The purpose of the meeting is to discuss the report of the high level group on financial supervision in the European Union, commonly referred to as the de Larosière report. In addition to the report, the following documents have been circulated for today's meeting: a consultation paper circulated by the Department of Finance to relevant stakeholders, a copy of the Department of Finance's submission to the European Commission and a copy of the European Commission's communication Driving European Recovery. I welcome the officials from the Department of Finance, Mr. William Beausang, assistant secretary, Mr. Colm Breslin, principal officer, and Mr. John Moore, assistant principal officer. Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the Houses or an official by name or in such a way as to make him or her identifiable. I draw attention to the fact that members of the committee have absolute privilege but the same privilege does not apply to witnesses appearing before the committee. I call on Mr. Beausang to make his opening presentation which will be followed by questions from the committee.
Financial Supervision in the EU: Discussion with Department of Finance.
Mr. William Beausang
I thank the joint committee for giving us the opportunity to appear before it today to discuss the report of the high level group on financial supervision in the European Union, more generally known as the de Larosière report, which was published on 25 February. In summary, the report contains a detailed analysis of the causes of the international financial crisis, identifies weaknesses in national and international systems of financial regulation, including in the European Union, and makes very significant recommendations, particularly in respect of the future shape and direction of financial regulation and supervision in the Union.
As the committee will be aware, there is a detailed and comprehensive legal framework in place at EU level to underpin the operation of the single market in financial services. In overall terms and despite the impact of the financial turmoil, a relatively high degree of financial integration is being maintained in wholesale financial markets. However, greater consistency in the EU legal framework for financial services and enhanced co-operation and co-ordination of financial supervision are believed to be imperative in maintaining wholesale integration and supporting the future development of an integrated EU retail financial services sector with the benefits that will bring for consumers.
The committee may be aware that the Department of Finance made a presentation on the high level group's report to the Joint Committee on European Affairs on 31 March. I understand that committee has since provided its views on the report to Commissioner McCreevy. I also note that the Department has since responded to the European Commission's public consultation on the report. A copy of this submission has been provided for the committee. The Department has also requested the views of key stakeholders on the conclusions and recommendations of the report. A copy of the consultation paper circulated was also provided for the committee. The views received from stakeholders have been reflected in the Department's submission to the Commission. We will continue to consult throughout the process, as the Commission presents its own proposals to ECOFIN and as these proposals take shape into formal legislative proposals.
The de Larosière report contains a wide range of recommendations, many of which have significant implications for the future of financial supervision in the European Union. Therefore, while the Department welcomes the report and broadly supports its objectives and proposed recommendations, it is important to acknowledge that there is much important detail that remains to be elaborated on. Discussions at EU level are expected to progress quickly to the next stage. The European Commission's consultation expired on 10 April and the Commission's intention is to move forward to develop proposals for the implementation of the report for consideration by the European Council at its June meeting and the European Parliament in due course.
The report presents a broad range of recommendations relating to important technical features of the existing regulatory regime and to a phased and measured reconfiguration of the current system of financial supervision in the EU. It contains 31 main recommendations, many of which contain a number of sub-recommendations, so that the actual number of recommendations probably exceeds 100. It will require a major effort to work through all of the elements of the different recommendations and, as we note in our submission to the European Commission, there are several areas where further clarification is required. We expect this clarification as the implementation of the report proceeds so that a strong common understanding among all member states emerges.
Many of the recommendations relate to specific sectors, for instance with regard to the insurance sector, hedge funds, and credit rating agencies. Some of these are already under consideration at EU level. However, other recommendations, especially with regard to the proposed supervisory structures are new and more fundamental. This presentation will concentrate on those recommendations which refer to the reform of the EU supervisory structures.
In this context, I draw the committee's attention to recommendations 16 to 24. These are the most important in the report. They propose, inter alia, the establishment of a new European systemic risk council, ESRC, and the development of a European system of financial supervisors, ESFS. The ESFS will initially align national supervisors’ powers and create a single EU rule book for financial regulation. This will be followed by the transformation of the existing level 3 committees into three new authorities, with a specific legal basis and new legal powers, while national supervisors will continue to be responsible for the day-to-day supervision of firms in their jurisdictions.
