Restoring The Banking System: Reclaiming The Future

Background

Although undoubtedly exacerbated by the global credit crunch, the present financial crisis in Ireland was inevitable. The abandonment of the traditional prudential approach to lending for property - which fuelled the current crisis - was the latest in a series of unedifying experiences in the financial services sector - including the ICI debacle, the DIRT inquiry, the loans to politicians scandal, the NIB investigations, overcharging complaints, the Rusnak affair - all of which were symptomatic of an industry operating close to the edge, fixated with the maximisation of profits at any cost but primarily at the expense of customers and staff.

The movement away from the traditional customer-focussed banking culture to a target-driven approach was accompanied by the introduction of performance-related pay; an emphasis on individual rather than team incentives; a focus on sales ahead of service; the introduction of human resource policies which prioritised naïve enthusiasm and bravado over experience and prudence; an environment which placed competition before compliance.

In contrast to the traditional model of banking which adopted an approach based on long-term objectives, the new imperative was framed within very short-term targets to create a culture dominated by fear and driven by the relentless pursuit of excessive paper (as it transpired) profits.

IBOA The finance Union has consistently attempted to alert legislators and opinion leaders to the dangers inherent in these developments: the Union made a submission to the Joint Oireachtas Committee on Finance in June 2004 highlighting many of these concerns. Unfortunately, our views seemed to be regarded as unnecessarily alarmist at that time - as if we were merely party poopers throwing cold water on the burgeoning boom.

We take no satisfaction from saying we told you so. The current crisis is unprecedented in its gravity - both for the financial services sector and for the wider economy. Unlike in the recent past, simply doing nothing is not an option. Indeed the recent recovery in the share prices of the major financial institutions is predicated on the anticipation that action will be taken.

More than NAMA

In launching the draft legislation on the creation of NAMA, the Minister for Finance said that he wished to encourage a wide-ranging debate on the future of the financial services sector in Ireland rather than a narrowly focussed discussion on the mechanics of NAMA, itself.

Such an approach is entirely consistent with IBOA's own perspective on the issue since we believe that the need to address the problems of liquidity and severely impaired loans which has given rise to the NAMA proposal is one element (albeit a significant element) of a much bigger picture relating to the role of the financial services sector in the wider economy and how it can best serve the public good, how it can and should be developed in the medium and longer term to ensure that it can play its part in stimulating the economic recovery which is so vital to our future prosperity.

We, therefore, believe, that no matter how the issues of liquidity and impaired loans are ultimately to be addressed, the following initiatives should also take place in parallel:

a) Learning the Lessons of the Past
It is important that lessons must be learnt from the past - not out of academic interest or not even for the sole purpose of pointing fingers or apportioning blame but rather to provide guidelines for the future of the financial services sector. IBOA The Finance Union supports the call for an independent investigation - along the lines of the DIRT inquiry - into the recent collapse in our industry. This investigation should aim to identify the interplay of factors which have contributed to the destabilisation of the Irish banking system and should seek to develop recommendations to prevent any future recurrence.

b) Effective Regulation
It is now generally recognised that the principles-based approach to banking regulation has not worked. Indeed, the "light touch slight touch" approach has been a significant contributory factor to the current crisis.

We believe fundamental changes are necessary along the following lines:

• merger between IFRSA and the Central Bank to provide for a comprehensive and integrated regulatory structure which ensures that prudential issues are given due recognition while at the same time strengthening consumer protection by providing a more effective customer complaints mechanism;
• the proper resourcing of the regulatory function to ensure that sufficiently qualified professional staff are in post to carry out an extended legislative remit;
• the inclusion of professional staff from the regulator's office on the boards of financial institutions;
• the expansion of the role of the regulatory authority beyond simply reviewing capital requirements to include responsibilities to ensure that the financial institutions comply with enhanced standards of corporate governance and competence and guidelines on a new culture of banking;
• the creation of an appropriate oversight mechanism to monitor the supply of credit to the economy; and
• in light of recent events, the introduction of an effective mechanism for whistle-blowing to com­plement other measures to improve transparency in the financial services sector in the public interest.

c) Corporate Governance
The principles of corporate governance of banks must be reformed in order to reflect the critical role of financial services in the economy as a whole. The new remit must address the issue of corporate social responsibility by acknowledging that while banks need to operate efficiently and profitably, the pursuit of excessive profits is not in the long term interests of either the institution or of the economy - as recent events have demonstrated. The provision of credit into the economy at reasonable rates should be recognised as the primary economic imperative of the financial services sector.

