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Financial Mania: Nyberg report says large parts of Irish society let good times roll until last minute
By Michael Hennigan, Founder and Editor of Finfacts
Apr 19, 2011 - 4:01 PM
Financial Mania: The Nyberg report on the Irish banking crash published today,
says large parts of Irish society were willing to let the good times roll on
until the very last minute
The problems causing the crisis as well as the scale of it were
the result of domestic Irish decisions and actions, some of which were made more
profitable or possible by international developments. Though eventually
unsustainable financial risks were made attractive by outside factors, there
simply was nobody abroad forcing Irish authorities, banks or investors to accept
such risks. The way Irish households, investors, banks and public authorities
voluntarily reacted to foreign and domestic developments was probably not very
different to that in other countries now experiencing financial problems.
However, the extent to which large parts of Irish society were willing to let
the good times roll on until the very last minute (a feature of the financial
mania) may have been exceptional.
The Minister for Finance, Michael Noonan, TD, said earlier
today, that following the agreement of the Government, laid
before the Oireachtas and published the report of the Commission
of Investigation into the Banking Sector, Misjudging Risk:
Causes of the Systemic Banking Crisis In Ireland.
The Minister stated: “I welcome the comprehensive report
produced by the Commission of Investigation. It represents a
thoughtful and multi-faceted analysis into the causes of the
banking crisis in Ireland and bears careful and measured
consideration by all concerned.”
The Minister added that the Government will reflect on the most
appropriate approach for further consideration of the report by
the Oireachtas, following the statement the Minister will be
making to the Dáil on Wednesday 20 April, He intends to discuss
this further with the opposition parties.
The Minister said he wished to thank the Sole Member of the
Commission, Peter Nyberg, and his team for their work in
producing the report and commended the Commission on producing
the report within the demanding six month timeframe set down by
the Oireachtas.
Dr Nyberg was Director General of the
Financial Markets Department, Ministry of Finance, Finland,
until 2010.
The report says central banks and regulators abroad generally
were almost as unsuspecting of growing financial fragility as their Irish
counterparts. The method of regulation or the number of available
macroeconomists does not generally seem to have made a great deal of difference.
The same seems true of auditors, rating agencies, analysts and
investors, most of whom remained calm and optimistic until the crisis actually
broke. Internal investigations in the IMF also indicate a widespread lack of
understanding and clear communication of the accumulating risks by that
organisation. There were incentives to conform with prevailing views, even in
cases where proper analysis would have identified growing risk.
The fact that Ireland was not special does not, of course,
account for or diminish the failures in the performance of the people in private
and public positions responsible for financial stability and prudent banking. It
does, however, put the many undoubted failings found by the
Commission into perspective. Regardless, it indicates that the problems
experienced in Ireland in the 2000’s have a wider relevance, as do any
suggestions on how to prevent similar things from easily happening again.
Nyberg says it could be argued that bank management in Ireland,
like many banks elsewhere in the world, had forgotten the very nature of credit.
Providing credit is not a sale of bank services; it is the acquisition of a
risky asset. The appropriate prudential focus of such a transaction is therefore
limiting and mitigating risk (or, at the very least, understanding the real risk
and pricing it accordingly) rather than expanding sales. This apparent
inability, some might say unwillingness, of Irish banks to remember this basic
principle of banking was a major cause of the banking crisis in Ireland. This
problem was further exacerbated as many banks appear to have emphasised and
valued loan sales skills above risk and credit analysis skills.
It is not necessarily surprising that banks continued to lend
into the property sector considering the fact that the vast majority of
academics, independent economists, observers and, indeed, the Irish
Government, were strongly supportive of this expansion rather than doubtful.
Meanwhile, much of the media enthusiastically supported households’
preoccupation with property ownership. Bank leadership and staff also appear to
have taken comfort from the fact that neither the FR nor the Central Bank,
apparently, saw any problem worthy of a policy change with either the very rapid
growth of balance sheets or the related concentration of exposure to property.
Nyberg Report - REPORT OF THE COMMISSION OF INVESTIGATION INTO
THE BANKING SECTOR IN IRELAND (pdf)
Commission
of Investigation of Irish Banking Sector
Summary of findings of the report of the Commission of
Investigation into the Banking Sector
General
-
The main reason
for the crisis was the unhindered expansion of the property
bubble financed by the banks using wholesale market funding.
