Cyril Roux: Supervision and financial regulation at the Central Bank of
Ireland
Address by Mr Cyril Roux, Deputy Governor (Financial Regulation) of the Central Bank of
Ireland, to the Financial Services Ireland Annual Dinner, Dublin, 4 December 2013.
* * *
Ladies and gentlemen. Many thanks for this opportunity to share my thoughts and views on
supervision as I begin my term as Deputy Governor for financial regulation at the Central
Bank. I've started in my new role at a very busy period for supervision and regulation, both
here in Ireland and internationally. It has certainly become very clear to me in the two months
I have been here that supervision and financial regulation is high on the Irish public agenda
and an area which elicits many opinions and views from the general public, the media, and
the regulated firms themselves that you represent.
In recent weeks financial firms and the Central Bank's supervisory activities have been very
much in the public eye. Some of this attention has cast a public light on individual firms, their
provisioning practices and their solvency, some has been on topics touching the main banks,
namely the balance sheet assessment (BSAs) the Central Bank has recently concluded, and
its relevance for our supervisory dialogue on provisions and capital requirements, as well as
some broader issues such as mortgage arrears and conduct of business. You will be aware
that we have confirmed the outcomes of the balance sheet assessments with the respective
banks in recent days. The BSA exercise was conducted by the Central Bank at this particular
juncture as it was necessary to do so before Ireland exited the EU/IMF programme. The BSA
exercise conducted by the Central Bank will now feed into the ECB's assessment of banks
within the Single Supervisory Mechanism (SSM) which will culminate with the European
stress testing next year. As such, the results of the BSA were not published separately by the
Central Bank, as to do so would be inconsistent with the broader European approach. Of
course, the banks themselves may have an obligation to make certain disclosures under
their own reporting requirements and we have seen some of that over the past few days.
All the issues I have mentioned have a common thread - they pit the corporate and client
facing behaviours of your firms against our proactive and assertive, risk based, supervisory
engagement aimed at ensuring the appropriate outcomes that protect both financial stability
and consumers.
As an issuer of guidelines and regulations, the Central Bank has stepped up its game on
prudential issues, such as insurance reserves and banking provisions, as well as on
enforcement, client asset rules and consumer protection areas.
In this context it is timely that I have been offered this opportunity, at the start of my time in
Ireland, to discuss the evolving nature of financial supervision at the Central Bank. I will do
so by stressing, at every turn, the interplay of the domestic and the international sides of
these issues, as I believe that they are equally important, and equally present on your mind
and on ours.
Financial supervision operates on several levels. The first and most ambitious one is
systemic: to provide, or at least significantly contribute to, financial stability. The second is
more traditional: to protect the financial interests of the customers by assessing and, when
necessary, enforcing compliance with prudential regulation. The third emerged later, around
conduct towards customers. Indeed the Central Bank's own mission statement focuses on
these priorities at a very high level - 'Safeguarding Stability, Protecting Consumers'.
Let's look at these 3 areas in more detail.
Financial stability
There is a widely shared view that supervisors have failed to provide the financial stability
that they are tasked with. Ireland, in particular, has experienced the effects of this, with a
regulatory system that in the past failed to stop runaway lending.
Notwithstanding this egregious national failure there are three main reasons that make a
difficult task.
First, calling out imbalances and financial bubbles is a contentious area. Is there a housing
bubble building up now in Dublin, London, or elsewhere? Is the stock market overvalued in
Europe or in the US? People disagree and can adduce data and reasoning to make opposite
cases. When bubbles do grow, vested interests work at all levels of media, the economy,
public administration and elected officials to explain why this time it is different. So only by
thinking against the tide can one signal and maintain, while the economy is growing and jobs
abound, that something is rotten and will fall apart eventually. Contrarians are inherently rare;
contrarian public institutions which are run collegially rarer still.
The second reason is that financial regulators are first and foremost organisations set up to
conduct individual firm supervision. This is what they have been originally set up to do, and
where the core of their responsibilities lie. Although they do conduct sector-wide reviews and
assessments, their core powers, deposits of knowledge and history are rooted in the
microprudential arena.
