Contents

Executive Summary

1. Introduction
2. Basel Core Principles for Effective Banking Supervision
   
   1. Objectives, autonomy, power and resources
   2. Licensing and structure
   3. Methods of ongoing banking supervision
   4. Information requirements
   5. Remedial measures and exit
   6. Cross-border banking
3. Staff Commentary

Table 1. Ireland: Compliance with the Basel Core Principles--Summary Assessment

I.  Introduction

1.    In connection with the 2000 Article IV consultations, Ireland participated in the Financial Sector Assessment Project (FSAP).¹ The assessment of Ireland's financial system included an assessment of the individual components of the sector, as well as a review of systemic stability, including of potential vulnerabilities that could arise from the interlinkages among different financial sector participants.

2.    The attached in-depth assessment of  Ireland’s compliance with the Basel Core Principles for Effective Banking Supervision is based on an initial self assessment by the Irish authorities, and has been clarified through subsequent discussions during the FSAP mission. The final assessment benefited from further comments by the Irish authorities. As an EU member, relevant EU Directives are discussed when necessary and appropriate. The assessment also took into account the specific features of the Irish market.

3.    Credit institutions are by far the dominant participants in the financial sector, with banking sector assets in 1998 equivalent to more than 300 percent of GDP. The banking sector is fairly concentrated, with the three largest banks accounting for 47 percent of total banking assets. Excluding IFSC banks, concentration is even larger, with only two banks accounting for 60 percent of assets. International comparisons put Ireland in a middle group in terms of banking sector concentration and credit penetration. Following a major round of consolidation in the banking sector in the early 1980s, the sector now shows concentration ratios far above major EU countries (in particular Germany and the U.K.) but similar to those in countries such as Australia, Canada or Switzerland.²

4.    The banking sector has a strong capital base, significantly above Basel minimum standards, an adequate liquidity base and, for most banks, a sufficiently high level of provisions. Banks’ profitability is among the highest in Europe, and asset quality is high with nonperforming loans comparable to other European countries. Banks are generally liquid; however, there has been a tendency towards a decline of funding from deposits and an increased reliance on wholesale (interbank) funding. The major banks are geographically well diversified, with significant business activities in the U.S. and the U.K., and increasing operations in other countries. These banks' assets are also well diversified across sectors. In contrast, smaller banks, which are not systematically important, tend to be domestically oriented and are less diversified. Finally, there is also an active, but not systematically important, credit union sector.³
 

II.  Basel Core Principles for Effective Banking Supervision

A.  Objectives, Autonomy, Power and Resources

Core Principle 1

5.    The CBI is the authority for licensing and supervising banks and building societies, pursuant to the Central Bank Acts 1942 to 1998,  the Trustee Savings Bank Act, 1989, the ACC Bank Act, 1992, the ICC Bank Act, 1992 and various provisions implementing the EU Directives. The CBI is not responsible for the supervision of credit unions, credit intermediaries, insurance companies or insurance intermediaries. The recently published Insurance Act will lead to the transfer of insurance intermediaries to the CBI’s regulatory area.

6.    The CBI has sole responsibility for banking supervision in Ireland. In certain instances, such as denial or revocation of a banking license, and certain types of acquisitions, the Minister for Finance has a statutory role, as set out in the corresponding legislation.

7.    Timeliness of laws and regulations is facilitated by Ireland’s membership in the EU and the EMU. A requirement for membership is the incorporation of all EU Directives into national law, regulations and practices. Ireland has remained current in the implementation of all the EU Banking Directives. Following the establishment of the euro system, in addition to the independent internal audit function, the CBI accounts must also be audited by an independent commercial firm of auditors to meet the requirements of the statute of the ESCB.

B.  Licensing and Structure

Core Principles 2–5

8.    The CBI has an independent and “hands on” approach to licensing and supervision. The size of the Irish banking sector allows the supervisor to give each interested applicant individual attention during the application process. The CBI requires banks to receive prior approval for significant changes to business activities and also reviews changes in ownership and acquisitions in pursuant to the CBI’s Licensing and Supervision Requirements and Standards for Credit Institutions (CBI Standards). These standards, although nonstatutory, supplement the statutory requirements contained in legislation.

