Executive Summary
Executive Summary
Ireland’s banking crisis bears the clear imprint of global influences, yet it was in crucial ways
“home-made.” This report aims to clarify how different factors – external and domestic,
macroeconomic and structural – interacted to cause the crisis. On this basis, it seeks to draw policy
lessons, and it also fulfils the mandate of identifying follow-up areas for the planned Commission
of Investigation. It is thus a diagnostic rather than a forensic study; and it aims to complement the
parallel report by Governor Honohan.
In the run-up to Ireland’s crisis, global financial markets featured an extended period of high
liquidity and low risk premia. Monetary conditions in the euro area were also easy relative to the
levels of growth and inflation in Ireland. Financial integration in the euro area was deepening, and
banks in Ireland had unprecedented access to cross-border funding. As in many smaller EU
economies, moreover, the entry of foreign banks intensified competition in lending. Against this
backdrop, it is not surprising that Ireland experienced a strong and extended domestic financial
boom, accompanied by an influx of foreign savings.
This boom needs to be seen also in the context of Ireland’s strong and extended expansion during
the previous decade, when the economy caught up with and surpassed average EU living standards.
This fostered expectations of a continued rise in living standards and in asset values. Another factor,
with even deeper roots, was the strong and pervasive preference in Irish society for property as an
asset, and the fact that Ireland had never experienced a property crash.
This was a setting in which official policies and banking practices faced key challenges. There was
scope to mitigate the risks of a boom/bust cycle through prudent fiscal and supervisory policies, as
well as strong bank governance – thus raising the chances of a “soft landing” for the property
market and for society at large. In the event, official policies and banking practices in some cases
added fuel to the fire. Fiscal policy, bank governance and financial supervision left the economy
vulnerable to a deep crisis, with costly and extended social fallout.
While global and domestic factors thus interacted in mutually reinforcing ways, it is feasible to
disentangle the main “home-made” elements in the debacle.
Fiscal policy heightened the vulnerability of the economy. At the macroeconomic level, it should
have done more to dampen the powerful monetary and liquidity impulses that were stimulating the
economy. Budgets that were strongly counter-cyclical could have helped to moderate the boom, and
would also have created fiscal space to cushion the recession when it came. But budgetary policy
veered more toward spending money while revenues came in. In addition, the pattern of tax cuts left
revenues increasingly fragile, since they were dependent on taxes driven by the property sector and
by high consumer spending. Ireland was also unusual in having tax deductibility for mortgages, and
significant and distortive subsidies for commercial real estate development, yet no property tax.
As the boom wore on, some external and domestic commentators were critical of fiscal policy. The
OECD flagged the case for greater prudence. The European Commission worried about procyclicality
in policy as early as 2001; and by 2007 it flagged clearly the fragility of tax revenues.
Nonetheless, EU Council Opinions were favourable: with earlier fiscal reforms and the impact of
the boom, Stability and Growth Pact commitments did not seem in doubt. Equally, the IMF was not
strongly or consistently critical of the underlying dynamics of fiscal policy. In the event, when the
boom ended, fiscal policy was left cyclically and structurally depleted. There was no room for
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manoeuvre to support the economy. Indeed, the need to restore sound public finances left no choice
but to tighten policy as output fell and unemployment rose.
In this macroeconomic setting, bank governance and financial supervision faced major challenges.
Banks, moreover, were operating over the past decade in a setting of greatly increased wholesale
funding opportunities, following adoption of the euro; and banks from abroad began to compete
strongly in retail mortgage lending. Against this backdrop, strongly risk-averse reactions by banks
in Ireland and their supervisors would have been needed to help dampen a very risky boom-bust
cycle.
It appears clear, however, that bank governance and risk management were weak – in some cases
disastrously so. This contributed to the crisis through several channels. Credit risk controls failed to
prevent severe concentrations in lending on property – including notably on commercial property –
as well as high exposures to individual borrowers and a serious overdependence on wholesale
funding. It appears that internal procedures were overridden, sometimes systematically. The
systemic impact of the governance issues crystallised dramatically with the Government statements
that accompanied the nationalisation of Anglo Irish Bank. Some governance events are already
under investigation. There is a need to probe more widely the scope of governance failings in banks,
whether they were of a rather general kind or (apparently in far fewer instances) connected with
very serious specific lapses, and whether auditors were sufficiently vigilant in some episodes.
The response of supervisors to the build-up of risks, despite a few praiseworthy initiatives that came
late in the process, was not hands-on or pre-emptive. To some degree, this was in tune with the
times. The climate of regulation in advanced economies had swung towards reliance on market risk
assessment. Domestically, moreover, there was a socio-political context in which it would have
taken some courage to act more toughly in restraining bank credit. The weakness of supervision in
Ireland contrasts sharply, however, with experience in those countries where supervisors, faced with
evident risks, acted to stem the tide.
Moreover, bank supervisors in Ireland were not called upon to deal with technically complex
problems. Ireland’s banking exuberance indulged in few of the exotic constructs that caused
problems elsewhere. This was a plain vanilla property bubble, compounded by exceptional
concentrations of lending for purposes related to property – and notably commercial property.
Depending in part on the results of the parallel report by Governor Honohan, this is an area for
further investigation to determine what degree of censure is warranted for the failures of
supervision.
These supervisory problems, however, must be seen in conjunction with the absence of forceful
warnings from the central bank on macrofinancial risks – given that supervisors relied almost
entirely on the central bank for economic inputs. By mid-decade, the financial and property boom in
Ireland presented features – both macro- and microeconomic – in which financial stability analysis
should have sounded alarm bells loudly. Domestic financial stability reporting by the central bank
failed in this regard. It noted worrying features; but it failed to trace their interactions vividly or to
warn how severe were the emerging risks to bank soundness and, ultimately, to the living standards
of the ordinary citizen. In fairness, external surveillance sources fared little better. The IMF’s major
Financial System Stability Assessment of 2006 did not sound the alarm, and there is no evidence
that its private warnings did so either.
Thus it is clear that, in various ways, official policies and bank governance failings seriously
exacerbated Ireland’s credit and property boom, and depleted its fiscal and banking buffers when
the crisis struck. On the basis of that assessment, the body of this report seeks to highlight both
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broad policy lessons and also areas that deserve specific consideration when the planned
Commission of Investigation further explores responsibilities. Nonetheless, the true burden of
responsibility emerges as quite broad, and it extends to insufficiently critical external surveillance
institutions.