These are very significant issues. At this stage we would support this type of approach in broad terms subject to certainty, for example, on the legal basis for these changes and appropriate accountability arrangements. A significant amount of careful work will be required to align the proposed role and responsibilities of the new bodies with the role and responsibilities of member states in the area of crisis management and resolution, in particular in sharing the burden of potential fiscal costs. As ever, the details in any future European Commission proposals will be crucial. I will now go into more detail on the specific recommendations.
Recommendations 16 and 17 should be considered together. In these, the group has proposed the establishment of a European systemic risk council. It would be under the auspices of the ECB and it is proposed that it should be chaired by the President of the ECB. Its role would involve macro-prudential analysis and providing early warnings of financial risks. It could issue recommendations in the form of instructions to national supervisors. The proposed composition of the ESRC means that national supervisors would not be members of it – they would, instead, be represented by the chairpersons of the level 3 committees of EU supervisors.
The creation of the ESRC does not directly involve the transfer of national powers to a new authority. However, it might be noted that the last indent of recommendation 17 appears to give the new authority powers over national supervisors. This proposal would represent a departure from the current institutional arrangements and the desirability of such a change requires careful reflection. A particular priority would be the need to have a clear legal basis for the new authority. Alternative approaches, such as a "comply or explain" formula may be possible.
At national level, the proposed reforms to enhance the role of the Central Bank of Ireland in financial supervision and financial stability oversight and to provide for full integration and coordination of the prudential supervision and stability of individual financial institutions with that of the financial system as a whole is very much in line with the de Larosière recommendation on the establishment of a European systemic risk council.
Recommendations 18 to 24 should also be considered together. The report envisages a two-stage process. In the first stage covering 2009-10 national supervisors would be strengthened to upgrade the quality of supervision in the EU; all national regulatory authorities should align competences and powers on the basis of the most comprehensive system in the EU; and the EU would work towards the harmonisation of financial regulation and consistent supervisory powers and sanctioning regimes.
In the second stage covering 2011-12 the level 3 committees would be transformed into three new European authorities, managed by a board comprising the heads of national supervisory bodies. The authorities would have a range of key competences, including: the power of legally binding mediation between national supervisors; the adoption of binding supervisory standards; the adoption of binding technical decisions applicable to individual financial institutions; and the oversight of colleges of supervisors.
The authorities would have the power to adopt interpretations of EU rules which would be legally binding for national supervisors. This aspect of their proposed role could raise some legal doubts which will require clarification as, in principle, it could override the exclusive competence of the European Court of Justice to interpret European law.
Recommendation 23 may already have been overtaken by events. It recommends the immediate establishment of a high level group to come up with a detailed implementation plan for the second Stage before end-2009. However, the Commission, in its communication of 4 March 2009, said that it intends to opt for a one-stage process, not a two-stage one. It is fair to say that member states have differing views on this issue.
A harmonised rule book would remove much of the discretion or exemptions that currently exist in EU law. Member states have sometimes used discretion other than when objectively warranted by specific national factors. However, there are occasions when discretion is required to take account of the different legal regimes in place throughout the EU.
The report recommends that greater use be made by the EU institutions of regulations for enacting EU financial services legislation which would not require transposition and would apply directly to all member states.
The level 3 committees of supervisors for the banking, insurance and investment services sectors would have their roles strengthened in the short-term with a view to replacing them within four years with new authorities with a legal foundation. We support the establishment of the new authorities on the basis that the development and implementation of a single rule book could not be achieved otherwise. We would have to carefully examine the type of powers that would be assigned to the authorities.
Several member states have raised the question: if the authorities had powers to overrule national supervisors, and the use of such powers resulted in, say, the failure of an institution, who would bear the cost of that failure? The binding nature of these new powers in individual supervisory decisions is an important issue. The question has also been raised whether a single authority rather than three would be preferable in view of the large measure of overlap and co-ordination that will be required.
The European Commission want these new authorities to be established as soon as possible, whereas the report recommends a two-stage period of about four years in duration. We would prefer the two-stage approach. A too hasty decision on an appropriate EU-wide architecture could have unintended consequences. A period to allow for considered debate and evaluation of the options appears to us to be a sensible approach. However, it is important to bear in mind that, in the interim, substantial and significant progress would be achieved by strengthening the existing level 3 committees. Phased implementation will also allow all of the issues relating to the boundary between the roles of the authorities and that of member states to be examined and solutions hopefully to be found.
