Oireachtas Joint and Select Committees

Wednesday, 25 February 2015

Committee of Inquiry into the Banking Crisis

Context Phase

Professor Gregory Connor

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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The committee is now in public session. I remind members and guests to switch off their mobile telephones before we commence. Session A this morning is a public hearing discussion with Professor Gregory Connor from NUI Maynooth on issues relating to banking policy, systems and practices which may have underpinned the banking crisis in Ireland. I welcome everyone to the tenth public hearing of the Joint Committee of Inquiry into the Banking Crisis. Later this morning, we will hear from Professor Eamonn Walsh from UCD.

I welcome Professor Gregory Connor, who is professor of finance at NUI Maynooth, having previously been part of the finance faculty at the London School of Economics and director of research at MSCI Europe. He specialises in portfolio risk analysis, factoring modelling, financial economics and security market pricing. Professor Connor holds a BA in Economics from Georgetown University and he received his doctorate in economics from Yale University.

Before we begin, I wish to advise the witness that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the Chairman to cease giving evidence in relation to a particular matter and they continue to so do, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given. As you have been informed previously, the committee is asking witnesses to refrain from discussing named individuals in this phase of the inquiry. Members are reminded of the long-standing ruling of the Chair to the effect that they should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable.

I invite Professor Connor to make his opening remarks.

Professor Gregory Connor:

I thank the committee for inviting me. I have your thoughtful list of suggested topics on bank funding and the Irish banking crisis. Let me start with a key point. An enormous uncontrolled flow of foreign debt capital into the Irish domestic banking system is the key cause of the Irish financial crisis. Obviously, there are other secondary causes, but the basic and most fundamental cause of the Irish economic crisis was a poorly controlled very large inflow of foreign debt capital into the commercial banks of Ireland.

This foreign debt capital flow had two effects. One, it created unstable debt levels throughout the economy but, two, it acted as a Keynesian stimulus to the economy - it raised incomes, production costs, wages and tax revenues. That increase in tax revenues then led to an increase in Government spending. When we think about the fiscal calamity that hit Ireland after the banking bust, it was directly and indirectly caused by this foreign debt capital inflow. It was directly caused through the big costs of the bank bailout but also indirectly, because one had a sudden stop to the Keynesian stimulus from foreign debt funding and this fed disastrously into private and Government spending, so there was a sudden stop - basically a Keynesian effect.

From a global perspective, people often say this Irish banking crisis is unprecedented but it is not really unprecedented. Economists talk about what they call "a capital bonanza", which is a large flow of capital, equity or debt, into a national economy. Often if there is a regulatory policy or business failure or some combination, capital bonanzas lead to financial bubbles, followed by busts. This is what happened in Ireland. There were policy, business and regulatory failures and there was an enormous capital bonanza, financial bubble and bust, so it is not really unprecedented.

Where did the capital come from? In the early years of this century, there was a global tidal wave of liquidity across developed markets. We were aware of this at the time and people used that phrase "global tidal wave of liquidity". It was a period called the great moderation, which lasted about 20 years. If one looks across countries in the developed world and through time, there was fairly stable economic growth and people said this is a new paradigm, the business cycle is solved, we have new institutions, we have new technologies and there is going to be stable growth. It was just a tidal wave of liquidity across markets.

All developed markets were hit by the great recession which followed the US credit liquidity crisis of 2008 but only a handful, including the USA, Greece, Iceland and Ireland, had identifiably distinct credit bubbles and busts. If one looks at Iceland, its credit bubble and bust has a lot of parallels to Ireland. It too had excessive foreign debt capital into its banking system as the main cause of its credit bubble and bust. Another parallel, which I think has been underappreciated, was the very poor prudential oversight of the Icelandic Central Bank during their credit bubble.

If we turn briefly to Greece, their credit bubble and bust was very different. There, the same global tidal wave of liquidity did not go into the banking system but it went directly into Government borrowing, which was hidden in various ways, including with some complicity by the banking system and the international investment banks, in particular. It was a different source of capital, but again a credit bubble and bust in Greece.

A key objective of Economic and Monetary Union was to allow free capital flows across member states. That was considered one of the great advantages of EMU - that we were going to have funds flowing quickly into high funding cost states, like Ireland, from low funding cost states, like France and Germany. This worked, in fact, one could say one of the big causes of the Irish crisis was that this EMU mechanism worked too well. That was a deep clear flaw in the EMU system, and the economics profession shares some blame for that. We underappreciated the instability which would be caused by allowing very free capital flows across member states. That was an error in the design of EMU by the economics profession. Partly because of the political enthusiasm, which many of us share for EMU, we overlooked the problems - both in the economics and the policy world.

JK Galbraith said that one of the advantages of being an economist is that the more one messes up, the more they need one. There has certainly been a great deal of work to try to correct that EMU flaw but I do not think it has been fully corrected.

Let me turn to funding and capital risk at the Irish banks as the committee requested. The source of the funding is straightforward. During this period, German and French banks had more deposits than they could profitably use at home so they moved funds to a growing economy with high rated banks and no exchange rate risk, Ireland in particular, as well as others. Three main vehicles were used for the funding, namely, the interbank borrowing market, bond issuance by Irish banks and direct deposits by foreign financial institutions and corporations into Irish banks. In terms of the size of the funding, I said it was massive. The net foreign liability of the Irish domestic banking sector in early 2003 was €29 billion. This grew over the next five and a half years by 449% to €158 billion in 2008. The net foreign borrowing ratio to GDP was 88% in the third quarter of 2008, which was massive. That was a very large and very risky overhang of foreign debt. In fact, if one thinks about some of the early macroeconomist discussion and talk about the Irish debt ratio, or Government debt, one has to think about the 88% that the banks owed to foreigners. It was very unstable, hidden borrowing. The risk from this was amplified for property development lending which grew from €21 billion in early 2003 by 524% to €133 billion in late 2008. It was an enormous growth in what is one of the riskiest classes of bank borrowing. It is much riskier than mortgages and much less diversified than SME lending. This is a very narrow concentrated lending growing by 524% over five and a quarter years.

The Irish Central Bank and the Financial Regulator should have blocked the enormous debt capital inflow and should have blocked the too fast growth in property development lending. If they had done either of those things, the Irish banking crisis would not have happened. They should have done both. There was a massive failure by the Irish Central Bank and Financial Regulator in not blocking both of these. I do not blame the crisis entirely on them, however. Economists were mistaken also. Globally, there was an overly complacent attitude toward the risk of a banking crisis in developed markets. We had not had one in 50 years in many countries and were too complacent. There were also big errors in bank risk and liquidity regulation, in particular the level of bank equity capital was much too low. The definition relied too much on tier 2 equity, which is only available when a bank is no longer a going concern. It does not provide a buffer to a going concern bank. It provides a buffer to a bank which is being restructured. Relying on that was a big error. That interacted with a misunderstanding of the big risk of systemic liquidity problems in the banking sector. That was also missed. As such, the economists share some blame.

A solvent commercial bank has a backstop in the case of a serious liquidity problem. It can use its long-term assets as collateral. Central banks stand ready as lenders of last resort to provide funding to banks. In the case of the eurozone, this failed because the ECB had very strict rules. It could only lend for good collateral to solvent banks. This dichotomy between the lender of last resort function and the problem with insolvent bank restructuring was very problematic. The ECB's attitude was that it was in its charter that it would only lend to solvent banks for good collateral and that what happened where a bank was distressed was someone else's problem, namely, a national problem. That was a big issue and a major difficulty. Another problem of course was that, along with many other European countries, Ireland did not have an effective, quick bank resolution mechanism at that point.

The committee has asked me to address how interbank competition increased risk taking. Here I want to differentiate between blame and causes. In terms of risk taking by Irish bank managers, they are to blame for what they knew in many cases was overly risky lending. Many people in the industry knew that what they were doing was too risky. However, in terms of causes, there was a rivalrous environment from the maverick banks, particularly Anglo and Irish Nationwide, which increased risk levels and then pulled in the other banks. Irish shareholders were also leading this. They were forcing the banks to adopt more aggressive strategies. As such, the shareholders also contributed to this pulling of the strategies to be too risky. That is in terms of causation. In terms of blame, the bank managers who knew they were taking too much risk are to blame. In terms of causation, that was deeper. Without the control from the Financial Regulator and the Central Bank, it was very difficult in this environment to avoid the banks being pulled into this ethically wrong strategy.

I turn now to the capital outflows from Irish banks and the liability guarantee. The problems with refunding in the banks really started in August 2007 with the early stages of the crisis. Over the whole next year, the ability of various banks to access the three main vehicles became increasingly difficult. A global credit liquidity freeze hit after the bankruptcy of Lehman Brothers in mid-September 2008. There also had developed institutional bank runs, particularly in the USA, but spreading to some of the maverick banks in Ireland during October 2008. There were liquidity problems in the system at this point. They played a central role in the 2008 US crisis in that month. The US crisis is correctly termed a credit liquidity crisis. Ireland did not have a liquidity crisis, it had a bank credit crisis. It received €136 billion in liquidity support at peak from the ECB and Irish Central Bank. That was more than enough liquidity support. Ireland did not suffer a liquidity crisis, it suffered a bank insolvency crisis. The ECB began providing liquidity funding to the Irish banks in early 2008 and the funding amount rose sharply. The ECB began to question under its charter whether it was providing liquidity support or risky capital infusion, which it felt it could not do. In my judgment, in fact, some of the liquidity support provided under ELA was risky capital. It did not really meet the ECB claim that it was liquidity support only.

With hindsight, the domestic banking system's aggregate balance sheet was actually insolvent in September 2008. There was a claim at that point of €43 billion tier 1 and tier 2 equity but bank accounting statements even relative to other corporate sectors greatly lagged the reality. They presented a very lagged picture of reality as Professor Honohan noted earlier. The Government in fact injected €64 billion into these banks, after which the banks only had tier 1 equity of €13 billion. That is a minus of €51 billion somewhere. The banking system aggregate balance sheet was insolvent in September 2008. In September 2008, the Irish Government provided a blanket liability guarantee to an insolvent banking sector. It was a very costly error. There are three caveats to muddy the picture. First, the lender of last resort function of the ECB was not working properly. The liability guarantee was partly intended to allow access to this very flawed funding function from the ECB. Second, the guidance provided to the Government by the Irish Central Bank and Financial Regulator was poor. Third, the information provided by some of the banks may have been embellished deliberately to disguise their real capital positions. Those are my comments. I thank the committee for listening.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I thank Professor Connor. Before I bring in lead questioners, I will come back to his statement to deal with two matters. As he is aware, these hearings are broadcast to the public. In simplified terms, could he explain to the committee what he means by funding or liquidity risk and also what is meant by capital or solvency risk?

Professor Gregory Connor:

The assets of banks tend to be illiquid long-term loans. That is what banks do. On the other side - their liabilities and the money they owe - are short-term liabilities such as, for instance, deposit savings accounts where their liability claimant often has very quick access. If depositors come to the bank and want their cash now against long-term assets, then that is called a liquidity problem. The bank needs to have cash for its long-term valuable assets. An insolvency problem is when the value of the long-term assets has fallen. For instance, many of the property loans may be failed projects and do not have real cash value. The claims made by the savers and bondholders of the bank are larger than the value of the assets of the bank. That is insolvency. It is not that the bank cannot pay cash now as its central bank can always provide. It can never pay the cash. Someone is going to have to take a loss.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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One of the principle terms of reference of this inquiry is to examine the solvency vis-à-visliquidity of the banks in the lead-up to the crisis period, particularly around the time of the bank guarantee. Will Professor Connor explain to the committee what difficulties governments face when attempting to diagnose whether a bank has a liquidity or a solvency problem?

Professor Gregory Connor:

The first thing is to determine solvency. So, we need to value the assets of the bank and make sure they are larger than the non-equity liabilities. There is an equity, which is the residual liability or the buffer of the bank. That is just a residual claim which has to be positive. When that is negative, the bank is insolvent. If one takes the value of the assets and subtracts the value of the liabilities - claims from debt holders, deposits and savers - and gets a negative number, then the bank is insolvent. That is essentially the exercise.

The hard part is valuing the long-term assets of the bank. It has to look at these projects, which in the case of Ireland were mortgages and property development projects, and decide how many of these are not going to pay the bank back. That was the problem. It was difficult. The banks were also in the year-long habit of overstating their solvency because they had been trying to refund themselves, roll over their funding. They had got into a bad habit of embellishing the quality of their books.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Taking Professor Connor’s evidence to the inquiry so far this morning, at the time of the bank guarantee, what does he believe was the then Government’s view with regard to the banks being in need of liquidity or them actually being insolvent?

Professor Gregory Connor:

They were insolvent. I know Professor Patrick Honohan spoke on this. In his follow-up testimony, he said two of the banks were insolvent. Most of my work has been to simplify and provide an overview. I use the aggregate balance sheet. I net out the relationships between the banks and look at the overall banking sector. Although Professor Honohan does not say it, the domestic banking sector was insolvent on an aggregate basis. That is clear from the fact that we injected €64 billion into a banking sector which was then worth only €13 billion, plus a little bit of tier 2 capital.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Are Professor Connor's remarks inclusive of all banks that were Irish owned?

Professor Gregory Connor:

Yes. From their aggregate position, all of the domestic banks were insolvent. This was obviously due to some of the most insolvent. I have not tried to analyse individually which banks were insolvent. The aggregate position, I think importantly, was insolvency.

Senator Seán D. Barrett:

Professor Connor states in his submission:

If one or more senior officials in the Irish Central Bank had shown the wisdom and strength of purpose to block the massive and destabilizing debt capital inflow into the Irish banking sector, or its risky utilization in property development lending, the crisis would not have happened.

As we say in examination questions, will he expand on this?

Professor Gregory Connor:

Yes. I think Ireland was actually a strong economy and that was partly one of the reasons it received this capital bonanza. Ireland was a tiger economy. That was part of the reason this enormous capital bonanza came into Ireland. Ireland would have suffered, along with all other developed markets, from the Great Recession. It would not have suffered as much as the French and German economies from the 2008 US credit liquidity crisis because it did not own foreign bank assets. I think in fact the economic crisis is directly tied back to preventable actions and prudential banking regulation. I know that is a strong statement but I will make that claim.

Senator Seán D. Barrett:

If the capital inflow had been reduced, would there have been a less optimistic portrayal of Ireland abroad? Would it have been a case of telling foreign banks not to put capital in Ireland because we have enough of it already?

Professor Gregory Connor:

People talk about the too-big-to-fail problem from the bank’s perspective. Banks think they are too big to fail or that they have an implicit guarantee from their governments. One of the problems was that the money flowing in had an implicit guarantee from the European Union. The German, French and British savers and pension funds knew they could freely lend to the Irish banking sector and that they were safe because of the euro. There was an implicit belief that was part of the confidence.

The only bodies that had the power to stop it were the Irish Central Bank and the Financial Regulator. They should have said, "Stop". That is the normal function of a central bank. One pulls away the bowl just as the party gets started. That is what they were supposed to do. They did not do that, however.

Senator Seán D. Barrett:

In an article with Brian O’Kelly, Professor Connor states the Central Bank could have operated restrictions such as a 20% limit in total lending on property and that foreign borrowing in the domestic banking sector should not have exceeded 10% of the domestic deposit base. How would those rules have operated? Are there precedents in other countries?

Professor Gregory Connor:

There are certainly precedents for the Central Bank. The economics profession was also in this overconfident mindset. I do not want to overstate the error of the Central Bank. It was in the overconfident mindset like many other bodies. It should have had somebody, however, to say it should look at the banking system. AIB knew there were problems. It asked Professor John FitzGerald, as the committee has heard in testimony, to undertake a risk analysis to see if there was a problem. The Central Bank should have said it would look at this problem and then follow on it. Professor Honohan, in his document, goes through the many avenues and tools that the Financial Regulator and the Central Bank had. In his document, he states that if one looks at the powers the Central Bank Governor had up to 2008, it is clear the Central Bank and Financial Regulator had plenty of power to both act on concentration ratios. There was too much concentration on property. They should have gone to Anglo Irish Bank and the other banks and said, "No, this is too much property lending and is not allowed. You can lose your banking licence. Stop. No, this is too much liquid and very unstable funding from foreign debt capital. Stop". They had the power to do it.

In the then environment, as it has been said to me and Professor O'Kelly on this paper, there was a general overconfidence and it would not have been in the spirit of the times. I do not want to oversell it in that sense.

Senator Seán D. Barrett:

How did Canada, in particular, and Australia manage to achieve the success which Professor Connor has been telling us about this morning?

