Regulatory sins of the past exposed

Trinity economics professor, Philip Lane, has undertaken a piece of work that will be every bit as valuable in understanding the nature of the recent banking crisis as the unfolding Oireachtas Banking inquiry.

At a presentation organised by the Statistical and Social Inquiry Society of Ireland in the Royal Irish Academy on Thursday, Mr Lane unveiled the most comprehensive account yet of the behaviour of Irish banks in the years preceding the crisis.

One of the main findings, with possibly the most damaging consequences, was the change in funding patterns for the banks from 2003 onwards. They became increasingly reliant on short- term funding. For example, in 2003, the domestic banks were well below the euro area average for bond issuances.

However, this changed rapidly and by 2005, Irish banks were issuing bonds at a rate well above the EU average.

When market sentiment changed in 2008, the price of these bonds increased by up to seven times the rate banks paid in the boom period.

From 2008 onwards, Irish banks became increasingly reliant on sourcing funding from their UK and US subsidiaries, which increased their sterling and dollar debt obligations.

Competition from foreign banks played a role in stoking risky behaviour. In 2003, foreign banks had a 22.5% share of the market, but by 2005 this had risen to 25%.

There was an aggressive response from the domestic banks, with an increase in more risky lending. Ireland was not the only country to experience a credit-fuelled bubble, although the level of financial excess outpaced the rest of the EU.

In 2003, Irish banking assets accounted for 1% for total EU banking assets, but over the next five years this would grow to 2.5% of all EU banking assets.

These are only some of the findings of Mr Lane’s very detailed presentation. There are obvious lessons.

Any sudden movement in the funding profile of a bank from long-term to short-term should immediately set off alarm bells. But the presentation also clearly highlighted that Ireland was fully plugged in to the global financial sector.

Raising capital from any number of international sources was merely the click of a button away. This has huge implications for effective financial market regulation.

It is not clear that even if the Irish regulatory regime had been taking its responsibilities seriously, it would have prevented a financial meltdown. The financial sector had become globalised yet regulation remained the responsibility of the nation state.

It is to Central Bank governor, Patrick Honohan’s credit that he did not try and excuse the regulatory failures that happened in the period preceding the crisis when he appeared before the Oireachtas banking inquiry on Thursday.

The fact neither the then head of the Central Bank, nor the financial regulator understood the banks were fundamentally insolvent on the night the guarantee was introduced on September 29, 2008, was inexcusable and a complete abdication of responsibility.

Former Minister for Irish Finance, Brian Lenihan, emerged favourably from Mr Honohan’s testimony. He wanted to exclude subordinated debt from the guarantee and immediately nationalise Anglo Irish Bank and Irish Nationwide.

If his wishes had been followed, then a sum less than €64bn of taxpayers’ would have been needed to rescue to banking sector. He was over-ruled by former taoiseach Brian Cowen.

His appearance before the Oireachtas Committee will now be even more eagerly anticipated. It is unclear what the banking inquiry will achieve as it is exclusively backward looking. Yet the challenge of regulating the Irish financial sector is Irish ongoing. Ireland is now part of EU banking union.

This means from now on, the domestic banks will be supervised from Frankfurt. The single supervisory mechanism is still at an embryonic stage. It has to be hoped it is effective in bringing about change.

Ironically, regulation has moved to a pan-European level, but since the crisis, the banking system has retreated behind national borders. The Irish economy needs more banking competition, which in theory should come from other EU financial institutions.

But most importantly, the country needs an effective regulator to ensure the sins of the past are never visited on a bruised electorate again.

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