COMMITTEE OF PUBLIC ACCOUNTS debate -
Thursday, 13 Jun 2013

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

Mr. Seamus McCarthy (An tArd Reachtaire Cuntas agus Ciste) called and examined.

Deputy John McGuinness resumed the Chair.

Mr. Matthew Elderfield (Financial Regulator, Office of Financial Regulation) called and examined.

Chairman

I welcome the witnesses. The Comptroller and Auditor General has another meeting to attend and we have had a long session this morning. It would be helpful if members would keep to a tight schedule.

I remind members and witnesses to turn off their mobile telephones because they interfere with the sound quality of the transmission of the meeting.

I advise witnesses that they are protected by absolute privilege in respect of their evidence to the committee. If they are directed by it 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 should not criticise or make charges against a Member of either House, a person outside the House or an official by name or in such a way as to make him or her identifiable. I remind members of the provision within Standing Order 163 that the committee should refrain from inquiring into the merits of a policy or policies of the Government or a Minister of the Government or the merits or the objectives of such policy or policies.

I welcome Mr. Matthew Elderfield, Deputy Governor. I call on the Comptroller and Auditor General to introduce his special report.

Mr. Seamus McCarthy

The primary purpose of the examination reported on in Special Report No. 72 - Financial Regulator, responding to the financial market crisis - was to identify the measures taken or proposed by the Financial Regulator to respond to shortcomings in financial regulation that came to light as the financial market crisis unfolded during 2008 and 2009. It also reported on the regulator's response to recommendations in two earlier special reports that had dealt with regulation of financial services providers by the Central Bank and the regulator.

The first examination carried out by my office was reported on in 1999. It looked at the Central Bank's approach to the regulation of credit and investment institutions which was the extent of the bank's regulatory remit at that time. The report on the examination concluded that the frequency of the bank's on-site prudential inspection appeared low. The target levels of prudential inspection were not being achieved. The Central Bank had adopted a light touch to prudential supervision based on limited on-site inspection activity, combined with periodic review meetings with the management of the institutions. Also, the Central Bank did not base its prudential supervision work on a formal risk assessment system.

We recommended that a risk assessment system be developed on the basis that the prudential risk profile of financial service providers could potentially be used to gauge the stability of the credit and investment sectors. Following publication of the special report and the committee's 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 Services Authority of Ireland in 2003. That brought responsibility for most financial regulation into a single agency and operates as a stand alone entity within the Central Bank. The functions of the then Department of Enterprise, Trade and Employment regarding regulation of the insurance sector were transferred to the regulator, which was also given a consumer protection remit.

Having allowed a period for the new regulatory regime to settle in, a second examination of financial services regulation was undertaken by my office. The report on that examination was published in May 2007. The examination's main finding regarding prudential supervision was that the regulator had developed a formal risk assessment system.

However, the model used had been developed to assess risk on a relative basis only. It did not try to assess the underlying level of risk attaching to the financial institutions in question. In practice, the risk model operated to allocate the resources available for supervision work in each financial sector rather than to inform assessments about trends in sector riskiness or decision making about what level of resources might be required for effective prudential supervision work. As a result, in 2007 prudential supervision was still being resource-led rather than risk driven.

The 2007 report also repeated the earlier concern about the frequency and intensity of on-site inspection work. It found that the frequency of inspection visits to financial services providers remained low. We also noted that the regulator had up to then used its administrative penalty powers only in a very limited way. The report recommended that the regulator should arrange for an independent review of the adequacy of its prudential supervision processes, including the target frequency and duration of inspections, the resource levels applied, the type of checks carried out on site and the follow up processes. We suggested this work be carried out by means of peer review and that the regulator's inspection process be benchmarked against those of other EU regulators with similar mandates. The Financial Regulator did not carry out the proposed independent peer review. Instead it commissioned a firm of management consultants to carry out a review of the adequacy of its prudential inspection process as part of a general business process review. In the event, that review was carried out as the financial crisis was unfolding. It ultimately confirmed that the level of resources the regulator had allocated to banking and insurance supervision was lower than that for other national financial regulators.

Special Report No. 72 which was completed in December 2009 found that there had been a significant increase in the intensity of supervision of those credit institutions that had availed of the State guarantee for banking liabilities, including additional reporting of Ireland's increased on-site presence by supervisory staff and attendance at key meetings of the institutions. The regulator noted that the availability of additional resources would be a key factor in implementing a more intensive supervisory approach across all sectors. The regulator also committed to developing and extending its current risk model as a priority but stressed that the ultimate design of the system would need to be aligned with developments in the international regulatory framework.

Based on the report's findings and cognisant of the need to strengthen the regulatory framework, the report set out a number of proposals. We suggested the regulator should consider placing more emphasis on the testing of transactions and balances in the course of its on-site inspection work, especially testing that the relevant internal controls in financial institutions had operated properly. The reason this was suggested was that risk-based systems could only function optimally when they were informed by feedback from the review of actual transactions, in conjunction with top-down analysis of the sustainability of business models and associated strategies operated by the individual institutions. We also suggested consideration be given to a requirement that credit institutions' external auditors provide an annual positive assurance statement on the functioning of the internal corporate governance regime, including the risk management function. While this is likely to involve some additional cost, good internal regulation is in the interests of financial institutions and would strengthen public assurance. We also suggested consideration might be given to requiring the regulator to present an annual statement relating to supervisory matters to Dáil Éireann so as to ensure more formal cyclical public accountability for financial regulation.

The deputy governor will be able to update the committee on developments on these recommendations since the committee last took evidence on this matter.

Chairman

I ask Mr. Elderfield to make his opening statement.

Mr. Matthew Elderfield

I thank the Chairman and the committee for inviting me back to discuss the progress made in improving financial regulation and supervision since I was last here in May 2010, at which time we discussed the Comptroller and Auditor General's work on the lessons of the financial crisis. There is a lot of ground to cover, but I will be brief as we can cover more of the detail in the discussion.

Let me spend just a few minutes on three areas: supervisory capability and approach, regulatory standards and powers and regulatory philosophy, including the role of enforcement. Let me mention one loose end from the Comptroller and Auditor General's Special Report 72 which relates to auditor assurance statements. They are the two measures the Comptroller and Auditor General mentioned that have been implemented.

I sound a note of caution that while good progress has been made in improving financial regulation and supervision in Ireland, we are by no means all the way there yet. As a supervisor, one is almost always playing catch-up with the industry and it is dangerous to think one will get to a point when one can rest on one's laurels. Therefore, it is important to maintain the momentum of improvements, keep the regulatory framework up-to-date and ensure supervisory capabilities are always at their best. It is also especially important to be vigilant against backsliding and attempts to compromise the independence or dilute the diligence of regulation, especially when times start to get good.

In terms of supervisory capability and approach, it was clear that supervision was under-resourced in a range of areas; therefore, staffing levels have necessarily increased in the past few years. My original estimation was that the regulatory function division of the Central Bank would need to be some 725 persons strong, but based on experience, process improvements and efficiencies, I think a target level of around 600 would be sensible for the end of the current three year Central Bank strategy in 2015. Continually striving to improve quality is also important, by ensuring the right mix of experience and investing in training in order that supervisors have the skills to challenge firms effectively. Ensuring the Central Bank can attract and retain the skills it needs will, no doubt, become an increasingly demanding challenge as the market for the relevant specialised skills improves. Having some 600 supervisors into more than 10,000 regulated entities requires some strategic choices to be made about resource allocation which we undertake through the new risk assessment framework we have developed called PRISM, probability risk and impact system, not the NSA's PRISM that is in the news. This involves an implicit exercise in setting risk appetite in terms of ensuring adequate resource levels for those firms that have the biggest potential impact on customers and their financial stability should they fail. Our PRISM system also provides a framework for systematically scoring firms on the risk they pose against particular categories such as credit risk, market risk and operational risk. We then communicate these risk scores to the firms, together with a risk mitigation plan which in plain English is a "to do list" for firms to address. This system is new to the Central Bank in the past couple of years and reflects best international practice in how to assess risks in an organised, consistent and systematic manner. The framework does not provide a guarantee that failures will never occur - we should expect that they will continue to do so in smaller firms - but it does mean that we will closely man mark the largest firms in order to reduce the risk of their failure.

Supervision is about how one polices the rules; regulation is about setting the rules. There is a very busy international agenda of regulatory change which is feeding into Ireland via the European Union, the G20 and the financial stability board. I have some sympathy for industry about the volume of change taking place and the challenges this poses for implementation. At a domestic level, the Central Bank has been focused in the initiatives it has taken on the statutory code for corporate governance, the new framework for fitness and probity and the major changes that impact on most sectors. These have helped to fill important gaps in regulation. I am also very grateful to successive Governments and the Members of this House for the support they have provided in upgrading the supervisory and enforcement powers available to the Central Bank, with legislation in this area close to final adoption. This is a welcome step towards improving the regulatory framework. It will be important to keep fine-tuning the rules based on emerging international best practice.

In this very brief survey I wish to say a word about regulatory philosophy. The lessons of the financial crisis are clear - supervision and regulation were too light touch. As the IMF states, good supervision is, in fact, intrusive. As Professor Patrick Honohan said in his review, supervisors need to be decisive in following through on issues. Our PRISM system is designed to provide a framework that prompts such action; for example, we closely track the risk mitigation programme plans we send to firms to ensure they are doing what we ask them to do. However, at the heart of the approach there needs to be a robust regulatory philosophy that encourages challenge. We have described this as "assertive risk based supervision underpinned by a credible enforcement deterrent".

This is designed to put a few concepts front and centre, namely, that we operate a risk-based approach in which we differentiate based on impact and probability; that there are consequences and accountability for non-compliance; and that our supervisors are empowered to insist upon actions to mitigate risk where we are not satisfied by the explanation of a firm's management.

As today's session is, I understand, formally designed to help close off the committee's review of the Comptroller and Auditor General's report into the lessons of the financial crisis, Special Report 72, I note there is one loose end in the recommendations that still needs to be concluded. This relates to the introduction of auditor assurance statements. The Comptroller and Auditor General referred to two other points. On the testing of controls, this is done in PRISM. One of the powers that is coming in the Act will be the ability of skilled persons to look at controls. Public statements are provided under the Central Bank Reform Act 2010.

The one loose end, as I noted, is the auditor assurance statements. Having conducted some preliminary consultation with stakeholders, we believe that a risk-based framework, with the obligation applied to the highest impact firms only, is the best and most proportionate way forward. The Central Bank (Supervision and Enforcement) Bill provides a clear mandate to introduce such assurance statements. Once the legislation is adopted, this matter can be progressed to a conclusion and we will have a consultation on the issue at that stage.

We could cover much more ground and I am sure there are more areas the committee is interested in discussing. This short introduction was by way of highlighting some of the key areas from my perspective. I thank the committee for its attention and look forward to our discussion and to answering members' questions.

Chairman

I thank Mr. Elderfield very much. May we publish his statement?

Mr. Matthew Elderfield

Yes.

Deputy Paul J. Connaughton

As I was not present for the final part of the previous discussion, I wish to confirm that I have never been contacted by a Minister or departmental official in connection with my dealings with the Committee of Public Accounts.

I welcome Mr. Elderfield and note that he had just started his job when he last appeared before us. This appearance coincides with his departure from his current role, which means he can say what he wishes without any fear of the consequences. I propose to cover some broad areas, including staffing, which the Financial Regulator raised on the previous occasion he came before the committee. How many staff are available to him now compared with when he took up his post three years ago?

