Business Irish

Tuesday 16 October 2018

Fearful regulators must climb to penthouse floor

The Central Bank here said it did not regulate Setanta
The Central Bank here said it did not regulate Setanta
Eugene McErlean
The Central Bank has let staff go

Eugene McErlean

YOU have probably never heard of Jim Kidney. But then there is no reason you should. He is the sort of character who could easily feature in an Oliver Stone movie or a John Grisham novel. Until he retired last month he was Wall Street's financial enforcer having successfully prosecuted many high-profile insider-dealing cases.

A couple of weeks ago his colleagues at the SEC, the US financial regulator, gathered to wish him well in his retirement, no doubt awkwardly attempting to balance a glass of wine and a canapé in one hand while being introduced to the boss's boss with the other.

They probably expected to hear the normal platitudes mingled with the odd humorous anecdote.

Instead, Jim broke with protocol and told them a few home truths.

According to Bloomberg, Jim said that the SEC had become "an agency that polices the broken windows on the street level and rarely goes to the penthouse floors."

He caustically remarked that after the financial crisis, SEC lawyers were too "fearful" of Wall Street to bring charges against bankers, and that they were more concerned about lucrative gigs after their time at the agency.

"Tough enforcement, risky enforcement, is subject to extensive negotiation and weakening," he continued.

Just in case his audience were in any doubt about his message, Kidney concluded that his bosses "mouthed serious regard for the mission of the commission, but their actions were tentative and fearful in many instances."

I'm sure he expected a frosty silence. Instead he got a rousing round of applause. He had touched a nerve and identified an uncomfortable truth recognised by his colleagues in the room.

Despite the failed experiment of the light-touch regime, there have been creeping indications of soft regulation making a comeback.

Paradoxically, this trend has emerged at a time when banking scandals are still appearing like the Luas at rush hour. If you missed one don't worry. There'll be another one along in a minute.

Despite deepening public cynicism, a number of headlines such as "Derivatives rules softened in victory for banks" have gone relatively unnoticed.

Even the announcement by Brussels earlier this year that they were proposing easing flagship financial reforms so that big European banks are not automatically forced to split lending operations from risky trading was absorbed without much criticism.

In Ireland, we did appear to make a clean break from the regulatory capture of the boom. Matthew Elderfield not only said the right things but also backed them up with action, becoming the first regulator to impose a disciplinary fine on an Irish financial institution.

Encouragingly, the tough-talking Australian Peter Oakes took over as Head of Enforcement.

And anyone following the mortgage arrears crisis couldn't forget the scathing words of Fiona Muldoon, the Director of Credit Institutions, about the failures in dealing with the arrears crisis.

Unfortunately, all three have chosen to leave the employment of the regulator to pursue careers elsewhere.

However, if ever there was a time for the new Central Bank regime to flex its extensive regulatory muscles and apply some "tough enforcement" it was in last month's landmark announcement of its review of Payment Protection Insurance (PPI).

Even though the Irish Regulator was very late to the party, the result was disappointingly a pale imitation of "tough regulation".

Superficially it appears plausible. Eleven institutions are going to repay €68m in respect of policies missold to Irish customers. However, there is no mention of any disciplinary sanction or enforcement action. No mention of any fines for the offending banks – in sharp contrast to the regime imposed on UK banks. The UK regulator has subjected them to disciplinary sanctions for their bad practices, most notably with a fine of £28m (€34m) for Lloyds Bank.

To date UK banks have provided over £22bn for PPI misselling costs – which, if scaled on a pro-rata basis, is many multiples of the compensation the Irish banks have been asked to repay.

One of the reasons for this huge discrepancy is the fact that the Irish Regulator restricted the "look back" to policies sold after 2007.

As PPI was sold in conjunction with lending products and the vast expansion of lending occurred in the years before 2007, this meant that very significant numbers of policies were arbitrarily excluded from the review. Unfortunately, if you purchased a policy prior to 2007 you will be left to your own devices – and face the possibility of being excluded from making a claim because of time limits.

The Central Bank's stated justification for restricting the "look back" to 2007 is because this was when a new consumer code was introduced.

Who benefits from this 2007 cut off? Clearly the lenders and the Central Bank.

Who loses? The substantial number of customers who were missold PPI policies during the boom.

The implication of this decision is that prior to 2007 the sale of these kind of insurance products by banks was unregulated and that any misselling was beyond the reach of the regulator.

However, the Central Bank did have extensive powers of supervision prior to 2007 and it was well within their capacity to do something about it.

The fact that they have chosen the safe and tentative option is evidence that the behaviours described by Jim Kidney are not exclusive to the United States.

If the combination of the insipid PPI review, last week's commercial van insurance debacle and the repeated unproductive attempts to tackle the mortgage arrears crisis are key indicators of our regulators effectiveness, then maybe light-touch regulation never really went away.

One of the riskiest things we could do is to sleep walk our way back into the regulatory capture syndrome. Sounds like we may be taking the first steps.

If you talk to any credit union or insurance broker they are likely to agree with Jim Kidney that our regulator is very good at "policing the broken windows at street level" but rarely goes to the "penthouse floor."

Eugene McErlean is former head of AIB Group Internal Audit and a senior adviser to Transparency International Ireland

* Shane Ross is on holidays

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