Statements on Nyberg Report in Dáil Eireann on 20 April 2011
Minister for Finance
Michael Noonan, T.D.
A Ceann Comhairle,
Yesterday was a sobering day for anyone interested in how a successful economy can in parallel, develop the seeds of self-destruction and how these seeds can take root, grow and develop and eventually create enormous havoc. This is the third year of the banking crisis and I come to the Dáil chamber today in a somber but determined mood.
How it all came to pass is the subject of the Report we have before us today –Misjudging Risk: Causes of the Systemic Banking Crisis in Ireland, Report of the Commission of Investigation into the Banking Sector in Ireland, prepared by Peter Nyberg.
As I said yesterday, this report represents a thoughtful and multi-faceted analysis into the causes of the banking crisis in Ireland and bears careful and measured consideration by all of us in the House.
It requires careful consideration because we have to learn the lessons from these events, about how we got there, and how we managed during the period and about how we dealt with the crisis as it was developing.
Mr Nyberg’s report is a story about bank management who no longer understood what lending was about, and had forgotten the very nature of credit. Providing credit, Mr Nyberg says, is not a sale of bank services; it is the acquisition of a risky asset. The appropriate prudential focus of such a transaction is therefore limiting and mitigating risk (or, at the very least, understanding the real risk and pricing it accordingly) rather than expanding sales. This apparent inability, some might say unwillingness, of Irish banks to remember this basic principle of banking was a major cause of the banking crisis in Ireland.
It is a story about banks, whose boards did not fully understand their role in oversight and control; that, in certain cases lacked appropriate expertise to hold bank management to account.
It is also the story of national authorities who failed to read the macro-economic warning signals which could have indicated a pattern of unsound lending behaviour by banks in a timely fashion and who seriously underestimated the nature and extent of the risks in the Irish financial system and who had not gathered the necessary information. If more relevant information on and analysis of the underlying position of some of the banks had been available, discussions and policy recommendations may have been different.
That is why the report is important. That is why all of us in this house have a responsibility to reflect on it and see what lessons we have to learn from this appalling crisis in order to get back to rebuilding the country, rebuilding its institutions, rebuilding our communities and getting people back to work.
Background to the report and Terms of Reference
The Dáil will recall that the previous Government in January 2010 set out a framework to the Oireachtas for investigation into the banking sector. This investigation consisted of two distinct stages. The preliminary reports published in June 2010 by the Governor of the Central Bank, Professor Patrick Honohan, on The Irish Banking Crisis – Regulatory and Financial Stability Policy 2003-2008 and the report by Messrs. Regling and Watson, Preliminary report on the sources of Irelands banking crisis formed the first stage of this investigation.
The second stage consisted of a statutory Commission of Investigation. The establishment of a Commission of Investigation into the Banking Sector in Ireland was approved by Dáil Éireann and Seanad Éireann on 8 July 2010 and an Order formally establishing the Commission was made by the previous Government on 21 September 2010.
The Commission’s terms of reference which were for the period 2003 to 5 January 2009 were in summary to examine:
a)the main causes of the serious failure, within each of the covered institutions;
b)the main reasons why Anglo Irish Bank Corporation and Irish Nationwide Building Society adopted and implemented business models, strategies and lending practices, which resulted in those institutions experiencing severe financial distress;
c)whether external auditors of the covered institutions commented in their audit reports or other communications to the institutions concerned on the failures I referred to;
d)the main causes for the failures, in the performance of the statutory roles and responsibilities of the Central Bank and Financial Services Authority of Ireland and the relevance in that regard of any advices or directions given by the Department of Finance.
The previous Minister for Finance formally appointed Mr Peter Nyberg as sole member of the Commission of Investigation on 22 September 2010. The Commission submitted the Report to me on 22 March 2011, in keeping with its remit to complete its Report within 6 months. I would like to thank Mr. Nyberg for his work on the report completed so quickly and thoroughly and giving us an analysis that gives us plenty of food for thought.
Findings and conclusion of the Report
In accordance with the Terms of Reference of the Commission, the Report states:
The main reason for the crisis was the unhindered expansion of the property bubble financed by the banks using wholesale market funding. Attendant risks went undetected or seriously misjudged by the Authorities whose actions and warnings were modest and insufficient.
