by Shane Ross
O’Reilly-Hyland is now eighty-three, living much of his life abroad. According to Maureen Cairnduff, a society hostess of the eighties and author of Who’s Who in Ireland, he and his wife are ‘beautifully preserved and still exude charm’. Professor Dermot McAleese, a fellow director of the Central Bank with O’Reilly-Hyland, confirms that he was a ‘delightful person’.
The High Court inspectors refused to mince their words in their report on the Ansbacher deposits. They blamed the Central Bank for failing to follow its own nose in pursuit of the accounts. They condemned the Central Bank for accepting Traynor’s promise to run down the scam. They even suggested that the Central Bank should have known on the evidence available that Traynor was lying.
Ansbacher and other banking scandals at last prompted moves to reform bank regulation. These moves commenced against the backdrop of Ireland’s adoption of the euro between 1999 and 2002. We no longer had our own currency, with the power to devalue or revalue; nor did we have the right to set our own interest rates. Questions began to be asked about what the governor of the Central Bank, his army of economists and the currency gurus down in Dame Street were going to do for a living. A re-examination of the Central Bank was long overdue.
Meanwhile, a turf war was brewing between the Department of Finance and the Department of Industry and Commerce. While the need for a single regulator for all financial services was now agreed upon, there was no consensus about which arm of the state was going to pull the strings. Two political heavyweights, Minister for Finance Charlie McCreevy and Minister for Industry and Commerce Mary Harney, good friends in private life, went to war over who should regulate Ireland’s banks, insurance companies and lesser outfits.
McCreevy, an instinctive sympathizer with the cause of the banks, favoured the Department of Finance’s line that little change was required. Harney, a consumer champion, wanted a new financial regulatory body to be independent of the Central Bank, in order to protect punters from the worst excesses of the banking vultures. Harney was supported from the sidelines by Michael McDowell, temporarily out of the Dáil but serving as chairman of the Progressive Democrats, who wrote the definitive report on how to make a new regulatory body work.
McCreevy was the eventual winner, securing a hybrid model which left the balance of influence with the old Central Bank. A new Financial Regulator was given limited autonomy. The membership of its board overlapped with that of the Central Bank. The result was a fudge, well illustrated in the gobbledygook posted on the Financial Regulator’s website to explain what the two outfits do.
The roles are complementary and we enjoy the closest cooperation with our colleagues in the Central Bank. Indeed the recent and ongoing market turbulence has reinforced our view that prudential supervision, financial stability and consumer protection are inextricably linked so as to merit the combined approach to supervision that our structure demands.
There was no break with the old mindset.
Nowhere was that more apparent than in the appointment of the Financial Regulator’s first chief executive, Eugene McErlean’s Central Bank nemesis Liam O’Reilly, who took the helm of the new body at its inception on 1 May 2003. O’Reilly jumped straight out of the old Central Bank stable. Deeply imbued with the Dame Street headquarters ethos, he was appointed after what Financial Regulator chairman Brian Patterson called a thorough search of the ‘private and public sectors’. Patterson insisted that there was ‘extensive interest from both Ireland and overseas’ in the position. Perhaps there was, but the interview board decided to look no further than the next-door office. The Central Bank’s number two was given the role as the new regulator’s number one.
O’Reilly’s pedigree was predictably dreary. He had been assistant director general of the Central Bank since 1998 with responsibility for its supervision functions, precisely the area that had not covered itself in recent glory. Before that he had held all the dullest jobs imaginable in the Central Bank. In short, he was a man hardly likely to bring radical thinking to his new post.
In an ominous response to his appointment, O’Reilly declared: ‘I know we already possess within our existing regulators a team of young, talented and dedicated staff.’ Far from a new outfit sprouting up, many Central Bank staff merely found themselves re-employed under a new flag. O’Reilly did not see the need to look any further. Although the structure was about to change, the same regulators with the same approach were set to move offices, just down the corridor. The culture was undisturbed.
