Credit supply to business is the key to growth, but the cure may be painful, writes Bill Hobbs
The outcome of a credit boom, banking crisis and real estate boom-bust cycle is what we are now seeing emerge – a creditless recovery.
Writing of creditless recoveries, the authors of a recent IMF paper found that they tend to be weaker and more protracted with economic growth on average one third lower than normal recoveries. They also report that many creditless recoveries are followed by years of stagnant growth.
It’s clear that without working banks providing a supply of affordable credit to productive enterprises and consumers, recovery here will be anaemic and largely jobless. In a creditless recovery, stagnant economic performance will push this country towards sovereign default. There won’t be enough fuel to fund the revenue tank to finance an unaffordable mountain of sovereign debt, bank losses and recapitalisation costs. Since 2008, normal financial intermediation has all but stopped and there is only one solution. And that is to get commercial banking working again at a cost this country can afford.
Economic growth rates, predicted under government’s recovery programme, are predicated on getting credit flowing again. Much of the emphasis is being put on an export led recovery. But, while multinationals don’t rely on our domestic banking system, an export led recovery won’t happen unless indigenous exporters, who are highly dependent on bank credit, have access to a supply of affordable short and long term bank loans. The same is true of almost all of the non-export sectors. Indigenous Irish businesses are acutely exposed in a creditless scenario as they have a disproportionate reliance on bank credit compared to their peers in other advanced countries. While Government is planning a small business loan guarantee scheme, it will only work if there’s a supply of credit and working banking system.
Restoring the supply of affordable credit will mean fixing some of our banks by pumping them full of fresh untainted capital to meet future trading conditions. But first their loan losses have to be paid for.
After three years of one of the worst recorded banking crisis, the wholesale destruction in collateral values underpinning banks boom time lending has not yet been accurately quantified.
The Central Bank is trying to estimate how much it will cost to make banks whole again. Its capital assessment review is expected to establish the mountain of capital required to fund expected loan losses and the higher levels required by banks if they are to retain a banking licence. Along with its close cousin the liquidity review, the outcome will set the scene for rebuilding the banking system using the new banking resolution laws.
Last week, the Bank published the base and stress case economic assumptions being used by its expert consultants to scrutinise troubled bank’s loan books. These economic assumptions have to be translated into expected loan losses. And there’s a problem as real estate collateral values are hard to pin down. Without enough people willing to buy, with banks unwilling to lend, without a national price data base and unknown future demand, it’s a classic black box. Furthermore plans to outlaw “upward only” rent reviews on commercial property will cause value to drop. And reforming bankruptcy laws - making it easier for people to earn a fresh start will negatively impact on expected loan losses. There are hints the consultants are considering a US style, property repossession loss scenario. Noises off stage are quietly softening us up for some pretty shocking figures.
The outcome will set the scene for the inevitable restructuring of banks which may include consolidating the good bits of some with others to make them whole again. Banks will also be expected to bring their loan to deposit ratios down, which is a herculean task, given that their foreign and domestic deposits continue to haemorrhage and their main largest depositors are the ECB and Central Bank.
The cost of getting banking working again and restoring the supply of credit to business and consumers will come at a price that this country simply cannot afford. The resolution for our banking system will largely depend on what happens at EU level. It could well be that the outcome of the Central Bank’s review may finally unravel the EU policy of protecting bondholders at all costs. If so bond holders would have to first share the pain of the bust, before sharing in any economic recovery. These include Irish institutional investors such as pension funds and credit unions.
Whatever the outcome over the next year, one thing is absolutely essential. To convert a creditless recovery into one that will sustain the growth required if this country is to pay its way and retain its sovereign status as a creditworthy state, credit supply to indigenous Irish businesses must be restored. And for this to happen some of the banks must be made whole again.
A version of this article appeared in the Irish Examiner, Business Edition, Monday 21st March 2011
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