Regulation blues…

The always readable Michael Casey, formerly of the Central Bank, and now a board member of the IMF writes in the Irish Times about the banking inquiry with a set of questions that he believes should be put to said inquiry.

It’s all good stuff, and he’s certainly pointing the finger in no uncertain way at the key pressure points – did the government give specific responses to information, if any, passed by the banks and the regulator… or did the regulator express concerns in the first place?

It’s not hard to pick out what he’s getting at…

But one comment that caught my eye was the following…

This is the most fundamental question and it is important to explore it further. In its mission statement the regulator is strangely silent on the question of intervening in a troubled financial institution. It could be argued that the failure to intervene is due to bureaucratic inertia. The regulators wait and wait and hope the problem will disappear. The point then comes when the troubled institution hits the wall and it is too late. We then go suddenly from the possibility of preventative action to the need for damage limitation – which as we have seen in Ireland is extraordinarily complex and costly.

And also…

What is intriguing is the possibility that the Financial Regulator does not have an endgame. Is it conceivable that regulators never have any intention of intervening? This is the fundamental question that must be pinned down by the investigation because it raises profound issues about what regulation is all about.

It’s perhaps useful to look at the Financial Regulators website…for under the ‘Role of the Financial Regulator’ one will read the following…

Role of the Financial Regulator 
The purpose of the Financial Regulator is:
• to help consumers to make informed decisions on their financial affairs in a safe and fair market; and
• to foster sound dynamic financial institutions in Ireland
The Financial Regulator undertakes its role in a number of integrated ways:
• Rigorous authorisation procedures for entrants to the financial services market
• Supervision of financial service providers which focuses on their solvency and risk management processes
• Recurring compliance with consumer protection code so that financial service providers act in a fair and transparent manner in their dealings with consumers
• Provision of independent information to consumers to raise awareness of the costs, risks and benefits of various financial services 

Y’know, he’s right. The pertinent words are ‘help’… ‘foster’… ‘supervision’… ‘recurring compliance’ (not entirely sure what they’re trying to say there). But curiously, not a single phrase that indicates that they actually intervene. All very hands off.

Now it’s not as if it has no powers… for under ‘Processes’ we can read…

The Financial Regulator has a number of key processes that apply to most financial service providers.  These processes are: 
Administrative Sanctions
The Financial Regulator has power to impose sanctions for prescribed contraventions of legislation or regulatory rules by financial service providers.  For more information visit our Administrative Sanctions Section. 
Anti-Money Laundering
Financial institutions currently designated under the Criminal Justice Act, 1994 (the Act) are obliged to take the necessary measures to effectively counteract money laundering in accordance with the provisions of the Act.  For more information visit our Anti-Money Laundering Section.
Authorisation
The following is a general overview of the authorisation regime applied by the Financial Regulator when authorising financial service providers.  For more information visit our Authorisation Section.
Consumer Protection 
The Consumer Protection Code, which came fully into effect on 1 July 2007, is the foundation of the Financial Regulator’s work in protecting consumers of the financial services providers we regulate.  For more information visit our Consumer Protection Section.
Establishing in Ireland
The Financial Regulator is responsible for the regulation of most financial service firms in Ireland.  The first step for a firm or individual proposing to provide a financial service in Ireland is to ascertain whether they need an authorisation/licence/approval from the Financial Regulator.  For more information visit our Establishing in Ireland Section.
Industry Funding Levy
Any financial service provider who is authorised and regulated by the Financial Regulator on 31 December of a given year is liable to pay the levy for the following year.  For more information visit our Industry Funding Levy Section.
Minimum Competency Requirements
The Minimum Competency Requirements introduce a competency framework that is designed to establish minimum standards for regulated entities. For more information visit our Minimum Competency Requirements Section.
Supervision Approach
The following is general information on our supervisory process for financial service providers is provided.  For more information visit our Supervision Section.

But these are, at least to judge from the accompanying texts, aimed more at issues relating to consumers rather than systemic oversight and it’s notable that the FR is split into a Prudential and Consumer Directorate dealing respectively with… well.. you can guess….

One might reasonably, given the events that overtook the financial system in the past number of years, wonder if the gulf between mission statement as noted by Casey, and processes available, indicates a broader philosophical approach to such matters and a consequent deficit in not merely instruments available to pry into and regulate such matters but a hesitancy to do so.