Down at AIB headquarters in Ballsbridge they should have been cheering. Bank of Ireland and Anglo Irish Bank must have been equally euphoric. Here they had a man whom they all knew well, sliding comfortably into the hot seat. No danger of any of those free-thinking foreigners, who would not understand how regulation works Irish-style.
The creation of the new Financial Regulator did bring one substantive change: a far sharper consumer profile. Mary O’Dea was appointed to front the budding division, with the title of Consumer Director. Addressing this appointment, Brian Patterson insisted that the board had surveyed ‘a field of very impressive candidates for this position and the selection panel was unanimous in its view that Mary O’Dea was the best person for this job’.
O’Dea had worked in the Central Bank for sixteen years, since her early twenties. The press release announcing the appointment noted that O’Dea came hotfoot from the Regulatory Enforcement and Development Department of the Central Bank, where she had been responsible for policy across all its supervision departments. More sensitive employers would have kept quieter about this aspect of O’Dea’s past, as supervision had never been the bank’s strongest suit.
Once again the interview panel had opted for an insider. Consumer champions without a Central Bank pedigree were rejected.
The scene was set for a new era in the supervision of Ireland’s banks. Never has so much been promised and so little delivered. The delivery on the consumer side was strong on the optics. A website was set up with price comparisons, consumer advice, helpline numbers, surveys, fact sheets, an information centre and a range of services designed to give the impression that the Financial Regulator was the consumer’s friend. Mary O’Dea tried to turn the belated 2004 discovery of the overcharging scam at AIB to her advantage, promising to pursue the bank for every last penny. Here was the punter’s pal, handed an opportunity to restore money to bank customers who had been robbed. But behind the bluster the awkward question still lurked: where were the regulator’s hit squads when the whistleblower was warning them? Why did it take RTÉ to reveal the scandal?
Behind the scenes the Central Bank and the Financial Regulator still shared the same press officers. They shared board members; they shared a building; they shared staff; they shared secrets.
While Mary O’Dea gave the consumer division a vocal and visible start, in the background her boss, Liam O’Reilly, rarely surfaced. He was a participant in Oireachtas committee hearings, when summoned. Unlike O’Dea he was camera-shy. He briefed the media in one-to-one interviews on appropriate occasions, but generally he kept to the twilight zone. O’Dea’s mission was to tell the public how much the Financial Regulator cared about them. She must have hoped that her love would be requited.
Initially it was – partly because the public had no idea that the Financial Regulator had another duty, to ensure that the banks were solvent. To do that it had chosen a ‘principles-based approach’ to regulation. According to Liam O’Reilly’s successor Patrick Neary, speaking in 2007, the principles-based approach ‘places responsibility for the proper management and control of a financial service provider, and the integrity of its systems, on the board of directors and its senior management’.
Decoded: ‘We leave it to the banks.’
The bankers loved it. It was regulation without rules.
Imagine the reaction of Sean FitzPatrick, Brian Goggin, Eugene Sheehy, Denis Casey and Michael Fingleton when they first took their jobs and read the rules, only to discover th
at there were none. Just long-established ‘principles’, which they were expected to respect. Poor Pat Neary spelled them out ad nauseam at an IFSC conference in 2007: banks should be transparent and accountable; act with prudence and integrity; maintain sufficient financial resources; have sound corporate governance procedures; have clear oversight systems; have adequate internal controls; maintain sufficient financial controls and risk policies; comply with solvency needs; produce accurate information when required.
It was a list so banal that only an eighteen-carat crook could argue with it. And in an alarmingly consistent reference to what banks should do about their own liquidity and funding requirements, Neary stated: ‘Banks must assess the most appropriate stress tests and scenario analysis to be applied to their own exposures and operations. This approach is in line with best practice and ensures that proper risk assessment is conducted rather than a tick-box approach.’ If they were worried about their liquidity risk or funding requirements they could decide what to do themselves. This was self-regulation by another name.
