Mr. Dargan Fitzgerald:

Thank you, Chairman. Good afternoon. My name is Dargan Fitzgerald, I am an audit partner, specialising in the audit of financial institutions, and EY Ireland's audit compliance partner. I was the audit partner for EBS for the years ending 31 December 2007 and 2008. I am happy to endorse the comments made by Paul and I would like to add some detail regarding our audit of EBS.

Paul has addressed a long-standing question on the role of audit and the apparent misapprehension that it was the role of auditors to advise on banks' prospective commercial lending strategies, strategies which proved extremely successful for some banks for some years, but which ultimately left the banks exposed in the global recession. As Paul mentioned, auditors do not advise on the business models which our clients adopt. We do not advise clients on the wisdom or prudence of their commercial decisions. Stakeholders do not and should not look to audits to provide commentary on business risks. Auditor independence is a fundamental principle and we could not provide an independent audit while simultaneously advising management.

When considering the impact of the banking crisis on EBS and the commercial strategies it adopted, the turning point as identified by various investigations into the crisis appears to have been the board's decision in 2005 to follow the example of its competitors by increasing its exposure to development property lending. While the board of EBS has since described that commercial strategy as, I quote, "a mistake", I have no reason to doubt that it was adopted in good faith by the EBS board at that time. I know that the board was satisfied that such a commercial strategy was in the best interests of EBS. As far as I am aware, the Financial Regulator did not raise an objection at the time. EY Ireland was not consulted on the decision to adopt this strategy. Our firm had no role in the EBS decision to adopt that commercial strategy in 2005. On the contrary, as statutory auditors, it was important that we were independent of this commercial decision making.

Nevertheless, if, during our audit work, we became aware of control weaknesses or of issues which gave rise to a significant risk of misstatement of the financial statements, then we would draw these matters to the attention of those charged with governance. There were various issues that we identified and raised with management over the years, as can be seen from the core documents which are before the committee.

However, future commercial decision making and its associated risks and financial consequences were matters for the board. It was the auditors' role to express our view as to whether the financial statements fairly presented the institution’s financial performance for the particular period. In our opinion, the EBS financial statements did so. For example, the 2008 annual report presented by the directors, which accompanied the financial statements, acknowledged the unsuccessful commercial strategy and the resulting losses and impairment provisions as at 31 December 2008. The 2008 annual report, presented by the directors, also disclosed that those provisions and losses were likely to increase in subsequent periods.

Now with hindsight, the banks’ business models and lending practices have attracted universal criticism. I agree that, in the light of what transpired from 2008 onwards, many of the banks’ earlier commercial decisions have proven extremely damaging. The exposure of individual institutions in Ireland and elsewhere became increasingly obvious as the credit crisis developed. By the time Lehman Brothers collapsed, it was evident that the banks were in serious difficulty. By that time, far less development lending was taking place in Ireland in any event. The board of EBS had taken the decision to stop development property lending by April 2008. However, by then the damage had been done before the frailties of the system had been laid bare when global liquidity abruptly dried up.

The need for foresight on the part of those responsible was greatest at the time at which the banks embarked on development lending at what, with hindsight, we now know was the height of the boom. I cannot say that the auditing profession foresaw these developments any more than any other stakeholders did. However, unlike the directors and the prudential regulator, our primary responsibility was to provide an opinion on the past year’s financial statements and to consider the risk that those historic financial statements were misstated. A statutory audit is not designed to anticipate future trading risk. That would be akin to a corporate finance role, a very different function. The auditors did not make any assessment prior to the 2008 audit that EBS’s business strategy left them unacceptably exposed in the event of a future financial crisis, nor, as I have outlined, was it the auditors’ responsibility to do so. We were aware, as auditors, that EBS had changed its commercial strategy, increasing its development lending. This was following a strategy which was widely viewed as being successfully pursued by other Irish banks. Our approach to the audit of the last year’s financial statements reflected our understanding of the strategy being pursued. It was not our role as auditor to advise on the mix of commercial and residential lending which EBS should adopt in the future. Nevertheless, if the auditors had been concerned about the wisdom of EBS increasing its development property lending, what could or should they have done? Disagreement with the bank’s commercial decisions would not have been a basis to resign or to qualify the previous years’ financial statements, unless, for example, those financial statements were misstated or there were corporate governance issues which had led the auditors to doubt the integrity of management. Furthermore, the auditors were constrained by client confidentiality and could only have divulged confidential information to the Financial Regulator in limited circumstances, such as where there had been a regulatory breach. None of these three scenarios had occurred in the case of EBS. Accordingly, the auditors’ only option would have been to ensure that the directors were fully aware of management’s actions. In this case, as is clear from their annual reports, the directors of EBS were aware of and had endorsed the increase in development lending.

I agree with Paul that we carried out high-quality audits of EBS’s financial statements throughout the period. In preparing for the session, I discussed the changes that have taken place since the financial crisis with Paul and also the changes that could happen in future. I will briefly outline the changes that have been implemented already.

First, dialogue with regulators is an important consideration. At the time, auditors did not have an open channel of communication with the Financial Regulator. Bound by client confidentiality, auditors were limited in the information they could divulge, except in exceptional circumstances such as a suspected regulatory contravention. I should be clear that, as audit partner, I had no particular concerns or no particular information in respect of EBS which I felt should be divulged to the Financial Regulator. That said, the desirability of a more open and two-way dialogue with prudential regulators is a clear lesson from the crisis. Progress has indeed been made on this point. The Central Bank’s auditor protocol provides a framework for auditors to raise issues about financial institutions with the prudential regulator, now the Central Bank of Ireland. This is welcome and consideration should be given to placing this on a formal basis and to enabling communication in both directions. The Financial Regulator, who has greater market-wide visibility, may well be able to inform the auditor's approach to the audit, ensuring that the auditor can take account of the regulator’s concerns during their audit work.

The second area where progress has been made is on accounting standards. Accounting standards provide a common international approach to the presentation of financial statements, just as auditing standards promote consistency in approaches to audit. Changes have been made to accounting standards to allow financial institutions to report unexpected losses in their loan book, as well as reporting actual incurred losses. The need for this change was recognised internationally in the wake of the banking crisis. The standard setters have worked hard to engage with all stakeholders following the crisis, including EY, and I welcome this change.

Thirdly, I support strengthening the role of audit committees. I believe that audit committees should be strong, dedicated and fully engaged in carrying out their functions. They are there to represent shareholders and to challenge management. Strong audit committees ensure financial reporting is scrutinised and challenged. Again, this is an area where progress has been made but more could be done.

Finally, and perhaps most significantly, changes have been made in prudential regulation and in capital requirements for banks through Basel III and other regulatory initiatives. The committee will be well aware of the scope of these changes and of their impact. Prudential regulation and international capital requirements, the responsibilities of the board, especially non-executive directors and management, all play their own roles. However, it is important to emphasise that audit forms only one part of the wider system of assurance available to stakeholders. It is important that audit, as part of this system of assurance, continually improves and becomes more useful to all stakeholders. Therefore, as we look to the future, I’m happy to endorse Paul Smith’s three recommendations.

That concludes my statement and I welcome any questions the committee might have.