Mr. Dermot McCarthy:

Thank you, Chairman. The scale and impact of events which are the subject of this inquiry are such that the work of this committee constitutes an important public service. I wish to support fully the committee in its work by answering your questions and by furnishing, as I have, a statement regarding 15 lines of inquiry before the committee. I will seek in my answers this evening to assist the committee as much as I can, as I sought to do in my statement, by setting out matters within my direct knowledge as Secretary General to the Government within the constraints of Cabinet confidentiality and acknowledging that many were matters in respect of which I didn't have expertise or responsibility. I will summarise my statement under six headings. In my statement, I indicated that I believed the conclusions of the Nyberg commission of investigation provided a broadly convincing account of the circumstances that led to the crisis. Nyberg describes serious failings by a wide range of actors, including a number of key elements of the public service. He notes that, ''Each one is [...] responsible for their own actions and inactions contributing to the accumulation and realisation of risks in financial markets''.

Everyone who was in a senior position in the public service over the relevant period, including myself, is burdened by these failings, and the deep awareness of their human consequences. With the knowledge and analysis of that period which is now available, like others I am challenged by the question of whether I could have done more to avert the damaging outcomes from the crisis. My regret is tempered only by the belief that I have performed my duties to the best of my ability.

On the regulatory regime, following consideration of the report of an implementation group, the Government approved a proposal to establish a single Financial Regulator within a restructured Central Bank. The proposed arrangements were altered following consultation with the ECB. The Government reviewed the provision for a separate board structure for the Financial Regulator as an important focus for accountability and responsiveness to public and consumer concerns. Following publication of the proposed legislation in 2002, further comments were received from the ECB, as a result of which the Governor's role in relation to the budget and staffing of the regulator was strengthened. The ECB also welcomed the fact that the Financial Regulator would remain a constituent part of the Central Bank.

The annual reports of the Central Bank and the Financial Regulator were submitted for information to the Government. These recorded the significant number of inspections of financial institutions carried out, and regulatory returns examined. The report in respect of 2006 highlighted that international independent reviews of the Financial Regulator's performance contain positive assessments of the regulatory system in Ireland. In its report of 2007, the IMF supported as appropriate the risk-based framework operated by the Financial Regulator in prioritising supervisory resources. The Government decided in 2009 to create a new, integrated regulatory system under the direction of the Governor. The Government was advised that, pending the enactment of new legislation, the boards of the Central Bank and the Financial Regulator had made changes to the operation of the existing legislative framework through improved linkages between banking supervision and financial stability.

On fiscal policy, the budgetary cycle involved the Minister for Finance setting out the broad economic framework within which budgetary decisions should be shaped. This provided a context for the engagement by the Department of Finance with individual Departments to settle their spending Estimates. The Department of Finance's proposals were based on securing financial stability and the productive capacity of the economy, while avoiding inflationary pressures and addressing priority needs. The Department pointed out the potential for reverses, both domestic and international, associated with declining competitiveness, exchange rate movements, increases in commodity prices and the possibility of a downturn in construction activity. The Department recommended the maintenance of a cyclically-adjusted positive general Government balance and containing the growth in current expenditure to the nominal rate of economic growth. From 2003 to 2006, the stability programme reports presented to the Government identified a gradual and orderly reduction in housing output to a more sustainable level as a significant factor likely to impact on economic performance, partially offset by growth in other components of investment expenditure. In the report for 2006, the potential for economy-wide consequences of construction-specific developments, such as rising interest rates, was noted. The moderation in prices and activity in the property market in 2007 was highlighted. The absence of a sense of impending crisis was reflected by an assessment by the IMF in 2007, which noted that the banking system was well-capitalised and profitable and that stress tests by the Central Bank indicated that even in an extreme scenario, the major lenders had adequate buffers to cover a range of shocks. Economic policy was not formulated by Government in the belief that there was a serious risk to financial sector stability.

The framing of budgetary proposals in Government discussions had regard to the terms of the relevant programme for Government and specific objectives adopted by the Government. The substantial reduction in the debt-to-GNP ratio, substantial budget surpluses, significant annual transfers to the National Pensions Reserve Fund and an ambitious programme of investment in infrastructure to increase productive capacity, with little or no recourse to borrowing, created a sense of confidence with regard to fiscal matters. There wasn't a single view about the conduct of policy or the outlook for the economy. There was of course awareness of contrarian views occasionally expressed in the media regarding the risks of an economic collapse. It was widely considered that this was improbable, while vulnerabilities were nonetheless acknowledged to exist.

Most decision-making requires judging the probabilities of events occurring while striking a balance between competing objectives in the context of Government policy.

Collective responsibility requires members of the Government to support decisions once taken. The legitimate exercise of its democratic authority by the Government must be respected by officials. For example, the Department of Finance in its budgetary submissions signalled a preference for a lower rate of expenditure increase than occurred in a number of years. In the years leading up to the crisis the direction of Government policy was not significantly altered in the light of parliamentary scrutiny.

On banking matters, the primary relationship between the banking sector and the Government was through the Minister for Finance and the Department. The banking industry was represented by the Irish Bankers Federation and Financial Services Ireland on general policy matters such as the development of the national payment system. From the establishment of the IFSC, the Department of the Taoiseach chaired the Clearing House Group whose members included representatives from the Departments of Finance and Enterprise and Employment, the Revenue Commissioners, the Financial Regulator, the IDA and, later, Enterprise Ireland.

