Okay, so I now propose that the committee go back into public session; is that agreed? And we'll now deal with session 3 of our hearings today with Mr. Con Honan ... Horan, Central Bank of Ireland IFSRA, and the Committee of Inquiry into the Banking Crisis now resuming in public session and can I ask members and those in the public Gallery to ensure that their mobile devices are switched off? This afternoon, we will continue our hearings with witnesses from the Central Bank of Ireland Financial Regulator. At our next session, we will hear from Mr. Con Horan, the senior official from the Central Bank of Ireland IFSRA.

Mr. Con Horan joined the Central Bank in 1979, where he held a number of roles. In 2003, he became head of banking supervision at the Financial Regulator and was appointed as prudential director in February 2006. Mr. Horan was appointed in February 2011 to the position of special adviser to the head of financial supervision, Matthew Elderfield. He was since seconded to the European Banking Authority in April 2011. Mr. Horan, you're very welcome before the committee this evening.

Before I hear from the witness, I wish to advise Mr. Horan that, by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect to their evidence to this committee. If you are directed by the Chairman to cease giving evidence in relation to a particular matter and you continue to do so, you are entitled thereafter only to a qualified privilege in respect of your evidence. You are directed that only evidence connected with the subject matter of these proceedings is to be given. I would remind members and those present that there are currently criminal proceedings ongoing and further criminal proceedings are scheduled during the lifetime of the inquiry which overlap with the subject matter of the inquiry. Therefore, the utmost caution should be taken not to prejudice those proceedings. In addition, there are particular obligations of professional secrecy on officers of the Central Bank in respect of confidential information they have come across in the course of their duties. This stems from European and Irish law, including section 33AK of the Central Bank Act 1942. The banking inquiry also has the obligations of professional secrecy in terms of some of the information which has been provided to it by the Central Bank. These obligations have been taken into account by the committee and will affect the questions asked and the answers which can be lawfully given in today's proceedings. In particular, it will mean that some information can be dealt with on a summary or aggregate basis, such that individual institutions will not be identifiable.

Members of the public are reminded that photography is prohibited in the committee room. To assist the smooth running of the inquiry, we will display certain documents on screens here in the committee room.

For those sitting in the Gallery, these documents will be displayed on the screen to your left and right. Members of the public and journalists are reminded that these documents are confidential and they should not publish any of the documents so displayed. The witness has been directed to attend the meeting of the Joint Committee of Inquiry into the Banking Crisis. You have been furnished with booklets of core documents. These are before the committee, which will be relied on in question and form part of the evidence of the inquiry. So I now ask the clerk to administer the oath.

Thank you again, Mr. Horan. And if I could invite you to make your opening remarks this evening please.

Chairman, members of the committee, thank you for hearing my evidence today. It provides me with the opportunity to assist the inquiry in its work into what has been the most catastrophic, financial and economic crisis in the history of the state. The crisis has left many indelible marks, the system of oversight of the Irish banking sector clearly failed. The lessons learned from these events, as well as those in European banking over the recent years, have and will continue to drive major changes so as to avoid a repeat of what occurred. Commentators have implied that I personally did nothing to prevent the problems of 2008. Nothing could be further than the truth. Four years have passed since the report of the commission of investigation. Accordingly, I very much welcome this opportunity to have my voice heard and communicate the actions I took in seeking to avert the collapse.

When the Governor of the Central Bank, Professor Honohan, spoke to you in January this year, he advised that the people who took corrective action had been vilified in the media. He was speaking about my situation. When the commission of investigation report spoke about the lack of professional scepticism in the Financial Regulator, it also identified that there were exceptions at the level of the regulatory authority. I believe that exception was me. I can, however, assure the inquiry that this does not alleviate the sense of deep regret I feel, as a member of the senior management team in a registered authority that was not more intrusive and did not prevent the collapse of the financial system.

Before going into the events leading up to the crisis, it is important to distinguish between the roles of the Financial Regulator and the Central Bank. Briefly, the Financial Regulator was primarily responsible for supervising the safety and soundness of individual banks and their compliance with prudential requirements. The Central Bank, on the other hand, monitors stability of the overall banking system and the threats to the financial system. The Central Bank's views of market ... of the market inform the Financial Regulator in its supervision of the banks. The Financial Regulator in turn, contributes to the analysis of the stability of the overall system by communicating what it was observing in individual institutions.

I joined the Financial Regulator in mid-2003 as head of banking supervision. I reported to Mr. Patrick Neary, who was the prudential director. In this role I was not a member of the senior management team and only occasionally attended meetings of the authority. I was required to implement the strategic principles-based approach to regulation adopted by the authority prior to my appointment. As it would be expected, I acted at all times within the structure and the approach set down by the authority.

However, I believe the records demonstrate that I continually pushed the boundaries seeking to make the regulations of banks more intrusive and assertive. During this time, I proposed interventions in the property market to address high-risk mortgages. I proposed the imposition of formal corporate governance requirements on banks, including specific proposals to address the most difficult cases. I advocated for the establishment of a dedicated unit of specialists to pursue administrative sanctions. I also took on the role of head of banking supervision at a time when the international approach to the regulation of banks was undergoing the most radical change in decades. The Basel II accord was published in 2004, it was designed by central banks and regulators from major countries in the world. It established the key prudential ratios the banks needed to comply with and how these ratios should be calculated. The approach containing the accord was, in effect, the continuation of the deregulation of the industry which had been happening for more than a decade. While not fully responsible for the crisis, it provided poor incentives and moved supervision towards a greater recognition of banks' own methods for managing risk and calculating capital. The system of regulation supervision contained in this accord has proven to be grossly deficient and I will revert to this point. While I cannot be specific as to the dates, I believe it was around the end of 2004 or early 2005 that I grew increasingly concerned about the way property-based lending was developing in Ireland.

My concerns were supported by my research of international banking crises and, in particular, what had happened in Scandinavia in the 1990s. In mid-2005, I made a written proposal to increase the bank's capital requirements on high loan-to-value mortgages. This sought to put more capital aside in the event of a downturn and to establish a standard in the market for prudent lending. However, the proposal was not accepted. My understanding was that senior management in the Financial Regulator and the Central Bank had considered the matter but did not believe the action was necessary. Macro-prudential analysis on mortgage growth conducted around this time suggested that the developments could be explained by economic fundamentals.

