Bankers should not be lending to get a bonus
Following are the excerpts from an interview with former ACCA Global President and BDO Ireland Partner and Healthcare Head Brian Mcenery. Mcenery noted that good governance is essential for long-term survival and success of a financial institution and depends greatly on the skills, experience and knowledge of its board and top management. The interview was done during Mcenery’s recent visit to Colombo. What was your previous position and is it your first visit to Sri Lanka?
No, it’s my second time in Sri Lanka and I was here exactly 12 months ago. I was then the President of the global accounting body ACCA. This year I was asked to come back. I have just stepped down as ACCA Global President. I am now the Immediate Past President but I’m delighted to be back in Sri Lanka.
As you are one of the leading insolvency practitioners in Ireland, could you explain the Irish banking crisis and how you became a Non-executive Director at the National Asset Management Agency (NAMA)?
Irish banking crisis came as a real shock in 2008 because the economy had been growing at an extreme level. It was the fastest growing economy in Europe for about six years in a row and even before that it had been growing very fast. Part of that growth was as a consequence of the rising asset values and that created what can only be described as a bubble and the bubble burst in 2008.
It was a significant problem as it led to the country being unable to borrow from the international markets and hence, we needed the IMF to become a lender to the country. This was the scale the problem we had in Ireland and the most prominent part of the crisis was the banking crisis. As a result, the government set up a specialist agency to deal with the loans that had gone bad, which were referred to as toxic loans.
The finance minister appointed seven people to lead that bank and I was one of the seven representing the accounting and insolvency profession. So, for the last eight years, I have been a Director of that bank and that bank has been described as the best bank in the world by the Financial Times, for converting non-performing loans into performing loans.
We have done our job. We paid all the money that we had to get on behalf of the banks from the government to bail out the banks and we have fully repaid that and now make a profit of around four billion euros. So, it’s been a good result during a horrendously difficult period for our economy.
Why was it essential to create a specialist agency to restructure the toxic loans?
It is because we felt it was important to take the bad loans and illiquid loans out of the existing banks as they had so many problem loans. If the troubled banks tried to manage a bank, which was supposed to lend the economy, while also trying to manage these big non-performing loans, that was not going to be easy for the banks.
Moreover, the same borrowers would probably come to the banks looking for more to keep their loans alive. Thus, we said it’s important to have a specialist workout unit and that’s why all the illiquid loans were transferred. You know the concept of ‘The good cop bad cop’. NAMA is the ‘bad cop’ in the banking world. We had to go in and I suppose to use the phrase we’ve got to kick ass; we had to do that, which was difficult.
And we weren’t liked and we were not popular but we were the custodians of billions and billions of euros on behalf of the taxpayer and we couldn’t be soft and therefore, that’s why we felt it was important to take it out of the current banks, which still had to go out and continue to lend. So, it was not easy for them to play hardball with the borrowers while at the same time having to provide more credit to the economy.
What was the process and challenges in collecting the bad loans?
The process was that we went to all of those borrowers who had borrowed money and now weren’t repaying it. We wanted them to convince us that we should still support them in repaying these loans.
If they came to us with a credible business plan and also, if they decided that they were going to accept a much more humble lifestyle and dispose of some of their personal assets, which they had built up, if they did agree to this, then we would work with them and if they didn’t, we took them out of the equation and we took control of the loans and assets directly.
How has the regulatory environment changed since the crisis?
I think it is important to say that the regulator was changed and it’s very fair to say that the Irish public would say that the regulatory regime was not fit for purpose during 2006 to 2008 and maybe even before that. The financial regulator was terminated and a new international and well-respected financial regulator was brought into the banking system in Ireland, who had a no nonsense attitude. That was important for the new regime because the old regime had failed and the new regime is one around ensuring that banks are adequately capitalised.
I spoke this morning about banker compensation; there is a cap on banker compensation in Ireland, to ensure top bankers are not lending to get a big bonus but lending because it’s the right thing to do. So, in Ireland and at this moment, you cannot have remuneration, which is based solely on the bank’s lending book because that is a misalignment of their objectives.
What you don’t want is banks dolling out depositors money, so that the top team can have big bonuses. The regulatory environment has got tougher after the crisis for executive compensation.
In your opinion, who would you blame for allowing this crisis to happen?
I think many parties were part of what became the global financial crisis; it wasn’t just the people with the developers because they were the borrowers. But they got the money from somebody and the people who they got the money from were the bankers. There should have been better oversight of the bankers by the regulators and the whole political system encouraged this borrowing for property development, so whether it’s politicians, the regulators, the bankers or the developers, they were all responsible for the crisis.
