COMMITTEE OF PUBLIC ACCOUNTS debate - Thursday, 21 Jul 2011

Finance Accounts 2009

Mr. Kevin Cardiff (Secretary General, Department of Finance)called and examined.

Chairman

I remind everyone to turn off mobile phones because they interfere with the transmission and sound quality of the recording.

I advise witnesses that they are protected by absolute privilege in respect of the evidence they give to the committee. If they are directed by the committee to cease giving evidence on a particular matter and continue to do so, they are entitled thereafter only to qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and asked to respect the parliamentary practice to the effect that, where possible, they do not criticise or make charges against a Member of either House, a person outside the Houses, or an official by name or in such a way as to make him or her identifiable.

Members are reminded of the provision within Standing Order 158 that the committee shall refrain from inquiring into the merits of a policy or policies of the Government or a Minister of the Government, or the merits of the objectives of such policy or policies.

I welcome Mr. Kevin Cardiff, Secretary General, Department of Finance, and ask him to introduce his officials.

Mr. Kevin Cardiff

I am accompanied by Mr. Paul Ryan, corporate services division; Ms Ann Nolan; Mr. John McCarthy; Mr. David Moloney from the new Department of Public Expenditure and Reform who will obviously be covering matters in respect of that Department, and Mr. John Warn, banking division.

Chairman

I ask Mr. Buckley, the Comptroller and Auditor General, to introduce the 2009 Annual Report of the Comptroller and Auditor General and Appropriation Accounts.

Mr. John Buckley

The net cost of running the Department of Finance in 2009 was €65 million, as disclosed in Vote 6. The Department classified its operations that year under four main programmes - budget taxation and economic policy; public expenditure and sectoral policy; financial services and public service management policy. Since the recent restructuring, public expenditure and sectoral policy, as well as public service management has transferred to the new Department of Public Expenditure and Reform. Certain functions of the Minister are also performed through the NTMA, which had an administrative budget of €39.4 million in 2009. That money is made available directly from the Central Fund.

As well as the Vote, the Department also produces a composite report account of State financial activities known as the finance accounts. For ease of reference, the key payments are set out in chapter one of my report. The chapters before the committee today set out the overall account of State transactions I just alluded to, some information on the major liabilities and assets of the State at the end of the year, the obligations at the end of 2009 of the State under public private partnership arrangements and the measures that have been adopted to stabilise the banking system and its institutions up to the point where we finalised the report. Also, Ireland's financial transactions with the European Union are covered.

The salient facts included in the chapters and updated for 2010 transactions are that the State deficit was €24.6 billion in 2009 and in 2010 it was €18.7 billion; tax revenue fell from €47.3 billion in 2007 to €33 billion in 2009 and dropped again slightly in 2010 to €31.8 billion, a drop of a third in three years, €15.5 billion in money terms; and after taking account of cash balances of €21.8 billion, or a liquidity buffer that had been built up, the net national debt at the end of 2009 was €75.2 billion. The corresponding net debt at the end of 2010 is €93.4 billion.

Those figures are in net terms. The gross Government debt at 31 December 2010, after taking account of promissory notes that were issued in connection with bank stabilisation and other liabilities in connection with the semi-State sector, was €148 billion. If there was a whole-of-Government balance sheet, another item that would appear is the cost of occupational pension liabilities that represent the present value of the amounts that would fall to be repaid in respect of pensions that have been earned up to end December 2009 of the order of €116 billion. In addition there were commitments of €4.1 billion, representing future cash outflows under public private partnerships that had been entered into up to the end of 2009. We also paid €1.5 billion towards the EU budget and received back €1.8 billion.

Chapter six in the report deals with the bank stabilisation measures that been taken up to July 2010. The matter was discussed previously at the PAC last October and subsequently the committee held a session based on the records of the domestic standing group. In the wider context, the former committee also examined special reports on NAMA and on banking regulation.

The key stabilisation measures that have been taken are the guarantee of deposits and liabilities that covers sums up to €334 billion at mid-2010. There was continued provision by the euro system of liquidity and emergency lending guaranteed by the State to banks domiciled in Ireland and the nationalisation of Anglo Irish Bank and the acquisition of two building societies. NAMA purchased at a discount impaired assets that had an original book value of €71 billion. These were acquired for around €30 billion, with 95% of this sum being paid by way of Government-guaranteed floating rate notes and the balance of 5% being met by way of subordinated debt. There was provision of capital of €47 billion to Irish banks up to the end of 2010, with a commitment to increase this by up to €24 billion, if required. Another element was the reform of financial regulations, reintegrating the systemic and institutional aspects of regulation and in this connection the Central Bank, as required by the legislation, has published its first annual performance statement on financial regulation, which covers 2010-11. It did this in April 2011.

Certain banking functions of the Minister have been delegated to the NTMA. While the chapter we have before us provides a snapshot of the banking stabilisation situation at a point in time, that position is continually evolving and the Accounting Officer will be able to update the committee on subsequent developments.

Mr. Kevin Cardiff

I thank the committee for giving me the opportunity to make a short opening statement. In my comments around this time last year, I mentioned that 2008 marked a negative turning point in Ireland's economic performance and in the stability of and outlook for our banking system. International and domestic factors combined to create some of the most difficult financial conditions the State has ever had to face. These conditions persisted during the course of 2009 and while there was some amelioration on some measures in 2010, market conditions remained very difficult and they culminated in the requirement for financial assistance in the form of the EU-IMF programme of support that was agreed in late 2010. Much of the Department's time during the past two and a half years has therefore been focused on these key issues - restoring fiscal stability, safeguarding the banking system and developing the EU-IMF programme of support, including the ongoing reporting requirements associated with that support.