Professor Gregory Connor:

Banking crises and financial bubbles-and-busts, almost by nature, are unpredictable. The US had a terrible 2008 credit liquidity crisis. Why? It was because it was not controlling the reselling of mortgages or the leveraged packaging of mortgages. Why? It was because it had never that phenomenon causing a crisis before. It was not having a savings and loans crisis like it had 20 years earlier. It was certainly not having one of those again. It was not having a Great Depression-type crisis because that was caused by people borrowing from the banks and using it to buy shares. That had been ruled out. One always tries to prevent them. One sets in place good procedures to prevent them. It was partly bad luck that Ireland had a collection of bad policies.

Some of them were good things. For example, the fact that Ireland had growth contributed to the capital bonanza coming to Ireland. However, there were also bad policies, such as light touch regulation. The political environment also contributed.

Photo of Sean BarrettSean Barrett (Independent)
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Professor Connor stated that we need a modern and practical legal pathway for quick and effective bank resolutions. What would he include in such a pathway?

Professor Gregory Connor:

This was a mistake made by many European countries, including the UK, which found that their bank resolution mechanisms were insufficient for the modern world. I think that has been taken care of with the bank resolution and recovery directive, which came into power last month, and the single supervisory mechanism, which includes resolution controls. The US was overconfident partly because its system, which has now been brought to Europe, works well. Liquidity funding and bank restructuring need to be done by the same body. Somebody needs to decide whether it is a liquidity problem or an insolvency problem and, if it is the latter, have the authority to restructure the bank. That was missing but I do not think it is a missing piece now.

Photo of Sean BarrettSean Barrett (Independent)
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The value of the protection that parliaments give to banks was estimated at approximately €300 billion per year in the United States. That would be equivalent to €5 billion here. Should we move towards a system whereby the banks pay us for the insurance of bailing them out?

Professor Gregory Connor:

That certainly was a problem in Ireland. It was not just the banks. The bank managers knew there was implicit insurance. More important in Ireland's case was that the funders to the banks also relied on that insurance. The insurance actually went to the funders. The German, British, Swiss and French funders of the banking system were all paid in full. That was a problem.

Photo of Sean BarrettSean Barrett (Independent)
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Did any bank managers go to Professor Connor to advise him their banks were about to go down the tube because of what was happening?

Professor Gregory Connor:

No. Bear in mind that I was in the London School of Economics, LSE, until mid-2008. I certainly recall people asking whether Greece should be in the euro. The response was "shush, do not talk about that, be politically enthusiastic". That was heard strongly during my time in LSE but we did not worry much about the Irish banks. I have been studying the Irish banks since 2008, however.

Photo of Sean BarrettSean Barrett (Independent)
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Should the auditors have seen this happening? They were in the banks auditing the accounts.

Professor Gregory Connor:

I will pass on that. Professor Eamonn Walsh will be here this afternoon and I hope he can provide a more detailed answer to that question. I do not feel comfortable evaluating it but it certainly seems to be a sensible point.

Photo of Sean BarrettSean Barrett (Independent)
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Professor Connor's estimate is that the banks were worth minus €51 billion before we put €64 billion into them. Have other people made similar estimates? His is the first I have heard.

Professor Gregory Connor:

As I mentioned in the follow-up document from Professor Honohan, that is also his point. He spoke about scenario one hindsight. He broke it down by bank whereas I preferred the aggregate numbers because I believe that we were uncomfortable about which of the banks, other than Anglo and Irish Nationwide, were solvent. On the aggregate basis they were insolvent. Note that this was done in hindsight and because one has a lag and these are pro forma. When I say "insolvency" I do not mean technical insolvency or that the State accounts are insolvent. On a pro formabasis, adjusted for predictable losses, they were insolvent.

Photo of Sean BarrettSean Barrett (Independent)
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The Keynesian stimulus that Professor Connor mentioned in his opening remarks would have required the Irish Government to have run a massive fiscal surplus, which is probably impossible to imagine even now. A huge capital inflow requires the Government to counteract the stimulus by running a surplus.

Professor Gregory Connor:

That was Ireland's hidden borrowing. Greece had hidden borrowing. It had worked out ways to rewrite its national income accounts to hide borrowing and it worked with investment bankers to hide the debt issuance. Ireland's hidden borrowing was through its domestic banking system. When macro-economists like Professor John FitzGerald from the ESRI say they missed the problems, they did so because when they worked through the fiscal accounts there did not appear to be a lot of borrowing but they missed the 88% of GDP coming in as hidden borrowing through the banking system. We are on the hook for that. It was difficult politically but it was a mistake.

Photo of Sean BarrettSean Barrett (Independent)
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Commercial property emerged as a major destabilising sector for all of this capital inflow. We now have rules for residential mortgages. What kind of rules should operate for commercial property given its explosive contribution to instability?

Professor Gregory Connor:

With hindsight, it does not take much insight for the Financial Regulator to enforce concentration ratios on commercial property. I suspect that in almost all of the domestic banks some knowledgeable person was saying "yikes, our exposure to property development is enormous and really risky". Property development consists of nothing more than holes in the ground and half built buildings, unlike a mortgage on a residential property that has somebody living it. It is a very risky operation to have all that concentrated risk. I do not think we need new procedures because it is dead obvious with hindsight, and was probably obvious at the time.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I ask Professor Connor to outline his views on the concentration limits for the Irish banks prior to the guarantee. Does he believe they were excessive?

Professor Gregory Connor:

As can be seen in the graphs, they greatly exceeded appropriate limits for property development.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Was that each and every bank?

Professor Gregory Connor:

As I noted, I worked with the aggregate balance sheet. Professor Brian O'Kelly and I have not broken it down bank by bank. That is a good question, but I did not address it.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Professor Connor indicated that the Central Bank had sufficient powers but it was not in the spirit of the times to intervene. Are we correct to understand that the Central Bank was caught up in the spirit of the times?

Professor Gregory Connor:

Yes, more than most. All of the central banks made errors at that time and they all probably regret some of their actions. Across Europe, the second worst central bank in terms of responses to the credit bubble was Ireland's. Only the Icelandic central bank had worse prudential oversight during that period. The Spanish, Portuguese and Italian central banks obviously did not have the same enthusiasm as Ireland in the Celtic tiger but their behaviour was more modestly risky, whereas Ireland's was excessively risky. It was quite a bit worse than average. This was in the spirit of the times, and more. It took the spirit of the times and ran with it.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Are we correct to believe that in the years before it all went down that the Central Bank must have known about some of the things that were happening? It had the power to intervene but it did not do so.

Professor Gregory Connor:

Correct.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Professor Connor closed his opening contribution by stating "the information provided by some of the banks may have been embellished deliberately to disguise their real capital positions". Can he elaborate on that comment?

Professor Gregory Connor:

During the 12 or 13 month period up to the end of September 2008, they had a lot of trouble rolling over their funding. They had gotten into the habit of embellishing how good their accounts really were and how solvent they were. That is a natural activity for the banks. I know there are records of discussions in the banks from the capital desks.

The capital desks have to be recorded for regulatory purposes. If one listens to the recorded discussions on the capital desks, some of the bankers knew they were insolvent and they knew they were hiding that insolvency so it is clear that they knew they were solvent. The banks either knew they were insolvent or someone in the bank knew they were taking on too much risk or they had too much concentration in property or they were borrowing too much through very volatile funding sources. The interbank borrowing market is quite volatile. It is normally used just to manage short-term liquidity needs; it is not normally treated as a source of long-term funding. It is for short-term management so they knew they were using volatile sources of funding, they had too concentrated a loan book and property prices had gone up too much. I suspect many bankers knew what was going on in that sense.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Professor Connor used the word "embellish" and talked about them doing this deliberately. What were they embellishing?

Professor Gregory Connor:

That was in the context of the liability guarantee, which was a very short-term period. Over that period, there is evidence that at least some of the banks were providing information. Some of the banks knew that they were insolvent. Some of the bankers have been recorded stating that they were effectively insolvent.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Mr. Nyberg refers to the loan loss provisioning levels in covered banks falling between 2003 and 2007 in page 43 of his report, stating, "As a consequence, increased accounting profits effectively provided additional capital of up to €3.5 billion to the covered banks and this, in turn, increased their capacity to lend by over €30 billion". Can Professor Connor dwell on that for us? Does that make sense?

Professor Gregory Connor:

The Senator should bring that up again with Professor Walsh but I will address it. Bank accounts are unusual in how long the lag is between when a bank gets into real trouble and when the trouble is reflected in its accounts. The accounting profession had a strategy of minimising another phenomenon which was earning smoothing. They forced the banks to only take a loss when there were observable actions which could justify it. If you notice that you have funded a €50 million shopping complex and you know that no one will shop there because the economy has turned, you cannot take a loss. You have to wait until there is a default on loan repayments. Even as things got bad, there was no provisioning for the losses. You have to have a material action generating the provision. That was one of the problems. That is very much an accounting problem, although it touches on my area. There were errors in the way the banks' accounts were handled in terms of the slowness of recognising loan losses in the accounts.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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If a bank makes a decision to alter its loan loss provision, is that something it knows it is doing or is it done accidentally?

Professor Gregory Connor:

That again is a good question for Professor Walsh. There has to be material event generating your addition to your loan loss provisions.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Professor Connor said on page 7 that the bank guarantee was a "costly error". When Mr. Donal Donovan appeared before the committee, he said it was difficult to see any alternative that would "have led to a materially different outcome". Governor Honohan said that while he was critical of some elements of the guarantee "something had to be done for at least some of the banks". What is Professor Connor's view, given his description of the guarantee as a "costly error"?

Professor Gregory Connor:

The blanket liability guarantee was an error. The two banks that were most obviously insolvent should have been left out and restructured and that should have been obvious. If the information provided by the Central Bank, Financial Regulator and the banks had been appropriate, it would have been obvious to the Government that the two most insolvent banks should not have been included in a liability guarantee. They were very costly errors. I note €35 billion just for those two. I disagree with Donal Donovan on that point. Obviously most of the damage had been done. The economy was going into a long slump but it could have saved a big chunk of that money. Obviously, you would have the problem that if you default, then you lose some access, they say, so there would have been some repercussions from that event. The private banks would have defaulted on their liabilities but that tends to quickly dissipate. It was not a claim by the Irish taxpayer; it was a claim by private banks and they should have defaulted on those claims.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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I thank Professor Connor. On page 5, he refers to "irresponsible lending policies during the credit bubble". What was he thinking of in this regard?

Professor Gregory Connor:

I was thinking mostly on the property development side. On the mortgage side as well, the mortgages were becoming too risky and the loan to value ratios were becoming too high, though compared to the terrible situation in the USA at that time, the mortgage problem was not as bad. It was wrong but not as wrong. Property development was a notably bad problem for the Irish banks. They massively over concentrated in very risky property development loans.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Given that bankers anywhere at any time know that property development is riskier than mortgages and SME lending, why then would they have sought to increase their own risk? Why would they do that when they know something less risky is available?

Professor Gregory Connor:

One of the reasons the mortgages became more risky is they needed to generate a place to put the funds. They were pulling in this capital bonanza of €158 billion into the economy and then they had to place it profitably so they were looking for opportunities. SMEs were not providing opportunities. They would have preferred SME lending if they could have found it. Many of the banks were probably looking for SME opportunities. They were also looking to issue mortgages. It was very easy. They were encouraging mortgages. Property development was the worst lending but the most available. Many well connected business people wanted to be billionaires and were willing to take the risk, take the money and develop property. They found the channel that was accessible to them.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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At the Trinity Economic Forum in 2014, Professor Connor said that up until 2010, Irish banking regulation was the world leader in feather light regulation and at the Dublin Economics Workshop in Kenmare in 2010, he described this as the "pivotal Irish policy error". I acknowledge he has discussed some of this but given he has said the Central Bank and the Financial Regulator had the powers, how could they simultaneously be the world leader in feather light regulation?

Professor Gregory Connor:

Obviously they did not exercise their powers. I think part of the problem was the success of the IFSC turned, in particular, the financial regulatory authority into a booster for light regulation. That fed into this very light-touch approach of the Financial Regulator. It was way overboard relative to competitors, except Iceland, and was the second worst prudential performance in the world. It was partly induced by the flawed mandate, which has now been split. You should not have your financial regulator simultaneously flying around the world telling people "Bring your financial services to Ireland and we will adopt a very light-touch approach". That contributed to what was a very bad performance.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Is Professor Connor confident in his professional capacity that if he were to conduct all the analysis that would be required, Ireland would still emerge as the world leader in feather light regulation?

Professor Gregory Connor:

Perhaps after Iceland. Ireland was shocking and Iceland, a very small country, was even more shocking.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Professor Connor mentioned the concept of banks being "too big to fail". Is it that no bank should ever be allowed to fail or is it that, at the time, that was the mood? It is an expression that occurs a lot in conversations, not just in this room but more generally but I have never been really sure what it means and where it came from. How did we arrive at a position where a bank can be considered ---

Professor Gregory Connor:

When any large corporation or manufacturing facility fails, it causes economic dislocation. It is not just the owner who suffers but also the families of those who work there, local shopkeepers and others. Banks, by their nature, are tied into everything so when a bank fails it causes widespread economic dislocation. There is naturally a big public externality to bank failure. The question then is whether we should offset that with a moral hazard problem and never let them fail. When banks start to fail, do we inject free taxpayer-based funds to keep them in business? It is a very difficult problem. The "too big to fail" problem is not a simple one.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Is there a psychological mindset in banks based on a belief that they will not be allowed to fail?

Professor Gregory Connor:

Yes, I think so, and also among the funders of banks. In Ireland's case, the funders of the banks were correct in their belief that they had an implicit guarantee.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I wish to round off with an issue raised by Senator O'Keeffe. Does the professor believe that the Government should have made a different decision in 2008, given the information it had to hand and will he outline to us the information he believes the Government had at that time?

Professor Gregory Connor:

I do not know exactly what documents the Government was looking at. That is something this committee will have to tease out. We know that the advice from the Financial Regulator was poor and we know that from statements made in October to the effect that this was just a liquidity problem when that clearly was not the case. It was obvious at that point to many analysts that it was not a liquidity problem but a deep insolvency problem. I do not know exactly how bad the information provided to the Government was so that is why I have provided those caveats. That said, a thoughtful Cabinet meeting at that stage should have been able to see that Anglo Irish Bank and Irish Nationwide, at least, were insolvent, even with the poor information provided by the Financial Regulator. Maybe the information was so bad that the Government missed that but that is my opinion. I admit that it is speculative. I do not have the documents that the Cabinet had when it made that wrong decision.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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In the written statement submitted by Professor Connor prior to this meeting, he said there was an excessive inflow of debt capital into Irish banks during 2003-07 and that the business, regulatory and policy failure to control this flow was the most fundamental cause of the Irish economic crisis of 2008-12. Why was there so much global liquidity at the time?

Professor Gregory Connor:

We now know that this was partly the fault of the USA generating excess monetary expansion. That came out of some worries about the dotcom bubble of 1999-2000, the September 11 incident and low rates of inflation. There was a bit of a new paradigm, as is happening now. The central banks were able to create massive liquidity with low inflation and the US central bank did so. This generated a reach-for-yield. Rates fell and there was a lot of saving coming out of the emerging markets, in particular, from China. There was a wave of liquidity in the markets that was not specifically Irish.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Was it not from Europe that much of the capital came into the Irish system?

Professor Gregory Connor:

Yes, it was pushed but debt was being pushed by the USA too. The US generation of capital affected European markets as well.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Why did investors specifically come to Ireland at that time when, for example, there was a major unemployment crisis in Europe? Why did they not invest in infrastructure or the creation of jobs elsewhere instead of piling into the Irish property market?

Professor Gregory Connor:

They did not pile into the Irish property market; they piled into high-rated Irish bank liabilities, which they viewed as safe. The liquidity funding was not at the risky equity end in terms of things like new manufacturing facilities. That is risky, equity investment but what was happening was low-risk, liquid investment comprising interbank lending, Irish bank bonds, bank deposits and so forth. It was low risk but with some yield. Yields had fallen at the low-risk end but Ireland provided a safe-----

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Did they know that the funding was going into property, largely?

Professor Gregory Connor:

Yes, and they did not worry about it because they were correct in thinking that they had an implicit guarantee. Ireland is a euro country after all and they felt that if they put money into a eurozone bank, especially a well rated bank, it would be safe. That is what they felt and they were right. They were correct in that. Despite the money going into very risky investments by insolvent banks, most of their money was safe, except for some undated subordinated bonds which were a very risky, high-yield vehicle.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Why did they feel it was safe? Was it because their money would be guaranteed?

Professor Gregory Connor:

Yes, while I cannot go into their mindset, I think they felt that there was some implicit guarantee in a euro area bank, even though this was way beyond any deposit insurance limits.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Professor Connor's submission states that "Economists were aware of these types of macroeconomic feedback effects, but in the widespread political enthusiasm for EMU, the potential macroeconomic instability from EMU-induced capital flows was down played by economists". Is he saying that economists deliberately downplayed the destabilising effects and, if so, why did they do so?

