I thank the Chairman and members for their invitation to address them as a representative of the board of the Financial Regulator. I am joined by my colleagues, Ms Mary O'Dea, Mr. Con Horan and Ms Mary Burke.
I address the joint committee in extraordinary times. We are witnessing the greatest crisis in the international financial system in living memory. It has affected not only every financial institution but every economy, business and household throughout the world. It demands and is receiving a response on an international scale, as well as on a domestic level. None of us should deny the scale of the crisis and the regulatory challenge it presents.
I propose to set out how we have responded to the international crisis and how we have been working together with our colleagues in the Central Bank and the Department of Finance. I will outline how we have been responding to the changing economic environment here at home and what this means for our banks and our supervision of them. I will detail some of the new measures that we are putting in place to ensure our financial institutions are in a position to assist their customers, the businesses and households that depend on them for their finance, and to deal with the dual problems of the international crisis and the domestic economic downturn.
The action by the Government to introduce a State guarantee was taken to deal with the enormous crisis that the world is facing in respect of funding and liquidity. Liquidity means the cash available for banks to meet their day-to-day operations, including loans and payments. The turmoil in global financial markets can be traced back to early 2007. In August of last year, central banks around the world began to inject significant additional liquidity into the system. This was done to help alleviate the problems that were emerging in capital markets due to losses on securities linked to US subprime mortgages. Since that time, due to problems in the subprime market and the ensuing global liquidity shortage, there have been a number of serious problems in banks such as Northern Rock, Bear Stearns, Fannie Mae, Freddie Mac and so on.
Over this period of about 15 months, the interbank and wholesale funding market deteriorated. As the international situation got worse in the latter half of 2007, we increased our surveillance of the liquidity position of Irish banks. This initiative built on arrangements we already had put in place earlier that year, in advance of the turmoil, to strengthen the regulatory structure. This ensured that Irish banks already had in place strong liquidity reserves. Other actions we took included an increase in the frequency of liquidity reporting, from quarterly to weekly and, more recently, to daily. Along with the Central Bank we ensured that each of our banks had sufficient arrangements made to access ECB funding. With the Central Bank, we also intensified our engagement with the chief executives of every bank. The focus of these engagements was to ensure proper contingency arrangements were being put in place in these very challenging global market conditions.
While the situation remained manageable, everything changed in mid-September with the collapse of Lehman Brothers. The markets, which previously had only been working at a fraction of their capacity, froze. This meant that no interbank or international wholesale term funding was available for either Irish or international banks. Put simply, without this type of liquidity, banks cannot function without government action.
No regulatory authority, including the Financial Regulator, central bank or any other part of the international financial system anticipated the scale of the meltdown in international markets or the dismantling of the interbank credit markets that arose from the collapse of Lehman Brothers. One thing, however, was clear, namely, the ability of all banks, including Irish banks, to raise other than very short-term funding in the market essentially was eliminated. The fear in the market caused large corporate deposits to move out of the banking system and seek the safety of sovereign instruments.
In the run up to the Government decision, we were engaged in an intensive dialogue with the Central Bank and the Department of Finance. A dialogue on these systemic issues had begun in 2007 with the establishment of the domestic standing group. All relevant options were considered by the board of the regulatory authority and the advice to the Government was to proceed with the guarantee proposal. The action by the Government was taken in order that Irish banks had access to sufficient liquidity. Capital of itself would not have dealt with this situation. The problem was liquidity. The guarantee was the best way of ensuring that international funds flowed back into the Irish banks.
We believe this was the correct thing to do in the interest of avoiding serious economic disruption in the State. While the measure has proven successful in that it has stabilised the funding situation, market conditions remain extremely difficult. We continue to be on high alert. This is particularly important as we see very clearly how each international event sends ripples across the world. Our Government acted quickly and decisively. Other European governments have since followed suit with their own approaches, many very similar to that in Ireland. In Washington at the weekend, the IMF stated that government guarantees of financial liabilities were unavoidable at this stage to allow activity restart in the markets. Overnight we have seen the US Government initiative to give a blanket guarantee for all deposits and to invest regulatory capital in a number of its leading banks.
