A report examining the performance of the regulatory authorities in the run-up to the financial crisis has sharply criticised regulators, the Government and senior management at the banks.
The report by Central Bank governor Patrick Honohan, who took up the role in September last year, identified a “major failure” in regulation and the maintenance of financial stability at a systemic level.
It said senior managers at Irish banks did not maintain sound banking practices and criticises Financial Stability Reports (FSR) that predicted a “soft landing” for the economy. It said Government reliance on insecure sources of tax revenue was also a contributing factor.
"The Government's procyclical fiscal policy stance, budgetary measures aimed at boosting the construction sector, and a relaxed approach to the growing reliance on construction related and other insecure sources of tax revenue were significant factors contributing to the unsustainable structure of spending in the Irish economy," Mr Honohan said.
“This helped create a climate of public opinion which was led to believe that the party could last forever”.
The report found that lending standards were lowered due to competition, and policies governing adequate documentation and security were “defective”. Stress tests reported in the FSRs were unreliable as none of the banks had reliable models tested and calibrated on Irish data, and the unfavourable macroeconomic scenario taken into account was not severe enough.
"The banks were naturally prone to over-optimism and even (later) denial," Mr Honohan said.
He identified complacency about the performance of “well-governed” banks and an “excessively deferential and accommodating” approach to the banking industry by the Central Bank and Financial Services Authority of Ireland (CBFSAI) that was insufficiently challenging and not persistent enough”.
“It would have been known within the Financial Regulator that intrusive demands from line staff could be and were set aside after direct representations were made to senior regulators,” the report said.
Regulators failed to comprehend the scale of the potential exposure of banks to a fall in the property market, and the CBFSAI appeared unwilling to recognise the real risk and take corrective action to tackle it in time, the report notes.
“Rocking the boat’ and swimming against the tide of public opinion would have required a particularly strong sense of the independent role of a Central Bank in being prepared to ‘spoil the party’ and withstand possible strong adverse public reaction,” the report said.
Mr Honohan also concluded the style of supervision of the CBFSAI relied too much on verifying governance and risk management models, instead of independently assessing risks.
A lack of staff resources contributed to the situation, with only two members within the Financial Regulator allocated for supervision at each credit institution.
“It was already difficult to staff-up to intended levels given the high salaries and plentiful job opportunities available at the time in the financial sector,” the report said.
"There clearly was some friction at board and senior management level between the Financial Regulator and the Central Bank on matters relating to human resources and the quality and cost of services (particularly of IT resources) provided to the Financial Regulator."
He also criticised the financial stability reports, which were “too reassuring”, and did not compel the banks or policy makers to adjust behaviour. The financial stability reports were supported in part by the views of outside bodies such as the International Monetary Fund (IMF) and OECD, and a defensive approach was taken towards those who took contrary views.
The report specifically referenced a financial stability report from 2007 which appeared to reach conclusions based on “selective reading” of the evidence and predicted a soft landing for the economy.
“This appears to have been a ‘triumph of hope over reality’. More generally, a rather defensive approach was adopted to external critics or contrarians," Mr Honohan said.
He said domestic macroeconomic imbalances had also built up in the Irish economy, with Government policy contributing to "economic overheating".
This led governments to narrow the income tax base and lower taxes, and left the public finances highly vulnerable.
Government incentives geared at the construction sector helped fuel the property boom, he said. “This helped create a climate of public opinion which was led to believe that the party could last forever.”
The Central Bank governor also said there was a comprehensive failure of bank management to maintain sound banking practices, and said auditors and accountants should probably have been more alert to weaknesses in the banks’ lending and financial position.
Mr Honohan said Anglo Irish Bank and Irish Nationwide Building Society were on the way to insolvency, even before the collapse of Lehman Brothers in September 2008.
He said Anglo’s business model was thought by many to be “irrevocably broken”. However, the full scale of the problem did not appear to be apparent to regulators.
“In the case of Anglo Irish Bank, management was seen by at least Financial Regulator staff as perhaps ‘slick and buccaneering’ but not as presenting a large or imminent risk,” Mr Honohan said.
He also commented on former INBS chief executive Michael Fingleton.
“The central management figure in Irish Nationwide Building Society was seen as an overly dominating figure that needed to be surrounded by a stronger governance structure,” Mr Honohan said.
“While it was understood by all that he was politically well-connected, the failure to resolve the issue is not attributed by anyone involved to his having a privileged status.”