9.    Any person engaged in “banking business” must hold a license authorized by the CBI. The EU uses the term “credit institutions” which includes building societies but not credit unions. The CBI requires all applicants to provide as part of their licensing application, information on ownership structure, detailed business plans, financial and capital adequacy projections for the first 5 years of operations, board composition (including background information), organizational structure, details of internal control systems, and details of own core funding.

10.    The CBI allows subsidiary banks to use systems housed and operated out of its parent entity provided adequate and reliable backup systems exist. All license holders are required to have an internal auditor/internal audit function where the size or nature of the operations of the credit institution warrant it, even if one exists at the parent entity.

11.    In acquisitions of 20 percent or more of total assets of all license holders in Ireland, the CBI must receive prior consent of the Minister for Finance to approve or refuse the acquisition. In conjunction with the provisions of the Mergers, Takeovers and Monopolies (Control) Act, 1978, the Minister will consult with the Minister for Industry and Commerce. The EU’s Competition Commission would also review such a major acquisition.

12.    All significant acquisitions of bank stock, by another bank or by a nonbank entity, require the approval of the CBI per the 1989 Act. Banks’ investments in nonbank entities are not allowed to exceed 15 percent of own funds in the acquisition of 10 percent or more of any “relevant body corporate” (an institution different than a credit or financial institution) and the total of all such holdings cannot exceed 60 percent of own funds.  A credit institution should not acquire, directly or indirectly, more than 10 percent of the shares or other interest in another company without the prior written approval of the CBI. There are no absolute barriers to the CBI approving hostile acquisitions.

C.  Prudential Regulations and Requirements

Core Principles 6–15

13.    Consistent with the Basel Capital Accord, minimum capital requirements set by the EU Own Funds (89/229/EEC) and Solvency Ratio (89/647/EEC) Directives ⁴ and implemented by the CBI in Administrative Notice of July 1991 (further amended in 1995) require the capital-to-risk-weighted-assets ratio for credit institutions to be 8 percent, half of it in the form of equity capital. The CBI may increase this requirement for any bank based on a bank’s activities and risk profile. In November 1995, the CBI set out the Capital Adequacy Directive (CAD) to be implemented in January 1996. The CAD extends the concept of capital to cover market risks. Amendments related to the recognition of mathematical models (such as Value-at-Risk [VaR] models) for capital adequacy calculations were implemented in Ireland in June 2000. Ratios for institutions, which are parent entities, are calculated on a consolidated basis. In addition to the required minimum ratio on a consolidated group basis, the CBI also applies minimum ratio requirements below the group level to achieve an appropriate capital distribution throughout the group.

14.    Credit institutions are required to have appropriate policies related to the management and control of lending that include credit assessment, credit review, risk management, the monitoring and control of large exposures and prudent provisioning for loan losses. The CBI checks that the Asset and Liability Committee and Credit Committee of credit institutions operate independently of the business units taking the corresponding risk.

15.    The CBI Standards do not indicate specific asset grading/classification. The CBI requires that credit institutions have an internal loan classification system in place. The Standards provide specific limits in relation to credits granted to directors, significant shareholders and businesses where the bank is a shareholder. Directors are limited to 2 percent of a bank’s own funds and the aggregate of all directors and their businesses must not exceed 10 percent of own funds. A credit institution’s exposure to significant shareholders is limited to 10 percent of a bank’s own funds; the aggregate of all such exposures is limited to 30 percent of own funds. The CBI’s Standards requires monitoring and control of large exposures, as part of the implementation of the EU Directive on Monitoring and Control of Large Exposures (92/121/EEC). Credit institutions report large exposure information to the CBI quarterly. The CBI monitors compliance with large exposures on a consolidated basis.

