Mr. William Beausang:

With the committee's permission, in my opening statement I would like to summarise three key themes in my written evidence as follows: the Department of Finance's role in relation to financial regulation, the Department's relationship with the Financial Regulator and the Central Bank and financial stability planning carried out by the Department in the period preceding the onset of the crisis, up to August 2007 and thereafter.

From April 2005, I was responsible, at assistant secretary level in the Department of Finance, for policy and legislation for financial regulation. In essence, this related to putting in place, in the Statute Book, the regulatory framework applying to financial institutions. In practice, this primarily involved my unit participating in the negotiation and transposition into Irish law of what was at the time described as an avalanche of EU financial service directives, under the EU financial services action plan or FSAP. The FSAP was designed to put in place a common pan-EU framework for the regulation of the financial sector. This was considered essential to building a single market in financial services in the EU and promoting the provision of financial services on a cross-border basis. Each of the directives was the outcome of an extended period of expert analysis and debate at the EU level. The process involved in advanced ... in addition to finance ministries, the European Commission, committees of the EU financial supervisors and intensive consultation with industry representatives. The financial service directives were regarded and represented as embodying cutting-edge modern models and approaches to financial regulation, such as the state-of-the-art Basel II accord for banks, which I'll say a little bit more about later.

The existence and presumed full implementation of this detailed and comprehensive EU regulatory framework, endorsed at EU level by all member states and supervised domestically by the Financial Regulator, provided very substantial reassurance to the Department as to the safety and soundness of individual institutions and indeed, of the stability of the domestic financial system as a whole. Once this EU-determined regulatory framework had been put in place in legislation by the Department of Finance, the Financial Regulator was responsible for implementing and enforcing it and supervising the financial firms to which it applied. The legislation establishing the Central Bank and Financial Services Authority of Ireland and the EU regulatory framework did not provide the Minister of Finance with any statutory role in overseeing or scrutinising the Financial Regulator's performance or the exercise of its supervisory functions and responsibilities.

Strict supervisory independence was a key principle internationally, such as under the Basel core principles for effective banking supervision. The concept of supervisory independence was also central to the design of the EU framework for financial regulation. The authoritative expert consensus at the time was that banking supervisors should benefit from the same high degree of independence as central bankers. It was therefore integral to my area of the Department's relationship with the Financial Regulator that we should not take any significant action or step which could interfere or encroach on that strict supervisory independence. This was essential to rule out any scope for any perception of political interference in financial regulation and supervision, given the major conflicts of interest that might potentially arise. Any perceived breach of that principle would certainly have given rise to major concerns at regulatory authority level, given the authority's statutory mandate. In addition, the professional secrecy obligations under which the Financial Regulator operated, set out in EU and domestic law, prohibited the disclosure of information held by the Financial Regulator by virtue of the exercise of its statutory role and responsibilities. This was a very wide non-disclosure provision.

The strict independence conferred on the Central Bank under the CBFSAI legislation, and the EU treaties as part of the Eurosystem, created an identical dynamic in terms of my area's responsibilities vis-à-visthe Central Bank on financial stability matters. The stability of the financial system was a core function of the Central Bank under national legislation and the EU statute establishing the European system of central banks. My unit in the Department did not therefore have any legal mandate or statutory role which would have permitted it to seek to critically assess or second-guess the Central Bank's assessments of the financial conditions and the capital buffers available to the banks to deal with economic shocks, as set out in the Central Bank's financial stability reports during the relevant period.

Against this backdrop, the Basel II accord provided what proved to be entirely unwarranted reassurance to the Department that the supervisory, prudential and financial stability systems in the CBFSAI were operating effectively. Basel II was the detailed and comprehensive regulatory regime for determining capital requirements and carrying out bank supervision introduced under the EU capital requirements directive or CRD. The CRD was officially adopted by member states in June 2006 to enter into force from the start of 2007. The very substantial programme of work in both the Financial Regulator and the credit institutions involved in transitioning to compliance with the CRD is evidenced, for example, by the extensive consultation documentation issued by the Financial Regulator in October 2006. Basel II and the CRD were characterised as modernising and making capital requirements for banks more robust, comprehensive and risk-sensitive, fostering enhanced risk management in credit institutions, as well as strengthening financial stability overall. However, as early as February 2009 the high-level group on financial supervision in the EU, commissioned by the President of the Commission to make proposals to strengthen European supervisory arrangements, concluded that the international banking crisis heightened the need for a fundamental review of the Basel II CRD framework. The high-level group concluded that Basel II underestimated some important risks and overestimated banks' ability to handle them, that the Basel methodology seemed to have been disproportionately based on recent past economic data and good liquidity conditions and that these mistakes led to too little high-quality capital being held by the banks.