I highlight the fact that this is a report prepared for the European Commission. Although it contains many recommendations, there are no legislative proposals on the table at this time. However, the European Commission has presented its initial positive reaction to the report and is expected to present a suite of legislative proposals in the coming months.
The Department of Finance, which has a very positive view of the report, warmly welcomed it and believes the recommendations cover the main areas that need to be addressed in the short and in the medium term.
My colleagues and I are happy to answer any questions the committee might have on the report.
I thank Mr. Beausang for his presentation.
Could somebody please explain what a level 3 committee is?
Mr. William Beausang
The level 3 committees comprise the existing structure where all the national regulators come together to discuss issues of common interest. They also have a role in issuing guidelines or standards and recommendations on the implementation of EU law, but they have no formal legal status and cannot enforce a decision other than through mechanisms such as "comply or explain". In effect, one either complies with the recommendation or explains why not. A central part of the de Larosière report was to put these level 3 committees on a more formal legal basis.
The background to this from our viewpoint is that Ireland has suffered a catastrophic regulatory failure in this area of banking. Our regulatory failure was of a more traditional nature than the very intricate securitisation models being discussed, by and large, in this committee report. The question that has to be asked is what this report can tell us about the way in which we can rectify the gross failures that occurred here. How does the Legislature play a more effective role in overseeing the regulators we have appointed? Clearly, the regulatory role the Dáil has played to date has been ineffective. Time after time, the Dáil received assurances that everything in the garden was rosy, but clearly it was not. Could we have had a more forensic system with more detailed examination of the information that was reported to the Dáil? The problem is that our banks sucked in short-term money from all over the world to, as someone described it, pump in to a property bubble. Single market bubbles such as property bubbles are probably the oldest form of banking crisis known to man. What will the new system offer us? Is the suggestion that there will be this systematic risk council at EU level, which will consider Ireland and countries like it and have mandatory powers that did not exist before? To be fair to the EU, it issued warnings to Ireland, as did the IMF, but they were not heeded. Does the recommendation propose that, when the EU issues a systematic risk warning to a property sector in a member state such as Ireland, there will be mandatory powers? Will our Central Bank, the regulator, the Government, the Oireachtas or someone else be obliged to act? Are we satisfied that this is a robust approach to the problems?
What light does the report shed on how we can cope with the current position? There is an issue about how we value impaired assets. In scanning the report, I gather that it recommends new approaches to valuation in the market. Are new procedures coming from the EU's work that will enlighten us as we handle the issues in the context of the NAMA Bill?
I note from page 23 of the report that the group is extremely withering in its criticism of supervisory and sanctioning powers in respect of misdemeanours. It states:
Member States sanctioning regimes are in general weak and heterogeneous. Sanctions for insider trading range from a few thousands of euros in one Member State to millions of euros or jail in another. This can induce regulatory arbitrage in a single market.
What emerged from the EU's assessment of Ireland's sanctioning regimes in respect of misdemeanours? The misdemeanours of a small number of bankers have had catastrophic consequences for our reputation as a place to do banking. Has the EU's work identified weakness in our legal system, our enforcement system, upon which we now need to act? We need to get that right so that we can start to rebuild our reputation, which has certainly been exposed. To put the matter in a nutshell, it is all very well to talk about our input to getting the architecture right at the EU level, but I would like to know the EU's assessment of our architecture and how it failed us. Are there lessons we can learn?
It was suggested that the Minister's proposal that the Central Bank's role should be enhanced is in line with the EU's approach, but the Central Bank was not short of tools to get its thinking across, if it had clear thinking. The two agencies — the Central Bank and the regulator — were joined at the hip. They largely had common board membership. If I am not mistaken, the Governor of the Central Bank was on the board of the regulator. There was a high degree of integration. As I recall, the authors of the legislation took that approach so that macro-systematic issues would be brought to bear on the regulatory system. It is now fashionable to say that the Central Bank saw the train crash coming but was powerless to do anything about it, that it sent little bleating cries to the regulator but they were ignored. That does not ring true given what we were told when the regulatory structure was presented to us here in the Dáil. I was a member of the committee at the time, and we were told that the system was robust and progressive.
