Open Dissent (16 page)

The Government has clearly determined that, if possible, the banking system in Ireland should stay free of total nationalisation, meaning 100 per cent ownership by the state. There are two distinct reasons for this. First, experience suggests that government-run banks are less likely to be a success. This is evidenced by the lack of socialised banking throughout the developed world. The second reason is that the temptation for politicians to spend their way into office would be too easily accommodated through government-owned institutions. It is easy to put forward a case that suggests that 100 per cent state ownership might not be a bad alternative as private ownership has brought the country to its knees. A conclusion might be that
anything other than private ownership could do no worse. My belief is that we should do everything to ensure that private ownership is retained in this sector for the good of the country and democracy.

Government support packages to financial institutions are influenced by a process that has been developed by the European Commission (EC). The EC oversees whether state assistance is in line with the principles of the Common Market and whether institutions require restructuring. A broad outline of the European process and how it might apply to the Irish Government bank guarantee and the recapitalisation of the banks follows.

After the Government provides assistance to an institution, the member state notifies the EC of the nature and dimension of the support. It is implied that there would be some verbal communication between the Government and the EC in advance of the announcement. The EC then determines if the support is compatible with the principles of the Common Market. As part of the EC's assessment, it examines the exit plan of the institution in terms of the support, and consideration is given to the imposition of penalties to compensate for market distortions. The institution that has received the support is required to provide a continual update on the restructuring, which may include such things as the sale of subsidiaries, withdrawal from certain businesses and likely reduction in foreign branch networks. During this period of restructuring, it is unlikely that the institution receiving the support would be permitted to acquire new businesses.

The foregoing process has had an influence on the restructuring of the banks in Ireland. It has to be repeated that the idea of looking at the restructuring plans of individual banks in the absence of a national banking plan is tempting failure. The creativity and vision of the Department of Finance has been tested during these turbulent times and, unfortunately, I believe they were found wanting in this regard. If the sole outcome of the planning of individual banks is the deferral of state ownership of the banks then this will be disastrous. Our banks, if slow to recover, will become the target of takeovers by European banks if they are viewed as viable partners and are priced cheaply. The EC assesses whether an institution that is in receipt of state aid has a long-term future and, if not, what the time frame is for its closure. This is surely the situation for Anglo Irish Bank as justification for its survival spreads thinner.

Anglo is the living embodiment of the cause of the crisis. It is difficult from most people's perspective to recognise that those who were in charge – directors and senior executives – have departed and have been replaced by a superior calibre of very experienced international bankers. But the effigy of the crisis is Anglo and the desire to burn this effigy runs very deep. To satisfy the emotional outburst of the electorate in its search for retribution, some plan has to be devised that enables Anglo to be absorbed into another entity or to have it as part of another strategy that would see it run down in a short period of time. Both of these suggestions would have a potential contagion
effect on the Irish banking system and, in turn, on the sovereign rating of the country for international debt raisings.

Any precipitous actions on the future of Anglo could have, and are likely to have, dire consequences for the country's ability to borrow. Currently, the state raises funds in an orderly fashion in its own name while the banks now require hundreds of billions to be borrowed, with the guarantee of the state to keep their books in balance. The international markets view the various debtraising activities of the banks and the state as being separate and independent for the moment. International investors have internal categories of ratings and portfolio concentration guidelines that restrict them from investing excessively in one borrower. For the moment, the market recognises the difficulties the country faces but respects the difficult decisions that have been made to turn the economy around. If all the entities in Ireland that borrow on the international markets had to be recognised as a single borrower, there would possibly be a lack of capacity in the market to satisfy the total borrowing requirements of the country.

The management of Anglo, the Government and the Regulator have all concluded that the liquidation of Anglo at this time would be prohibitively expensive. The combined losses and funding requirements might well exceed €75 billion,
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which would have grave systemic consequences.

The plan put forward by the new executive of Anglo to separate the activities into a good bank–bad bank structure
is a replica of the previous success story in Sweden in the early 1990s. There is a greater likelihood that this approach will provide the least expensive solution for the country over time, for several reasons. The single most positive outcome of this option is the creation of a new well-managed, strongly capitalised Irish financial institution that provides much needed liquidity and competition for the SME sector.

The six Irish banks are being viewed from the perspective of what needs to be done to them so they can return to their glory days: recapitalisation, the establishment of stable boards and executive management, the maintenance of risk profiles that are consistent with SME lenders, and the creation of effective governance regimes with an active regulator presiding over them. The banks lost most of their money on poor judgment in property lending, which did not recognise the mass of weaknesses in the market. The caution that will now be observed in bank lending practices will be frustrating for the credit-thirsty SME sector. By April 2010 there was a 34 per cent increase in the number of companies placed in liquidation, receivership or examinership compared with the same period the previous year.
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Are we going to experience one of the worst years for business failures on record? At this stage it would be a fair bet.