To deal with 2009 specifically, that year was characterised by a rapid fall in economic activity, where GDP fell by 7%, and a consequent major deterioration in the labour market, where employment fell by over 8%, and a huge fall off in tax revenues. Internationally, 2009 was a bad year but Ireland fared much worse than most given the bust in the construction sector. The peak to trough fall in GDP has been 12.5% and for employment about 15%, from about 2.1 million to around 1.8 million. Since the peak in tax revenue in 2007, it fell by a third by end 2010.

Restoring order to the public finances is a key condition for returning the economy to sustainable employment growth. Substantial efforts in this respect are continuing, with significant steps also being taken on the structural reform front. For example, the expenditure control initiatives mentioned last year, the comprehensive analysis for the special group on public service numbers and expenditure programmes, the policy development work on public service pension reform and the comprehensive review of capital expenditure have been supplemented by multi-annual planning and performance budgeting, the national reform programme and a jobs initiative.

Encouragingly, economic activity has started to pick-up again, although slowly, while the public finances are showing signs of stabilisation, with targets being met. After a difficult couple of years, these are welcome developments. A strong export performance is projected to translate into GDP growth of 0.8% this year, and 2.5% next year. Over the medium term, a gradual firming of domestic demand is also expected as the recovery broadens out and spills over to the labour market. For the period 2013-15, the economy is forecast to grow by 3% per annum on average.

Turning to today's agenda, on Vote 6 – for the Office of the Minister for Finance - there was a net outturn of €65.147 million in 2009, compared to a net Estimate of €68.355 million, leaving a surplus to be surrendered of over €3 million and representing a net reduction in spend of 25% year on year. In keeping with the Government savings directive, the Department continued to make significant savings in the administrative budget area, with an 8% reduction in 2009 following on from a 20% reduction in 2008. Other savings arose on programme depend as certain programmes reached their natural conclusion. A final key driver of this saving arose as a result of additional appropriations-in-aid arising from the pension related deduction initiative and recoupments under the bank guarantee scheme.

On to the chapters listed for review today, chapter 1 - financial outturn 2009 - sets out a summary of the major Exchequer liabilities and assets as at 31 December 2009. The committee will be aware that this position has moved on significantly in the intervening 18 months. The financial outturn for 2009 shows that total Exchequer expenditure was €59.4 billion, of which some €47.2 billion relates to voted expenditure. The Vote group allocations set out in the 2009 Revised Estimates for Public Services amounted to €47.4 billion. Therefore, a small underspend compared with profile was recorded in voted expenditure. Other expenditure of €12.25 billion brought total expenditure for the year to just under €59.5 billion. Receipts totalled €34.75 billion, resulting in an Exchequer deficit of €24.6 billion in 2009.

A contributory factor in the large Exchequer deficit was the very significant year-on-year decline in tax revenues. Tax revenues in 2009, at €33 billion, were €7.75 billion or 19% down on the previous year, and nearly €10 billion below the original estimate. There were two exceptional factors which contributed to the large Exchequer deficit in 2009. There was a frontloading in 2009 of the 1% of GNP contribution for 2010 to the National Pensions Reserve Fund, NPRF, bringing the total payment to the NPRF in 2009 to €3 billion. In addition, there was a payment of €4 billion to Anglo Irish Bank. Both of these payments were accounted for as non-voted capital expenditure.

Even allowing for these once-offs, a deficit of the order of €18 billion in a year when tax revenues amounted to €33 billion and when the economic situation was creating further spending pressures indicates the strain on the public finances that has been at the heart of our fiscal situation. Fortunately tax revenues declined at a slower pace in 2010 and are rising in 2011, and tax and expenditure are within the expected ranges so far this year, but the deficit remains high and will require further attention in the coming years.

As outlined in the report, chapter 5, financial commitments under public private partnerships,has been compiled to provide financial commitments entered into by central government and agencies. Until the establishment of the Department of Public Expenditure and Reform, the Department of Finance had the same role in relation to PPP projects as it did in relation to capital investment projects generally in terms of setting the overall capital investment framework and the basic principles to be observed for the appraisal, assessment, procurement and evaluation of projects. Individual Ministers were responsible for projects and programmes in their areas, within that overall framework. As Deputies will know, the National Development Finance Agency, NDFA, was closely involved in giving advice on those.

A key issue for PPP projects is financial sustainability. The Department of Public Expenditure and Reform will be examining PPP projects from the perspective of long-term financial affordability and sustainability. There are some difficulties in the PPP funding market at present resulting in a reduction in the number of banks participating in the market. Reflecting this, the Department of Public Expenditure and Reform is working very closely with the NDFA to examine what options may be available that will provide a cost-effective solution to enable projects to secure funding on a value for money basis.

We now come to chapter 6, banking stabilisation measures. As was discussed with the previous committee last year, there were a number of developments on the banking side over the course of 2009 and into 2010. At the end of December 2008, the Government had announced the allocation of €10 billion for the recapitalisation of domestic banks, but in the course of the consideration of this process and the associated due diligence work, it became apparent that there were issues in Anglo Irish Bank that were qualitatively different from other institutions and which had to be dealt with differently. In mid-January, the Government announced its decision to nationalise Anglo Irish Bank, and in February it was announced that AIB and Bank of Ireland's first recapitalisation would consist of a preference share injection of €7 billion between the two. In April, the NAMA project was announced and a great deal of work was done subsequently in turning this announcement into legislation, which passed in November. At the same time, a replacement scheme for the original bank guarantee was put in place and approved by the Oireachtas at end 2009.

Work on the stabilisation of the banking system and improved banking regulation continued during 2010 and 2011. Over the course of 2010, the former Minister for Finance, the Department, the Central Bank and the National Treasury Management Agency took a number of actions to address the worsening situation in the banking sector, including stress tests, further recapitalisation, and following the agreement of a programme of support with the EU and IMF authorities, legislation to facilitate the reorganisation and restructuring of the banking sector in the form of the Credit Institutions (Stabilisation) Act.