It is a bit self-serving to say that the de Larosière report endorses giving the Central Bank a greater role. That sounds like all the insiders circling the wagons to protect themselves, rather than a genuine squaring up to why regulatory failure happened in Ireland. Was it genuinely about this structural issue or simply a matter of ethos and culture? Was a cosy group not asking the hard questions? Was it accepting answers that were not up to scratch and moving on instead of treating them with probing scrutiny? We have to be honest with ourselves, against the background of the extraordinary failure that has occurred. We are facing up to it at one level, but in a weaselly way, by making a few changes here and there and moving on.
The Irish debate must now be more robust. I am delighted that the witnesses from the Department of Finance are here. I hope the deputation does not feel constrained in giving us information about how jaundiced or otherwise the EU's view is of what happened in Ireland and what we can learn from its analysis of our failures.
Mr. William Beausang
The ESRC, the stability council, is an important innovation that mirrors the issues that arose in Ireland, where there was not seen to be a joined-up approach to considering the risks that could materialise at a macro level — the so-called macro-prudential supervisory issues. If we look back to April 2007 and consider how things developed from the first indications that there were significant problems in the financial markets, the projections that were made at that time are nothing like what materialised. Events were initiated with the collapse of Lehman Brothers. Few analysts or commentators would ever have envisaged that there would be a wholesale drying up of liquidity in the financial markets. The de Larosière analysis is that there needs to be at EU and national levels a body that focuses on the risks that can arise throughout the financial sector, and join that up in a much more co-ordinated and direct way with the supervision of individual institutions.
The issue of mandatory powers is one of the more contentious points in the report. A pan-European body with the mandate to issue instructions to national supervisors would encroach on fiscal sovereignty. If an instruction is given to do something or not to do something, and that is seen to culminate in a failure, we get into delicate and difficult issues of burden sharing and co-operation between the fiscal authorities. Our experience of the implementation and enforcement of EU recommendations on the regulatory side is that, certainly for a small country, the "comply/or explain" mechanism can be very effective. That is the case in a number of instances where the level 3 committees made recommendations on how rules would be implemented. It would not be tenable or sustainable for the regulator in this country to discount these recommendations on best practice. For a small country there is a way in which the findings can be enforced that does not require the EU-wide body to have mandatory or legal powers of enforcement of its recommendations. That will have to be worked through by looking at all the details and issues included in the de Larosière report.
More generally, our presentation has concentrated on the supervisory architecture. It is fair to say there are some very important recommendations relating to the regulation of financial markets which try to identify and respond to very significant weaknesses that have been disclosed. I refer to issues such as capital provisioning, the Basel II framework and the strong assessment which encouraged pro-cyclicality rather than the building of buffers during good times to deal with issues that arose or might arise during bad times. There are issues concerning the definition of capital and making sure it is significantly loss absorbing. There are also issues of risk management in institutions. In this respect, looking at the framework for financial regulation adopted in many EU countries, including Ireland, one sees there was an onus under the principles-based system on the boards and managements of financial institutions to identify risks and respond to them under the aegis of the general framework put in place by the regulator.
The Deputy mentioned the question of valuation. Regarding the NAMA initiative, there is a great deal of guidance available to us on how we should go about following the valuation process for impaired assets in our financial institutions. Members will understand this is a case of trying to maintain the integrity of the Single Market. The European Union will take a very keen interest in how that process operates and the work we will do in this country will be subject to oversight by the European Commission. It will set up an expert valuation board drawn from its own members and the European Central Bank which will look, not only at this country, but also at all the recommendations or proposals made to deal with impaired assets in member states. The valuation process, therefore, will need to meet best practice in European standards. We are working closely with the Commission on these issues.
Mr. Breslin may have something to say on the sanctions regime.
Perhaps the delegates might send us details of the EU expert valuation board to inform us how it will operate.
Mr. William Beausang
Certainly.
I must leave but I wish to follow up on some of the questions asked. The submission from the delegates states that the views received from stakeholders have been reflected in the Department's submission to the European Commission. Will the delegates identify the stakeholders involved? They did not include the Opposition in the Dáil. I do not recall being consulted and do not know if Fine Gael was consulted.
Mr. William Beausang
We have circulation lists which we use to refer legislative proposals from the European Union. We made available a copy of the report.
I make the point that the stakeholders obviously do not include the Opposition parties.
Mr. William Beausang
We provided a copy of the report for the committee. The Joint Committee on European Affairs——
We were not consulted about its formulation. We were presented with the report as a fait accompli.