The boards of directors of financial institutions should be reconfigured to reflect a much wider diversity of experience and interests by including representatives of staff, customers, the regulatory authorities and the State - in contrast to the present arrangement under which directors are drawn from a small pool of business leaders - an arrangement which conveys the impression of a golden circle with interlocking cross-membership of key commercial and financial undertakings.

d) Culture
The culture of banking has changed quite dramatically in recent years in ways which neither the staff nor the customer has found acceptable. For both, the relationship has effectively been dehumanised. For many staff the drive to meet sales targets imposes a relentless physical and psychological pressure: while for customers there is now a deep suspicion that they are no longer receiving objective advice from their financial service provider but a "hard sell" to buy a particular financial product. For staff working in some parts of the industry, their interactions with customers are also monitored as to their length and frequency as well as content - with the result that customers often feel rushed or short-changed by the experience as staff are under time pressure to move on to the next customer

In a recent survey of IBOA members undertaken by Red C Research and Marketing before the onset of the credit crunch:
– 87% of respondents agreed that profits appear to be the major driving force for most decisions made at senior level in their institutions with only 2% disagreeing; and
– 56% were worried that their bank was forgetting about customers in its drive for profits.

A review of culture is urgently needed to ensure that an optimum business model is achieved which reflects a much greater emphasis on customer service and satisfaction, supported by positive staff motivation and security, while at the same time sustaining the financial institution as a profitable business.

The development of this new business model to promote a new banking culture should be accompanied by an extensive overhaul of reward systems along with policies and practices in relation to appraisals, grievance handling, promotion and diversity.

The Current Debate

IBOA The Finance Union welcomes the current debate on the future of the financial services sector - even though on occasions it appears to have generated more heat than light. At times the tone of the debate has left much to be desired - particularly in terms of some of the attacks on bankers which do not distinguish between ordinary bank officials and the leadership of the institutions. The vast majority of bankers are men and women of high integrity who bear no responsibility for the current crisis. Indeed despite the unjustifiable decisions taken by those charged with directing these institutions, the staff have continued to work in extremely difficult circumstances where they are often required to bear the brunt of public anger in person. Nevertheless, we consider the debate around NAMA to be a useful opportunity for the ordinary staff working in finance to articulate their concerns about the development of the industry.

The unprecedented level of the crisis in the financial services sector in Ireland means that there are no easy solutions to the current difficulties. Quite simply we are in uncharted territory - and while we can seek to draw on examples from the recent past in other countries, none of these possible models replicates the current circumstances in this country - either in terms of the scale of the problem in financial terms relative to the size of the economy or in terms of the accompanying backdrop of a major crisis in the financial services sector worldwide.

IBOA has considered the various propositions advanced by politicians and others from the perspective of our members - both as employees working in the sector and as taxpayers concerned about the future well-being of the community.

a) Nationalisation:
At face value, the proposal to nationalise the covered institutions appears to offer a simple and direct solution to the crisis. The most simplistic argument suggests that even after rallying during the year, shares in the institutions are still relatively cheap and could be picked up at relatively little cost to the State. But of course the true cost of the nationalisation option would be significantly greater than that.

The issue of recapitalisation would not be resolved by nationalisation - as the recent nationalisation of Anglo Irish Bank has demonstrated. The question of repayments to the providers of senior and subordinated debt would also remain. Of course, the State could default on these debts or try to negotiate very generous discounts, as some commentators have suggested, on the presumption that these international investors would take the hit, mark it down to experience and move on.

While there may be some prospect of this happening in normal times, we are concerned that in the teeth of a global credit crunch - where institutions and sovereign States are competing for scarce credit - Ireland's credibility among these lenders would be severely damaged by such an approach and Ireland would effectively be placed at the back of the queue for future investment at a time when borrowings are particularly critical to our economic survival.

