Last year, the Finnish regulator Peter Nyberg* was asked by the Irish Government to head a commission to make a thorough report on the Irish banking crisis. Nyberg’s report, Misjudging Risks: the Causes of the Systemic Banking Crisis in Ireland has now been published. The period investigated is 1 January 2003 until 15 January 2009, when the Irish Government nationalised the troubled Anglo Irish Bank.
For an avid SIC report reader the Nyberg report is a fascinating read. Compared to the SIC report, Nyberg’s report is only 156 pages, the SIC report 2600 pages so the width and depth isn’t comparable. But the parallels between the whole atmosphere surrounding the banks in the two countries, the consensus, blinding admiration and lack of scrutiny, drawn out in both reports, are striking. Ireland and Iceland are small countries that sought national glory in a fast-growing banking sector.
His report follows two other reports, by two economists Klaus Regling and Max Watson and one by Brian Honohan Governor of the Central Bank of Ireland, both of which I have already dealt with on Icelog.
Compared to the Icelandic SIC report the Nyberg commission couldn’t go into areas protected by banking secrecy. Consequently, Nyberg could not recount loan stories nor go into details about the relationship between the large clients and the banks, i.a. the area where the Icelandic banks allegedly committed financial crimes now being investigated both in Iceland and the UK. I have earlier blogged on what the Irish don’t know – and to my mind, possible fraud in the Irish banks hasn’t been tackled as systematically as I believe is needed. The story of Anglo Irish loans to the ‘golden circle’ – where the bank lent money to ten men (only some of the names have come out), against insufficient guarantees to buy the bank’s shares from the bank’s biggest shareholder in the summer of 2008 has many parallels in the Icelandic banks. Is the Anglo Irish loan really the only example of a bank taking on a possible loss to save favoured clients?
The title of the Nyberg report indicates the major flaw, the misjudging of risks, to be at the centre of the Irish banking crisis. Indeed, a headline for the failings of international banks in judging risk related to individual lenders and whole countries like Ireland, Iceland and Greece.
The Nyberg report, in addition to the SIC report, makes it glaringly obvious that other Western countries need to look at their own banking systems, UK being a case in point because had it not been for Government intervention the situation in October 2008 would have been an unmitigated catastrophe. German banks lent recklessly all over Europe, wrecked havoc from Iceland to Greece. The German Government should take notice and examine its banking sector far more closely.
Below are the topics explored and the main findings.
This Report explores what the Commission considers to be the most important policies, practices and linkages that contributed to the financial crisis in Ireland. A very large amount of documentation was analysed and many relevant people were interviewed. In explaining the simultaneity of the failures in Irish institutions, the Commission frequently found behaviour exhibiting bandwagon effects both between institutions (“herding”) and within them (“groupthink”), reinforced by a widespread international belief in the efficiency of financial markets. Based on this, the Report finally offers some lessons that could help avoid future similar occurrences in Ireland and elsewhere.
The willingness of banks to accept higher risks by providing more and shockingly larger loans primarily for commercial property deals was an important reason for the gradual increase in financial fragility in Ireland. This willingness occurred because of the emergence of strong foreign and domestic competitors within both the residential and commercial property lending markets.
Interestingly, the report points out how deteriorating loans led to losses. Interestingly, this also happened in the foreign banks, operating Ireland, which are not part of the report’s investigation. This is a sobering thought since it makes you wonder about the state and status of other European and American banks.
One of the striking features of the Icelandic banks, the political class, regulator and public authorities in Iceland in the years up to the crisis was the consensus that the banks could do no wrong, that there was nothing to question. The same appears to have been the case in Ireland.
A minority of people indicated that contrarian views were both difficult to maintain during the long boom and unhealthy to present to boards or superiors. A number of people stated that had they implemented or consistently supported contrarian policies they may ultimately have lost their jobs, positions, or reputations. Other signs were also noted pointing to sanctioning of diverging or contrarian opinions as well as self-censorship because of this. The apparent strength of these expected sanctions is difficult to judge, but the absence of opposition, barring only a handful of identified vociferous contrarians, may have made it easier for institutions to accept toning down the application of vital, tried and traditional prudential practices.