In March 2011, following the completion of the prudential capital assessment review, PCAR, and the prudential liquidity assessment review, PLAR, by the Central Bank, the Minister announced the Government's proposals to restructure the banking sector comprehensively. This restructuring will create two Government supported universal pillar banks that will be smaller and more focused on the Irish economy. Pillar 1 will be Bank of Ireland and pillar 2 will be a merger of AIB and EBS, which merger has already happened in legal terms. The existence of these two pillar banks and a radically restructured Irish Life & Permanent along with the continued operation of Ulster Bank and other foreign owned institutions will ensure a competitive environment is maintained in the banking sector.

Deleveraging plans have been agreed with all the banks, subject to Government support, providing for the deleveraging in the aggregate of approximately €70 billion of assets, more than 70% of which are assets located outside of Ireland. Each of the pillar banks has moved to establish core and non-core divisions and management teams for each business. Deleveraging committees with involvement of staff from the Department of Finance banking division have been set up in each of AIB, Bank of Ireland, IL&P and Anglo Irish Bank to ensure delivery of the targets.

The PCAR process identified a capital requirement of €24 billion, including a buffer of €5.3 billion. While the Government has committed to ensuring the banks are fully capitalised up to that level, direct contributions to solving the capital issues of the banking system have been sought by looking for further significant contributions from subordinated debt holders, by the sale of assets to generate capital and, where possible, by seeking private sector investors. It is expected that the effect of these actions will be to reduce very significantly the amount of capital required. We have set ourselves a target of achieving a reduction of at least €5 billion in the capital requirement. The sales process for Irish Life & Permanent's insurance arm is already under way, and significant burden sharing with subordinated bondholders is under way.

As verified last week by the troika, significant steps have taken place since March 31 on the banking side. The legal merger of Allied Irish Banks and EBS was completed on 1 July 2011, well ahead of the end of September 2011 deadline. The merger of Anglo Irish Bank and Irish Nationwide Building Society to form the Irish Bank Resolution Company, IBRC, was completed on 1 July 2011. A plan to recapitalise Irish Life & Permanent has been finalised again ahead of schedule and the Irish Life subsidiary has been offered for sale again in advance of the October 2011 deadline for that process. The recapitalisation of Allied Irish Banks, Bank of Ireland, Irish Life & Permanent and EBS, which is part of AIB, will be completed by 31 July, net of the remaining liability management exercises and disposal of IL&P's insurance arm, and the process of renewal of the boards and management of banks is under way. The Department and the other authorities are continuing to work towards the goal of a restructured and re-sized banking system in Ireland.

Chapter 7, European Union financial transactions 2009, sets out details of Ireland's contributions to and receipts from the EU budget in 2009. It also has details of total contributions and receipts for the period 2005 to 2009. The chapter describes the basic features of the systems of audit of EU funds. The Department of Public Expenditure and Reform has overall policy responsibility for Ireland's EU Structural Funds programmes and, in this context, sets out the financial management and control procedures to be followed to ensure EU rules and regulations are complied with and to avoid loss of Ireland's Structural Funds allocations.

The Department of Finance itself is changing rapidly and significantly. The most radical example is the restructuring of the Department on foot of the Government decision to establish a new Department of Public Expenditure and Reform. The legal split of functions was completed this month, although we have been working the split on an administrative basis for some time so that the new Department is now up and running on a statutory basis. The new Department assumes the public expenditure control functions previously carried out in the Department of Finance, and in this regard it is charged with ensuring the effective management of taxpayers' money. That Department has also assumed responsibility for public service management and reform, functions which were previously done in the Department of Finance and the Department of the Taoiseach. Staff from the latter Department have moved to the new Department. In undertaking this work, an overriding principle will be the efficient delivery of quality citizen and business focused services from a modernised public service. The Croke Park agreement will be a key enabler of this reform.

Committee members will be aware that the Government has established an economic management council. The Government has also recently announced the establishment of a fiscal advisory council in line with commitments in the programme agreed with the troika. These are two very important steps and they will have an important bearing on the work of the Department of Finance and the Department of Public Expenditure and Reform over the coming years. Comprising the Taoiseach and Tánaiste as well as the Ministers for Finance and Public Expenditure and Reform, the management council is responsible for managing the Government's programme in respect of economic planning and budgetary matters, the EU-IMF programme and negotiations associated with it, the integration of the work of Departments and agencies in these matters, as well as the co-ordination of the banking policy of the Government.

The report of the independent review panel on the Department of Finance, the Wright report, has provided the Department with an external expert view of both its positives and negatives and has given us plenty to work on. Though completed late last year, this was published in March and is being used by the Department, with appropriate adaptations, as a guiding document for reform and improvement. Some elements of the recommendations are already well under way and others have been planned for. Some of them will be challenging in the current circumstances. There is a real determination to adapt and improve the Department to deal with the realities of our economy. One element of this adaptation relates to skill levels. Contrary to popular opinion and press comment, the Department has been open to atypical recruitment and secondment arrangements to bring in highly skilled staff. This has accelerated in recent times. Further changes in organisational structure, human resource management and the management of performance are also needed. Progress has been made in this regard. It is envisaged that further significant advancement will be achieved over the coming months.

This emphasis on skills is reflected in the restructuring of the Department's interaction with the banking system and the establishment of a new banking division which will use, on an in-house basis, the skills of departmental officials with relevant training and experience, people seconded from certain outside bodies and, in particular, officials from the NTMA banking unit which has been responsible for much of the policy advice and implementation up to now. This restructuring of functions will make for cleaner lines of reporting and accountability and some reduction of duplication, all of which are essential for the implementation of the Government's banking policy as announced at the end of March.

