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Monday 16 December 2019

Conall MacCoille: 'Ireland's stagnant bank lending data hides underlying problems'

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Conall MacCoille

Central Bank of Ireland data last week showed bank lending into the Irish economy remains very weak. Lending to households was flat on the year at €109bn and to companies up by 3.9pc, but off a very low base of €40bn.

Some may welcome this news as a sign we are not repeating the mistakes of the Celtic Tiger era. The risks inherent from Brexit, the fall-out from Donald Trump's trade war with China and the global slowdown point to a cautious approach. But there are also risks from the 'stability of the graveyard'. Stagnant bank lending shows we have not fully addressed many legacy problems from the last financial crisis, which could hold back the economy going forward.

One eye-catching statistic released last week is that Irish households now hold €110bn of deposits in the banking system, up an enormous 7pc from €103bn one year ago. Job gains and wage growth are delivering strong growth in household incomes, allowing consumer spending to grow while households can still pay down mortgage debt - building up their savings in the banking system. For the first time, the household sector now has more deposits than loans from the Irish banks.

This is not necessarily a healthy situation. Household de-leveraging has reflected the skewed fortunes of the different generations. Millennials have been held back from owning their own home. The 2016 Census revealed 20pc of 25-29-year-olds, were in employment but still living with their parents.

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Had home-building been stronger, satiating demand, an extra 45,000 people in employment between the ages of 20 and 39 might have flown the nest. So household debt has been depressed by weak home-building and falling home ownership, clearly not a desirable outcome. The lack of housing also potentially stops past emigrants returning to Ireland - those whose skills are sorely needed to allow the economy to continue growing. Thankfully, the situation is slowly improving, evident in the 20,000 housing completions and 26,000 housing starts recorded in the year to September.

At the other end of the spectrum to the millennials are those who bought their homes at the peak of the last cycle - still saddled with high levels of debt or, in some cases, in mortgage arrears. Of outstanding mortgages accounts, 40pc were originated between 2005 and 2008, with loan-to-value ratios still averaging more than 50pc. These borrowers clearly still have a lot of work to do to pay down their debts.

Progress has been made. In 2017, the top 10pc of indebted borrowers were spending 29pc of their disposable income on servicing their mortgage, down from 37pc in 2011. One concern has been these groups might struggle if the ECB tightened policy. So if the European slowdown has a silver lining it is that some vulnerable Irish borrowers with tracker mortgages will be protected from rate hikes.

The cautious behaviour of Irish households is a world away from the consumer credit boom being experienced in the UK, reliant on pay-day loans, PCP car finance, instore credit and 0pc balance transfers on credit card lending. Indeed, Ireland's household debt to disposable income ratio is now 120pc, falling below the UK for the first time, albeit still the fifth highest in Europe.

However, the official data overstates the improvement because it is calculated by the 'market value' of Irish household debt. This means the aggregate data on household debt has been written down as banks have sold non-performing mortgage loans at a discount to private equity and other funds. From the prospective of the borrower, little or no discount may have been passed through.

So in truth, Irish household debt levels are probably still higher than in the UK, and the concern remains that some borrowers in arrears may still not have been put onto sustainable repayment arrangements.

Weak SME lending reflects structural problems

At face value, corporate de-leveraging since the financial crisis has been staggering. Bank lending to Irish corporates has fallen from €170bn over the past 10 years to only €40bn in October. This decline largely reflected the transfer of property loans to the National Asset Management Agency.

But even excluding property-related sectors, bank lending to corporates has halved from €60bn to €30bn. In a similar fashion to households, Irish corporates now hold more deposits, €60bn, in the banking system than they have borrowed in the form of loans.

There have been signs of green shoots in lending, up 3.9pc over the past year, albeit off a very low base. But the growth has been lumpy, concentrated among larger companies, with lending to small medium enterprises (SMEs) still falling by 3pc in the year to June. The big picture here is that bank lending to Irish companies seems surprisingly weak given the broader economic recovery.

A decade on from the financial crisis, it would be natural to expect Irish SMEs to start borrowing again to expand their businesses. Department of Finance and ECB surveys had shown Irish SMEs have done more work in repairing their balance sheets and had been more prepared to invest than their counterparts in many euro area countries, albeit more likely to draw on retained profits to finance investment than take out bank debt.

However, Brexit appears to have put a spanner in the works. A recent AIB survey showed 50pc of SMEs had put off expansion plans because of Brexit uncertainty.

Given Ireland's exceptional economic performance, it might be easy to make light of the performance of the SME sector. Ireland's 8pc GDP growth in 2018 was split between a 14pc expansion among multinational companies, but 4pc rise in indigenous sectors. The underlying message is that Ireland's recovery looks far less impressive once multinationals are stripped out.

Indeed, the OECD's 2018 review of Ireland's economy found productivity growth in most Irish companies had stagnated over the past decade, reflecting a lack of investment with weak competition in many indigenous sectors. Buoyant foreign direct investment (FDI) has papered over the cracks, hiding the long-lasting malaise often created by financial crises. Whereas countries like Greece, Portugal and Spain found it more difficult to emerge from their crises, Ireland benefited from its attractiveness as a location for FDI its export performance.

However, that doesn't mean there is room for complacency. Enda Kenny's assertion that Ireland should be the best country in the world in which to do business doesn't ring true for the indigenous economy. For now, many of pernicious structural problems identified by the OECD have not been tackled - high legal and insurance costs, low use by SMEs of the R&D tax credit, regulatory barriers to competition, high commercial rates and the fear of 'zombie' companies, kept alive by bank forbearance but with little prospect of expansion. Perhaps too often vested interests have been successful in stifling reforms.

In summary, while it may be tempting to throw stones at bankers, weak bank lending reflects badly on how our indigenous sectors are performing, and our ability to tackle the thorny issues left over from the last financial crisis.

Conall Mac Coille is chief economist with Davy

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