Attendant risks went undetected or seriously misjudged by
the Authorities whose actions and warnings were modest and
insufficient. [ES]
-
The speed and
severity of the crisis was made worse by world-wide economic
events but notwithstanding these external factors, the
problems causing the crisis as well as the scale of it were
the result of domestic Irish decisions and actions. [5.3.1]
-
Many of the
problems and failings in Irish banks and public institutions
were similar to those in other countries [ 5.1.1]
-
The emergence
of a systemic banking crisis requires that a number of
important safeguards all become ineffective simultaneously
[5.6.1]]
Findings in relation to the banks
-
Banks
set aggressive targets for profit growth. This drive for
growth really implied a partial change in business model and
strategy without the necessary corresponding strengthening
of governance, procedures and practices. [5.2.1]
-
Bank
management in Ireland, like many banks elsewhere in the
world, had forgotten the very nature of credit. Providing
credit is not a sale of bank services; it is the acquisition
of a risky asset. The appropriate prudential focus of such a
transaction is therefore limiting and mitigating risk (or,
at the very least, understanding the real risk and pricing
it accordingly) rather than expanding sales. This apparent
inability, some might say unwillingness, of Irish banks to
remember this basic principle of banking was a major cause
of the banking crisis in Ireland. This problem was further
exacerbated as many banks appear to have emphasised and
valued loan sales skills above risk and credit analysis
skills. [2.12.4]
-
It seems to
have been quite generally accepted that – traditionally
volatile – market funding would continue to be available to
enable the achievement of growth targets. [ES]
-
The common
issues identified with lending and credit policies in the
covered institutions included: the relaxation of formal
lending policies into only guidelines; a lack of operational
limits on loan size or on total exposure to connected
parties or sectors; the slow slide from lower-risk to
higher-risk lending, from cash flow-lending to asset backed
lending and from small to large to enormous loan amounts; an
increasing amount of facilities provided on an interest
roll-up or interest-only basis; higher loan-to-value ratios,
equity releases and increased loan complexity (particularly
involving investor syndicates later in the Period). [2.7.18]
-
Boards and
relevant observers appear to have had little appreciation of
how the banks actually were run at grass-root level; at
least they did not seem unduly concerned about the practices
referred to above. The inadequate attention banks generally
paid to credit risk management is, in the end, evidenced by
the extent and nature of their subsequent problem loans.
[2.7.27]
-
In addition, in
many institutions, governance, systems and processes were
also inadequate, exposing the covered banks to significant
but often unrecognised operational risks. [2.9.1]
-
Management
and boards in general appear not to have fully appreciated
the two key risks to which their banks were exposed. These
risks were increased exposures to funding-dependent
development projects with future refinance risks and
volatile wholesale funding [2.9.1]
-
Bank management
and boards seem to have been totally unprepared for both of
their key risks (property loan impairment and funding
problems) occurring simultaneously. This must be seen partly
as a direct consequence of the insufficient attention paid
to the assessment and management of risk over several years.
[2.9.5]
-
It appears now,
with hindsight, to be almost unbelievable that intelligent
professionals in the banking sector appear not to have been
aware of the size of the risks they were taking. [2.11.7]
Findings in relation to Anglo and INBS
-
In Anglo,
credit risk management structures were, in practice,
deficient and there was ineffective overview of Group credit
decisions. Lending policies were treated as guidelines
rather than strict rules; exceptions to policy were very
common. In addition, the internal sector limits which did
exist were not enforced. Loans were not clearly or
appropriately classified by commonly used sector lending
categories [2.7.4]
-
INBS’s credit
management was unusual in many respects. Credit policies
were applied very flexibly and, in addition, it had no
effective, independent credit risk management function.
Consequently it operated without the “checks and balances”
normally considered necessary in banks. [2.7.9]
-
At
INBS, a number of essential, independent functions either
did not effectively exist or were seriously under-resourced.
[ES]
-
As a result of
the extensive governance issues in INBS, the loan approval
and administration process was not up to accepted banking
standards, files were often badly maintained and loans were
not subject to regular review or appropriately graded and
classified. [2.7.11]
-
Contrary to
public perception at the time, lending at Anglo and INBS had
proceeded with insufficient checks and balances during the
Period. Traditional risk evaluation procedures and risk
mitigants were not implemented in practice. [ES]
-
The Risk
function in Anglo was inadequately resourced and did not
have the conviction necessary to ensure compliance with
credit policy. The lack of adherence to good credit
standards was manifest with exceptions to policy a frequent
occurrence. These issues were particularly problematic
because most Anglo Board members did not appear to have
sufficient experience or specialist knowledge to fully
recognise the specific risks attaching to a fast-growing
monoline bank and the necessity for high quality management
information systems. Also it is not clear whether all key
letters from the FR, highlighting inter alia lending and
risk management shortcomings, were disclosed to or
considered by either the Risk and Compliance Committee, or
the Board. The Board therefore lacked an internal, robust
source of risk assessment and external feedback. [2.9.6 &
2.9.7]
-
Neither
Internal Audit nor the Audit Committee in Anglo was in a
position to challenge credit decisions per se, where the
main problems ultimately arose. The IA role in credit risk
was limited mainly to carrying out inspections on processes
such as adherence to terms and conditions of loan sanctions,
which it duly did. [2.10.2]
-
The Internal
Audit function in INBS, while effective for its traditional
residential mortgage type business, proved to be inadequate
in the growth oriented commercial lending environment. It
was lacking the requisite knowledge and skills in key areas
such as IT, Treasury, and Commercial Lending and, as a
result, responsibility for these areas was required to be
outsourced to a large auditing firm. During the Period the
FR identified a significant number of weaknesses,
shortcomings and concerns in IA. [2.10.3]
-
The Financial
Regulator was clearly aware of many of these problems in the
two banks: throughout the period, it raised significant
concerns regarding governance at INBS. It also submitted a
comprehensive list of procedural and portfolio problems to
Anglo. It furthermore raised minimum capital ratios for both
banks. Such remedies did not prove effective to ensure
sufficiently greater prudence and accountability in either
of the banks. [ES]
-
Despite
the fact that the FR detected numerous governance and
process issues in INBS throughout and, indeed, prior to the
Period, the FR remained hesitant to take effective action
even when the engagement with INBS resulted in little
material change. As a result, the very significant risks
inherent in INBS’s business model described above had time
to develop essentially undisturbed. [4.3.4]
-
Had
the FR rigorously enforced its recommendations to improve
structures and process, it is possible that Anglo would have
grown its property lending in a more prudent manner.
