with the auditors of these various institutions? Obviously, a statistically significant sample would be done by them. I cannot believe for one minute that the auditors of the various institutions missed some of the things that were missed. It was not possible for auditors to miss those. Can there be more interaction between Mr. Elderfield's office and the outside auditors of the various organisations to try to keep the banks under more control?

Mr. Matthew Elderfield

Those are good questions. I spoke a little about powers but I shall mention some of the things we are thinking about. The clearest answer to the Deputy's question is "No". The current Act would not deal with all the powers we think are appropriate. We asked for the fitness and probity requirements to come in the first wave and we are very thankful to the Government for doing that. That is a good first step. We are still studying some of the detail of how it will work in practice. However, there are some things we need to look at for the second Bill. As I mentioned, we are creating an inventory of what we think is appropriate. This includes the levels of the penalty and whether we should move on the €5 million. It also includes the whistleblower protection, a topic about which this committee's sister committee, the Joint Committee on Economic Regulatory Affairs, marked my cards. This is an area where we have sympathy and where we believe statutory protection for whistleblowers needs to be examined. The question about the role of auditors must be considered as well, as do such issues as stronger information gathering and a special resolution regime in terms of the ability to deal with troubled firms. This is the top of the list and we will consider it some more.

I will make several remarks on credit unions. The risk-based approach should apply to them as well, whereby we calibrate our approach based on the size and risk profile of a credit union. There are some very small credit unions but there are some very large ones as well. The very large ones, which aspire to be more bank-like and carry out more bank-like activities, are probably getting closer on the spectrum to being regulated like banks, but we should not apply that to everyone.

There have been some encouraging signs in the health of the credit union movement in respect of dividends. Liquidity levels have improved in aggregate and the reserving levels have improved in aggregate. However, the arrears levels and the provisional levels of credit unions in general have gone up as well. It is very important for the voluntary boards of credit unions to examine very closely their dividend policies and to err on the conservative, prudent side when considering the risks they face and to ensure their reserves are adequate. If that means trimming or cutting the dividend, then so be it.

I refer to the future of the credit union movement. The Minister has mandated a strategic review of the movement which will examine all aspects of its profitability and health, the activities credit unions can carry out and how the movement is to be regulated in future. We have been asked to do this on an independent basis. We are organising it but the review will be carried out by independent consultants. We are at the point where we have finished the tender process and we will appoint consultants. This will run to the end of the year. The result will include a report with some conclusions to set out the future direction for regulation of the credit unions.

Chairman

A final question from Deputy Broughan, please.

Deputy Thomas P. Broughan

There is a good deal of territory to cover and I realise the Chairman will have a view on many issues, including those in the Comptroller and Auditor General's report to which I wish to return. Does the regulator believe that all banks and financial institutions should have a living will? We were discussing a dead bank. How it is possible to have a living will if a bank is dead?

Mr. Matthew Elderfield

The matter of living wills is a good question. It involves the idea that systemically important banks should be required in advance to indicate how they will die, and which parts should have Government support and which parts should not. The idea has been pioneered by the FSA in the UK but it has not yet been adopted as standard practice as part of EU law or financial services regulation. There is a debate at G20 level about how to deal with systemic banks. There are several things one can do in that space, including more regulation and resources, tougher capital and better co-ordination between supervisors, all of which we are doing. I am not so sure whether we should go into the space of living wills as well and this is why I am still thinking about it. It is more important for the complicated, cross-border international companies——

Deputy Brendan Kenneally

Are other countries doing it?

Mr. Matthew Elderfield

I do not know if the Canadians or the British are doing it. Let us consider the case of a bank, an investment bank and an insurance company with a holding company here and subsidiaries elsewhere. The governor of the Bank of England used the phrase that banks live globally but die locally. This is what living wills are about and about how such firms unpick themselves over time. The Irish banks are not as complicated in terms of their activities and international presence. Perhaps it is inappropriate for now, but something to think about.

Chairman

Does Mr. Buckley wish to administer the last rites, or at least a living will?