The other crucial unresolved issue in terms of the nationalisation option is the toxic assets themselves. Nationalisation would not remove the problem of managing and ultimately resolving those impaired assets. Indeed, by adding those impaired assets directly onto the balance sheet of Ireland Inc., the State would be forced to seek more funds from international investors to finance day-to-day Government spending at a higher rate of interest.

Since the State would now be the main conduit for the flow of credit to business within the country, the likely outcome of such a development would be increased charges for loans to business with the distinct possibility that in the best case scenario these businesses would seek to trim their own costs by reducing their pay bill or in the worst case scenario they could close down completely.

As for the future shape of the banking industry, with the cost of increased cost of borrowing from international lenders, it is likely that the State would be driven to seek cost reductions across the board - leading to widespread consolidation and significant job losses. It is virtually inevitable that six State-owned banks would be rationalised down to no more than three and probably two. If the period under State ownership was extended beyond five years, it may even be difficult to sustain two State-owned banks in a phony kind of competition with each other.

Notwithstanding undertakings from the State to protect employment in this scenario, the inexorable logic of a fully nationalised banking sector would be substantial job losses accompanied by a significant erosion in pay and terms and conditions of employment as well as a tightening of credit and other services for customers at all levels. Therefore, both for the sake of employment within the banking sector and within the wider economy, nationalisation in the current circumstances, is in our view, the least acceptable option currently on the table and should only be considered as the last possible resort.

b) The Good Bank:
While at first sight the concept of the "good bank" may have some merit as a device to ensure that credit is channelled directly into the economy and so provides a much needed stimulus to economic activity during these recessionary times, a detailed proposal on precisely how this concept could be implemented successfully has still to emerge. Given the urgency of taking action to address these underlying economic issues, it would seem that even this element of the Fine Gael proposal would take somewhere between six and twelve months to work out - time which, frankly, our economy cannot afford.

As for the other elements of the proposal which envisages dividing each of the covered institutions into two parts, these require extensive clarification before we could pass judgement on them. It would appear that the proposal may include the effective establishment of a number of zombie banks - which would be a highly undesirable development both for the banking system, the economy and for our members' job security. In so far as this proposal might also involve defaulting on either senior or subordinated debt or both, we have similar concerns as outlined in our view of the nationalisation option above - especially in terms of the potential impact on employment within the financial services sector and the implications for our members' living standards

c) NAMA:
NAMA has been described by some commentators as the "least worst" of the options proposed so far in this debate. While that may hardly sound like a ringing endorsement, it captures the fact that in the present situation, there are no simple solutions. Each approach comes with a high degree of risk and will require a significant level of sacrifice. Furthermore, the success or otherwise of any initiative can only be truly measured in the fullness of time - whether that means five years or twenty years no one can say at this stage. Nevertheless, as we indicated earlier, doing nothing is not an option.

The banking system must be restored - not for the sake of shareholders or high-level financiers - but because without a properly functioning banking system with the capacity to provide credit, economic recovery becomes impossible. Indeed if this issue is not addressed, the recession will be even deeper and longer than we have experienced so far.

In order to ensure that credit is provided on the most competitive terms into the economy, it is important that a range of providers are available. In our view, the NAMA proposal offers the best prospect for survival of a competitive banking system - and with that, the best prospect for the protection of jobs in the industry.

IBOA acknowledges that all of the propositions advanced so far in the debate have implications for the employment prospects and for the terms and conditions of our members since they are all likely to result in consolidation and rationalisation within the financial services sector to a greater or lesser extent. However, we consider that the NAMA proposal offers the best prospect for an orderly and well-managed process which would ensure the retention of the expertise which will be necessary at all levels in the industry for the recovery of the banking sector into the future - especially in maintaining effective relationships with customers.

In terms of the wider economic benefits - which will in turn generate ongoing and future business for the financial services sector, we consider that the NAMA project offers the best prospect for restoring international confidence in the Irish economy. Indeed, as we indicated earlier, the improvement in Irish financial stocks since the spring has been largely attributed to the announcement of the NAMA scheme to deal with the impaired loans on the balance sheets of Irish banks.