A fiscal advisory council is being put in place as part of a wider agenda of reform of Ireland's budgetary architecture. The council will be an independent body. Its existence and independence will be underpinned by the proposed fiscal responsibility Bill, which will be introduced later this year. The role of the council will be to provide an assessment of, and to comment publicly on, whether the Government is meeting its own stated budgetary targets and objectives. It will also be charged with assessing the appropriateness and soundness of the Government's fiscal stance and macroeconomic projections as well as providing an assessment of the extent of compliance with the Government's fiscal rules. The rules in question will also be brought forward in the proposed fiscal responsibility Bill.

I hope further substantial progress will be made in the coming months to build on this change agenda. I might have an opportunity to update the committee from time to time. We had several meetings last year due to the sheer number of events in the Department and developments relating to the Department. We are open to making ourselves available to the committee to work through these processes when it suits the members. Last year, we were able to provide documentation and assistance to the committee. If members have views on what material they would like, we will try to provide it to them. We faced some restrictions last year with regard to Cabinet confidentiality and so on, but we were able to deliver a great deal of documentation none the less. We are all equipped with large amounts of briefing material, most of which is neither confidential nor commercially sensitive. I propose to have it checked and evaluated before a briefing is provided to the committee, if the committee wishes.

Chairman

I will take Mr. Cardiff up on his offer. We are considering how we might conduct our business during this term. It is clear from the documents we quickly browsed in advance of this meeting that there is a case to be made for taking segments of the work of this committee and that of the Department of Finance, understanding them and having shorter exchanges with the officials on specific aspects of them. Perhaps some officials from the Department will meet members of the committee to discuss how that might be achieved this year and how a new arrangement might be put in place.

I thank Mr. Cardiff. There is a vote in the House. I think they are trying to make us work longer. That is why some members are gone. I ask Deputy O'Donnell to commence his examination.

Deputy Kieran O’Donnell

I thank Mr. Cardiff and his colleagues for coming before the committee. I would like to pick up on a few points in Mr. Cardiff's presentation. I do not want to dwell on historic matters other than to deal with them in an appropriate context. Under the formal procedure for today's meeting, we are dealing with the 2009 accounts. How did it arise that the outturn for tax revenues was €10 billion below the original estimate? The Wright report was quite critical of the way the Department of Finance went about its business. It said the Department should adapt its advice, tone and urgency after a number of years of fiscal complacency. It said there was a need, "to formalise Department's records of Budget advice [and] to strengthen the rigour of the Department's policy advice". How did the revenues end up being €10 billion below the budget figures the Department provided? I would like to get an understanding of how the Department feeds into the advice given to the Minister. How have the procedures changed on foot of the Wright report, which was quite critical of the Department of Finance?

I would like to set out the current context. In my view, this is probably one of the most historic financial days for Ireland. I refer to what is happening in Brussels today. What is the Department's view of the budgetary impact of a reduction in the interest rate under the EFSF fund, an extension in debt maturity dates, a discount on or buy-back of Irish debt in the secondary market or various other measures that are being proposed? Mr. Cardiff might give us an indication of the expected budgetary impact of those proposals.

The second issue I would like to raise is the banking system. When does the Department expect that the State's investment in the banks will start to deliver to the Irish taxpayer in the long run? When does it expect full recapitalisation to have taken place? What will be the cost per institution? The ECB provides medium-term funding to the Irish banking system in that context. Media reports today have suggested that the ECB is appointing consultants to examine the Irish banking system. Perhaps Mr. Cardiff might comment on that. How does he view the overall question of the funding of the Irish banking system? What is his view on the directors of the covered institutions? I refer to the banks. How many of them-----

Chairman

Those questions are very detailed. Would the Deputy like an answer after each question rather than all together? That might be more interesting.

I will skirt around the legal-like issue of criticising Ministers. We had a problem in that even if we had a view that a particular fiscal stance was a bit too generous or that we needed to be more careful in that regard, we were not in a position to say to a Minister, "If you do X, Y will happen" or to suggest there was some certainty around that. Part of what happened, as the Chairman said, was that our view of where the economy was going was out-performed by the economy itself and people were saying, "The Department of Finance is just doing its usual under estimating from a sense of conservatism" and so on. Therefore, there was a sense those two things combined would have been an issue.

Also, I have always taken the view that ours is a Department whose job is to serve its Minister, not to seek to overturn or run the Minister. I would not, therefore, use the term "meek" as respectful of that democratic position. That is probably a better representation of the situation.

We had a highly uncertain environment in 2009. The Deputy may recall the 2009 budget was brought forward to cope with some of that uncertainty. The risks we outlined in both budgets 2008 and 2009 came to pass. What might have been different is that they all came to pass at once. It was not just that one of them came to pass, they all happened.

There was a huge forecasting variation, but was it a forecasting error? The real question should be, as the Chairman suggested, what could have been better about the forecasting? Perhaps what was missing from the forecasting perspective was not the baseline forecast, which was more or less the same as everybody else's, but the extent to which we accounted for the risks either side. The environment was becoming more risky, so even if we had a particular central forecast, we ought, perhaps, to have also spent more time on the risk based assessment around that central forecast.

Deputy Kieran O’Donnell

Was there a lack of skills in the Department of Finance in that area?

Mr. Kevin Cardiff

I do not think it was a lack of skill in the area. There is not, nor was there then, a lack of forecasting skill. However, as we go through things now, we are more conscious of not just the forecast but of risks to the forecast in either direction. We try to challenge the forecast more and to get a broader range of perspectives on it. In truth, I am not sure if the challenges to the forecast lead us to very different conclusions but they force us down a broader route of thinking to make sure we are less capable of missing-----

Deputy Kieran O’Donnell

If there is a €10 million differential, it has a huge impact on people's daily lives.

What is the Secretary General's view of what is happening in Europe today and his view on the budgetary impact of what is expected to come out?

Mr. Kevin Cardiff

There are people in rooms negotiating this, so I do not want to step into their shoes or pretend I know exactly what is going on. I am here and they are over there.

