Ethics And Corporate Governance

Identify and discuss with clear examples the governance mechanisms that were lacking / deficient in Ireland during the financial crisis, according to the Nyberg report. The Nyberg report was published in April 2011 outlining the causes of the systemic banking crisis in Ireland. It covers the period of January 2003 to January 2009. Some of the root causes of the financial crisis were identified as being market position, profit motivation and survival. According to the report there were governance mechanisms lacking both externally and internally during the financial crisis which are outlined below.

The property sector was increasing aggressively which led to some banks taking a more risky approach to its lending policies and procedures. Nyberg states ‘Property-related lending was seen as “really the only game in town” for growth-oriented banking. ’ Although there appeared to be Credit processes and procedures implemented within these banks, they were relaxed and neglected in an effort to increase their Market Share and drive for profit. Anglo Irish Bank is mentioned as one who relaxed their lending policies; they were seen merely as a guideline. These procedures should have been recognised as not being adequate and should have been reviewed and strengthened as a matter of urgency however management and boards did not seem to be aware of the size of the risk they were taking so was not a priority. Banks were also lacking in the area of identifying and monitoring risks that they were exposed to. Nyberg went as far as saying ‘It could be argued that bank management in Ireland, like many banks elsewhere in the world, had forgotten the very nature of credit. Providing credit is not a sale of bank services; it is the acquisition of a risky asset. ’ It is critical that they banks know that they are not over exposed in a particular sector, company or connected parties. It seems that the quality of MI being provided to the Boards was poor so they could not identify the likely risks they were undertaking nor did the Boards seem to mind how the banks were being run at ground level. INBS did not even have a proper risk management unit in place which could have identified risks and in turn challenged the Banks credit risk appetite.

Although most Banks appeared to have the Boards and sub committees in place, the commission found there was a lack of structure and governance within them. Over time there was a loss of experienced Board members, others were implemented without the sufficient banking experience necessary and there were times internal appointments were made to senior roles. The former CEO of Anglo was appointed as Chairman which was outside the norm at the time however no one seemed to object to it and unbelievably INBS did not have a Risk Committee in place however did implement one when the Financial Regulator instructed them to do so. Also, lacking during this time were knowledgeable and strong public authorities.

The Central Bank and Financial Regulator seemed to misjudge or ignore the risks the banks were taking especially the concentration risks within the property market. At times staff pointed out the serious risks that were being undertaken and insisted on stronger measures; however it seemed to fall on deaf ears. Even in 2005/06 when warning signs were starting to show the authorities did not enforce meaningful sanctions on the banks and they continued to communicate on existing well known risks. An effective Central Bank would have acted on the early warning signals at this time and worked alongside the other authorities on a strategy to reduce the impact of the financial crisis. Within Chapter 2, the report mentions that the Financial Regulator did regularly engage and at times questioned the banks on procedures or lack of governance however they did not challenge the banks or enforce sanctioning. An example of such is the Financial Regulator requested on numerous occasions to INBS to improve their Corporate Governance however INBS never took any action as did not feel pressurised to do so. Good corporate governance also includes External Auditors.

In the report Nyberg refers to these as ‘The Silent Observers’. These auditors had the skills and the tools to identify any potential risks although the primarily function is to confirm the accuracy of historic accounts and confirm the bank is in a position to remain solvent for the next year. Although it was not a requirement it seems the auditors were aware that that Anglo and INBS were exposed however they took any action or initiative to highlight this and influence the bank on their findings. Although the three key parts of Good Corporate Governance (Internal and External mechanisms and External audit) were visible, the decisions and actions from internal and external bodies demonstrates there was a lack of understanding, poor communication and behavioural issues that all contributed to the financial crisis. Critically discuss the move from principles to rules-based corporate governance regulation for financial institutions in Ireland post financial crisisAs outlined in the Nyberg report, there were numerous factors that contributed to the financial crisis in Financial Institutions. One of which is that Banks complied with Principles based Corporate Governance regulation. It gave the banks the opportunity to do whatever they pleased without any penalties or consequences. There can be advantages and disadvantages to both methods.

Rules Based Regulation

Advantages

The main advantage of the rules based regulation is there is no ambiguity of what is expected from a bank. It contains clear cut rules and guidelines so that it is easier for the banks to comply with and invoke. It allows little room for misinterpretation. It also means that all banks have to meet the same standards that are introduced by the financial regulator; they are all on the same playing field this should eliminate the herding factor. Finally at the end of the day the Regulator remains answerable to these rules based regulations. The Regulator is not delegating their obligations and they are ensuring the regulatory objective is always at the forefront while enforcing these rules.

Disadvantages

The main disadvantage to rules based regulation is that it is not flexible and it can struggle to keep up with the fast paced changing environment of banking. Procedures and rules can take time to be altered and when the need may arise, it may leave the bank at a disadvantage, not being able to implement new changes when either a negative incident or a positive event comes to light. Aligning with the point above, rules based regulation can be quite costly to a financial institution. Examples of such are production costs, regulatory changes and detailed reporting requirements. Although it will always be best efforts basis there is always a possibility that not every eventuality will be thought of and may leave areas open to be abused.

Principle Based Regulation

Advantages

The principle based approach can supply direction in a number of different scenarios; it encourages the promotion of professional judgement within financial institutions. It allows them to take more responsibility to work through the guidelines to achieve the regulatory goal and by doing so avoid the situation turning into a tick box exercise. With the above in mind it needs to be noted the flexibility that principle based regulation provides. This means it can adapt easily to any changing circumstances that may occur. It allows banks to be innovative and use its resources to identify if there are more efficient and robust ways to achieve the regulatory goal while ensuring it falls within the banks risk appetite. With this in mind it could also reduce costs whether it’s in technology or compliance related.

Disadvantages

The main disadvantage of the principle based approach is the uncertainty and the vagueness of this approach. It opens banks to misinterpretation of the specific requirements. This indeed can cause cost implications as they may have to source SME’s to identify the requirements that they need to undertake to be compliant. This can also result in being under compliant or in fact being over compliant which has its own implications. Using the rules based corporate governance there is no illusion or misinterpretation of what is expected from each bank. It provides the rules that they must follow with full transparency. It is ensuring that we learn from our past and not make the same mistakes again. Although I do believe we have to be careful that the banks do not suffocate in rules and guidelines so we need to find a balance of the two by considering the advantages and disadvantages of both methods.