Banking Inquiry recommendations show we are learning no lessons at all

Last year I discovered the phenomenon of binge-watching Netflix. We started off with Breaking Bad, which was quirky but strangely addictive.
Banking Inquiry recommendations show we are learning no lessons at all

Over Christmas we started watching House, the US medical drama. House was a bit different.

It tended to be the same storyline repeated from episode to episode.

The recurring moral of the series was that if you don’t diagnose the underlying illness correctly you are going to end up only treating the superficial symptoms and the patient won’t recover.

Which is a bit like the Banking Inquiry Report.

One of the first criticisms made in the Report was that the almost universal theory of a soft landing was accepted without any substantial test or challenge.

The criticism implies that had a test been carried out and evidence provided that a soft landing was likely, there would have been no cause for concern.

Indeed, much of the evidence from bankers was predicated on the belief in a soft landing.

The problem is that as soon as you start following this line of reasoning you have turned from being a banker/regulator into being a punter.

A banking system should never be in a position where the ranch has been bet on any type of landing no matter how strong the evidence.

The flaw wasn’t the failure to carry out a test.

If you get as far as quibbling about carrying out a test you are already lost.

The flaw was in a failure to properly diagnose the underlying condition that caused the banking system to be exposed in this manner in the first place.

Unfortunately when you read the Banking section of the report there is an absence of any technical analysis of this nature.

If you ask of every recommendation: “what difference would that have made?” the answer is invariable “none”.

Many of the recommendations are a repackaging of existing best practice.

Many bank boards had directors with excellent financial skills and experience.

Management information systems, particularly on credit, were state-of-the-art.

In most banks, the risk function is represented by a senior independent position in the management structure with direct access to the chairman and board.

In most banks, the new product approval process involves approval by risk functions.

The bank asset and liability committee (ALCO) regularly reviews mismatches between liabilities and assets and the output of ALCO deliberations would be included in board reports.

Bank Internal Auditors spend their professional lives focussing on the areas of highest business risk, including loan concentration, capital and liquidity risks and the management of the organisation.

Internal audit has always been subject to regular reviews to ensure that it conforms to best practice.

The closest direct comparison of what standard of inquiry recommendations we should expect is the Vickers 2011 Report in the UK.

British banks had distinctly different problems than Irish banks, centering on exposures in their capital markets divisions.

Consequently, Vickers recommended that British banks should be forced to ring-fence their high street businesses from their investment banking arms.

The Vickers committee specifically say that had their recommendations been in place before 2007 they would have helped prevent the run on Northern Rock and the fallout from the collapse of Lehman’s which led to the 2008 crash.

At its core, the Irish banking crash was caused by a wholesale breakdown in the internal control system.

One of the more telling findings from the 2011 Nyberg report was that regulatory sector credit limits were exceeded by large margins and that insistence on observing these limits in itself would have reduced the Irish banks’ exposure to the property market by some €62bn.

One would have expected the Committee to address in some detail why the control systems around breaches of sector limits did not work and to suggest some improvements.

For example, one simple suggestion would be that whenever a limit is breached in excess of a particular threshold for a particular period of time, then a bank should be obligated to disclose this breach publicly.

An extension of the “Comply or Explain” principle.

One of the founding fathers of the EU, Jean Monnet used to say that people will accept change if they see the necessity for it, however they will only see the necessity for it when there is a crisis.

In Ireland we have had the crisis and people accept the necessity for change.

There is just one problem, if the recommendations of the Banking Inquiry are anything to go by, there will be no change of any meaningful substance.

Eugene McErlean is an expert on banking and corporate governance.

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