Professor Gregory Connor:

Yes, that is what I am saying. There was a strong feeling among the political establishment which was shared by the economics profession, even though it was not strictly their business, that European integration was a good thing and that it should be encouraged. For instance, it was argued that we need Greece to be a fully-fledged member of our club. That was a very strong feeling, so-----

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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So, for political reasons, economists-----

Professor Gregory Connor:

Economists bought into that although they knew that there were some problems, for instance, in the case of Greece. We all knew at the time that Greece would be a problematic member, given that there would be free capital flows into that country. That looked very problematic but we thought that Greece should be brought in, for political reasons. There was a trade off. Many economists kept their mouths shut and kept their doubts to themselves.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Is that not a perversion of what economists are supposed to be about? The professor provides three caveats to his criticism of the bank guarantee, the last of which is that the information provided by some of the banks to the Irish Central Bank may have been "deliberately embellished" to disguise their real capital positions. What does the professor mean by "deliberately embellished"?

Professor Gregory Connor:

What I mean by that is that there were bankers who knew, as they were being called into meetings and telephoned prior to the liability guarantee, that the banking system was, in aggregate, insolvent. Some of the bankers in senior positions also knew that their bank, in particular, was insolvent but they were not saying "We are insolvent; it is not a liquidity problem".

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Was it not a Government-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I cannot take that question, Deputy because we are out of time. I now call Senator MacSharry.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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The professor did not-----

Professor Gregory Connor:

On the earlier question about the economists-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I cannot take the judgment question that Deputy Higgins just asked.

Professor Gregory Connor:

I accept that, but he had an earlier question about economists. I agree that it was wrong. Economists should have spoken more forthrightly. Despite the fact that they agreed with the political enthusiasm, they should for example have said "Keep in mind, there is some serious economic risk with bringing Greece into the euro". As we now know, it was a massive error. That is related.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I thank the professor for being here. In connection with the National Asset Management Agency, Professor Connor co-authored with Thomas Flavin and Brian O'Kelly "The US and Irish Credit Crises: Their Distinctive Differences and Common Features in 2010". He stated there that the Irish Government set up the National Asset Management Agency with the explicit goal of overpaying for banks' distressed assets in order to keep privately-owned equity capital in the banks from collapsing in value. Can he discuss that in a little more detail? What is his opinion of how the Government used NAMA to take over distressed assets in Ireland and does he consider that a more optimal approach could have been taken?

Professor Gregory Connor:

Looked at now, NAMA has been a success. Overall, it is a pretty clear success at this stage. I found as did others that the setting up of NAMA was delayed inordinately, which was a mistake. At the time, I felt there was a political aspect to that. It was delayed to provide an opportunity for borrowers in the property development community to rearrange their affairs in ways that were not optimal for the taxpayer. I think there was a delay in setting up NAMA.

The overpayment goes back to some of the questions about insolvency. Who knows how to value long-term assets? That was deliberate, as was stated in the accounts, and a 30% premium was paid which went through the EU's criteria and was allowed. The US did the same thing. If one looks at the targeted asset relief programme, another success, it also overpaid for the assets. The idea of overpaying to market value to allow the banking system to recover worked in the long run. I do not think I have a problem with that. They could have paid less, but they deliberately overpaid rather than force all the banks into insolvency and then restructure them. It was to allow three of the banks to continue in something that looked like non-bankruptcy. It looked like that. Effectively, two of them are State owned.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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In terms of the restricting of capital inflows, some of this was touched on before. Professor Connor said he believed that was possible. How were these policies controlled in other countries? Were there policies in other countries that restricted capital inflow and kept the punchbowl sufficiently at bay at key times? Can he give some examples?

Professor Gregory Connor:

That is difficult. Does the Senator mean on the property development side or the net foreign borrowing side?

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I refer to net foreign borrowing.

Professor Gregory Connor:

I looked at that question as it was in the suggested questions list. It is a difficult question and I find looking globally that there are a lot of links across countries. There might be situations where one could have a large net foreign borrowing. It was certainly very dangerous in the Irish case and that should have been obvious to the Irish banks. I am not sure whether 88% of GDP is the second worst in the period. It is certainly not as bad as Iceland. It is a good question and I will follow up. Whether that is the second worst globally, I do not know.

In terms of property development lending, it was certainly excessive. The bank managers knew. I rely here on anecdotal discussion with banks. Most of them had someone in a senior position, perhaps even the CEO, who knew that the concentration in property development lending was excessive. That is anecdotal.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Professor Connor spoke about blame and causes earlier. If we were to consider pillars such as the Irish Government, banks, the regulatory position and external factors such as the ECB, can Professor Connor apportion a percentage weighting of blame or cause?

Professor Gregory Connor:

That is difficult. The ECB as an institution, which I know the committee is trying to get to attend, is sometimes overly blamed. It had a very flawed situation in that it could only provide liquidity funding and could not get involved in restructuring. That created an intolerable situation for which it had no solution. It did not offer much. It broke its charter and provided funding through ELA that was, in effect, risky funding. I put less blame on the ECB. I certainly blame business analysts and economists on our over-enthusiasm and over-confidence around banking crises that we know we did wrong. Our Financial Regulator, as I have already mentioned, was notably poor. In terms of the business community, our banking community other than the maverick banks, namely, Anglo and Nationwide, was drawn into it. While they are to blame and a lot of them knew that what they were doing involved poor business ethics, causally they were pulled in.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I take up that point. Professor Connor provided a table on page 14 of his document which sets out the share of the aggregate balance sheet of the local banks. It is fair looking at it that the only institution that had an increase in the share of the aggregate balance sheet was Anglo. Taking up Professor Connor's point there about the banks, is it fair to say looking at that figure that the shares of all the other banks went down? Did that particular bank's way of doing business lead the others astray, or not?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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That is a leading question.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I said "Or not".

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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The Deputy could just ask how the banks behaved.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Can Professor Connor comment?

Professor Gregory Connor:

I said specifically that it led the others astray.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Professor Connor is the witness and can say whatever he likes.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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I note Professor Connor's testimony. Can he comment on the profile of the schedule he has given which shows that Anglo Irish Bank was the only bank to increase its share of the aggregate balance sheet between 2000 and 2008?

Professor Gregory Connor:

If one looks at the figures, one notes that the domestic banking sector was growing excessively fast. They were all growing too much. Anglo Irish Bank, as Professor Honohan has stated in several papers, was growing massively too fast, as was Irish Nationwide. Professor Honohan gives some numbers and says this should have been obvious to any trained regulator. They were all growing. The figure that Professor Lane produced is the proportion of market share. There was a growing pie but Anglo was growing so fast that it was taking a larger slice of that growing pie.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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All the others were reducing.

Professor Gregory Connor:

Their proportion was shrinking. Let us pick on AIB for example. AIB was saying, and this is why it went to John FitzGerald, "We are growing too fast but our shareholders and senior managers are saying we are not growing fast enough". It is both of those. They were being pulled but they should have known they were going too fast. It is both of those. They were being pulled but they should have realised. Even the laggards should have realised that this was too much.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Were the banks following the bank Professor Connor identified, namely, Anglo?

Professor Gregory Connor:

That is clear. Anecdotally, one hears this repeated in conversations with bankers. They knew they were growing too fast. They say they knew their property development concentration was too high and that they were growing their liability side too fast but they were being pulled by their shareholders and managers to not let their market share continue to fall. One of the painful but necessary outcomes was that the cash value of all these shares went to zero. That was important and had to be done because shareholders shared some blame.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Professor Connor produced the paper "Sliding Doors Cost Measurement: The Net Economic Cost of Lax Regulation of the Irish Banking Sector" with Brian O'Kelly. In hindsight, at what point should the Financial Regulator have moved and put controls in place to prevent the growth in property development and inflows of foreign debt?

Professor Gregory Connor:

In early 2005 the Financial Regulator should have realised the problem.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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In property or debt inflows?

Professor Gregory Connor:

Both. The two are obviously linked. The growth of the two is related.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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What practical measures does Professor Connor believe the regulator should have put in place to control the excessive growth?

Professor Gregory Connor:

The first and obvious measure, as Professor Honohan stated, is that they should have stopped all growth and imposed some limits on Anglo Irish Bank and Irish Nationwide, which were growing at rates that were, clearly, beyond.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Professor Connor said the Irish crisis was different, that it was purely a credit crisis and that Ireland did not experience a liquidity crisis. Surely the fact that the Irish banks were being forced to go to the ECB for funding was an indication. Was the fact that emergency liquidity assistance, ELA, funding was not provided to Anglo Irish Bank and Irish Nationwide on the night of the bank guarantee an indication that the Irish Central Bank and the ECB were queasy that there was a solvency rather than a liquidity issue?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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This is a leading question. Just ask the question.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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What does this indicate to Professor Connor?

Professor Gregory Connor:

At that stage, ELA funding was in violation of the ECB's charter. We have it clearly stated. It is allowed to provide liquidity funding only to solvent banks, which is the definition of liquidity funding. Funding to an insolvent bank is not liquidity funding. Liquidity funding is replacing good quality assets with cash.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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What does the fact that ELA funding was not provided to Anglo Irish Bank on the night of the bank guarantee indicate to Professor Connor?

Professor Gregory Connor:

That it was a solvency crisis, not a liquidity crisis. Anglo Irish Bank was not seeking liquidity funding but a cash infusion. It was a risky capital infusion.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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The Deputy is out of time.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Connor is very welcome. My time is tight, so I will be brief in my questions, and Professor Connor could be brief in his replies. Does Professor Connor think anybody in authority outside the banks, such as the Central Bank, the Financial Regulator, the Department of Finance and the Government, knew at the end of September 2008 that the banks were insolvent?

Professor Gregory Connor:

Yes.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Who?

Professor Gregory Connor:

Certainly, the senior management of Anglo Irish Bank knew it was insolvent.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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I mean outside the banks.

Professor Gregory Connor:

For example, in the Department of Finance?

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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I mean anybody in the Central Bank, the Financial Regulator or the Department of Finance, politicians or anybody in authority outside the banks.

Professor Gregory Connor:

To know a bank is insolvent is very difficult because it might not be technically insolvent. Its stated accounts do not show a negative equity residual, which can happen. The probability that the banks were insolvent was very high and I suspect many business people in the IFSC knew they were insolvent.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Is Professor Connor saying, as he appears to have said earlier, that some of the top executives in the main banks knew their banks were insolvent?

Professor Gregory Connor:

Yes, I am, certainly.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Who?

Professor Gregory Connor:

I think I am not supposed to name names.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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You are not to, although you can name institutions.

Professor Gregory Connor:

In at least two institutions, Anglo Irish Bank and Irish Nationwide, I suspect senior people knew they were insolvent. I more than suspect it. I feel strongly that there were senior people at each of those who knew the banks were insolvent.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Should the Central Bank and the Financial Regulator have known at that time that Anglo Irish Bank and Irish Nationwide were insolvent?

Professor Gregory Connor:

Absolutely. One does not provide a blanket liability guarantee unless one is 100% sure that one of the banks is insolvent. One provides a blanket liability guarantee because one is 95% sure that it is not insolvent. It is exactly the opposite position. One does not provide a blanket liability guarantee because there is only a 90% chance of insolvency; it has to be the opposite. It was very risky.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Connor has given his view that Anglo Irish Bank and Irish Nationwide should have been let go at the time. In that scenario, what would have happened to depositors? Anglo Irish Bank had over €50 billion of customer deposits.

Professor Gregory Connor:

It is a good question. They are "power passive" with the senior debt holders who should have been forced to take losses. The Government could have passed legislation to compensate the depositors, and I think it would have happened.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Would that have been up to the deposit guarantee level?

Professor Gregory Connor:

Perhaps it would have been up to a limit. It is a difficult question for me because it is a political question. I think the Government would probably have decided to refund depositors entirely or up to a high limit. This would be typical in such a situation.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Had the banks been let go, would there have been some losses for depositors?

Professor Gregory Connor:

Yes, for some large corporate depositors and foreign financial intermediaries.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Connor attributed blame to bank managers for engaging in risky lending. In Ireland, the term "bank manager" tends to mean branch manager. Could Professor Connor clarify to whom he referred?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I advise Professor Connor to be mindful. In the nexus phase, we will deal specifically with individuals from the financial institutions. I would not advise him to name individuals, but he can base his response on evidence in terms of behaviour and attitudes in the banks.

Professor Gregory Connor:

I have left that-----

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Connor mentioned "bank managers".

Professor Gregory Connor:

I have left it vague.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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I am giving him the chance to clarify it.

Professor Gregory Connor:

"Blame" is a loose, ambiguous concept. The blame goes right down to the line manager providing mortgages and property development loans that he or she knows are dodgy. I would blame them as well, although they are in a chain of command. Causally, it is not a fundamental.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Connor cited the massive inflow of foreign debt capital as the main cause of the banking crisis and said the Financial Regulator and Central Bank had the powers to prevent it. Looking at the history of the years leading up to the crisis, when should they have acted? When was the evidence clear that they should have intervened?

Professor Gregory Connor:

They should have acted early in 2005, and even 2006 would have been better. The charts in my paper show that had they acted in 2005, although the system was already unstable, it would not have been as disastrous as it was.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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If, during the meetings of 29 September and the early hours of 30 September 2008, the Government had said the problem was potentially too big for it and contacted the ECB to seek a temporary line of credit, an extension of ELA, to keep the banks afloat so it could assess their true health, would such support have been forthcoming?

Professor Gregory Connor:

The ECB did not have in its functional mandate providing risky capital. That flaw in the system has been dealt with. I am not sure the ECB would have responded. We can see that it had a flawed system in the fact that it broke its own rules in providing risky capital to the Irish banks. Some of the capital provided through ELA was not liquidity funding, given that the banks were insolvent and, therefore, any funding was risky capital injection. Obviously, the banks had a Government guarantee, and that was how they allowed themselves to call it liquidity funding.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Connor stated that the net foreign borrowing of the Irish domestic banking sector was 88% of Ireland's GDP in the third quarter of 2008. Did this represent a financial stability risk to the country at that time?

Professor Gregory Connor:

Enormous. If one reads some of the other speakers, it was net of property development lending. Most of the foreign property development lending is Northern Irish or British construction by domestic-based borrowers.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Should it have featured in the financial stability reports from the Central Bank?

Professor Gregory Connor:

Yes, that was a big mistake and John FitzGerald has noted that this big debt overhang was missing from the macro perspective because it was hidden.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Picking up on the previous questions and on this knowledge of insolvency in two of the institutions - this knowledge the management would have had - how do you know they were aware their bank was insolvent?

Professor Gregory Connor:

Only from the discussions on the capital market desk, which I recommend the Deputy listen to. That was key, I think. Other than that, there are few direct quotes but it certainly looks obvious after the fact. I do not want to discuss individuals, so I do not think I can answer that question without discussing individuals. I apologise.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Just to clarify, you are basing your knowledge on the recordings that you have listened to from the capital desk-----

Professor Gregory Connor:

And other statements by individuals, who cannot be named, so I-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Deputy, you are moving into individual territory and also into matters that might be the subject of a criminal investigation, so I will pull you back from that area and ask you to change your line of questioning.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I thank the Chairman. Professor Connor, you said earlier that it was dead obvious with hindsight, and probably at the time - the insolvencies in the banks. You also said that a thoughtful Cabinet meeting should have been able to see that Anglo and INBS were insolvent, even with the bad information they were getting from regulators. Can you expand on that, please?

Professor Gregory Connor:

Yes. Keep in mind that for a blanket liability guarantee, you only need a credible risk of insolvency so they did not need to know, as I have stated and as Professor Honohan has stated. With hindsight, it is completely clear they were insolvent but you only need a credible high risk of insolvency for a bank liability decision to be clearly wrong. I think it was obvious to any thoughtful analyst when the blanket liability guarantee was given that, in fact, two of the banks were either insolvent or were highly probably insolvent. There was a high probability that they were insolvent. I think that was fairly obvious, even with the poor information provided by those banks. Just by looking at their sets of accounts and the enormous exposure to property development lending and their need to roll-over liabilities, which are in a frozen global interbank borrowing market, they were in deep trouble.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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When you say "thoughtful Cabinet meeting", what are you saying?

Professor Gregory Connor:

In other words, if they had thought "What is best for the Irish public this stage?". I think there was a political bias. In other words, I suspect - again, I was not at this Cabinet meeting - they thought it is politically in our interests. I suspect that played a role, which it obviously should not in such a high-stakes, expensive decision. They should have said, "Let's just think about this from the perspective of the public". I suspect there was a political angle to the decision because it seems such a wrong decision. I think Professor William Black, in earlier testimony, said the decision was insane. That is an overstatement. It was a wrong decision, clearly, on balance. Despite the poor information, it was wrong and I suspect the thing that tipped it into the wrong category was probably the political benefits they saw from the policy.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Can you just expand on the political benefits from the policy?