The third reason for this failure, even when, against the odds, the financial regulator has
rightly adopted a contrarian outlook, is that it may not be in a position to force this contrarian
outlook on the economy. The institutional power of domestic unelected regulators is naturally
less than that of elected governments and parliaments. To take one familiar example, when
the elected representatives in the US decided to promote home ownership through subprime
lenders, (also helping the labour-intensive construction sector), the democratic force of that
decision was unassailable, and its financial stability consequences could hardly have been
wholly contained by the regulators - even if they had tried more single-mindedly to do so.
More generally, few regulators anywhere have been granted the autonomy to take actions
that will clearly slow overall economic growth, even if this course is more sustainable, or
more conducive to financial stability. Of course, very often regulators didn't even try.
Given these three structural reasons for the repeated failures of financial regulators to ensure
financial stability, should we abandon this mandate as being simply beyond our reach? I
would rather say these failures call for a radical rethink of the tools and institutional set-up
required to succeed. This is why the combination of the SSM and the macro-prudential tools
of the Basel 3 accord make such a potent change in the likelihood of success in the euro
area. The ECB is an institution of great influence, whose strength, powers and independence
are safeguarded by the Treaties of the EU. It wields more power and can draw on more
resources than most domestic euro area regulators. And this institutional weight can help it
wield the macro-prudential tools that its national predecessors did not have, or did not use.
Never in Europe will the banking regulator be better positioned to discharge its financial
stability mandate than the ECB.
Supervisory activity
Let me turn now to the practice of micro-prudential supervision. This is the less grandiose
mainstay of our work. This is also the level on which we interact daily with your firms. Here
our mandate is to protect the interests of your customers by ensuring a great number of
things: that your firms are run in a responsible manner by competent people who are fit and
proper; that the firms that you run do not take undue risks with their customers' funds, that
regulated firms know; mitigate and reserve appropriately for the risks that they do take; and
that they have sufficient capital and appropriate funding structures, amongst other
responsibilities, not least, appropriate governance structures
In carrying out these tasks the Central Bank has undertaken significant changes in recent
years with our new regulatory, risk based approach to supervision introduced by my
predecessor Matthew Elderfield and the management team. The now familiar-to-you PRISM
approach underpins our practice of micro-prudential supervision. As you know, this approach
segments the firms we regulate by measuring the potential impact of their failure and
engaging accordingly. We focus our resources on the areas of greater relevance and try to
ensure the risks therein are mitigated as appropriate. That involves ensuring that regulations
are complied with, but there are few better ways to raise our hackles than to call this
supervision glorified box-ticking, as was done recently by a commentator. We certainly give
ourselves higher goals than routine compliance checks. We devote time and effort to
understand deeply the firms' business models. We put great stress on forward-looking
assessments rather than snapshots of past situations, looking for the exercise of supervisory
judgment throughout our engagement with regulated entities, and we constantly review our
actions to make sure they achieve satisfactory outcomes, and don't just satisfy internal
metrics. This is why we put great store in the remedial programs that we ask of you and
monitor energetically their implementation
However, business models evolve, international regulatory standards develop, and
responsive supervision is not static. The procedures and processes that are in place today
may need to be revised so that they are relevant tomorrow. For supervision to be successful
it must continually adapt and change to new environments and activities, and as part of this
you can expect that our engagement with your firms will evolve. A number of forces are at
play in this regard. The first is the Reports on the Observance of Standards and Codes
(ROSC) review that we asked the IMF to conduct. The IMF has examined our markets, funds
and banking supervisory practice in the light of international standards put forward by IOSCO
and the Basel Committee on Banking Supervision. I expect the final report of the IMF will be
published shortly and we will take on board their recommendations, as applicable to the
organisation.
We have also launched a review of our PRISM engagement model in which a few of you
have been invited to participate. Our reviewers are to report to the Bank's Commission early
next year about potential areas for development or amendment in our current engagement
model. It is likely that the focus on supervisory outcomes will be given even greater weight as
a result - supervisory engagement is all to the good, but only so far as it leads to successful,
transformative outcomes.
