Patrick Honohan: Institutional reform in the Central Bank of Ireland since
2009
Introductory statement by Mr Patrick Honohan, Governor of the Central Bank of Ireland, at
the Oireachtas Banking Inquiry, Dublin, 15 January 2015.
* * *
The Report that I submitted to the Minister for Finance in May 2010 entitled The Irish
Banking Crisis: Regulatory and Financial Stability Policy 2003-8 responded to a request by
the then Minister for a "preliminary investigation of...the performance of the respective
functions of the Central Bank and Financial Regulator" over that period. Drawing on internal
files as well as interviews of key officials, the Report was able to provide answers to two
questions: First, why was the danger from the emerging imbalances in the financial system
that led to the crisis not identified more clearly and earlier and headed-off through decisive
measures? Second, when the crisis began to break, were the best containment measures
adopted?
The Report noted the relevance of factors other than the performance of the Central Bank
and Financial Regulator (including the performance of directors and senior management of
the banks, as well as their auditors and accountants, as well as pro-cyclical elements of
Government policy), but, in line with the terms of reference, it focused on the design of
microprudential aspects; the approach to overall financial stability; and the failure to undertake
decisive and effective remedial measures.
As far as micro-prudential policy is concerned, the supervisors did not accumulate enough
relevant information, because of
1. an excessive reliance on a regulatory philosophy that implicitly trusted that
wellgoverned banks could be relied upon to remain safe and sound. This approach
emphasised process over outcomes, and downplayed the quantification of risk; and
2. deficiencies in skills and staff resources.
There should have been a greater degree of intrusiveness and assertiveness, and a less
deferential approach to the banking industry. This would have disrupted the pattern of
inconclusive engagement with the banks, a pattern which spilled over to the macro-prudential
arena, reflected in the fact that the belated and relatively modest tightening in 2006 of capital
requirements for high loan-to-value mortgages was adopted only after prolonged and
agonised debate.
In terms of the analysis of systemic risks, the language of successive published financial
stability reports was too reassuring: a triumph of hope over reality.
Much has been made of the institutional separation of the regulatory authority from the rest
of the Central Bank. The 2003 legislation did create the risk of ambiguity with regard to which
entities were responsible for what. Certainly, communication between the macroeconomic
specialists assessing systemic risks and the micro prudential supervisors dealing with
individual banks was not fully effective: each side felt they would have acted more vigorously
had they been more aware of what the other knew. But that probably reflected a lack of
mutual understanding of the methodology and professional language as between economists
and supervisors more than the institutional separation, which was by no means rigid. In the
end, senior officials in both institutions, as well as many elsewhere at home and abroad,
were too optimistic about the strength of the economy and the Irish banks.
One should recall that several other central banks and financial regulatory authorities
suffered similar failures in the run-up to the crisis. But (with the exception of Iceland) they
had not allowed the scale of their banking systems to get so completely out of control as
happened in Ireland.
The Report's section on crisis containment includes an assessment of the 29 September
2008 decision to guarantee substantially all of the liabilities of the banks. While several other
countries followed suit in subsequent days with more limited guarantees, the guaranteeing of
subordinated debt of the banks was clearly a mistake; the formal guarantee, backed by
legislation, of all long-dated debt was also unnecessary and bound to constrain the
authorities' ability to restructure or wind-down failed banks before the expiry of the initial
guarantee.
With the benefit of hindsight - had the regulatory authorities had any notion that heavy
losses could be involved - an alternative strategy (mentioned in a footnote on page 132 of
the May 2010 Report) of putting Anglo (and INBS) into liquidation on September 29, while
standing behind the rest of the system, should have been more favourably considered. Given
how resistant external authorities subsequently proved to be to the imposition of losses on
unguaranteed senior bank debt of failed banks, external partners might have responded to
such an idea with compromise proposals that might have alleviated the subsequent
pressures on the Irish Exchequer. More generally, greater consultation with EU partners
would have been highly desirable and could have helped Ireland to be less on the back foot
in subsequent negotiations.
Despite the passage of time, I see no reason to alter the assessments I made in May 2010.1
Accordingly, extensive changes have taken place within the Central Bank to ensure that the
identified shortcomings have been removed as far as possible. While not strictly the topic for
today's hearing, it seems appropriate to include some words on this.
Institutional reform in the Central Bank since 2009
The 2010 legislation (Central Bank Reform Act 2010) confirmed the reintegration of the
regulatory and supervisory apparatus fully within the Central Bank. The separate Authority
was abolished and its powers transferred to the renamed Central Bank Commission, with
most regulatory powers delegated to the Deputy Governor (Financial Regulation). The
legislation also introduced some other changes including a clearer definition of the goals of
the Central Bank.
Extensive actions were launched to enhance the Central Bank's capacity and ensuring its
delivery of an intrusive and effective risk-based financial supervision as well as a pro-active
approach to systemic financial stability policy. These have been addressing, inter alia, the
identified issues of insufficient cooperation and limited communication between different
divisions and sections, an unduly hierarchical structure and deference to authority and a
reluctance to carry decisions to conclusions and effective action.
There have been significant changes in the policy approach. For example, banking is no
longer de facto exempt from enforcement actions as it was in practice before 2008: banks
now know that regulatory breaches leave them open to penalties. Thanks to the new
legislation the Central Bank's focus is no longer blurred by the potentially conflicting objective
of developing the financial services industry. Substantial expansion of staff on supervision
and regulation (responding not only to objective assessment against comparators that more
staffing was needed but also to public demand that underachievement could not be
tolerated). This included injecting new energy and a fresh approach by opening up the
numerous senior appointments that needed to be made to candidates outside of the Bank.
I will not elaborate here on the additional powers which have been sought by the Bank and
granted by the Oireachtas on various regulatory and resolution issues. As far as bank
supervision is concerned, the EU Single Supervisory Mechanism SSM has (since November
2014) taken over much of the decision-making, while implementation remains primarily a
locally-managed task.
There are improved decision making processes in regulation (separation of policy and risk,
and enforcement functions from supervision; significant strengthening of the legal division;
emphasis on better working interaction between the macro and micro prudential staff). There
is an extensive and continuing programme of cultural renewal engaging all staff and using
many tools (clearer definition of mission; performance management; all-staff meetings;
monthly cascade briefings; investment in IT systems; leadership training etc.) in order to
ensure a more effective working environment (more conducive to, among other things,
constructive challenge).
Current plans involve even greater use of on-site inspection of banks, as well as a thoroughly
overhauled organisational structure to further decentralise decision-making, cooperative
working and career progression.
No regulatory system can or even should attempt to eliminate all possibility of failure, and
regulation and supervision must be able to change with a constantly changing financial
industry. But I think the more assertive and risk-based system of prudential supervision that
we now have in place has struck the right balance and will help ensure that the banking
system helps the economic performance of Ireland, rather than causing the economic
destruction which we have all been seeking to repair and rebuild.