Mr. Matthew Elderfield

When I took up my post there were, if I remember correctly, approximately 350 staff. The figure has increased to about 620. When I did the first budget I thought we would have to increase staff numbers to about 725 but I no longer believe we will have to go that high. I think we will be able to trend down towards 600 as a couple of our tasks start to roll off. There is a lot of activity around dealing with the troika and EU-IMF programme and this will fade away over time. Certain regulation and supervision projects will also fade away over time. The principal way of becoming more efficient, however, and we have started to do so, is by putting more of our staff on front-line activities rather than processes. We still do too much using manual processes. We have been trying to automate different aspects of our work. In the area of regulatory information and the sending in of returns and financial information, much of this work involved sending in spreadsheets on pieces of paper. Almost all of this work is now done online. Under our fitness and probity framework, if one comes into the system and wants to become a director or work in the industry, one must file a questionnaire with us and be assessed. We now do this online in an automated process and we also plan to have our authorisation processes completed online. We will be able to reduce staff numbers when we bring these different elements online.

Staffing, which was under-resourced, has reached about the right level. The thing to watch out for after I leave, if one likes, is to make sure current quality is retained as markets get hotter, as they will at some point, and staff are not poached. The key issue is to retain good quality staff who have experience of the industry and are experienced supervisors.

Deputy Paul J. Connaughton

On his previous appearance before the committee, Mr. Elderfield expressed concern about the skills mix of his staff. Has this issue been addressed in the past three years?

Mr. Matthew Elderfield

It has improved considerably. We now have a mix of experienced supervisors who have done supervision for a while. They are people who have come from industry, some of whom are from overseas, while others are home-grown, as it were. We need to keep investing in training and improving technical training. There are some very complicated, technical aspects of what we do, for example, stress testing for the banks, looking at loan loss forecast models and actuarial assessments on the insurance side to ensure the reserve levels of the firms are adequate. Holding on to one's most skilled staff is a constant battle and struggle. Obviously, the difficult pay environment is a challenge in this regard. We need to keep an eye on that and maintain investment. One should never say: "We are there, it is done and we are in a happy place." One must keep working at it.

Deputy Paul J. Connaughton

What has been the position regarding staff turnover since Mr. Elderfield was appointed?

Mr. Matthew Elderfield

Staff turnover has not been too bad. I do not have the numbers to hand but it has been below 10% for most of the time I have been in place. The one area that tends to have a higher turnover is insurance supervision because we have a large international insurance market and there is a great deal happening in regulation and solvency, which is an issue we can discuss in greater detail if Deputies wish. This is a highly skilled technical area in which we have an above average turnover. As we all know, the job market is constrained because of the economy. This is particularly the case in banking where turnover has not been high. However, if one looks ahead to when things start to go well, that is when it will become difficult for a supervisor. One must then start to say "No" because one needs well-qualified staff who understand the business models and can challenge when things are getting too hot. That is the moment of risk when turnover could increase and it is one to watch.

Deputy Paul J. Connaughton

A number of individuals were appointed to senior management positions in the Central Bank at the same time as or shortly after Mr. Elderfield's appointment. For example, the director of enforcement at the bank, Mr. Peter Oakes, moved on a number of months ago.

Mr. Matthew Elderfield

Yes.

Deputy Paul J. Connaughton

Are the individuals in question moving on for any specific reason or is it a natural phenomenon?

Mr. Matthew Elderfield

Two directors left. Peter Oakes wanted to do something a little different and in the case of Mr. Jonathan McMahon, I think his family wanted to return to the United Kingdom. In both cases, we had two good internal promotions for the roles. There is a strong team in place.

Deputy Paul J. Connaughton

Were insiders appointed to the vacant positions? These were individuals who were already employed in the Central Bank.

Mr. Matthew Elderfield

Mr. McMahon's role in banking went to Ms Fiona Muldoon, who has an industry background and has only been with the Central Bank for a couple of years. Ms Derville Rowland, who was appointed director of enforcement a couple of months ago, is a very experienced former prosecutor and lawyer who has worked in enforcement.

Deputy Paul J. Connaughton

Mr. Elderfield has been vocal on the issue of mortgage arrears, the banks and the way in which the domestic economy is struggling. More than 126,000 mortgages are in arrears. What is his estimate of what the figure will be in the next six, 12 and 18 months?

Mr. Matthew Elderfield

It would be imprudent to make a prediction on what the number will be. We are seeing a slowing of the rate of increase, which is encouraging. Economists will tell one that it tends to lag unemployment by a couple of years. Given that unemployment has peaked and is declining a little, one would hope that the rate of increase would flatten out. There are, however, many uncertain drivers for that. The new personal insolvency framework is in the mix as well.

Our focus has been on trying to accelerate the pace at which the banks are tackling the mortgage arrears problem in two senses. They need to move faster and the solutions that are provided to customers need to be sustainable, rather than short term and lacking proper traction. We had a period in which we asked the banks for their mortgage arrears resolution strategies. If I remember correctly, we went in to the banks at the beginning of last year and found that their operational capability to process and get their hands around the arrears problem was very weak. Our staff did a third party report on that issue. Much of the intervening period has been about building the infrastructure. Banks are great at lending and being able to market but they were not very strong in collections and triaging these numbers. The operational base is now better, albeit not perfect.

It is far from ideal but I believe it is strong enough for us to set the targets we have set for them. We are saying to the banks that over a period of months we expect them to re-underwrite their population of arrears cases, propose solutions and then conclude those solutions. This is set to ramp up the speed of the process. We are also saying that these arrangements need to be on sustainable terms. The default options tend to be short-term interest-only arrangements, which will work in some cases, for example, if a borrower knows his expenses will come down in future or if he is confident that his spouse will get another job in future that might be okay. Anyway, we are saying that it is not acceptable as a blanket approach. There must be sustainable terms and we need to assess the capacity to repay the principle over the full term of the mortgage. Therefore, we are keen to see a wider range not only of interest-only arrangements but term extensions or split mortgages. We could talk about these if we have time because we believe they are important tools. Unfortunately, in some cases repossessions will take place and no solution will be possible because the arrears situation is so bad or the affordability is so bad. Anyway, we need to break the impasse irrespective of what is happening in the trend of arrears numbers, to which the Deputy referred, to make some progress.

Deputy Paul J. Connaughton

Does Mr. Elderfield envisage much of an increase in repossessions?

Mr. Matthew Elderfield

I have said before that we have to steel ourselves for a significant increase in repossessions. It is not desirable, it is a last resort, but the relative level of repossessions in Ireland compared to the United Kingdom is rather low. There are good reasons that will be the case in future but it would be surprising if they stayed at those low levels. A legal case, the Dunne judgment, has stopped the legal proceedings in the meantime, but I expect that if one does not co-operate with the bank and share financial information then the bank will move swiftly to take legal action under the new framework. However, if one is a co-operating customer and one declares all one's information and one is upfront, then the banks will work step by step through the process and have a wider range of options. However, as a last resort in some cases if a customer is right at the cusp of insolvency or insolvent then it is possible there will be repossession cases. I imagine there is likely to be more voluntary surrenders whereby the banks say it will be impossible to keep a person in his home but if he surrenders the house, they can work out some sort of deal on the shortfall if there is negative equity.

Deputy Paul J. Connaughton

I understand the Financial Regulator has set targets for the banks. When are they due to first report to the regulator?

Mr. Matthew Elderfield

We have set targets. I believe we will get them back shortly. The deadline for the first targets is the end of quarter 2. We will get raw reports from the banks but they will be un-audited by us. In the first instance I will be somewhat sceptical or cautious, for the reasons suggested by the Comptroller and Auditor General, because we want to test these things. I believe the banks will hit the targets in terms of the numbers. The senior management are saying to me that they are very confident about doing so. However, we need to check that they are on sustainable terms. There are two aspects to it. Did they get the numbers and are they going fast enough? What are they offering on sustainable terms?

Deputy Paul J. Connaughton

If the bank does not reach its target and if the Financial Regulator finds out that it offered a deal to a customer and it appears a deal was completed but it does not work for the customer at all, what powers does the Financial Regulator or the Central Bank now have to ensure that they learn from it and that it will not happen again or that they will fix it properly?

Mr. Matthew Elderfield

We have said that when we do our audits we are prepared to adjust down the level of hitting the targets, if we believe the arrangements are not on sustainable terms. If they miss the targets we have two principal sanctions, and, for the Government-owned banks, there is a further one that is quite tough. First, we have the ability to impose capital add-ons to the banks. Second, we have said that for those mortgage solutions not done on a sustainable basis we will require the provisioning to move to a repossession level and we will insist the banks cannot assume any revenue from those mortgages other than the cost of disposing of the underlying home. That is quite a robust level of provisioning and it will come in at the end of next year.

Vice Chairman

Will you go over the provisioning mechanism again because it is quite significant?

Mr. Matthew Elderfield

I am not an accounting expert but I will give it my best shot. One examines a loan that is in place, even if it is in arrears. There are two things one can recognise. The first is the stream of revenue coming from payments and interest, maybe not full interest payments but some payments over time. The second is that at the end of the day there is the collateral value to be realised. We are saying that if the solution a bank is offering to the customer is not on sustainable terms then we will not let the bank count the first stream of income. We will insist that the bank assumes that it will only get the value of the disposal when it comes to repossession, in order to be suitably prudent and conservative. To do so, one must make some assessment about where house prices will be and factor in disposal costs, which can be quite significant.

Vice Chairman

There may be higher disposal costs.

Mr. Matthew Elderfield

Let us suppose a bank has on its books a stream of revenue of 100 units and the value of the property is 100 units. Then the bank cannot count the stream of revenue and for the value of the property the bank must figure out what the real disposal costs will be and what the house price will be, because they may not amount to 100. To dispose of a house there are administrative costs and so on. That is quite a significant incentive for the banks to get through it as well as the capital measure.

When I launched the targets with the Minister for Finance he said in quite a pointed way that he expects the management of the State-owned banks to get on top of the targets before it gets to that and that, basically, their jobs were on the line.

Deputy Paul J. Connaughton

Does Mr. Elderfield believe he has the staff and resources to make that happen? If there are unsustainable solutions will the people in Mr. Elderfield's office be quick enough to turn it around, decide that it has not worked and suggest how to move on with it?

Mr. Matthew Elderfield

Yes, I think so. It is possible that we might get some temporary help to do the audit. We are still thinking about that but we will have the capacity to do it.

Deputy Paul J. Connaughton

Has Mr. Elderfield been frustrated by the banks?

Mr. Matthew Elderfield

I have said that the pace of the arrears work-out has been frustratingly slow. Professor Honohan and I were surprised by it. One core skill of banking is lending but another core skill of banking is being able to get money in. That collection side was very weak, having looked at the banks and their operational capability. We examined this aspect and BlackRock examined it as part of the last engagement. We found that the number of staff doing collections and managing mortgage arrears was rather low and that the expertise levels were rather low. The systems were very weak too. I heard some particular feedback. Someone told me that a staff member would have to interrogate three or four different systems, pull all the documents together, write them up and then get ready to call Elderfield. All that would take 20 minutes of preparation time. Then Elderfield would not be there when called. Then he would move on to the next case, which also involved 20 minutes of note collation and preparation and another official would be called who was not there either. That was not very efficient and they have had to work with big systems. It was frustrating that it was not in place but there has been enough time to improve the operational capability. Now is the time to reach these targets.

Deputy Paul J. Connaughton

Does Mr. Elderfield believe the banks are steadfast behind these targets now and that they will deliver on them?

Mr. Matthew Elderfield

They have no choice about the targets, but from talking to all the senior management teams I believe they are very committed and they know that they have to deliver.

Deputy Paul J. Connaughton

The banks were bailed out by the taxpayer. They are in a catch-22 in that they are trying to get more money in to get out of public hands but they must do deals on mortgage arrears as well. When are the next stress tests due on the banks?

Mr. Matthew Elderfield

We must ensure a balancing act on mortgage arrears. A great deal of capital has been put into the banks. The average is approximately 15% and it is higher in some cases. The level is a good deal higher than our minimum of 10.5% and a good deal higher than the EU requirements. There is some capacity to absorb levels of loss on the mortgage portfolio over time. However, it is not an unlimited amount. We have to be cautious about debt forgiveness or doing deals that would create moral hazard, and people would be wanting more and more of this. Getting a balanced approach between trying to assess the right solution case by case is very important.