In 2006, Mr. Patrick Neary became the CEO, following the retirement of Dr. Liam O'Reilly, and I was appointed prudential director. The Irish Times quoted in an article as follows "Shortly after Neary became the regulator's chief executive in 2006, Con Horan, who replaced him as prudential director, knocked on his door and warned that something had to be done to restrain property speculators as house prices reached new highs on spiralling land values and the market was awash with 100 per cent mortgage offers." Reflecting these concerns, my first week as prudential director, I presented proposals to the authority for capital measures to address high loan-to-value lending ... mortgage lending. This was the first time in almost a decade of an exceptional property market that the regulatory intervention was instigated. Prior to this, moral suasion was the tool used to try to persuade banks to rein in the practices. Therefore, the taking of direct action represented a significant change and met with internal resistance. There was concern that such action would jeopardise the stability of the Irish financial system. There were concerns that such intervention was inconsistent with principles-based supervision. However, it was approved, after what Governor Honohan has described as long and agonised debate.

I wish to point out that I took these actions immediately on my appointment because it was imperative to signal to the banking industry that the approach of property-based lending was changing under the new senior management regime. The speed and level of consultation in the introduction of the measures led to me being rebuked by the statutory financial services consultative industry panel. The panel considered the lack of consultation with its members in the preparation of the measures as regrettable and retrogressive. The chairman of the panel wrote to me reflecting those concerns.

Later in 2006, I followed up these mortgage measures with the introduction of the most stringent capital requirements in Europe for speculative commercial property lending and additional requirements for buy-to-let mortgages. There was also resistance to these measures. Clearly the majority view at the time was that the property market was going to have a soft landing as interest rates increased. There was fear about the message that regulatory intervention would communicate in terms of the property market in Ireland and how it might affect the competitiveness of the banking system. It is important to point out that a public consultation undertaken on the introduction of the measures did not produce support for these regulatory actions. The responses received to the consultation were largely critical, with the banks and their representative body expressing the belief that such action was unwarranted and raised the prospect of international investors reacting negatively to the Irish market. It took a lot of persuasion and a number of board meetings to get agreement on these actions.

I would highlight that had the actions been the catalyst for a sharp correction, as many had feared, it would have raised very serious consequences. However, I did not leave matters there. In July 2007, revised prudential stress testing guidelines were issued to credit institutions to address loosening underwriting standards. In effect, my first ten months as prudential director were spent pursuing this agenda of change, culminating in the most stringent regulatory regime in Europe for the key areas of property risk. Initiating such changes met a lot of internal and external resistance and an absence of public support.

The following slides demonstrate how the market slowed after the measures were introduced. Okay, I'll be very brief on this. The first slide deals with residential mortgage lending, and I just really tried to show the sequence of events, that in February 2006 I was appointed prudential director. I immediately proposed the change and the new rule was introduced on 1 May 2006.

I think the committee can see that thereafter there's a very clear and consistent decrease in the level of mortgage lending.

And if I can have the other slide please? This relates to non-mortgage credit, and again it's from October 2005, and again just appointed prudential director February 2006; I proposed the measures in around September '06 with the capital requirements directive coming in. The measures came into effect on the 31 December 2006, and again I think you can see in general how the mortgage market, or the non-mortgage credit, went thereafter.

In all my research and in making my recommendations I was conscious of the views of external contrarians and used their arguments to support the positions I was putting forward. However, I was also conscious of other views as it would have been entirely wrong and counterproductive to ignore what the domestic mainstream authorities including the ESRI and the Department of Finance were saying. You must also remember that private sector professionals such as rating agencies, stockbrokers, investment managers and analysts were broadly supportive of the way markets were performing. The IMF has also acknowledged that it provided few clear warnings about the risks and vulnerabilities associated with the impending crisis. From its on-site reviews, it was supportive of the approach of supervision that was being taken. In 2006 it proposed that the prudential director should be appointed to the authority so the position would be on a par with the consumer director.

Other international bodies such as the OECD were also supportive of the macroeconomic analysis of the domestic Irish authorities. And the ECB, with its financial stability mandate, was not advocating macroprudential action. It was positive towards the strength of the EU banking sector prior to the crisis. It is of some comfort to me that the Basel II accord and the capital requirements directive which provided the foundation of the regulatory regime in Ireland have in recent years been acknowledged to be grossly deficient. In addition to permitting grossly excessive levels of leverage, Basel II encourage pro-cyclicality, failed to provide for systemic risks and allowed banks to operate on extremely low levels of capital, resulting in buffers that were far too low prior to the collapse. The weakness of the regime has now been identified by many authoritative sources, including parliamentary committees in other jurisdictions. The process of correcting the deficiencies has been ongoing since 2008, but even now, seven years on, the reforms are not complete.

To conclude, I wish to repeat that as a member of the senior management team in the Financial Regulator from 2006, I deeply regret and I'm sorry that the system of supervision did not prevent the collapse in the banking system. I do hope the inquiry will recognise that I took risks to address key problems by introducing stricter regulations in a difficult environment of groupthink. It was of course my duty as prudential director to do so. While the ten years as prudential director I saw the introduction of some of the most stringent capital and liquidity rules in Europe, regrettably, however, these measures were too late and were not sufficient to reverse the excesses of the previous decade and save the financial system when the global financial crisis struck.

Thank you for your attention, members. Can I also add one additional point if I can, Chairman? I do want to correct a point on my earlier statement ... just a brief correction on page 4 ... the third paragraph down under macroprudential supervision. There is a reference there to the IFSRA board, that reference ... the IFSRA should be removed it should just be the board. It's the Central Bank board I was referring to there.

Thank you for the clarification, Mr. Horan, and thank you for your opening statement. I now invite first lead questioner, Senator MacSharry. You have 15 minutes.

Thanks very much and welcome, Mr. Horan, and thanks for being here. In your written statement you mention your proposals for regulatory intervention were put forward in 2006. You also say that concerns at the Central Bank senior management levels about the impact, the potential impact of it. And it also mentions the desire to temper what was perceived as the appetite for heavy intervention, that's a quote from page 4 of the statement. Your proposal for regulatory intervention was met with significant concerns, you say, from the senior management of the Central Bank. Was this level of intervention, in your operation as a financial regulator, normal?

It's hard, Deputy, to say normally, because literally this was my first week as prudential director.