Lest we forget, the markets are very critical of institutions that have poor prospects for growth, and substantial growth at that. In addition, the banks will want to get out from under the government guarantee as soon as possible. In order for the banks to get an improvement on their credit
ratings they are going to have to produce clean balance sheets, excellent profits, growth prospects in their respective markets and no surprises in their loan portfolios. This vision of the future for the banks has to be achieved within Ireland.

The growth of the two major banks, AIB and Bank of Ireland, offshore during the 1980s and 1990s was in response to their shareholders' demands for increased growth. The banks were forced abroad due to the lack of investment opportunities in Ireland during that period. Safe havens were sought for the investment of the surplus capital of the banks that could not be invested productively at home. This expansion into the UK, the US and, later on, Poland might today be considered a blessing in disguise. The value of these offshore investments grew and, when divested, will provide a much needed capital injection into the respective banks. The sale of the offshore assets will in no way replace the massive capital shortfall created over these past two years but it will contribute to a reduction of the banks' capital deficit. However, if the major offshore assets are sold to enable the banks to strengthen their capital ratios, some of their most profitable activities will be gone. What they may gain from the sale of the assets in terms of strengthening their structure will be offset by the loss of profits for the future, as they would be making themselves less attractive propositions for domestic or foreign investors.

More than anything else the Government needs the banks to be independent and free from government support. The
€400 billion worth of creditors' guarantees needs to be erased in a short time span and not on the never-never. Ireland's sovereign credit rating is affected severely by the guarantees, and the cost of borrowing by the state is accordingly higher than it should be. The price of this guarantee ought to be borne by those who are being protected – that is, all depositors. This group of creditors should be charged some twenty-five to fifty basis points per annum to cover this insurance. The banks need to stabilise and be able to attract deposits rather than being another burden on the Government or taxpayer. An active and aggressive plan has to be put in place to relieve the Government of the cost of the guarantee programme. These grand steps can only be taken when the loan-todeposit ratio is closer to 1:1 than it is at the moment. The wholesale element of the banks' funding will continue to be guaranteed until the banks have regained satisfactory independent credit ratings. The dependence the country has on foreign debt and deposits should not be underestimated. Prevention of the loss of domestic deposits has to be high on each bank's agenda.

So, one way to restore health to the banking system in Ireland is through the resuscitation of the major banks by enabling them to continue operating as they have done for decades. We are looking at an uphill battle for the next several years to get the banks back on their feet and our sovereign credit rating restored to its preferred AAA status. Over the past twenty years, the banks have attracted more foreign capital into them than was available domestically.
This was in both debt and equity. The shareholders' register is a good place to start looking to see what percentage of the banks was owned by international investors. At our peak, in excess of 70 per cent of the value of our major banks was owned by foreign investors. As long as the institutions were managed domestically, we were happy to say they were Irish. In fact, they were foreign-owned, but rarely did one foreign entity exceed a 10 per cent shareholding.
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On the debt side, when we examine the growth in lending over recent years we can see that the domestic retail deposit base of the banks did not grow in tandem with the growth of the loan portfolios of the banks. In fact, the massive growth of the banks was supported by foreign deposits from the international wholesale markets, which were at the heart of the credit bubble. There was no end to the availability of credit for lending into the property sector until the liquidity crisis occurred. Then we realised the error of our ways.

This is the scenario we are looking at if we pursue what might be described as the ‘more of the same' option. However, there is no getting away from the fact that the mould of traditional banking has been broken. Perhaps it is time to look at devising a national plan for financial services that enables us to erase the errors of the past while fulfilling the need to alleviate the Government of the massive contingent risks it has taken on as a consequence of the crisis. The thinking to date has been somewhat stifled with respect to the future activities of the banks being put ahead of the interests of the Government and the country.

If we are to consider the development of a new banking model for the country then it is best that we initially identify the key imperatives that must be observed:

•  The plan must comply with EU directives on national banking.

•  The structure has to provide an attractive investment opportunity for both international and domestic investors.

•  The government guarantee and associated contingent liabilities should be reduced substantially and preferably erased.

•  The capital structure of the financial institutions should be maintained at the highest levels recommended by the ECB and the EU.

•  The sale of certain bank assets to provide capital should include a review of the potential sale of the Irish banks' payments system.

•  Governance and risk management systems of world-class standards must be adopted and policed.

•  Competition must exist in the Irish market at acceptable levels in product choice and pricing.

•  Employment levels should be maintained but not without regard for efficiency.

•  Every business must become best in class, including retail banking, insurance, fund management and SME lending.

•  Reputational damage has to be repaired.

Depending on what perspective one has, one can place a conscious hierarchy on the significance and importance of each of the ten imperatives. More emphasis can be given to one imperative over another, but in the end the balance between strong numerical analysis and attention to social effects has to be achieved.