I gather the Government is publishing the ninth or tenth EU-IMF review today and it will have some wording on the stress tests.

The basic point is that because the single supervisor is coming in, this changes the timing a little bit with regard to how the stress tests are going to work. One of the pillars of banking union - we can discuss the other pillars if the Deputy so desires - is having a single supervisor, namely, the ECB. The single supervisor is going to come into force probably in July of 2014. Therefore, there will be a 12-month run-in period. In preparation for the single supervisor, two exercises are going to be carried out. One of these will be an asset quality review, to be carried out towards the end of this year. This is a phase 1 exercise. The second exercise will be a stress test, which will be carried out in either the first or second quarter of next year. The agreement with the troika is to try to align, as much as possible, the work we are doing under the programme with those. The Minister has stated that these will be done in close proximity. What we will see towards the end of this year is a kind of first phase of work. The asset quality review will examine provisioning levels and the banks' risk models. This will feed into the asset quality review of the ECB and the stress tests will come after that. It will be a phased process, with some deliverables before the end of the year.

Deputy Paul J. Connaughton

Mr. Elderfield obviously knows the position inside out. As matters stand, is he of the view that the banks will require a further bailout?

Mr. Matthew Elderfield

I thought this question might be posed. I will try to provide a short answer and then a more complicated one. The short answer is that the banks have plenty of capital right now. However, we know that in the future they are going to need more capital because of Basel III and matters of that nature. The questions are how soon they are going to require that extra capital, whether they can obtain it on their own and how much they will require.

I will comment first on why I believe they have plenty of capital now. On the previous occasion on which I commented publicly in respect of the banks, I stated that AIB has 19.9% capital, Bank of Ireland has 14.3% and Permanent TSB has 21.5%. The position may have moved since then and this will be shown in their published accounts. I did not have time to check the accounts. Those amounts are above 10.5% by a wide margin and are also above the EU minimum levels. The banks, therefore, have a buffer. We know, however, that this buffer will be eroded over time as losses occur. Then there are the international rules such as Basel III and the EU capital requirements directive IV - same difference - and these are going to institute tougher capital requirements over time. The banks have perhaps not a mountain to climb but they certainly have a hill to walk up in the context of capital.

The banks are already at the ratio levels at which they need to be and mostly they are also on equity. However, there are deductions which they must make. For example, they must take from their capital any tax losses they have accumulated. They have quite a number of such losses. That is the big, moving number and it will probably amount to approximately €6 billion over time, just from Basel III. It must be remembered, however, that there is a five-year phase-in period, so the banks have plenty of capital-----

Vice Chairman

Is deducting tax losses a new requirement under Basel III?

Mr. Matthew Elderfield

Yes.

Vice Chairman

When will Basel III come into effect?

Mr. Matthew Elderfield

Basel III will be phased in over five years from 2014, at 20% each year. Some other governments, including that in Spain, have changed the nature of tax assets in order that it will not be necessary to do this. There are some options.

Vice Chairman

And the amount involved will be €6 billion.

Mr. Matthew Elderfield

I think I have said in public on a couple of occasions that the figure will be approximately €5 billion or €6 billion. The banks have a great deal of capital right now and they have a slight hill ahead of them.

What other factors are in the mix? In the first instance, we know there are more losses to come in the banks. The questions which arise relate to whether there will be enough money in the pots they have put aside to cover these and how quickly those losses are going to come due. We will carry out an analysis in this regard in the next set of stress tests. We will bring BlackRock in again to obtain an independent, market-recognised approach. There are some positives, some negatives and some uncertainties in respect of this matter.

On the positive side, the arrears levels are still inside the stress test levels. This was shown up in the most recent stress tests, which is a positive. House prices have stabilised. In addition, there are the asset disposals which the banks have been required to do. The banks have many non-core assets and we informed them that they had to slim down their operations and reduce their loan-to-deposit ratios. They have managed to sell those assets without crystallising as big a loss as we feared when we carried out the stress tests. Those are all the positives. On the negative side, arrears continue to rise bit by bit and the domestic economy - rather than that which relates to exports - remains weak. The big unknown relates to the impact the insolvency framework will have. At some point we will consider all of these points and try to envisage what is going to be the outlook. I am not going to make a pre-emptive guess today. We will do that when the time comes. That is the first factor.

The second factor revolves around how we are going to apply stress tests in respect of all the aspects I have mentioned. How tough a test should be applied? Do we really want to pile stress upon stress? How far do we want to twist the dial when it comes to stress testing? The ECB and the European Union, as part of the single supervisor, are going to make the decision in this regard. The questions which arise relate to how quickly loan losses are going to pan out and how tough should be the stress tests.

The third factor involved is profitability and how fast the banks are going to accrue profits. The capital they have now is going to erode over time and we must ask how quickly they are going to realise profits to replace the capital they will lose. The position of the banks in the context of profitability and their net interest margins have not been strong. There are some early signs of improvement but there is still some way to go. Again, we will have to assess the position in this regard and include it in the mix.

The final issue which arises is somewhat political in nature and is, quite frankly, somewhat above my pay grade. If, hypothetically, there was a shortfall in another country, we must consider when this should be dealt with and who should have responsibility for dealing with it. As stated, the banks currently have a great deal of capital. We must ask whether, in the context of a stress which has been identified in the middle distance, we should immediately invest more capital in the banks. It is not strictly necessary to do so because there is already a buffer in place. This brings us to the issues of debt, the banking system and the sovereign and the banking union. The Government's policy - which I think is the right one - is to say that European Union instruments such as the European Stability Mechanism, ESM, should be used to provide for direct recapitalisation. All of the elements to which I refer are going to have to be considered in the context of how quickly it will be necessary to phase in Basel III, the speed at which capital will be eroded by loan losses and other, different scenarios, the severity of stress, the level of bank profitability and what is happening in Europe in the context of the ESM. Decisions will have to be taken and judgments will have to be made around these in the fourth quarter of this year, the first quarter of next year and over time. That will lead to a decision being made on whether there is a shortfall. As previously stated, I will not pre-empt the position and make a guess now. However, I have outlined the process and the factors involved.

Deputy Paul J. Connaughton

I will conclude with a final point because other members are champing at the bit. Mr. Elderfield will leave his post in October. He stated earlier that "as a supervisor one is almost always playing catch up with industry and it is dangerous to think one will get to a point when one can rest on your laurels". Is he concerned by the fact that in the past six months certain individuals have complained about the level of regulation that has been put in place in the past three years? I refer to John Bruton of the IFSC, individuals from the SEC and Michael Somers. Mr. Elderfield made the point that one can never rest on one's laurels. Is he concerned that when he leaves his position, we may slip back to where we were previously? Will he have any input with regard to the appointment of his replacement in the context of ensuring we remain on our current track? If he had been in position prior to the financial crisis, would that crisis have occurred?

Mr. Matthew Elderfield

We must be wary of suffering amnesia when it comes to the financial crisis. The costs that arose are so significant that it is important to learn the lesson that light touch regulation did not work and that, in the context of some of the issues the Comptroller and Auditor General has assessed in the past, the lack of proper testing and a strong framework led to weaknesses. I again make the distinction between rules, regulation and supervision in this regard. In the context of regulation, a great deal is happening. The G20's financial stability board has a very large agenda which flows into the EU and on into Ireland. There is much for the industry to digest.

I have sympathy with that approach in terms of getting the pacing right on that and making sure there are no unintended consequences of all these different things happening simultaneously. There are some valid points in there. I think what it means is that at the Central Bank, when one is doing something extra, one needs to pick and choose one's spots and make sure one has a strong case for that. I think we had that. I think we needed a corporate governance code. That had been stalled or pushed back and we needed a fitness and probity regime. That is fair in terms of how much regulation and when.

Supervision is something to watch. One wants to make sure of a number of elements. One must have the right number of supervisors, the right system and the right degree of independence from the Government, politicians and the Department of Finance to make the calls on these things. Having the right philosophy of being challenging to firms is very important. That is one to keep an eye on. Professor Honohan is very committed to that. I am sure there will be a lot of continuity in that regard. One must be alert for when the next bubble comes, be it five years, eight years, ten years or whenever that is, as that is the moment of risk. When everyone is making lots of money and the regulators are an irritant, then Deputies, media commentators and the Central Bank must ensure the supervision is strong. If people are complaining about it, then one must examine their motives and goals. I hope we have got a good platform for the future and I am sure there will be much continuity, but it is always something about which one should be vigilant.

Deputy Paul J. Connaughton

Is Mr. Elderfield not concerned that even though we are in a depression at the moment, there is talk about over-regulation? We have gone in the complete opposite direction to where we were. Will Mr. Elderfield have an input into his replacement at any level? Does he believe that a crisis would have occurred were the changes he implemented in place prior to the crisis?

Mr. Matthew Elderfield

I think the formal selection process will not involve me but I give advice to Professor Honohan and know a bit about what is going on. There is a special process for recruitment.

It is really hard to make that hindsight judgment. I think it is probably unfair for me to make a judgment on that. Let me put it this way. If one had all the elements in place – supervisors, the right challenging approach, as well as stuff we have not talked about such as a resolution framework where one could wind down banks – on the night of the guarantee, I think one would probably have known at that point that Anglo Irish Bank was insolvent and Irish Nationwide Building Society was in trouble. One would have had a toolkit already available to deal with the problems in terms of the ability to wind down those institutions, which would have made a big difference. It would not have been attributable to me personally but a better framework would have helped out on that fateful night.

Deputy Paul J. Connaughton

I have a lot more questions but it is only fair to allow someone else to speak. I thank Mr. Elderfield for his answers and wish him the best of luck in the future.

Deputy Shane Ross

I thank Mr. Elderfield for coming before the committee. I imagine it will be the last time he comes before the Committee of Public Accounts because he is leaving in October. I am sorry that he is leaving because under his stewardship the situation has undoubtedly improved a great deal and I thank him for that. Could Mr. Elderfield tell us why he is leaving?

Mr. Matthew Elderfield

It is for personal reasons. I mentioned the other day publicly that last August my wife and I were in London for the Olympic Games and we just realised we missed London a lot. We have been away for a long time. It is almost six years, because I did my Irish time, which I have enjoyed, but I was in Bermuda for two and a half years beforehand. I felt that if I had stayed for the full term, it would be something like seven and a half years away. I mulled it over for a while and then at Christmas I thought about it and lots of lobbying took place from family and friends in London saying, "Come on, you have been away too long", so I told Professor Honohan at the beginning of the year that I would give it another year but it ended up being a bit earlier. I have really enjoyed Ireland and living in Dublin. I have lived in lots of cities in the world. I grew up in Manhattan and I think Dublin is a great city. I have really enjoyed living here but I want to get back home.

Deputy Shane Ross

Mr. Elderfield is on his third year of a five-year contract. Is that right?

Mr. Matthew Elderfield

That is right. I will be three and a half years into the five years when I go.

Deputy Shane Ross

Yes, but the decision was made after three years. Does not that not reflect some disappointment with the situation here? Mr. Elderfield anticipated coming for five years and he suddenly decided that he would go home after three years.

Mr. Matthew Elderfield

No, it was not disappointment with Ireland or the experience.

Deputy Shane Ross

Does it have any reflection on the state of the economy, the state of the job or the Central Bank in any way?

Mr. Matthew Elderfield

No.

Deputy Shane Ross

Mr. Elderfield is leaving us at a time when the project upon which he embarked and on which he has done well is still in its infancy to some extent and is very fragile. Does Mr. Elderfield accept that?

Mr. Matthew Elderfield

I would not say fragile. I know there is unfinished business and that is something I debated a lot about. That is a fair point. I know there are still big challenges ahead. A big one is the single supervisor. That is kind of a big break mark where banking supervision is going to go to the ECB. One could ask whether it makes sense to be in there for a short amount of time. I would not say the situation is fragile. There is a strong platform. The numbers are there. The staff quality is there. With the powers Bill, on which members will vote in the next month or so, there will be a strong legislative framework. We have a risk-based framework – PRISM – in terms of how we are looking at firms. It is clear that an intrusive, challenging approach to supervision is embedded. There is a strong foundation.

