European sovereign debt problem and fiscal crises – Challenges for Public Audit

1. European sovereign debt problem and fiscal crises – Challenges for Public Audit Olavi Ala-Nissilä CGR, Senior Adviser (Ex-Member of The European Court of Auditors Den 30. Nordiska Kommunala Chefsrevisorskonferensen 20.8.2012

2. CONTENT • I Reasons and consequences of the Financial Crisis • II Lessons to learn from Nordic Countries and from Canada • III The Future Challenges for Public Audit on National level • IV The future Challenges for Public Audit on European level • V Good Public Governance and Public Audit

3. I Reasons for the Financial crisis • Too much debt (which lead i.a. bubbles in real estate) • Global imbalances (not excuse, there will always be) • Supervision not efficient (esp. in cross-border banking) • Regulatory weaknesses (banks/society can afford to better regulation) • Risk management failed (least efficient banks = biggest risks) • Transparency missing (in many stages, Europe laggard) • Not enough own skin in the game (borrowers, lenders)

4. The consequences of the crisis - Output collapsed In 2009 global economy in collapsed Back to normal (or close to normal) quickly, in countries where the fundamentals were in good shape and financial sector sound

5. The consequences of the crisis- budget deficit widened Public deficit increased significantly in all countries Still in 2011 in some countries deficit more than 10%

6. The consequences of the crisis- public debt exploded (to unsustainable level in some cases ) Many countries still in steep upwards curve

7. Financial crises are likely to occur at regular intervals • Between 1970 - 2010 globally there are approx. 130 systemic banking crises episodes • Governments, regulatory systems and Public Audit shall learn to live in such a world • Semi-public financial institutions significant concentration of risks • Ensure coverage of the regulatory frameworks and proper accountability and audit

8. II Lessons from Nordic Countries - Transparency • Face the facts. Quickly and openly. Don’t hide them! • If the facts are not known (e.g. in the balance sheet), impossible to solve the problems. • And when the facts are not known, impossible to have confidence. In the interconnected financial markets without confidence there is nothing (money does not flow). • Supervisory bodies need to monitor and report regularly the soundness of the finance sector institutions (In Finland, Financial Supervisory Authority assesses regularly the entitites which are under its supervision)

9. Lessons from Nordic Countries - Own responsibility (own skin) • There has to be own responsibility in game, in every stage of banking activities. • 100 % mortgages (loan-to-value) is not sound business model • 100 % distribution of securities (originated by the same bank) leaves no responsibility to originator • 100.000 euros deposit guarantee does not promote responsibility (neither client, nor bank) • If taxpayers money used to bail-out financial institutions, there has to be a possibility for special audits. And if these audits reveal offences, filing a suit for damages against wrong-doers • When own responsibility missing, there is a “licence” to take over- excessive risks. Moral hazard. This can not be tolerated.

10. Lessons from Nordic Countries - Consolidate the banking sector • Save the system! All the banks don’t need to be saved! • Banking sector is no different from other sectors: if there is over- capacity, structural changes are needed. • This crisis proved again: the least cost-efficient and the least profitable banks took the biggest risks. • If taxpayers money used for bail-outs, conditions must include assessment of long-term sustainability (possible selling of some parts of activities).

11. Lessons from Canada - Tight regulation • Regulator’s job is to tell what to do, not to help banks grow! • Three areas where the regulation was more than minimum: Capital ratio 7%), quality of capital (at least 75 % had to be common shares), leverage (debt to equity: max 20 to 1). • Regulators also reacted pro-actively to booms (in housing market in February 2010): maximum amount for refinancing lowered, second home down payment requirement raised, introduction of measures to cope with higher interest rates • Canadian regulators were not interested in race-to-the-bottom.

12. Lessons from Canada - Clear roles and good cooperation • Uncomplicated and well-coordinated framework • Clear roles: Central Bank (responsible for stability of overall system), Superintendent (responsible for stability of financial institutions), Consumer protection agency (looks for individuals), Ministry of Finance (broad rules on ownership of financial institutions, design of financial products) • These key players meet regularly. No gaps.