16.    The CBI reviews asset quality information on a monthly basis, including reports on nonperforming assets, nonaccrual assets, provisions, write-offs and recoveries including on- and off-balance sheet items. The CBI’s Standards require credit institutions to have in place appropriate policies related to credit assessment and review, and prudent provisioning for loan losses. Supervisory action concerning problem assets can take the form of a condition on the license or direction to the Board to curtail loan growth and/or increase bad debt provisions or raise the level of capital to compensate for the higher risk associated with problem assets. Such supervisory action would normally be done in connection with an on-site inspection.

17.    The CBI has implemented the EU Directive on the Monitoring and Control of Large Exposures of Credit Institutions (92/121/EEC) in February 1994. A credit institution may not incur an exposure to a client or group of connected clients the value of which exceeds 25 percent of its own funds. A large exposure to a client or group of connected clients is one that exceeds 10 percent of an institution’s own funds. An additional aggregate limit of 800 percent of own funds applies to large exposures. Large exposures and sectoral concentrations are reported to the CBI quarterly on a consolidated basis.

18.    The CBI applies more stringent limits to connected parties than those applied to large exposures. However, there is no formalized written CBI requirement covering transactions over a specified amount to connected or related parties being subject to Board approval. Nevertheless, the CBI has the authority to restrict or limit future transactions with connected parties detected during on-site inspections, and require approval of such transactions by the bank’s Board.

19.    The vast majority of credit institutions are involved in cross border activities. In instances where a particular country experiences problems, the CBI will survey its banks in conjunction with reviewing the currency and large exposure reports to identify the magnitude of the exposure and determine if any supervisory action is needed.

20.    The EU Directive on market risk (93/6/EEC) was implemented by the CBI in 1995. The CBI has established a separate Risk Policy Unit with specialists for the evaluation of bank models, who should keep abreast of the products offered by credit institutions. The CBI collects information on interest rate, equity, foreign exchange, settlement/counterparty risk and large exposures related to trading activity through monthly prudential returns. In implementing the CAD, capital requirements for market risks are set out. Most banks involved in activities subject to market risk are international institutions using some type of internal VaR model. The CBI looks into an institution’s internal audit process for support in ensuring that banks conduct periodic validation/testing of the systems used to measure market risk. A number of banks have requested the CBI’s formal review and approval of their models under CAD. The CBI plans to require that an institution with an approved model perform stress testing, scenario analysis and contingency planning.

21.    The CBI’s Standards require banks to have comprehensive risk management systems commensurate with the scope, size and complexity of all the bank’s activities, including derivatives and associated risks, for continuous measuring, monitoring and controlling of risk. A minimum ratio of liquid assets to total borrowing of 25 percent is set in the CBI’s Standards, which will be substituted in the future by a stock and maturity mismatch approach (gap-based), which has been piloted with several banks throughout last year.

22.    The May 1992 “Auditing Guidelines” (for banks in the Republic of Ireland) together with the EU Second Banking Directive (89/646/EEC) set out guidelines and requirements related to internal controls. Publicly quoted companies are expected to comply with best practice on corporate governance issues. The CBI’s Standards require that credit institutions have in place “such committees of directors and management as are necessary to ensure that the business of the credit institution is being managed, conducted and controlled in a prudent manner and in accordance with sound administrative principles.” The CBI’s Standards require that every bank manages its business in accordance with sound administrative and accounting principles and put in place and maintains internal control and reporting arrangements and procedures to ensure that the business is so managed.

On-site inspections rely on the CBI’s on-site examiner inspection manual and on guidance notes prepared by the Money Laundering Steering Committee to determine that institutions carry out appropriate customer identification procedures, including guidance on the prevention and detection of criminal activity of fraud. An evaluation by the Financial Action Task Force in April 1998 concluded that Ireland has a comprehensive and solid legislative scheme in place for combating money laundering.

D.  Methods of Ongoing Banking Supervision

Core Principles 16–20

23.    The CBI’s on-site examiner inspection manual contains sections on corporate governance, risk management, internal controls, management information systems, loan portfolio, treasury and liquidity, capital adequacy and standards related to reporting. Credit institutions are required to report details of solvency, liquidity, large exposures, sectoral concentrations, nonperforming loans, bad debt provisions and arrears statistics to the CBI on a monthly/quarterly basis, as well as provide annual audited financial statements and interim accounts. Inspections are complemented by regular review meetings with senior management of credit institutions.