Deputy Shane Ross

Okay, but Mr. Elderfield is leaving us with a lot to do.

Mr. Matthew Elderfield

I know there is still work to do. In supervision one has to do one’s shift but there is always more stuff on the horizon.

Deputy Shane Ross

Is it correct that the stress tests have been delayed?

Mr. Matthew Elderfield

Basically, they have been delayed a bit and aligned with the EU framework.

Deputy Shane Ross

Does that give Mr. Elderfield any cause for alarm? Would it not have been better to keep to the original timetable?

Mr. Matthew Elderfield

I personally do not think so. It makes sense to align the methodology as much as possible with what is happening in Europe and to do it on a consistent basis. It does not make sense to have to do an Irish stress test exercise and immediately after to have to do an asset quality review and then another stress test. I was very comfortable with changing it to a more phased approach. I think we will have a bit more experience under our belt on the mortgage arrears and the insolvency legislation. Having to do two exercises would not be wise.

Deputy Shane Ross

Is Mr. Elderfield happy with the results of the last stress tests?

Mr. Matthew Elderfield

They were very robust. The conservatism level was significant. The BlackRock numbers were some €8 billion tougher than what the banks wanted and we put some extra buffers in there on top. My successor will have to look again at how all these factors are looking some two or three years on.

Deputy Shane Ross

I think Mr. Elderfield knows that I have been alarmed about the last stress test and I have never been able to get to the bottom of the problem. There was a whistleblower in the Central Bank at that time.

Mr. Matthew Elderfield

There was an individual who used our internal speaking-up policy. There was an internal audit investigation of that but it was all settled.

Deputy Shane Ross

What was the allegation by the whistleblower?

Mr. Matthew Elderfield

I do not think I can really go into that. We looked at that situation. An internal audit person looked at it and I do not wish to do anything that compromises the individual concerned.

Deputy Shane Ross

Was the individual suspended?

Mr. Matthew Elderfield

It is a sensitive HR matter. I really cannot talk about individuals.

Deputy Shane Ross

It is important that the public is happy that the whistleblower system in the Central Bank is working properly.

Mr. Matthew Elderfield

Yes.

Deputy Shane Ross

As Mr. Elderfield is aware, some issues got into the public arena in bits and pieces.

It is somewhat clouded but my understanding is that the whistleblower was suspended and then taken back. Would that be correct?

Mr. Matthew Elderfield

I do not think I can comment on what happened to the individual. There is employment law and human resources, HR, issues there-----

Deputy Shane Ross

Without naming the individual.

Mr. Matthew Elderfield

I cannot go there but people will figure out who the individual is. The person's name might even be out there so-----

Deputy Shane Ross

It was.

Mr. Matthew Elderfield

-----I think I need to not go there. I do not have-----

Vice Chairman

Is the person still in the employment of the Central Bank?

Mr. Matthew Elderfield

I am cautious about what I am allowed to say about a HR matter such as that. I can say that a matter was raised. It was looked at by someone independent to the management line there. I think it was looked at thoroughly. I do not think there was anything there. The person was satisfied with the report that was prepared but I will not talk about when they left, what the terms were or anything like that. That is a private matter. It is a confidential matter and we need to respect that person's confidentiality.

Deputy Shane Ross

If someone within that department who was involved in the stress testing at a high level, and I understand they were, made the allegation that the stress tests were flawed, which I understand is what they were saying, the way they were treated is very important. It is important to us that the Central Bank, which obviously is accountable to the State, is operating a whistleblower procedure in a satisfactory way. What is important about this, and I understand Mr. Elderfield's reticence about the individual, is being sure that anybody from the inside with an expertise in this area who goes through the whistleblowing process is not silenced, dismissed or suspended for those reasons. It is to make sure that the right and fair procedures are put in place and because it is not clear, it seems to me that this episode is a little murky. It would help if Mr. Elderfield could say to us that in terms of what happened, they made these allegations, they were investigated, we suspended them for a period, or whatever happened, and then we took them back, if that is what happened. This is a very serious issue because the way these stress tests are conducted is very important to the nation but we would need to be sure that the Central Bank is behaving in a way which protects the integrity of the process, not just the integrity of the Central Bank.

Mr. Matthew Elderfield

What I have to do is try to break it down into three components, so to speak. The status of the individual through it and what has happened is a matter for employment law and confidential with the individual but I will try to reassure the Deputy on a couple of points. We have a speaking up policy. When the person raised this concern it was treated very seriously under the speaking up policy. We had the internal auditor separate from that area investigate it thoroughly and feed back to the individual, and the individual was satisfied.

For the stress test itself, we had peer review from other regulators. We had the European Banking Authority. We had our own consultants. We had the troika, the ECB, the Commission and the IMF. We had many people looking at those numbers, and the stress test results we published were the most transparent in terms of the details we provided. If the Deputy looks at the PCAR information we provided that March, he will see there was a lot of information there. In terms of the integrity of the stress tests and the ability to track and test them, there is a lot there and there were many eyes on that.

Deputy Shane Ross

Was some sort of independent investigation carried out into this whistleblowing allegation?

Mr. Matthew Elderfield

We asked the internal auditor to look at that, yes.

Deputy Shane Ross

An internal auditor is not an independent investigation, is it?

Mr. Matthew Elderfield

The internal audit was independent of their management line and the individuals who were managing that individual, yes.

Deputy Shane Ross

But it was someone in the employment of the Central Bank?

Mr. Matthew Elderfield

The internal auditor, yes.

Deputy Shane Ross

Does Mr. Elderfield regard that as satisfactory?

Mr. Matthew Elderfield

Yes.

Deputy Shane Ross

Was this person someone with an expertise in the stress test area?

Mr. Matthew Elderfield

The person had access to people who understood the stress testing.

Deputy Shane Ross

But was not employed directly in that area?

Mr. Matthew Elderfield

He certainly was not, no.

Deputy Shane Ross

We are not saying whether it was a he or a she.

Mr. Matthew Elderfield

The internal auditor is a he.

Deputy Shane Ross

I will leave it at that, but I am concerned that these things are done behind closed doors to such an extent there is no way we can be sure that queries of this sort are being given the proper consideration they deserve.

Mr. Matthew Elderfield

Can I just say-----

Vice Chairman

Can I make a suggestion? Could Mr. Elderfield review the particular circumstances of the case within the Central Bank and send the committee a specific note as to how far he believes he can go legally? He might also outline the whistleblower policy within the Central Bank, and the protection for whistleblowers.

Mr. Matthew Elderfield

We can happily send the committee our speaking up policy.

Vice Chairman

Will Mr. Elderfield see how far he can go in terms of the specific circumstances?

Mr. Matthew Elderfield

I am positive that we cannot get into the individual circumstances.

On whistleblowing more generally, there is one frustrating aspect about it for the whistleblower and, I am sure, for Deputies. In terms of the new law that is coming in, we will have this framework that says one can now make a protected disclosure. We have to treat that individual in a confidential way. Unless there is an exclusion it is necessary to reveal the person for the purposes of pursuing the investigation. We are thinking through that in terms of the circumstances in which the information would be disclosed. The Financial Services Authority, FSA, for instance, tries under all circumstances not to disclose the individual's name but sometimes it is very hard to investigate that. That is one aspect of it.

The protected disclosure is great. The new framework means employment action cannot be taken against the individual. They are protected, etc., but we also have a duty as a regulator - I am talking in our context - to keep the firm's information confidential. We will have the whistleblower present information to us but we cannot come back to them, and I think that drives them nuts. It probably drives the members nuts when they talk to the whistleblowers, but that is the nature of it. We must be confidential towards the firms and the individuals. We also must be confidential, in this context, to our staff members under employment law. There are protections for whistleblowing. One cares about the policies that are in place but when one wants to get to what happened to it, typically it happens internal to the supervisor in terms of the actions that are taken.

Of the approximately 42 whistleblowing incidents we had last year, we took actions on about half of them. Half of them we find do not have any legs, so to speak; there is not enough to go on. Sometimes they go to enforcement and sometimes they go to supervisory action. We take whistleblowing seriously internally and from the point of view of the firms too.

Deputy Shane Ross

I appreciate the need for confidentiality to protect the individuals but it would be very helpful if Mr. Elderfield could give us a resumé of the detailed allegations about the stress test. I do not understand why we should not get those when they are considered to be untrue by the Central Bank and have been dismissed. I do not understand why we should not hear those allegations, the reason they were dismissed, the procedures and the outcome. Those are procedures about which we are entitled to be satisfied that they are working.

Mr. Matthew Elderfield

We did not give the procedures but we had a statement covering those other points at the time. We can look at that, see what we have got and send it to the Deputy.

Deputy Shane Ross

It was a one-liner.

Mr. Matthew Elderfield

I think it was a bit longer than that but-----

Deputy Shane Ross

It was one or two lines. We will move on and we might get something from Mr. Elderfield that is more fulfilling.

As for recapitalisation, on which Deputy Connaughton touched, it is an area that is unclear and on which it is difficult to make judgments. While the Government states it is not needed, I think Mr. Elderfield is saying it will be needed at some stage. From where will the money come?

Mr. Matthew Elderfield

If the banks return to profitability-----

Deputy Shane Ross

If.

Mr. Matthew Elderfield

-----before the capital is eroded through losses, that is the principal source one would like to see. If the banks become a better investable proposition, one then would see private capital and this obviously has happened in the case of Bank of Ireland in the past couple of years. In respect of any public support, the clear Government position is the best approach is the use of the European Stability Mechanism, ESM, as direct recapitalisation. There will be much debate on that over the next nine months or so, as to exactly how much and in what circumstances. Given the link between the banks and the sovereign finances, it is very important to have available that tool for Ireland and across Europe. One would want to have such ESM direct recapitalisation in order not to add to this vicious cycle between the banks and the sovereign finances.

Deputy Shane Ross

The first option is that the banks become profitable, which is an aspiration. I agree with Mr. Elderfield that Bank of Ireland obviously is the best prospect in that regard. While AIB may or may not become profitable, does Mr. Elderfield think we must rely on ESM for recapitalisation otherwise?

Mr. Matthew Elderfield

I would not dismiss the first two entirely, because a timing question arises. At present, there is a lot of capital in the banks to absorb losses for the foreseeable future. One may identify in the stress test a hypothetical loss in the future. Consequently, there is a question as to how fast one might wish to deal with that. One might decide one should have a plan to get there in stages between now and the end of Basel III. The circumstances may well be that a private investor decides this is a reasonable plan in which it will take part. Consequently, I would not rule that out as an option. One should think very carefully about how fast one wishes to address these things until one knows what will be the European policy framework. This probably is a good reason to align our stress tests with the European stress tests, in order to ascertain what the European framework will be for direct recapitalisation.

Deputy Shane Ross

To some extent, is that not putting off the evil day? It is kicking the can down the road by stating one will recapitalise when one has the money rather than when one needs to.

Mr. Matthew Elderfield

One could argue this both ways, as there are pros and cons. One could also decide to accelerate and bring everything right now, because it is kicking the can. One might decide to get as much capital into one's banks as needed to enable them to start lending. That is a very plausible argument. However, if one is a stressed sovereign and the only way to do this is through borrowing, one might then decide this is not the best way in which to do it. Were one a supervisor in the United States with a triple-A rated country at one's back with lots of money, one would simply state one should err on the side of more injections in the short term and one's microprudential need for recapitalisation would trump any macroprudential concern. However, if one is in a situation in the eurozone with a stressed sovereign, one needs to make one's judgment about timing. It is a fair point and there are arguments both ways about the speed of it. However, because there is a debate under way on ESM recapitalisation, it makes sense to see how that emerges and work on the stress tests in parallel.

Deputy Shane Ross

Yes. What is Mr. Elderfield assuming in terms of legacy debt from the ESM?

