Risk strategy falls foul of Central Bank

THE Central Bank has expressed serious concern at the lack of progress within the Irish banks concerning risk management.

After the property bubble it emerged that Irish banks were paying key executives and those under them pay and incentive packages that resulted in the risk factors being ignored in the lending policies pursued virtually across the entire banking system.

In its review carried out in September/October 2010, the Central Bank found just one of the banks had made reasonable progress in this key area.

Jonathan McMahon, head of financial institutions supervision at the Central Bank of Ireland, said: “We conducted this review to determine whether banks have ceased those remuneration practices which fostered inappropriate risk-taking and inadequate risk management in the 2000s.

“While the majority of banks have started to reform their remuneration policies and practices, the balance of our findings is discouraging, with only one bank having taken an obvious lead,” he said. “If a bank is not employing the right financial incentives, it is not managing its risks — it’s as simple as that.”

In a letter to the CEOs of the various banks he said “we expect banks to have dealt with these issues when we review their remuneration practices again in 2011”.

In 2008, as the property market was going under, Irish banks were found in general to have inappropriate incentive arrangements, with bonus structures biased towards commercial lending, with “rewards insufficiently tied to risk management, particularly the management of funding risks”, it said.

That was not unexpected for that year and it chimes with many international studies which have pinpointed inappropriate remuneration practices as a material contributory factor to the financial crisis.

While a strong case for change has been made since then “the review shows that while banks have started to reform their remuneration practices, there has, with one exception, been inadequate progress,” the report said.

It added: “The prevailing shortcoming is that the link between remuneration and risk management remains poorly defined, poorly articulated and poorly governed.”

It warned unless pay packages carry with them a more definite form, “banks risk repeating past errors”.

Leadership within banks is required to close these gaps. As leadership in this area is a bellwether for corporate culture more generally, the bank said it will be keeping a sharp eye on how the banks move towards better practice in that regard.

A spokeswoman for the Central Bank said she would not name the “one bank” that had made the best progress on the risk management front.

ISME, the Irish Small & Medium Enterprises Association, reacted furiously to the lack of reform highlighted in the findings.

It called on the Government “to give more power to the Central Bank to impose stricter conditions on bankers’ wages,” in the wake of the report.