In the same speech Neary emphasized that the whole principles-based method of regulation was founded on trust. So trusting was the regulator of the banks that he kept on-site inspections of their books down to a minimum, and gave prior notice in advance of such inspections.
In Liam O’Reilly’s last full year in office, 2005, the Financial Regulator – which was responsible for forty-eight financial institutions – carried out just eight on-site inspections. This fell short of even the watchdog’s own lamentably modest target of inspecting 25 per cent of regulated institutions every year – it had set itself a low bar and then failed to clear it. Worse still, it did not make a single unscheduled inspection of a bank during 2005. All eight banks were given advance warning when the inspectors were coming to call.
Insurance companies had an even easier ride. Only 9 per cent of them were subjected to the rigours of regulatory scrutiny in 2005, and there were no unannounced inspections.
The Comptroller & Auditor General was critical of the number of inspections carried out in 2005, when Neary was prudential director, and he marginally stepped up the numbers when he became chief executive: in 2006 there were thirteen inspections and in 2007 there were fifteen. In neither year was the regime of trust threatened enough for a dawn raid to be instigated. All the big bankers must have slept easy. If the watchdog’s boys were going to drop in, they could expect a tinkle to alert them.
Independent assessments of the Financial Regulator’s performance were hard to find. It did not benchmark itself against global counterparts – many of which have rules to govern their banking sectors, not merely principles.
Until 7 October 2008 not a single Irish bank or banker had been fined as a result of inspection; banks that were found to have overcharged their customers had merely been compelled to restore the money. In response the Financial Regulator justly pleads that it did not have powers to fine until 2006; but even then, it failed to use them. In the UK – proud home of ‘light-touch’ regulation – the Financial Services Authority levied an average of £14 million in fines on banks and building societies between the years 2002 and 2007, and more than £27 million in the eighteen months from January 2008 to June 2009. While Ireland’s bankers had been spared any punishment at all for their sins, during that period the Financial Regulator had fined the Irish Times €10,000 and Phoenix magazine €5,000 for minor offences.
Eventually, taunted by jibes that he had never fined a bank or building society, Neary slapped a penalty of €50,000 on Michael Fingleton’s Irish Nationwide. In the context of the large-scale malfeasance and mismanagement that had plagued Irish banking for years, the offence was petty. Fingleton’s son, also Michael, a salesman for the building society, had emailed clients following the government’s guarantee of bank deposits, advising them that the Irish Nationwide was now far safer than non-Irish competitors. The government was furious, as any move to use the guarantee for competitive advantage might have offended the already raw nerves of European Commission competition officials. Neary overreacted, seizing the opportunity to fine a financial institution for the first time. His response could have been interpreted as more a nod in the direction of the anger of his political masters than a sudden conversion to regulatory vigilance. It was in any case the beginning and the end of Neary’s appetite for fining the banks.
The nub of the issue had been coldly addressed by the Financial Regulator’s own consumer panel chairman, Brendan Burgess, in 2005. Burgess noted that ‘producing leaflets and codes of conduct’ was the easy part. And then, with lethal precision, Burgess stuck the knife in:
We have seen very little evidence in the year under review that the Financial Regulator had the resolve to stand up to some institutions and individuals who were misbehaving. It appears that this lack of resolve is due to fear of having its decision challenged in the courts and losing. It seems that when challenged by misbehaving institutions the Financial Regulator simply backed down.
The so-called independent regulator – just two years in existence – was a paper tiger, frightened of the banks, and its own consumer panel had said so.
Patrick Neary’s appointment in early 2006 to succeed Liam O’Reilly came as no surprise. Neary’s main competitor for the €260,000 job was the ambitious Mary O’Dea; but the regulatory body’s board was in no mood for its thrusting consumer arm to win a victory over the old guard. Neary had been in the Central Bank since 1971. He wasted no time putting his stamp on the office, baldly stating at the 2006 Regulation 360 Conference that, ‘Our regulatory approach is good for business… We will seek to implement rules to the minimum extent necessary.’