The accountancy profession had a part as some were the auditors for some of these banks. We should have been the ones saying there is a considerable level of concentration risk. We should have asked why the banks were exposing themselves so much to the property sector. There were many who I blame, which I call the blame index and it is essential that every one of those characters involved in creating that crisis takes responsibility. If we all deny that we had a role to play, then history will repeat itself.
In your opinion, how has Basel III capital requirements and IFRS 9 impacted the banking sector?
Before IFRS 9, there was an accounting standard called IAS 39 and that meant you didn’t impair loans unless there was a probable loss and I believe that was wrong. I think IAS 39 was not fit for the purpose and now IFRS 9 is on the basis of an expected loss rather than a probable loss. Therefore, there is a better basis of predicting a loss now as supposed to having it been almost incurred under the old accounting standard.
Thus, that accounting standard was not fit for the purpose. So, with IFRS 9, there is a greater level of provisioning, which means that if there’s a greater level of provisioning, there needs to be a greater level of capital. So, that’s an integral part of IFRS 9.
Before the banking crisis, the level of capital that was required by Basel was about 4 percent and that was far too low because when we saw property values collapse by 40 percent and 4 percent is tiny by comparison, so now we can see the bank capital levels are up at 12 to 13 percent. That is a healthy level of bank capital.
Therefore, the banking supervision committee that’s known as Basel has realised that Basel II is not fit for the purpose. So, a lot of lessons have been learnt but you know, I did talk about some of the jurisdictions already beginning to soften the banking regulation and in particular, I’m worried that it is happening again in the US.
Do you think that there might be an impending crisis in the US?
Many of the measures brought in by Doddfrank have already been reversed in the US and in my opinion the push towards deregulation in the banking system in the US is a wrong move. Ultimately, they were the ones who brought in the subprime loans and the catalyst for the global financial crisis and it is now beginning to soften regulation.
Previously, the whole separation of investment banking from retail banking was enshrined after the previous big collapse, which was the first major global recession, the Wall Street crash. Therefore, the Glass Steagall Act was introduced, which separated investment banking and that was reversed around 20 years ago.
Then we had Dodd-frank, which was to ensure that we don’t have another banking crisis. Already we can see the considerable amount of softening of those provisions of the Dodd-frank Act. I do worry about the fact that we see banker compensation being misaligned with compensation mechanisms around the promotion of lending again. I think we’re going down the slippery slope once again. Next time the magnitude of the crisis will be much greater.
In your opinion, what is the optimal amount of capital a bank should hold?
You shouldn’t have a desire to have too much capital because if you have a lot of capital, which is not deployed towards lending, then that drives up the amount of equity that you have in the bank. If you drive up too much equity, then you will let your return on equity fall as a consequence. So, it is about getting the right balance and that’s why there are some parts of Basel III, I do like.
Therefore, in a growing economy, Basel says you should have more capital because the asset values are rising and that was the constraint on the amount of lending and apparently it’s the opposite when the economy is beginning to feel a little bit of pain so you can relieve some of that. Do I think we’re in a better place with capital levels of about 10-13 percent than 4 percent? I do, but if it is a whole pile more, then the return on equity will be too low for the shareholders.
On a final note, what lessons from the Irish banking crisis can be applied to Sri Lanka?
I believe prevention is better than cure. I do see that there is a strong property market in Sri Lanka. It’s like when the milk is in the pot and the problem is when it boils over, it’s too late. So, the thing is to keep a very watchful eye now and ensure the milk does not spill over and to keep a lid on it. I think that is a good analogy to ensure that the system doesn’t boil over and prevention is always better than cure. Bankers should be at the centre managing and controlling it. They owe it to their depositors. (Cathrine Weerakkody, a graduate in financial analysis, an Associate of CIMA with a Master’s Degree in Financial Management, is currently employed as an Analyst at an MNC insurance company)
I believe prevention is better than cure. I do see that there is a strong property market in Sri Lanka. It’s like when the milk is in the pot and the problem is when it boils over, it’s too late. So, the thing is to keep a very watchful eye now and ensure the milk does not spill over and to keep a lid on it. I think that is a good analogy to ensure that the system doesn’t boil over and prevention is always better than cure. Bankers should be at the centre managing and controlling it. They owe it to their depositors
What you don’t want is banks dolling out depositors money, so that the top team can have big bonuses. The regulatory environment has got tougher after the crisis for executive compensation