I thank the Chairman and members of the joint committee for inviting us to meet them. As the Chairman said, I am accompanied by Mr. Dermot Quigley, a member of the authority, Ms Mary O'Dea, acting chief executive, and Mr. Con Horan, head of prudential regulation.
The Financial Regulator's key responsibilities are prudential regulation in financial institutions in Ireland and consumer protection. Today, I would like to cover three main areas with the joint committee. First, the system of financial regulation that is in place in Ireland and how the Financial Regulator carries out its prudential regulation role within the system. The second is the examination which is now under way in the Financial Regulator to determine the changes required to the system of regulation in the light of events over the past 18 months and, third, the new regulatory measures we have put in place in regard to the banks covered by the Government guarantee.
The Financial Regulator's responsibilities include the prudential regulation of the individual financial institutions and consumer protection. Some 13,000 entities varying from investment intermediaries and funds to banks are regulated by the Financial Regulator. Developments in international financial markets over the past 18 months, and particularly in recent months, have rightly focused attention on systems of regulation employed, both here and in other jurisdictions, and on the issues of global co-operation between regulators.
When the Financial Regulator was established in 2003, all the key stakeholders in the economy were consulted to determine the most appropriate system of supervision. A principles-led supervision system was agreed with the key stakeholders and was set out in our strategic plans each year. This approach was aimed at protecting consumers while facilitating competition and innovation among financial services providers required in a growing economy.
This system was aligned with the principles outlined in the Government's better regulation approach and was considered a cost-effective approach to regulation. It was well regarded internationally. Indeed, a number of reports from bodies such as the IMF and the OECD recognised this explicitly.
Under our principles-led supervision system, responsibility for the proper management and control of a financial services provider and the integrity of its systems rests with the board of directors and senior management. Prudent risk management, ethical behaviour and transparency in business dealings are key values expected of boards and senior management in regulated firms.
I stress that the principles-led supervision system that was applied to the 48 banks we regulate is not a rules-free environment where regulated firms can do as they wish. In addition to the principles set out by the Financial Regulator, there is a vast number of rules that apply to the banking industry. These range from rules and requirements put in place by the Financial Regulator, including capital requirements and weekly liquidity reporting, and the consumer protection code, to rules applied under EU directives and the rules that apply under the law of the land. For example, under Basel II, the EU capital requirements directive, there are hundreds of detailed rules with which banks must comply.
In operating the principles-led supervision system, the Financial Regulator has relied on appropriate management and controls in firms, ethical behaviour and true and fair reporting by firms and their auditors, as well as on-site inspections by supervision actions by the regulator. It is clear that in the case of Anglo Irish Bank this did not happen. The authority takes an extremely serious view of the issues around directors' loans that have emerged at Anglo Irish Bank. We are currently carrying out a comprehensive investigation into these matters. We have been in contact with the Office of the Director of Corporate Enforcement and, therefore, it is not possible to get into any specific detail on it with the committee today. However, I can assure the committee that the authority is committed to fully investigating all aspects of this and completing such investigations without delay, and taking whatever actions are appropriate.
We are also engaged in a parallel investigation into all other covered institutions regarding directors' loans and we expect to complete our work in this area within a matter of weeks. We are committed to putting in place measures to try to ensure that nothing of this sort can happen again, including, if necessary, requesting Government to introduce new legislation in this area. Furthermore, we will engage with the auditing profession on any changes that may be required.
Apart from controls over directors' loans, it is clear that key areas such as risk management, compliance and general control processes in banks need to be re-examined in light of recent market turmoil. Liquidity management and risk concentration are also areas that need particular attention.
In carrying out its functions, the regulator is informed by the assessments of both international and domestic economic developments. It is instructive to read the forecasts made over the past 12 to 24 months. While they varied in their assessments, it is fair to say that almost without exception the severity and rapidity of the downturn, both in Ireland and internationally, far exceeded their forecasts.
Against the background of these positive assessments, we nevertheless took strong action on lending. Our steps included the following. In 2004, consumers were warned about the risk of debt, including warnings about re-financing personal debts into mortgages. In October 2005, new requirements for credit loss provisioning, including requirements for credit risk management, were introduced. In May 2006, increased capital requirements on high loan-to-value mortgages were introduced. In August 2006, we tackled aggressive lending by introducing consumer protections on affordability and suitability, and banned unsolicited credit offers. In June 2006, we introduced new liquidity requirements which came into effect in mid-2007. In January 2007, a stringent approach to property-related requirements under the capital requirements directive was introduced, with 150% risk weighting from the previously 100% weighting on exposures to speculative real estate and high capital requirements on residential investment properties. These measures recognised concerns that were being expressed at that time about problems in the property market.
