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Ireland: reshaping the regulatory and banking system

Good morning ladies  and gentlemen.  Thank you Jodie for your kind introduction. My thanks  also to Tom Gilbert, Huw Jones and colleagues at Reuters for giving me  this opportunity to talk about reshaping Ireland’s regulatory framework  and its’ bank system.

I know that there is  a huge amount of interest in the financial position of the Irish banks,  our recent stress tests and the plans for restructuring the banking  system.  I propose to make that the principal focus of my remarks today  by explaining the stress test results and their design in some detail.   However, I would like to start by taking a bit of time to talk about the  reforms that we have been implementing on the regulatory front more  generally.  Not only has the banking crisis resulted in the need to  refinance and restructure the Irish banks, but it has also brought into  sharp focus serious failures and gaps in the regulatory framework.   Since I arrived to the Central Bank at the start of last year, reshaping  the regulatory framework, along with the banking situation, has been my  top priority, so, let me take a few moments to outline the principal  changes that are taking place.

Post crisis it is  common to hear regulators make a distinction between capacity to act,  and will to act.  There have been a number of reports on the Irish  banking crisis, including one by the Governor of the Central Bank of  Ireland, Patrick Honohan, and another by Max Watson and Klaus Regling,  now head of the EFSF, which indicate that Ireland had weakness both in  terms of capacity and will.  Another official investigation into the  crisis due to be published shortly, this time by Peter Nyberg, will no  doubt make similar points.  Making changes on both fronts is therefore  central to the agenda.

Making sure we have  the right resources to do supervision effectively is crucial to having  the capacity to act.  We are mid-way through a programme of doubling our  numbers to address the very weak staffing levels at the Irish Regulator  in almost all areas, but most notably front line supervisors and  enforcement.  Pre-crisis there was only one dedicated supervisor for AIB  and Irish Nationwide combined, for example, which was clearly  unacceptable.  With the help of Oliver Wyman consultants, we have done a  benchmarking exercise to establish our staffing numbers in line with  our peer regulators taking account of the size of the markets we  supervise.  These recruits are a mix of experienced industry hands,  special risk advisers with senior management experience and talented  graduates.  We have also increased our investment in training.

Capacity to act is  not just about staffing numbers, but also adequate powers, and ensuring  an appropriate set of rules is in place.  For example, we now have new  statutory fitness and probity powers across all sectors which will allow  the Central Bank to vet individuals who wish to enter the financial  service sector.  It also provides us with stronger powers to investigate  and, if appropriate, suspend or prohibit individuals who are in  controlled functions. We are consulting on the detailed operation of  these new powers, which are due to come into force later this year.

Incumbent staff will  be grandfathered under the new regime.  However, as I announced  recently in Dublin, we plan to review the fitness and probity of all  existing executive and nonexecutive board members at the Irish banks who  have received government assistance.  We will assess the incumbent  directors against the new statutory Fitness and Probity Standards,  including, where it is relevant, their competence and track record in  the period leading up to the financial crisis. We will use our new  investigative powers, where appropriate, to ensure that the people in  those positions meet the required level of fitness and probity. Where  they fall short of the required Standards, we will not just remove  individuals, but we will also, where appropriate, issue notices to  prohibit individuals from continuing as directors. I don’t underestimate  the legal challenges we might face in using our new powers, but we are  prepared to make difficult judgments on fitness and probity, and it is  right that we should start with this group.  We will be writing to all  bank directors to advise them that this process will apply to anyone  that plans to be in office as of 1 January 2012 to allow them an  opportunity to make their plans accordingly.

The new fitness and  probity powers are a welcome first step in strengthening our capacity to  act as a supervisor but more is needed and, indeed, planned.  The  government intends to bring forward legislation to provide for a general  strengthening of the legislative framework governing regulation in  Ireland and discussions are well advanced as to the nature of those new  powers. We will, for example, be seeking the ability to required skilled  persons reports comparable to the FSMA powers available to the UK FSA  and are requesting a significant increase in fines available for  enforcement cases against individuals or companies.  We are also seeking  broad special resolution powers, similar to those introduced in the UK  Banking Act 2009, which are currently awaiting legal enactment.

Improving Ireland’s  capacity to act also means having the right rules in place to govern  financial services activity.  In many instances this will be a case of  ensuring that Irish standards match prevailing international  requirements, for example promptly implementing the new Basel III  framework.  However, Ireland’s financial crisis was not solely caused by  weakness in international standards of bank capital or liquidity,  although they certainly played a big part.  There were home grown  elements too, where it is important that the Central Bank is prepared to  act with more rigorous standards than prevail internationally.