The speed and severity of the crisis was made worse by world-wide economic events but notwithstanding these external factors, the problems causing the crisis as well as the scale of it were the result of domestic Irish decisions and actions. [5.3.1]
Many of the problems and failings in Irish banks and public institutions were similar to those in other countries [ 5.1.1]
Banks set aggressive targets for profit growth. This drive for growth really implied a partial change in business model and strategy without the necessary corresponding strengthening of governance, procedures and practices. [5.2.1]
Boards and relevant observers appear to have had little appreciation of how the banks actually were run at grass-root level; at least they did not seem unduly concerned about the practices referred to above. The inadequate attention banks generally paid to credit risk management is, in the end, evidenced by the extent and nature of their subsequent problem loans. [2.7.27]
Management and boards in general appear not to have fully appreciated the two key risks to which their banks were exposed. These risks were increased exposures to funding-dependent development projects with future refinance risks and volatile wholesale funding [2.9.1] Bank management and boards seem to have been totally unprepared for both of their key risks (property loan impairment and funding problems) occurring simultaneously.
The Report also concludes that for several years before the banking crisis, the authorities operated under the assumption that financial markets generally were efficient and self-regulating. A banking system requires oversight the report says and, when necessary, intervention of alert, aware and empowered authorities. This is because of the economic and social importance of banking, as well as its high leverage, public depositor support and a tendency to exhibit occasional problems. The core policy challenge of the authorities was to recognise early warning signs, within banks and the economy, in time to take pre-emptive action and mitigate any potential threats to financial stability.
The main findings in relation to auditors were
Auditors’ commentary regularly focuses only on issues which they consider relate to the accuracy of the historic accounts. In practice, this means that auditors look primarily backwards and at technical issues that may influence the accuracy of the accounts. The auditors clearly fulfilled this narrow function according to existing rules and regulations. [ES]
there appears to have been no challenging dialogue with the covered banks on their business models and their growing property and funding exposures. [3.9.5]
The Commission finds it unfortunate that sufficient, timely and challenging auditor dialogue was not used to influence the banks’ business models and lending practices. [3.9.6]
These findings and recommendations set out in the report in relation to auditors are a matter for the Minister for Enterprise, Trade and Innovation to consider and I have written to him seeking his views.
However, it now appears to me that auditors may be able to take on a more enhanced role in cooperation with supervisory authorities, while recognising their specific statutory functions. The Central Bank is already engaging with the audit profession to explore how it can assist the Bank in exercising its supervisory functions. I will be keen to see progress and developments here.
Building on reforms in the banking sector
In light of the reports conclusions and recommendations contained within the Report on specific areas, I would now like to draw attention to some of the actions that the Government now plans to take to meet the recommendations set out in the Report.
Structure of Banking Sector
The Commission has made recommendations in relation to the structure of the banking sector, stating that it may be necessary to limit the size and growth of banks and the banking system relative to the economy. The State’s November 2010 agreement with the external authorities envisages a programme of deleveraging and restructuring to take place within the banking sector over the next two years.
As you know, I announced details of the Government’s plans in this area following the conclusion of the Central Bank’s stress test results on 31 March. The Government’s plans to radically restructure the banking sector as announced on 31st March last. There will be a structured programme of disposal of non-core assets in the banks between now and 2013 so the two Pillar banks are in a better position to serve the economy as functioning banks and begin to focus on the real job that banks are supposed to do, that is getting prudent lending going again to the productive sectors of our economy so that jobs and investment can begin to grow.
In relation to the Commission’s recommendations on capital, the capital targets announced by the Central Bank on 31 March, which will collectively require the banks to raise an additional €24 billion of capital, will see the banks remain above a minimum capital target of 10.5% of Core Tier 1 capital in the base scenario and 6% Core Tier 1 in the stress scenario. The Banks will additionally, as part of the deleveraging process, be required to realign their balance sheet capital and funding so as to meet the upcoming new regulatory requirements under Basel III.
Capacities of bank boards and management
The Commission’s report is highly critical of the role played by the board members and senior management of banks in failing to properly oversee their institutions. As a result of these board-level failures, I am setting out three measures designed to strengthen Bank Boards and Bank management:
First, the chairman of each institution will have to provide me and the NTMA with a Board Renewal Plan. The Board Renewal Plan will have regard to company law and regulatory requirements and will set out, for each institution, the steps to be taken to ensure that the skills and competence levels of board members are fully adequate to the demands of the current situation and the planned future for the Irish banking system.
Second, the board of each institution will be asked to provide a Management Renewal Plan. The management renewal plan will set out for the relevant institution the steps to be taken to ensure that the skills and competence levels of senior managers are fully adequate to the demands of the current situation and the planned future for the Irish banking system and that each senior manager will be capable of meeting the Central Bank’s new fitness and probity standards.