Mr. Matthew Elderfield

I have not been involved in the discussions. The Department of Finance deals with that. I do not know which way that will fall in terms of legacy debt and the levels. I simply do not know how that will come out.

Deputy Shane Ross

When the Central Bank makes forecasts or provisions, does it not come into that?

Mr. Matthew Elderfield

Not on the bank side. To the extent to which there might be a debt-for-equity swap in the future or for more capital to be available, we are telling the banks they must increase their provisions and deal with their mortgage arrears and that we will come and stress test them shortly.

Deputy Shane Ross

May I ask Mr. Elderfield specifically about a number of issues? In respect of fitness and probity, what procedures does the Financial Regulator put up for appointing or allowing and giving a certificate of fitness and probity to people who are made directors of banks?

Mr. Matthew Elderfield

When the fitness and probity framework came in, effectively everyone was grandfathered under the law. That was the way it worked. Any new applicants must apply to us in what we call an individual questionnaire. This gives a lot of information to help us assess both the fitness and the probity sides of the equation. This comes into a central team and we look through that and make a judgment. For the higher impact firms, including the banks, we tend to do interviews for these roles and assess the fitness and probity. We have put in place a flagging system whereby if someone from one of the banks that required a Government bailout tries to come back into the system, a flag is raised. We then slow down the process and state we will be obliged to carry out an assessment of the individual in question and to ascertain what was the history of the position. For example, were they in human resources and therefore had no responsibility or were they in charge of commercial lending and, therefore, have some questions to answer?

Deputy Shane Ross

To interrupt, is that for executives, rather than directors?

Mr. Matthew Elderfield

We say this for both executive and non-executive directors. Consequently, for people who wish to re-enter, we will have an additional check in the sense that we decide we must look more closely and establish what was this person's role in the institution in the pre-crisis period, to what extent was he or she responsible and how that affects the current role for which he or she is applying.

Deputy Shane Ross

Does Mr. Elderfield conduct these interviews himself or is there a panel?

Mr. Matthew Elderfield

No, it tends to be the supervisory staff who will do that. A couple of them will do that. Usually, the heads of department tend to do it but sometimes it is the director.

Deputy Shane Ross

Has the Financial Regulator turned anyone down?

Mr. Matthew Elderfield

We have had a fair number of people who have withdrawn their applications. I think that approximately 3% of people withdraw their applications.

Deputy Shane Ross

How many people is that?

Mr. Matthew Elderfield

I think it was 93.

Deputy Shane Ross

Some 93 people have withdrawn.

Mr. Matthew Elderfield

Yes, if my recollection is correct. If the Deputy gives me a second I will just-----

Deputy Shane Ross

These are not people who have been turned down by the Financial Regulator, are they? They are people who simply have withdrawn.

Mr. Matthew Elderfield

What tends to happen is that when one starts to raise issues, they tend to simply withdraw. I read that figure only this morning and am pretty sure that is the number - it might be 94 people. Anyway, that is what tends to happen. One raises the questions and rather than having a formal determination against them, people tend to withdraw.

Deputy Shane Ross

So the Financial Regulator has not actually barred anyone at any stage. It has not ever said "No".

Mr. Matthew Elderfield

We have come very close to doing it formally and then, at the last minute, the person withdrew.

Deputy Shane Ross

However, the Financial Regulator has never refused anyone.

Mr. Matthew Elderfield

We have never yet been obliged to get to that stage. Under the regime in the past two years, the person has always withdrawn before getting to that stage, yes.

Deputy Shane Ross

How many has the Financial Regulator approved?

Mr. Matthew Elderfield

While I cannot do the maths off the top of my head, a decline rate of 3% equates to 94. If the Deputy gives me a second, in 2012, the numbers approved, withdrawn and returned as incomplete were 2,234, 93 and 331, respectively.

Deputy Shane Ross

Okay.

Mr. Matthew Elderfield

We also carried out a retrospective review on the sitting incumbent directors at the covered institutions. Basically, the position is that of the bank directors, both executive and non-executive, who were in place on the night of the guarantee, which is a reference point we often use, 71 of the 73 have now left the system.

Deputy Shane Ross

Did the Financial Regulator have any influence on them leaving?

Mr. Matthew Elderfield

I want to be careful about what I say here. It was without prejudice to guilt or responsibility. We stated we felt there should be a refreshing of the system and that this review would be held. Really, a lot of people simply decided to withdraw before the review took place.

Deputy Shane Ross

Does the Financial Regulator have the powers to remove them if it so wished? Can it send a message to the bank stating he or she should go? Can it do that?

Mr. Matthew Elderfield

Under the Central Bank Reform Act 2010, on which members voted, we have the power to prohibit individuals who are sitting in place.

It probably works, both as a gatekeeper role and as a removal process, but you have to go through various legal checks and balances and establish your case. You have to be able to provide evidence that the person is failing to be fit and proper for his or her current role. You have to meet certain evidential tests. It has to be confirmed by the courts after a certain period of time. One has powers, but I would not say it is the most straightforward process.

If the committee would not mind a small digression about accountability for individuals, that is one reflection - since perhaps I am here for my final appearance - that I would like to mention. I spoke about it previously. There is an open issue about how effective the system is, if I can call it that - that is, ourselves, the Garda and the Office of the Director of Corporate Enforcement - and about being able to ensure individual accountability through the enforcement and sanctions process. We have taken a lot of enforcement cases against firms - we have been very successful in that, I think, in terms of raising standards there - for systems and controls lapses, for mis-selling and for overcharging, but it is much harder to take cases against individuals. The firms tend to settle with you quite quickly and individuals tend to fight you tooth and nail to the very end. We have a couple of cases from the financial crisis period in which we are still taking action against individuals. That is more protracted and drawn out. A reflection I have is that white-collar crime seems to be an area in which the system is just not operating well in terms of being able to tackle that. It is too protracted. The deterrent value of taking actions against firms is good but the deterrent value of taking actions against individuals is much better. One of the thoughts I had, maybe a few months ago, is that this is something that somebody in Ireland, such as a retired judge, a former Attorney General, the Law Reform Commission or, if it is the correct jurisdiction, the Committee of Public Accounts, should look at. They could do a stock take, ask "How could we tackle white-collar crime more effectively?", and set out a few thoughts. There is one question, which is really about the capabilities of the different players. Does the Garda have the resources and the capabilities? Does the ODCE or the Central Bank? What is the right split between the three of them in that regard? One has some questions about powers, the questioning of suspects-----

Vice Chairman

How does Ireland compare to other jurisdictions?

Mr. Matthew Elderfield

The track record is weaker, certainly, than in the United States. The United Kingdom has had some banning and some big fines for individuals who were involved with failed banks. That has not happened here. There has not been, as far as I am aware, the criminal prosecutions there have been in the United States. I think it is relatively weaker. Obviously, we still have the big court case on Anglo Irish Bank to come - I want to be careful as I do not want to say anything prejudicial to that - but you could really have somebody do a stock take about how well are we prepared as a system and also how good the law is. There are issues such as whether there should be a strict test establishing individual responsibility when there is an enforcement case against a firm. It is quite a tough test that the enforcement lawyers have to do, which makes it hard for us to do that. The United Kingdom is looking at whether there should be presumptive liability or presumptive sanctions for directors of failed banks. That might be in the banking standards report on Friday when it comes out. Should there be a reckless trading offence for financial services? Exactly how the constitutional protection of ability to earn a living interacts with the fitness and probity regime was a complicated matter in the drafting of the law, which affects the ability to take action against individuals. There could be a stock take, a report by the Law Reform Commission, a wise person's report or something like that to draw this together. I would say we have done a good job of enforcement against firms, but I wish we had done more on individuals, and the system could do better on them.

Deputy Shane Ross

I take Mr. Elderfield's point. I am unclear as to how he exercises these powers. As he will be aware, there is an extraordinary reappearance on the boards of current banks of persons from banks which have not necessarily failed - certainly from the boards of banks which have subsequently been bailed out - or persons who have been involved in failed departments or failed areas of banks. That, I presume, is not a factor that bars them, but it certainly should not be one that is encouraged. The fact that persons who have been identified with failed banking enterprises in the past are popping up on the boards of banks is something which alarms some of us. Obviously they have not been involved in any activity which is criminal or anything like that, but they have been involved in identifiably failed projects of a mega nature. I wonder how they get through Mr. Elderfield's fitness and probity tests.

Mr. Matthew Elderfield

If the individual was a director or senior manager of one of the banks that has required Government support, we have a flagging system for that explicitly to slow the whole thing down - as I said, to catch that. On our standards for fitness and probity, the probity side is a matter of one size fits all. You must be proper whether you are a small director or a big director, if Deputy Ross knows what I am saying, and it is about criminal background and the rest of it.

Fitness is very much relevant to the individual and the role that he or she plays, but one point we explicitly wrote in - there was much debate about this internally and I insisted it should go in there - was a reference to the track record of the individual in his or her previous roles. You have to interpret that in the context. I tend to be bad at giving good examples, but the questions are what sort of role the person held in the past, how directly responsible he or she was for the failure, and how big an institution he or she was in compared to where he or she is going now. I will give an extreme example. If a person who was a HR director or senior manager in a bank that got into trouble now wants to be a non-executive director of a fund, one thinks, "All right; the person was in a bank that got into trouble," but he or she gets through. If a person who was a senior manager or head of commercial property lending in a bank wants to go into a similar role in that bank, then one would slow it down. I am not going to say we have done it in that type of case, but there are cases that I am aware of in which we have said, "We have problems with you because of your track record in the past. We know about you from the past," and those persons have withdrawn.

Deputy Shane Ross

I am thinking specifically, I suppose, of executives in banks who have been much identified with failures in those banks and who are popping up as non-executives on the boards of public banks. Mr. Elderfield might flag that for his successor.

I have one question for Mr. Elderfield about Custom House Capital. Like many members of the committee, I have received many representations about Custom House Capital, which had 1,500 staff. It was identified as being in trouble by the Central Bank in 2007 - I think my dates are correct, although I am open to correction - with a €4 million deficit, but it was slow to be identified as being in really big trouble and running a Ponzi scheme. Eventually, it was discovered what was going on, not by the Central Bank but by a company called Appian Asset Management, which took it over. Was that a major lapse on the part of the Financial Regulator?

Mr. Matthew Elderfield

Many parties - ourselves and others - missed a key problem on the client assets. That was a very frustrating experience. There was this history from 2007. I first heard about it in the spring of 2010 and I approached it in two ways. The aim was to make sure the client assets were okay. From memory, we did a review, we had a third-party review, and we had two external auditor reviews - something of that order. All of them said there were some questions about systems and controls but the client assets were fine. The question was, if the client assets were fine, did we want to close the company down or liquidate it, or did we want to try to get the management out? If we had liquidated it then, we would have crystallised a loss for the investors because of all of the illiquid property investments.

We debated it back and forth and decided that as long as the client's assets are secure we would bring in an outside chairman or non-executive director and try to sell this thing to another person. With hindsight, two problems arose. The first is that we were getting false positives on client assets. We got a false positive on the third party report.

Deputy Shane Ross

What was the false positive?

Mr. Matthew Elderfield

They were all saying the client assets were there because it was a fraud.

Deputy Shane Ross

Who was saying that?

Mr. Matthew Elderfield

We carried out a review and commissioned a third party report - two if I recall correctly. The old auditor and the new auditor were also involved.

Deputy Shane Ross

Did the third party report also come back with a false positive?

Mr. Matthew Elderfield

Some of the reports found systems and controls issues at the margins but none identified the diversion of client assets.

Deputy Shane Ross

That is appalling. Was the third party paid for that report?

Mr. Matthew Elderfield

I am afraid it was paid before the issue emerged.

Deputy Shane Ross

Who was the third party?

Mr. Matthew Elderfield

I cannot remember. I am not being diplomatic but I cannot quite recall.

Deputy Shane Ross

You are being diplomatic as well.

Mr. Matthew Elderfield

I could just guess because it would be one of four.

