I wish to highlight a number of key elements that currently dominate regulatory policy development and new regulatory activity. In terms of magnitude, first on the agenda is the resolution of the banking crisis. The weakened financial position of the banks and the extensive Government guarantee provided to their depositors and other claimants clearly call for exceptional measures. There has been greatly intensified and what has been termed "intrusive" supervision of the operations of the main banks covered by the guarantee. This involves on-site presence on a daily basis by several regulatory staff in each of the institutions. They have been sitting in as observers on the banks' key decision making committees as well as conducting specific investigations and reviews.
The Government's crisis resolution strategy involves cleaning out a large block of troubled property-related loans from the banks' balance sheets and replacing them with NAMA bonds guaranteed by the Government. This will ease the banks' ability to mobilise funds for their ongoing operations. At the same time, since these loans are to be purchased by NAMA at "long-term economic values" not far above current market prices, the purchases will serve to crystallise losses on the banks' books in amounts likely to be in excess of the provisions already taken. This is likely to give rise to a need for measures to increase the banks' cushion of capital, which is necessary to absorb any future losses. To the extent that requisite capital cannot be sourced by the banks, the Government has indicated that it will be prepared to make the necessary investments. Quantifying the needs and the possibilities is an important task in which the regulatory staff are centrally involved.
Ensuring the safe and sound operation of financial firms, both those dealing with the domestic market and those primarily concerned with the export of financial services through what used to be called the IFSC, is an ongoing task. I stress that some of this safety and soundness work is routine in character, requiring precision, predictability and efficiency, for example, the authorisation of investment fund prospectuses. Many thousands of such funds are given a standardised vetting by our staff before they can be listed. In this way some degree of protection is provided to their investors.
Other parts of the safety and soundness work are more qualitative and judgmental. Regulation attempts to limit reckless or self-dealing behaviour by financial firms ex ante by vetting the persons in charge for their fitness and propriety and checking on compliance with clear rules of behaviour and ex post by means of penalties if it is discovered that violations have been committed. We are on the lookout for ways of improving both dimensions.
Beginning with our ex ante approach, thousands of financial firms are regulated entities. Experience worldwide shows how difficult it is for regulators to detect all fraudulent behaviour on the part of financial firm management. Often, important breakthroughs are made thanks to the revelations of whistleblowers. For example, Transparency International in a recent report highlighted this issue for our financial system. We are seeking the introduction of a statutory regime to encourage whistleblowers and to provide a specific process for them.
Regarding our ex post approach, enforcement of clear rules is crucial and I am determined that there will not be any reluctance on the part of the regulatory staff to pursue violations. There will be full co-operation with any criminal prosecutions. Where these do not arise, we will impose the appropriate administrative sanctions. For this reason, following discussions with Matthew Elderfield, the new head of financial supervision who will be starting in a few weeks, we have decided to make a senior appointment to take charge of enforcement. As members know, there have been high-profile allegations of wrongdoing in the context of the banking crisis. I do not want to talk about them in any detail, nor can I beyond saying that detailed investigations are in progress and the regulatory staff have contributed vigorously to it.
More generally, there will be an increase in staffing and the introduction of new internal structures in what is rapidly becoming a unitary central banking organisation without artificial and unnecessary internal barriers. With Matthew Elderfield, who brings his own considerable experience and skills to upgrading and restructuring regulation, we have been planning details of the new structures and approaches that will be adopted. As far as structures are concerned, in addition to the enforcement role, we have just announced the creation of new senior level positions with responsibility for markets supervision and policy and risk. This will restructure the way in which the work is organised so that it can be more effective.
Supervision will be calibrated to the risks posed by the different firms in the sector and will involve applying the existing rule book, strengthened as necessary to plug the holes revealed by the crisis. In particular, we will not be slow in implementing new stronger rules, being developed as we speak by international bodies such as the Basel Committee on Banking Supervision, BCBS.