Mr. William Beausang
The Deputy is referring to our response to the Commission.
Yes. Mr. Beausang has said the Department consulted the stakeholders. Will he let us know who they are? He need not give this information now but might send a list to the committee naming those who were consulted.
Mr. William Beausang
We can do that, certainly. We had sight of the response of the Joint Committee on European Affairs to the report when we finalised our own consultation paper and it would have been of help to us when we looked at some of the issues on which we reflected.
The point I make is slightly different. In the material available, particularly with regard to all the papers written on what had happened in Sweden, two factors are stressed repeatedly. First, it is essential to have broad political consultation in which the political parties are involved and seriously consulted. I had the honour to meet Mr. Beausang on a few occasions, usually in emergency scenarios when decisions had already been made. If we are to learn from countries that have got out of the hole in which Ireland finds itself, we should take from some of the positive experiences mentioned. This includes consulting Opposition parties. I do not believe we were consulted on this issue.
I wish to know what Mr. Beausang's Department believes is involved in stress testing. He might send this information in a note. We were told AIB had been stress-tested on several occasions. On Monday we were informed a new stress test showed an extra capital requirement of €1.5 billion. Will Mr. Beausang explain to the committee his definition of stress testing? Does it have any meaning? What does it involve? Is the stress testing undertaken in recent days about which we have heard, based on the deep down drilling process of PricewaterhouseCoopers, to continue? How many times will this have to be done? Every time PricewaterhouseCoopers performs a stress test it seems to come up with a different answer.
Risk management is an area where our banking system collapsed. Does Mr. Beausang have any insights into why risk management supervision collapsed in our regulatory system and within the banks? I do not know if his Department saw itself as having a role in the oversight of risk management but it was a catastrophic failure in this country.
There are references in the paper and the EU report to systemic failure. Mr. Beausang might send me the following information because I must leave. What does he mean by "systemic failure"? I was astonished recently when somebody referred to the Irish Nationwide Building Society as a "systemically important bank to the Irish banking system". Is that the view of the Department? If so, why is it systemically important? Is that judgment based on its financial activity or the number of its depositors? It is merely a small building society.
It is a mutual society.
It is a small mutual society. Why is it systemically important to our banking system? I am afraid I must leave. I apologise to the Chairman. Perhaps Mr. Beausang might send me a note in reply to these questions. That would be helpful.
Mr. William Beausang
Yes.
Mr. Beausang might reply to Deputy Burton. He can speak again if he has further points to make about what was raised.
Mr. William Beausang
Mr. Breslin has a few words to say about the sanctions regime and how we stand up relative to our EU counterparts.
Mr. Colm Breslin
As I understand it, the de Larosière committee did not have Ireland in mind with regard to the sanctions regime. We have relatively strong sanctions regimes in force. There are provisions in our legislation for multi-million euro sanctions on institutions which breach their authorisation requirements or the instructions given to them by the Financial Regulator. There are other countries in the European Union which apparently have very modest sanctions to apply if financial institutions do not obey the rules. The concern is that an opportunistic financial institution which might be working at the margins of legality could put a regime in a place under which the sanctioning powers would very limited and the level of sanctions very low. That there is freedom to provide services authorised in one member state across the European Union could be a disadvantage for other member states and put them at risk. It does not apply to Ireland because we have heavy sanctions available.
Deputy Bruton inquired how the committee might play a bigger role in financial supervision. It is a fundamental international principle of financial supervision that where a financial regulator is established, it must be completely independent in the exercise of its functions on a day-to-day basis. This is so that it will not be amenable to political influence but objective in the way it goes about its job. However, it is also standard practice that it should be accountable in some way to the body which authorised it in the first instance, for example the Oireachtas here. That is why this and other committees have been able to call in a range of people from the Central Bank and the Financial Regulator and subject them to detailed questioning. That is the sort of accountability in mind, and it is already available here. In terms of a more hands-on role for the political authority in the Financial Regulator, this would not be feasible and maintain the objectivity of the Financial Regulator.
I welcome the report. Initially there were requests for recommendations from the Oireachtas to this report before the final draft. The area of particular interest was the amount of responsibility the inter-bank seller would retain when securities were offered to other banks. What was the final decision on that and how was that decision made in light of the fact that there were specific requests that this be at a very high level to eliminate the risk of future greed and difficulties?