Deputy Shane Ross

Will Mr. Elderfield find out and let us know who wrote the third party report?

Mr. Matthew Elderfield

If we are allowed to do so. We had our risk advisers prepare a report on Custom House Capital and client assets, which we published. We put a lot of our dirty linen into the public domain. I will have to check whether we can disclose the information requested by the Deputy. It was very frustrating.

Vice Chairman

We have full privilege today.

Mr. Matthew Elderfield

I must also observe section 33A(k) and the other legislative provisions governing what I do. It was very frustrating because it was like a false premise for our decision making. If we had known of the fraud we would have taken a different course but fraud is difficult to identify. That was one problem in hindsight. The second problem is that we only had the nuclear option of liquidation. We do not have the ability to put investment firms into administration. This is a gap in the law. We would have preferred to appoint an administrator, clear out the management entirely and have the administrator run the organisation. All we could do was work with the management until we could sell the operation or liquidate it but liquidation would have crystalised losses for the customers.

Due diligence was also required during the sales process. Off the top of my head, four or five counterparties came through but none spotted the client asset hole. It was just before settlement of the deal that Appian finally spotted it. We published our lessons learned and were quite open about them. We learned lessons about how we should approach these matters. It is important to have a low risk tolerance about handling client assets. We tightened up in that regard. We have a dedicated client assets team and put a protocol in place for problems with client assets. We intervened with a spreads company at the beginning of last year to ensure everything was in proper order and have done some other interventions which required the use of third parties to get the management of client assets out of the firms in question. There are lessons for us and the auditors in the way the matter unfolded.

Deputy Shane Ross

I will finish by asking Mr. Elderfield to address an important issue, if he does not mind. I ask him to stop me if I misinterpret what he said. He commissioned a report from the third parties to tell him about the client assets.

Mr. Matthew Elderfield

Yes.

Deputy Shane Ross

They misinformed him.

Mr. Matthew Elderfield

They did not find the problem.

Deputy Shane Ross

Did he pay them?

Mr. Matthew Elderfield

I am sure they were paid at the time.

Deputy Shane Ross

Is action being taken to recoup the money?

Mr. Matthew Elderfield

We missed it, they missed it and the auditors missed it.

Deputy Shane Ross

That is not good enough.

Mr. Matthew Elderfield

No, it is not.

Deputy Shane Ross

When Mr. Elderfield missed it, he came out with his hands up. They also missed it but they have been paid.

Mr. Matthew Elderfield

We could investigate our chances of recouping the costs.

Vice Chairman

Were they appointed specifically for that exercise? Auditors would be general.

Mr. Matthew Elderfield

The examined a range of issues if I recall correctly.

Vice Chairman

Would it have been part of their terms of reference to look for the particular issue to which Deputy Ross referred?

Mr. Matthew Elderfield

All of those reviews examined the client asset controls but none found the fraud. I am not going to make an excuse for that but fraud is a really hard thing to find in client assets. All of the documents provided appeared to reconcile but they were false. It is difficult to freeze the company and go down to a full reconciliation of client assets. We have done that on a couple of occasions under our new framework but it is a very difficult exercise. I am not making excuses for them or for us. A considerable number of firms have gotten into trouble in respect of client assets in the UK and the US. This has been a problem area over the last several years.

Deputy Shane Ross

This fraud was discovered by Appian.

Mr. Matthew Elderfield

At the 11th hour it discovered a reconciliation problem.

Deputy Shane Ross

It was buying the mess. The people commissioned by Mr. Elderfield were appointed because the company was in turmoil. I presume they were specifically mandated to look for something like this but they appear to have failed completely. They returned what he describes as a false positive, which basically is an indication that everything was okay. Surely he should investigate a means for holding them accountable to some extent because they were acting on his behalf and, indirectly, on behalf of the taxpayer and the customers. We certainly should be getting our money back, if not investigating how thoroughly they did their job.

Mr. Matthew Elderfield

We can certainly do that. I know Deputy Ross has worked in financial services companies. When he reads the small print on what an auditor sends him, he will see a variety of exclusions and wriggle room clauses, if that is the technical term. I would not be surprised if there is plenty of that in the material they sent us. It is a fair point, however. We will examine the issue, although I do not want to give the impression that it will be easy to get the money back.

Deputy Shane Ross

That is fine. I ask him to let us know what they were commissioned to do, how much they were paid, what they found and what is being done about it. Is that a reasonable request?

Mr. Matthew Elderfield

We will provide as much of that information as we are allowed to share.

Vice Chairman

Has the regulator held discussions at the most senior level with the partners of the company that the consultancy took on in regard to the fees paid?

Mr. Matthew Elderfield

I do not know.

Vice Chairman

Does Deputy Ross know the identity of the consultants?

Deputy Shane Ross

No, but I could find out.

Vice Chairman

I suggest that Mr. Elderfield should go to the top to discuss the matter at partner level because ultimately it is the taxpayer's money. Is it something he will take on board with a view to reverting to the committee?

Mr. Matthew Elderfield

Sure.

Vice Chairman

In respect of recapitalising the banks, recent media reports suggest that the troika is insisting on stress tests prior to the formal exit from the bailout. What form will those stress tests take and how does Mr. Elderfield envisage they will go? Am I correct in my summation?

Mr. Matthew Elderfield

The Vice Chairman will be able to see the exact wording in the programme documents published today. The way I would describe it is that there will be a phased process through autumn and into next year. A certain amount of work will be done before the end of the programme to input into the asset quality review.

That will be examining provisioning levels-----

Vice Chairman

We will get around to that. The main question is what form of stress testing happens prior to the bailout.

Mr. Matthew Elderfield

I am describing it. I think of it as a process with different stages. The first stage is examining the loan losses, asset quality and provisioning levels. That sort of work will be lightly done. It is not 100% pinned down before the end of the programme. That is handed in to the asset quality review with the ECB and that goes into the stress tests. There will be different stages of the process. Some of it will be done before the end of the year. Some of it will go into next year.

Vice Chairman

Does Mr. Elderfield anticipate that there will be any further capital requirements for the banks on foot of those stress tests?

Mr. Matthew Elderfield

As I mentioned, we will have to wait and see what the results are. We know there is a lot of capital in the banks now but we will have to assess future trends on loan losses, profitability, how quickly the Basel requirements will come in and the level of stress. I will not prejudge that exercise today. Those will have to be assessed at the time.

Vice Chairman

When does Mr. Elderfield expect that stress testing to conclude?

Mr. Matthew Elderfield

There will be different deliverables or outputs at different stages along the way. The end of the process will be at some point in early 2014 but the exact timelines have not been pinned down yet. To a certain extent we are in the hands of the ECB and the European Banking Authority where there is still some fine tuning of the timeline.

Vice Chairman

Mr. Elderfield referred to white collar crime. In his time as Financial Regulator, against how many people has he instigated legal proceedings for white collar crime and how many of those has he been able to hold to account legally? I refer to individuals.

Mr. Matthew Elderfield

On firms we have done a lot of work. We have a couple of cases regarding individuals that are open and ongoing but they get very extended because the individuals tend to fight one all the way.

Vice Chairman

Does Mr. Elderfield believe the current legislation on our Statute Book is strong enough to bring people to account for white collar crime?

Mr. Matthew Elderfield

No.

Vice Chairman

I understand the Bernie Madoff case in the US was pursued under reckless trading legislation. We have no similar legislation here.

Mr. Matthew Elderfield

It would make sense to have a stock take by an independent expert or wise persons group because it takes too long, it is too protracted. It will not help with the current cases because the offences were committed under the old law but there is an opportunity to learn some lessons. I can give my short list of areas we could examine. Do we have reckless trading legislation, as the Vice Chairman mentioned? Should we have a presumption of direct disqualification for failed banks? How do our administrative sanctions work? That is just the tip of the iceberg. One would want somebody who would systematically examine that. In due course we will be able to take some actions against individuals and we are pursuing that in a couple of cases but I wish it had happened faster.

Vice Chairman

Mr. Elderfield is saying it is not fit for purpose, and it is more than four or five years since the night of the guarantee.

Mr. Matthew Elderfield

In the round, the white collar set up - capabilities, resources, powers, constitutional interaction - is not working sufficiently well.

Vice Chairman

In the media it is generally written that property prices have stabilised and rental yields have come up to the point where it is beneficial to buy property based purely on rental yield value. Does Mr. Elderfield believe it is potentially possible we could have a further property bubble in years to come? What types of measures could be put in place vis-à-vis the banks and legislation to ensure that does not happen?

Mr. Matthew Elderfield

That is a good question. I do not know when the next property bubble will occur. Inevitably there is a cyclical element here where there are pressures to build up and so one wants to think about the right tool kit. My colleagues on the economist side of the Central Bank talked about some tax changes to do that. I am not an expert in that. From the regulatory side they talk about a macro-prudential tool kit. Does one have the ability to slow things down when times get good? The typical way to do that is to ramp up capital charges and make it more expensive for banks to lend when times get good. We are a long way off from that. The other tool one could use is loan-to-value limits. We have visitors to the Central Bank from places such as Hong Kong and Singapore and they have quite strict loan-to-value limits as a way to cool their markets down. That is something one would want to have available.

Vice Chairman

What about loan-to-income limits? Traditionally here it was two to two and a half times principal salary and one to one and a half times second salary and it served us reasonably well. During the Celtic tiger it went up as high as six times one's salary. Could Mr. Elderfield see room for that measure, which is very straightforward? Could he elaborate on the particular engagement with the banks on laying down such rules now?

Mr. Matthew Elderfield

Yes. Loan-to-income limits would be a possibility. Most jurisdictions do loan-to-value rather than loan-to-income. It has not been a live issue in Ireland for obvious reasons right now so I have not spent much time examining the different trade-offs and what is the best way of approaching this. We are doing an assessment of our powers on macro-prudential tools but it is not a burning issue right now. In the next phase of the journey of improving regulation that will be something to engage the banks with but it is not top of the priority list for the short term.

Vice Chairman

Are there regulations in place to prevent a property bubble?

Mr. Matthew Elderfield

We can take action on the capital front to deal with that. Internally we are examining loan-to-value limits and to what extent we have the powers. We might need some fine-tuning but that is something to worry about putting in place in the next two to three years rather than the next two to three months.

Vice Chairman

In the banking sector since the crisis, mortgages have always been the elephant in the room. Where does Mr. Elderfield see that progressing in terms of arrears? Does he believe the banks' provisioning is robust enough in that area? He might refer to individual banks such as AIB, Bank of Ireland and Permanent TSB. Generally, where does he see that market going? What are his views on repossessions and the family home? As public representatives we deal with people every day who are under enormous pressure in terms of mortgages and retaining the family home. That is the next big issue with the insolvency legislation coming on board. How are the banks dealing with that issue? That feeds into recapitalisation.

Mr. Matthew Elderfield

Operational capacity has improved greatly but is not all the way there. There is a strong commitment to hit the targets but there is still much work to get through to put sustainable solutions in place. The pressure is on to do it in the next 18 months before our new, tougher provisioning rules come in. There are uncertainties on how the personal insolvency regime will interact with this but there is a commitment to get these arrangements in place. There are so many different areas we could talk about. We are under time pressure. Rather than forcing everybody into the personal insolvency framework we would like banks to work out solutions beforehand.

It is important that both the unsecured creditors and the secured creditors come together for that. Banks are not going to give deals if the unsecured creditors, credit cards and credit unions are getting paid 100 cent in the euro. Both sides have got to come together. So I think there is a burden-sharing initiative that we have done, which I understand a lot of credit unions have signed up to. It is very important and welcome. I think one can get a fair approach there. It is a real win-win situation that rather than paying the personal insolvency practitioner and dragging this whole thing out, one can find a way that the credit union gets something, the bank gets something and the customer gets a deal and can move forward. That is one observation to share.

