Neither banks nor credit unions will be able to lend freely for some time, writes Bill Hobbs
The Governments assertion that NAMA would “get credit flowing again” was contradicted by the IMF which said it wouldn’t. The IMF view is not surprising as informed Irish commentators have long pointed out that asset managers or bad banks are not designed to get credit flowing again. This is not their purpose. They are designed to bail out troubled banks by taking over their bad loans. NAMA is no different, even if the Finance Minister has powers to direct banks to lend. No more than King Canute could order the tide back, the Minister cannot order a bank to lend when it can’t nor order it to make bad loans.
NAMA was marketed as an investment, offering to make money over ten years. It’s an offer based on past historic performance and wholly unrealistic, optimistic assumptions about future market conditions. Yet its business plan did not demonstrate what would happen if these conditions do not occur. Were Nama a consumer investment product, its prospectus (business plan) would probably breach regulatory consumer protection codes and its promoters would probably be ordered to withdraw the product.
It’s known that banking crisis cause prolonged credit starvation and higher costs of credit. It’s also known that credit starvation leads to credit rationing which in turn marginalises financially vulnerable businesses and people – in many cases excluding them access to affordable credit on favorable terms. This is precisely what is happening here, even where funds have been specially earmarked by banks for making new loans.
Irish banks are victims of a self generated earthquake that almost brought them crashing down. The damage wrought by the initial shock wave is represented by NAMA’s €90bn nationalisation of construction and property development loans. The state will unwind these loans at a huge cost that some have convincingly estimated could be €12bn or more. Once “Namatised”, the recapitalisation requirement of four state guaranteed banks is being estimated at about €10bn, before factoring in the higher levels of regulatory capital required by regulators and capital needed to fund further loan losses. Furthermore state owned Anglo Irish Bank will also need billions in fresh state capital. The state will have to fund recapitalisation effectively taking the banks into near full temporary public ownership, as private investors are unconvinced other loan losses have been fully addressed.
These losses are the after shocks; the second, third and fourth wave of bad debts. They are the souring loans below the NAMA buy out threshold, loans to consumers and loans to small businesses. Irish consumers and small business owners, who are the most indebted in Europe, are facing declining turnover or incomes, higher taxation and as banks increase their lending margins to keep alive, higher costs of credit. This combination of factors along with negative equity will inevitably trigger loan defaults. And business loans, frequently secured by their owner’s personal guarantees, will morph into personal debt as they go bad. Billions will have to be written off, as people simply cannot repay what they owe.
Will the banks be profitable enough to self-fund reconstruction and write off their post-Nama balance of bad debts? Many doubt they will. For now they will not make new loans but will focus on driving down costs and driving up profits through increasing their lending margins. Already most foreign owned banks are closed to new business and have announced large scale branch closures and staff redundancy programmes.
Whilst other countries have similarly troubled banks, the exceptional thing about here is the entire banking system and its participant firms are in trouble including the credit union sector. While home mortgage arrears are rising, these are lag indicators given that people prioritise mortgage payments. Unsecured, credit union loans are a lead indicator of consumer debt problems. Its been estimated that close to 10% of their loans are in arrears, many of which were made to first time house buyers to fund down payments on their homes. Trade body ILCU (Irish League of Credit Unions) said last year credit unions were increasing lending but their published accounts are showing a dramatic decline in new loans. Significantly under lent – only 50% of assets are in loans- they are nonetheless suffering from many of the same problems the banks have. Experiencing declining profitability they are struggling to safely lend, provide for loan losses and fund higher levels of regulatory capital.
Fearing the new Central Bank Commission may become a more effective regulator; the ILCU appears to want nothing to do with it. It is proposing the credit union sector should not be regulated by the financial services regulator but should once again be regulated by an independent credit union regulator under the Department of Enterprise Trade and Employment. However it has not demonstrated why this would lead to better regulatory outcomes, improve safety and soundness or ensure credit unions make more loans.
One thing is certain, neither banks nor credit unions will be able to lend freely for some time to come. Billions of household deposits are funding loans already made. Locked into zombified balance sheets, savings cannot be mobilised for productive lending by the banking system. Meanwhile an onrushing tsunami of debt – the stuff NAMA is not designed to take over, is appearing on the horizon.
This article appeared in the Irish Examiner, Business Section, Monday 15th February 2010
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