ANALYSIS:The Government has brought the transformation of financial regulation full circle – back to a single entity

AND SO the Government has announced the long-awaited plans to reform banking regulation after years of excessive property lending and bank borrowing in the wholesale money markets brought the country’s lenders to the brink.

The Government will create a single regulator under the guise of a new entity, the Central Bank of Ireland Commission, to be chaired by the Central Bank governor. It will supervise both the stability of the financial system and individual firms in that system.

The Minister for Finance Brian Lenihan has decided to consolidate responsibility for financial stability, which is held by the Central Bank, with the supervision of individual firms, which is currently the Financial Regulator’s bailiwick.

Gone is the twin-track approach to regulation which falls under the existing joint regulatory authority – the Central Bank and Financial Services Authority of Ireland.

The current regime, like most regulatory systems across the world, has been shown up to be wholly inadequate, with warnings about over-exuberant property lending and the threat of an international crisis falling through the cracks between the Central Bank and the Financial Regulator.

The reforms spell the end to two boards – the board of the Central Bank and the Financial Services Regulatory Authority – and the creation of one entity with one board effectively under the one roof.

Under the new regime, the Government plans to make the governor, currently John Hurley, the chairman of the commission.

Below the role of governor will be two top-level posts – head of financial supervision and head of central banking – who will monitor the two areas of responsibility that makes up the commission.

The former position is the existing post of chief executive of the Financial Regulator, which is being filled on an interim basis by the regulator’s consumer director Mary O’Dea, following the departure of Pat Neary last January.

The latter position is essentially the director general of the Central Bank in all but name, a position currently held by Tony Grimes.

The changes will mean that the governor whose job has been to issue warnings on the state of the economy and the threats to the banking sector can now act on those warnings. He will have direct control of the supervision of companies and the head of financial regulation will report to him.

“The Government is taking the necessary measures to allow the domestic banking sector to service effectively the needs of the real economy and to restore the reputation of the country as a sound and secure centre of excellence in international financial services,” said Mr Lenihan in a statement.

The approach mirrors arrangements proposed at EU level and will ensure “a cohesive approach between critical elements of effective financial regulation”, he said.

It follows guidelines recommended by the EU report on the reform of banking regulation by Jacques de Larosière, the former head of the International Monetary Fund, published in April.

The Department of Finance has said that the reforms will be supported by “a significant expansion of regulatory capacity within the new structure”. This means the new entity will recruit “substantial additional staff with the skills, experience and market-based expertise needed to meet the objectives of the new structure”.

This includes recruiting staff who have an “expertise to regulate the international financial services sector”, the department said.

The existing consumer directorate within the regulator, which has a staff of about 100, will be broken up and the consumer information and education section, which provides advice, promotes public awareness campaigns and employs 30 staff, will be moved to the National Consumer Agency, which is being merged with the Competition Authority. It’s not clear how many staff will move.

The commission’s headquarters is likely to remain at the current home of the Central Bank and regulator in the existing building on Dame Street in Dublin city centre.

Over 1,000 people were employed at the Central Bank (409) and Financial Regulator (362) at the end of last year, with 237 employees being shared by the two organisations in areas such as IT services and human resources.

The regulator has a budget of €55 million, half of which was paid by the financial sector and the other half by the Central Bank.

The Department of Finance has said that the search for the new head of financial supervision is under way. Sir Andrew Large, former deputy governor of the Bank of England, is advising on the recruitment process, with the assistance of London headhunters, The Zygos Partnership, who are also involved in a search for a replacement for Mr Hurley.

The governor was asked to stay on for several months after his term of office ended in March.

A spokesman for the Central Bank said that Mr Hurley had been asked to say on again for a period of months. He is expected to remain in the job until the autumn by which time his successor is likely to have been appointed and the legislation creating the new Central Bank Commission will have been passed.

Mr Lenihan has previously said that he will break from convention and widen the search for the next governor outside the public sector.

“The traditional practice whereby it is axiomatic that a senior public servant should be appointed as governor of the Central Bank will not be followed by me,” Mr Lenihan told the Oireachtas Committee on Finance and the Public Service last February.

The Government’s reform practically brings the transformation of financial regulation in Ireland over the past decade full circle, back to a single entity.

This week’s opening of the Director of Corporate Enforcement’s disqualification case against former National Irish Bank chief executive Jim Lacey (which he is resisting) is a coincidence. It was improper practices including tax evasion and customer overcharging at NIB – on top of the Dirt bogus accounts scandal in the 1990s – that led to the current system of financial regulation.

A Government-appointed committee chaired by Michael McDowell recommended in 1998 that the supervisory and regulatory functions of the Central Bank be moved to a new regulator.

The motivation behind creating such an entity was to instil greater confidence among consumers and bank customers that regulation would be taken more seriously.

The Progressive Democrats, the junior government party at the time, pushed for the creation of a regulator that would be independent of the Central Bank, but the Department of Finance and the Central Bank resisted the plan.

A compromise was reached and the Central Bank and Financial Services Authority was created in May 2003 with the regulatory function operating as a distinct component alongside the Central Bank.

The focus of the regulator was towards principles-based regulation where the banks and financial firms would abide by agreed codes of conduct and practice laid down by the Financial Regulator.

However, the emphasis of the regulator’s focus was primarily on issues affecting consumers rather than on prudential matters such as liquidity and funding affecting the banks and their lending practices.

This was illustrated by the fact that the regulator’s prudential director, Con Horan – the man responsible for ensuring that banks lend prudently and set aside enough capital for protection – does not have a seat on the regulator’s board, while the consumer director, Mary O’Dea, does.

While the regulator monitored companies, the Central Bank issued regular financial stability reports warning about the main threats to the banking system.

Many of the warnings were not acted upon sufficiently and the system was unable to cope when the banking crisis deteriorated sharply in September 2008.

Occasionally the regulator did act, such as when new rules were introduced forcing financial institutions to set aside more capital against development lending and 100 per cent mortgages.

However, the measures proved too little too late, leaving the banks far from prepared to deal with the property crash. The light-touch regulation also failed as it relied too heavily on the probity of individuals charged with running the financial institutions. Their lending decisions went unchecked by the regulator, leaving the banks and ultimately the taxpayer shouldering massive property losses.