Monday 20 January 2020

Brendan Keenan: A cosy cartel of controlled lending may be part of what our nation needs

Brendan Keenan

Brendan Keenan

OH, what one wouldn't give for a nice cosy cartel. The brutal departure of Bank of Scotland Ireland from these shores provoked a flurry of worry that we were now all going to be screwed by a not-so-cosy cartel of AIB and Bank of Ireland.

It probably is going to feel like that. One can almost hear the howls of complaints about lack of competition as rates go up and lending conditions tighten. Which suggests -- as do many other things -- that people have not fully grasped the implications of the banking crisis.

They do things differently in China. 'The Economist' magazine was puzzling over it the other week. Credit is certainly controlled and allocated to banks by some administrative process rather than market forces. But exactly what the process is, what the criteria are, and, critically, who is in charge, are questions even the learned article could not get to the bottom of.

The fact is that cartels can have their merits, if the purpose is sound and it is done properly. Of course, everyone caught fixing markets says their cartel is one of the good ones, but such circumstances are rare. They do exist however.

One of them, in my opinion, is the oil producers' cartel, OPEC, which aims to maintain stable prices for a finite resource currently in abundant supply.

Unfortunately, OPEC does not work very well.

One of the reasons OPEC has failed in its objectives is that the new financial trading technologies have swamped the effects of supply and demand so that producers turning the spigots off and on makes little difference to the price. In this, as in many other areas, the price no longer seems to perform its function of signalling the state of the market.

Take this business of credit default swaps, which we journalists dutifully report as the cost of insuring government debt against default. But, as a recent article in the 'Financial Times' from a former hedge fund manager trenchantly pointed out, these CDSs are now traded for profit between people who don't hold any government debt and people who don't sell any insurance.

Their activities do influence the cost of insurance for those who are actually lending to governments. But it is impossible to deduce much about the actual risk of default from the CDS price, even though that is what it ought to tell us.

Economists have always recognised that there are market failures. Unfortunately, those who did not recognise it rather took things over during the past 20 years. It is even more unfortunate if financial technology means market failure is on the increase, as it seems to be.

But it was hard to escape the thought that, within limits, they might have something to teach us -- or at least remind us. After all, it used to be not so different here.

The amount of lending capacity in the banks was largely controlled by the Central Bank. Banks sought to grow by increasing their deposits rather than their lending, as in recent years. Margins were fat enough for both safety and a comfort -- perhaps a little too much comfort.

There was neither safety nor comfort in the combination of growth through lending on terms too lax to keep either the banks or their customers solvent.

The cheers from would-be homeowners which greeted BOSI's madly aggressive pursuit of this strategy have more than subsided. They are due to be replaced by tears as the remaining banks seek deposits and pay for them, and their own losses, with significantly higher lending rates.

Trying to alleviate this with calls for more competition seems quite the wrong response. As the latest Tesco versus suppliers row illustrates, competition threatens both businesses and jobs, even if one believes it provides better business and more jobs in the end.

However, it is one thing for a wholesaler or a supermarket to go bust in some process of creative destruction: it is quite another for a bank to do so. In fact, as we have seen, they will not be allowed to go bust. But if companies cannot fail, competition cannot work. Some other system is required.

This is so heretical to the prevailing faiths that the loss of competition, and the possible return of a cartel, is seen as the great loss from BOSI's departure. Good riddance would be a more rational response.

This is a bank which was offering mortgages at 0.6 percentage points above ECB rates. That simply should not have been allowed. It is time the Central Bank explains how it intends stopping such behaviour in future -- or at least what it intends to say to the EU authorities about it.

It goes without saying that cheap credit will not be the problem for many years to come. But a new, safer, more rational system needs setting out for a different reason to show the public how an inevitable situation of more expensive loans, bigger bank profit margins, and refusal of credit to many who feel they deserve it will be managed.

Yet what do we see? Not only no new arrangements, but the two big banks offering so-called 'fixed' mortgages for one year, at less than 2.5pc. No more than 0.6pc margins, such lethally dangerous products for the customer simply should not be allowed. Especially not when interest rates have only one way to travel -- up.

The old regulator's mantra that the borrower's ability to repay was the only thing that mattered helped get us into this mess. Something a lot more sophisticated will be needed to prevent even more people finding themselves in the mire.

There is one bit of good news for small firms. They helped pay for the cheapest mortgages in Europe with the dearest business loans in Europe. As mortgage margins go up, the margins on their loans can come down. There will not, however, be enough loans to go round. Sound credit cannot be created out of thin air, not even by 'good' banks. Especially not by good banks.

All of this is terrifying for politicians, because it will all be wildly unpopular. It may therefore be a shrewd move to hand over direct responsibility for banking to the NTMA. But the rules within which they will work are a matter for government and the Central Bank. They will have to be very different from the ones which currently apply.

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