A question that has arisen is whether the loan exposures of Irish banks that are ultimately secured on property has contributed to the liquidity problems the banks faced before the Government guarantee was put in place. The global systemic failure in capital markets leading to the closedown of international interbank markets clearly is the main contributor to the lack of available funding. However, although Irish banks do not have exposures to the subprime losses and have had limited contact with so-called toxic products, the decline in share prices of the quoted Irish banks is being attributed by market commentators to the decline in the economic position here and the consequent prospects for both commercial and construction-related lending ultimately secured on property.
The Financial Regulator had been alert to this concern for some time and has already taken significant action. In 2006 and 2007, in response to the emerging issues in the property market, we took a number of measures aimed directly at speculative commercial real estate loans and high loan-to-value ratio mortgages, especially 100% mortgages. We required banks to set aside much more capital with regard to these types of loan. We also disapplied a number of options for lower capital weighting which were available under the capital requirements directive. Our capital regime is thus one of the more stringent in Europe.
The extent to which profits will be adequate to sustain capital levels in Irish banks depends on the level of the provisions arising from those property-related exposures and also on dividend policies. There will be losses on property-related loans and increased provisions and write-offs will be necessary. The potential difficulties in this regard are linked to how the economy unfolds.
What we can say is that all Irish banks are currently above their regulatory capital requirements, with average regulatory capital ratios of almost 11%, compared with a European required minimum of 8%. In practice, what does this mean? This means the six Irish banks covered by the scheme have a total regulatory capital base of €42 billion. This figure takes account of provisions of €2.1 billion against impaired loans totalling €3.6 billion.
Speculative lending to construction and property development in Ireland amounts to €39.1 billion, of which €24 billion is supported by additional collateral or alternative sources of cashflow and realisable security. This leaves a balance of €15 billion secured directly on the underlying property. There will undoubtedly be some losses on these exposures. However, any such losses would occur over a number of years and would be offset by profits on performing loans over the same period.
In other countries we have seen individual banks being given substantial capital injections by governments, and in the UK we have seen the whole sector being offered public money to bolster their balance sheets. I have already mentioned what happened overnight in the US.
We must be mindful that the rules of the game are changing internationally. Some countries are guaranteeing all bank deposits and interbank lending, while some are putting equity into banks. Market expectations could push other banks to seek equity injections, irrespective of whether they continue to meet their regulatory requirements.
The point is that the state is now intervening in the banking sector across the world. As the committee knows, at the weekend the governments of the euro area committed to make capital available to financial institutions in appropriate volume while favouring the raising of private capital. Markets need the stability that state intervention can bring but it is not possible to say at this point where that state intervention will take us, what impact it will have on the interbank market or whether further action, for example with regard to capital, might be necessary to ensure the liquidity of Irish banks. I assure the committee we are all highly focused on this.
Whereas we have been heavily involved in devising the Government scheme, we must await the approval of the scheme by Government and its presentation to the Oireachtas before I can go into specific detail on its elements. In addition to what is contained in the scheme, the regulatory authority is instigating a series of new regulatory measures to take account of the changed environment — one that has now brought the taxpayer into the frame. We will be increasing our focus on the management of credit and liquidity risks of the banks.
Among the actions we are taking are the following: we will immediately recruit an additional 20 senior supervisory staff with banking experience to be placed on-site in key banks to monitor developments; we are now requiring banks to set out new business plans focusing on the need to reduce their risk profile and how their models of banking are sustainable in the new environment; and there will be enhanced reporting obligations regarding capital, asset quality and individual large loans to supplement our daily liquidity reporting requirements. In addition, there will be a number of other measures announced by the Minister as part of the guarantee scheme.
Like all banking regulators, our job is one of ensuring that banks are solvent in order to protect depositors and savers. This remains our job. I believe it is important to state that all banks are solvent and that all savings and deposits are fully safe and secure. Since the guarantee scheme was put in place we have a new responsibility to protect the taxpayers' interest in our main financial institutions. The Government's scheme, which will underpin the guarantee, will give us a key role in safeguarding these interests. As always I can assure the committee, on behalf of the regulatory authority, that we will continue to fully play our part in the public interest.