The Clearing House Group and a range of associated working groups provided a forum for exchange of information and suggestions between different categories of participant in the sector. As its name implies, the group was primarily a vehicle for commercial intelligence gathering in the context of the competition between jurisdictions for investment. The focus of the group was the identification of opportunities and a variety of specialist activities, the marketing of Ireland and the tackling of barriers to growth, such as availability of skilled personnel. The operation of a credible regulatory system was seen as critically important in securing the reputation of the industry and attracting appropriate new entrants. Discussion at the Clearing House Group covered a broad range of public policy. Concerns voiced at times about proposals which were seen as disproportionate, by reference to international practice, were pursued bilaterally with the relevant agency. In published strategies for the future of the sector, industry representatives expressed their support for a regulatory system which was effective, consistent and efficient.

Turning to the bank guarantee, in the period leading up to 29 September 2008 the Government was briefed on liquidity difficulties in the Irish banking system by the Minister for Finance and increased the deposit guarantee to €100,000 on 20 September. On the evening of Monday, 29 September a meeting attended by the Taoiseach, Minister for Finance and the Attorney General was advised that, unless measures were taken before the financial markets opened on Tuesday morning, irreversible damage could be done to the economy through a banking collapse. The expectation that no Government would allow a bank to fail, especially in the aftermath of the Lehmans example, was reinforced by the potential consequences outlined to the meeting. It was made clear that no European or ECB initiative was in prospect which would address the immediate crisis faced by Ireland. The advice was that the Government had one opportunity to make a decisive intervention, to stabilise liquidity and secure the Irish banking system. It would have no certainty of success but the alternative was certain disaster.

A request to meet from the chairs and chief executives of AIB and Bank of Ireland was agreed. The banks' representatives confirmed the gravity of the funding situation for the Irish banks, with difficulty in getting even short-term funding from the money markets. The negative sentiment towards Ireland was focused on particular institutions, but all were now impacted. They argued that effective action was necessary to reassure the markets. The Taoiseach and the Minister resolved that a broad guarantee would be recommended to the Government. The option of nationalisation of Anglo was considered, but it was concluded that such action could have more negative than positive effects on market confidence. It was also understood that a decision to nationalise Anglo could be taken at a later date, should it be appropriate.

The guarantee would be offered on commercial terms and would provide a framework for any measures required to build market confidence in the Irish banking system. The approval of the Government was given by an incorporeal meeting which was conducted in the early hours of Tuesday, 30 September. A particular concern was that the guarantee might be challenged on European state aid grounds. It was agreed that a formal notification to the European Commission would be made immediately. A full supporting case, including all of the material considered in the discussion, would be detailed in a submission at the earliest opportunity. The European Commission subsequently approved the decision as an appropriate means to remedy a serious disturbance in the Irish economy.

On the programme of assistance, in response to international concerns by mid-2010 about the State's financial position, the Government began the preparation of a medium-term expenditure framework in tandem with the fiscal responsibility framework.

It was considered that public confirmations for a recovery plan of the adoption of a comprehensive programme of fiscal reforms and specific measures to achieve the necessary deficit reduction by 2014 would improve market sentiment towards Ireland. The continuing dependence of the Irish banks on ECB liquidity support was evident, as was a market view that further recapitalisation would be necessary. The ECB Council conveyed to the Minister for Finance that the Government should apply for European financial support. Department of Finance officials travelled to Brussels for exploratory discussions on the parameters of a possible programme of assistance if the Government were to decide to apply. The tentative nature of these discussions reflected the Government's concern that the conditionality of any such programme could include unacceptable terms such as changes to the Irish corporation tax regime. On 19 November the President of the ECB wrote to the Taoiseach and to the Minister for Finance stating that ELA could only be continued if Ireland applied to the Eurogroup for financial support and proceeded with a decisive restructuring and adequate recapitalisation of the Irish banks. The Minister, in consultation with the Governor and the CEO of the NTMA, sought the approval of the Government for a formal request for external assistance, given that the Government could not borrow in the market at current rates and the serious liquidity problems in the Irish banks. Some days later, the national recovery plan was published by the Government - the programme of external assistance was formally announced on 28 November. Imposing haircuts on unguaranteed senior bondholders was raised with the international institutions during discussions on the programme of assistance. The concept was strongly resisted because of their concern about its potential impact on wider financial stability. In March 2011 the agreement of the ECB was sought but declined for the announcement by the Government of a statement of intent to impose burden-sharing on unguaranteed senior bondholders in Irish banking institutions in wind-down.

On changes since the crisis, with regard to the conduct of economic policy the establishment of the Fiscal Advisory Council and the oversight by the European institutions as part of the European semester have brought a greater transparency to Irish fiscal policy. Policy analysis is supported by greater economic expertise within the public service. The national risk assessment framework is a positive development and the legislation to provide for the registration of lobbyists and lobbying activity should also assist in the monitoring of efforts to influence public policy. It is clear, however, that irrespective of any structural or capacity developments that may be implemented, Governments will still be faced with a need to exercise judgment in setting fiscal policy and in assessing the risk to be taken into account in framing budgetary decisions. That concludes my opening statement Chairman and I am happy to answer the committee's questions.