It didn't happen frequently. It was an event that occurred right at the start of my term as prudential director, and wouldn't have been frequent thereafter.

Yes, okay. You mentioned also in your statement a formal proposal in August 2005 to introduce measures to address high loan-to-values ... "the proposal met resistance from senior management of the Central Bank and was shelved". Subsequent to your appointment as prudential director, you implemented the same proposal, which then met with a rebuke by the chairman of the FSICP, as you mentioned there again in your oral statement as well. Can you explain the nature of this resistance to your proposal by the senior management of the Central Bank?

Well, in relation to the August '05 measure, I made a proposal in mid-August 2005 to increase the capital on high loan-to-value mortgages. I did that directly up my own reporting line at the time to the prudential director, and ... who took to bring it forward and address it. And the feedback I got at that time ... I tried to set out a fairly good argument in terms of why we should take measures at that point in time, but the feedback that I got was that the matter had been considered by senior management in the Financial Regulator, and the Central Bank, and the view was that the measures were not necessary at that time.

So it was a timing thing, as opposed to a "Look, we're not going there".

Well, that was ... it was kind of "We don't need to go there at this point in time". There was other macroeconomic analysis conducted around the same time, which was suggesting that the mortgage market, the growth in the mortgage market, was being driven by economic fundamentals, so ... that seemed to be the background as to why it was not accepted at that point.

And did that go ... was that a decision by your direct line director, as you say, the prudential director at that time, or did it go to the board, or Governor----

My understood that it went to the senior managers in the financial ... the chief executive level in the Financial Regulator and the Central Bank.

The seventh floor we were hearing about earlier, is that where all those guys hang out?

That would have been, yes, that would have been the seventh floor at the time.

Okay ... we're not allowed use names, are we, Chairman?

Well, I always advise members to speak to legals before they get into specifics but-----

Yes, well, we might go back-----

-----so I'll ask you to err on the side of caution, if you haven't spoken to legals.

Can you comment on the solvency protection measures in force, and taken before and during the crisis, and the stress-testing exercises carried out with the financial institutions?

Just to be clear, Deputy, you're talking about the 2006 stress tests?

Yes.

Well-----

And other solvency protection measures which were in place or in force?

So, there was a stress test conducted in 2006, which was in conjunction with the IMF, who were carrying out their FSAP visit. It was a normal round of stress testing, albeit with the IMF involved. And the outcome of that process was that the belief was that in an adverse scenario, the banking system was going to still hold up strong. I would say around the same time, obviously, Deputy, the ... I was also proposing the measures towards September '06 to increase the capital requirements on the commercial real estate lending activity. So that was also another solvency measure that was being put in place to try to address the problems at the time.

And, I mean, what was the regulator's view on the deterioration of properties' values and what implications did that have on the assessments in terms of stress tests? Did that come into it, the fact that property values were declining from, kind of, late 2006?

Well, I think the stress tests were actually conducted a little bit before there was decline.

Were there no further ones, no?

There may have been a further stress test in 2008, but I can't be sure of that.

Yes, well, what's your involvement with them then? Had you have an involvement with the stress tests?

Yes, we would have had an involvement. They were primarily run by the Central Bank, but we would have been involved in feeding in information from the bank, from the individual banking sector.

And would the concerns that you had to the extent that you were, you know, raising corporate governance provisions and raising loan-to-value issues and so on up to that date ... I mean, were you happy that these assessments could be accurate, on the basis that your suggestions had been rebuked by your own definition?

Well, just to get the sequencing right: in 2005, the measures I proposed had not been accepted for increasing the capital on high loan-to-value mortgages. In 2006, February 2006, they were accepted. And towards the end of 2006, when the capital requirements directive was coming in we implemented another set of additional requirements on commercial real estate and ended speculative commercial real estate lending, which in effect gave us the most stringent capital regime in Europe for that type of activity. So, that was all being conducted around the time of the stress tests, but the stress tests were generally coming out in 2006 as broadly positive in terms of the capacity of the banks to deal with a downturn.

We had been listening earlier to Mary Burke's testimony, and she spoke about resources particularly and said that requests for resources were endorsed by you as her line director, as prudential director, but rebuked higher up. Would you be in a position to outline for us who was responsible for refusing that request and why, in your view, that took place?

I'll give you my recollection of the sequence of events around 2006. If I recall ... I'm not sure there was a request for additional resources in 2006, I may be wrong here, but one of the problems that was faced in 2006 was we had a huge number of vacancies in the organisation and the organisation was not capable of filling those vacancies. So I don't think there was a request to the senior ... to the budget and remuneration committee in 2006. There may ... there would have been one in 2007, which was a large request for, I think, over 70 staff and I think we got 25 in that particular situation. I may have my dates there wrong, Deputy, in terms, but-----

And is that specific to the bank supervisory department?

No, sorry, that would have been across the board. So, I mean, I would have been-----

No, no, I'm interested specifically in BSD, I think ye call it?

BSD, yes.

Or that's what it was referred to earlier on. So, Ms Burke was telling us how, and she had ... gave quite a vivid description of a chaotic scenario where people couldn't effectively do their job, that there were difficulties even in carrying out the requirements on the capital requirements directive of the banks and so on. So, in that context, she had made a ... what she said was a number of requests, certainly one of which was endorsed by you, in her own words, but that these were refused.

Yes.

And I'm anxious to know who refuses them?

Okay-----

May 2008, I think, specifically we're talking to ... talking about. Thanks.

Right, thank you. Well, certainly, yes, Deputy, I mean, I had come ... I had been head of banking supervision, so I had a particular sympathy for that department in terms of its resourcing, and was supportive of the additional staff in it. One of the problems that was faced ... I mean, the process worked in whereby each individual department put forward their requests for resources and then that proposal was made into the budget and remuneration committee of the bank. My recollection is that the budget and remuneration committee did not fully endorse the request from management for the additional staff, for a number of reasons. I think they felt that the ... there could be savings gained from some of our work. I think there was a broad belief that, from a technology perspective, we were very weak and we needed to improve in that area, to be more efficient and cost-effective.

And was that consistent with your concerns generally in terms of the level of lending that was going on in banks at that stage? Of course we've had ... we'd have had the Northern Rock situation and so on that-----

Yes, well, I mean, I would say, Deputy ... I'll repeat: I was very supportive of the banking supervision, and-----

Yes?