Mr. Colm Breslin
Earlier this week that matter came before the European Parliament. The general thrust of the proposal is that 5% be retained by the issuing entity. Deputy Bruton has described that before as "skin in the game". In the course of the debate in the European Parliament there is a minority view among MEPs that the level to be retained should be approximately 15%. Up to close of play yesterday I had not heard that this disagreement on whether it should be 5% or 15% had been resolved. Securitisation is moribund because investors are not prepared to take on securitisation given the experience they had with the sub-prime market in the United States. I understand from people in the industry that given this fact, and the fact that loans are being guaranteed by state entities such as the Irish Government and others around Europe, not much is happening around securitisation.
The issuers have been saying that if they were obliged to hold on to 15% of an issue, this could make the whole process not viable and it would not be worthwhile incurring the cost of a securitisation issue if one were unable to generate an income from 15% of it. It can take up to six months to organise and launch a securitisation issue, and given the major costs and preparation involved, if they could not get the vast bulk of it away, that type of revenue raising activity might not be viable. That is the professional view of the industry. When it comes down to the wire, the consensus will probably be that they will settle on 5% as the "skin in the game" required.
I welcome the Department of Finance and its explanation. I was a strong fighter against over-regulation over the years. As Minister, our Chairman listened to me and gave way on some of the regulations that were being introduced. Part of the great success we had over those years was our lack of regulation and the fact that we were regarded as the third freest economy after Singapore and Hong Kong. I thought this was part of our success and then I read yesterday in The New York Times that this was part of our failure. We were so free that we did not regulate well enough.
I am interested in what Mr. Breslin said today, that central Europe has said that it was not concerned about Ireland because we had the penalties, systems and controls. On that basis, if we went wrong, as we did, surely it is our fault. I mean this committee, the Oireachtas, the bodies we established to protect us from what went wrong. When I see these new bodies coming in I almost feel Europe as games master is saying it wants its ball back and we are not to play unless it wants us to play. Part of our success story was our freedom to do what we thought was right, and part of our failure was that we, as Oireachtas Members — I accept responsibility — did not operate the controls we had. If we had the controls in and we did not use them, we are responsible.
My concern is that Europe and the high level group is almost over-reacting by putting in such controls rather than allowing the 27 countries to do what they think is right. We have learned our lesson and suffered. In this country we will ensure we behave ourselves in future. I am very reluctant to hand over as much financial supervision authority as seems to be going to head up into Europe. The European systemic risk council and the EU system of financial supervisors appear to take our power in the Oireachtas away from us. Perhaps the witnesses could put my mind at rest that in our support for this we will not lose the ability to run our own show as we did in the past.
Mr. William Beausang
There is a proposal that the European systemic risk council would be able to give instructions or directions to national supervisors. As I discussed, that would be a very contentious issue due to questions on how it would align with national sovereignty and the responsibilities of national supervisors and their accountability to national parliaments. In principle the establishment of a body with oversight responsibility on financial risks that might be emerging or might arise across the entire financial sector is a very good recommendation. An important aspect of the design of the council will be to put in place some kind of mechanism that ensures its recommendations are listened to and acted on but that it does not have a power of direction that overrides the responsibility of national governments, parliaments and supervisors.
The question on under-regulation or over-regulation is interesting and much time has been spent at national and EU level on examining designing regulation in an appropriate way and ensuring it is both effective and efficient. There is a whole structure there, as members know, the better regulation principles which guide the design of regulation, similar processes for EU financial services law and a very detailed and comprehensive cost-benefit analysis, impact assessments and so on. We operate within a detailed and comprehensive common template of EU financial regulations. The de Larosière report identifies areas where those regulations have been found to have unintended consequences and not to have worked. A more important point is how regulations are implemented and the supervisory procedures. These have been emphasised in the de Larosière report and other reviews particularly the Turner review in the UK which examined weaknesses and deficiencies in its regulatory system.
It is the quality and intensity of supervision and the implementation of the regulations that is most important. The Financial Regulator made a number of presentations here and spoke about the more intrusive, more intensive process of supervision it now has in place, particularly on account of the powers provided under the guarantee scheme. It is important, therefore, to make a distinction between the issue of regulation and whether regulations are meeting the objectives that are designed for them, and the way those regulations are enforced. One can have all the regulations one likes but unless they are properly implemented they will not meet the objectives that have been set for them.