Neary was as good as his word throughout his short tenure in the job. In his first annual report, covering 2006, he stated: ‘I am satisfied that the majority of financial service providers operate to a high standard.’
He had come to the post at a time of economic boom. Bank shares were heading for fresh highs and the housing spurt was still in full flow. Nothing would stand in the way of eternal growth and bankers’ exuberance. Certainly not the Financial Regulator. But Neary’s honeymoon was short. In late 2006 the tide began to turn.
Ireland’s stock market – dominated by financials – topped out in February 2007 after years of outperforming most global markets. Now foreign investors started dumping Irish bank shares because of the banks’ heavy exposure to a property sector that had all the hallmarks of a bubble. Meanwhile, in the United States, sub-prime borrowers were missing repayments on their mortgages, which in many cases had been bundled into ‘securities’ that were held by financial institutions all over the world. The uncertainty created by the sub-prime contagion caused banks to become nervous of lending to one another, and this brought about a global credit crunch, starting in the summer of 2007.
As early as 2005 the New York Times had branded Ireland the ‘Wild West of European Finance’. We had shrugged that off, but consistent criticisms of our regulation in the UK press were beginning to hit home in the minds of foreign investors.
A few minor measures were taken to dress the darkening windows. Neary responded to the market turmoil by requiring the banks to give weekly, not quarterly, liquidity reports, though it’s not clear if anyone ever read them; and the banks were forced to set aside additional capital to cover increasingly risky mortgage and commercial property lending. One or two other gestures were made, including setting the bar higher for stress-testing mortgages.
Meanwhile, the plunging prices of Irish bank shares were blamed on derivatives markets, short selling, hedge funds and vague global forces. We were asked to believe that while neither the banks nor the economy could be completely sheltered from outside influences, Irish banks were robust. Similar reassurances were voiced by Brian Goggin of the Bank of Ireland and Eugene Sheehy of AIB, always emphasizing that Ireland had no exposure to the dreaded American sub-prime mortgages.
Bankers and regulators alike were in denial. Ireland’s trouble
was not caused mainly by external forces. It was self-inflicted. We were not exposed to US sub-prime mortgages – that much was true – but we were fuelling a ruinous property inferno of our own. The banks, almost unchecked by the Financial Regulator, had embarked on a competitive frenzy of lending. Anglo Irish Bank led the way and all the others followed. Mike Soden, Bank of Ireland chief executive until 2004, admits that he used to ring Sean FitzPatrick after sensational sets of annual figures and congratulate him. Then Soden and his board of directors sat down and wondered how on earth they were going to compete. If Seanie was defying gravity, so would they. AIB, Bank of Scotland, Ulster Bank and the others joined the stampede. Even the two mutual building societies, Irish Nationwide and, eventually, the traditionally cautious EBS, gatecrashed the party. They all competed for the business of property developers, now on the rampage. Neary watched from the sidelines. His beloved ‘principles-based’ system would see them through.
Neary’s self-congratulation in the 2007 annual report is breathtaking. As Ireland’s banks faced into their worst year ever, he wrote:
I believe our actions and increased vigilance and monitoring have provided useful supports to a strong system of supervision which has enabled the industry in Ireland, which had no sub-prime expos ure to any degree, to withstand this prolonged period of serious turmoil in international markets.
Just over a year later, he was out of a job.
The failure was not Neary’s – or Liam O’Reilly’s – alone. The annual stability reports from Central Bank governor John Hurley during the years in which Ireland’s property bubble inflated hardly predicted the doomsday that was approaching. Hurley was the inheritor of a long tradition. He came to the Central Bank governor’s job through a time-honoured route. For decades the secretary of the Department of Finance had – almost without exception – a personal right of automatic succession to the plum job as governor. Consequently, the deeply conservative outlook of the Finance Department was, over time, transferred to the Central Bank. One of the best gigs in the entire state sector was inherited by an insider rather than subjected to competition. One consequence of this was that these two arms of the state often moved in lockstep, and change was not easy to effect.
