This year’s task is to refashion banking to a size where it can restart prudent financial intermediation writes Bill Hobbs
Early last year I wrote of how in 2010, banks would prove too costly to bail out and predicted the inevitable nationalisation of one of the two dominant commercial banks, AIB.
This year Bank of Ireland will struggle to remain outside of total state ownership as it attempts to shrink its loans to deposits ratio, achieve higher capitalisation levels and sell off its family silver. It may end 2011 in full state ownership or have been taken over by an international bank with the resources to resolve its problems.
In a sign of things to come, Bank of Ireland’s dramatic increase in the price of basic consumer banking services last month augurs badly for 2011, as other banks will undoubtedly increase their prices this year. It’s also likely retail lending rates will be increased again for all but the safest of lending propositions. This year an increasing proportion of people and small businesses will be marginalised by stricter lending criteria, higher rates, fees and costs.
Entering the third year of Minister Lenihan’s “cheapest of banking bailouts”, there is no certainty that a fourth round of recapitalisation will finally work to kick start banking. The IMF/EU bank bailout allowance of €35bn includes €10bn for immediate use to aggressively “overcapitalise” what remains of the banking system.
It’s a “shock and awe” tactic, that has yet to convince the financial markets as our banks remain systemically dependent on their €181bn twin ECB and Central Bank funding lifelines. The liquidity problem that saw tens of billions flow out of the main banks last year, has not gone away. And with the next round of loan loss estimates’ to be unveiled in March, any increase over current expected losses will automatically trigger the need to dip into the remaining €25bn bail out fund.
In this fourth round a new loan dump site will be fashioned from merging what remains of Anglo Irish Bank’s and Irish Nationwide’s loan books with their €18bn in retail deposits switched to address other banks still far too high loan to deposit ratios. These two “banks”, fuelled by billions in taxpayers’ will be wound up over time.
It appears AIB will be shrunk under state ownership and Bank of Ireland under State direction. But not before they are injected with at least €7.5bn of the State’s pension reserve fund. The plan is to refashion them as small domestically focussed regional banks. They will have to sell anything that no longer relates to their core domestic business of retail deposit gathering and lending. They will also have to sell off or securitise many of their good loans which will be insured against losses by State.
Cost cutting, rationalisation and consolidation could see them agreeing to shut down a significant number of overlapping branches. Once this is done, it’s hoped they may be of value to a larger international parent with the resources to solve their liquidity and capitalisation dilemmas. However this may not be possible without some form of bond holder “burden sharing”.
There may be some form of merger between the EBS and Irish Life & Permanent leading to the creation of a “competitive third force”. Given their limited banking franchise and IL&P’s stratospheric loan to deposit ratio of 250%, it is difficult to see how two a marriage of two turkeys’ could morph into a swan.
Expect also to see some form of state intervention in the troubled credit union sector this year.
While the Irish State has secured fiscal funding for the next few years, the Irish banking system has not.
The trick for 2011 will be to refashion banking to a meaningful size where it can restart the process of prudent financial intermediation. What size the new banking system will be and how it will be constructed is up the war-time-like emergency draconian powers vested in the Finance Ministry, already used to nationalise AIB.
Once dubbed “the wild west of banking”, Ireland has adopted the most intrusive and interventionist of emergency banking powers that has a lot of people, including the ECB, concerned about public censorship and subrogation of personal property rights to a common good.
Much depends not only on March loan loss estimates, which should include more realistic figures on personal debt such as mortgages and other loans, but also on the wider dimension of the continuing crisis of confidence in the Eurozone. Portugal is next for the sovereign bailout protection and after that the prospect of Spanish and Italian sovereign indebtedness looms large in 2011.
The Eurozone crisis will continue to dominate. Expect more muddling through as its leaders are pushed inexorably to a point where survival of the Euro may trigger greater fiscal integration.
While this uncertainty prevails, there may be a significant flight of domestic deposits as wealthier, concerned Irish citizens shift some of their money to what they perceive as safer sovereign and banking havens.
A version of this article appeared in the Irish Examiner, Business Section, Monday 3rd January 2011
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