Such measures were not taken elsewhere in countries with similar growth in property prices. Indeed, it was argued that the fact that we only had the power to impose the requirements on our domestic banks put them at a competitive disadvantage to other foreign banks operating here.
In the changed environment in which we operate, there is now much debate here and abroad about how banking regulation should be structured for the future. This is a complex debate and will embrace issues such as principles versus rules, market transparency, accounting changes and the extent of co-operation between regulators in different jurisdictions.
The current debate seems to be focused on changing the current principles-based supervision system to a more intensive rules-based system. This would involve detailed prescriptive rules to cover virtually every aspect of the business of banking and would require a significant increases in resources to implement, with associated costs. However, as we know from the Enron experience in the US, a rules-based system would not necessarily guarantee the required regulatory outcomes. Indeed, no system of regulation will guarantee a problem-free environment.
Any system of regulation will be greatly challenged by unethical or dishonest behaviour, collusion to conceal information or the impact of global events outside the control of the local regulator. Notwithstanding this, the need to revisit and improve the regulatory system is clear against the background of both the international crisis, the severity of which no banking regulator, central bank or Government anywhere was able to foresee, and the domestic economic downturn and its implications for our financial system.
The authority is now examining this as a matter of urgency, including an assessment of the effectiveness of our regulatory approach in the context of EU and international developments, whether a differentiated approach is needed for different financial sectors or institutions, our risk appetite, including an evaluation of our risk-rating system, and our inspection framework.
It is clear that a more intensive form of regulation is now required. We have already begun to put this in place in the banks covered by the Government guarantee scheme. The new regulatory measures for the covered institutions are as follows. A number of actions have been taken by the authority since September last to deal with the evolving international financial market crisis and its impact on our own system and institutions. For our part, under the legislation introducing the Government guarantee scheme, the Financial Regulator has a number of specific new responsibilities which we must carry out in consultation with the Minister for Finance. These are to impose conditions regulating the commercial conduct of a covered institution's business, having regard to capital ratios, market share and balance sheet growth in order to minimise any potential competitive distortion that may otherwise arise and to avoid any abuse of the guarantee.
To meet these responsibilities, we established a new supervisory unit, the role of which is to define, impose and monitor conditions and targets under the Government guarantee scheme. Our involvement with the institutions covered by the scheme is intensive, including an on-site presence and increased interaction with their boards. We are closely monitoring corporate governance, credit, liquidity management, audit and risk.
We have requested and received detailed business plans from the institutions. These plans focus on the need to reduce the risk profile of the institutions and to outline how their business models are sustainable. We have examined these plans and commenced a series of engagements with the institutions at the most senior level in order to determine the soundness of their plans. The key areas we are addressing are: the performance of existing loans; ensuring that the institutions are making progress in achieving the targets set in their business plans; ensuring that the institutions have in place robust processes in respect of credit risk management; actively monitoring compliance with liquidity requirements; and assessing the ability of the institutions to fund their business without undue reliance on ECB operations.
We are also reviewing the governance structures of the institutions to ensure that there are proper systems of internal control. As part of this process we are working with the banks on clarifying for the Minister for Finance their plans to grow lending to small and medium-sized enterprises. We will be reporting to the Minister shortly on the levels of lending that the banks are applying in respect of this sector.
The chief executive and chairman of each institution must report on a quarterly basis to the Financial Regulator — acting on behalf of the Minister for Finance — regarding overall compliance with the guarantee scheme. These are significant measures and they are necessary as a result of the changed environment in which we are operating. It is a priority for us to ensure that the institutions covered by the scheme are subject to the highest form of scrutiny.
I wish to assure the committee that the Financial Regulator has already made changes to the way in which it goes about its business. We will continue to work closely with our colleagues in the Central Bank and Financial Services Authority of Ireland at board and executive level. This system, which includes common directors and high level working committees, provides a basis from which to move forward and ensure that the financial system operates to the highest standard. I will be glad to answer any questions members may wish to pose.
