Ruinous banks won't apologise or even explain
No heads have rolled yet, but banks need to rebuild confidence as much as balance sheets, says Colm McCarthy
There have been three official reports into the implosion of the Irish banking system, most recently the long-awaited Nyberg report. Central Bank governor Patrick Honohan prepared a detailed document focused on the failures in regulation and supervision while the Regling/Watson report was mainly about macroeconomic policy errors. But there has been no comprehensive explanation of what went wrong in the banks and the Nyberg report sadly did not deliver. The balance sheets of the surviving banks have been rebuilt at extravagant cost to the taxpayer, but their credibility has not.
Economic recovery requires a functioning banking system as well as a visible exit from the deficit crisis. Ireland has made limited progress under both headings. The sheer scale of the credit-fuelled property bubble and consequent collapse of the banking system is what distinguishes Ireland from the other casualties of the financial crisis. Some countries mismanaged their public finances and several permitted excessive credit growth and incurred severe bank rescue costs.
Ireland did both, with a banking rescue that has cost the Exchequer, relative to the country's economic capacity, far more than in comparable countries and resulted in the effective insolvency of the state.
The allocation of bank rescue costs between Irish taxpayers and bank shareholders has been resolved: the shareholders have been more or less wiped out. Amongst bank creditors, depositors have been protected in full but the treatment of bank bondholders has been indulgent.
Banks that have lost multiples of their capital continue to remunerate bondholders, courtesy of the bank guarantee, and Irish taxpayers are contributing disproportionately to the resolution of the European banking crisis. But the surviving banks are finally rebuilding their capital, the deposit outflow appears to have slowed and the shape of a new banking system is beginning to emerge.
All of the retail banks in Ireland got into serious trouble and several have disappeared altogether. Lloyds Bank, the owners of Bank of Scotland (Ireland), threw in the towel and shut up shop, reporting recently that over 90 per cent of their Irish loan book was impaired.
The government has closed Anglo Irish and Irish Nationwide, while Educational Building Society has been merged into AIB. First Active has been folded into parent Ulster Bank's operations. The surviving retail banking landscape includes three substantial foreign-owned banks. National Irish belongs to Denmark's Danske Bank, which has taken substantial losses but has trimmed the cost base and committed to a long-term presence in Ireland.
Ulster Bank, which has a larger market-share than National Irish, belongs to Royal Bank of Scotland and the latter has also committed to staying the course.
Finally Rabobank from the Netherlands operates the former ACC business and also sees a long-term future here focused on farming and agri-business. The country is fortunate that these three have chosen to re-commit to Ireland. There are other foreign players, including Belgian-owned KBC in the mortgage market, and several offering corporate banking services.
The three surviving Irish-owned banks are AIB, Bank of Ireland and Irish Permanent. The latter was a particular victim of the tracker-mortgage product, which has locked it into a substantial loan book at negative margins. The regulator has required it to divest the Irish Life insurance business to restore capital; it will effectively be owned by the government and will struggle to keep its extensive branch network occupied in the dwindling Irish mortgage market.
Bank of Ireland, whose shares trade at less than one per cent of their value five years ago, has avoided full state ownership, the reward for incurring horrendous loan losses at a somewhat slower pace than the rest. AIB, a few years ago the largest Irish bank and with international ambitions, has lost a multiple of its capital and is effectively state-owned, an epic disaster.
The government has designated AIB and Bank of Ireland as 'pillar' banks in the new Irish market, whatever that may prove to mean. They have the largest nationwide branch networks and both offer the full range of both personal and corporate banking services. They each hold 30 per cent or 40 per cent shares in Irish retail banking across the various product categories.
There will be no satisfactory outcome until these two banks are restored to normal functioning, and this requires more than just recapitalisation. Courtesy of taxpayer support in the case of AIB, and with a little help from shareholders in the case of Bank of Ireland, both banks now have
capital adequate to meet the recent Central Bank stress tests and hopefully to withstand any further loan losses. Both now have enhanced capacity to retain deposits.
The immediate challenge for both is the deleveraging of their balance sheets, which requires the disposal of loan assets at prices which do not erode unduly their new capital endowments. The need for deleveraging arises from the excessive level of loans relative to deposits, a hangover from the bubble exacerbated by the deposit drain.
Refusing loans to solvent borrowers is the default option for banks unable to sell surplus assets and would damage economic recovery. The banks need time to dispose of surplus assets and to rebuild deposits. Medium-term financing from the ECB, to replace the current hand-to-mouth arrangement, should be a component in the next inevitable revision of Ireland's deal with the EU/IMF. Indeed the IMF has already called for this measure, to no avail.
But what these two 'pillars' need more than anything else is the reconstruction of confidence in their leadership in the minds of staff, depositors, customers, government and their involuntary benefactors, the Irish public. The 'pillars' label, an undeserved rosette that has doubtless irritated some of the other banks, is nonetheless apposite.
AIB and Bank of Ireland were indeed more than just financial companies. They were important national institutions, repositories of unspoken public trust down the generations. That they have joined the long list of the no-longer-trusted, along with Fianna Fail and the Catholic Church, is a matter for profound regret.
Both have been observing a weird (and presumably lawyer-inspired) radio silence these last three years, as they limp along in denial about the enormity of what has happened. Neither has produced even a report to their own shareholders explaining why and how these two traditionally conservative banks, older than the state itself, bet the ranch on a property bubble and lost.
It does not greatly matter in the great scheme of things that Anglo Irish has been consigned to the dustbin, although it is galling to have to pay for it. AIB and Bank of Ireland were in a different category, taken for granted, part of the familiar furniture of the independent state. That they have vaporised their balance sheets, and contributed so much to the destruction of the country's solvency, is not just a business failure.
AIB has been the more accident-prone over the years. In the Eighties, Ireland's biggest bank had to be rescued by the government in the wake of the ICI insurance debacle and appears to have led the pack in the DIRT scandal. A decade ago, the bank lost $700m in a rogue trader fiasco in its US subsidiary, non-fatal damage for a bank of its size. But on that occasion the board commissioned and published promptly a thorough report and some senior managers took the blame.
This time around, AIB has taken down the entire edifice and helped to put the state itself in receivership, but no report has issued.
Not a whisper.
The performance of the second 'pillar', Bank of Ireland, has been equally damaging and equally unapologetic. The bank has survived outside state ownership due entirely to a policy accident in September 2008. Neither bank, so far as I am aware, has identified a single staff member who deserves to be fired. Not a single one.
The reconstruction of the Irish banking system should be seen as a political as well as a financial challenge. It needs a full accounting for the failures of the two pillars. The Nyberg report unfortunately did not attempt to execute this task but the government intends to empower the Oireachtas, through referendum if necessary, to conduct a full and public investigation. This is an undertaking of huge national importance. Public support for the unavoidable cutbacks has already been eroded through the unwillingness to explain and the failure to accept responsibility. The pillars need to be credible as well as solvent.
Colm McCarthy lectures in economics at UCD. He headed an expert group examining State assets and chaired the Special Group on Public Service Numbers and Expenditure Programmes, An Bord Snip Nua. He also authored the report into the semi-state sector from the Review Group on State Assets and Liabilities.