Despite the extensive powers already available to the regulatory authorities, it would be useful and appropriate to have clarity on a number of additional points, which are being discussed with the Department of Finance with a view to their inclusion in the proposed legislation to restructure the Central Bank. One area relates to the requirement of confidentiality. As currently interpreted, this seems to go well beyond what is necessary or appropriate for the purpose of ensuring privacy of customers and commercial interests. Since European legislation also raises issues, it is complicated overall. As matters stand, the regulatory staff can appear passive and defensive when called to speak on specific issues in public.
A final aspect of safety and soundness to which I would like to refer is the admission of large and complex export-oriented financial firms into the market. I welcome the participation of foreign owned firms, those aiming to supply the domestic market and those that are export-oriented, as they provide competition and business opportunities, but the crisis has revealed the reputational risks to Ireland of having a failure in such an entity. This means that we must redouble our efforts to ensure that only sound institutions are allowed to enter and that they are comprehensively supervised to ensure that they continue to be sound. I will certainly not allow Ireland to become a soft option for firms or activities that are no longer welcome elsewhere. This means more supervisory staff with the necessary skill levels, who can be paid for by a levy on the supervised firms. We should move towards a 100% charge-back basis from the current 50% basis. Specific steps must be taken to ensure that there is no expectation that the State will take exceptional steps to rescue such entities in cases of need.
Consumer protection cannot and will not be ignored in the regulatory structure. Failures in this regard are not as spectacular as a solvency crisis, but can be as damaging to the affected consumers. There will be no downgrading of this aspect of the regulatory work. The statutory codes of conduct for mortgage and small to medium-sized enterprise, SME, lending are already making some impact on what are difficult current issues. The Law Reform Commission, LRC, also made valuable recommendations, but more will be required.
In this area, a central concern is that of achieving an improvement in the flow of credit to SMEs. To an extent, this would generally not be considered part of the remit of the financial regulator, conflicting as it can so easily with the requirement of safety and soundness, but wearing my wider hat as Governor, it is right that I should be alert to possible policy changes that might help. The financial restructuring of the banks will help set them on a course that not only gives them financial resources, but also the incentive to focus on new business. However, experience elsewhere shows how slow recovering banks are to get lending going smoothly again. We know that credit is not growing and that interest rate spreads have widened. At least some of this reflects the poor creditworthiness in present market conditions of many loan applicants.
The difficulty in improving the situation is that second-guessing banks on their credit appraisal decisions and their pricing of credit risk, which decides interest rates, is fraught with threats to the Exchequer, which will largely absorb any additional credit losses incurred by the banks. This is a challenge for which I have found no ideal solution. The banks could improve their loan appraisal technology. Many advances in this area in other countries have not been fully exploited by our banks, given their concentration in recent times on property-related lending. Perhaps the credit review system announced in the budget, with its comply or explain mechanism, if well implemented, could be the catalyst for such improvements. Banks might up their game in making loan appraisals if this is what is required to escape from the credit review system.
The failures of our banking system have rocked the economy and the public finances, with severe effects impacting almost all members of society. As the acute phase of crisis management and resolution draws to a close, it is time to start thinking how we might learn the lessons about our society that an understanding of the crisis can give us. Now that we have the prospect of the banks emerging in the coming months with a strong financial underpinning and renewed management, an imminent recurrence does not seem to be on the cards. We understand some of what occurred, but some of it is still difficult to understand. At the Central Bank we have taken important lessons on board and are making significant improvements in the way financial regulation and financial stability work is conducted. I expect that the Oireachtas will, in time, decide to authorise some form of inquiry to try to understand the deeper underlying causes of this crisis so that wider lessons can be learned for the future. In considering how best to do this, I suggest that new models of inquiry be explored. The crisis is not simply a question of discovering who did what and who knew what. Uncovering the deep roots of the crisis will require expertise and broad social scientific understanding more than merely forensic skills.