-----to the extent that I could push for additional resources for that area, it would have been an area I certainly would have pushed for.

So, is it your testimony that you did all you could to secure the staff but the budgeting committee said no?

Yes, there was ... we didn't get the resource ... we didn't get the full request that we looked for, yes.

Okay, all right, that's fine, well then we can bring that question on to tomorrow then. Can I ask, from 2003 to 2008, when you had obviously a very, very serious increase in commercial lending throughout the country, and you had very regular breaches in what you might describe as prudential regulation, that there was no enforcement actions taken against any institution in that period? Why is that?

I think it's useful just to kind of recall the approach and the strategy that was employed by the Financial Regulator. And I would say, Deputy, and I'm not trying to avoid the question, I wasn't a member of the board here, so some of these issues would have been dealt with within the board. My understanding-----

But ... and I'm not holding you responsible, or anything. I'm merely asking.

No, no. I'm just trying to explain-----

You were the manager, or the head of the bank supervisory department for 2003 to 2006, and then you were the head ... the prudential director.

Right. Yes.

Isn't that correct?

Yes.

So, in that context. So I'm not ... you're not answering ... you're not answering for everybody here, just give me your view. Why was there no enforcement in that period?

I'll give you two key reasons. First of all, the system of administrative sanctions did not come in until July 2005, and at that point the authority had made the decision that the resources for administrative sanctions were to be primarily deployed towards consumer protection issues.

Could you just clarify one thing for me there, just for people watching at home? Is that ... when we say consumer things, is that things like overcharging on credit cards, and that type of thing, or-----

Yes.

As opposed to a bank transferring-----

As opposed to capital insolvency and liquidity.

-----€6 billion from one to another, for example?

Yes.

Yes. Okay, okay. That's great, thanks.

So the regulator had been set up in 2003. It had been set up, and my understanding was left the regulation of the ... prudential regulation was a key factor in the decision to leave supervision within the Central Bank structure. And the approach to supervision at that time was one of dialogue and interactive engagement. It was not an enforcement driven approach. And that approach was deemed to be suitable because there was a long record of safety within the banking system and it was also suitable to the development of the International Financial Services Centre.

But on the other hand, were you not concerned to the extent that as soon as a new boss took over you were at his door to say "I'm concerned, you know, I want to implement this, that and the other", as we've outlined earlier in 2005. And then you actually did implement them yourself in 2006. I mean, was that not against a backdrop that far from being safe, this was a situation that had a culture of regulatory breach?

Yes. I think just to get again the sequencing right. I think, again, I provided some documents to the inquiry. In advance, in 2004, I was making the case that we were structuring the organisation in the wrong way in that we hadn't set up dedicated inspection units to pursue administrative sanctions. I think that's a matter of record and I was very much in favour of setting up dedicated units at that time. And in preparation for moving ahead I had proposed corporate governance requirements in May 2005 to be imposed as a requirement on the licence of banks to enable us to take administrative sanctions, actions, against the banks, and some of the more difficult cases I was dealing with.

Okay. In the period after 2006, then, you've got your stuff in place. How is it that there was no enforcement in the period 2006 to 2008?

Again I think we hadn't set up a dedicated inspection area.

So, though we had the rules but just not the enforcement, was that-----

Yes. It wasn't an enforcement driven approach to regulation.

Okay. I put it to your colleague earlier on, and I used a somewhat unfortunate football analogy, so I'll adjust it slightly for you today and say is it a case that the principles-based regulation that was being employed by yourselves at the time, when it came to prudential regulation was a bit like a football match and the FAI with no referees?

I think it's probably fair to say there were actions taken against the banks but not in the administrative sanctions area.

So can you give me an example of one without one breach and one enforcement sanction without naming the bank or the individual involved?

I think the best ... there is examples given in Governor Honohan's report, I think, where on one occasion and with a particularly difficult institution, in 2004, and I think again in early 2008, we increased the solvency ratio on the bank from - I won't give the numbers - but we increased it by 1%, which was a pretty significant, and I think Governor Honohan called it a noteworthy intervention.

So there were things that you could do, even though in 2004 we didn't have administrative sanctions powers, there were actions that we could take to penalise poor behaviour in banks and that, I think, is an example that would have had a significant impact on the institution. The institution involved appealed that but-----

But materially, what would that have meant to the institution, just again for us lay people?

Well, it sent a signal to them in terms of ... they needed to keep additional capital aside, so that they wouldn't have had as much capital available for additional lending. So the level of regulatory capital they had to keep was increased which kind of reduced the buffer that they had for other activities. And there were other things that could be done at that stage including sending in, you know, consultants to carry out work, etc., which was often very expensive and not something that the banks enjoyed. I think in another case we reduced the level of joint venture activity they could get involved in. So there were some measures within the structure that could be used but, as I say, that was in advance of the administrative sanctions regime which didn't come in ... I just make the point again ... I think until July 2005 and the guidelines were only issued in October 2005. So that explains a lot of that earlier period, I think.

Okay, thanks.

Thank you very much. Just to clarify two issues there on Senator MacSharry's questioning to you, there was two items: there was your comment on page 4 of your witness statement about your proposals for regulatory intervention being put forward in 2006 and then later in page 6 of your statement about holding contrarian views to the groupthink on property lending and so forth. And you elaborated to some extent on those two questions, Mr. Horan. But maybe what I'd like you to do now is elaborate on the influence or the role of the Central Bank in terms of how they responded separately from that of the regulator's office.

Just to be clear again, Deputy, in particular in relation to those issues?

Yes.

Well, I think, in both those cases ... so in 2005 when I made the initial proposals-----

Yes.

-----I can't give you much insight into what went on from the Central Bank's perspective. I understood there was discussions between the Central Bank and the Financial Regulator at the time and the view was the measures were not necessary. In 2006, I understood that the chief executive had had a discussion with senior Central Bank officials who believed there's a potential for these-----

Chief executive is the Governor now or the regulator?

Sorry, of the Financial Regulator ... had spoken to senior Central Bank officials and the view was that, taking these actions at that time, had the potential to bring the market down and there was concern ... real concerns from a stability perspective that these interventions would cause a problem.

Can you ... I want to kind of segregate those two, if you don't mind. You've given us a kind of ... a very understandable position as to what you saw the regulator's role was but can you tell us what the positioning of the Central Bank was on these matters?