Third, it is essential that Boards of banks would continue to have an appropriate number of independent non-executive directors. Having regard to the size of its shareholding in each institution, and the necessity of ensuring that the State’s interest is properly represented on each Board, I will actively nominate members of the boards of each bank, from among qualified individuals with appropriate skills and experience.
As a result of recent events the Government now has or will have a substantial stake or a full controlling interest in six credit institutions. The Government is determined that proper governance arrangements should apply, and that the Board of each institution should continue to be responsible for management and policy within the institutions.
Central Bank requirements on corporate governance standards
The Central Bank is also undertaking a wide-ranging programme of reform of the way it regulates the corporate governance and board-level membership of our financial institutions. Last November the Central Bank initiated new requirements, through a statutory code, on corporate governance standards. The Code sets out clear requirements for directors and boards of banks and insurance companies.
As part of this programme the Central Bank launched further proposals for consultation on 22 March 2011 for a new fitness and probity regime for board members and ‘controlled functions’ in banks and other financial sector institutions.
Significantly, the Central Bank also plans to conduct a review of the fitness and probity of all existing executive and non-executive directors at the Irish banks which have received Government support. The Central Bank will assess the incumbent directors against the new statutory fitness and probity Standards, including, where it is relevant, their competence and track record in the period leading up to the financial crisis.
Enhancement in Central Bank Powers
It is also important that we continue to strengthen the Central Bank. The House will be aware that a number of measures have been put in place since the onset of the crisis. These include legislative changes to merge the Central Bank and Financial Regulator and to enhance the powers of the unified organisation. Further enhancements to the Central Bank’s powers will be introduced to the Oireachtas shortly in the Central Bank (Supervision and Enforcement) Bill and these will be outlined at that stage.
Department of Finance
The Report contains important messages and conclusions for the Department of Finance. While this Report relates principally to banking matters, some of these messages may also be of importance to the Department of Public Expenditure and Reform and to Government Departments generally.
Critical assessment and review of past actions can sometimes be difficult, the challenge for all of us is to adapt what we do and in the process changing and improving how we do our business in order to best serve the State and the wider public. This is particularly important for Departments of state. I will take the report from Peter Nyberg and the broader review of the Department that was chaired by Rob Wright and determine how to reform and build the capacity in the Department to service the demands of the economy in these uncertain times.
In addition there needs to be ongoing adaptation and better definition of roles and functions of the Department and the NTMA and its associated bodies to ensure that the structures in place take full account of the developing situation. A stand-alone unit accountable to the Minister through the Department of Finance and with a clear set of objectives to manage the government’s holdings in the financial sector will be created to fulfil the oversight role.
The restructuring of the banks announced already by the Government must be implemented. This will require a hands on approach by the Banking Unit in the Department of Finance, which will drive the reform. This Unit will be strengthened as necessary and will draw on the resources of the NTMA to carry out its work. In the first instance, the Unit will operate within the Department of Finance but in due course, it will become more independent of the Department while still reporting to the Minister for Finance. A detailed implementation plan will be developed in consultation with all the relevant organisations.
Oireachtas Scrutiny of the Report and proposal to hold referendum
Before concluding A Ceann Comhairle, let me address one other point.
The publication of the Commission’s Report yesterday and the statements on the report in the Dáil today provide an opportunity for public debate and consideration of the report. It is important that the Oireachtas have adequate opportunity to consider and discuss the report.
Having consulted with the Attorney General I can confirm that while the publication of the report will not prejudice any criminal proceedings that are pending or in progress, I was also advised that the Abbeylara judgement makes it very difficult for Oireachtas Committees to effectively fulfil their important oversight role. Therefore, as I stated yesterday, the Government proposes to hold a referendum on a proposed Constitutional Amendment by the end of this year to address the consequences of the Abbeylara judgement.
A Ceann Comhairle, the Nyberg report has identified the main causes of the banking crisis. Together with the two preliminary reports they set out all the interlinked elements that, each in their own way, contributed to the financial crisis that we found ourselves in since 2007. But we have to learn the lessons from this crisis and put in place the building blocks for moving our economy on to growth.
This Government are bringing about a radical restructuring of the banks so as they can support economic growth and jobs. Unfortunately, as we have seen in the Report of the Commission and other issues today, there remain legacy issues in the banks that this Government will have to address and is determined to address.