FINANCE:Trying to solve an international problem through national regulators is asking for trouble

A small German bank facing collapse because of a $3 billion (€1.96 billion) debt owed by an obscure Dublin investment company is about as surprising as the international money markets shutting down due to a crisis stemming from US homeowners defaulting on their mortgage repayments.

The two are symptoms of how finance has become a global game. A button can be pressed in Frankfurt transferring funds through Dublin to New York. This is how risky US home loans caused turmoil in world markets.

Think of the IFSC as a Stansted-type hub through which money passes on a much longer journey. There was nothing unusual in Sachsen LB, the German state bank of Saxony, using a Dublin investment vehicle called Ormond Quay to raise money in the international markets to fund the heavy expansion of its business.

Many international banks have chosen financial centres such as Dublin to set up investment vehicles, availing of low corporate taxes, skilled staff and a flexible regulatory environment.

After German regional banks, or Landesbanks, lost the financial cushion of state guarantees for their loans in 2005, they had to look elsewhere for funding. This prompted Sachsen LB to turn to investing in high-risk but high-yielding assets linked to the sub-prime market.

Sachsen LB almost went bust last year due to a $3 billion exposure to sub-prime debt through Ormond Quay. A consortium of German state banks stepped in with a rescue package of €17.3 billion to protect the bank. Another state bank, LBBW, eventually bought Sachsen LB.

Another German-owned Dublin casualty of the credit crunch was a vehicle of Germany's Industrial Credit Bank (IKB), a specialised commercial lender. Dublin fund, Rhinebridge, faced huge losses on investments in high-risk US home loans.

IKB was saved with a rescue package backed by German state bank KfW, with help from Deutsche Bank and Commerzbank.

So-called conduits such as Ormond Quay and Rhinebridge have become commonplace in world finance. The funds are used to purposefully keep investments off the balance sheets of their bank owners, so bigger punts can be taken on investments.

When the losses of Ormond Quay and Rhinebridge, forced them to call on the line of credit to their German owners putting the parent companies in jeopardy, the Irish Financial Regulator was quick, and right, to point out the policing of the conduits was the responsibility of the German financial regulator, BaFin.

According to Department of Finance documents seen by The Irish Times, the Financial Regulator in Dublin had discussed the regulation of German bank subsidiaries in Ireland at a meeting in April 2007 and "it was agreed that there were no outstanding issues" concerning a 2005 inspection of these subsidiaries conducted by KPMG on behalf of BaFin.

So the high-risk German-owned Dublin conduits had received a clean bill as recently as 11 months ago. But few could have foreseen the credit crunch that struck four months after this meeting.

Department officials said in a briefing note drafted last year that "where banking groups operate across a number of jurisdictions, responsibility for requiring that the group's consolidated capital requirement covers all its subsidiaries lies with the consolidating regulator".

In other words, the Dublin conduits are German-owned, and as such should be managed by their German managers properly and policed by the German authorities.

The departmental papers also show that the Government was quick to allay concerns internationally that Dublin had no major problem with conduits, and that Irish financial institutions had no direct sub-prime exposures.

Dublin was listed 13th in a ranking of the world's leading financial centres in a City of London survey published earlier this month - up nine places from a year earlier - so Ireland was never going to avoid the subprime woes of international banks.

Almost all of the massive flow of money passing through Dublin funds is owned by international investors and institutions.

Of the €1.7 trillion in funds being administered in Ireland, half this amount is serviced by Irish-registered legal entities monitored by the Irish Financial Regulator.

Building protective dams is not just an issue for the Irish regulator, but for regulators around the world.

Trying to solve an international problem by relying on cooperation between national regulators is asking for trouble.

As the case of the German-owned Dublin conduits showed, issues about the exposure of the German banks to these investment vehicles were never flagged despite discussions between the regulators in Dublin and Berlin.

The current crisis has been caused by runaway credit markets. Financial wizards have in recent years continuously devised new and complex products by which to make money in the international credit markets and the regulators have struggled to keep up with the innovation or to understand the changing market.

Although Eurocrats have argued against a knee-jerk reaction to the financial crisis, a single European financial regulator, if not an overarching international regulator, must be considered to keep the financial markets in check in future.