Well, so that ... I understood there was resistance at official level-----

Central Bank level or the regulator?

The Central Bank level.

Okay.

There were concerns that the measures would create instability in the market. But the reality was we decided to hold our ground on that and we went ahead and I believe the Governor gave his support to those measures at that time. So, there was concerns at official level ... at senior official level but in the end when the measures ... it took a number of meetings to get the measures through and in the intervening period, the Governor supported the measures.

So you're saying both ... the Governor was both aware, cognisant and was in line with the measures and the position by the regulator?

Yes, I mean these measures, Chairman, were, you know, considered to be issues that impacted on overall financial stability-----

Yes, indeed-----

-----and, therefore, we had to get the Governor's agreement to take those actions.

Okay, thank you. Deputy Murphy.

Thank you, Chairman. Thank you, Mr. Horan, you're very welcome. I just want to move forward to 2007, if I may. You were a member of the domestic standing group?

Yes.

Okay. Were there any deficiencies in the DSG's operating model?

I think in early 2007 I wouldn't call it there were deficiencies in the model. It had only been set up in 2006 under EU legislation, this type of structure. So, I think, certainly for much of the time it was beginning to find its role and understand what its role was.

It probably wasn't as proactive in retrospect, given what occurred subsequently, but it was trying to find its feet in terms of preparations for crises and running crisis simulation exercises, etc.

Why was the NTMA brought in in 2008?

So the NTMA became involved, I think, around September 2008, at the peak of the crisis. So they would not have been involved in-----

It was late 2008, sorry, when they came in it was-----

Yes-----

Is that what you were saying, it was late 2008-----

Yes, around September 2008. And that would have been at the peak of the crisis when a number of issues had ... specific issues had occurred. They weren't involved before that to best to my recollection in the, kind of, early days of the domestic standing group.

Would their absence up until that point be seen as a deficiency, do you think, in terms of the membership?

I didn't believe so because, you know, a lot of what we were doing in the domestic standing group at that stage was just understanding what was going on in Europe, preparing documents, etc., within the three authorities - the Department of Finance, the Central Bank and the Financial Regulator - in terms of how well that group would operate in a crisis situation.

And was there any agency missing from the DSG?

To the best of my knowledge, Deputy, the DSG construction in Ireland at that time was similar to that that operated in other European jurisdictions. So I am not aware that there were additional parties elsewhere.

You said that the level of contacts, interaction between both yourself and the Central Bank with the Department of Finance increased as a result of the establishment of the DSG. So did it increase to what would be seen as a normal level of activity or a heightened level of activity?

I think as the crisis evolved ... so early 2007, there would have been, let's say, ongoing regular contact. Post-9 August 2007, after the ECB's intervention, it became more frequent and regular at that stage.

But prior to the establishment of the DSG, in your opinion, would have the interaction between Financial Regulator and the Department of Finance been sufficient?

To the extent that we needed to engage with the Department of Finance, we did so on a bilateral basis. It was often around the introduction of legislation, etc. We wouldn't have been actively involved pre the 2007 in discussions on regulatory issues at that point.

Okay. The simulation exercise that was conducted at the end of December, or, sorry, at the end of 2007 in December ... were you involved in that simulation exercise?

I believe I was, yes.

Okay. I'm just wondering, how close to reality are these exercises? I mean, do the observations that are made in the simulation, do they translate to the real world?

In reality, no. Being absolutely frank, I've been involved in these at a European level and I've been involved in them at a domestic level. And they are largely simulations around a small group of facts that are conducted over an afternoon or a full day with papers prepared and people able to read documents in advance of that. So, the reality is they do ... you do learn lessons and you do pick up issues in relation to how it would happen in reality, but, in effect, having experienced crises in Ireland and in Europe in recent years, the reality is always an awful lot more complicated and different.

One lesson learned by the Financial Regulator was that the ... there was insufficient contact between the regulator and the Department of Finance and the Central Bank's feedback was that finance was out of the picture. So was that in the exercise or does that reflect the reality?

My recollection is that was that the exercise in that the simulation of the financial information in that exercise took a lot longer than expected in terms of the Central Bank and the Financial Regulator pulling together information. And the Department of Finance were not involved until very late in that process. So that was one of our lessons from that exercise.

In Mr. Hurley's evidence, when discussing the stress testing exercises, he said that "One of the conclusions was that there was too quick a movement to a guarantee in the context of the stress test''. Do you remember that?

I can't recall that specifically from those tests, no.

Okay. Do you recall the 2005 crisis simulation exercise? You were working in banking supervision at the time.

Yes, again I'm aware they were on, Deputy, but I couldn't be sure that I recall the specifics of that in 2005.

Because one of the observations from that exercise was that there was a lack of clarity about the supervisory regime and the nature of information that would be available in a real crisis. That was following the exercise in 2005. Do you recall that at the time?

I think that ... I can't say I specifically recall it from the ... but that would have been pretty consistent with the type of issues that happened in simulation exercises.

And would they have been acted upon?

Well ... I mean, we would have done some preparation out of that in terms of trying to be more prepared in terms of deposit guarantee ... deposits and information that may have come up, but I can't put my hand on specifics from the exercise.

But did that sentiment remain true into 2008 when the actual crisis emerged, that there was a lack of clarity about the supervisory regime and the nature of information that would be available in a real crisis?

Well, by two thousand ... by 2008 we obviously had experienced the crisis and, you know, there was ... clearly the information you needed at hand when matters started to evolve was not sufficient. There was clearly a lot of work needed to be done to gather information. But I would say that's pretty consistent across the board and was a feature in an awful lot of jurisdictions - that the information you needed immediately was not at hand.

Sure, but the observation that was made from the exercise here in Ireland in 2005 still stood when the crisis emerged in 2008?

I think that it's fair to say that that's correct ... that the nature of the crisis can ... the nature of a simulation exercise can never fully reflect what actually happens in a crisis, and every crisis is different so you'll always have a desire or a need for additional information than that which is on stream.

Of course. No, I think my point related to the feedback that was given after the exercise and then whether or not it was acted upon. But if we can look at the scoping paper that was prepared by the Department of Finance at the end of 2007 - were you involved in the preparation of that scoping paper? It looked at possible powers to be given to the Minister for Finance to guarantee the banks, to liquidate a bank ... it talked about a possible guarantee for all liabilities in the Irish financial system.

I don't recall that I was involved in the paper.

