Banks need profits to survive -- but not at expense of regulation
BANKING, as we now know to our extreme cost, is a lot more complicated than it looks. Even in the days when customers went into the branch, with all that rubber-stamping and twisting of elastic bands, it seemed a simple enough process.
Now it is largely a matter of putting a card in a machine and getting money out -- or not, as the case may be.
Yet, at the highest (or is it lowest?) levels of investment banking, the complexities proved too much even for banking regulators.
To its credit, the central banks' own organisation, the Bank for International Settlements, said publicly that it did not fully understand the new financial products. I wrote about it at the time, but I should have bought gold.
The simpler failings of our own banks are still not all that simple. I recall Central Bank governor Patrick Honohan valiantly trying to explain "fat tails" -- which seemed to amount to the fact that the only way to estimate future bank losses was, er, to make your own estimate.
This is coming up again, with the looming issue of mortgage losses. They have always been lurking in the background, but most people keep up their mortgage payments for as long as they can. It is only now that we begin to see the cracks really showing through.
There will be plenty more on this subject, but it cannot be ignored that it is developing against an alarming background in European banking, to judge from a recent IMF analysis.
In its Global Financial Stability Report, IMF analysts estimated that 58 large EU banks plan to shrink their balance sheets by a staggering €2trn. That sum, you will notice, is more than twice the funds available to eurozone rescue schemes.
The private de-leveraging will far exceed the conceivable public leverage to offset it. And there is an unpleasant bit of complexity in that jargon, "shrinking the balance sheet".
There are several ways of doing it, but the most common is to lend less money. Fewer loans on one side of the balance sheet means fewer deposits are required on the other. Regulators want a better balance between the two, while the banks want to write off or run down dodgy loans.
Making fresh loans to customers slows the process and increases the need for capital. Fundamentally, banks exist to make loans, but it is just not an attractive proposition for them at present.
Irish bank de-leveraging has its own characteristics apart from its sheer size. The withdrawal of the foreign banks has accelerated the reduction in credit capacity, as outlined in a recent analysis from the Central Bank.
This is a bitter pill. The arrival of Halifax Bank of Scotland, and the corruption of safe, solid Ulster Bank under the soon-to-be-ex-Sir Fred Goodwin, launched and intensified the mortgage bubble. Now HBOS has departed altogether, as have other foreign banks, and Ulster has cut back ferociously.
The Central Bank paper worried about the competitive effects of the new bank "concentration," with AIB and Bank of Ireland now dominating the scorched landscape.
Given the dire consequences of excessive competition among the banks, I was glad to read that there are conflicting theories as to whether bank concentration is a good or bad thing.
It depends on the circumstances, the paper says. The authors think Irish circumstances are more likely to lead to the bad result, where credit is further constrained and charges are higher.
That sounds plausible, but it raises policy issues which this paper does not cover.
Would selling AIB to a foreign bank -- the dearest wish of the Department of Finance and Central Bank -- lead to more bad concentration effects, rather than less?
The paper does find that lending to small companies requires strong local connections, which is something the Irish-owned banks themselves let slip.
A foreign bank may not be too keen to compete in this sector, which is already the one carrying the biggest cost premium.
It may have been a fundamental mistake by European and other authorities to apply the competitive model for competing products, such as cars or (with less success) plumbers, to financial products, where the relationship with their purchasers is entirely different.
Most banking may not be suitable for straight market competition. In Ireland's case, the extreme concentration means competitive forces are unlikely to have much force.
One possible answer is tough corporate regulation, not just the prudential kind, where companies are obliged to keep to certain cost ceilings and must find their own ways of making profit within those.
This is the kind of thing the Central Bank has always resisted vehemently. One can see why.
Its interest is in healthy profits for the banks so that there is no threat to their stability.
As we know, central banks failed dismally in this task. They need a broader underlying philosophy if they are ever to regain credibility.
Banks do need profits, which is a point often ignored, or even disputed, by their critics. But as the crash shows, they need more than that: regulation which can assess the quality of those profits and take action if they are deemed to be illusory.
But their customers need more even than that. They need a reasonable supply of credit (the crash also shows that too much is as bad as too little) at the best price the banks can safely afford.
In the meantime, those debating the referendum might care to look at the IMF's scenarios for policies which deal with bank de-leveraging, and the crises which make it necessary.
Its benign scenario would see the euozone's leaders pursue bank restructuring, invest public capital in the banks, where necessary and possible, and create a "bail-in" system which would allow losses on bank bondholders.
Credit would still be squeezed, but by less than half the 1.7pc it sees coming from existing policies. But if eurozone governments and citizens grow weary of the fray, the contraction could be a crippling 4.4pc. The point is that the benign scenario incorporates a more financially and fiscally integrated monetary union, and mechanisms to secure fiscal discipline and coordinate fiscal policies.
Whatever the result, the referendum represents, not the end, but the start of a very long, uncertain journey, the outcome of which is as yet unknown.