We have taken a  conscious decision to do this in the area of corporate governance. There  are some notable examples of Irish financial companies who have  suffered from over dominant CEOs, or ineffective challenge in the Board  room.  Poor governance at the Irish banks was exacerbated by the  concentrated nature of corporate life in Ireland, with challenge and  awkwardness in the board room perhaps blunted by the social constraints  of working and living in a small business community in a small country. 

These changes speak  to the capacity of the Central Bank to act as a supervisor in a reformed  regulatory system, but it is also important to have the will to act.   Our objective is to development a framework of assertive risk-based  supervision underpinned by a credible threat of enforcement action.  In  the past year we have set a record fine for a domestic financial  institution and have also shown a willingness to take decisive  supervisory action regarding serious and persistent solvency breaches at  one of our largest domestic insurance companies.  We are developing a  risk assessment framework that will allow a more systematic review of  the firms that we supervise based on their impact ranking and which will  require mitigation plans for areas where we identify risks.  As  supervisors, we should be prepared to discuss the adequacy of  management’s proposed mitigation actions but, where we are not  satisfied, be prepared to take an assertive approach, and insist on  action.

These changes will  help build a better regulatory framework for the future but the  immediate challenge is to implement a plan to rebuild the banking  system.  This plan involves a number of interconnected exercises under  the Financial Measures Programme agreed with the IMF, ECB and European  Commission, the results of which were announced at the end of last  week.  These are:

·          First, an independent loan loss forecasting exercise, carried out by  consultants BlackRock Solutions the results of which have helped to  establish the capital requirements of the banks under the Prudential Capital Assessment Review (PCAR).

·         Second, the PCAR itself,  which is an annual stress test of the capital resources of the domestic  banks within a given stress scenario to calculate the capital required  to meet Central Bank imposed requirements.

·         Third, a liquidity review – the Prudential Liquidity Assessment Review (PLAR) – to establish quantitative and qualitative targets for banks  participating in the PCAR. These targets are aimed at reducing the  banks’ reliance on short-term funding and ensuring convergence to Basel  III liquidity standards over time, and,

·          Fourth, a review of the structure of the domestic banking system and  the viability of individual banks.  Undertaken together with the  NTMA and Department of Finance, this review looked at the conditions for  the maintenance of a sustainable domestic banking system. It is the  basis for decisions on both the composition of this system and the  structure of its constituent institutions.

Let  me take the first of these two exercises together and explain the  approach we have adopted to loan loss forecasts and the capital stress  test.  We know that these exercises are taking place in a fundamentally  different context to a year ago.  We now face a severe crisis in the  euro sovereign debt markets, a weaker Irish economy subject to further  fiscal consolidation, a formal EU-IMF programme for Ireland, and, above  all, a lack of market confidence in the Irish banking system, reflected  in the stressed wholesale funding position of the banks, and, concerns  about future loan losses under adverse scenarios. 

Given this context,  the Central Bank took a more conservative approach in the latest  exercises, and built in more transparency and stronger external  validation into the exercises.

I want to talk about conservatism in a fair bit of detail in a moment but let me briefly mention validation and transparency.

In terms of  validation, the stress tests were informed not only by the banks’ own  views, but also a fully independent assessment of portfolio loan losses  conducted by Black Rock Solutions.   The data inputs for this exercise  were themselves subject to an assurance process by a number of  accounting and legal firms acting as BlackRock subcontractors to make  sure that the information was in fact a reliable basis for the  calculation.  As I will explain, the BlackRock assessment itself was in  fact determinative for the capital calculation for the stress test.  In  addition to this, we used Boston Consulting to provide quality assurance  over the capital calculation and loan loss methodology.    And, as you  would imagine our process and detailed findings were also subject to  close scrutiny by large teams from the IMF, ECB and European  Commission.   By any measure, then, this has been a very thorough  process with very extensive external validation.

In terms of  transparency, I would encourage you to take an opportunity later today  to go on-line and download our Financial Measures Programme report.   This 80 page report provides loan loss information from BlackRock on a  life time and three year basis under a base and stress scenario, as well  as base and stress calculations by the banks, broken down by  residential mortgage, corporate, commercial real estate, consumer and  other portfolios, all set out for each bank individually.  We also  provide details of the deleveraging plans of each of the banks,  including the amount of assets required for sale to meet target loan to  deposit ratios.  We provide considerable detail as to the macroeconomic  assumptions, including detailed house price assumptions, underpinning  the stress test.  And, of course, we provide detail as to the capital  calculation.

The goal of this  transparency is straightforward:  to address market scepticism of the  banks’ financial position by being completely open about the results of  this process so that market participants can make an independent  judgement about the conclusions of our exercise.

Most importantly of all we have approached this exercise from a perspective of conservatism.