Interest rate reductions have a direct positive effect for Ireland, which is of the order of a few hundred million euro for each 1%.

Deputy Kieran O’Donnell

What is the calculation for that 1%?

Mr. Kevin Cardiff

I am reluctant to qualify too much for fear that I interfere with the process that is going on.

Deputy Kieran O’Donnell

What impact will a 1% reduction have on the budgetary process?

Mr. Kevin Cardiff

Over the course of seven years or so, we are talking about €6 billion or €7 billion. We will have the exact figure for the Deputy in a moment. If we have the same interest rate reduction over a longer period, relative to what is being paid on the market, then that also helps. Longer maturities also help in another way. The people who lend money to us for five or six years will see that we are getting money for ten or 12 years from somewhere else, and they will figure that they will get paid first in five years, which will create a priority for the shorter term borrowing that we might get from the private market, as opposed to the longer term borrowing from the public market.

When the seven year term was agreed, that was a bit of a win, because the original terms for Greece have been for three and four year money. There were some small interest rate advantages for us over the original Greek package. These things have been rearranged now. Longer maturities have that double benefit.

Another problem for us has been the persistent worry in the market that the programme terms might include a deliberate default on them. In other words, we have always said that we will repay our debt, but the market has been concerned that if we ever were to acquire more money from Europe, then Europe would require us to reduce the value of its debt. This has been a cyclical thing. The fact that this happens increases our interest rate and reduces the speed at which we can get back into the market. It accelerates the process of thinking that it looks more likely we will not get back into the market, so it is more likely we will require further funding and, therefore, that this negative effect will happen.

It ended on the basis that we are now asking all the banks to provide us with what we hope will be a standardised set of data which will allow us to respond to deputies questions. One Deputy asked many questions last week but we were not able to answer them all because they were too broad to answer in the time available. We will try to get standardised templates for data which we will expect each institution to give us on a consistent basis. They will be accountable if they do not deliver that to us.

Mr. John Moran

A HR director in Bank of Ireland joined around the same time this issue arose. She would admit, given the complexity of the various historical compensation arrangements put in place in the banks which were not standardised, that it is very difficult for her to give us a definitive response to many questions. We made our feelings known to the various HR directors in the banks who have attended meetings with us on the importance of getting this right.

As Mr. Cardiff said, we are trying to move the banks to a position where the compensation arrangements in them are simplified and that the pages and pages of potential bonuses, benefits and various arrangements for travel expenses and whatever are addressed. In as much as is possible, those arrangements would be removed from the system. There is a difference between what is possible for the banks to do domestically in Ireland and what can be done when they must hire people externally to the country. To some extent they must also take account of the environment of their business operations and competitive pressures, and that difference is appearing in many requests to the Department now with regard to compensation arrangements.

Deputy Kieran O’Donnell

Is the bonus culture in the banks gone?

Mr. John Moran

The bonuses payable are basically prohibited currently in banks; they are not able to give bonuses. There are some residual payments and since I began in March there have been discussions regarding bonus payments made in the past which were deferred for years. That was a standard practice but it may not have been done as well as it might have been.

Deputy Kieran O’Donnell

We are in a different environment now. Bonuses are being deferred from a period when an unreal market existed. Will those bonuses be paid?

Mr. John Moran

Where bonuses were contractually due, there must be a question as to whether the bonuses should still be paid or the banks should be advised to get into litigation with employees. We have drawn a distinction between the recent position in Bank of Ireland, which was reported in the press, where bonuses and retention payments to employees to keep operations going in countries outside of Ireland were given rather than engaging in litigation which the State would likely lose. Having investigated the payments it was decided that the distribution of the bonuses was relatively modest, by reference to salaries, and widely distributed among the staff in the operations.

Where the bonuses were payable in Ireland, the bank took the view - it was effectively taken before March - that it would, in effect, stand up to the body of employees in Ireland, even if there was litigation, and claim inability to pay the bonuses.

Chairman

Arising from that round of questions and relating to the Wright report discussed earlier, reference was made to the fact that there is no critical mass in areas where technical economic skills are required. There were too many generalists in positions requiring technical, economic and other skills. It was also indicated in the report that the Department is more numbers-driven than strategic, etc. The last observation was that there was poor human resource management.

I am concerned that the Department provides the necessary forecasts and figures for the Minister. I am not venturing into the policy area but considering the structure of the Department and how it reacts. It was clear in 2006, 2007 and as we went on, that there was a so-called consensus. Naysayers or those with an alternative view would have prompted any company to have another look at the figures to see if the naysayers were right. The Department did not seem to have the range of skills within it at that time, which was referred to in the report. Was the Department driven to question the issues within the Department or query the management as to whether the tools were at hand to deal with emerging issues? Staff in the Department do not seem to have made that calculation either.

To compound that worry, the Department informs the Minister but it also oversees how other Departments spend and perform. A significant cultural change is required in how business is done and I am not convinced, although there are new faces in the team, that we have yet achieved what is required by the Department with regard to its business and management of other Departments. Extending this to the information received from the banks in 2008, as well as what was received by means of parliamentary questions, it seems the Department was misled not once but a number of times by those banks. These are the very same banks telling us they are lending to the small and medium enterprise sector at a rate of €8 billion, with the sector arguing that this is not the case.

Mr. Cardiff has indicated that those banks had human resource issues, as did the Department, in dealing with new queries emerging from parliamentary questions. As we manage our way through this horrific time in the Irish economy, we are faced with significant difficulties in achieving good governance on the side of both the Department and the banks. There seems to be a clear culture that banks do not mind misleading the Department of Finance. It is outrageous that people within the banks have no respect for Parliament, as evidenced by their poor information. This must be corrected immediately rather than over time. The information given is critical to the decisions to be taken. I am giving my view on the matter before calling Deputy Ross.

