Patrick Honohan: Regulatory policy development and new regulatory
activity
Introductory statement by Mr Patrick Honohan, Governor of the Central Bank & Financial
Services Authority of Ireland, to the Joint Oireachtas Committee on Economic Regulatory
Affairs, Dublin, 15 December 2009.
* * *
Mr Patrick Honohan was accompanied by Martin Moloney, Secretary to the Financial Regulatory Authority, and
Joe Doherty, Head of the Central Bank's Legal Unit.
I would like to highlight a number of key areas which currently dominate regulatory policy
development and new regulatory activity.
1. Resolving the crisis
First and foremost in the magnitude of its impact is the resolution of the current banking
crisis. The weakened financial position of the banks and the extensive government
guarantee provided to their depositors and other claimants clearly calls for exceptional
measures here. There has been greatly intensified and, indeed 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 covered by the government guarantee. They have been sitting in as observers on
key decision-making committees in each of these banks as well as conducting a number of
specific investigations and reviews.
The government's crisis resolution strategy involves cleaning out a very 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, needed to absorb any future losses. To the extent that
needed capital cannot be sourced by the banks themselves, the government has indicated
that it will be prepared to make the necessary investments. Quantifying the needs and the
possibilities is an important task here in which the regulatory staff are centrally involved.
2. Ensuring safe and sound finance
Quite apart from this problem of crisis management, there is the ongoing task of ensuring the
safe and sound operation of financial firms in Ireland, both those dealing with the domestic
market and those primarily concerned with the export of financial services through the IFSC.
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, and in this way some degree of protection is provided to the investors in these
funds.
Other parts of what I call the safety-and-soundness work is more qualitative and judgmental.
Regulation attempts to limit reckless or self-dealing behaviour by financial firms both (i) ex
ante
in advance by vetting the persons in charge for their fitness and propriety, and by
checking on compliance with clear rules of behaviour and (ii) 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.
(i) Thousands of financial firms in Ireland are regulated entities. Experience worldwide
shows how hard it is for regulators to detect all fraudulent behaviour on the part of
financial firm management. Very often important breakthroughs are made thanks to
the revelations of whistleblowers. Transparency International, for example, has 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.
(ii) 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 of
course be full cooperation with any criminal prosecutions, where they arise, and
(otherwise) 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 you know there have been high-profile allegations
of wrongdoing in the context of the banking crisis. I do not wish to talk in any detail
about these (indeed I cannot do so) beyond saying that, detailed investigations of
these are in progress and the regulatory staff have contributed vigorously to this
process.
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 in Ireland, we have been
planning details of the new structures and approaches that will be adopted.
As far as structures are concerned, I can mention that, 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.
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 to implement new stronger rules, being
developed as we speak, by international bodies such as the Basel Committee.
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; these are being
discussed at present with the Department of Finance with a view to their inclusion in the
proposed legislation restructuring the Central Bank. One particular area relates to the
requirements of confidentiality, which (as they are currently being interpreted) seem to go
well beyond what is necessary or appropriate for the purpose of ensuring privacy of
customers and commercial interests. As things stand, the regulatory staff can end up
appearing 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 firms into the Irish market. I welcome the participation of
foreign-owned firms - both those aiming to supply the domestic market and those that are
export-oriented - 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 have to 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; these
can be paid for by a levy on the supervised firms (I think we should move towards a 100%
chargeback basis). I also feel, though, that specific steps need to be taken to ensure that
there is no expectation that the state would come in to take exceptional steps to rescue such
entities.
3. Consumer protection
Consumer protection cannot and will not be ignored in the regulatory structure. Failures here
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 SME lending are already, I believe, making some impact
on what are difficult current issues; and the Law Reform Commission also made valuable
recommendations - but I feel that more will be needed.
In this area a central concern is of course 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 here. To be sure, the financial restructuring of the banks will
help set them on a course that gives them not only the financial resources but the incentive
to focus on new business, but experience elsewhere shows how slow recovering banks are
to get lending going smoothly again.
We know that credit is not growing and that spreads have widened. At least some of this
reflects the poor creditworthiness in present market conditions of many loan applicants. The
difficulty is that second-guessing banks on their credit appraisal decisions and on their
pricing of credit risk is, under present circumstances, 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. It may be that the banks could improve
their loan appraisal technology: there have been many advances in this area in other
countries, which 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, can be the catalyst for
such improvements.
4. Understanding what happened
The failures of the Irish 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 happened, but some of it is still hard to understand.
At the Central Bank we have, I believe, 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
learnt for the future. In considering how best to do this, I suggest that new models need to 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.