This conservatism  has a number of elements.  Of course we are starting with an adverse  scenario to begin with.  For example, the stress scenario assumes a 60%  peak-to-trough drop in Irish residential house prices and no recovery at  all in these prices for a decade.  The macroeconomic stress scenario  was developed principally by the ECB and is on a comparable basis to  that which will inform other European stress tests. 

However, given the  parlous nature of the Irish banks and the level of market scepticism  regarding their financial strength, we recognised that further  conservatism was required.  I would highlight four elements:

·         The  target stress core tier 1 capital requirement is set at 6%, rather than  the 4% we used last year or the 5% that is contemplated for other  exercises;

·         The stress period was three years, rather than the two year norm;

·         We relied on the BlackRock loan loss estimates as being determinative of the capital calculation; and

·         We applied an additional capital buffer on top of the results of the three year stress test.

The application of  an additional capital buffer of €5.3bn in aggregate for the system is  principally designed to take account of possible losses beyond our three  year assessment.  I don’t know of any supervisor who would propose to  capitalise their banks now for remote hypothetical loan losses over the  full lifetime of the assets.  Such losses are inherently uncertain due  to their long term nature and only emerge over decades.  In addition  offsetting income would potentially arise and offset losses.  However,  we decided to publish both stress and base lifetime loan loss  projections by BlackRock for all the banks and all the portfolios  assessed as part our transparent approach.  And we also decided to apply  the capital buffer to take account of potential losses in the immediate  period after the three year assessment horizon, without any recognition  of offsetting income.

The use of BlackRock  as being determinative in the setting of loan loss estimates, rather  than the banks, was another important element of conservatism:  the  difference between the two estimates resulted in about a third of the  overall additional capital required by our exercise.  That is not to  criticise the banks approach, which were an entirely plausible  methodology for considering losses in their portfolios.  The BlackRock  methodology took what I might describe as a more hard-nosed capital  markets approach to assessing the loan losses, focusing on the intrinsic  value of the loans in light of the value of collateral and putting  aside the possible ameliorative impact of forbearance techniques.

The banks’  residential mortgage portfolios are a good case in point.   Understandably, the banks own internal provisioning models, generally  speaking, place considerable weight on the rate of unemployment in the  economy and see greater potential for rescheduled loans to move out of  arrears as employment improves over time.  In contrast, the BlackRock  model places greater weight on loan-to-value in assessing likely  delinquency levels and takes a more US-view of the likely roll rate from  delinquency into foreclosure.  This would, based on the stress  assumptions about flat house prices for a decade, hypothetically lead to  unheard of levels of repossession in Ireland.  We recognise that is a  very unlikely scenario, but we have in fact required the banks to be  capitalised to that level to address market scepticism about their  financial position.

As you well know,  loan losses and credit quality is only half the story in the  resuscitation of the Irish banking system. The other half of the story  is the funding position of the banks which in turn is linked to their  structure. 

During  the period from 2003-2007 the assets of the domestic Irish banks rose  dramatically on the back of a booming property and construction sector.  This asset growth was funded in large part by short term wholesale and  interbank borrowing. As a result, the banks experienced rapid balance  sheet growth. However, between September-December 2010, the 6 Irish  banks lost over €100 billion in funding as debt instruments failed to  roll over and deposits were withdrawn. This outflow came mainly from the  retreat of wholesale providers of funds from outside the euro area.  These counterparts had placed funds with the Irish banks when the  Sovereign and the principal banks had high credit ratings. This loss of  confidence, punctuated by downgrades of the Sovereign, and of the banks,  reflected increased market uncertainty.

The  PLAR was specifically designed to rebalance the funding mix of the  bank’s Balance Sheets through a combination of agreed deleveraging  transactions or asset disposals, and a set of liquidity metrics to be  achieved by December 2013. The four institutions, AIB, BOI, EBS and ILP,  must execute the PLAR plans agreed with the Central Bank.

Three key target funding ratios have been set under the PLAR:

·         A loan to deposit ratio; 

·         A Net Stable Funding Ratio (“NSFR”); and 

·         A Liquidity Coverage Ratio (“LCR”).

We have set a target Loan to deposit ratio of  122.5% that each of the each of the four banks must meet by December  2013. Each bank must identify non-core assets and establish plans to  deleverage their balance sheets by disposing of these assets by 2013.  The purpose of  the 122.5%  target is to begin the Irish banks’ return  to a more appropriately leveraged and more stable funding position. The  main driver of this ratio for each bank will be sales of asset.  In this  respect the PLAR and PCAR process interact and we have required the  banks to set aside sufficient capital to fund their deleveraging plans.

The Net Stable Funding Ratio targets  are aimed at ensuring that banks create more medium and long term  funding of their activities and encouraging them over time to build more  stable deposit bases, issue longer term wholesale funding and reduce  their Central Bank borrowing. Each bank has been set an individual  target for end 2013 and interim targets for end 2011 and end 2012. These  are to ensure that convergence to Basel III standards can be readily  met.