Mr. Kevin Cardiff

The Chairman said he has seen a few new faces in the Department but he believes we are not yet there, which is correct. We are in a process of change and I am not trying to pretend we are at the end of it. It is an outfit under enormous stress, with everything that is ongoing, and change in the middle of this is an added complication. We are trying to achieve that goal and address some of the issues outlined. We are not doing it as quickly as we would like because of everything else that is ongoing.

I suspect the next question is what we are doing differently to a few years ago. Perhaps the people who had my job at that stage would have a different view but we are looking to ensure our economic view is supported by good internal economic staff. We have such staff and they are up against the best in the world from the Commission and the IMF, and they are not at a disadvantage in terms of technical skills and abilities. The Wright report indicated we did not have a critical mass, and that is probably correct; we are trying to build up numbers on that side without increasing overall numbers.

In the past few months we have taken advantage of a previous recommendation by the Committee of Public Accounts that we look to the wider public sector for economic skills. We have a senior economic advisor from one of the universities, with two or three people, including Mr. McCarthy, on a sort of long-term loan from the Central Bank. We have a highly qualified econometrician from Teagasc and we have brought in people from the Courts Service. Despite bringing in people we have also lost personnel, often temporarily, to the Commission and other public sector bodies. We are in a constant struggle to upkeep skills even as we look to increase them. We are making a good effort and we have also brought people back from the Commission to help out on the forecasting side. We seem to be winning that short-term battle to keep economic skills at a high level. A longer-term worry is that it is fine to do this on the basis of secondments and borrowings but we must have a base that is a structural part of the system.

As there has been no public sector recruitment of late, we have not had a new intake of economists at the graduate level in quite some time. We are looking at that problem to see if we can address it. Our last two graduate intakes were some years ago and were aimed at people with specific economic and financial skills. Those people have turned out to be a godsend to the Department, providing us with a really good underpinning of quality at the graduate levels. We have some really good people but the Wright report indicated we did not have the critical mass and I do not disagree with it. We must try to build up that element in the context of general constraints.

On the banking side, we have been very reliant on the services of the National Treasury Management Agency, NTMA. We are trying to generate additional benefit from those services by bringing them in-house, so the people in the NTMA will be in the same building as the Department people working on these issues. There will be improved governance and reporting to the Minister, and through the Minister, to the Department. There will also be reduced duplication. Currently, if there is an issue that touches on both the NTMA and Department staff, we might send two, three or four people to a meeting where one or two could do the work. In addition, the reporting back may not be as clear.

On top of that we have been building in-house expertise on the banking side. We do not need 75 people with doctorates but we need a relatively small number of very good people. We have recruited people to ensure we have in-house commercial expertise, including a banking analyst who was a direct hire from Davy's, and a banking partner from one of the accountancy firms on a short-term position. We also brought in a senior manager from another accountancy firm, and we have an in-house legal resource from the banking side as well.

We have been trying to carry out what the Wright report advocated. It was finished in December 2010 and published in March this year. We are far from implementing all the recommendations but are on the right track. Given the daily constraints of work demands, the question is whether we can get there.

On the human resources front, we have relied much on the goodwill of our staff, which equates in many cases to working very hard and for long hours to deal with our current position. We must put a better system of recruitment and development around that. For example, we are doing specific training with a qualification at the end for tax specialists, which is an area that Wright examined. We would do the same for the banking area except we have not been able to spare time for those personnel. We are working on getting something done in that respect.

I fully agree with the Chairman's analysis. We have not fully implemented the recommendations of the Wright report but we are working hard in that direction, while at the same time ensuring the day job gets done.

When one looks at what is going on around Europe, people naturally look at our Greek friends and others and say certain things are inevitable but they are not inevitable. We have the great advantage over our Greek friends of being wealthier as a country and better prepared as a country with better institutions. In fact, we are so good, one would wonder how we got into this mess in the first place, but that is a different matter.

It is a very real question. How can good institutions end up in the situation in which they are? We have good institutions and we can prepare for dealing with the situation in a way that does not lead us into any of that kind of area.

We have strong European partners who are also very anxious that those kinds of things should not happen and we have strong partners in the IMF who are anxious to avoid those kinds of situations occurring. The Government of Ireland pays its debts, always has and plans to do so.

Deputy Shane Ross

I take that as a "Yes".

Mr. Kevin Cardiff

I have lost the question but it is certainly a "Yes" to one of the Deputy's questions.

Deputy Shane Ross

Mr. Kevin Cardiff

I apologise, Chairman. I should have remembered that. Let us move away from the cases entirely and discuss how appointments are made generally.

Deputy Shane Ross

Regarding mergers, the troika examined our programme in March and set us some targets for the restructuring plan based on our recommendations. The troika set targets they considered ambitious in respect of the radical restructuring we need to do at the banks. This included merging Anglo Irish Bank and Irish Nationwide Building Society by December, merging EBS and AIB in September and dealing with the Irish Life & Permanent disposition in October. We took the view that quick execution of the plan was needed to get the banks functioning properly. We brought forward the first two mergers to 1 July and these have been completed on a legal basis. We brought forward the sale of the Irish Life & Permanent institution so that information memoranda have already circulated. That allows us to move more quickly to the next phase, which is the operating plans for the merged institutions in terms of a review by the bank management and board of the resources available to them from both institutions and a review of duplication in the system to remove costs. To the extent that there are people doing the same functions in Irish Nationwide Building Society and Anglo Irish Bank, they are being identified and interviewed for those roles. We are reviewing the plan to ensure it is aggressive enough in moving those institutions forward. One of the key parts of the restructuring of the banks, particularly the ongoing banks, was to split them between a deleveraging plan, a non-core part and a core part of the balance sheet. It is helpful for the deleveraging plan but is essential to get the banks back to normal functioning.