And by way of contrast let us briefly consider the Financial Services Authority (FSA) in the UK which has the following mission statement;

We are an independent body that regulates the financial services industry in the UK.
We have been given a wide range of rule-making, investigatory and enforcement powers in order to meet our four statutory objectives. In meeting these, we are also obliged to have regard to the Principles of Good Regulation.
We summarise our Statutory Objectives and Principles of Good Regulation in three Strategic Aims:
• Promoting efficient, orderly and fair markets;
• Helping retail consumers achieve a fair deal; and
• Improving our business capability and effectiveness

And…

The Financial Services Authority (FSA) is an independent organisation responsible for regulating financial services in the UK.
The FSA’s aim is to promote efficient, orderly and fair financial markets and help retail financial service consumers get a fair deal.
The FSA was set up by government. The government is responsible for the overall scope of the FSA’s regulatory activities and for its powers.
The FSA regulates most financial services markets, exchanges and firms. It sets the standards that they must meet and can take action against firms if they fail to meet the required standards.

Furthermore…

We have a wide range of rule-making, investigatory and enforcement powers to enable us to meet four statutory objectives summarised as one overall aim: to promote efficient, orderly and fair markets and to help retail consumers achieve a fair deal.
[…]

In January 2000, we set out our proposed approach to regulation in A ‘New Regulator for the New Millennium’. This explained the operating framework we intended to put in place to enable us to meet our statutory objectives.
This framework is more commonly known as ARROW, which stands for the Advanced, Risk-Responsive Operating frameWork, and it is at the heart of our risk-based approach to regulation.
We reviewed and updated ARROW after its first few years in operation. The current framework, ARROW II, was rolled out in 2006.
We explain more about how we specifically apply ARROW II when supervising firms in ‘how we supervise firms’.
As a risk-based regulator, our approach is based on a clear statement of the realistic aims and limits of regulation; it recognises the proper responsibilities of consumers and of firms’ own management, as well as the impossibility and undesirability of removing all risk and failure from the financial system.

Note a very specific point made in the following…

How we supervise firms

‘Supervision’ is the term we use to describe our day-to-day regulatory relationship with authorised firms. It is our process of monitoring and regulating firms to ensure they are complying with the regulatory requirements.
As a general principle, we supervise firms according to the risks they present to our statutory objectives. We assess risks in terms of their impact (the scale of the effect these risks will have on consumers and the market if they were to happen) and probability (the likelihood of the particular issue occurring).
The nature and extent of our supervisory relationship with an individual firm depends on how much of a risk we consider it could pose to our statutory objectives. The framework we use to assess that risk is called ‘ARROW’ – the Advanced Risk-Responsive Operating frameWork. We introduced an improved framework (ARROW II) in 2006.

The reference to the ‘market’ indicates that the FSA doesn’t merely see this in terms of consumers and/or firms but also in a systemic fashion. And FSA supervision is rigorous (albeit and obviously not perfect).

Medium and high-impact firms
In relation to medium and high-impact firms, we coordinate our work through a relationship manager, who carries out a regular risk assessment (on a cycle of one to four years) and determines a risk mitigation programme proportionate to the risks identified. The precise volume and type of work we undertake will depend on the size and riskiness of the firm concerned.
We also apply baseline monitoring activities (as this is undertaken for all firms regardless of their impact scores). This involves analysing a firm’s financial and other returns, and checking compliance with notification requirements. Breaches and other indicators of risk may be followed up by the supervisory team.

For high impact firms, we apply a closer monitoring regime (we call this ‘close and continuous’ work). This is essentially a planned schedule of ARROW visits to the firm throughout the regulatory period. This allows the supervisory team to meet the firm’s senior management and control functions regularly.
Where possible, we will centralise our supervision of all of the firms within a group in a single team. When appropriate (for example, if we believe the group has an integrated management and/or control structure) we will produce a combined ARROW risk assessment and risk mitigation programme covering all the firms in a group.

It looks like Casey’s thoughts bear further consideration. He makes another point…

The people who took bad decisions should be named since this is part of the process of reforming the system. It is unlikely, however, that many people will be named – because of our Houdini-like capacity to unshackle ourselves of responsibility. It is also worth remembering that our system of political appointees allows senior politicians pull the strings without the public knowing.

One would be sanguine indeed to believe that in any such process, political appointees or not, that the line of communication (and potentially more) went in but one direction.