The Liquidity Coverage Ratio target is aimed at ensuring  that banks have sufficient high-quality liquid assets to survive a  significant, one-month liquidity stress scenario. Setting this target  will encourage banks to strengthen their liquidity buffer once their  reliance on central bank borrowing has been reduced to a sustainable  level. Each bank has been set a target level for LCR for end 2013 that  is designed to ensure that convergence to Basel III standards can be  readily met.

We will monitor progress towards achieving all these three key targets. Banks  will have to submit a detailed point-in-time liquidity profile every  quarter beginning at end-Q2 2011. Funding ratios will be calculated and  compared against the interim targets established as part of PLAR 2011.  In addition, the Central Bank and other public authorities will interact  more regularly with banks to monitor progress towards the disposal of  non-core assets. Further full Prudential Liquidity Assessment Reviews  will be carried out in 2012 and 2013 in accordance with the terms of the  MOU. Plans and targets may be updated as a consequence of these  reviews.

Deleveraging at  individual banks is therefore a critical part of restructuring the Irish  banking system.  This Deleveraging Review started with the submission  by the banks of formal deleveraging plans for assessment by the Central  Bank and its advisors.  This has resulted in the proposed sub-division  of assets on a core and non-core basis, with the latter cohort  representing the assets to be deleveraged over time, a significant  portion of which should be achieved by end 2013. The core components of  the banks will focus on supporting the Irish economy.  This  core/non-core approach is similar to that adopted by RBS and Citigroup.   

As noted above, we  have ensured that capital is set aside to support the deleveraging  process.  But there is common cause between the Central bank, Government  and the banks that deleveraging should not come at any price and that  fire sales should not be adopted for the deleveraging process.  We  therefore plan to monitor the process closely and take a pragmatic  approach as the banks sequence their non-core disposals to take account  of prevailing market conditions.  

We recognise that in  the meantime the banks will continue to be reliant on Central Bank and  Eurosystem support for their funding.  The Eurosystem has already  provided considerable liquidity support to the Irish banking system,  which is very welcome.  The ECB noted in its press release welcoming the  stress test results that the stress tests provide the banks with a  sound capital basis and that, against this background, the Eurosystem  will continue to provide liquidity support to banks in Ireland.

This progress on  deleveraging comes in the context of a broader government strategy on  restructuring the banking system.  The strategy is the creation of two  pillar banks to support the economy going forward, comprising Bank of  Ireland and a merged AIB and EBS.  The fourth bank in the stress test  exercise, ILP, will also require government assistance and will hive off  its profitable insurance arm as it slims down and rebuilds its capital  position.  The government has taken a clear decision that action will  not be taken against the senior bond holders of these four institutions,  as they represent the basis of the restructured banking system for the  future.  There has been considerable debate about this point but the  markets now have certainty about government policy.

What of the  implications of all this for the Irish sovereign finances?  I fear that  is a topic for another speech in its own right.  Let me just make two  points. 

First, that the €24bn total from the stress test exercise is the gross  cost to the government and will be offset by asset sales and liability  management exercises involving subordinated bond holders.  Also, €3bn of  this total is in the form of contingent capital instruments which will  be able to be redeemed by the state after a period of time if the stress  case does not materialise. 

Second, even at a  gross cost of €24bn this is still within the envelope of €35bn made  available under the IMF/EU Programme for the banks, which was assessed  by the lenders to be a sustainable level of additional borrowing.

Let me conclude by  acknowledging that it will take some time before a reformed regulatory  system and a restructured banking system are in place in Ireland.  The  financial crisis was rapid in its damage to the banking system and its  exposure of the weakness of the regulatory framework.  Addressing these  challenges and rebuilding market confidence in the banks is going to  take considerable time.  But the process of improving regulation in  Ireland is well underway.  And the conservative, transparent and  externally validated stress tests concluded last week are an important  milestone in the process of rebuilding a well capitalised and  right-sized Irish banking system.

Thank you for your attention.

http://www.financialregulator.ie/press-area/speeches%5CPages%5CAddressbyMatthewElderfield,HeadofFinancialRegulation,.aspx

Die Rede zeigt :

1. Keine "Notverkäufe"

2. Quartalsweise Anpassung an die tatsächlichen Wirtschaftsdaten.

3. Finanzierung des Umbaus bis Ende 2013 durch die ECB / EZB zu - momentan - 1% und damit günstiger, als die bisher gültigen 1,75%.

4. Verkauf der Britischen Beteiligungen und Konzentration auf die Finanzierung des irischen Marktes - Staatshaushalt, Industrie und Hauskäufe.