Mr. Brian Patterson:

The regulator had no powers to investigate the affairs of bank customers. After the crash, it emerged, as we know, that some large developers had never been asked by their bank to provide a statement of affairs nor had the bank properly assessed their net worth. In hindsight, the executive should examine ... should have examined this more closely and, if necessary, forced the banks to improve the standards of inquiry on which they based their lending decisions. The prudential pack did not include micro-trend statistics which could've become the focus of discussion had they been present. This reflected the view that the regulator was a micro-prudential supervisor only, with a mandate to ensure every individual bank had strong capital ratios, rather than to analyse if risk was building in the system as a whole.

Much has been said on the subject of sector limits. It is my understanding that the Central Bank had effectively relaxed these limits in the 1990s, prior to the setting up of the Financial Regulator, in order to encourage the development of the IFSC and in particular to facilitate the arrival of one large foreign bank which had a major sector exposure. It was then felt that foreign and domestic banks had to be treated the same, a level playing field, in order to avoid giving substance to any impression that Ireland was host to an offshore centre that was being treated more lightly than its domestic banks. Furthermore, sector limits are notoriously difficult to define and so were used more as guidelines than rules. And as banking supervision got closer to the full implementation of Basel II, it became less and less tenable to give any weight to sector limits, which were to be superseded by the Basel II approach. Nevertheless, and again in hindsight, while sector exposure was monitored by the executive, we paid insufficient attention to this indicator.

The regulator paid close attention to the Central Bank’s stress tests, which were largely carried out in the banks themselves under supervision of the Central Bank. As presented to the authority, they indicated that even under their most pessimistic scenarios, for example, slowdown in economic growth, rise in unemployment, the banks were well capitalised and capable of withstanding any external threats.

However, in hindsight they did not factor in, number one: the degree of reliance on international wholesale funding which, as events were to prove, was highly volatile - the banks were borrowing short to lend long; two, the risk of a calamitous collapse in property prices and the consequent impact on the banks’ balance sheets; and, three, severe economic recession, which impaired the ability of borrowers to repay loans. The authority took great comfort from the results of these stress tests. Had they shown a risk to any bank’s solvency, let alone to the banking system as a whole, the alarm bells would have been ringing loudly and action would surely have followed.

The annual financial stability report, as you have heard, was issued by the Central Bank in each of the years 2004 to 2007, inclusive. The report was prepared by a joint Central Bank-Financial Regulator committee under the chairmanship of the then director general of the Central Bank. The report was based on the Central Bank’s economic analysis and most recent stress tests, plus input from staff in banking supervision. Even though the magnitude of the risk was not properly understood, there was often disagreement in this committee about how strong the report should be in identifying risks to the banking system. The report was finalised by the Governor and the board of the Central Bank. As the clouds gathered, there were concerns that a strongly worded financial stability report could have resulted in the unintended consequence of causing the very collapse the Financial Regulator and the Central Bank were seeking to avoid. However, the Governor had regular one-to-one meetings with the Minister and it was believed that he could be more direct in private than he could be in public.

The authority was also given a false sense of security by a series of external reports: number one, audit reports on the regulated banks, which did not raise any concerns about liquidity or solvency; number two, the 2006 IMF financial sector assessment programme report, which gave the banks and the Financial Regulator a glowing report; number three, the PwC 2007 report, which again concluded that the banks were in good health and able to weather any storm; and, number four, the IMF report of September 2007, which found that the banking system is "well capitalised, profitable and liquid, and non-performing loans are low". Again, the authority took great comfort from these reports. They seemed to confirm what the internal processes and reports were saying, that is, that the banks were well capitalised, and could withstand any downturn or external shocks.

To summarise this section on practice, the regulator was operating a system of principles-based regulation, which was internationally accepted as best practice at the time. It was also embedded in the Basel II accord, a regulatory system to which the Irish Government was committed and which called for dramatic increases in data gathering from the banks. Implementing Basel II challenged the Central Bank’s IT capability and diverted banking supervision staff from normal duties. None of the many internal processes or external reports that I have described raised serious red flags about the banks’ viability or pointed to any of the cataclysmic events that were to follow. Had any of them shown a risk to the banks' solvency, let alone to the banking system as a whole, the alarm bells would have been ringing loudly and the authority would have been impelled to investigate and to take action.

In conclusion, Chairman, the Financial Regulator had an overly complex structure with an extremely broad mandate, which emphasised consumer protection as the main priority, with constrained powers and limited resources devoted to banking supervision. The complex entanglements with the Central Bank also limited the regulator’s effectiveness in a number of ways. However, shortcomings in the structure do not alone explain why the system failed. The regulator’s processes and reports and the findings of external scrutineers, any of which should have raised red flags or sent warning signals, all failed to do so. As a result, the authority simply did not see the enormity of the risks being taken by the banks themselves and the calamity that was to overwhelm them through the speed and severity of the crash. Had we known then what we know now, we would, of course, have acted more strongly and used whatever powers were at our disposal with the forcefulness required to rein in the banks’ lending. But we did not know then what we know now. And so, as a key part of the defence against banking failure, the Financial Regulator failed in its responsibility to uphold the safety and soundness of the Irish banks. As a former chairman of the authority, that is something I will forever regret.

Thank you, Chairman.