The Faldor debacle could not happen under current regulations, writes Ray Kinsella, who says the only effective regulatory system is based on ethics.

The successive disclosures of failings in controls, procedures and, most important of all, in practices, have made this a bad week not only for AIB but, even more importantly, for the wider Irish financial services sector.

And it's not over yet. Sometime over the next few weeks the report commissioned by the Tánaiste, Ms Harney, into failings at National Irish Bank (NIB) will be published. Once again, the whole issue of the subversion of consumer's trust in financial institutions will be debated.

The "high-trust" relationship between the consumer and the management of the financial service provider is the "contract" on which all of the other elements of the value-proposition to the customer - efficiency, transparency, competition and innovation - must be built. Trust is hard-won and, in the absence of integrity and leadership, easily lost.

There is an important distinction between what might be called the "foreign exchange reporting debacle" - which was a reporting failure compounded by corporate communications breakdown - and the disclosure regarding the AIB Investment Management/Faldor off-shore banking scheme, which spanned from 1989 to 1996.

The first issue deals with operational efficiency and, of course, it's hugely important. But the second one strikes at the very heart of what banking and financial services are all about, namely "fit and proper standards" in management.

A failing to appreciate just how important core banking values and practices are to the trust which customers and other stakeholders invest in management is something approaching a "black-hole" in the vision of an institution's management.

Some hard things have to be said. The first one is this: the short-term shareholder-value maximisation model on which banking, and particularly investment banking, has been based is fatally flawed. The notion that an institution, the life-blood of which is integrity and trust, can operate by looking over its shoulder every quarter at its share-value rating is absurd.

The "dance of death" whereby stock analysts, the large institutional investors and top management each try to second guess one another in predicting and messaging forecasts, has been at the heart of the collapse of the short-term shareholder value model in the US.

It has caused enormous collateral damage and the regulators, notably the Securities and Exchange Commission, have wreaked a savage vengeance on the major banks for buying in to such a model.

The victims have not only been the consumers and small investors but also middle and lower-grade management who have been cajoled and bullied into accepting a code of values that was entirely alien to that which they instinctively felt was right.

The responsibility for this rests unequivocally with a wholly flawed view of leadership. Leadership, as the Harvard Business Review has pointed out, is "humility with fierce resolve".

In the Republic, the culture of greed, which characterised the late 1980s and early 1990s was a societal phenomenon, which inevitably infected the financial services sector. But that has changed.

The DIRT and other related scandals sensitised people to the erosion of the "high-trust" relationship that was being subverted by perverse incentives, corrupt sales practices and "mé féin-ism".

The whole regulatory and compliance system has now changed. It's important to point out that the Faldor debacle, disclosed by AIB on Thursday, simply could not have happened after the Investment Intermediaries Act was enacted in 1996. This Act put in place codes of practice that are effectively binding.

Equally, within AIB, the enormous investment in risk management and compliance initiated post-Rusnak would wholly preclude the possibility of such practices today.

The regulatory system now in place vindicates the right of consumers to expect a set of ethical principles that permeate the whole organisation.

What has also changed is the scale and scope of financial regulation. We are now looking at an infrastructure that embraces not only the Irish Financial Services Regulatory Authority but also a wider network of agencies - including the Criminal Assets Bureau, the Office of the Director of Corporate Enforcement and the Revenue Commissioners - all of which are now communicating effectively with each other.

It would be wrong not to acknowledge that financial institutions - as well as the regulators - have also "raised their game". To a public that is jaded by a drip-feed of debacles that may seem cold-comfort. But it's the truth.

I have seen it in my classroom, where post-graduate students have talked with the leaders of these agencies and with management responsible for implementing internal controls and the implementation of compliance. It is a different world, compared with even five years ago, into which my students are moving.

The new reality is that the Irish financial sector is now regulated more rigorously and according to higher standards than at any time in the past.

This is not in any way to condone the legacy-old sins that are being revealed. Instead, it is to welcome the fact that the financial services industry, which employ's 10s of thousands and serves as the central nervous system of our economy, is now encompassed within a rigorous and transparent compliance system. And that's important, because that is the benchmark against which international investors, fund managers, service providers and rating agencies assess the credibility of our economy and the standards by which Ireland Inc operates.

That is why we do not need more regulation. From the perspective of the customer this just adds to costs and undermines competitiveness. And no amount of regulation can wholly guarantee protection against subversion.

That's why, when the governor of the Central Bank meets with the Oireachtas All-Party Committee and the public service, the emphasis should not be on more regulation but on implementation and, more especially, the need to focus on corporate culture and ethics.

The key point is this. In all countries, including Ireland, we are witnessing a profound shift in what can only be termed as the "regulatory paradigm" within which financial institutions operate. We have moved from "box-ticking" regulation, through corporate governance, to a realisation that the only truly effective regulatory system is based on ethics - "obedience to the unenforceable".

Prof Ray Kinsella is based at the Smurfit Graduate School and is author of Regulation, Corporate Governance and Ethics in Financial Services.