It came up with our discussions with Mr. Hurley. So when we look at the preparation or the agreement in early 2008, that legislation would be drafted to empower the Minister to guarantee the banks and nationalise financial institutions - do you recall that, those discussions?

I don't think I was actively involved in it at that point in time. I became a lot more involved in the legislation around September 2008. So I think the outline of the legislation had been prepared at that stage, and then as events unfolded from very early in September, that was probably our key focus was getting the legislation prepared for a nationalisation.

Okay.

Yes.

With Mr. Hurley we discussed as well the green jersey agenda where ... the Financial Regulator and the Central Bank Governor went to financial institutions and asked them to provide each other with funding support in order to maintain financial stability, given what was happening in international markets. Were you kept informed of this agenda, this action?

I would have been aware ... yes I would have been aware that banks-----

At the time?

Yes at the time, yes.

Okay. And in your view was this agenda designed to support any particular institution?

No. Certainly in the early stages it was international markets had frozen. We were aware that this was happening in other jurisdictions as well and it happened right across the board where interbank lending reverted to national borders and that continued for a considerable length of time afterwards. So it was relatively consistent with what was going on, that lending began. And people were probably more familiar anyway with some of the local operations.

And given what was happening in relation to the work of the domestic standing group in early 2008, and the approaches being made at the time by the Central Bank and the Financial Regulator, do you think that, looking back now, that the Government should have intervened in the banking system in March 2008, or closely after?

It wouldn't be clear to me what the intervention would have been at that stage that would have made a significant difference. You know, at that stage I think certainly liquidity was running short. I think it might have been better if the ECB or someone had announced measures in terms of providing additional liquidity to the system at that stage, as they did in 2011-'12. But it's not clear to me, when you put your question, what that measure would have been around March 2008.

Prior to that, prior to the share difficulty that one institution ran into in March 2008, the domestic standing group was already talking about possibly guaranteeing all liabilities in Irish banks. It was already looking at legislation to potentially nationalise a bank, liquidate one.

So these concerns would have been there at the time, before then we had this extraordinary event in March 2008.

Yes, so, so, you know, at that time, I mean, I would say from 2007, I mean, there were lots of issues being talked about in terms of how we might oil the wheels of the system and remove some of the liquidity stresses were ... that were there, and there was contingency planning going on at that time in terms of what might happen.

Okay, let's move on to ... then, to July 2008. There was a domestic standing group meeting, and it's on page 124 and 125 of the booklet. The core booklet, Vol. 2.

Vol. 2. Sorry, Deputy, the page again, sorry?

Page 124. So you represented the Financial Regulator at this meeting?

Yes.

And if we just go down to the ... the bottom paragraph, there's a discussion held concerning the increase risk of a general loss of confidence in Irish banks, and the international viewpoint provided at the meeting is that the banks will see significant loan losses and would need to raise significant capital, and would be disadvantaged in doing so on account of the delay in going to the markets. Do you remember who expressed that view?

Sorry, sorry, I'm actually struggling to find the reference. It's Vol. 2, page 124?

Vol. 2.

And it's the ... the domestic standing group of 8 July?

That's correct, yes, and it's the paragraph at the bottom of the page, the large paragraph.

Of the ... of the first page, long-term investors?

Yes.

Yes, sorry.

And there's ... an international review of the-----

Sorry-----

An international viewpoint is provided, sorry, at the meeting, about risks ... significant capital risks facing the banks and potential for significant loan losses.

Yes.

Do you remember that discussion?

I, I can't say I remember it specifically, but I remember those type of discussions, yes.

Okay, but, you know, who might be providing the international viewpoint at that meeting?

It may have been the Central Bank through the ECB's ... their ECB contacts. It may have been some information we would have been picking up from the banking sector, but I couldn't say exactly what the source of that was.

Okay. Can we just drop down, just to the final sentence, because that states that the Financial Regulator "reported a detailed line-by-line examination of its loan book by one of the major Irish banks which highlighted that even allowing for 'worst-case' loan losses, profitability would remain strong". You made that point.

Yes, yes.

Okay. Is it possible to identify which institution you had-----

No, I would advise not to. There's no need to.

Okay, well, I mean, how did that information come to you and did you verify it?

So ... so that would have been part of the ongoing engagement at the time with ... with the institutions to see how they felt about their books in terms of what was ... was going on and the type of ... so they would have been doing their own analysis and contingency planning. I don't think that we went in to check that at that time, in July 2008, but it would have also been the case that around that time, rating agencies, etc., were looking at the Irish institutions and, you know, in most cases, I think, affirming their ratings in terms of their strength and their capacity to ride out the problems. So, there would have been a ... a view at that time, I think, even from international rating agencies, that the Irish banks were able to ride out the problems at the time.

And, so ... sorry, were you then expressing that view depending on what the rating agencies were saying?

No, I think really what we were doing there is just giving feedback that we were getting at a time of heightened crisis, so we were ... we were well into the crisis at this stage. It would have been the feedback from the institutions in terms of their observations and their belief, in relation to their book.

Okay, but not feedback-----

Last question, Deputy Murphy.

Thank you, Chair. Not feedback that you, as Financial Regulator, would have verified before bringing it to the domestic standing group, to overrule a point made by someone else as to the international viewpoint on significant loan losses, potentially, in the Irish banks?

Yes, I mean, the nature of the domestic standing group was, you know, it was a forum for clearing views that we were picking up through our various contacts. And it was an open forum for engagement, so the Central Bank would bring information that it would pick up, say, from the ECB, we would bring information that we were picking up, the Department of Finance would bring in information. It wasn't an effort to overrule, it was just feeding into the system of what we understood at the time.

So, it wasn't a decision?

Sorry, Deputy, I'm going have to bring you in ... 'cause I have stuff to come back to here. I'll bring you back in the wrap-up.

Thank you, Chair.

I just want to stay with the domestic standing group but I want to come back to the nationalisation, or the, the ... in spring 2008, the Minister was proposing the legislation with regard to a financial institution. Now, in questioning, Deputy Murphy, you spoke about the events, but what was the analysis behind that, where ... what was the raison d'être, where was that coming from?

I mean, there were very serious issues around March 2008. I think ... the famous St. Patrick's Day massacre, I think, it was known. So it was clear that there were institutions under significant pressure at that time and, I think, one of the contingencies that was being considered was preparing legislation in the event of it being necessary.