24.    The CBI has the legal authority to require submission of information by banks, pursuant to corresponding sections of the 1971 Act, and as amended in the 1989 Act. The implementation of additional directives confers other specific powers to the CBI. The EU Directive on the Annual and Consolidated Accounts of Credit Institutions (86/635/EEC), implemented in 1992 establishes the proper accounting in banks’ financial statements. The EU Directive on the Consolidated Supervision of Credit Institutions (92/30/EEC), implemented in 1992, requires the CBI to supervise a credit institution and its associated enterprises on a consolidated basis. Implementation of the EU Post-BCCI Directive (95/26/EC) enables the CBI to require the information necessary to establish the existence and degree of close links between the institution and third parties.

25.    Under the 1989 Act and implementation of the EU Post-BCCI Directive, there is a duty on the part of external auditors to report matters noted during the course of an audit to the CBI. This refers to matters likely to affect the solvency of the institution; material deficiencies in the financial systems of control; material inaccuracies or omissions in returns of a financial nature made to the CBI; any fact or decision likely to affect the continuous functioning of the institution; and anything that would lead to a refusal by the auditor to certify the accounts or to the issue of a qualified audit report.

26.    The CBI obtains an understanding of the activities of all material parts of supervised banking groups by the collection of consolidated quarterly returns, discussions with senior management at review meetings at which the performance of all the group’s business units are discussed and meetings with other supervisors, e.g., annual meetings with the supervisor of Irish banks’ foreign subsidiaries and with the Irish supervisor of banks’ life assurance subsidiaries.

E.  Information Requirements

Core Principle 21

27.    The standardized reports required by the CBI are collected from all institutions on a comparable basis and relate to the same dates and periods as appropriate. The CBI prepares “Notes on Compilation” that are based on best accounting and banking practice and standards as set out in Financial Reporting Standards and Accounting Practice Standards. Annual accounts must be prepared according to the EU Accounts Directives (86/635/EEC and 89/117/EEC). The CBI does not rely primarily on the work of external auditors to perform on-site type inspection activities.

F.  Remedial Measures and Exit

Core Principle 22

28.    The CBI may impose conditions on the license of a bank; issue directions where it is in the public interest to do so in the judgment of the CBI; direct a bank not to advertise for deposits from the public; petition to the High Court to wind up a bank; petition for the appointment of an examiner; revoke a banking license; seek a Court injunction prohibiting continuation of certain contravention or failures to comply with CBI legislation; or prosecute summarily certain offenses.

G.  Cross-Border Banking

Core Principles 23–25

29.    The CBI ensures that local management pays particular attention to higher risk foreign operations and operations at geographically remote locations. The EU Directive on Coordination of Supervision requires that supervisors consult with the competent authority in another jurisdiction prior to granting authorization to a credit institution to start cross-border operations.

30.    Information sharing arrangements are generally established on a formal basis through Memoranda of Understanding (MOUs) which set out the respective duties of home and host supervisors. Bilateral MOUs have been signed with the banking supervisory authorities in Belgium, Denmark, France, Germany, Italy, Luxembourg, the Netherlands and the United Kingdom; and are under negotiation with the Isle of Man, Austria, Poland, Spain, South Africa and the USA.

31.    Subsidiaries of foreign banks and licensed branches from out of the EEA are subject to the same full set of requirements and standards as domestic banks with the following exception: branches of non-EEA countries are not required to have capital and thus requirements regarding own funds do not apply. The CBI will not authorize a bank unless it is satisfied that the home country supervisor effectively exercises its supervisory responsibilities on a consolidated basis. It can share information with a foreign supervisory authority where that authority exercises functions which correspond to the licensing and supervision functions of the CBI and has obligations in relation to non-disclosure of information which are similar to the obligations imposed on the CBI.