Having reviewed the situation in the early months of the year, our view is that where banks were struggling at management level to deal with capital constraints, liquidity constraints and serious questions about the future of the institutions, management was distracted by the problems and was not doing normal day-to-day business. As a key deliverable, we have switched the amalgamated banking management structure into a subdivision of the legal entity that is the bank, dealing only with deleveraging and not worrying about what is happening with deposits or lending. Their issue is simply targets about the deleveraging that needs to take place over the next three years.

Independent of those people there is now an independent management team focusing just on lending issues. That is a key deliverable in terms of getting the banks focusing on going back to lending on the normal business.

On the restructuring plan, such as it was, we had two options at the beginning of March. The first was to continue with the plan and the way things had been dealt with up to that, which was to allow a deleveraging of the banking system to take place to reduce the monetary financing taking place in the system. That would take account of amortisation and sales or reduction of loans in the Irish economy and outside it, in effect targeting our €40 billion of essential leveraging that needed to take place by including all of the deleveraging. However, we said we will not do it that way but identify the parts of the banks' activities that are essential to the functioning of the economy, which includes private lending, consumer lending and small and medium business, SME, and business lending.

Deputy Derek Nolan

Will Mr. Moran concentrate on the SME business lending?

Mr. John Moran

Yes. We can do all three. The banks have now got a capacity as lending amortisers over the next three years so that mortgages will get repaid and the large amounts of excessive real estate lending that took place in the economy relative to normalised conditions will essentially amortise down in the amount of €30 billion between now and the end of 2013. Notwithstanding the deleveraging process, therefore, we have protected that amortisation and said the banks need to lend that back into the system.

Deputy Derek Nolan

Is Mr. Moran saying it will cascade out in three years and that we will not be back to a fully functioning, healthy system for three years?

Mr. John Moran

The Central Bank would have conducted an analysis for us that would say that of that €30 billion the only amount needed in the Irish economy for the current growth numbers is €16 billion to €18 billion. I do not expect necessarily to see €30 billion of actual lending in the system because people do not need that much money in the system for the economy to grow and for businesses to function.

The problem we had up to that point was that there was no supply of credit in the system because the banks did not want to lend; they wanted to keep the money they had to allow them repay other borrowings that were coming due. Now they are obliged, and effectively structured, to have a capacity to lend €30 billion back into the system. The Chairman referred to a figure of €8 billion of sanctions that took place between AIB and Bank of Ireland on the SME lending between March of last year and March of this year but €8 billion was not taken up by the SME people who got those sanctionings. The loan sanctions have been made but people have not taken them up.

We are not yet clear, in the short time we have been looking at this issue, whether the problem is a problem of the conditions attaching to the sanctions, which is quite likely, that the banks have withdrawn out of fear of making the same mistakes one made before and therefore they are applying conditions that are perhaps too stringent for people, and that needs to be analysed. It might also be a question of the fact that lending in Ireland was available on terms that were frankly unacceptable and way too easy in the years of the boom, and that this could also be just a withdrawal into terms and conditions that are normal and that, as the Deputy mentioned, the businesses looking for the money do not need or deserve the money because they cannot be sustainable themselves.

Beginning with the banks we are about to conduct a survey in the coming months of demand for credit. We believe we have a sense of the supply. We have mandated the banks against targets which increase over time. There is €3 billion for this year and €3.5 billion and €4 billion on SME lending. Each of the two large pillar banks, as a quid pro quo for the capitalisation by the State, have signed up to those targets but making those sanctions will not necessarily make the SME system work. What needs to happen is that we must find a way to have a demand for credit matched to supply of credit.

A guarantee scheme will go in place that will help bridge some of that gap in terms of the type of institutions involved. However, we must also get a sense of the real demand for credit in the sector and the obstacles to those people. Is it a question of people believing the banks are not lending and therefore they do not go near them or is it a question of the banks not wanting to lend? By asking on the demand side to try to get answers as to why people think they have demand and it is not being supplied, I hope to have a better sense of the reason for that.

We are in that discussion. We have not concluded on it yet. The Minister will have to make some decisions on that. Without suggesting what the policy view should be, it is a difficult enough balance. The people who run significant financial institutions in other jurisdictions which have fewer difficulties than us sometimes get paid very large amounts of money. The people who are available in Ireland probably would expect less, given the way the market is currently. On the other hand, the public acceptability and the acceptability of the Government of some of the Irish candidates might not be as high as it would have been in years past. We have to fish in a pool and use the right bait, but not too much bait. Getting that balance right is difficult enough but there are real costs in getting the wrong people also. Big money does not guarantee us the right people. In fact, it might guarantee us people with the wrong motivations but a certain amount of flexibility is necessary too and the Minister and the current chairman of AIB have to work through those balances between themselves. There are many other issues in the frame as well in terms of public sector pay and so forth, some of which are being put out of the way for the moment at least.

As for being paid more than the Taoiseach, many people in this economy have been paid more than the Taoiseach. The Taoiseach and people like the members are paid much more than the average and therefore I do not believe it can be about finding some sort of artificial benchmark and saying, "Thus far and no further". It has to be a sensible judgment based on the real public interest.

Deputy John Deasy

I apologise for having to leave to vote a few times. I apologise in advance also if members have touched on areas on which I am about to ask questions.

The IDA tells us there is a pretty strong pipeline of foreign direct investment. We are maintaining and fighting hard to maintain the tax treatments that help to generate foreign direct investment. It is not just a question of the tax treatments, however. There are many positive factors. We differentiate between ourselves and others on the aforementioned measures. They are very real. What matters in terms of foreign direct investment is the cost of doing business in Ireland. If one can say to a new business that its property costs, staffing costs and staff turnover will be considerably lower than they were five years ago, it will be of benefit. Many firms' problem was not the amount of money they were paying staff but that there was a staff turnover every two or three years.