Okay. And was that discussed at the domestic standing group meetings?

It may have been. I haven't seen reference to it in the documents that I've seen, but it's the sort of thing definitely ... you know, I would've expected would've been broached in that forum.

To be more specific, was it prominent ... was it a prominent item of discussion at the standing group meetings?

I don't recall that it was prominent item. You know, at that stage we were in the depths of a fairly significant crisis so a lot of contingencies would've been floated at that point in time. I don't remember it being the predominant issue that we were considering.

Okay. Just ... on earlier comments as well ... reports ... comments from known reports were quite agreeable that in the measure ... that the measures taken, you were talking about the measures for 2006 ... specifically the measures you were talking about today, such as increased weightings and high LTVs, loans and later on speculative commercial loans ... that these may have been too little too late. Ms Burke, in her engagement with the committee this evening, said really that after 2006 it ... any measure or any number of staff may have not actually been possible to actually avert the crisis. So could I put it to you or maybe ask you, Mr. Horan, that the measures taken maybe were showing the right way, but why was not more done to alert the banks more strongly and were you satisfied with the relativity moderate measures that were being taken?

Well, I would make the point that I had tried, in 2005, to begin this process and I think, you know, the process of intervening in the market was going to be very important in terms of the signal it sent to the banks because there had been an approach over the years ... and, Chairman, I'd go back into the ... my view is the bubble commenced in the mid-'90s and there were letters going out requesting banks to control their lending, etc., but the rates continued to grow. My view was that we needed to do more than that and directly intervene with some capital measures to show we were willing to act. That's what I proposed in 2005. I think it would've been better if it had been introduced then. I think it would've been even better maybe if it was introduced earlier. But my concerns formed in early 2005-late 2004 and those concerns were based on my reading of what happened in the Scandinavian economies when ... researching that, they were saying that their growth rates were above 20% and that was indicative of problems. In Ireland we were growing higher than 20% - 25%-30% - and that's what was causing me concern and that's why I believed we needed intervention.

When did you join the domestic standing group, Mr. Horan?

I think the domestic standing group was established in 2006, to the best of my knowledge, so I probably was in there from the commencement of that process.

And were you bringing these concerns to the attention of the domestic standing group?

Well, I mean, obviously ... yes, because the measures were successfully introduced. From February 2006 onwards we began the process of intervening in the market. So it would have been very clear and we would've communicated that to all parties. People like the IMF supported those measures, etc., and the DSG would have known that we were proposing additional measures in September 2006. I had made it known to the industry in May 2006, which was three months after my appointment, that we were going to look at the commercial real estate sector at that point. So I was trying to send out a very clear signal that the process and the approach was changing.

And with regard to the contrarian views that you have stated to the committee this morning, how were the domestic standing group receptive to those? Were they listening to them, acting upon them or were they just considered contrarian?

Well, from 2006 I don't recall there was any objections from the domestic standing group because the measures were actually introduced. It wasn't that we had to pre-clear them, etc.

We did speak to the Department of Finance in 2006 to advise them of the proposals in February. I don't recall that they objected to them. They did question why they felt they were necessary, but nobody ... once the measures were agreed by the authority, there wasn't objections to them.

Okay. And just to finalise on this, I just want to return to the stress tests just for a moment. Were the stress tests from the banking supervisory teams ... or, sorry, were the stress tests moved from the banking supervisory teams to the Central Bank?

What happened in, I suspect around 2005 ... prior to 2005, the 2004 stress test was ... again, they would always have been led by the Central Bank because they were largely economically-driven exercises. We would have been actively involved with them at that time. With the introduction of Basel, we hadn't got the resources to spend a lot of time on the stress-testing exercises, so we provided direct access to the economic people to our data so that they could extract information and then we were available to help. Our role was less at that time in the stress-testing exercise but we were still making ourselves available to assist.

So who in the Central Bank was responsible then for the collection of the analysis and the analysis stress testing?

I think it would have been the ... either the financial stability or the monetary policy people. Probably the financial stability people were in the lead on those stress-testing exercises.

And who had responsibility for developing the model when it moved there?

Again, modelling would have been primarily done at the econometric level, so that would've been Central Bank's. So, the Central Bank was really, I would say, the driver on the stress tests and we were assisting them in that.

And who checked the responses from the banks?

Again, I couldn't be sure who it was but I believe it was probably going to be a combination of economists from the Central Bank and from the financial stability area, with input probably from the banking supervision department.

Well, are you able to confirm this afternoon that the responses were checked?

I'm not in a position ... I'm ... I mean, my assumption is that the process ran through and I've never heard that ... that the information was not checked.

But, to your knowledge, do you know they were checked?

I wouldn't have been directly involved so I can't say that they were checked. But I would say, Chairman, I mean, in 2006 the IMF were directly involved in that exercise as well.

Okay, tell us more about that. Tell us more about that.

Well, the 2006 stress test was carried out in conjunction with the financial services assessment programme that the IMF were conducting on Ireland in 2006, so the previous ... so the financial services assessment process was essentially where the IMF came into a jurisdiction and looked at the approaches and the methods of supervision, engaged with the banks, etc., to find out was the system suitable in terms of protecting financial stability. As part of that exercise, they did the stress testing. They also analysed the system of supervision and they were directly involved in the process as well, so ... and they would have issued their report and commented in the financial services action plan assessment of Ireland. So, quite frankly, I'd no reason to believe that that ... that that wasn't conducted in a diligent way because, if I recall correctly, the IMF actually said that there was a richer level of information in 2006 than there had been previously, primarily because banks were developing their own risk models under the Basel process.

Okay.

So the information available to them at that time, my recollection is that it was better than it had been on the previous exercise.

Thank you. Deputy Joe Higgins.

Mr. Horan, in September 2008, were you involved in any discussions in the Central Bank, or regulator, in relation to the potential insolvency of any financial institutions?

I would have been engaged in discussions in September 2008 about, yes, all the financial institutions and their solvency positions.

There was reference this morning about a high-level meeting on 26 September, where the Taoiseach, the Minister for Finance, the Governor of the Central Bank and others attended, and there is a question comes out of that as to whether two particular institutions were insolvent at that time. Were you aware of any of that discussion?

I don't recall. The reference I have is 26 September meeting-----

No, you don't need to refer to it-----

Okay, so not-----

-----just take my word for it.

