Sunday 24 February 2019

Banks probe still needs to shine light into the darkest corners

Banking inquiry has had two unproductive weeks, says Colm McCarthy, who argues the terms of the Trichet appearance should have been declined

Jean-Claude Trichet
Jean-Claude Trichet
Colm McCarthy

Colm McCarthy

the banking inquiry has had two unproductive weeks. The dog-and-pony show at the Royal Hospital a week last Thursday gave Jean-Claude Trichet a platform from which to declaim his personal narrative about the eurozone mess. This narrative has few adherents aside from its author.

Trichet gave Ireland's elected public representatives no new information about the ECB's role in aggravating the self-inflicted wounds that have proved so costly. The terms of engagement accepted by the Oireachtas committee ensured this outcome, and should have been declined. When Vitor Constancio, the European Central Bank's vice-president, comes to give evidence in June he will address the finance committee rather than the banking inquiry proper, another contrivance designed to duck even the appearance of accountability. In the light of the Trichet performance, the Inquiry should consider whether this visit from Constancio is worth the effort.

The most prominent witnesses at the inquiry this past week have been current and former senior personnel at several of the banks which went bust. The public knows quite a lot about aspects of the Irish banking collapse, one of the biggest banking busts ever to have occurred anywhere.

The report of the inquiry needs to shed light in the darkest remaining corners. We already know that the bank guarantee was a mistake and the politicians responsible have already been punished at the polls. We know that the regulators failed and that the ECB favoured creditors of bust banks over taxpayers. The darkest corner, about which least public information has become available, is the speedy transformation of a traditionally cautious banking system into a world-ranking disaster. Very little light was shone into the origins of this decade-long Rake's Progress in Kildare Street last week.

It is timely to remind ourselves, half-way through the inquiry, about what actually happened. For the best part of a decade prior to the crash in September 2008 the Irish banking system had been extending credit, mainly to its traditional household and business customers in Ireland, at breakneck pace. For individual banks, and for the system as a whole, rates of credit growth regularly exceeded 20pc per annum. Unless the broader economy is also growing at these impossible rates credit growth will eventually over-leverage both the banks and their customers. On resigning from the Bank of Ireland board in September 2006 the businessman Denis O'Brien described banking as a "5pc growth business...". The previous accounting year to March 2006 saw domestic lending at Bank of Ireland grow by 23pc. The bank declared dividends that year which exceeded today's share price.

Contrary to persistent claims to the contrary, the dangers of explosive credit growth were pointed out much earlier, and so was the consequent runaway bubble in residential and commercial property prices. The refrain from the chief protagonists that "nobody saw it coming..." is entirely self-serving as well as untrue. Nobody who was paid to see it coming may have managed to do so, but numerous unpaid commentators drew attention to the risks from the year 2000 onwards, and the then-Central Bank governor Maurice O'Connell sounded warnings even earlier.

Not merely did credit grow at a dangerous rate, the banks financed the credit expansion through reliance on external borrowing - deposit growth in Ireland could never keep up. When these capital inflows reversed, the absence of an Irish currency meant that the missing bank liquidity could not be replaced by the Irish Central Bank, a weakness of which both the banks and the authorities seemed unaware. Finally, the banks not merely expanded lending too rapidly, they put most of the eggs in the same ill-fated property basket.

Unlike their counterparts in the USA and elsewhere, they did not come a cropper because of complex and poorly-understood financial innovations, unless you count the ingenious 100pc mortgage. With a few exceptions there were no exotic overseas adventures either. The Irish banks went bust mainly through making plain-vanilla loans to Irish people in Ireland, an activity in which they had engaged without serious mishap for generations.

The principal task of the inquiry is to explore precisely what led this traditionally-conservative banking system (every single bank got into trouble and had to be rescued) over the precipice. The rescuers were not just the Irish taxpayers: last week's evidence included an estimate that Ulster Bank's losses cost its rescuers €14bn. The benefactor was identified as Ulster's parent, the Royal Bank of Scotland. The latter however went wallop too, the worst casualty of the banking crash in the UK, so the ultimate rescue party for Ulster Bank comprised that decent body of men and women, the taxpayers of the United Kingdom. If it is any consolation to them, their Irish counterparts are footing the bill for the sizeable losses of Irish banks in the North and elsewhere in the UK. Irish policyholders are also picking up the tab for the UK expedition of Quinn Insurance. So the citizens of these islands have been involuntarily re-united in this amicable two-way traffic in financial bail-outs across the Irish Sea.

There may indeed be more to discover about the failures of regulators, the government's gamble on bank solvency the night of the guarantee and the mismanagement of the ECB response by Trichet and others. But in fairness to all of these people, there would have been no Irish banking crisis if there had been prudent management of the Irish banks. The first line of defence against bank failures is the board of each bank and the senior management to whom the board's policy is delegated. There would have been no risk of regulatory failure, or of poor decisions at political level, if the first line of defence had held. In no other eurozone country did that first line fail so catastrophically as in Ireland.

The inquiry is working its way through a demanding schedule of hearings and the documentary evidence it has collected will provide much additional material for the final report. It is essential that the lending policies and practices of the banks through the bubble are explored in detail. Who took the decisions about loan concentration? Is it true that branch managers were issued with lending targets? Did loan officers receive bonus payments in line with the amount of money they lent?

More generally were the wiser heads in bank branches ignored in the centralised push for market share? Was there internal dissent? How was collateral value in commercial property lending assessed? Were weak borrowers accommodated through the bubble with never-ending credit, effectively lent the fictitious equity portion of their deals? Were bank executives themselves involved improperly in property dealings? Was bail-out money diverted to top up underfunded pension schemes for bank staff?

It would be reasonable to expect that banks which had wiped out their shareholders and were gifted taxpayer funds to satisfy depositors and other creditors would have themselves, without prodding from politicians or anyone else, conducted searching internal inquests into what went wrong.

Some of the answers to questions from inquiry members seemed to deny that such internal inquests have ever taken place. Should it transpire that the boards of the banks have neglected to conduct thorough internal reviews of what went wrong, the Oireachtas should draw the obvious conclusion, namely that the new boards have flatly refused to document the failings of the old.

Sunday Independent

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