I thank the representatives from the Department of Finance for the presentation and for answering questions.
The most common question I am asked as a public representative is how this happened when we had so much regulation. It is a fair question, but it is a question that I honestly cannot answer. I agree with Senator Quinn's point that people should not be regulated to the point where they spend most of their days trying to fill in forms while trying to run a business. This has been an abject failure. However, as Senator Quinn said, I hope we can look forward. Mistakes have been made, but the most important thing in any life is to learn from one's mistakes. We must first accept that mistakes were made and that there was a major weakness in the structure. Last September, the Governor of the Central Bank told me and others that he had stress-tested the financial institutions in this State and that he was happy with the results. I am sorry to have to say that he was incorrect. He indicated quite clearly that he did not see any great problem when there was a massive problem hidden behind everything.
Whether we like it, we are dealing with European institutions, and people doing business here will have to be controlled at a European level. Are there are any proposals to restrict the licensing of financial institutions in the context of the types of business they are allowed to carry on? In the 1980s, AIB found itself in deep trouble as a result of involving itself in the insurance business. Clearly it did not have the management structure in place to recognise the dangers of what was going on in the ICI. That nearly brought about its downfall and the Government of the day had to bail it out. We should learn a lesson from this.
I am a great believer in the maxim that plumbing is for plumbers. If I have a plumbing problem I do not look for a carpenter. I look for the qualified plumber. If banks stuck to banking, if insurance companies stuck to insurance, and if building societies stuck to what they are supposed to be doing, we would not have the spectacle of Irish Nationwide having paid a €1 million bonus to a retiring chief executive, shortly afterwards withdrawing it or having it handed back because of public pressure, and subsequently learning that the society was experiencing massive losses. Where were the boards of management? Where were the boards of directors? When its behaviour was examined it was discovered that 80% of its business was in commercial properties, some of them abroad.
It is my understanding that a mutual building society is set up so that individuals may deposit moneys, obtain a rate of interest and build up credit so that they may obtain a loan, which they pay back over a period of years. However, all of these institutions have gone off the rails. They all want to be bankers. In some cases they are now moving into insurance. Have we learned any lessons at home and at European level? Will restrictions will be placed on financial institutions by licensing their authority to transact certain types of businesses?
Much of what has happened here, in Europe and worldwide is the result of institutions going outside their own professional knowledge and expertise. Irish Life & Permanent plc is another example. It is an amalgamation of the largest life assurance company, a very successful life assurance company, and a permanent building society which was once a mutual building society, to become a major bank. Irish Life was good at life assurance but its knowledge of banking is limited. Such developments were allowed to happen at the expense of the taxpayer. What steps, if any, can be taken at European level or nationally, to rein in the institutions that are going beyond what was intended under their licences and carrying on certain types of business, so that we can go back to a scenario where the plumber does his job and the carpenter does his, and we can all live happily ever after? As long as there is a mixture of contracts that make certain institutions attractive to so-called investors, we will be stuck in the situation in which we find ourselves.
Mr. William Beausang
The Deputy asked what we understand to be the cause of this crisis. I refer him to the short description at the start of the de Larosière report. It is drafted in the context of what has happened at EU and indeed international level. However, each of the headings and the narrative outlined in the report makes it very clear that the kinds of issues that emerged internationally have very strong echoes and are mirrored in terms of what happened here in Ireland, and that they are the issues to be addressed.
In responding to those issues and in designing a response to them, one needs to take into account the following: the overall macro-economic framework in terms of interest rates and the fact that liquidity was so freely available; that recycling of surpluses between major trading partners was not consistent with global economic balance; the search for risk; the fact that investors were seeking out high yield products without fully understanding the risks that were attached to them; significant problems in risk management in institutions; and their ability to assess complex products. Account must also be taken of the following: loans in the Irish banking sector; the lack of transparency in the banking system overall on account of the growth of the shadow banking system; the role of hedge funds and so on; the role of securitisation which has been highlighted as a major cause of the difficulties; credit rating agencies and the reliance on credit ratings to inform investors' decisions without proper due diligence being carried out; corporate governance failures; and regulatory, supervisory and crisis management failures. As one works through all of those issues, notwithstanding that the report is drafted for an EU audience and reflects what has happened internationally, those are the kinds of issues that explain the difficulties that arose here as much as they explain the difficulties internationally.
