Regulators need to pay close attention to the activities of banks if the global economy is to avoid another GFC, says Association of Chartered Certified Accountants (ACCA) Global President Brian McEnery. “The real and only conclusion I can come to is that the regulatory environment needs to become more effective,” he warns.

McEnery served as a non-executive director of Ireland’s National Asset Management Agency (NAMA) after the GFC, charged with recovering the €32b outlay the government made to support the country’s banks, which found themselves overexposed to a property crash when the crisis hit.

NAMA was at one time described by the Financial Times as the biggest property company in the world and it presented one of the great insolvency recovery challenges of modern times. “When NAMA was established, it was the biggest non-performing loan agency in the world,” says McEnery.

“It was a very daunting assignment. There was an expectation among the public at the time that this would be a calamitous failure and the taxpayers would not recover the €32b in bonds that had been lumbered onto their backs.”

But through careful shepherding of assets and improvement of value where possible, NAMA was able to return €38.1b (total cash flows) by the end of 2016. When the agency’s work is completed, it will make a profit of in excess of €3b, says McEnery. “I think it will be one of the most successful non-performing loan workouts in the world.”

The crash

Soon after the GFC struck, there were fears of a run on Anglo Irish Bank. To head this off, the government moved to guarantee the deposits of all Irish-owned banks – to the tune of €440b.

McEnery describes this as an audacious move, given the total guarantee was beyond the scope of the government to fund. But it did prevent an immediate banking system collapse. But the real challenge was still to come.

“This was initially the scandal of it. The banks categorically stated to government that their problem was not a solvency issue, and that it was a liquidity issue. Whether the senior bankers fully knew it or not at that point, the information they provided to government was hugely inaccurate and it soon became painfully apparent that it was a solvency issue that ailed the Irish systemically important banks.”

What the banks really wanted to do was to continue to get liquidity assistance from the Irish Central Bank and the European Central Bank and to keep on drawing down on emergency liquidity assistance without taking in new capital, and allow themselves to self-repair.

As the government set out to review the banking system, it emerged that Irish banks were superficially restructuring loans to try to present themselves in a better financial position than they actually were. Examples of this restructuring were allowing interest-only repayments on loans that were previously to be repaid with both interest and capital repayments, and allowing a moratorium on repayments.

Banks could then claim the loans were within terms and thus did not require incremental impairment, he says.

“However, the European Banking Authority became more established as a consequence of the GFC and started to say that now, on a European level we are going to do stress testing from a central base on all the systemically important banks in Europe.” This led many banks to “put up their hands” to the solvency risk, he adds.

 

The truth of it is that the banking sector equally does not want to go back to being as broken as it was

 

NAMA was created to take over the non-performing loans. It issued nearly €32b in bonds for the loans, just over the assessed value of €30b but below the par value of €74b. In effect, it paid the banks a small premium over and above the current market value of those loans at the valuation date of November 2009.

“The majority of the systemically important Irish banks really needed to be nationalised. What they were left with was token shareholding in the private sector, so that they could keep a stock market listing. Effectively they were 99% government controlled.”

In response to the cost of bank recapitalisation, the government imposed new taxes, raised minimum working hours and sought reduction in public sector salaries and pensions. This was politically unpopular, but McEnery argues it is almost implausible that a government would let its banking system fail. Consequently, he argues regulation of the industry needs to be tight.

“And the other thing is that some of the criticisms of Basel III [requirements for banks to improve capital adequacy, stress testing and market liquidity risk management] and IFRS 9 [which comes into force in 2018] that the banking system is voicing, if I was government I would be very intolerant of listening to those protestations.

“Don’t governments need to regulate much more effectively if a country clearly needs a banking system as part of its infrastructure, particularly a country like Ireland which has significant ambitions to being a global financial services location?

“Banks need a much higher level of oversight than they have had in the past, and more effective oversight.” McEnery already sees worrying signs surrounding banker remuneration, which in some parts of the world is close to being back to pre-GFC levels. He believes excessive short-termism in banker remuneration is not well aligned to a banks’ longer-term strategy and feels the majority of the performance-related pay element of bankers should be in the form of a long-term incentivisation programme.

New rules

When IFRS 9 becomes effective in 2018, it will introduce new classifications and measurements of financial assets and liabilities, and disclosures related to hedge accounting. While welcoming the new standard, McEnery warns the required tests for debt could prove challenging for “community-type banking organisations, savings banks and credit unions” to implement.

“Imagine the application of IFRS 9 to credit unions – that is going to be a real challenge to them. They are going to have to do the same levels of provisioning scenarios and analysis as the large banks.

“It will pose challenges for auditors to assess the reasonableness of the scenarios around the models that banks have developed in assessing [debt risk]… that will be difficult. I think we are in for a challenging couple of years in terms of implementation of Basel III and IFRS 9.”

But despite unhappy noises from the banking sector, he is confident the new rules will bed in. “The truth of it is that the banking sector equally does not want to go back to being as broken as it was. I hope we wouldn’t go back to those types of syndicated investment products that were pervasive.”

McEnery does point out that the level of capital held in financial institutions has increased due to  Basel III provisions and this is a positive. He also believes the level of provisioning in bank loan books will increase as a consequence of IFRS 9 and so again this should help insulate taxpayers from future banking troubles. The move from an incurred loss model (under IAS 39) to an expected loss model (under IFRS 9) is the biggest single change of the accounting standard surrounding financial instruments and a very welcome change in McEnery’s view.

NAMA’s recovery

As NAMA sought to recover the €32b in bonds issued to stabilise the Irish banks, it became a large asset management company which sought to make the most from property assets. Most of the bad debt it had absorbed was based in property and McEnery says the warning signs were there in 2008 for all to see:

• Irish banks by the end of 2009 had borrowed €150b on the wholesale money markets and lent it to property developers.  
• House completions for Ireland for 2006 were 93,000 units for a population of five million, compared to 160,000 completions in the UK for a population of 61 million.
• Over €84m was paid per acre for property in exclusive parts of Dublin. 

While NAMA first tried to recover the loans, it also found itself improving and selling the collateral – which was the property. 

“NAMA acquired quite a number of loans related to the Dublin Docklands. Government asked us to look strategically at the development of those docklands over many, many years. They effectively asked us to put in the infrastructure. In that instance, we were very active in taking the underlying assets and trying to enhance their value.”

With Brexit and the potential relocation of financial services from London, Dublin is now lucky enough to have a pipeline of brand new offices, he says. 

But the GFC has had a long-lasting effect on the business community in Ireland. “It is amazing that such was the effect of the GFC that even when things began to heal when banking credit became available, there wasn’t really an appetite. There was an aversion to risk in the business community. To my mind that isn’t fully healed yet.”