Professor Gregory Connor:

That is speculative but, of course, the property development community was a very strong lobby at this point. The banks also had lobbying power but the property development community had very strong relationships with members of the Dáil and they were going to hurt most if the two biggest supporters of the property development community were let go in a shock bankruptcy. They would all be then subject to immediate restructuring. So I suspect that played a role, but that is clearly beyond my expertise. I do not know why they made the wrong decision but I believe strongly that the decision was wrong.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I will move to a different area in the time I have left. There was a delay in setting up NAMA and you said there were unfortunate consequences of that. Do you know why there was that delay?

Professor Gregory Connor:

I do not but again this probably feeds on my distrust of the property development community. This was very convenient for wealthy property development borrowers. The delay in setting up NAMA was very convenient for many large borrowers to the detriment of the Irish taxpayer.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Thank you.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Cuirim fáilte roimh an tUasal Connor. In your 2012 co-authored paper, The U.S. and Irish Credit Crises: Their Distinctive Differences and Common Features - I think we have given you notice that I would be asking questions in relation to this paper - the following point is made. A key feature of an asset price bubble is that "traders are often not interested in the asset for its intended use or its earning capacity but only in its expected price appreciation." The paper goes on to state that in Ireland this interest in expected asset appreciation and not the intended use of the asset was "reflected in a significant increase in the number of vacant properties, especially in the investment sector of the market". Can you explain to the committee what you mean by this point? Why was this interest in asset price appreciation reflected, as you say, in a significant increase in the number of vacant properties?

Professor Gregory Connor:

In an asset pricing bubble, particularly on the mortgage side more than on the property development side, especially in investment mortgages, people were interested in flipping properties, that is, buying a property not because they had a long-term interest in holding it for rental but to flip it quickly within a few years for a profit. This worked for several years in a row. That is common in asset pricing bubbles - that people buy a property not for its intrinsic value but the fact that they can sell it on in what is sometimes called "the greater fool problem". You think you can buy a property, even though it is overvalued, because you can sell it to someone who will pay even more. There was some of this. As the debt capital inflow into the Irish banks manifested itself in excessive of mortgage lending, that pushed up prices properties. The banks then encouraged speculative investors to buy properties in order to flip them. It was obviously a Ponzi scheme which could not go on forever.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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As you are probably aware, if you are following the inquiry - it is clear from your testimony that you are - the inquiry will move into the property, State and finance nexus quite soon and it will look at the relationships between finance, property and the political and State institutional worlds. With that in mind, in that paper I mentioned, the following point is made: "Another source of regulatory imprudence in Ireland was the long and close relationship between the Fianna Fáil political party (the dominant party in coalition governments during most of the pre-crisis period) and the Irish property development industry." You touched on this in regard to Deputy Murphy's question. Could you briefly explain to us what you meant by that statement, what you mean by regulatory imprudence and how this is linked with the long and close relationship between Fianna Fáil and Irish property development industry?

Professor Gregory Connor:

I would say I am not an expert. That is a political question and that relationship requires someone who really knows the political landscape at a deep level, which I do not. In terms of overview - that paper is a comparison of the US sources of their credit liquidity crisis and the sources of the Irish crisis - in both cases, as in the Greek case, some of the problems are political over-enthusiasm or political biases. For instance, in the US, there was a massive political movement to increase mortgage lending to poorer sectors of society. There was a massively strong political consensus to do that. In Ireland, the equivalent was the relationship with the property development sector - between the coalition governments and that sector. I do not think I can give you a deeper understanding of that. I just do not think I have the expertise and the deep knowledge. That requires a deeper statement than-----

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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This is something the committee will have to examine. You are the person who made this claim. The effort is to either back up that claim or withdraw it. Do you stand over that claim?

Professor Gregory Connor:

I stand over that claim. I think most of you are familiar with that situation being true at the time. If you read the books about the bubble, they all clearly state that. I do not remember the author of The Builders but if you read that book or the book on the Anglo bank, that is clearly stated in those books. I am a consumer of that. I do not know the political landscape at that level of depth. I am an economist.

I am very interested in the Irish economy but I am only here since 2008, so I do not have the depth of knowledge others might have.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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I appreciate that. In the same paper, Professor Connor uses a phrase the committee has heard on a number of occasions, with Dublin being described in the pre-crisis period as the "Wild West of European finance". The paper states: "Starting in the early 1990s, the Irish government made a strategic decision to become a world-leader in 'offshore' financial services." Among the attractions of this country was the "light-touch, almost nonexistent, tax and regulatory oversight". The paper goes on to state:

An unintended consequences of the extremely light-touch financial regulatory regime in Ireland was to hobble Irish regulators in their oversight of domestic banks. The actions of the Irish financial regulator [were at that time] secretive with limited public disclosure.

Will Professor Connor explain these very strong statements?

Professor Gregory Connor:

The IFSC has been a success in many ways but it does specialise in very light regulation. German taxpayers probably have bigger losses than Irish taxpayers arising from the light regulation of the broader Irish financial sector through their losses in the IFSC. It specialises in regulatory arbitrage and tax-type situations that are perhaps pushing the limits. That has worked and is partly what offshore centres do, but it probably has been done to excesses in some cases in the IFSC. Furthermore, that tendency or philosophy washed back to the domestic economy. The regulation of financial markets in domestic Ireland was hobbled by the very light-touch approach that was one of the founding principles of the IFSC.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I welcome Professor Connor. Will he outline for the committee the different factors that affect a bank's ability to attract corporate deposits versus bondholder funding? What are the principal factors there?

Professor Gregory Connor:

Deposits are considered a more stable source of funding than bank bonds. However, corporate deposits can be quite volatile, whereas retail deposits are a very stable source of funding for banks. As to the relationship between bank bonds and corporate deposits, bonds can give a more stable stream but it depends on their length. A long-maturity bank bond is somewhat more stable than a corporate deposit and the most stable is the retail deposit. The Deputy is asking what would lead a bank to have more corporate deposits than bonds. I am not sure that is something it would prefer from a risk perspective. It might prefer the longer-term bonds because they are more stable than a volatile corporate deposit.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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In his opening statement Professor Connor spoke about the difference between blame and causation and noted that shareholders were pushing other banks to follow some of the leading banks he mentioned. Were there any other groups, either internally within the banks or externally, that were pushing some of the more long-established financial institutions to go down that route?

Professor Gregory Connor:

That is a good question and it raises a factor I have not mentioned. The foreign entrants to the Irish market tended to be a very bad influence. Bank of Scotland (Ireland), for instance, was a very bad influence in its actions. Even the Icelandic banks were threatening to enter the Irish market, with talk of one of them attempting a takeover of Irish Nationwide Building Society. The foreign banks were another troublesome feature in the Irish banking landscape. The statement of the proportions of market share misses that there was also an increase in foreign actors. The foreign share grew but the domestic versus foreign shares were roughly constant.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Aside from financial institutions, were there any other push factors?

Professor Gregory Connor:

In terms of causality, there was this enormous debt inflow which spread into the banks, with the latter forcing themselves to take more and more as part of the inter-bank rivalry that was going on. Shareholders were part of the problem. We had pensioners with their Bank of Ireland and AIB shares, many of whom never voted. Are they to blame? They paid the cost; in fact, all shareholders equally paid the cost for encouraging the banks down that route.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I have a direct question regarding a point on which Professor Connor touched. Does he believe our EMU membership was a critical part of the financial collapse in Ireland?

Professor Gregory Connor:

There has been a great deal of work by Paul de Grauwe and others on the very deep error in the design of EMU, which relates to the inability to control fast capital flows across member states. That was fundamental, yes. If Ireland had its own currency, French and German savers would not have felt they had the implicit guarantee of investing their low-risk, high-yield money into Irish banks.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Professor Connor referenced Iceland, which did have its own currency. Previous witnesses, including Professor John FitzGerald in particular, have noted that Latvia and Estonia had property bubbles similar in nature to Ireland but were outside EMU. What was the difference in those countries, which were European Union members but not members of EMU at that time? Why did they have the same type of property bubble we had?

Professor Gregory Connor:

Those are small economies - even smaller than Ireland - and they saw a lot of German fund inflows despite the currency difference. The euro currency is not necessary for a financial bubble. An important feature of bubbles is that they are all different and, superficially, each looks different from the previous one. That is the nature of them because one prevents bubbles wherever one can, which means the next one will be something one did not think of.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Professor Connor mentioned several times that economists at the time downplayed the potential difficulties involved in economic and monetary union. I was a student of economics at the time and recall several significant voices in Irish economics who did express concern. In fact, it could be argued there was a 50:50 divide.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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The Deputy is over time. Will he put his question?

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Will Professor Connor comment on that?

Professor Gregory Connor:

I agree there were economists who expressed concern and they actually received a lot of grief for stating something that was so politically unattractive as to deter countries which we wanted to be members of our club for good reasons. Economists should have been more forthright and allowed that level of criticism to have more impact. Whether they would have had an effect on the decision makers is not clear.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Professor Connor is very welcome. He has made strong statements about insolvency. Specifically, he said that Anglo Irish Bank and Irish Nationwide Building Society were insolvent at the time of the guarantee.

Professor Gregory Connor:

I repeated that from Professor Honohan's report and I agree with him. I say I repeated it but, in fact, I made that statement and then received Professor Honohan's follow-up document where he also states it.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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How does that statement tally with the PricewaterhouseCoopers report that was issued immediately after the guarantee?

Professor Gregory Connor:

That is a very good and difficult question in that the PwC report is not consistent with the fact that the Irish taxpayer had to pay a €35 billion capital infusion to close these banks. A going concern should not need €35 billion to be closed. In fact, it was a supported closure because, as we know, the NAMA assets were bought at above their value to provide some support.

I believe the PwC report is clearly flawed. That is all I can say. I agree there is an inconsistency, that they provided such a report, which is not justified.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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In terms of the special resolution regime, we know from Mr. Peter Nyberg's evidence that the Department of Finance began thinking about the resolution regime in 2007 after Northern Rock. Many of us were unaware that the Department of Finance had even considered a special resolution regime. Should that have advanced?

Professor Gregory Connor:

Yes, although I do not believe this is strictly an Irish problem. One of the reasons that Northern Rock had a run was that the British bank resolution system was also flawed at that point. It was a fairly widespread European problem, including in Ireland. Ireland has had to renew many of its finance related legislative systems following the crisis, for instance, bankruptcy was also very out of date.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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Mr. Nyberg stated also that the Department of Finance brought the resolution regime to the Domestic Standing Group, DSG, and other institutions did not believe that this was a good idea. Can Professor Connor comment upon his evidence that the other institutions, the Financial Regulator and the Central Bank, believed that this was not a good idea following the Norther Rock debacle?

Professor Gregory Connor:

No, I do not believe I can comment upon that in a useful way. I do not remember that statement in his evidence.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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In page 6 of Professor Connor's statement he says that Irish bank shareholders and share markets also pressurised bank management to pursue risky strategies; there was an expectation of rapidly increasing annual earnings and dividends in the absence of which share prices suffered relative to competitors and the bank risked becoming a takeover target. When he mentions Irish bank shareholders is he referring to individual shareholders or institutional shareholders?

Professor Gregory Connor:

I am talking about the AGM and the feedback from shareholders to the board of directors. The board of directors is responsible to the shareholders; the shareholders clearly wanted more of this and questioned why their bank was not growing the way Anglo Irish Bank was growing. That is the claim, obviously partly to diffuse the blame. I know from speaking to managers that they were under a lot of pressure, both internally and from shareholders, to follow Anglo Irish Bank. Until it collapsed, Anglo Irish Bank's stock price had increased spectacularly, and shareholders believed that they were lagging and that their share price should do the same.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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In Professor Connor's presentation he spoke about high growth economies and that the investment from the very stable deposits flowed into Ireland on the basis that Ireland had the potential to be a high growth economy. Would that have been standard or unique in terms of very stable deposits moving towards a high growth economy?

Professor Gregory Connor:

That contributed. Ireland was unlucky in that it was seen to be a reliable, fast growing, economy, and that generated over-confidence in the banks, in the property development community, in the mortgage buying community, and in the policy makers. Yes, the fact that Ireland had a long, very good period of growth contributed to over-confidence and that contributed to policy errors.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I want to move on to deal with a couple of matters. In Professor Connor's deliberations today he spoke about net foreign borrowings and the proposal that Irish banks should have contained or limited these at that time; I assume that in terms of a recommendation he would be making that going into the future as well. Could Professor Connor explain to the committee how that can happen, given the nature of EU laws and the principles of free movement of labour and capital, and how we could keep other European funds out of the Irish financial institutions?

Professor Gregory Connor:

The net foreign borrowing figure is delivered every month by the Central Bank in table A4.1 so the number is there and I am sure the macro-prudential economists in the Central Bank are following it, as they should have been following it then. When it is a problem the Central Bank should immediately turn to the individual banks and take action on a bank by bank basis. I do not believe it is necessary, when alarm bells ring, to take action against all banks; instead, each individual bank should be looked at and told what they must do.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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That is not the question I am asking Professor Connor. I am asking him whether this can actually be done under existing European law?

Professor Gregory Connor:

Absolutely. Any one of the banks may be prevented from focusing excessive concentration in a sector or on illiquid volatile sources of liabilities.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Professor Connor spoke at length this morning about illiquidity and solvency. In general terms, in any given country or at any given time, should a Central Bank and a financial regulator be cognisant of the solvency of the banks under its remit? Should that be part of its day-to-day job?

Professor Gregory Connor:

That is and should be a part of its job. The Central Bank should be sure at every point in time that the banks under its remit are solvent and, if they are close to insolvency, it should move in immediately and restructure.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Was that behaviour visible during the crisis period?

Professor Gregory Connor:

They missed that and they should have acted much more strongly. That is very clear with hindsight.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I want to touch back upon the issue of ELA because this has been referred to by a number of different witnesses so far. Was ELA provided to the Irish banks after the guarantee?

Professor Gregory Connor:

Yes.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Given Professor Connor's comments this morning that two of those banks were insolvent prior to the guarantee - one would then assume that they remained insolvent after the guarantee - how was it that the ECB was able to provide ELA? The rules of ELA are very clear with regard to solvency; money cannot be given to insolvent banks.

Professor Gregory Connor:

That is correct. The liability guarantee was a fix-up. It was a patch-up to allow funding into the banking sector in the absence of solvency. That is the first of my three caveats regarding the liability guarantee. It was used as a fix-up. The ECB said it was not liquidity funding but that it had a Government guarantee that the funding would be repaid. In my opinion they were using the liability guarantee indirectly.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Can Professor Connor expand upon that? Did the provision of ELA after the guarantee reflect the structure of ELA's intended use?

Professor Gregory Connor:

Could the Chairman repeat that question?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Was the provision of ELA after the guarantee in line with its intended use?

Professor Gregory Connor:

No, it was not. I believe that in reality the €136 billion of liquidity support was not all liquidity support.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Does that mean that ELA was being provided to banks that were insolvent?

Professor Gregory Connor:

Yes, certainly the €30 billion in terms of promissory notes.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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What was the consequence of the provision of ELA to insolvent banks at the end of the guarantee period, two years and two months later?

Professor Gregory Connor:

That is a difficult question. I have trouble working through all of the possible scenarios there. I do believe it is clear that the ECB was in some sense pushing its charter to the limit in the amount of liquidity support it was providing and it was using the liability guarantee as a cover. The ECB was in an impossible situation where it had to keep the bank system running yet could only provide funding to solvent banks and could not deal with insolvent banks, because those were a national responsibility.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Did this have any relationship with Ireland entering a bailout programme two years later?

Professor Gregory Connor:

Certainly. The other aspect was that much of the €136 billion in liquidity support was made during 2009.

As the banks could not roll over their bond funding, they turned it into liquidity support from the Irish and European Central Banks. They then realised this liquidity support was risky capital. They had a Government guarantee but that was no longer good enough. Now providing funding to the Irish Government was risky capital, meaning the backstop for liquidity support was also risky. It was like someone who had a mortgage but who lost their job and their backstop - their parents - also lost their jobs. Liquidity funding was provided to risky banks, backed up by a risky government. That was a lot of the reason the ECB wanted Ireland into the troika bailout programme. It wanted its support to turn into liquidity support and not become a risky position.

Photo of Sean BarrettSean Barrett (Independent)
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Regarding the Watergate moment, are the tapes of the capital market desk distinct from the Anglo Irish Bank tapes? How many bankers are recorded on those tapes admitting they were insolvent? How long did it take place before the embellishment document that Professor Connor described?