Observers may sometimes suggest that our calibration of PRISM overemphasizes the high
impact firms at the expense of assigning fewer resources to low and medium low impact
firms. Probably that is not the majority view in the present audience, and I think it is clearly
wrong during this period of post-crisis repair of the main firms. However, it is something
which we are keeping under review.
Our engagement model will also evolve in tandem with European developments. The
convergence of prudential supervisory practice and enforcement policy has long been talked
about and stated as a worthy aim, while national supervisory authorities went about their
ordinary business. Only Colleges of Supervisors, for internationally active insurance and
banking groups, gave a modicum of substance to this aim. But the time of actual common
supervisory practice and enforcement, as set out by European authorities with the powers
and the resources to ensure adherence, is about to come. For euro area banking
supervision, the SSM is actively writing a supervisory manual which already runs to 700
pages, and it has commenced the recruitment of staff in Frankfurt to implement the model in
the banks it will supervise. Much of the PRISM model approach and reasoning has been
taken on board by the SSM; it will have been one of the main precursors of the SSM
approach - but it will be superseded like all national models by the single euro area
supervisory approach in banking.
In insurance, convergence will not be as strong nor come as fast. There is no institution that
can play the role of the ECB, and Solvency II will come into force two years after CRD 4. Yet,
in the coming years, EIOPA will endeavour to work on increased convergence of supervisory
practices. EIOPA and its staff will step up its review of national approaches, and will likely
develop a cohesive supervisory manual for insurance in Europe.
Enforcement
For supervision to be successful it must be underpinned by an appropriate recourse to
enforcement. Enforcement is a necessary component of any effective regulatory framework.
Where regulated entities fail to comply with their regulatory requirements, enforcement is an
important tool to effect deterrence, achieve compliance and promote the behaviours and high
standards that we expect. We aim, through our approach, to leave little doubt that where
there is clear evidence of regulatory breaches, enforcement action by the Central Bank may
follow. We have been active in taking enforcement cases against regulated firms. Last year
alone, fines totalling over €8.4 million were imposed on firms. Enforcement will remain an
integral part of our strategy and this is in keeping with best international practice.
The responsibility for ensuring regulatory compliance, of course, lies not only with the
regulated entity, but also with those holding relevant functions within the firms. On the basis
of the Central Bank Reform Act 2010, we have put in place a pre-approval process for
persons who apply for relevant positions (called Pre-Approval Controlled Functions or PCFs)
in regulated firms, to ensure that they meet the required standards of fitness and probity.
This approach is very important since business decisions do not just happen, it is the people
who run business who take them. If concerns arise that a person or persons in Controlled
Functions in a regulated firm do not meet the required standards of fitness and probity, they
may be investigated by the Central Bank and could ultimately be prohibited from carrying out
a Controlled Function in their firm, or any other regulated firm. These powers equip us to
ensure that the people in senior roles are capable, competent and act with integrity.
The Central Bank will continue to focus on anti-money laundering compliance. In early 2016,
the Financial Action Task Force will review our compliance and Ireland has much to lose if its
adherence with the highest standards of anti-money laundering procedures is left open to
doubt or criticism. Our current self-assessment is that we have a distance to travel in this
area if we are to reach international standards or best practice. It is likely that the current IMF
review will concur with this view. It is therefore important that we continue to focus on this
area and you can expect our supervisory focus on AML to remain high.
Consumer protection
The third level upon which financial regulation operates is that of customer protection - one
in which the Central Bank of Ireland has been very active at a domestic, EU and international
level, not least in 2013. Our overarching aim here is "to get it right for consumers" and this
mission is underpinned by our 5Cs framework. This framework focuses on achieving
outcomes for consumers under key headings: Placing the Consumer at the centre of the
regulatory framework, promoting a consumer-focused Culture (as in our ongoing work on
sales incentives across the sectors, the importance of which is borne out by the level of
redress we are requiring in the area of payment protection insurance), enforcing Compliance
including through sanctions where appropriate, instilling Confidence in financial services,
products and regulation (including through the extension of our remit into emerging areas
such as debt management) and Challenging ourselves, those we regulate and others to get it
right for consumers. As we draw up our plans for 2014, we continue to enhance this
framework and challenge the firms we regulate. I believe that by putting the long term needs
of consumers at the heart of your business models you can not only deliver quality financial
services but also play your part in restoring confidence and contribute to safeguarding
stability.