The de Larosière report is a response to those issues in terms of developing a system of financial supervision in the EU, a system of financial regulation that reflects what happens and a proper system of financial regulation at national level. For the foreseeable future, notwithstanding the issues highlighted in the de Larosière report, it is clear that financial regulation will remain a national responsibility. The home and host model underpins how financial supervision in the EU will be maintained.
The scope of the activities of financial firms has been a major issue internationally. Large institutions expanded activities across a wide landscape and core business may have been undermined by speculative activity in esoteric financial products. There has been an important lesson for financial firms to learn from what has happened in recent years. A call has been made for a return to more traditional banking and financial service provision with more focus on the needs of households and businesses, rather than financial engineering and gains through such activities. The capacity of board members and the expertise of senior management will be examined more closely in all countries to ensure that the necessary skills and knowledge are there. Senior managers and those on boards of institutions must fully understand what they are doing and the risks inherent in their activities, which must be properly managed. Regarding banks and building societies expanding their activities outside their areas of expertise, lessons have been learned from events internationally and in Ireland in recent years.
Stress testing was mentioned and many approaches can be adopted, such as a top-down approach, which would examine only the headline figures in the balance sheet of a financial institution. There can also be very detailed, loan-by-loan stress testing that would be carried out in the context of due diligence; this had to be done before Bank of Ireland's recapitalisation and is ongoing for AIB's recapitalisation. There are many approaches and methodologies but whichever one is adopted, it is important that it be informed by as much knowledge as possible regarding the financial state of the institution in question. In Ireland the implementation of the guarantee provided the regulator with the opportunity to conduct more intensive and detailed stress testing on the individual loan books of institutions. This was done in the context of assessing the risks taken on by the State and it was reflected in the PricewaterhouseCoopers report, some of which was put in the public domain. The approach continued as the due diligence for the recapitalisation programme got under way. Stress testing will not be a static process; how one assesses risks changes over time alongside changes in the overall economic environment. As I said, recent events in national and international finance have taught us that extreme risks can materialise and that they may have consequences one would not have foreseen as a result of a mainstream, balanced analysis that would have been carried out in a more normal economic environment.
Is Mr. Beausang happy that there will be the power to tell institutions they cannot carry out certain types of business?
Mr. William Beausang
I understand the Financial Regulator has the power to attach any condition to the authorisation of a financial institution; this was the mechanism used to impose the new restrictions directors' loans. A wide degree of discretion is available to the Financial Regulator to impose conditions on authorisations.
Will it be possible to tell banks not to stray into the area of insurance?
Mr. William Beausang
A bank needs authorisation as an insurance firm to carry out insurance business and must meet the associated regulatory requirements.
A bank may have the authority. Is it still possible that banks will act as insurance companies and insurance companies will act as banks? It has been said that the institutions have learned lessons and should revert to what they were originally set up to do. I accept this but will the institutions do so? If not, will the Financial Regulator be able to tell an institution that it has neither the expertise nor qualifications to get involved in certain areas?
Mr. William Beausang
That relates to the oversight, probity, fitness and capacity at board level. It also relates to the assessment of the risk a financial firm may take in extending into activities it cannot carry out successfully.
I do not support the approach Deputy Barrett seems to take; it is over regulation. If a business chooses to invest in something it is playing with its own money. I do not feel an external controller should decide businesses should not do so.
I think Senator Quinn is missing the point. If an institution invests in a way the jeopardises money that belongs to other people it is not merely acting in a private capacity. If banks become involved in business that they are not capable of conducting their shareholders may be left penniless; Senator Quinn and I know many such people. In such circumstances a regulator should be able to step in. This is not comparable to private businesses that lose their own money; we are speaking of money belonging to the public and it is only right and proper that institutions be stopped from straying beyond their areas of expertise.
I thank Mr. Beausang, Mr. Breslin and Mr. Moore for attending this meeting. I have been involved in the regulatory side of business and I found the report very interesting. This committee conducted a report on financial regulation from 1997 to 2002 and another was conducted under the aegis of the former Minister for Justice, Equality and Law Reform. The latter report was put into operation but some of the findings of the committee's report are now being enacted; perhaps people should have listened to us at the time. That is history.