13. Lessons from Canada - Values and principles • No matter how tight the regulation and how comprehensive the supervision, without values one can always find a consultant to help overcome the rules! • It is not a shame if bankers are ”boring ” in a good way • Conservative and egalitarian banking: not excessive and short-sighted risk-taking.

14. Lessons from Canada - Regulation and supervision has to be comprehensive • Canada is a federal state: i.e. federal government and 10 provinces and three territories (especially provinces have real powers, incl. collecting taxes). • → Regulation and supervision can work, when designed and implemented in comprehensive way (in the case of Canada, regulation and supervision are ”cross-border ”) • In Europe/EU, supervision will remain – even after the establishment of European Systemic Risk Board and three supervisory authorities – under the responsibility of national supervisors. • - New reforms of supervision will be done during autumn (bank union)

15. Lessons to Europe • WhatEurope (EU) canlearnfrom the NordicCountries and Canada? • Transparency. Therehas to bereliableinformationabout the finance sector and about the publicfinances. Stresstestscausemorestressifnotdoneproperly. • Regulation is not an issue to play with. Basel III givesvery long transitionalperiod. Betterregulation is needed. Basel-rulesmustbetransposed into EU law • Key playersmustworkindependentlybut in goodcooperation. SystemicRiskBoard and threeagenciesare EU levelbodies. Theyhave to ensureeffective supervision of cross-borderbanking. • Hugeamounts of taxpayers money are at stake. Sufficientpublicaccountability and publicauditarrangementsmustbe in place (e.g. EuropeanStabilityMechanism) • Economicfundamentalsarecrucial: sustainablegrowthbased on competitiveness/innovation, goodgovernance, mobility, soundpublicfinances.

16. III the future challenges on national level and for National audit offices (SAIs) • To ensure efficient public audit and accountability • To assure the reliability and quality of core financial and performance data of the Governments • To assure sound governance • corruption, conflicts of interests, dysfunctional institutions and budgetary processes • Effectiveness of the management of systemic risk • Effectiveness of the financial regulation and supervision in large sense (no caveats) • Audit and accountability in the crises management mechanisms and exit procedures

17. IV The future Challenges on European level FOR THE European court of auditors AND SAIS • “When public money is used, transparency, public accountability and public audit is always needed” • Functioning monetary union requires • a functioning economic union • a functioning stability union • a functioning control arrangements • European Stability Mechanism (ESM) • Decent audit and accountability arrangement attained Are result of the co-operation of European SAIs (ESM Treaty articles 28 - 30) and ECA • Performance audit and audit of the risk management by the Audit Board

18. The future Challenges on European level FOR THE European court of auditors AND SAIS • The EU Commission • The Commission will have a bigger/stronger role in the surveillance of the Member States’ economic and budgetary policies. The bigger role needs to be taken account by external auditor (ECA) • According to the ECA’s Position Paper: ”Within its mandate the Court will carry out audits in relation to new supervisory authorites, assistance mechanisms with EU budget guarantee and – to the extent possible – the Commission’s activities in the European Semester…the Court notes a number of cases where accountability and transparency issues need to be reflected on by competent institutions (EP, Council)..they concern accounting/audit standards, central banking activities and new set of rules being established

19. The future Challenges on European level AND FOR THE European court of auditors AND SAIS • the European Central Bank - Role of as lender of last resort somewhat open • European Financial Stability Facility and other extra-institutional arrangements - public money is involved, public audit arrangements are needed

20. V Good Public Governance and public audit • In the global world, in the single currency area, undermarket pressures: competitionistougher; in order to receive the benefits of globalisation, requirements of good public governance have to beaddressed. • Every state has to put its house in order. Austerityis not enough, growthis not enough, financialstabilityis not enough. The foundation (public governance) has to besound. It is a pre-condition for growth and job creation. • Plenty of studies (e.g. OECD) showingthat public governanceisstillunsatisfactory in many EU MSs. • If the good public governanceismissing, thereis a risk of isolation from the markets. • Main elements: effective spending control/monitoring, comprehensivetax collection system, accountability of ministries, results-orientedbudgeting, integrity.

21. Public control/audit has become and will become even more important!