Professor Gregory Connor:

It would be very interesting for the committee to hear more of those tapes. I do not know if the committee can ask for them. I have only heard little bits-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I need to put on the record that these are matters that may be subject to a criminal investigation and cannot be dealt with by this inquiry. I will give the Senator some leverage to ask a different question or else we will move on.

Photo of Sean BarrettSean Barrett (Independent)
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Esmond Birnie wrote very strongly against entry into the euro. In the Northern Ireland Parliament, three of the five parties accepted the dangers of the euro. There were some in Irish economics and public life who acknowledged there were dangers in entering the euro without reading the small print.

Professor Gregory Connor:

Several prominent Irish economists who I will not name were strongly opposed to euro entry. There were more who were sceptical about the Greek entry, not the Irish entry. Many of them found it quite uncomfortable because of the political pushback from expressing that view.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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In 2008 in a letter Professor Connor co-wrote to The Irish Times, he spoke about bank management and shareholders failing in their duties with managers presiding over a loss of wealth unprecedented in the modern economy and shareholders failing in their duty to monitor and control management. He said, "Neither side should get away with this dereliction of duty". Does he believe there needs to be individual penalties for banking officials or fines levied against their institutions? Does he believe officials in the Central Bank or in the Financial Regulator should resign?

Professor Gregory Connor:

It is very easy, especially in this Chamber, to talk about punishing the bankers because the only bankers left, except for Bank of Ireland, are the taxpayers. There is no one left to punish. All the shareholders have walked away with zero cash. There is nothing left under limited liability. The shareholders cannot be punished any more than being left with zero cash. As for the bank managers, it is true. It might be through the criminal system and not part of the committee's investigation.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I thank Professor Connor for his participation today. It has been a very informative and very valuable meeting which has added to our understanding of the factors leading to the banking crisis.

Professor Gregory Connor:

I thank the committee for inviting me to make a presentation to it.

Sitting suspended at 11.25 a.m. and resumed at 11.45 a.m.

Professor Eamonn Walsh

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I welcome Professor Eamonn Walsh, UCD, to discuss the regulatory and supervisory policies, systems and practices which may have underpinned the banking crisis in Ireland and, in particular, accountancy standards and auditing. Professor Eamonn Walsh is PwC professor of accounting at UCD. He has served as Dean of the Smurfit School of Business and chairman of the accounting department. Prior to joining UCD he held faculty positions at the London School of Economics and New York University. Appointments have included UC Berkeley and Peking University. A consultant to a number of leading European, US and Asian corporations, he has also completed assignments with governmental organisations, the International Monetary Fund and the United Nations. His primary research, teaching and consulting interests are in the areas of financial analysis, equity valuation and US security markets. A co-author of three books, his research has been published in Accounting Organisations and Society, the Journal of Business Finance and Accountingand the Journal of Accounting Auditing and Finance. He was the founding editor of European Accounting and served as associate editor of the Journal of Accounting Auditing and Finance. He was the inaugural recipient of the Institute of Chartered Accountants Excellence in Education Award and has been a presenter at the World Economic Forum.

I wish to advise the witness that by virtue of section 17(2)(l)of the Defamation Act 2009 witnesses are protected by absolute privilege in respect of their evidence to the committee. If witnesses are directed by the Chairman to cease giving evidence on a particular matter and they continue to do so, they are entitled thereafter only to a qualified privilege in respect of their evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and, as the witness has been informed previously, the committee is asking witnesses to refrain from discussing named individuals in this phase of the inquiry. Members are reminded of the longstanding ruling of the Chair to the effect that they should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable. I now invite Professor Walsh to make his opening statement to the inquiry.

Professor Eamonn Walsh:

I thank the Chairman for his introduction and the committee for the opportunity to assist the inquiry. I was asked to consider the role of accounting in bank crises and also external auditors. I have prepared some brief remarks on these two topics which, in the interests of brevity, I have distilled from my published statement. I would be happy to elaborate on any of the points I have raised. I am also happy to discuss other accounting issues of relevance to the banking crisis.

When we think about banking crises, accounting is largely a silent bystander. A bank crisis generally involves rapid loan growth alongside which we get concentrations of risk. Often this rapid expansion is funded from volatile sources. When one is in this expansionary mode, if a regulator or anybody else questions the business model, management will dismiss them because they will be able to point to excellent accounting profits and, as a result, great contributions to capital. This pattern of behaviour was evident prior to 2008 in Ireland. Our banks were among the most profitable in Europe. It was widely believed that in what appeared to be challenging scenarios there were sufficient cushions to withstand risks. Balance sheets and income statements formed the basis for this analysis so accounting was clearly implicated in the misperception of risk. By 2009 it was apparent that the capital cushions available to Irish banks were entirely inadequate. Some financial institutions had liabilities that exceeded their assets; they were insolvent.

Balance sheets and income statements are prepared using accounting rules or accounting standards. In general these are known as international financial reporting standards. They are a large body of rules which indicate how one should measure assets, liabilities and income for an enterprise. However, during banking expansions these accounting standards may be a little unhelpful and they will serve to over-estimate the profits that are reported to external investors and lenders. If we start thinking about bank lending which is going to be the principal asset for banks, and the Irish banks in particular, essentially the big problem is estimating loan impairments. Loan impairments are the amount of the loans that will not be repaid and it is a challenging accounting problem. Impairment may be understood as something not performing as anticipated. If we think about it in American terms, one would speak about someone being visually impaired - it means the eyes are not working as originally anticipated. The notion of impairment means that things are not working as originally anticipated.

With bank lending, if one knew exactly how much the bank was going to lose the accounting would be straightforward. For example, if a bank engaged in very risky lending and we knew in advance just how risky that was and the risks entailed, impairment accounting would be very easy, because we would say we expect to lose all the money we lent to a particular customer, therefore, we should buck a loss and decrease profits and decrease capital. The problem is that this scenario is highly unlikely. If we lent money to a customer and we knew we were going to lose it all immediately we would not lend in the first place. Lending is based upon the proposition that we do not expect to lose our money when we lend money to a particular identified customer. The problem then is that we must engage in some estimates of the defaults that might occur. Given that there are estimates and judgment calls involved in determining these impairments, it is necessary to have additional guidance. The accounting standards as they stand require an entity to assess at the end of each reporting period whether there is any objective evidence that a financial asset or a group of financial assets is impaired. In other words, one is required if one is preparing financial statements for a bank to sit down and ask at the end of an accounting period whether there is objective evidence that an impairment has occurred. The rules go on to state that a financial asset is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset. In other words, one must point to some event that has occurred since we originated the loan that constitutes objective evidence that we have made a loss.

If we believe that a loss has been made it is necessary to estimate the impact of that loss and one is required to produce a reliable estimate of the amount of that loss. The most counter-intuitive part of all of this is that the standard explicitly states that losses expected as a result of future events no matter how likely are not recognised. In other words, if the dogs on the street expect that losses will occur they are ignored by accounting standards. One is required to have objective evidence that the loss has been incurred rather than a belief that events will occur in the future which will endanger these loans. Therefore, it is a very conservative definition of impairment since it requires objective evidence that a loss has been incurred. As a result, impairment accounting is pro-cyclical. What this means is that in a period of expansion as a bank expands its loan book, the bank will appear far more profitable because as it originates the loans it does not expect to lose money, it has not incurred a loss and so the bank will appear incredibly profitable. In turn that means it will have additional capital so it will appear that it has additional cushions against future losses. In a period of contraction the reverse happens.

When the bank expanded it made lots of loans. When there is contraction it becomes apparent that some of these loans are impaired. That immediately means a swing from having excessive loss of profits to excessive losses. That is what we mean by procyclicality.

There are two additional features of accounting policies which lead to even greater procyclicality, one of which is the accrual of interest.

It means that if one lends money to a customer and agrees that they do not need to repay interest immediately then instead the interest will be rolled up on the loan. That roll-up of interest will be recognised as a profit even though the cash has not been received from the customer.

The second thing that can juice up the amount of income that is reported during the expansionary phase is the existence of loan arrangement fees - in other words, some agreement whereby the lender will give money to the bank, at the origination of the loan, as compensation for the origination costs of that loan. It does mean that accounting rules give rise to excessive reporting of profits when we are expanding credit and it will also lead to substantial declines later in the cycle. This cycle was quite evident in Ireland. We had exuberant new lending which gave way to no lending at all because we went from having very high profits to almost no profits at all. Nevertheless, it is difficult to conceive an outcome that would have been very different. Even had accounting rules permitted the use of expected losses, as distinct from incurred losses or other alternatives, I believe that profits would have exhibited a similar pattern.

Impairment accounting is largely diversionary for four reasons. First, the rules are well understood by informed users of bank financial statements. In other words, what I have said today is not new and has been known for decades.

Second, individual banks could create additional provisions despite the accounting rules. There is nothing to prevent a bank from saying "We believe, to give a true and fair view of our results, that we should book additional provisions this year."

Third, there is nothing to prevent the Financial Regulator from insisting upon additional provisions or enhanced disclosure. The regulator did exercise such powers.

Fourth, the expected loan losses during the growth phase in Ireland were likely to have been low anyhow. No matter how one tries to cut it, during the period 2004 to 2006, inclusive, it is very difficult to conceive of any type of a mechanism that would have resulted in a large decrease in the reported profits of banks.

While these measurement rules are quite different it is important to realise that banks also make disclosures. This is a key part of financial reporting, and it is not just what is in an income statement and a balance sheet, but also the additional disclosures in the financial statements. Additional disclosures help one to understand exactly what is going on in terms of reported income. In my opinion, the disclosures concerning the increased risks within Irish banks were inadequate during the period.

Through the lens of 2002 balance sheets - which were balance sheets dominated by residential lending - users could have easily concluded that increased profitability was synonymous with increased cushions but a seismic shift occurred during 2002 to 2007. There was a big change in the composition of loan portfolios for Irish banks. Rather than residential mortgages dominating property landing, commercial and development lending became almost 50% of property lending. In other words, the composition of the assets changed very dramatically. There were concentrations of risky lending that displaced less risky home mortgages. The distribution of the shift is also significant. It is clear that these additional risks were not distributed equally across banks in Ireland at the time. Further, a significant proportion of the loans were concentrated among a relatively small number of borrowers.

In summary, I believe that the real challenge for external users of financial statements was understanding the changing nature of the risks on balance sheets before 2007. Had users fully understood the increased exposure to commercial and speculative lending, and that it was concentrated amongst a very small group of borrowers, it would have been far easier to realise that the quality of profits had declined and that capital mattresses, rather than cushions, were required.

The second point I was asked to talk about was bank audits. What do auditors do? Directors are responsible for preparing and approving the financial statements of a company or a bank and then auditors issue an opinion on the financial statements. For example, an audit report will state something like the group's financial statements. It will give a true and fair view, in accordance with international financial reporting standards as adopted by the European Union, of the state of the group's affairs as at 31 December 2015 and of its profits for the year then ended. The first thing auditors do is express an opinion that the financial statements have been produced in conformity with international financial reporting standards.

Bank auditors have some additional responsibilities to a regulator and are required to bring certain matters to the attention of a regulator. That means there are some additional responsibilities between an auditor and a financial regulator.

In addition to these responsibilities, a regulator has the power to request information from an auditor. There is a particular additional set of duties with respect to bank auditors. For example, bank auditors would have been required to perhaps produce reports of any breaches of prudential sector lending limit guidelines. As Nyberg concludes, in the majority of cases the auditors did not report regulatory sector lending limit excesses to the Financial Regulator. Even if all excesses had been reported, it appears unlikely that any action would have been taken by the Financial Regulator who was already aware of, and not concerned about, such excesses. In other words, there were alternative reporting mechanisms between the banks and the Financial Regulator that are quite independent of annual financial reports prepared for shareholders and lenders. While I have not had access to the auditors' communication with the Financial Regulator, Nyberg states that the auditors clearly fulfilled this narrow function according to existing rules and regulations.

The committee might wish to know what else auditors do apart from expressing this opinion. For say loans and receivables, there would be a general expectation that auditors should go along and look at a sample of some of the lending files within a bank. As part of their audit they would do the following: ensure that lending policies are adhered to; review concentration reports and related party loan reports; establish evidence of any collateral assigned to the institution; check the financial condition of co-signatories and guarantors, examine past experience with the enforcement of guarantees, and confirm terms with the guarantor; compare loan amounts with appraisals; and ensure that construction loans are correctly classified as loans rather than real estate investments. For significant construction projects, they would ensure that advances are based on progress and that there are offsite-onsite inspections to verify the collateral and the progress with the construction.

Auditors should also assess management's loan reviews for impairments. Audit procedures should establish that management has looked beyond the collateral to identify potential borrower weaknesses, to identify if collateral appraisals are adequate and that up to date borrower financial information is available.

Auditors are also expected to review performance against the original loan agreement and be alert to any biases, for example, loans to public figures or personalities.

In summary, when published financial statements are prepared in accordance with international financial reporting standards, auditors also play a valuable role in assuring the veracity of the loans and receivables on a bank's balance sheet.

I shall make some concluding observations. Between 2002 and 2007 the aggregate loans in Ireland grew rapidly and exhibited significant concentrations of commercial lending, and speculative commercial lending. However, these concentrations varied across banks and there were also significant individual borrower exposures which gave rise to exponentially greater risks. Contemporaneous knowledge of these loan portfolio risks would have alerted external users to the sources of bank profits and their sustainability.

While there was no requirement to report these risks in the published financial statements, especially for financial statements prior to 2007, there were requirements to report capital adequacy, liquidity, impairment, large exposures and sectoral limits to the Financial Regulator. It is an empirical matter as to whether these amounts were correctly reported to the regulator and to the boards of financial institutions.

I thank the committee members for their attention and I would welcome any comments or questions you might have.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Thank you Professor Walsh. In order to set the scene, can you outline briefly the types of public reporting the banks engage in as part of their day-to-day work, publicly and internally, such as annual reports?

Professor Eamonn Walsh:

International accounting rules are essentially concerned with reporting to shareholders such as public financial reports and reporting performance to investors and other external parties. In general this involves an annual report consisting of a very large document - for a bank this may be 200 pages - which gives much detail about the bank's directors, how governance works, a balance sheet, an income statement and notes to the financial statements. This is not timely information and is produced four or five months after the year end. If the bank is quoted on a stock exchange it will, at a minimum, have a preliminary announcement of its results. This might be a month or two ahead of the publication of its annual financial statements but about two to three months after the end of its financial year. If a bank is listed on a stock exchange it might also produce a half yearly report. If the bank is listed in the United States it might also produce quarterly reports for investors. Investor reporting is generally not very timely. There are time-lags between events occurring and the publication of those financial statements.

Reporting to a financial regulator is the next type of reporting. A regulator is almost omnipotent regarding the information it can demand from a regulated entity. Regulators set up rules which can call for quarterly reporting of large exposures; there will be quarterly reporting of detailed balance sheet information; there will be far more detail than information available to external investors and there might be more frequent reporting concerning matters like liquidity. There are two universes - one is reporting to external users and the other is reporting to regulators, where the regulator sets the ground rules.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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You mentioned the regulators. In regard to external users, would auditors have obligations concerning risks associated with concentrations of lending limits by banks?

Professor Eamonn Walsh:

I am sorry, is this in regard to regulators?

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Do external auditors have obligations concerning disclosure of risks associated with concentration of lending by the banks? If there is a particular concentration of lending in an area, does the auditor have a requirement to report that to the regulator?

Professor Eamonn Walsh:

As I understand it, the banks will report this information quite frequently to a regulator. The auditors' responsibility is to make sure that if they become aware of information which might not have been correctly reported to the regulator, then that would be reported to the regulator.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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We heard from Professor Connor and from others that there were high lending concentration limits within the banks to the property development sector. From your examination of the practice of accountancy and auditing, was there any reporting by auditors to the Central Bank between 2007 and 2008, the period of high concentrations by banks in that sector?

Professor Eamonn Walsh:

I would not know. The communication between an auditor and a financial regulator is not available to external users. I believe the Nyberg report would have had some access to that communication and an opportunity to look at it. A lay member of the public, such as myself, would not have access to that communication.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Good morning Professor and thank you for being here. Not being an accountant, and conscious of the people at home, could you confirm that IAS No. 39 is the standard applied in accounting and auditing in Europe?

Professor Eamonn Walsh:

Thank you Senator. International accounting standards have been around for a very long time. They started in the 1970s. A big change occurred in 2005 when the European Union introduced a requirement that if you issue equity to the public you are a listed enterprise and as such you are required to prepare your financial statements in accordance with international financial reporting standards or IFRS. I have a copy here with me and as you can see it is a thick volume of accounting standards. There is one standard within this called international accounting standard No. 39. This IAS No. 39 deals with financial instruments. The principal assets and the principal liabilities a bank is likely to have are its financial instruments. When one speaks about accounting for banks the principal guidance is IAS No. 39. These rules apply to all enterprises. A retailer applies the same rules as a bank or an insurance company. These rules do not have a specific standard which deals with banks, they have a general standard that deals with financial instruments.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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What circumstances, if any, would need to have been in place where the standard would have allowed the value of loan assets to be written down, with losses reflected by the banks? It is clear from Professor Walsh's opening statement there were limitations on IAS No. 39 in that regard.