The Commission suspects that this conformity of views and self-limitation of responsibility would have tended to reduce the perceived need for monitoring, checking and thinking about what was really going on. There would have been little appreciation – both domestically and abroad – of the fact that Irish economic growth and welfare increasingly depended on construction and property development for domestic customers, funded by a growing foreign debt.
Flawed lending: Anglo and INBS
Anglo and to a much lesser extent INBS are important for the wider crisis because they were both seen as highly profitable institutions to which other Irish banks should aspire. As other banks tried to match the profitability of Anglo in particular, their behaviour gradually, and even at times unintentionally, became similar. Accordingly, when the crisis broke, large losses were realised not only in Anglo and INBS but in other banks as well.
In Iceland, Kaupthing was the bank that in record time became the largest bank and very much set the example for the two other banks and the whole financial sector.
Following the strong example, this was the unavoidable consequence:
The Herd: Other Banks
Bank management and boards in some of the other covered banks feared that, if they did not yield to the pressure to be as profitable as Anglo, in particular, they would face loss of long-standing customers, declining bank value, potential takeover and a loss of professional respect. The few that admitted to feeling any degree of concern at the change of strategy often added that consistent opposition would probably have meant formal or informal sanctioning.
The Silent Observers: External Auditors
The auditors clearly fulfilled this narrow function according to existing rules and regulations. They did not, however, generally report excesses over prudential sector lending limits to the FR. Even if they had, it appears unlikely that anything would have been done about it as in general the FR was already aware of such limit excesses.
The Enablers: Public Authorities
The CB was not powerless; it had the right to direct the activities of the FR and it could advise the Government. There are, however, no records of such direction or advice or even efforts at such. These institutions worked separately and their respective independence was repeatedly stressed; however, this was counteracted by their partly common board members. Until the crisis, many of the staff of the CB and the FR apparently did not cooperate in a sufficiently meaningful way in assessing financial stability.
Policy with Insufficient Information: the Guarantee
The logical but catastrophic consequence of all of this was that when the Irish Government gave the blanket guarantee to all the Irish banks on September 29 2008 (the day that Glitnir collapsed in Iceland) the Government didn’t have the proper information, knowledge and understanding to give this guarantee.
The lack of suspicion and the absence of sufficient information on the underlying quality of the banks’ balance sheets is likely to have had a significant impact on the alternatives that were considered reasonable on September 29, 2008. Proper information is a precondition for any crisis management based on reality. As it turned out, decisions were made on the erroneous assumption that all banks were and would remain solvent. Only on that assumption could the decision to simply provide a broad guarantee be understood.
If accurate information on banks’ exposures had been available at the time it seems quite likely to the Commission that a more limited guarantee combined with a state take-over of at least one bank might have been more seriously contemplated. Indeed, on the basis that such information had been available, banks could have been directed to raise substantially more private capital well before end-September 2008. As it turned out, however, the Government was advised that banks’ insolvency risks were small relative to liquidity risks and it was eventually decided not to consider nationalisation. This proved to be only a temporary reprieve, however. After a series of insufficient government actions and initiatives, Anglo was nationalised on January 19, 2009 following the disclosure of significant governance failings. Shortly afterwards, the solvency implications of several banks’ excessive property exposures started to emerge.
The lessons that Nyberg draws refer, not surprisingly, to the regulator but also to the governance of the banks, the level of vigilance and scrutiny and the need for a robust discussion of policies and directions, both in public and private institutions. Last but not least: the incentive structure:
Finally, it appears to the Commission that little seems to argue against policies to markedly limit (even properly structured) bonus and pay for management in both banks and authorities, in Ireland and internationally. A consistent message of the bankers interviewed by the Commission has been that money is only part of their work incentive. For people serious about professional public service, money should be even less of an incentive.
*On Peter Nyberg: Since 1998 he has been director general of financial services at the Finnish ministry of finance, where his team is responsible for financial market legislation, supervision of the Finnish treasury and financial stability. He previously worked as a senior economist at the International Monetary Fund and as an adviser to the board of Bank of Finland. He completed his doctorate in economics in 1980.
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