Banks Around THE GLOBE are reassessing risk management of their foreign-exchange operations after a banking regulator confirmed that Allied Irish Bank's risk controls failed, prompting AIB to voluntarily refund corporate and retail clients ?34.2 million ($41.9 million) for foreign-exchange transaction overcharges over eight years. Last month, the Irish Financial Services Regulatory Authority said it wouldn't prosecute AIB, though it had breached the Consumer Credit Act, because the law has no sanctioning provision.
The next Irish bank that overcharges clients won't get off so easy, notes Liam O'Reilly, IFSRA's chief executive. The proposed Central Bank and Financial Services Authority Act, filed in June, would "provide much better protection for consumers than that currently in place," such as bank fines and requirements to refund overcharges, he said in a statement.
"Allied Irish had an undersized currency business that didn't have the proper risk management in place," sums up Standard & Poor's analyst Tanya Azarchs. "This happens occasionally and can lead to large losses and all banks need to study this case and see if they have the same holes in their risk-management controls to prevent that. ...Regulators can't be very happy about this."
The IFSRA, which is also the Irish central bank, says AIB isn't legally obligated to refund the overcharges, because customers had willingly paid higher fees that differed from those that were advertised, contracted or negotiated. However, the bank says it will compensate every customer who can be identified. Bank officials apologized for having charged a one percent margin to customers who conducted non-cash foreign-exchange transactions of more than ?500 ($920), even though the margin authorized by the Office of the Director of Consumer Affairs was half that sum. Bank officials say the one percent margin had been entered into the bank's systems in 1995 and was never changed. They also admitted an incorrect notification to the ODCA in 1996 was "a pure mistake" and "human error," and that they failed to notify the regulator of other charges, officials noted in a press statement.
The IFSRA is examining AIB's operational and control systems to determine if technology changes should be made to prevent a recurrence, but the bank has already beat the regulator to it. "The issues brought to light by the investigations show that, in most cases, the errors arose from over-reliance on manual systems to apply product benefits and discounts," say bank officials in a press statement. "AIB is undertaking a major technology investment focused on enabling the automation of a wide range of processes that are now manually driven. The aim is to have this new technology in place in all our branches in the U.K. and Ireland by mid-2006."
The bank also installed special software, which officials declined to identify, to create a process by which the foreign exchange charges can be automatically repaid from August 2003 on. It will facilitate better control of our business and improve accuracy, dependability and speed of response to customer requests." AIB officials declined to be interviewed.
The AIB scandal highlights banks' need to "be more aware of risk management," says Standard & Poor's analyst Mark Young. "In an environment where price regulation of fees is an issue, then obviously this becomes a risk. In a market where fees are driven by market forces, this isn't such a large deal." Only four percent of the bank's 1.5 million customers in Ireland were affected, including 34,000 students. Though the overcharging was noticed internally in 2002, AIB didn't investigate until the problem became public last April after a bank whistleblower called the IFSRA. The overcharging occurred between 1996 and last April.
It's hard to know if the scandal will tarnish Dublin's reputation as a low-tax, lightly regulated center for international financial services firms. Today, Ireland earns more than ?700 million ($858 million) in annual taxes from the sector, which employs 12,000 people in the funds-administration, corporate-treasury, insurance and reinsurance industries.
Probably the most damage has been to the reputation of Ireland's largest bank. "They'll have to manage the reputational risk," Young says, noting that the bank showed good faith in uncovering overcharging in other business lines, such as student loans.
Worse yet, noted AIB Chairman Dermot Gleeson, is the breach of trust between bank and regulator. "Perhaps more serious than the strictly legal breach was...that it represents a breach of the trust which should properly subsist between a bank and its customers, and perhaps equally importantly, the trust which should subsist between a bank and its regulator," he said at a recent press conference. "In terms of trust in public institutions and important private institutions like the bank, I believe that by saying that our relationship to our customers is not just to be confined by legalities...but by saying, 'Look, we are taking a bigger view of this. We'll forget about what the strict law may be, we're going to give you the money back.' ...[We have] a relationship with customers and regulators which is candid, and on this occasion, contrite."
A second IFSRA report on AIB is due this fall, and the bank also is being investigated by the Revenue Commissioners and the Office of the Director of Corporate Enforcement. This is the second foreign-exchange scandal to rock the bank in two years. In early 2002, AIB revealed that John Rusnak, a currency trader at its Baltimore-based Allfirst unit, had incurred $691 million in losses through unauthorized currency trading over five years.
