Stabilising our banking system is key to the national interest

Government’s strategy to stabilise Ireland’s banks and make them work again has a wider national interest dimension as the national banking system could become dominated by foreign owned banks.

Of all banking systems Irelands’ is the most acutely damaged. No other government is faced with tackling the insolvency of all its domestic banks. Few countries have had to support their entire banking system to the degree Ireland has been required to do and will be required to do for the immediate future. Much public concern and commentary has been focussed on Government’s strategy of adapting a bad bank model whilst eschewing temporary nationalisation.

Much as people would prefer banks were forced to book losses in full, the systemic risks posed by their imprudent exposure to a handful of large borrowers means that choices are limited in the extreme. NAMA may not be the only option but for now it appears to be the only game in town.

Debate is focussed on how best to structure the clean up to limit tax payers’ costs, with public opinion highly sensitised to the price to be paid by NAMA for developers debts. Government may yet fall should it not convincingly sell its banking strategy. No one, including Government is adequately addressing what form of national banking system will be required and how its regulation, governance, ownership and control may be optimally structured to support economic recovery.

Having a workin banking system is critical. Cleaning up banks or arranging for new banks that work is key. The banking system is in a perilous state as a consequence of an economic policy that facilitated a bank credit fuelled, construction led boom in domestic consumption.

The hope is that the rising tide of global recovery will once again lift all boats including Ireland’s. The risk is recovery will be too weak, more so if predictions of a double dip recession triggered by rising commodity, food and oil prices come to pass.

Sorely damaged, the economy will struggle to recover in the face of fiscal constraints, a mountainous national debt, mass unemployment, increased taxation together with consumer and business reluctance to spend and invest. In the throes of a deflationary spiral Government is leaving the prospect of additional state equity support for banks, or temporary nationalisation, quietly on the table.

So far Government has deploying an escalating stabilisation strategy through its blanket guarantee, emergency capitalisation of AIB and Bank of Ireland, nationalisation of Anglo Irish Bank and NAMA bad bank approach. Rather like an earthquake the first shock wave serious damaged banks property lending portfolios. But powerful after shocks impacting commercial real estate loans, but-to-let lending, home mortgages, small business and consumer lending are exposing banks to further losses.

The IMF, anticipating losses yet to be realised as the wider economy contracts, advised extending NAMA’s powers to buy up other assets. It also advises temporary nationalisation as responsive strategy should banks be insolvent as a consequence of bad debt buy outs.

For Irish banks the headline data is ominous. House prices will fall by 50% and housing completions will drop to 10,000 next year from a height of 70,000. Residential rents are down over 20% forcing investors to default. Commercial property vacancies are climbing, rents are falling as yet to be completed buildings add to a massive stock pile of “see through” vacant buildings. Unemployment may reach 540,000 next year. Tens of thousands of homeowners are in negative equity. Private sector credit is contracting as consumers and business increase savings and pay down debt. New car sales have shrunk dramatically. Retail sales are falling and VAT receipts are down. Governments’ revenue targets, set in April will not be reached.

The elephant in the room no one has attempted to synthesise the scale of economic downturn and banking system capacity required to support recovery. The real problem is not just how bad things will get but how the economy responds to improving global circumstances. Downsizing may rob the country of the resources needed when times improve. Through what economists call the gap between actual and potential output, should national resources shrink to match actual output at far lower levels of activity then there may be no capacity to aid recovery.

One of the national resources required is a functioning banking system. A critical dilemma faced by Government is how to ensure that any reconfigured banking system that evolves is not dominated by foreign owned banks. Some observers maintain the national interest requires that at least one major bank remains headquartered in Ireland and is predominantly national in focus. As Government rolls out its bank stabilisation strategy it may also have an eye on the design of the new banking system and how to ensure the national interest is protected. Governments elsewhere have been known to hold strategic stakes in banks to ensure a functioning banking system is not captive of the constraints of foreign owned banks.