The indications are that with their impaired loans removed, some at least of the covered institutions will become attractive to private investment from Ireland and abroad - thus reducing the degree to which State funds will be required to recapitalise these banks. Even though after recapitalisation, the State's share-holding in some institutions may rise to a substantial level, it is important in our view that some proportion remain in private hands to ensure that these institutions maintain their stock market listings and thus continue to attract further investment - either in the forms of equity or loans.

Furthermore, while we believe that the Irish banking sector is strengthened by as diverse a pattern of ownership as possible, the maintenance of AIB and Bank of Ireland as separate entities, as envisaged in the NAMA proposal, is of systemic importance to the future of Irish banking and to the protection of the jobs of our members. We consider that of the options currently available, the NAMA project offers the best prospect of ensuring these objectives into the future.

By remaining as publicly quoted companies, these institutions should also have easier access to credit from international lenders than under any other scenario proposed so far - as well, of course, as receiving the State-brokered credit allocation from the European Central Bank under the terms of the NAMA arrangement.

In order to ensure that this delivers the necessary stimulus to the economy - which would justify the intervention by the European Central Bank - it is vital that steps are taken to ensure that the additional credit made available to banks through the NAMA project is not used for the sole purpose of repairing the banks' own balance sheets by reducing the loans to deposit ratios. Regular monitoring of banks' lending practices is essential to ensure that credit begins to flow again within the economy in order to protect existing employment and, where possible, generate new employment opportunities to begin to redress the haemorrhage of jobs in the last eighteen months.

Furthermore, financial institutions should be required to ensure that repossession of houses where the mortgage holders are in financial difficulties as a result of redundancy or any other sudden drop in income is only considered as a last resort after all other approaches to reschedule and reconfigure the terms of the mortgage have been exhausted

On balance, therefore, and recognising that there is no easy solution to the problem, IBOA considers that the NAMA project, if accompanied by the kind of measures we have outlined earlier in relation to regulation, governance and culture, offers the best prospect of all of the options proposed so far in both the national interest and in the interests of our members in all three jurisdictions - Republic of Ireland, Northern Ireland and Great Britain.

After NAMA

In order to ensure that the likely consolidation and reconfiguration of the Irish banking landscape proceeds in an orderly manner following the transfer of assets from the relevant banks into NAMA, IBOA is seeking an overarching framework to be agreed with the participating institutions and the Government. The key principles of this framework should be as follows:

• the application of partnership principles - to ensure that the introduction of major change in any of the institutions should be subject to full negotiation and agreement with employees and their trade union representatives;
• the recognition of trade union representatives for those employees who have historically been denied such representation in order to ensure that they can negotiate on equal footing with their colleagues and with management;
• the implementation of any redundancies on a voluntary basis in order to maximise protection of employment; and
• the maintenance of established pay rates and terms and conditions of employment.

Summary

IBOA's qualified support for the NAMA project is conditional on the following:

• the introduction of a suitable mechanism to monitor the provision of credit by the participating institutions - either as part of NAMA's remit or of another agency such as the regulator;
• the introduction of an expanded and more effective regulatory regime - which would include a greater emphasis on prudential issues and would also provide for representation for the regulatory authority on the boards of financial institutions;
• the introduction of a Whistle-blowers' Charter for staff working in the financial services sector underpinned by legislation;
• a major change in the culture of banking which would be reflected in the governance structures, a new approach to remuneration and new human resources policies and practices;
• appropriate protection for homeowners in default;
• a public inquiry into the banking crisis in order to learn the lessons to avoid a recurrence of the same mistakes;
• the development of a comprehensive strategy for the future direction of the financial services sector - which would take account of the role of Irish-owned banks; foreign-owned banks; and any State-owned institutions; and
• the implementation of an agreed framework for the management of change in the participating institutions after the transfer of assets to NAMA - which would provide for negotiated settlements on the basis of no compulsory redundancies; the maintenance of established pay rates and terms and conditions of employment; with full trade union representation for all workers in the financial services sector.