Yes. So I'm looking at DOF 028-----

No, no you don't need to, Mr. Horan. I am just saying that, as a matter of fact, we have evidence of a high-level meeting and there is questions arising form the minutes of that as to whether two particular institutions were insolvent or not at that time. I'm just asking you if you were aware of that discussion?

I can't say I'm aware of the specific discussion. I am aware that some of the banks ... there was more concern about some banks than there were of others, in general, at that time.

Did you have a view on 29 September as to whether any of the banks were insolvent with the advantage of the position you had?

I didn't believe they were insolvent at that stage. At that point, we had an exercise being undertaken by external consultants to go through the individual banks and analyse their financial situation. And I think we probably were awaiting their response at that point in time.

Okay. Mr. Horan, following the legislation of 2003 in relation to the Central Bank and the Financial Regulator, the memorandum of understanding between the Central Bank and the regulator dealt with the responsibilities of both sectors, if you will. Do you think there was clarity on which ... what was the responsibilities of the Central Bank, on the one hand, and the regulator, on the other?

I believe there was clarity. I think I ... it was one of the first points I tried to address in my opening statement. I think the memorandum of understanding, if I recall correctly, the headings on it were the Central Bank had responsibility for financial stability. And the Financial Regulator heading is the Financial Regulator's contribution to financial stability. So the Central Bank was in lead on financial stability issues, and the Financial Regulator fed into that via the information it had from individual institutions.

So, would you believe or not that the board of the Central Bank, therefore, retained a serious responsibility in relation to financial stability arising from what the regulator was in charge of?

Yes.

And, are you aware that that's a direct contradiction of what the former Governor of the Central Bank told the inquiry?

Well ... I ... certainly, again, I go from the memorandum of understanding and my practices in there. I think the headings in the memorandum of understanding are very clear. One is responsible for the financial stability and one is responsible for contributing to it, so I think that it is clear. I would add, for instance, that the financial stability department was located within the Central Bank; it wasn't within the Financial Regulator. And I think that's pretty indicative of where the primary responsibility lay.

Okay. Was it significant that six or seven members of the financial authority board were also members, and, in fact, constituted a majority of members, of the Central Bank board?

Absolutely, I mean ... and this was ... I mean the information coming from the Financial Regulator and the purpose ... my understanding of the ... I wasn't on the Central Bank board ... my purpose of ... my understanding of the purpose of those ... that cross-membership, was to ensure that the board of the Central Bank had prudential information to assist it in its role. And it was my understanding that prudential information, the prudential pack, etc., was given to the board of the Central Bank to assist it in its role.

That was your understanding?

Well ... I know the prudential pack in the chief executive's reports were brought to the board of the Central Bank.

Okay. Can I refer you then quickly to your statement ... written statement, page 4. And in reference to why so-called principles-based regulation and you refer to the IMF calling it light-touch regulation, why that was the case ... and you make reference to:

The ... Board was, however, concerned about generating instability and the risks attaching to shrill warnings. It also had concerns about the impact that regulatory intervention might have on the competitiveness of Irish banks.

This is to answer the question as ... as to why it was light-touch or principles-based regulation. And then you refer on footnote 11.12 to three sets of board minutes: July 2006, June 2006 and October 2007. What's that reference to? Where does shrill warnings-----

I need to allow some time to reply as well because you're going to run out of time with your questions, so if we could maybe move to the question so I could allow Mr. Horan ... so I'll give you a few moments to wrap-----

Yes. So-----

-----no, I ... just allow Deputy Higgins to wrap up the question and then I'll bring you in, Mr. Horan.

Yes. In other words, this concern that regulatory intervention might damage competitiveness, might perhaps affect the IFSC, which was a subject of discussion with Mary Burke ... is it that those minutes that you have footnoted here refer to that?

Yes, I think they give ... they give some examples of where the board ... for instance, when the Basel II measures were being proposed in mid-2006, I think one of the references at that stage was, you know, if you're going to do this, you need to be conscious of the competitiveness of the Irish banking system. So that was the sort of concerns that were being expressed at that time about the regulatory interventions.

Okay. So the prudential information that was getting through to the board on a regular basis, which you said-----

I'm going to have to wrap you up here quickly now with a question-----

Yes, I am-----

-----because you're way over time.

Notwithstanding that, we still had this type of concern on the board about people who might be raising red flags about dangers in lending, etc.

Well, I think there was a concern about the property market, you know, in that some of these ... and this was the argument that was being put to me, that some of these arguments ... this type of intervention could attract negative international interest in Ireland and, you know, we had to be very careful with that, and there were ... there are issues for the competitiveness of the Irish banking system as well. So, you know, they were reflected then, I think, in those minutes.

Okay. Yes.

Senator Barrett.

Thank you, Chairman, and welcome. Do you believe that there were effective instruments available to deal with excessive credit growth and sector risk concentration?

In terms of credit growth, I think the instruments ... and I hope the chart that I showed, showed that when we actually did intervene, there was definitely a change in market behaviour. I'm not saying it was entirely responsible for it. There were also interest rates, etc., that were effective at the time but if you look at mortgages, for instance, the speed of decline on the Irish growth rates was quicker than any European country after we introduced the measures. In relation to sectoral concentrations, clearly they would have been beneficial, but I think, again, I'd make the point that at a European level, issues like central ... sectoral concentrations were not part of the Basel process. While the Basel process did have specific limits on individual exposures, it didn't have anything on the sectoral front.

But doesn't that bring to one of our problems, Mr. Horan, that our banks seemed to do nothing else except invest in property at some stage? The remainder of the loan book was shrinking as a percentage of the total at a very rapid rate.

Yes.

So we needed them-----

Well, I think, just again, without getting into the technicalities of it too much, the rule and ... you know, was where you had an exposure that had a common predominant risk factor ... and the issue and the arguments that the bank made - and I would say, Senator, that this preceded the establishment of the Financial Regulator - was that if you had a hotel ... funding a hotel in Sligo and an apartment block in London or an office block in New York, they were not subject to the same common predominant risk factor, and that was the argument that banks were putting forward in terms of that they weren't exposed and weren't breaching the limits per se.

You said that the measures, on page 7 of your paper, that the measures were the most stringent capital regime in Europe, but the downfall was also the most adverse. How did the most stringent rules produce the worst outcome?

I think, very simply, that they were too late.