In summary, from my perspective the sophisticated and technically complex modelling of banks' risks and reliance on risk weightings based on assessments by external credit rating agencies to determine capital requirements under Basel II helped contribute to an entirely misplaced confidence in the capital adequacy of banks and the efficacy of bank supervision, even as the liquidity crisis intensified. Indeed one regulatory expert in his evidence to the UK parliamentary commission on banking standards characterised Basel II as "a complete waste of time". It contributed to a situation where bank supervision seems to have essentially comprised an administrative procedure to review systems and processes for the management of risk put in place by the banks themselves. According to the Nyberg report, prudential supervision comprised tick-box checks that formal procedures were in place, not checks on how they operated in practice. The false sense of security engendered by the CRD was compounded by the outcome of the stress tests reported in the Central Bank's financial stability reports. These extreme but plausible scenarios appeared to show that even if a hard rather than a soft landing occurred for the property market, capital buffers in the bank were adequate.

I turn now to contingency planning in the period 2005 to 2006. Financial stability planning carried out in my unit involved the development of contingency plans for any Government intervention required to resolve an individual financial institution in distress or stabilise the banking system as a whole. There are a number of distinct strands to this work stream in my area of the Department over the period from mid-2005 onwards and an important focus of our work, at least initially, was in reviewing the Central Bank's crisis management manual, the black or red book, and reviewing the case for putting in place a corresponding manual for the Department. It also encompassed a first assessment of the many legal issues that arose in relation to the successful resolution of a distressed financial institution. This included consideration in particular of the legal issues involved in facilitating a market solution, where a large overseas bank might be encouraged to take over a distressed, at risk, domestic institution. It also identified the need to review the legal framework for crisis management, and examine the legal powers that should comprise part of the public authority's toolbox where intervention was required to support an individual institution or the banking system as a whole. There was also a significant EU dimension to this work at the EU financial services committee, at which the Department of Finance was represented at second secretary general level, relating to arrangements for responding to the failure of a cross-border financial institution. A critical backdrop to this work throughout 2005 and 2006 was that the Financial Regulator consistently and strongly highlighted to the Minister and the Department that the credit union movement represented the most significant risk to financial stability in Ireland during ... at that time. In light of the Financial Regulator's assessment of national financial stability risk, in the Department we prioritised the assessment of the credit union sector and undertook and completed a major programme of work to review, assess and respond to the various issues and concerns raised. In parallel we continued to progress broader financial stability planning, tracking developments and recommendations at EU level.

Turning to financial stability planning in 2007 and 2008, in terms of broader financial stability planning, an important focus in 2007 was aligning national planning with developments at EU level, given the growth in the cross-border provision of financial services and following participation in the EU crisis simulation exercise in April 2006. A key next step flowing from deliberations at EU level was the establishment of a national ... of national domestic standing groups, on which work commenced in the Department in the last quarter of 2006. This led to the formal establishment of the DSG, comprising representatives of the Department, the Financial Regulator, and the Central Bank in July 2007. The DSG played a crucial role from August 2007 with the onset of the liquidity crisis, ensuring that the Minister was fully informed of the Financial Regulator's and Central Bank's assessment ... assessments of financial conditions and the funding pressures on the banking system. The stringent confidentiality requirements that I've already referred to would otherwise have seriously inhibited communication between the public authorities and this crucial information flow from Dame Street to Merrion Street. The DSG was a forum for communication and information exchange. It provided the basis for multiple reports to the Minister and Government on financial conditions, many of which are in the public domain. The DSG did not have a decision-making role, nor did it have any joint mandate in relation to the distinct and differentiated responsibilities of the organisations participating on it.

As the crisis intensified in 2008, and as foreseen by the governing documents for the DSG, management of the crisis migrated to the top management level in the Central Bank, Financial Regulator and the Department of Finance, with the NTMA involved from end-2007 and increasingly prominent. As set out in my written statement, from the autumn of 2007 we did seek to utilise the DSG to seek to develop the principles and agree a shared analysis and methodology that would better guide and inform crisis management on a co-ordinated basis among the public authorities. This work did not progress significantly beyond the Department's February 2008 scoping paper on financial stability planning on account of, for example, the important differences in emphasis with the Central Bank's assessment, as reflected in the Central Bank's comments on the Department's scoping paper, and its own paper on resolution options circulated in June 2008, the Financial Regulator's evident preoccupation over that time with the resolution of the CFD-related share overhang issue in one institution and the Central Bank and Financial Regulator's enduring assessment that the crisis was exclusively attributable to international liquidity situation, and the consequent sole focus on supporting bank funding.

The Department, therefore, continued to prioritise over the period, the preparation of draft emergency legislation to nationalise a bank. In early September 2008, this work was reorientated to taking a building society into public ownership on the basis of a major contribution from the office of the Attorney General, and, at a late stage, the Department's commercial legal advisers. By end September 2008, our contingency planning advanced to the point that legislation to do either could be finalised for publication and enactment at very short notice. The draft legislation also contained provisions to set aside competition law requirements to facilitate a market solution, provide financial assistance to credit institutions in the form of guarantees or capital, and provide the required legislative basis for the proposed secured liquidity scheme for bank funding.

In conclusion, my written statement and the supporting document I have submitted to the committee covers the foregoing issues, as well as those lines of inquiry which I have not referenced in this overview in considerably greater detail. Thank you. I am happy to answer any questions.