Second, as Professor Patrick Honohan mentioned recently, when one looks at the menu of approaches, short-term interest only might work in some circumstances with term extensions in cases where there really is not a prospect of being necessarily repossessions. We think that this device of the split mortgage is a very important way to do it. I know people are impatiently waiting to ask questions. I am just going to take two minutes to explain how that would work and why it is valuable. Basically, one would look at the customer and ask how much they can afford. We are going to right-size based on affordability into part A, a mortgage they can pay principal and interest on. On what they can afford, one has got to accept disposable income is going to come down, minimum living expenses - all that debate has to go on there. I do not think one can keep people on the absolute minimum living expenses ad infinitum - it is not going to stick - but there have to be sacrifices to get that. Then one parks the remaining bit of the debt in the part B for the warehouse and one has two scenarios. The person could actually improve their income and start to pay the part B down. Therefore the bank has not written off a debt owed to it and there is not more cost to the taxpayer.

Vice Chairman

What is Mr. Elderfield's view of some banks charging interest on the split mortgages?

Mr. Matthew Elderfield

I will come to that. Then there is the other scenario which is actually the customer cannot pay that down. We have thought a lot about this - about whether one should allow interest charged and the rest of it. We think the best approach is to say - I think this got missed in the press release from one of the trade associations on Monday - we will only accept as sustainable a split mortgage if for the part B, for the warehoused element, the bank accepts that it cannot pursue the full amount and cannot try to get the shortfall. Therefore if at the end of the term of the mortgage, with interest accumulated or not or whatever, the part B is bigger than the value of the house, the bank must accept it will not get the shortfall. Then the person going into the split mortgage knows that their worst-case scenario is that they get to the end of the term of the mortgage and do not have this debt hanging over them.

We are also saying that if at the end of the term of the mortgage the person is 70 years old and cannot trade down, one needs to keep them in the house until the end of their life. That way the person stays in the home and the bank has the option if the income improves. Regardless of what happens to the interest it cannot pursue the person to the ends of the earth for the shortfall and one keeps them in the home. We think this is a sensible, balanced approach. It is not debt write-off, but it is pragmatic and it also allows the option that if things improve then the debt can be covered.

Vice Chairman

How does Mr. Elderfield envisage the arrears going with the banks with the mortgages in the coming years?

Mr. Matthew Elderfield

As I said to the Vice Chairman's colleague, it is hard to predict what the level will look like.

Vice Chairman

Does Mr. Elderfield believe it will work? Does he believe it will increase?

Mr. Matthew Elderfield

The rate of increase is slowing down. The economists we talk to about this say one has a time lag after unemployment peaks and that one would expect it to tail off, but I cannot make a prediction as to exactly what is going to happen in the future. What I can say is we have set very strong targets for the banks. We are very serious about that and they have said to us they are serious about hitting those targets.

Vice Chairman

Does Mr. Elderfield believe their provisioning is strong enough? Are the provisions they are making sufficiently robust?

Mr. Matthew Elderfield

That is also a good question. We published some pretty tough provisioning guidelines a year and a half ago, which prompted a lot of increased provisions and more transparency. We published another set of provisioning guidelines a month ago which we would anticipate at the end of the year will prompt even more robust provisioning. We are saying if they are not on a sustainable basis we are going to require even more conservative provisioning. I think the provisioning policy framework is quite tight and the provisioning has got a lot better.

Deputy Paschal Donohoe

I thank Mr. Elderfield for coming in this afternoon. I apologise for keeping him waiting earlier in the day. I thank him for all the work he has done in his role in which he has had a very positive impact. I wish him the best of luck in his next assignment.

How many split mortgages are there at the moment?

Mr. Matthew Elderfield

There are not many split mortgages - hardly any. Do I have the breakdown of the types? It is unfortunately very low. The last statistics show that it is overwhelmingly interest only. These are the statistics as of end December.

Deputy John Deasy took the Chair.

Deputy Paschal Donohoe

End of December, is it?

Mr. Matthew Elderfield

End December. I think we have got the end Q1 ones. Have I got that right? The Q1 statistics are due to be published shortly. As of the end of December statistics it is overwhelmingly interest only - different variations on that. What I would like to see over time is for the mix to change.

Deputy Paschal Donohoe

How many are there?

Mr. Matthew Elderfield

There were 52 split mortgages as of the end of December.

Deputy Paschal Donohoe

For the entire country there are 52.

Mr. Matthew Elderfield

Exactly.

Deputy Paschal Donohoe

Mr. Elderfield and the Government have been identifying split mortgages as a strong policy option for dealing with this crisis and Mr. Elderfield is telling me that at the moment there are 52 of them across the entire country.

Mr. Matthew Elderfield

Not to split hairs, I am not saying at the moment; I am saying as of the end of December.

Deputy Paschal Donohoe

Okay.

Mr. Matthew Elderfield

I do not know how many had taken place by the end of Q1. What would be more interesting is the targets. The targets state they have to offer sustainable solutions by the end of Q2. It will be very interesting to see by the end of Q2 when those statistics come out now that the banks are under pressure on the targets and the sustainability if they have put more split mortgages into the mix.

Deputy Paschal Donohoe

Up to the end of December there were 52 across the entire country. What does that tell us about the progress we are making in dealing with this crisis?

Mr. Matthew Elderfield

Well, a couple of things. Split mortgages were put on the table by the Keane report of about October the year before. We required the banks to pilot split mortgages last autumn. If one wants to be generous, that is why it is a bit late. The problem really is, as I say, it has been predominantly short-term interest only, which is not satisfactory. Hence the reasons for the targets, which is to say not only must one go faster, it has got to be on sustainable terms and short-term interest only is not good enough.

Deputy Paschal Donohoe

What does Mr. Elderfield expect that figure to be for the end of the first quarter?

Mr. Matthew Elderfield

I honestly do not know where it is going to be. I would say it probably will not be much improved by the end of Q1. By the end of Q2 - because that is when the targets will be biting - I think the number will be increased, but we are going to have to wait and see.

Deputy Paschal Donohoe

Coming from a base of 52, what kind of increase can we expect? Are we talking about hundreds or thousands?

Mr. Matthew Elderfield

My guess is - I know one bank advised me it had done, if I remember, a couple of thousand offers in this area. So I would hope we will have significantly more.

Deputy Paschal Donohoe

Why has there been such reluctance to deploy that? Taking on board Mr. Elderfield's generous interpretation as to why there might be so few, if one forgot we were talking about mortgages and laid aside for a moment the financial difficulty our banks are trying to escape, the principle of split mortgages is a very obvious principle when considering difficulty with stressed debt or the management of debt among people finding it difficult to pay. The idea of paying some now and leaving another amount to be dealt with in the future makes sense. With the obviousness of such a solution in mind, what does the fact that only 52 are in place tell us about the state of our banking system in terms of the operational capacity within it and in terms of the potential capital foundations of the system?

Mr. Matthew Elderfield

I think a few things. I think the operational capacity to deal with the mortgage arrears has been frustratingly slow as I have mentioned.

There was great investment in lending and marketing but not in sorting out the problem. This had a number of dimensions on the collection side, with regard to the disciplines, resources and skills and also in inventiveness. It has been said that split mortgages are obvious. We think they are sensible but it is not a widely used practice in other jurisdictions, such as the UK or the US which has had many problems. The repossession numbers tend to be a lot higher in these jurisdictions instead. We are trying to craft for Ireland a situation whereby having this device means we do not have to have the same levels of repossessions one would naturally get. The scale of the challenge in Ireland has been much more than that in the UK and US. As a result, there is a need to be more innovative. This is partly a reflection on the banks' weak operations, a lack of innovative thinking and a desire to hope things will get better, and partly it is a reflection on the scale of the challenge in Ireland and the need to go into new areas and develop new approaches which have not been used elsewhere.

Deputy Paschal Donohoe

To go to another area touched on earlier with regard to implementation of the fitness and probity standards, will Mr. Elderfield read out for us again the statistics he gave to Deputy Ross on how many applications were made and the response of his office?

Mr. Matthew Elderfield

In 2012, 2,234 were approved, which was 72%, 331 were returned as incomplete, which was 11%, and 93 were withdrawn by the applicant, which was 3%.

Deputy Paschal Donohoe

So 2,234 were approved, 331 were returned as incomplete and 93 were withdrawn by the applicant.

Mr. Matthew Elderfield

Exactly. We receive many applications each year for the funds we authorise. There tend to be many directors and retail intermediaries such as mortgage brokers as well as insurance firms, investment firms and credit institutions.

Deputy Paschal Donohoe

A question frequently put to me in my constituency is why more people have not gone to jail over this. Why have more people not been visibly held to account? If Mr. Elderfield were standing in my shoes, what answer would he give?

Mr. Matthew Elderfield

It is a very good question. I have a lot of sympathy with this concern and it is an area which the enforcement system, if I can call it that, comprising ourselves, the Garda and the Office of the Director of Corporate Enforcement, has not done so well. Perhaps the political and legal systems need to take stock. It is probably a narrow slice of this. This is our gatekeeping role and how many people do not get through? Perhaps it is 3%. If I remember correctly, the UK has a higher return rate, but it is pretty consistent with other countries in Europe. There is a weakness in the approach to white collar crime and accountability for individuals. Part of it is with regard to the capability and role of the enforcement agencies. Are we resourced and staffed up to pursue this? Part of it is the legal framework. I can do a stab in the dark analysis or diagnosis and I may not have it right. It makes sense for someone to step back, look at it very systematically, put the pieces together and make improvements. We have done enforcement well against firms but the system has not done enforcement well against individuals.

Deputy Paschal Donohoe

Another point is with regard to the people needed to do this work. Mr. Elderfield referred twice today in our session to the ability to keep people-----

Mr. Matthew Elderfield

Yes.

Deputy Paschal Donohoe

-----in the context of inducements and wages offered elsewhere. I noticed over the weekend that another State body, NAMA, is looking at offering reward schemes to its employees because of the salaries the staff are offered by private companies. Do we pay enough to the people we need to keep them in these roles?

Mr. Matthew Elderfield

I have worked for three regulators and we have always had this struggle for retention. When a regulator states he or she wants to examine an issue or it is a hot topic, then a job market is created for it and all the staff working on it become very attractive and poachable. We have done relatively well. We have had some difficult areas of turnover. I would say in future it could well be a difficulty. When the market starts to get hot, we will have pressure and there will be a need to have more flexible ways of thinking about retention of staff in future.

Deputy Paschal Donohoe

Such as?

Mr. Matthew Elderfield

We have a single payscale for everybody in the public service. I am more used to job families whereby someone with technical actuarial skills is on a different payscale from an enforcement lawyer or a policy person and there is more benchmarking for this. It is a case of looking at the pay framework and how it is organised. There is best practice that can be examined in due course.

Deputy Paschal Donohoe

Deputy Ross asked about whistleblowing and Mr. Elderfield mentioned in his answer that there were 42 whistleblowers last year. Were they from throughout the entire banking system? Were they from within his organisation?

Mr. Matthew Elderfield

That is the number from all the financial services sector. We closed 42 cases during the course of last year. It is a very useful and valuable source of information. I get letters and sometimes they are sent to the public complaints unit. Sometimes we receive calls. We collate them and send them to the relevant supervisory area. Approximately half tend to not go anywhere and half lead to action. Sometimes we have a supervisory response when we say systems and controls must be tightened up, or we make a direction to stop doing something. I recall one case where we said that, because the whistleblower was known to the firm, it needed to engage with the whistleblower and have a proper dialogue with the individual. We have had revocations of authorisation, supervisory warnings, enforcement and further monitoring. It is a useful tool. My guess is we will probably receive more under the new legislative framework the Oireachtas will pass because of the protected disclosures approach. I chair a meeting of our supervisory risk committee every quarter to track where we are on whistleblowing cases and ensure both that they are being progressed and that I am comfortable that the actions being taken are appropriate. We have tightened up the process but with the new legislation, we have the prospect to do more.

Deputy Paschal Donohoe

I want this on the record because we had a discussion about whistleblowing in the Central Bank.

Mr. Matthew Elderfield

No, it is outside financial services.