Table 1. Ireland: Compliance with the Basel Core Principles—Summary Assessment

III.  Staff Commentary

32.    Ireland complies with all Basel Core Principles of Effective Banking Supervision. Since many of the EU Directives, to a large extent, parallel those Principles, implementation of these Directives—which is currently required under the EU rules—has facilitated compliance with the Basel Core Principles. Since January 1, 2000, a Financial Supervision Policy Committee was established to better coordinate supervisory activities, and additional steps were taken to further enhance the "risk-based approach" to supervision. This approach is based on using results from the CBI’s off-site bank analysis to determine the frequency and depth of on-site inspections and the contents of meetings with credit institutions. The detailed assessments of principles found:

• Laws are in place for banking and for the supervision of banking by the CBI, whose objectives and responsibilities are clearly defined. The laws and supporting regulations provide a framework of minimum prudential standards that banks need to meet. The CBI also has the necessary independence, staff and monetary resources, and power to authorize and supervise the banks licensed in Ireland. The CBI has set up a mechanism for coordinating actions with DETE, the insurance supervisory body. A framework exists for sharing supervisory information, as long as it is kept confidential and used for supervisory purposes only.
  
  
• The term “bank” is clearly defined in laws and regulations and its use is limited to licensed and supervised institutions. The CBI has the right to set criteria for licensing banks. The criteria for issuing licenses are consistent with those applied in ongoing supervision. “Significant ownership” is clearly defined in Irish laws and regulations.  Laws and regulations clearly define what types and amounts of acquisitions and investments need the CBI’s approval. The criteria used by the CBI includes that new acquisitions and investments do not expose the bank to undue risks or hinder effective supervision.
  
  
• Laws or regulations require all banks to maintain a minimum capital adequacy ratio, not lower than what was established in the Basel Capital Accord. Capital adequacy ratios are calculated on both a consolidated and a solo basis for the bank entities within a group. The CBI seeks to ensure that prudent credit and investment criteria, policies, practices and procedures are developed, approved, implemented, and reviewed by bank management and the board of directors. It requires banks to formulate specific policies for identifying and dealing with problem credits including procedures to ensure that classifications, loan-loss provisions and write-offs reflect realistic repayment expectations. CBI regulations impose limits on large exposures to a single borrower or “closely related” group of borrowers, and more stringent limits to connected parties. The CBI monitors whether a bank’s policies and procedures give due regard to the identification, monitoring and control of country risk, transfer risk, and market risk. Credit institutions must have in place a comprehensive and updated risk management process that identifies, measures, monitors and controls material risks.
  
  
• The CBI’s supervision of credit institutions includes an in-depth analysis and evaluation of individual banks for which it relies on both on-site and off-site supervision. The CBI has legal authority to require banking organizations to submit information on both a solo and consolidated basis. To a certain extent, CBI examiners may rely on the work of external auditors, as deemed appropriate. The CBI is aware of the overall structure of banking organizations or groups and has an understanding of the activities of all material parts of these groups, including those that are supervised directly by other agencies.
  
  
• The CBI has the authority to hold management responsible for ensuring that financial record-keeping systems and the data they produce are reliable, and that supervisor-required reports are submitted on a timely and accurate basis.
  
  
• The CBI has the authority, backed by legal sanctions, to take an appropriate range of remedial actions against, and impose penalties upon, banks, depending on the severity of the situation.
  
  
• The CBI has the authority to supervise the overseas activities of locally incorporated banks and to determine whether management is maintaining proper oversight of the bank’s foreign branches, joint ventures, and subsidiaries. For significant overseas operations of  Irish banks, the CBI has established informal or formal arrangements with host supervisors for appropriate information sharing on the financial condition and performance of such operations in the other’s country. Local branches and subsidiaries of foreign banks are subject to similar prudential, inspection and regulatory reporting requirements as domestic banks.

33.    Like supervisory authorities in other developed economies, the CBI will continue to be challenged by license requests for innovative operations (such as Internet banking and electronic purses) and requests for approval of increasingly complex activities and products. The CBI will need to monitor its current supervisory approach, as it may need to rely more on rules as the market expands and complexity increases.