Professor Eamonn Walsh:

The rule IAS No. 39 says that one should not book an impairment until one has objective evidence of an actual loss. There is, however, nothing to prevent a financial institution from saying it has losses coming down the road, and in the interests of presenting a true and fair view to its shareholders, it might make an additional allowance for those expected losses. It would not conform with international accounting standards but it could be something a financial institution could do - Anglo Irish Bank did so in 2008. In its annual financial report Anglo Irish Bank put in an additional provision of €0.5 billion. There is nothing to prevent a bank putting in an additional provision, albeit being against the rules. There is a big body of rules and if one goes against the rules people will ask what it is that is being tried here.

Alternatively, one could have a disclosure which says the impairments are low, the profits are high, and loans have been made which could go bad quite quickly. A disclosure could be made to investors which states that loans may get into difficulty despite the fact they are not reflected in the balance sheet or the income statement.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Is this the way to account for an impairment?

Professor Eamonn Walsh:

Yes. There is a post-change to these rules, largely as a result of the financial crisis. I believe that from 2017 or 2018 the banks will be required to record impairments using expected credit losses. This will involve making an estimate of expected losses so that greater impairment can be recognised earlier in the cycle. When one makes loans, one does not expect to make huge losses.

It is only as the cycle progresses that it becomes apparent that one has some borrowers who cannot or will not repay their loans.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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If there had been acceptance of the credit risks that banks were running during the 2002-07 period, was there any scope to report on them in annual reports or periodic statements?

Professor Eamonn Walsh:

There was very little in the way of requirements. There was a standard up until 2007 known as IAS 30, which dealt with bank disclosures in a general sense about concentrations, but largely the guidance was so woolly that I do not believe one could find anybody who was not in compliance with the standard. In other words, what some regulators did, for example, in New Zealand, was put in additional interpretations of what they had said banks should be disclosing under IAS 30, but in the absence of such additional guidance, it is fair to say there was no requirement to make extensive disclosures. Nevertheless, there is absolutely nothing to prevent any financial institution from engaging in additional disclosure. As a financial institution is not required not to disclose, a bank could have engaged in significant additional disclosure and a financial regulator could have given guidance to a bank that additional disclosures should be made in the published financial statements.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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In Professor Walsh's opening statement - the published statement, as opposed to the briefer one - he referred to the work of the US Federal Deposit Insurance Corporation in documenting the life cycle of a bank failure in 1997. Rather than quote every word, it spoke about rapid loan growth, concentrations emerging, aggressive lending and so on, as it stated and the record would show. In Professor Walsh's view, were such features understood adequately by the Irish authorities, including the Central Bank and the regulator, during the pre-crisis period?

Professor Eamonn Walsh:

To be honest, I have no idea. I largely think this is an empirical matter, that is, to ask them whether they knew about these risks. If so, what did they do about them? Did they know about the risks and do nothing or, alternatively and quite possibly, did they not know about them? It is quite possible that, given the way information was being reported and making its way through channels, they were not fully aware of the nature of these risks.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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In Professor Walsh's professional opinion, does he feel it is likely, unlikely or impossible to judge?

Professor Eamonn Walsh:

It is impossible for me to judge based on the information I have available to me, in my professional opinion.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Professor Walsh could nearly consider another profession with an answer like that one.

Professor Eamonn Walsh:

Yikes.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I mean no disrespect. In Professor Walsh's statement he described the growth and the change in the composition of loan portfolios at the aggregate level in the Irish banking system as being the seismic shift that occurred between 2002 and 2007. He also stated: "The risks associated with increased commercial lending are well known and have been well known for many years." Given that such lending had been recognised for some time as an important risk factor in banking crises, was the accumulation of such risk disclosed in periodic reporting by individual banks during the period 2002 to 2007? If so, what is Professor Walsh's assessment of the disclosures?

Professor Eamonn Walsh:

Again, I had a very short period of time in which to prepare my statement for today. These financial statements date back to about seven or eight years ago. Unfortunately, it would be quite difficult for me at this stage to recall specific reporting practices. If I were to say in general, one of the difficulties is that, in the absence of disclosure, it means that one just reports a number like that for loans and receivables. We have loans and receivables of €50 billion and that is all of the information one receives in the annual report. It would clearly be very helpful if one said, "We have €50 billion of loans and receivables, €48 billion of which is speculative development lending." To an investor, if he or she were to receive that information, he or she would immediately know that this was quite a risky loan book and chances were that the income might not persist in the future for this particular financial institution.

Post-2007, disclosures were made. One of the problems with international financial reporting standards more generally is that they are designed for general purpose use. It means that the requirements for credit disclosures are not very well specified or articulated; the Senator can imagine, therefore, how disclosure could be quite difficult. Let us consider examples. Suppose a bank lends money to a retailer and that retailer is going to use the proceeds of the loan to purchase some development land, seeks rezoning of that land and then extends the retail store onto that land if the rezoning is successful. The question is: is that a loan to a retailer or is it a loan for speculative property development? One of the difficulties with the disclosures is that it is possible that somebody might look at this in the cold light of day and make a determination that this was a loan to a retailer rather than a loan for speculative property development. One of the difficulties with disclosure is that the absence of specific guidance means that it is possible that in that situation, there would be some judgment involved in determining whether it was a retail loan or a speculative development loan.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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If I were a bank or if there was a bank that decided to make a very large investment in an institution or a pension fund, would this be reflected in any way such that an auditor would see it? If that were the case, would there be any reporting obligation on auditors to regulators if, for example, an investment was seen to be particularly large, on the one hand, or, on the other, for a particularly short period of time?

Professor Eamonn Walsh:

Could the Senator give me an example in order that I could answer his question?

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I do not want to be specific. I will not give the example, but if I were a bank and wanted to invest €10 million in Deputy Murphy's bank for one week and he gave it back to me the following week, would there be anything in auditing that would ring an alarm bell or would there be any obligation within the system or standards that would suggest to Professor Walsh that one would need to report this to the regulator or say to the regulator that Senator MacSharry and Deputy Murphy were investing in each other's companies for unusually short periods of time?

Professor Eamonn Walsh:

One of the difficulties - it is a sort of twist in international accounting standards - is that one could actually maintain that the proper accounting for this would be to recognise an asset, namely, an investment, and recognise a corresponding liability, namely, an obligation to repay that investment later. The accounting rules - they are very specific rules - are called offset rules. In other words, one could construct a transaction whereby offset rules under international accounting standards would forbid one from offsetting these two amounts.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Time, Senator.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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I am nearly there. In terms of lessons, if any, what can be learned about how banks disclose information on their lending practices, investments and financial performance to help to mitigate future banking crises? To what extent are new rules and practices being considered and applied? Are they sufficient?

Professor Eamonn Walsh:

From what we have seen, I think the Central Bank of Ireland does deserve some praise. It has actually issued additional guidance to banks in terms of their disclosures on their loan books, in particular disclosures on impairments. If we were to look at the financial statements of the larger banks in Ireland today, we would find that there were much more copious disclosures of impairments, of loans past due and so on and it would be much easier for an informed user to make a sensible judgment on what was going on with a loan book at a point in time. I think that, largely, the difficulty is that international accounting standards are aimed at all enterprises.

One needs some sort of regulatory overlay, or some other overlay, which requires them to disclose more information, in a sensible manner, to investors.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I want to go through the Nyberg report with Professor Walsh, if I may. I presume the professor has read that report.

Professor Eamonn Walsh:

Yes but it was some time ago.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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In the written statement provided to the committee, Professor Walsh references the argument that "international accounting standards had prevented more prudent provisioning for possible future losses during the growth phase of the cycle" but says he believes that this conclusion may be too strong.

Professor Eamonn Walsh:

Yes. I referred earlier to the idea that the focus on loan impairment accounting may be a bit of a diversion. What has happened, and this frequently happens after a crisis, is that people are looking for somebody or something to blame and loan impairment accounting has been identified as something that was wrong. There has been a huge effort by international accounting standards setters, since 2008, to devise a new set of loan impairment rules. Everybody then thinks that if we solve the impairment rules, we will prevent bad things happening in the future but I am not convinced by that argument.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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When the professor says a diversion, does he mean in terms of apportioning blame for how the risks were missed?

Professor Eamonn Walsh:

One could end up spending a lot of time thinking about the right way to account for impaired loans but largely the result will not be that different in the growth phase of a credit boom. Generally, one will have quite low loan reserves. For example, the Nyberg report makes mention of the Spanish authorities which required a particular form of provisioning. They said that they were not interested in the international financial reporting standards but wanted their banks to provide for loans in a particular way.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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That implies then that the banks understand the risks of this pro-cyclical impairment accounting.

Professor Eamonn Walsh:

Yes, absolutely. In 2006 the loan to value ratios for domestic mortgages were changed by the Financial Regulator, with an additional capital penalty for lenders if they issued a mortgage that had a loan to value ratio in excess of 80%. In the regulator's report on this, one of the reasons given for doing it was international financial reporting standards. In other words, because it knows that impairments were not being recorded in a timely way, it puts in an additional capital requirement for these particular riskier residential mortgages.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Professor Walsh spoke about inadequate disclosures concerning the increased risks faced by the banks. If there is nothing preventing the banks from disclosing, why do they not do so?

Professor Eamonn Walsh:

That is a very good question. Let us take a hypothetical bank that is really bad. There is no way it would want to tell everybody that it had a really bad loan book. There are no incentives for a bank with a bad or risky loan book to disclose that fact. If anything, the incentives that operate are such that it might try to convey the impression that the loan book is a lot less risky than it really is because that will lower the cost of funds and make the bank more profitable. In that sense, an intervention is required which demands additional disclosure.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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So, the auditor comes in, on an annual basis, to the banks. Nyberg also says that the new standards that we have referred to meant that external auditors could not insist on earlier loan-loss provisioning. Does the professor agree?

Professor Eamonn Walsh:

The auditors are basically determining whether the financial statements and the impairment accounting comply with international financial reporting standards. The auditor cannot insist, in that context; the bank can insist, but not the auditor.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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When one talks about "external users", are the auditors in that category? Do they understand the accounts in the same way the banks would? Do they understand the risks in the same way as those preparing the accounts for the auditors would?

Professor Eamonn Walsh:

The auditors are not like vanilla external users. Auditors auditing a bank would generally have had considerable training in how banks operate, how best to audit a bank and so forth. We would expect them to have a very high level of knowledge of how to audit a bank.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Is it fair to say that they would have understood the risks on the bank balance sheets being presented to them?

Professor Eamonn Walsh:

One would imagine they were familiar with the business models that had been adopted by the banks and the risks associated with those business models.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Nyberg also states that the combination of growing property and funding exposures, combined with material governance failings, should have raised questions for the auditors about the sustainability of a bank's business if they were exercising the necessary "professional scepticism". What does Professor Walsh understand from that?

Professor Eamonn Walsh:

To be honest I would need to revisit the report and read the paragraphs preceding and following on from that comment, rather than make a statement ---

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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I am trying to get a sense of the obligations on the auditors if they understand risks on a balance sheet but are performing their duties in accordance with the accounting standards. Are there obligations on them to ring a warning bell if that were required?

Professor Eamonn Walsh:

Again, we must distinguish between ringing a warning bell for external users or internal users. The former would happen, largely, at a very late stage. It is probably fair to say that in terms of audits for external users, any signals from the auditor's report published by a bank is going to come late in the day. That occurred for the British banks, the Irish banks and indeed, right across the banking sector. The audit report is something that comes late in the day and it is really only when the ship is sinking and has probably hit the bottom of the seabed that it suddenly becomes apparent that the audit report is flagging something.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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In terms of breaches in prudential sector lending-limit guidelines, four of the covered banks breached those limits for property and construction lending between 2002 and 2008 but in a majority of cases the auditors did not report these excesses to the Financial Regulator. Is that unusual?

Professor Eamonn Walsh:

Again, I am not a bank auditor so I cannot say whether it is unusual or not. My reading from Nyberg was very much that quarterly statements were going to the regulator, so the regulator was receiving this information anyhow. The auditors were probably assuming that the regulator was receiving this information. They would have seen the reports that were issued by the bank to the regulator - one would imagine - and would assume that it was largely known that these limits had been breached. The Nyberg report is very helpful in this regard with its diagram illustrating how much of the lending was taking place outside of these limits versus how much was within the limits. That diagram is very useful in showing the extent to which there seemed to be an absence of control with respect to those limits.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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In terms of information flowing directly from the banks to the regulator - in the context of how an external user would understand them - would the risks that were being built up on the balance sheets of the banks have been obvious to the regulator?

Professor Eamonn Walsh:

It is difficult for me to know exactly what was reported to the regulator. We can imagine how the process might work, but we are speculating here. It might be the case that there is some sort of standardised Excel spreadsheet issued to every bank to be filled in and returned to the regulator. The main challenge with the design of such a spreadsheet is the captions that are used, for example, whether something is a retail loan or a speculative development loan. The captions used will colour the information that goes through.

The second issue is sectoral lending exposures or large exposures to individual lenders. One would anticipate that this would be reported up through the system. What could happen that would mean that it was not reported up? First, the guidance issued for filling in the spreadsheet might not be sufficiently detailed to make clear what must go into every box in the spreadsheet. Alternatively, the spreadsheet might not have had enough places to put in extremely risky lending.

There is a final consideration. I am not suggesting this occurred in Irish banking but we know from other jurisdictions, that one might structure information in such a way that it comes out in a certain way in reports. In other words, let us consider a big loan as a big chunk of salami and find a way to slice the salami so that it might not be apparent when looking at aggregate reports. Equally, one can think further back the food chain and if I was someone borrowing money from a bank, I might seek to structure a large loan in a way that might make it easier for the bank to slice salami later on. I am not suggesting that has occurred in an Irish setting but there are other cases, like BCCI, that are very informative if one looks at the auditing processes that went on in banks. It is an awful example of how information was making its way through the system.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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If the regulator becomes concerned, he has the power to request more information.

Professor Eamonn Walsh:

I am not a bank regulator and I am not an expert on bank law but my understanding is that a regulator is basically able to go in and demand whatever information he wants. A regulator can insist on an on-site inspection and can seek whatever information is required.

Photo of Eoghan MurphyEoghan Murphy (Dublin South East, Fine Gael)
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Is it unusual, as happened in 2008, for the regulator to instruct auditing firms to report concerns with liquidity or solvency they might have had from the 2007 audits? Is that an unusual thing?

Professor Eamonn Walsh:

I cannot speak to whether it is unusual.

Photo of Sean BarrettSean Barrett (Independent)
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I welcome Professor Walsh. When Professor Ed Kane was before the committee, he said in his presentation that regulatory officials and industry lobbyists resist transparent performance accounting. How does Professor Walsh respond to that?

Professor Eamonn Walsh:

Things are a little different in the United States. There is a different regulatory environment and a different financial reporting environment. Comparisons between the US and Europe are difficult to make given our different environments. It is difficult to establish what might be transparent reporting and what the bank should be reporting. One would like to see good disclosure about the risks financial institutions have. The international Financial Stability Board has issued extensive guidance on the types of disclosures banks should make. This considers credit risk and involves extensive disclosure.

The second issue is the roll-up of interest. This is not apparent under international accounting standards. Under US accounting rules, there are various regulatory overlays to help us to establish how much cash interest a financial institution is receiving. Australia, which uses the international financial reporting standards, requires banks in Australia to tell the amount of cash interest they have received. It is quite possible to take international accounting rules and use it to basically insist the rules are applied in a particular way that involves disclosure of cash interest received. That would be very helpful in dealing with the interest roll-up issue. It gives users an immediate indication of what is being rolled up and the risky loans in it.

Outside of international accounting standards, one area where this is quite transparent is in Russian banking. The Russian banking regulator has a requirement that people say what is the amount of cash interest being received. I see that as being key.

Photo of Sean BarrettSean Barrett (Independent)
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What should be in a stress test?

Professor Eamonn Walsh:

The trick with a stress test is to understand what are the risks. If one were to look back and think that the risks were primarily the residential mortgage book then we would specify stress tests that say that if residential property prices change by a certain amount, we can ask what will happen to bank profitability. However, if it turns out that, instead of being primarily a residential property book, it is also a significant commercial book with significant speculative lending and significant concentration to individual borrowers, the way we would conduct stress tests and the kinds of stresses we would like to impose on the model would be entirely different. The perception of risk is important in terms of determining how we ultimately conduct the stress test.