Deputy Paschal Donohoe

It was across the entirety of the banking system.

Mr. Matthew Elderfield

The entire financial services sector.

Deputy Paschal Donohoe

I thank Mr. Elderfield.

Deputy John Deasy

Mr. Elderfield has been hanging around for a long time so I will be quick. Deputy Donohoe touched on the issue I wanted to raise, which is the lack of prosecutions. Mr. Elderfield mentioned there are some weaknesses in the area of white collar crime.

Mr. Matthew Elderfield

Yes.

Deputy John Deasy

He stated there is still a way to go with regard to what we need to do when it comes to a legal framework and the capabilities we have to prosecute people who potentially broke the law in this area. I deal with many people who have lost everything, and five years on the Financial Regulator has made this statement. People would be surprised that these weaknesses are still inherent in the system.

Can Mr. Elderfield tell me what he means by the weaknesses that remain? How can we strengthen them?

We have talked about a banking inquiry in this building for a couple of years. It is one of the obvious issues that will arise out of any recommendations that we would make following a banking inquiry. Why do weaknesses still exist when it comes to potential prosecutions of people?

Mr. Matthew Elderfield

A lot of progress has been made to improve supervision, the rule book, the powers and taking enforcement actions against firms. Action against individuals is the missing link and we all have put our fingers on that link.

I have got some ideas. I want to be very clear about where the weaknesses are. Like I say, the committee would need somebody to work through it more systematically than I have done. One of the questions is about the role of different enforcement bodies. We have the Garda Bureau of Fraud Investigation, the Office of the Director of Corporate Enforcement and my office. The UK has the Serious Fraud Office and the Americans have the FBI. We must ask ourselves what resourcing levels could we expect and the capabilities in terms of those areas. We have really geared up our enforcement area which now consists of between 50 an 60 people. Has everybody got the right skill-set? That is one set of questions. I know that we have done a lot of work on that, on ourselves, but I do not know about elsewhere. I am not criticising the Garda bureau or the ODCE. The following is an open question that the committee could ask. Do they have the capacity to do the number of cases that the public and the representatives of the public want? That is my first question.

There are some outstanding recommendations. The Director of Corporate Enforcement recommended improving the legislative framework and the ability to pursue cases. For example, he talked about the questioning of suspects and the rules for same. The Department of Justice and Equality has produced a White Paper on white collar crime. Where does the paper stand? What future action will be taken?

As I mentioned, a number of legal offences could be tightened up. If we take administrative sanction against a firm, then we will want to establish that the individuals are culpable as well. We have a test of responsibility for individuals which is quite a tough hurdle to get through. Is that calibrated the right way in order to take an action against an individual as well as against a firm? That needs some thought.

Like I say, in the UK there is a concept of presumptive liability. If one is a director of a bank that has failed, rather than the regulator having to establish that he or she is liable and whether he or she should be disqualified, there should be a presumption of disqualification. That matter should be examined. There are some pros and cons. Will it discourage people going into the system? Will it keep people on their toes? The committee should debate the matter. These are things it should examine.

The Vice Chairman asked if there was a reckless trading in financial services concept. The committee can take action on that.

The committee needs to conduct a very systematic trawl. There are certain constitutional protections for individuals in terms of a right to earn a living. How does that interact with action on fitness and probity? We really need a public debate. Perhaps an inquiry would be a good way. I had not thought about an inquiry as a way into it but instead thought of a wise person, a Green Paper or something like that. We must think about it systematically. There are pros and cons and the committee must do a thorough job. We must be very open about the fact that an inquiry will not help current cases. Is it not the case that all of the current cases are under existing laws?

There has been talk of lessons learned from the crisis and improved regulation. First, I shall consider the lessons learned. Who has done the stock-take in this area? We have had the Honohan report, the Comptroller and Auditor General's report, the Nyberg report, the Regling-Watson report and I am sure that I have not identified many other reports.

Vice Chairman

Is the legislation strong enough to put people in jail regarding current cases?

Mr. Matthew Elderfield

I do not know about the Anglo Irish Bank case and so on. I have not looked into that and it pre-dates me.

Vice Chairman

Surely the regulator has a sense of it. Does he believe that the legislation is strong enough?

Mr. Matthew Elderfield

I know my area of the administrative sanctions rather than criminal law. With regard to the administrative sanctions phase, we have a good prospect of successful actions against the individuals that we are pursuing. I am pretty confident about that. However, it could be recalibrated to make it swifter and more certain. There is a big question around the point made by the Vice Chairman.

Deputy John Deasy

Obviously the regulator has definite opinions about what needs to be done because he has examined the area.

Mr. Matthew Elderfield

I have definite opinions about the areas that need to be examined but I am trying to be cautious. There is a problem here. Somebody needs to go away and work it out very systematically and have it considered. I have identified areas for the committee to examine but I am not definitive about it.

Deputy John Deasy

Fair enough. A regular member of the public, whether they lost everything or not, would ask the following simple question. Why has it not been done yet? I presume that Mr. Elderfield, as regulator, related his opinions to the Garda Síochána or whomever. Has he done so? Is there a sense of frustration?

Mr. Matthew Elderfield

I see the point about the public's reaction to this which is spot on. What one wants is a deterrent effect that has public acceptance but also acts on individuals. A person can say, "All right, they are going to come after my firm but I am going to move on". One needs to have a deterrent effect on individuals in order to have confidence in the system.

There have been improvements in the sanctions powers going through in the supervision and enforcement Bill. A year ago, I raised the matter in a public speech so I have said it once. Today I wanted to say it once before I went. We need a special mechanism such as a wise person who can take a step back and think about the matter. That would be the sensible way to proceed.

Deputy John Deasy

I understand. Mr. John Moran, Secretary General, Department of Finance attends here quite regularly. In the early days of his job he was very overt and clear about where problems lay in the Department and where people did not talk to each other. He put together a simple system to make sure that people talk to each other and there are no gaps when organisations wish to deal with issues.

It is common knowledge that different organisations that were involved in finance in this country were not involved in communication, or at least not an appropriate level of communication. I mean by that whether it is the Central Bank talking to people in the Department of Finance and the regulator's office speaking to somebody in the Central Bank. My question is a general one. Has the regulator dealt with communications at all? It is a common perception that his predecessor was asleep at the wheel. The regulator's office must correct the communication gaps with other financial bodies working within government.

Mr. Matthew Elderfield

The communication gaps were probably even more exacerbated within regulation and the Central Bank. We have gateways to talk to the Department of Finance and we do. Frankly, my immediate priority, and we have made improvement, was how we work within the Central Bank. I shall list a couple of things. I meet all of my directors every morning or most days of the week so we are all in touch with each other. We have an escalation system. For example, a hot supervisory issue can be escalated to our supervisory risk committee where we can track its progress. That committee deals with whistleblowing once a quarter. It means that we have a line of sight and things cannot just crop up and then fade away. There is an audit trail.

We have a probability risk and impact system, PRISM, that allows us to systematically examine issues. We take our universe of firms, divide them up and decide which will get a very thorough risk assessment. Where that is the case, then the firm has its assessment on site. Then we have a risk governance panel and a challenge process. Before we communicate with the firm we bring people together, whether it is a bank or our financial stability colleague from the Central Bank who will also be present and we join up with the economists who can see the bigger picture.

In doing our risk assessment, we say to the supervisors that rather than considering what is at the front of their minds, they must systematically think about these ten risk categories - the market risk of their bond portfolio, the credit risk, the insurance risk, the operational risk management, anti-money laundering considerations and the rest of it. They have to score those formally and explain the scores to the risk governance panel, tell us the areas in which they have identified a problem, and in these areas, require the firm to do something about it. In Mr. Honohan's report, he had an issue with cases in which things were spotted but they rolled forward in a kind of perpetual analysis and perpetual dialogue with the firm. We say, in our assertive approach, that there should be a period of dialogue with the firm but that one should call it quits after a while so that it does not get into a filibuster. Having these new process, I think, reduces the risk of an issue coming up and getting lost in the woodwork as it gets caught in the system or is periodically looked at. That is a good legacy for the future.

Vice Chairman

On the question of white collar crime, we are doing work on bank stabilisation and we will incorporate that into our work. We will send a copy of today's transcript to the Department of Finance. Has Mr. Elderfield written to or communicated to the Department of Finance his views on the issue of white collar crime?

Mr. Matthew Elderfield

I think I have been very public about white collar crime. We had some discussions with the Department at the time of the Central Bank (Supervision and Enforcement) Bill 2011 but I am not sure if this is for that Department, the Department of Justice and Equality or the Oireachtas. It is a matter for public debate. I do not think it is something to be put into a letter to John and John will deal with it. There needs to be a debate among members, as they know the system better than I do. Is it an issue for the Law Reform Commission, an investigation by an Oireachtas committee, or a wise person's report?

Vice Chairman

Will this be incorporated into the annual report of the Central Bank? Mr. Elderfield obviously feels strongly about it. Since 2008, the financial crisis has cost the citizens of Ireland some €64 billion. Much of that money will be totally written off. I have no doubt that in society there are people who through the misfortune of losing a job have suffered the rigors of the law. That strikes me as extremely unfair. Is there a need for a combined effort? May I ask Mr. Elderfield to consider raising this in the annual report of the Central Bank? Is there a blueprint for dealing with this issue in other jurisdictions such as the United Kingdom or the USA? Often, it is not about reinventing the wheel but about looking at what has worked in other jurisdictions.

Mr. Matthew Elderfield

That is a very good question. Mr. Patrick Honohan does the annual report of the Central Bank and he feels quite strongly about this, as do my commission members. In fact, they have only just talked about this.

Vice Chairman

I strongly suggest that this be done.

Mr. Matthew Elderfield

We can make a reference to this as an issue to be looked at. If one had a wise person in each group or had one of the Departments do a Green Paper, one would want to look at best practice elsewhere. I do not think there is an off-the-shelf model; one could consider what the FBI does in some areas and what the UK Serious Fraud Office does in other areas. It has to be built in the Irish context. The Irish Constitution is different from other constitutions. The political culture is different and all such aspects have to be looked at. I think one would want to examine best practice elsewhere.

Vice Chairman

I am only speaking for myself, but would Mr. Elderfield share my concern for the ordinary person, who has experienced very difficult years? To the amazement of everybody, not a single person has been brought to account fully for the banking failures, which have effectively saddled them with debt to the tune of €64 billion?

Deputy John Deasy

There is a public perception that the reason is that the Director of Public Prosecutions needs time to prepare a case. These things take time. One needs to be deliberate and correct before lodging a case. What Mr. Elderfield is saying is that the systems have not been put in place to determine how the law can be changed to facilitate those prosecutions, when it comes to the bodies that actually look into these matters.

Vice Chairman

The Deputy has elaborated on my point.

Deputy John Deasy

I am agreeing with the Vice Chairman.

Vice Chairman

Effectively, it would appear the legal and administrative tools are not in place to ensure that people are legally held to account. From Mr. Elderfield's review of the system, that is obviously the view he has formed. Is that correct?

Mr. Matthew Elderfield

I think the cases the Director of Public Prosecutions is running with are based on the law that existed at the time of the offences. I have absolute sympathy with the DPP in that you must measure twice, three times or four times before you cut, and then you go on this and build the strongest case possible. I have a huge amount of sympathy for the difficult job they will have in making progress on these cases. I want to be absolutely clear that this is not a criticism of the DPP; it is a call for a stock take, a step back and a look at the issue in the round to see if we can do this better. I think we can do it better.

Vice Chairman

With a better toolkit.

I thank Mr. Elderfield for his patience. I wish him well in his new position in Lloyds in the United Kingdom and send greetings to his good lady wife. There is no doubt that Mr. Elderfield will be missed, but I hope he will come and visit Ireland.

Does the committee agree to dispose of Special Report No. 72 - Financial Regulator, responding to the financial market crisis? Agreed.

The witness withdrew.

The committee adjourned at 4.05 p.m. until 10 a.m. on Thursday, 20 June 2013.