There are improvements in all these areas and the improvements are showing up in performance. It is these factors, together with the fact that this economy has proven economic capacity that is not currently being utilised, that must be borne in mind. We have had a very severe recession. The economy is capable of producing a lot more and has the infrastructure, people and ability to do so. The proven infrastructure and sufficient capacity and workforce mean that, as conditions improve, there will be pressure for growth from below rather than an in-built demand.

We must get a few things right, however. Growth has reduced considerably in the construction sector. If, as is likely, we are not to have a construction sector as big as the one we had, it will be necessary for those who were trained to work in that sector to be able to compete in other sectors. It is a constraint, and we need these workers to be retrained and available to re-enter the workforce in a different sector. There are considerable potential benefits in the economy. It is these that we see feeding into growth, not just this year but also next year.

By Irish standards, we have quite a high savings ratio at present. This means people are saving and not spending as much as they did. Saving can mean more money in the bank or in investments, or it can mean one is paying down debts. The latter is a major factor. We regard this as bad in the sense that, if people were spending more, we would have more growth now. However, it is good in that it means people are adjusting their personal balance sheets in the same way the country is adjusting the national balance sheet so as to be better placed for the future. We must get through that process. If it takes a little longer than we hope or expect, so be it, but personal and family balance sheets must be adjusted to return to the growth phase. Picking the moment for that is difficult enough.

Mr. John McCarthy

I will put some figures on what Mr. Cardiff has spoken about. In the first quarter, output was up by 1.3%. This is a reasonably solid growth figure. Our forecast, which was published in the stability programme update last April, is for growth of 0.8% this year. That will be the first instance in three years. However, as important, if not more important, than the actual figure is the composition of growth. This relates to the point the Deputy is making. There is a clear dichotomy between the exporting sectors and domestic demand. The export sector is performing very well - there is no debate about that - be it on the goods side or the services side. Exports were up by approximately 7% in the first quarter in annual terms. Clearly, domestic demand is very weak. This is not nice but it is partly necessary because of the imbalances that built up during the boom. I refer to the high level of house building during the boom and the consequent oversupply that needs to be addressed. Mr. Cardiff mentioned households deleveraging and balance sheets in this regard. The rate of contraction in domestic demand is easing. While it is still negative, circumstances are not like those in 2009 in 2010 in that many of the adjustments have taken place.

Growth is returning to the economy but it probably does not feel like that because the average person is not directly affected by the export sector. The employment generated by that sector is, unfortunately, quite low. It will be some time before that feeds through to the next phase, which involves more investment, and eventually into the labour market, consumption and so forth.

Deputy John Deasy

How long will that take?

Mr. John McCarthy

That is a good question. Our numbers are based on growth of approximately 2.5% next year and 3% thereafter. I stress that it is all export-driven growth.

Deputy John Deasy

There is the dichotomy. Granted that export-driven growth is expected to be 3%, when does the Department believe the pick-up in domestic growth will begin?

Mr. John McCarthy

Two components are really dragging domestic demand. The first is the unwinding of construction imbalances, such as the huge level of house building. This is now as low as it can go; we have come down to such low levels it cannot fall much more and it should begin to flatten and bottom out. It will not return to the 90,000 units we produced in 2006 and 2007, but nonetheless it will not be a drag. The other unknown is something the Secretary General referred to, which is what is happening on the consumer side. At present, the savings rate is approximately 13% compared to long run average of approximately 7%. This has two elements. The first is the precautionary element as households are scared out of their wits. The other is deleveraging, some of which is already complete. As confidence begins to return to the economy we will probably see some unwinding of the savings rate. I will not state it is anybody's guess as to when this will happen, but there is correlation between precautionary saving and the unemployment rate. Once unemployment begins to stabilise perhaps we will see some unwinding of the savings rate. This will feed through to stronger consumption. I stress it is quite uncertain. To sum up, it is very difficult to put a time on it.

Mr. Kevin Cardiff

I will ask Mr. McCarthy to give the Deputy an idea of when our assumptions, figures and forecasts suggest the return to positive employment growth will be. This is the crucial point which he wants to know.

Mr. John McCarthy

To put it into context, for this year we project employment will fall by 1.6%, which is broadly consistent with the figures that have been published heretofore. Even though we have positive output growth this year we still see employment figures reducing, which is probably typical of a recovery pattern. Typically, there are lags between when the labour market reacts to output improving. In the short term, firms will use workers more productively. Next year, we see a small improvement in employment of approximately 0.5%. We see the labour market turning from next year and unemployment will reduce on foot of this. I stress it will reduce very gradually. A large part of unemployment is probably structural in nature and it will not be unwound by cyclical recovery. By this I mean construction workers; it will take a long time to retrain them to move into exporting sectors. We do not see unemployment reducing dramatically.

Deputy John Deasy

I will return to what Mr. Cardiff said about what the independent review group pointed to, which is the expertise and skill set in the Departments of Finance and Public Expenditure and Reform. One of the issues was that people such as those in the Department of Finance, the Financial Regulator and politicians worked in isolation. The level of interface, interaction and communication between the various groups that governed and administered our economy were not with each other at critical moments. How has the Department's reporting system changed, particularly as it has been split and has become a more complicated organisation? How has the reporting level between the Departments of Finance and Public Expenditure and Reform been improved?

We are building in a broader risk perspective in our day-to-day economic advice to the Government. There are formal papers explaining to the Government the risks of either side of a policy and how to respond to them. We have also introduced an economic adviser who sits separate from the line responsibility and is, what I would term, an internal-external challenge to some of the thinking in the Department. There are no longer just forecasters reporting to a senior manager who produces the Department's overall forecast but this new adviser who can ask for the figures to be thrown about.

While individually these developments do not mean anything different, they are a genuine attempt to see how to improve analysis and, even if we think it is good, how can we challenge it. While we are not there yet, we are a quarter of the way there.