Mr. John Buckley

I could discuss banks not having the will to live, but I will not discuss it. We have dipped into this area three times in the past decade. What is gratifying about today's hearing is that we now feel we are being heard on certain issues. We welcome the direction in which the regulator is moving and we understand that it will take time to move fully on all these issues. We welcome, in particular, the idea of being dynamically involved in regulation, rather than simply doing information or analysis-based work. That is a very positive direction in which to be moving. The minimum standard of engagement the regulator intends to set on the ground, namely, balanced scorecard-type reviews, is also a useful direction. The idea of trying to achieve coverage over set cycles also struck a chord with me.

On the establishment of an investigation team, obviously there is a considerable amount of work required, such as setting up the investigation teams to feed the enforcement process and the employment of more staff in order to be able to respond to the new regulatory drives which are coming from abroad, to be able to deal with the policy agenda, implement the new capital requirements which have been established and push forward, after the exposure stage, with the corporate governance regime. One of the crucial issues is information technology developments and making sure to bring that to a conclusion as fast as possible in order that the regulator can have speedy interrogation of the data to drive the work. Having the capacity to extract and analyse relevant ratios and statistics and so on could be crucial to the work in the future.

I wish to pick up on the reference to positive assurance. To be honest, as auditors we give out a set of suggestions and I can see that in one case the regulator is grappling with the idea of what we mean, namely, whether public reporting or reporting directly to the regulator is intended. It is really a matter for the regulator to decide, based on discussion. Once our suggestions are debated and discussed, the ultimate solution is best left open and is a matter for discussion between the regulator, the industry and the auditing profession. When I made that comment, I meant that we should move from the negative assurance that is now inherent in an audit certificate. In every audit certificate I produce I give negative assurance on corporate governance. It is a technical phrase and simply means that I am saying that I have not seen anything which would cause me to doubt what is in the organisation's statement of internal financial control.

The basis for that in central government is a code of practice which has been promulgated by the Minister for Finance. In the quoted companies it is the combined code. That was the origin of the suggestion. As I said, auditors do not enter the arena and take part, rather, we throw out suggestions. At this point it is entirely left to the regulator to see how it can best use them.

Chairman

The committee has heard evidence over the past number of weeks from the National Treasury Management Agency, the Department of Finance and the Financial Regulator. It is significant that even though it is a short time since the problems have happened, namely, the bursting of the property bubble and banking crisis, the three Accounting Officers who appear before us today are not those who were in place at the time of the crisis. That is an important point. At this stage our committee will have to assess the evidence given to it and will have a private meeting on 27 May.

At the same time, the Minister for Finance will receive the findings of the two independent inquiries into the banking crisis. The Dáil will have to decide what to do with those reports. There is no point in the committee carrying out a parallel inquiry into the situation if the Dáil decides on another avenue. We will meet NAMA in September but we will have to assess the situation at our meeting on 27 May. We will have to see what the Dáil decides regarding the two reports of the inquiries and decide on our position. Arising from the evidence that we have heard on the three hearings to which I referred, this committee will prepare a report on the basis of that evidence. We will also deal with NAMA in the autumn.

I hope that Mr. Neary, Mr. Doyle and Mr. Hurley would be brought before a committee or inquiry hearing. They may come before this committee — we will have to examine our powers — but it is in the public interest that the three people to which I referred be obliged to account for what happened in the time leading up to the crisis. It is beyond belief that a property bubble could happen, with nobody bearing responsibility for not knowing about it; I do not believe that. The banking crisis evolved and nobody seems to have spotted that either. It beggars belief and there is a need for this committee — the Dáil may decide otherwise — or another committee to ensure people account for their decisions.

The best course of action we can take is that we do not dispose of Special Report 72 of the Comptroller and Auditor General which is the report responding to the crisis in the financial market until such time as we meet to evaluate the evidence given.

I thank Mr. Elderfield, Mr. Brady and Mr. Sheridan for their very helpful evidence. They are straight talking. I thank the members for the four hours' work we did here.

The witnesses withdrew.

The committee adjourned at 2.20 p.m. until 10 a.m. on Thursday, 20 May 2010.