The Ludwig report analysis of the failings in Allfirst Bank and the recommendations made have already resonated through the international banking markets and regulatory agencies.
They are almost certain to prove, in retrospect, the catalyst for a restructuring in risk management and, equally important, in what is perceived to be the trading-based culture and mindset of the major banking institutions. The report's recommendations also provide significant food for thought for the international regulatory authorities - because internal control systems were subverted with a knock-on effect on the bank's capital resources. There is also the fact that these deficiencies remained undetected not alone within the institution but also from the scrutiny of external auditors and supervisors.
These are centrally important issues and no doubt will receive attention in the outstanding reports on events at Allfirst. But there is another issue which has attracted scant attention but may prove to be the single most important impact of Mr Ludwig's report.
It was not within his remit to evaluate the adequacy of the existing regulatory system in Ireland nor, more importantly, of the prospective regime involving the establishment of a Single Regulatory Authority. Nonetheless, albeit unintentionally, the Ludwig report provides such an opportunity. Due to be introduced before the end of the current Dβil term - is a Bill which proposes extensive changes in regulatory arrangements. There are several important issues. One is that consolidating such arrangements in respect of prudential and solvency requirements - across credit institutions, insurance companies, and the financial markets and exchanges through which they trade - is sensible. Developments in domestic and international markets, involving a convergence between banking and insurance, points to the need to adapt Ireland's formerly compartmentalised approach to regulation into a single agency. At present it spans several Government Departments and bodies.
The second issue about which the different institutions and Government Departments argued was whether this institution should be a "greenfield" agency or encompassed within the Central Bank which, over the last 10 or 15 years had, de facto, evolved as a quasi-prudential regulator - with the single exception of insurance.
While different views were expressed, there was always a compelling case for devolving responsibility for solvency requirements and supervision of insurance institutions to the Central Bank. The reality is that the Bank, responsible for monetary policy within the European central banking system, had to have responsibility also for the stability of the institutions. Banking and insurance institutions in global financial markets are inextricably linked and are the markets through which monetary policy is transmitted.
The third point - the crux of the matter - relates to bringing responsibility for prudential and solvency requirements in together with consumer protection, including conduct of business arrangements. That is what the Bill proposes.
The proposed Single Regulator, encompassing both prudential supervision and consumer protection, was born of the scandals within the Irish financial services sector of the 1990s. Following the Report of the Implementation Advisory Group on the Establishment of the Single Regulatory Authority (the McDowell report) in 1999, there was an extensive period of trench warfare as key institutional stakeholders fought over location, remit and structure of the proposed Single Regulator.
In February 2000, the Tβnaiste and the Minister for Finance, Mr McCreevy, said agreement had been reached on a structure and that the Government would be putting forward proposals for implementation.
Essentially what is proposed in the Bill is a regulatory structure - the Central Bank of Ireland and Financial Services Authority (CBIFSA). This will encompass a new authority - the Irish Financial Services Regulatory Authority (IFSRA) - which will be responsible for prudential regulation of banking and insurance and also for consumer protection. The proposals also envisage an interim board which will appoint a chief executive and a director of consumer protection. But on the establishment of the IFSRA, the latter will take over the functions of the Director of Consumer Affairs.
If you are confused at this stage, do not read on. Because the new structure will also include an Irish Monetary Authority (IMA) whose job it will be to "carry out the administrative functions required by the role of the Governor within the ESCB and to manage the external reserves": a task it should be said which has moved along effectively within the existing Central Bank system for quite some time.
The Central Bank Act requires banks to have regard to the quality of their internal control systems, which are monitored by the bank. The experience at Allfirst and in other banks where there was a trading-related collapse in internal controls demonstrates the impact which a subversion of these controls can have on capital adequacy and the bank's overall solvency.
It is never sensible to overstate an argument. And it is certainly the case that the proposals in the Bill and outlined above have received the most detailed consideration from experts, at a policy and a political level. Nevertheless, one is inevitably forced to conclude - especially after the Ludwig report - that this element of the Bill is flawed, overly complex, and compromises seriously the capacity of a Single Regulator to undertake its prudential responsibilities. Equally important, it is also very much a "second-best" instrument for consumer protection, compared with existing arrangements in financial services.
Can anyone seriously imagine that the proposed regulatory arrangements, embedded within an organisational structure that is elephantine to put it kindly, could possibly deal effectively with a sudden systemic crisis either within the Irish financial system or in the wider European and global markets of which Ireland is now a small subset?
The Bill should be withdrawn and these provisions recast. The reality is that prudential supervision and consumer protection have a very different focus. They deal with different issues and require very different skills and competencies. It simply makes no sense whatsoever to lump them together within a single organisation. There is a very real possibility of a conflict of interest leading to one gaining an ascendancy or crowding out the other.
To put this more positively, it makes far more sense to have one institution - the Central Bank - focusing on prudential and solvency issues which feed directly into its role in implementing monetary policy within the ECB; and a separate institution with a clear and undiluted focus on consumer protection. Such a structure would contribute to simplicity and allow each agency to get on with its respective responsibilities. This would not be possible with the Bill's proposed structure.
Ray Kinsella is director of the Centre for Insurance Studies at the Smurfit Graduate School of Business and author of Internal Controls in Banking
