Saturday 19 January 2019

There is no justification for massive bank profits - steps must be taken

Gardai should question bankers over trackers and an interest rate-capping law should be enacted

'new Irish home borrowers were charged an average interest rate of 3.2pc.' (Stock photo)
'new Irish home borrowers were charged an average interest rate of 3.2pc.' (Stock photo)
Dan O'Brien

Dan O'Brien

Irish banks, collectively and on average, are much more profitable than banks across the rest of the euro area. That has been the case for four years. These facts are not as widely known as they should be.

Among the biggest reasons the banks are making so much money is because the interest rates they charge their individual customers are the highest bar none among the 19 members of the Eurozone, according to European Central Bank figures.

Those figures show that in August, the most recent month for which Eurozone-wide rates are available, new Irish home borrowers were charged an average interest rate of 3.2pc. Finns, who get the best deal, paid 1pc. The average rate across the entire euro region was 1.9pc.

ECB figures also show that Irish business customers are not faring much better. In August, interest rates charged on overdrafts and revolving loans - a vital source of funding for smaller-sized companies -were the second highest in the single currency area, at 5.1pc.

Only in recession-ravaged Greece were banks hitting companies with higher interest charges. Irish companies were paying well over double the Eurozone average of 2.3pc.

It gets worse. Despite having long ago returned to profitability, one eighth of the loans in the banking system is not performing. That is far above the average in the Eurozone and one of the highest in the bloc. Having so much money tied up in dud loans means less money is available for new ones.

It also puts the wider economy at risk. Even a mild economic downturn would cause more loans to turn bad. Starting from such a weak position increases the risk of the sort of panic breaking out about the banks that did for the country in 2010. That balance sheets have not been cleaned up despite five years of strong economic recovery is an indictment of both the banks and their supervisory authorities.

These facts are damning. Taken together with the unfolding tracker mortgage scandal, which I believe increasingly resembles a widespread conspiracy to defraud, they paint a picture of a banking sector that has turned into an anti-competitive oligopoly.

What can be done?

Super-high interest rates and the banks' behaviour towards some people on trackers are two distinct issues. They need to be addressed distinctly.

A central issue in the tracker case is whether the banks worked within the law or whether they broke it.

The banks would have been within their rights if they had used get-out clauses in mortgage contracts to move people to variable rate mortgages or widen customers' interest margins. It might have caused great difficulties for customers who were affected, but doing so would have been a hard-headed decision in a calamitous commercial environment when banks were haemorrhaging losses on trackers (it should be noted that the banks are no longer losing money on the 300,000 outstanding trackers because their cost of funding is now very low).

It would be an entirely different matter if people in banks sat down in meeting rooms and decided very deliberately to breach contracts in a systematic way.

Despite everything that has happened in recent weeks, the relevant authorities do not know to what extent, if any, there was a conspiracy to defraud customers. That question should have been answered long ago. It is entirely appropriate that An Garda Siochana is investigating the matter.

One very good place they could start looking is the office of the Financial Services Ombudsman. It has already completed 700 cases in which banks were compelled to return to customers' trackers or adjust downwards their interest charges. If gardai were to interview the bank staff involved in those specific cases all the way up the managerial chain of command they would quickly establish if explicit instructions were given to breach contracts.

In response to the uproar of the tracker scandal, politicians up to and including the Taoiseach have warned of hitting the banks with financial costs of various kinds. This is not the right approach.

Higher taxes and penalties may well end up being passed on to the customers. Another reason this route is mistaken is because the taxpayer has a very significant stake in the banks. Punishing them with increased taxes and/or penalties could lessen their value as they are being prepared for sale. Taxpayers would be hit again. What really needs to happen is for the personnel in the banks who orchestrated, designed and carried out the tracker removal operation to be held to account.

It is all too easy for newspaper columnists to call for heads, but in this instance the dismissal of staff who have been involved in the design and execution of practices that have ended up costing the banks large sums in compensation would not be in any way disproportionate. If it is found that individuals were involved in the taking of money from customers by breaching contractual obligations they should be prosecuted.

People should not be allowed impunity for law breaking merely because they are employed by a corporate entity.

If there is still some uncertainty around why thousands of people who had bad mortgage deals imposed on them, there is none about Ireland's highest-in-Europe interest rates, and little about why that is the case.

A lack of competition in the market place is the main explanation. When there is too little competition in markets, sellers have pricing power. That works to the detriment of buyers. That, in turn, allows sellers to make what economists call "supernormal profits".

As the accompanying graphics and text make clear, Irish banks have been making supernormal profits since 2014. They are making inflated profits because they are hitting consumers with very high interest rates.

In a well-functioning market, foreign banks would see the juicy profits to be made in Ireland and join the party. Increased competition could result in better deals for customers and compete away the supernormal profits. That has clearly not happened.

In the absence of new players and greater competition, Fianna Fail's Michael McGrath has proposed legislation to give the Central Bank powers to cap the interest rates banks can charge home borrowers. Currently, the idea is undergoing an impact assessment. While it has flaws, with some changes it merits serious consideration.

In general, frequently laws designed to limit prices that are the outplaying of market forces don't work and all too often they have negative unintended consequences. In the case of the banking industry, there can be little doubt but that an instrument as blunt as a legislative cap would do nothing to encourage new entrants into the market. But as there have been no new entrants despite four years of supernormal profits being made, this downside may be less of a downside than it first appears. It could also be mitigated by writing a three-year sunset clause into the legislation.

Companies making profits in free markets form the basis of our prosperity. But from the crooked timber of humanity nothing straight is ever fashioned. Perfectly competitive markets are rare and market failures are commonplace. Legislative fiat is not the answer to every imperfection and failure, but given the costs to consumers and business of exorbitant interest rates, a three-year cap written into legislation, rather than as a discretionary power to be made available to the central bank (as the Fianna Fail bills proposes), is now the appropriate and proportionate response.

Sunday Independent

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