Business Irish

Tuesday 27 June 2017

Banking on a stressed-out time for Ireland as events come to a head

Five things the stress tests won't tell us

Ireland was unlucky, that the sovereign crisis came out of left field and doomed the first round of stress tests to failure before they'd really had a chance to prove their worth -- Patrick Honohan Central Bank Governor
Ireland was unlucky, that the sovereign crisis came out of left field and doomed the first round of stress tests to failure before they'd really had a chance to prove their worth -- Patrick Honohan Central Bank Governor
Laura Noonan

Laura Noonan

1. What the final cost of the bailout will be

WE'D all love if today's announcement could tell us exactly how much the banks are going to lose over the next few years, and exactly how much State cash they'll need to get them over the hump.

Unfortunately, though, we're not going to be finding out those two things any time soon.

Today's announcement on the next phase of the banks' bailout follows an extensive round of 'stress testing', subjecting the banks to various shocks and seeing how much they would lose.

The "shocks", like rising unemployment and falling house prices, aren't chosen at random, but there's still a lot of subjectivity in there.

The Central Bank is testing institutions against their ability to withstand a 60pc fall in house prices from boom to bust because that's the "adverse" scenario they've chosen.

There would probably also be arguments for choosing a fall of 70pc, or a fall of 50pc. The experts are essentially drawing a line in the sand, pinpointing how "adverse" they think the scenario could get, but they can't possibly know that things definitely won't get worse than the adverse case they're modelling.

If, for example, house prices end up crashing 80pc, then the figures all get rewritten and suddenly the banks need yet more money. That's not a criticism of the Central Bank or of the stress tests, it's simply a reflection of the limitations that surround the exercises.

All we're doing is looking at how much the banks would be likely to lose under a "bad" scenario and giving them the cash to deal with that -- the unpopular reality is we won't know how much the banks actually lose until the bad scenario plays out over the coming decade.

Everything else is just an educated guess.

2. When the banks will be able to return to the markets for cash

THE original idea behind 'stress tests' was to throw so much money at the Irish banks that nobody could possibly doubt their ability to withstand future losses, so nobody could possibly object to lending them money.

Unfortunately, the reality panned out a little differently. After the first round of stress tests last spring, Bank of Ireland got some cash from the money markets before things seized up completely when the sovereign debt crisis hit.

Central Bank Governor Patrick Honohan has argued that Ireland was unlucky, that the sovereign crisis came out of left field and doomed the stress tests to failure before they'd really had a chance to prove their worth.

This time round, we're in new territory.

Market sources say that, no matter how much capital is pumped in after the latest stress tests, big investment funds and international banks aren't going to be lending money to Irish institutions for a very, very long time.

Having already been through two rounds of stress tests where the problem got steadily worse, investors are deeply sceptical about the latest incarnation's ability to finally put an upper ceiling on the banks' future losses.

Some say Irish banks could be out of international money markets for as long as a decade, until investors can see how the losses actually played out, instead of how the stress tests "expect" them to materialise.

3. When normal service businesses will resume

ASK a businessman what they want to know about the banking crisis and they often won't reply by enquiring about the size of the ultimate bill to be borne by Ireland Inc.

Often they just want to know when normal service will resume and the banks will start lending again.

When NAMA was conceived in early 2009, the big promise was that it would take toxic assets off banks' hands and enable them to focus on more 'core' activities like lending to businesses.

A year in, against a fierce backlash from business lobby groups who claimed their members were being crushed by banks' refusal to advance credit, then-Finance Minister Brian Lenihan took another stab.

AIB and Bank of Ireland were required to provide up to €3bn in credit a year to SMEs as a condition of their bailouts, though Lenihan left the door open for the figure to be "reviewed" if the economy changed.

Last month, the Government's credit review office reported that both AIB and Bank of Ireland were meeting those commitments, despite "subdued" demand for new business loans.

Lobby groups like ISME tell a different story though, and businesses still regularly complain that they're not getting a fair hearing from their bank managers.

The latest bailout should certainly put banks in a better position to lend to businesses, but whether they will embrace the opportunities that presents remains to be seen.

4. Who will own the banks

TODAY will tell us a lot about who won't own the banks -- namely the shareholders of Irish Life & Permanent who look set for massive dilution and possibily the shareholders of Bank of Ireland, who could also be forced to cede a significant stake to the State.

What it won't tell us though, is who will own the embattled institutions over the longer term. Investors aplenty have been sniffing around Irish banks since the crisis hit, but they've largely chosen to wait until the next round of stress tests gives them a better handle on the crisis.

Now that that round of stress tests is completed, the more serious work will be done. AIB, which is more than 90pc State-owned, is already effectively on the block and suitors may step forward over the coming weeks.

Almost a year after its sales process kicked off, building society EBS seemed to be on the home lap to find a new owner, with private equity consortium Cardinal recently emerging as the preferred contender.

Yesterday, however, the NTMA dropped the bombshell that it would not be going ahead with the proposed Cardinal deal, leaving us back where we started a year ago.

The most recent acquisition to the Government's financial portfolio, Irish Life & Permanent, may be the scene for one of the first sales.

IL&P is home to Ireland's biggest life insurance company, and should attract plenty of interest. The life business has an embedded value of €1.6bn, so the Government has plenty of incentive to pass it on.

Bank of Ireland, which is already 36pc owned by the State, is the next question mark. The bank is actively fighting off efforts to cede a majority stake to the State, even though its capital demands dwarf the value of the plc.

Investment from a private source is the banks' only hope of survival, but with no obvious suitors stepping forward, how that will play out remains to be seen.

5. Who'll be running the banks

WE'VE had something of a management clear out since the financial crisis hit, but there's a long way to go before the next generation of banking leadership transpires, and we ain't going to get there today.

Over at Allied Irish Banks, managing director Colm Doherty and chairman Dan O'Connor announced their exits in September, when it emerged that the bank would fall into State control.

Since then, an executive chairman David Hodgkinson has been appointed but the chief executive's chair remains empty to date.

Hodgkinson recently told staff that a wide revamp of the top team would be "more immediate" than job losses.

Irish Life & Permanent and Bank of Ireland both face ceding bigger stakes to the State, potentially heralding changes at executive level as some chose to walk away rather than remain in a semi-state and Government looks to exert more influence.

Then there's also the Financial Regulator's new 'fitness and probity' code for bank bosses. Bank bosses and directors who were in place before their institutions took bailouts will be put through their paces to see if they "contributed" to their institution's demise.

If it is found that they did, appropriate sanctions will be taken. The regulator has given individuals until January to "make their plans accordingly".

All in, Irish banks' leadership could look very different by this time next year.

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