Photo of Sean BarrettSean Barrett (Independent)
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The point is raised in Professor Walsh's evidence that even if auditors had been willing to be whistleblowers, the regulator was not listening so it would not make any difference if they had blown the whistle. What should be the relationship between the auditors and the regulator?

Professor Eamonn Walsh:

I quoted from the Nyberg report because I do not have any direct evidence of these matters. It is not important to think about what the relationship should be because the Financial Regulator largely gets to dictate the relationship. It is largely a case of what one believes to be good regulatory practice. The regulator should dictate to the auditor the information required in the reports.

Photo of Sean BarrettSean Barrett (Independent)
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Should Ireland not have dumped the Generally Accepted Accounting Practice, GAAP, for International Accounting Standards, IAS, 39? Is there substance in that, as opposed to a technical accounting matter, that we can explain to the people at home? Was it a serious change?

Professor Eamonn Walsh:

We were using UK accounting standards prior to 2005. My sense is that the differences are not that great and if one wished to research the topic further, when the bank switched they were required to do a reconciliation for old GAAP to new GAAP. I had a look at two of the largest banks at the time and the differences are not that great in terms of moving from local Irish GAAP to the application of IAS. There were largely similar views of the world.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Professor Walsh is very welcome. Given that we are talking so much about disclosure, I will ask him a question about his position that jumped out at me. He is described as the PwC professor of accounting in UCD. What is the role of PwC in his title?

Professor Eamonn Walsh:

PwC kindly made a donation to UCD about 15 years ago for the creation of a chair in accounting. Subsequent to the donation by PwC, UCD advertised the position and I was appointed in an open competition. Subsequent to that, I had no obligation to PwC, nor is there any continuing financial involvement or anything of that nature that should be brought to the attention of the committee.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Is the amount donated on the record and public?

Professor Eamonn Walsh:

It predated my appointment to UCD so I have no idea.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Is the right to have the position named the PwC professor indefinite as a result of the donation 15 years ago?

Professor Eamonn Walsh:

Yes, to the best of my knowledge. I have not been informed that the title of my position has changed. It is fair to say that business schools generally, in order to get new posts in a university sector that is quite stressed, seek donations to create new positions in new areas of study and to appoint people to the positions.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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I am not suggesting anything improper but just want to have all the facts out in the open given that Professor Walsh is giving evidence to this inquiry.

Did the auditors of the banks in Ireland, during the years 2004 to 2006, inclusive, form the view, and during the course of their work, that the banks were following an unsustainable model? Did they think there were huge concentrations of risk being built up in terms of lending to one sector, for example? Did they feel the banks complied with the accounting standards and other legal requirements? What options were open to auditors to raise their concerns? What duties and rights had they to insist on disclosure, for example, of those risks?

Professor Eamonn Walsh:

It is probably fair to say that they do not have much power to mandate that particular disclosures should be made. If international accounting standards do not require those disclosures then I would imagine it is very difficult for an auditor to say, "Look, we expect you to make additional disclosures over and above the ones that are currently required by accounting rules".

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Would a disclosure of that nature have been entirely voluntary?

Professor Eamonn Walsh:

I believe it would.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Did the auditors have any duty, under accounting standards or law, to report concerns about the overall sustainability of the model being pursued and the concentration of risk to the regulator or the Central Bank?

Professor Eamonn Walsh:

I would probably need to go carefully through this. In terms of duties, my written statement fully discloses my relationship and the nature of my appointment as well. In my written statement I made particular reference to the auditing rules and the rules in terms of communication between an auditor and a financial regulator.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Has Professor Walsh formed a view as to whether the auditors of the main banks in Ireland, during the 2003 to 2007 period, fully met their legal obligations? Has he formed any view on that matter?

Professor Eamonn Walsh:

It would be very difficult for me, as an external observer, to form such a view.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Of course.

Professor Eamonn Walsh:

What I did was quote the Nyberg report. Certainly, the Nyberg report, in its introductory section, seemed to say that auditors had fulfilled their obligations. Clearly the Nyberg report had access to those communications but I would not.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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In regard to impairment provisions, clearly on a bank's balance sheet the liabilities are clear in terms of the accuracy of the figures but the real issue is the value of the assets. Does the professor agree that is where the variability and risk might lie?

Professor Eamonn Walsh:

In terms of accounting for the assets involved, when we lend money to a customer we record basically the amount that was lent as an asset. The accounting is then done in such a way that we must wait for an impairment to occur which means it is not reflected on the balance sheet.

There are other disclosures. For example, the fair value of the loans. Currently, banks have a footnote where they disclose the fair value of those loans, namely, the price they believe that an unrelated third party would pay for those assets in an arm's length transaction.

Photo of Michael McGrathMichael McGrath (Cork South Central, Fianna Fail)
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Are impairment provisions for loans related to specific loans? The professor did not speak about impairment provisions but that at the level of the individual loan, one must make a judgment as to whether an impairment should be booked against that loan. Is that how it works or it is more general?

Professor Eamonn Walsh:

There are a couple of aspects to that question. I have glossed over a lot of the technical detail with respect to these impairments but I would be delighted to go through that technical detail.

Basically, impairment assessment could occur in a number of ways. First, there is the level of individual loans. Second, one might look at groups of loans. That would be the case if one considered something like a mortgage book where it would probably be very challenging to go through each and every mortgage and assess it individually for impairment. One would be essentially engaged in a group assessment of impairment for those loans. One can view it that we could look at loans in groups and then individual assessments of loans. There are detailed rules with respect to how one conducts that assessment.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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To conclude this session, would Professor Walsh outline the concept of true and fair in the context of opinions of auditors and annual financial statements. What does true and fair mean?

Professor Eamonn Walsh:

If I could answer that question I would be very happy with myself. When I hear the term "true and fair" I think of the City of London in 1750 where everybody knows everybody else, my word is my bond and we engage in true and fair reporting. As I would understand it now, largely the term "true and fair" has become synonymous with reflecting international financial reporting standards. It is a legacy term that is used in Britain and Ireland, the idea of a true and a fair view, but it has largely been superseded by detailed accounting standards, which we did not have 50 years ago. The notion that somehow, there is a principle of the true and fair view that would guide one on the right way to account for a particular transaction becomes largely redundant when there are many rules governing guidance, as there are today. If the Chairman is interested, there is a legal opinion that was prepared about a year ago which explains how a true and fair view should be interpreted under UK law.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I ask Professor Walsh to revisit the matter as we conclude.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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The Chairman has stolen my true and fair question. In light of that question, I wish to ask a general one. Does Professor Walsh think that in the run-up to the crisis, the audits of the banks in Ireland served the true and fair purpose for which they were intended? What purpose did they serve?

Professor Eamonn Walsh:

The first thing they did was to say that financial statements should be prepared in accordance with this set of rules. That is probably not such a bad thing. In the absence of such a set of rules, and in the absence of somebody making sure that a financial institution had applied those rules correctly, one would have very little confidence in the reported financial information of a bank. It is a third party assurance that the financial statements have been prepared in accordance with a set of rules.

Let me outline the second aspect. I guess people are quite down on auditors and take the view that companies spend a fortune on audits but do not seem to get anything in return. One has to consider the counter-factual. If there were no audits then one would create a Wild West situation. That means one could create an asset on one's books and there would be no external attempt to verify that the asset existed.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I understand what Professor Walsh has said. Other witnesses have used the term "Wild West" a lot to describe the banking sector in the run-up to the collapse. A lot of commentators have made the point that the audit process did not reveal, satisfactorily at least, the difficulties that existed in the balance sheets of Irish banks. Did a Wild West situation exist? I do not want to ask a leading question or I shall be accused of doing so. Even with external auditing, and I do not suggest that there should not be external auditing, did a Wild West situation not exist in the run-up to the crisis?

Professor Eamonn Walsh:

I shall turn the question on its head. It is easy for people to have expectations in terms of what they believe an audit should deliver. It would be true to say, and it is not just in Ireland but across the world, that audits are quite limited in their scope. Audits indicate first, that financial statements have been prepared in accordance with rules and, second, that there is evidence these loans exist and so on. It is important to have a relatively low expectation of what an audit is meant to be delivering and then to look for other mechanisms that would blow the whistle on things such as a financial regulator.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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I have a question on the relationship between auditors and the financial institutions being audited. Is there not a contradiction at the heart of the traditional appointment of auditors by financial institutions as well as other companies? I do not want to ask a leading question. Is there not a contradiction in the sense that if one is a commercial bank and choosing one's own external auditors, does that not, potentially at least, lead to a contradiction in what the audit hopes to achieve, and in terms of the true and fair test that we mentioned?

Professor Eamonn Walsh:

The best way to view it is in terms of the long-standing literature, regulations and ethical rules in place for auditors and so on. The latter reflect the possibility that there could be a conflict. I refer to circumstances where one is getting, on inspection, a clean bill of health but one is paying the cheque for that clean bill of health. The question is whether the auditor can be truly independent if one is paying for the clean bill of health rather than perhaps a third party doing so. The same could be said of credit rating organisations as well. It then comes down to the individual rules relating to ethical conduct by auditors and so on which kick in to ensure auditor independence.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Does Professor Walsh believe, as some others have suggested, that financial institutions should choose their own auditors or should an external third party such as the regulator have responsibility in this regard? Is he of the view that it might be necessary that the auditors of financial institutions should change regularly and that the same firm should not be responsible for auditing a particular institution's books for a protracted period?

Professor Eamonn Walsh:

Again, there is a long history in this regard. Auditor rotation is an issue the EU is addressing at present. There is a notion that it might be unhealthy for a company to have the same auditor for 120 years and that perhaps some rotation might be in order. The more subtle point is whether there is partner rotation. In other words, we are basically down to four audit firms that are capable of conducting an audit of a large bank. I am not really being fair in this regard because there are a number of other mid-sized firms which could assist with or carry out such a process. Ultimately, investors looking at a large bank that is not audited by a big four firm would be concerned about the audit.

Photo of John Paul PhelanJohn Paul Phelan (Carlow-Kilkenny, Fine Gael)
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Should a bank or financial institution be allowed to choose its own audit firm?

Professor Eamonn Walsh:

I may be too old and cynical but I really think there are probably enough checks and balances in place to ensure that something sensible happens. Outsiders say these conflicts exist but I have never seen them in practice.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Will Professor Walsh outline the extent to which an auditing firm can be exposed to one financial institution in terms of its business book? Can a firm have 50%, 60% 80% or 100% of its business with one client?

Professor Eamonn Walsh:

Again, I am not quite sure what the ethical rules are in this regard. Clearly, however, one would like to ensure that an individual audit firm was not entirely dependent on a single client. This again brings us back to the big four. Outside investors or lenders to a bank would generally expect a big four audit, simply because that danger of having a smaller audit firm dependent on a single customer would clearly be incredibly unhealthy.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Is it 80%?

Professor Eamonn Walsh:

I honestly do not know.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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I welcome Professor Walsh. Will he outline his view in respect of some of the really important audits that occurred during the banking crisis? I specifically refer to the PwC report presented to the Minister for Finance prior to the introduction of the bank guarantee which indicated that the potential liability to the State in respect of Anglo and INBS was €5 billion. What is Professor Walsh's opinion on that?

Professor Eamonn Walsh:

I have only seen bits of the PwC report. If I understand it correctly, PwC was commissioned by the Financial Regulator to examine individual banks during September 2008. Is that correct?

Professor Eamonn Walsh:

It is just one of those things but when I received my invite from the committee some weeks ago, I immediately thought "I have to take a look at this again". That was because I had not looked at it in a long time. Unfortunately, I was not able to find it on the Internet but late yesterday evening I did obtain a copy of a small part of it that deals with Anglo. As I understand it, there were three phases to PwC's analysis, namely, a phase that was undertaken in mid-September 2008 - a report relating to which was submitted later that month - a second phase in November and a third in December. Is that correct?

Professor Eamonn Walsh:

Now that I know what I am meant to be looking at, what-----

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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I will amend the question a little. Professor Walsh is a university lecturer. If he was grading PwC's analysis of the institutions involved, what grade would he award?

Professor Eamonn Walsh:

In terms of tying up with what I said earlier, what I find interesting about this report is that as one reads about the phases of the project undertaken by PwC - it should be borne in mind that I have only seen the final report and I have not seen the intermediary outputs, of which there could have been many, that might have been produced for the regulator - one discovers that these concentrations of risk are becoming more and more apparent as the project progresses. One gets a certain sense about the concentration of risk when one reads the first one. With the next one, it is a case of "Oh my goodness, there are 20 large borrowers and there seems to be quite a bit of exposure to development lending in very concentrated areas of north and south Dublin". With the third phase, it was "We'll have a look at the next 50 borrowers and guess what? It seems they also borrowed money in much the same areas of north and south Dublin". As I read through the report, I felt that in September these concentrations did not appear quite as bad as when we get to phase 3 of the report. That is how I read it.

The other thing that jumped out at me relates to the sort of concentrations outlined. PwC lists the 20 largest concentrations in the UK, the US and Ireland in its report. As I looked at it, the question I would have felt remained unanswered relates to whether there was an overlap between all of those concentrations. In other words, that there was a super-concentration involved.

Photo of Michael D'ArcyMichael D'Arcy (Fine Gael)
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What is Professor Walsh's view on the PwC report that was commissioned after the guarantee had been introduced in order to evaluate its impact on the banks?

Professor Eamonn Walsh:

This relates to the estimates of what sort of capital requirements there might be. I stand open to correction but I am of the view that there was a change between phase 1 to phase 2. Paragraphs 4.8.4 and 4.8.8 of the Nyberg report deal quite well with this matter. Paragraph 4.8.4 states:

The outcome of the initial PwC assessment was generally viewed by the Authorities as reasonably benign. In early November a joint letter was sent by the CB and the FR to the Minister for Finance which included assurances as to the solvency of the covered institutions on the date of the Guarantee as well as their future solvency through to 2011.

While paragraph 4.8.8 states:

Notwithstanding the benign view generally taken by the Authorities of the PwC initial assessment it has been argued – correctly, in the Commission’s view – that the nature, scale and concentration of the exposures now listed should have aroused more heightened and widespread concerns that institutions were likely to face solvency difficulties.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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In Professor Walsh's written submission to the committee he says, "Prior to the Irish banking crisis in 2008 it was widely believed that Irish banks were highly profitable and that they had sufficient cushions to withstand a variety of challenging scenarios." He says also, "The belief was based upon accounting reports, particularly income statements and balance sheets." Let us leave that quote hanging there for a moment. Just above that Professor Walsh quotes the United States Federal Deposit Insurance Corporation which documents the life cycle of a bank failure. It says:

In the first stage there is rapid loan growth, loan concentrations emerge and lending is aggressive, internal controls in the growth areas are weak and underwriting standards are lenient. Management usually points to the excellent earnings and contributions to capital that the growth has provided.

If the Federal Deposit Insurance Corporation in the United States in 1997 can outline the life cycle of a bank failure, if Professor Black and other witnesses come in here and rehearse more or less the same scenario, and if those features were manifestly present in Ireland prior to the crash, how can accounting reports in Ireland imply that there was no problem, as indicated by what Professor Walsh has said, that the belief was based upon accounting reports, particularly income statements and balance sheets?

Professor Eamonn Walsh:

The basic problem is with the accounting rules. The accounting rules say a bank goes out and lends money to a customer and it earns interest from that customer. In Ireland between 2002 and 2007 banks expanded their loan books very dramatically. In the early years of issuing a loan to somebody, in general one would expect that nothing is likely to go wrong with that loan, so early in the boom when everything is going up there is very little objective evidence that anything might be going wrong with these loans.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Can Professor Walsh show the committee that impressive tome that he displayed; it looks like The Bible and The Koran rolled into one. How many pages are in that?

Professor Eamonn Walsh:

I thank the Deputy for the question. That is why I brought it with me. The index ends on page 2,719.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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That must be nearly 500,000 words.

Professor Eamonn Walsh:

It is quite a small font.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Professor Walsh says on page 3, "Unfortunately, accounting standards were especially unhelpful and served to obscure the underlying nature of both profits and loan portfolios." Given what Professor Walsh has just shown us, the obscuring was certainly not due to a shortage of space, so might that as well be a mystery novel, or were accounting standards framed in such a way as to deliberately obscure the real situation?

Professor Eamonn Walsh:

Part of the difficulty is that these accounting standards are written for all enterprises. They have the same set of accounting standards for a retailer, a bank or a manufacturer. The challenge is that banking is a different business to retailing or manufacturing. There is not a specific standard that deals with accounting for banks. As a result we get these unusual settings and the one I would worry most about is accrual of interest. A bank can make a loan to somebody and it can agree with that person that he or she does not need to pay any interest for five years. During the life of that loan, for five years, the bank can book interest every month as if it had received cash from the customer. It will then be able to say that the loan is continuing to perform because cash is being received from the customer.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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The Deputy has time for a final question.

