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Irish banks? And then there was one

Following its disastrous 2010 results, what future, if any, does AIB have? With the bank having now written off more than €20bn of bad loans since the middle of 2008 there is no sign of the tide of red ink ebbing any time soon.

AIB's 2010 results, which were published last week, revealed that the bank wrote off another €13bn of bad loans last year. With last month's stress tests by US financial consultancy BlackRock showing that the bank could lose up to a further €16.5bn in a worst-case scenario, bringing its total losses since mid-2008 to more than €36bn, it is now clear that AIB is a complete basket case.

When the Government published its plans for the future of the banking system at the end of last month, Finance Michael Noonan revealed that there would be two "pillar" banks, AIB and Bank of Ireland.

While the 2010 Bank of Ireland results, which were also published last week, reveal that Ireland's oldest bank has at least a fighting chance of overcoming its current difficulties, it's a very different story with AIB. Some pillar. If it were a physical structure the local authority would have slapped a demolition order on it long ago.

So what can be done with AIB? Even if, and that could turn out to be a very big "if", it does survive, the new AIB will be a far leaner more modest outfit than the swaggering institution which sought to out-Anglo Anglo in the mid-noughties.

The full impact of that disastrous policy is now being felt. Even after offloading €18.2bn of loans to Nama, AIB still has almost €30bn of "criticised" loans on its balance sheet, 30 per cent of its total loan book.

The continuing tsunami of bad news from AIB has not surprisingly spooked depositors, with another €21bn of deposits, a quarter of the total, walking out the door in 2010. AIB's loan book is also shrinking at an alarming rate. Even when loans which were transferred to Nama are excluded, its underlying loan book fell by 9 per cent from €95bn to €86bn.

With AIB having announced plans to shed 2,000 of its 12,000 remaining staff, its deposits down by quarter and its loans by almost a tenth, it now fits the description of "zombie" bank almost to perfection. Yet despite this, the Government is planning to inject a further €13bn of fresh capital into this broken bank. This will bring the taxpayer's total "investment" to over €20bn.

So what can be done to sort out the mess at AIB? Indeed, can it be sorted out at all or should it be consigned to the scrap heap of Irish banking along with Anglo and Irish Nationwide? Is the pillar strategy the best way to go or does the Government need to do a radical rethink?

At the very least the Government should be in no hurry to proceed with the shotgun marriage between AIB and the EBS building society, which announced 2010 losses of €590m on Friday.

So if AIB isn't fit for purpose what does the Government do for an alternative banking strategy? In truth, Michael Noonan has very few options, none of them very palatable. The foreign-owned banks are reducing their exposure to the troubled Irish market as quickly as they possibly can.

Last year Halifax pulled the plug on its Irish retail operation while NIB shut half of its branches. Even RBS-owned Ulster Bank, the one foreign-owned bank virtually certain to remain in Ireland, is pulling in its horns. As the recent appointment of New Zealander Jim Brown to succeed Colm McCarthy as chief executive demonstrates, RBS will in future keep Ulster Bank on a much, much tighter leash.

The disappearance of most of the foreign-owned banks will drastically reduce competition in the Irish market, which is why the Government is so keen to ensure that there will be at least two remaining Irish-owned banks.

While the Government can hardly be faulted for seeking to maximise banking competition, circumstances are conspiring against it. Put quite simply, are there enough good bits of AIB left to constitute a credible second pillar?

Last year's results don't provide much encouragement. Even when losses on loans transferred to Nama are excluded, AIB's core Republic of Ireland division lost €4.8bn last year, up by more than a third on the €3.6bn loss recorded in 2009. The main contributor to these escalating losses was a further increase in (non-Nama) Irish loan losses from €4.5bn to €5.1bn.

A quick glance at these numbers shows that, even if AIB's loan losses returned to more normal levels, the Republic of Ireland division would still struggle to achieve profitability. Even a four-fifths fall in non-Nama Irish loans losses would still leave it with losses of €700m.

While the staff cuts will go some way towards addressing the inherent unprofitability of AIB's Republic of Ireland division, there must be doubts about the viability of the entire AIB business.

This leaves the Government facing the nightmare scenario of seeing the number of banking pillars reduced to just one. This would see the rump AIB being subsumed into Bank of Ireland, whose 2010 results, which were also published last week, show that, unlike AIB, it finally seems to be getting a handle on its problems.

Sunday Indo Business