Moreover, determined public action by the FR early in the
Period could possibly have meant that other banks’
prudential standards would not have deteriorated to such an
extent over the Period. [4.3.5]
Findings in relation to auditors
-
Auditors’
commentary regularly focuses only on issues which they
consider relate to the accuracy of the historic accounts. In
practice, this means that auditors look primarily backwards
and at technical issues that may influence the accuracy of
the accounts. The auditors clearly fulfilled this narrow
function according to existing rules and regulations. [ES]
-
In the absence
of an express requirement for the auditors to do so, there
appears to have been no challenging dialogue with the
covered banks on their business models and their growing
property and funding exposures. Such dialogue could have
highlighted the business model risks and might have
influenced the banks in relation to their growing
vulnerabilities as the Period progressed. [3.9.5]
-
The Commission
finds it unfortunate that sufficient, timely and challenging
auditor dialogue was not used to influence the banks’
business models and lending practices. [3.9.6]
Findings in relation to the authorities
-
The Commission
found no evidence that the bulk of the problems within the
banks received the necessary attention of the FR. The FR
does not appear to have appreciated the funding and lending
risks accumulating in the banking system which were evident
from institution-specific returns made to it by the banks.
[4.3.1]
-
The real
problem in FR was not the lack of powers but lack of
scepticism and the appetite to prosecute challenges. [5.3.5]
-
There was a
major domestic policy failure at the CB in respect of the
maintenance of financial stability. Not only did the CB
seriously underestimate the nature and extent of the risks
in the Irish financial system but it was content to express
only nuanced and somewhat indirect concerns on possible
risks rather than study contingent worst-case scenarios.
[4.4.1]
-
An active and
suspicious CB would have had concerns over the
macro-economic data emerging in mid-to-late 2005. At that
stage, on the basis of available data at a macro level,
there were more than ample grounds for the CB to have
pursued a closer and more intensive dialogue with the FR
than actually occurred. The aim would have been to
determine, in sufficiently good time, whether the
macro-economic warning signals also indicated a pattern of
unsound lending behaviour by banks. [4.4.4]
-
An independent
and effective CB must first take the steps necessary to
ensure that it has an accurate picture of the financial
market. It must be willing to take unpopular actions.
Failure to perform either of these tasks is, in the
Commission’s view, difficult to reconcile with the
responsibilities of an independent CB. [4.4.11]
-
The Department
of Finance did not see itself as concretely involved in
financial stability issues. It did not have the necessary
professional staff for this. It saw itself as preparing
legislation to be implemented by the other authorities but
appears to have avoided addressing other financial market
issues. [5.3.9]
-
The
Department’s approach in dealing with FR was based on the
principle that the FR was independent of DoF in respect of
operational matters, a principle very much in line with
international practice. [4.5.11]
-
Had
the Department of Finance taken a greater interest in
financial market issues early on, preparations for dealing
with financial crisis would have been more comprehensive.
[5.3.10]
-
The relaxed
attitude of the authorities was either a result of not
understanding the data or not being able to evaluate and
analyse the implications correctly. [5.3.2] The external
watchdogs generally remained inactive and the new banking
model was introduced and implemented. There was no strong
reaction from the National Authorities when management
prudence eroded within the Irish Banking system, as
evidenced by the very rapid growth in lending and wholesale
funding. [5.4.9]
-
Given
the information provided the Commission understands the
Governments decision to provide a broad guarantee for the
banks. [5.3.13]
-
Discussions
for alternative measures before and on 29 September 2008
were conducted on the basis of very deficient information.
If more relevant information on and analysis of the
underlying position of some of the banks had been available,
discussions and policy recommendations may have been
different. [5.3.12] The lack of information on bank
exposures and the risk of future impairments among the
Authorities over time had profound implications for the
decisions actually taken. [5.3.14]
The
nationalisation of Anglo, some three months after the
introduction of the Guarantee, occurred finally only after a
series of announcements by the authorities outlining
alternative plans which in the end had to be abandoned. This
did little to build market confidence in Irish banks or in
government policy and forecasts. Combined with the emergence
of governance scandals at Anglo it created a sense that the
authorities did not understand the extent of the problems
and that further issues could emerge. Given the broad
guarantee, doubts about sovereign creditworthiness and thus
the credibility of the Guarantee began to crop up. This may
have contributed to the continued erosion in the liquidity
position of banks in the period that followed, despite the
existence of the Government Guarantee. [4.8.11]
© Copyright 2011 by Finfacts.com
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