Photo of Joe HigginsJoe Higgins (Dublin West, Socialist Party)
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Given the extent of the rules and given the huge financialisation of the world financial markets over the last 20 years, by common consent, should these rules not have been advanced considerably to avoid the type of situation that developed, whereby apparently, if I have interpreted what Professor Walsh has said correctly, there was no real reporting of the huge risks that were included in the banking, the speculation and the loans that were going on at the time?

Professor Eamonn Walsh:

The Deputy's question is a great one. The way I would have addressed it would have been to emphasise the notion of an informed user of bank financial statements. An informed user of bank financial statements would understand that these rules exist and therefore would know that during the up cycle the amount of profits is overstated and during the down cycle the amount of profits may be understated. I think the most helpful way I can respond is to say that there is this bundle of rules there and as a result of this bundle of rules, to simply say that profit went up 10% is probably not such a good idea. Instead one has to understand why profits went up by 10% and to what extent the increase was driven by particular twists in these rules with respect to accounting measurement.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Professor Walsh said earlier in response to Senator MacSharry that to go against the rules is not that wise. Would it be reasonable or not to say that accountancy rules are powerful tools for framing what passes as normal behaviour?

Professor Eamonn Walsh:

I beg the Deputy's pardon.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Professor Walsh has written about this in a paper he co-authored entitled From Moral Evaluation to Rationalisation where it says that, "Creating visibilities of payment behaviour, accounting numbers became powerful disciplinary tools in constructing the norm and punishing the deviant." Would it be reasonable to say that accountancy rules are powerful tools in framing what passes as normal behaviour?

Professor Eamonn Walsh:

Largely, it does normalise. In that way accounting does have a normalising role; accounting rules and accounting definitions of things become institutionalised. Our understanding of what profit might be, what income might be, what an asset might be, and what solvency might be, are driven by these conventions.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Would it be fair to say that the accounting rules are informed by that tension between what would be regarded as normal behaviour and what would be regarded as deviant behaviour?

Professor Eamonn Walsh:

I would need to think about that. It is a great question but I would need to think more carefully about the answer to it.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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I will move on, but Professor Walsh has said, "accounting numbers became powerful disciplinary tools in constructing the norm and punishing the deviant". How are accounting numbers a powerful tool in constructing the norm? Do they set the agenda of what is normal or not? Would Professor Walsh like more time?

Professor Eamonn Walsh:

The Deputy's question is quite a deep one about accounting rather than specifically dealing with the banks.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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If today's accountancy standards were applied to the 2008 Anglo Irish Bank balance sheet, would an audit still find on 30 September 2008 that the bank would make a profit just shy of €500 million after tax?

Professor Eamonn Walsh:

Yes, it would. While there are changes coming down the road in about three years’ time, there has been no change in the standards since the financial crisis. One would reach much the same conclusion today as one would have reached back in 2008.

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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Would an auditor have knowledge of the fact there was inadequate loan documentation for some loans? The chief executive of NAMA, the National Asset Management Agency, Mr. Brendan McDonagh, said in 2010:

[NAMA’s] our own detailed due diligence on a loan by loan examination has revealed a troubling picture of poor loan documentation, of assets not properly legally secured and of inadequate stress-testing of borrowers and loans - all born of a mindless scramble to funnel lending into one sector at considerable pace and of a reckless abandonment of basic principles of credit risk and prudent lending.

The Minister for Finance informed me in reply to a parliamentary question that, as a result of this poor loan documentation, NAMA paid €477 million less on the €32 billion it paid. Would an auditor be expected to pick up on some of these issues and report them?

Professor Eamonn Walsh:

That is an excellent question that goes to the heart of what might be going on here. In my written statement, I listed what one would be expected under US audit guidance to establish with respect to looking at a loan book. The interesting question is to take some examples that NAMA has referred to and step back to see what happened to these particular loans and their documentation in the process. Were they subject to audit?

Photo of Pearse DohertyPearse Doherty (Donegal South West, Sinn Fein)
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The questions are specific. We know NAMA paid just shy of €32 billion for these loans. We know €477 million of a write-down was given to NAMA, a large portion of €32 billion, as a result of poor documentation. Is this something an auditor is supposed to pick up? Should an auditor have picked up that €1 out of every €60 of the loans transferred to NAMA had poor loan documentation and their security was not enforceable? Alternatively, is it the case, as Professor Walsh said, that an auditor is guided by the provisions and if they did not expect them to do this, then they did not have to do it?

Professor Eamonn Walsh:

It is difficult without seeing what documentation was available and what work was conducted by the auditors at the time. I agree with the Deputy that there appears to be a disconnect between what was being reported as the amount of loans a bank had and what we know subsequently happened with NAMA where it would appear security was not perfected on these loans and, perhaps, there was a belief there were guarantees but they were inadequate. It is also possible that unanticipated events occurred. This is an excellent line of inquiry. In shedding light on what occurred, it would be a far more interesting line of inquiry than worrying about impairment accounting.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Is it fair to say the true and fair concept is the auditors' opinion of a company's actual financial position?

Professor Eamonn Walsh:

True and fair is a term that is used but how it is interpreted is the question. Is it in line with accounting standards?

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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In his written statement, Professor Walsh stated:

By 2009, it was apparent that the capital 'cushions' available to Irish banks were entirely inadequate. Some financial institutions had liabilities that exceeded their assets (i.e. they were insolvent or had negative capital).

In terms of the audit reports that were issued between 2003 and 2007, were there any qualified opinions in any audit of the banks?

Professor Eamonn Walsh:

I do not believe so.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Will Deputy O'Donnell explain what a qualified opinion means?

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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An auditor must provide an opinion on a company's financial statements. The auditor has to give an actual report based on whether the accounts show a true and fair view. If an auditor gives a clean audit report, that means they show a true and fair view. If the auditor gives a qualified opinion, it can go from a spectrum of not reflecting the true and fair view-----

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Okay. Does Deputy O'Donnell want to-----

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Will the Chairman give me some liberty? With due respect, you asked me to explain it.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I am holding the clock. I will bring the Deputy back into the time. There is no need for him to be like that.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Thank you.

Some banks had liabilities that exceeded their assets. They were essentially insolvent. Is it fair to say that clean audit reports, where they were not qualified, did not reflect the true and fair view of the financial position of the banks?

Professor Eamonn Walsh:

In terms of the legal definition of true and fair, they did.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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With due respect, there is a judgment call on the part of the auditor. Looking at the reports that were issued, did they reflect the financial positions of the banks at that time?

Professor Eamonn Walsh:

Unless there was fraud or something like that of which we are not aware, it is probably fair to say that there was a true and fair view as is understood by accountants. Is it true and fair for the public? Probably not. People have asked how one can possibly say last year this was a going concern but this year it is not.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Did the auditors’ reports reflect the true and fair view to the shareholders of the banks?

Professor Eamonn Walsh:

In so far as ticking the boxes and complying with their responsibilities as auditors, it is fair to say they were a true and fair view. If I were an individual investor in these banks, it would have been very helpful had there been additional information to me as an investor to understand the actual risks these banks were undertaking.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Were they required under Stock Exchange rules to provide additional reporting requirements such as emphasis on matters or additional work on the audit report where it would not be qualified? Is it fair to say that underlining a true and fair view is a going concern? When one looks at a set of financial statements, apart from the tomes of standards Professor Walsh referred to, surely the underlying criteria is going concern.

Professor Eamonn Walsh:

That is correct.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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The point I am making is that Professor Walsh stated some financial institutions were insolvent. One can speak all one wants about the bible of accounting standards. However, it is underlined by basic accounting principles such as prudence, accruals and, ultimately, going concern. Going concern should have been a fundamental criterion in any audit of a bank at the time. This, in turn, would have given rise to a qualification in the audit report.

Professor Eamonn Walsh:

This is a matter that has been extensively studied by the UK Government. The same question was expressed there. How could there have been a bank with a clean audit opinion one day and then, a day later, be in public ownership? There has been a certain amount of thoughtful work by the UK Government on the issue of going concern.

My recollection of its conclusions is that it said the definition of going concern used by auditors and within the accountancy profession and in case law is probably too restrictive to reflect what the man in the Clapham omnibus would consider to be going concern, namely, if the bank closes down today after getting a clean audit opinion yesterday, there is something wrong with the audit opinion.

Photo of Kieran O'DonnellKieran O'Donnell (Limerick City, Fine Gael)
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Is Professor Walsh saying he believes the accounting and auditing principles in place are flawed?

Professor Eamonn Walsh:

No, I am saying there is a mismatch between the expectations of a lay member of the public and what is actually done in respect of definition of going concern.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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As a general rule, are auditors and accountants allowed to be directors of companies for which they work?

Professor Eamonn Walsh:

Off the top of my head, absolutely not.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Has it ever happened? Has that ever been reported?

Professor Eamonn Walsh:

I would imagine that when a person joins an audit firm there is a prohibition on being a director of a firm that person is auditing, and probably restrictions on being a director of other companies.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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As regards the large book, the international accounting standards we have been discussing, there have been criticisms over the years by the European Parliament, the Securities and Exchange Commission, SEC, and other people. Who decides to change them? Obviously, it is a long and complex process but are corporations or large financial institutions allowed to lobby and keep things or change them?

Professor Eamonn Walsh:

In general, the approach is probably reasonably good. The International Accounting Standards Board is a stand-alone not-for-profit foundation. It issues rules and goes through due process. For example, with respect to loan impairments, it issued a proposal in 2008 I believe it was, and would have issued another proposal having obtained feedback from the banking community. All the feedback is on the public record. It then sought to work with the US authorities to change the rules. It goes through extensive due process but it is a largely independent body and lobbying would not work. That is not part of its cashflow, so to speak.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Is it not made up of representative accounting organisations in different countries?

Professor Eamonn Walsh:

The International Accounting Standards Board is a stand-alone foundation with a chief executive officer, and board members are appointed. It would not be described as being under the thumb of any particular interest. There would be a perception among some in the United States that perhaps it is a little too dependent on getting EU endorsement for things it does, that it has responded to EU political concerns at various times. I am not saying I hold this opinion. Some in America have argued that this perhaps is not such a good thing.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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Can Professor Walsh explain his comment on page 3 of his written statement, “In periods of expansion, as a bank expands its loan book, the bank will appear far more profitable since profit measures exclude expected loan losses.”?

Professor Eamonn Walsh:

Suppose we are in the boom days of 2004, we go out and grant an additional 5,000 mortgages. That essentially means that now we have interest coming in on those mortgages. Our interest goes up. We will pay some money out from funds we have managed to get to support those mortgages, which hopefully we receive quite cheaply. Our overheads are probably much the same as they would otherwise be, which means our profit shoots up as a result of expanding the loan book. However, we all know that some of those mortgages will not turn out as anticipated. It is only later in the cycle that will be reflected in the financial statements. As a result, profits will inevitably be high because in the early years a loan generally performs.

Photo of Susan O'KeeffeSusan O'Keeffe (Labour)
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That will always be in the cycle of banks.

In respect of the banks that reduced their loan loss provision themselves, and Professor Walsh refers to this when he says provision for loan losses declined from 0.7% of loans to 0.5% of loans, would the banks know they were doing that, or did it happen accidentally? Would they be obliged to tell the Central Bank they had done that or would the Central Bank have discovered it from their accounts?

Professor Eamonn Walsh:

This refers to the change from Irish accounting rule, the Irish GAAP, to international accounting standards in 2005. The old rules had something for expected provisions for losses, the new rules did not. There was a small change for the large banks, probably approximately €100 million in the provisions as a result of this. This would have been entirely transparent to the users of financial statements. It would also have been entirely transparent to the Financial Regulator and the Financial Regulator adjusted capital requirements for loan to value, for home mortgages and stated part of its reason for doing so was these new rules. The whole process was completely transparent.

Photo of Marc MacSharryMarc MacSharry (Fianna Fail)
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Considering everything that has gone on, does Professor Walsh feel there are any reforms required to ensure the independence of the appointment of auditors? The perception, and I am sure that is all it is, is that he who pays the piper calls the tune.

Professor Eamonn Walsh:

Some people believe there should be greater auditor rotation, greater switching between firms. Some countries have used proposals such as having two audit firms perform an audit and having checks such as that. There are many proposals that go around. I have not seen any evidence that these proposed measures result in better outcomes. It would strike me that people feel good because they pushed through a reform but I have yet to see evidence that it changes anything dramatically. I may be in a minority of one.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Is Professor Walsh familiar with the Central Bank’s winter quarterly bulletin 1995 where very clear and specific recommendations were made to external auditors with regard to concentration limits? This was referred to in the Honohan and the Nyberg reports.

Professor Eamonn Walsh:

I am not familiar with it. I saw it referred to in the reports and had difficulty trying to get it. I could be wrong. I do not know if it was available as soft copy.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I will not be drawing Professor Walsh on its specifics. I want to get his view of several aspects of it. There is a chapter heading for external auditors, section 3.4, Auditing Irish Banks. It covers sectoral concentration limits, prudential sector lending limits of 20% of a bank’s own funds for one sector, and 250% of a sector, subject to a common predominant risk factor. The Honohan report states:

Rules of this kind were actually in effect, but not enforced. Specifically, there was a long-standing ceiling (200 per cent of own funds) which was supposed to be applied to loans to any one economic sector (various classes of property loan were treated as different sectors, so the overall property ceiling was higher). This requirement seems to have become a bit of a dead letter, [Professor Honohan mentioned that in his engagement with us.] with violations being noted but not acted upon. Albeit old-fashioned, this kind of rule would, if enforced, have been quite effective in slowing the bubble.

These were rules for auditors going into banks to see how the sectoral concentration limits were operated.

How was it that the external auditors were not applying the recommendation or guideline indicated to them quite specifically in the Central Bank bulletin in 1995?

Professor Eamonn Walsh:

I think this goes back to the quote I had from the Nyberg report. Certainly how I would understand it is that largely it appeared that there were these limits in place but they were being ignored by the regulator. In other words, the quarterly reports that would go to the regulator or whatever would make it clear that there had been breaches of these limits, that auditors were basically seeing what was going to the regulator and Nyberg concludes that even if they had reported these things to the regulator, the regulator would not have done very much about it. My feeling is largely that the difficulty is not an audit one per se, given the audit communications with the regulator and the regulator potentially knew, rather it is more a case that these prudential limits would have made tremendous sense, had they been adhered to we would be in much better shape today than we are and the question is why those limits were not adhered to by the regulator.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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What is Professor Walsh's view on Professor Patrick Honohan's comment that this guideline or rule was a dead letter? Does Professor Walsh have a view on that?

Professor Eamonn Walsh:

From my reading of the reports that have been prepared, it would strike me that the conclusion is entirely correct, that the sectoral limits might have existed but nobody seems to have paid any attention to them. I would say the same if we move over to disclosures of individual exposures where clearly there were large individual exposures. When we look at the PwC report referred to, this becomes a super concentration of risk among individuals and with particular types of real estate lending.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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In chapter 7.18 of his report he concludes the paragraph by saying: "It is fair to acknowledge, however, that experience shows that quantitative credit limits can be circumvented fairly easily". What does Professor Walsh think he means by that?

Professor Eamonn Walsh:

This is again, a fascinating issue. It would be very easy to slice up something or characterise a transaction in a particular way to navigate around such specific rules. For example, we could take something that the man on the 44A agrees is speculative property lending and redesignate this as lending to a retailer.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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Does that mean in regard to the book Professor Walsh brought in to us today, to use Deputy Higgins's theological term, that one can either have biblical or subjective interpretation of Canon Law or religious law? In regard to Professor Patrick Honohan's final comments about being circumvented fairly easily, are the rules in that book subjective or are they determined?

Professor Eamonn Walsh:

There is an amount of guidance in here. This book is called Principles Based Accounting. The equivalent US rules would be about five times the size of this book. The US rules are much more specific and would have much more detailed requirements about disclosures of concentrations of credit risk in published financial statements and much more detailed disclosure about what listed entities should do. International accounting standards do not have that level of detailed requirement and then the opportunities for creating particular impressions for being able to slice up a transaction in particular ways, for example, to say that part of it was a UK exposure and part of it was an Irish exposure and, particularly, given Northern Ireland it would allow one to represent things as if concentrations were a lot less than it appeared.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I thank Professor Walsh. Is there anything else he wishes to add?

Professor Eamonn Walsh:

No.

Photo of Ciarán LynchCiarán Lynch (Cork South Central, Labour)
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I thank Professor Walsh for his participation in the inquiry. It has been a very informative and valuable meeting which has added to our understanding of the factors leading to the banking crisis in Ireland.

The joint committee adjourned at 1.45 p.m. until 9 a.m. on Thursday, 26 February 2015.