A key element of our consumer protection framework is the Code of Conduct on Mortgage
Arrears (CCMA), which is a central part of the framework being used to address the
challenges of mortgage arrears. Mortgage arrears have been a key priority for the Central
Bank for some time and we are now starting to see some progress in terms of addressing
these issues. Our work has been driven by the need to ensure fair and reasonable treatment
of consumers through the CCMA and the need for lenders to move away from short term
forbearance measures to long term sustainable solutions. The Central Bank has pushed hard
for lenders to resolve the high levels of arrears cases by applying long term sustainable
solutions.
We have recently published the outcomes of the targets set for the main mortgage lending
banks for the second and third quarters, which the banks were found to have met. However,
a key focus of our work was not just in determining a pass/fail for the banks, but on a
comprehensive audit of the banks' processes of determining and proposing sustainable
solutions. A number of issues were identified which will need to be addressed by lenders to
ensure that the solutions they are applying are sustainable in the longer term.
Another central area of focus for our consumer protection mandate is the Safeguarding of
Client Assets,. Our review published in March 2012, made a number of recommendations
aimed at improving the Client Asset Regime in Ireland. It recognised that the existing rules
could be improved so as to provide better protections for investors and so as to be more
workable for investment firms. As a result we formed The Client Asset Specialist Team in
June 2012. It works with the other supervisory teams to fulfil its specific mandate of ensuring
that firms are safeguarding client assets. With the enactment of the new Central Bank
(Supervision and Enforcement) Act 2013, new client asset rules will come into effect next
year.
We will continue to work to enhance our consumer protection framework at a domestic,
European and international level. This will include renewing our attention to the SME lending
sector, where we will be conducting a review of our code, as well as a review of compliance
with the CCMA and following through on our sales incentives, pensions and property
insurance claims reviews. Sales channels will remain an area of focus for us (including
dealing with those intermediaries who have not been engaging with us or fail to meet our
authorisation standards), as will bedding down a robust regulatory regime for debt
management firms. Whether one looks to the (at-times confusing) array of options for
consumers in key staple areas (witness for example the position on health insurance, where
VHI's anticipated application for authorisation would give us full coverage of this market for
the first time), the challenges faced by consumers in understanding the implications of long
term pension investments in these uncertain times or key European initiatives such as the
Payment Accounts Directive, it is clear that our consumer protection mandate is a live issue
of relevance to citizens' daily lives.
Conclusion
Our regulatory agenda continues to be a full and challenging one. The continuing
developments at European and international level will ensure we have a full schedule for
2014, notwithstanding the issues at home.
I am keenly aware of the importance of a level playing field for your firms. Some of your
activities are mobile and the Irish regulator cannot go it alone to make up for issues that
arose in the past. But equally Ireland will not align itself with every piece of domestic
regulation in Europe that appears more favourable to the financial industry. Your regulator
works under the watchful eyes of the country and heightened international standards and
reviews. Past failures are still very much with us. And the last few months have uncovered
new instances of ill-advised underwriting and debatable provisioning judgments, ineffective
internal and external auditing or follow-up to such auditing, and weak governance in areas
across all of the financial sector that remain still too frequent for comfort or complacency.
Each instance works against the rebuilding of the public trust that you work hard to foster.
The knock-on effect of new failures on costs, reputations, and the country, would be severe.
Hence our renewed commitment to the high standard of supervision introduced by my
predecessor. I am confident that with it, the Central Bank is on the right path to deliver its
mandate, and our work in recent times has shown, in practical terms, the outcomes of
successful supervisory engagement.
Thank you for your attention.