Munich Personal RePEc Archive The Irish Banking Crisis: Regulatory and Financial Stability Policy Honohan, Patrick and Donovan, Donal and Gorecki, Paul and Mottiar, Rafique Central Bank of Ireland 31 May 2010 Online at https://mpra.ub.uni-muenchen.de/24896/ MPRA Paper No. 24896, posted 11 Sep 2010 10:08 UTC The Irish Banking Crisis Regulatory and Financial Stability Policy 2003-2008 A Report to the Minister for Finance by the Governor of the Central Bank 31 May 2010 TABLE OF CONTENTS TABLE OF CONTENTS .............................................................................................................. i ABBREVIATIONS ...................................................................................................................... iv INTRODUCTION ......................................................................................................................... 1 Section 1: Terms of Reference ................................................................................................. 1 Section 2: Approach ................................................................................................................. 1 Section 3: Outline of Report..................................................................................................... 3 Section 4: Investigation Team .................................................................................................. 4 Section 5: Some Conventions .................................................................................................. 4 CHAPTER 1: SUMMARY AND CONCLUSIONS ................................................................. 6 Section 1: Introduction ............................................................................................................. 6 Section 2: Crisis Prevention ..................................................................................................... 6 - Micro-prudential policy (Chapters 4 and 5) ........................................................................ 8 - Overall financial stability policy (Chapter 6) ................................................................... 10 - The failure to take sufficient macro-prudential corrective action (Chapter 7) .................. 12 Section 3: Crisis Containment (Chapter 8) ............................................................................ 13 Section 4: Overall Conclusions .............................................................................................. 15 CHAPTER 2: THE MACROECONOMIC BACKGROUND .............................................. 19 Section 1: Introduction ........................................................................................................... 19 Section 2: The Celtic Tiger .................................................................................................... 21 Section 3: The Emergence of a Property Bubble ................................................................... 22 Section 4: The Role of the Banks ........................................................................................... 25 Section 5: Fiscal Policy and Competitiveness ........................................................................ 27 Section 6: Disentangling the Effect of Lehman Brothers ....................................................... 31 CHAPTER 3: INSTITUTIONAL BACKGROUND .............................................................. 34 Section 1: Introduction ........................................................................................................... 34 Section 2: Origin of the CBFSAI ........................................................................................... 34 Section 3: Formal Structure.................................................................................................... 36 Section 4: The Work of the CBFSAI Board and Authority ................................................... 38 Section 5: Conclusions ........................................................................................................... 42 CHAPTER 4: GOALS AND PHILOSOPY OF REGULATION .......................................... 43 Section 1: Introduction ........................................................................................................... 43 Section 2: Objectives, Content and Rationale ........................................................................ 45 ii - Objectives ......................................................................................................................... 45 - Content .............................................................................................................................. 45 - Rationale ........................................................................................................................... 47 Section 3: Creating the Governance Architecture for Principles-Based Regulation: Directors‘ Compliance Statements, Fit and Proper Requirements & a Corporate Governance Code ........................................................................................................................................ 48 - Directors‘ Compliance Statements.................................................................................... 48 - Fit and Proper requirements .............................................................................................. 51 - Corporate Governance Code ............................................................................................. 53 - Limited success ................................................................................................................. 54 Section 4: Enforcement .......................................................................................................... 54 - The status quo: Walk softly and carry no stick ................................................................ 55 - An alternative model: Walk softly but carry a big stick .................................................. 56 - Which enforcement strategy?............................................................................................ 56 Section 5: Conclusions ........................................................................................................... 59 CHAPTER 5: MICRO-PRUDENTIAL SUPERVISION ...................................................... 61 Section 1: Introduction ........................................................................................................... 61 Section 2: Staff Resources...................................................................................................... 61 - Resources devoted to micro-prudential supervision ......................................................... 61 - The scale of the credit institutions sector .......................................................................... 63 - Allocation of supervision resources .................................................................................. 64 Section 3: Supervision and Regulatory Processes and Procedures ........................................ 66 Section 4: Supervision and Regulation in Practice ................................................................ 68 - What were the governance and prudential issues? ............................................................ 68 - What enforcement and prudential action was taken? ........................................................ 72 Section 5: Conclusions ........................................................................................................... 75 CHAPTER 6: MACRO-PRUDENTIAL REGULATION AND THE FINANCIAL STABILITY REPORT PROCESS ............................................................................................ 76 Section 1: Introduction ........................................................................................................... 76 Section 2: The Key Messages ................................................................................................ 76 Section 3: Procedures Followed ............................................................................................. 78 Section 4: Identification of Issues .......................................................................................... 79 Section 5: Analytic Content ................................................................................................... 80 - Current financial indicators of the financial system ......................................................... 80 - Background analytical work ............................................................................................. 81 - Stress tests ......................................................................................................................... 86 iii Section 6: The Views of Outside Observers .......................................................................... 89 Section 7: Conclusions ........................................................................................................... 93 CHAPTER 7: MACRO-PRUDENTIAL POLICY IMPLEMENTATION .......................... 97 Section 1: Introduction ........................................................................................................... 97 Section 2: Instruments – Options and Choices ....................................................................... 97 - Moral suasion .................................................................................................................... 98 - Increased capital requirements: Risk weighting