Banks will be biggest winners from Budget

Business Opinion John McManus:Budgets tend to be characterised in terms of winners and losers and Brian Cowen's fourth effort is no different.

There are, of course, many winners and many losers, but one group does seem to have done surprisingly well out of the Budget and that is the banks.

They and not prospective house purchasers will be the biggest beneficiaries if the changes to the stamp duty regime that were the grand finale of the Minister for Finance's speech last Wednesday succeed in breaking the logjam in the market.

If the Minister had really wanted to help people buy homes, he would - as several commentators including this paper's economics's editor Paul Tansey, have pointed out - done nothing.

Instead he has intervened to bring to halt what many consider an overdue and necessary adjustment in the housing market that was bringing about the thing house buyers most desire: lower house prices. And lower house prices are the best way to engineer lower stamp duty bills.

So why did he do it? Pressure from the Taoiseach? Only the Minister knows the answer, but it may have had more than a little to do with ensuring the stability of the banking industry.

There is no doubt that the banking sector is facing into a difficult year.

AIB's trading statement last week was not exactly brimming with optimism and analysts are sticking with their forecasts for next year, which will see earnings growth slip from about 12 per cent this year to a much more modest 2 or 3 per cent next year.

The warning given by the FSA to the UK banks last week also has resonance here. Clive Briault, managing director for retial markets, said that lenders should be willing to rein in growth in order to build up liquidity reserves.

In this context, the issue for banks is not falling house prices and negative equity. Although most analysts are predicting an increase in bad debts next year at AIB and the other retail lenders, the impact on their balance sheets will be relatively small.

As international experience has shown, the bulk of home owners keep paying the mortgage regardless of negative equity.

The bigger issue is the one identified by UCD economist Morgan Kelly earlier this year: the Irish banking sector's exposure to the commercial property market.

Kelly estimates that the banking system has lent €100 billion to the commercial property sector, which is on a par with the their exposure to residential property and pretty much the equivalent of their deposit base.

As Kelly likes to put it: "Effectively the Irish banking system has taken all its shareholders' equity with a substantial chunk of its depositors' cash on top and handed it over to builders and property developers."

Kelly identified two potential threats that could rapidly destabilise this market leading to the sort of property-related banking crises seen in other markets such as Japan.

Both of them have now materialised. The first was if international banks curtailed the supply of liquidity to the Irish banks. This has happened, albeit not for the reasons put forward by Kelly but the reality that the ability of Irish banks to pass on some of their exposure to international banks is severely curtailed.

The other factor that could precipitate a crisis, according to Kelly, is if property developers start to default on their loans because they cannot shift new houses.

Again history has shown that developers tend to cut and run in these situations, and that there are domino effects.

We already know that property developers cannot shift new houses, but what we don't know if whether or not any are defaulting on loans.

On top of that, prices are down 8 per cent this year and many argue they should be down even more with the big developers still trying to avoid cutting prices. Although that appears to be changing, with one firm cutting the price of apartments by 22 per cent on the same day that the Minister cut stamp duty.

If prices were to fall by a similar magnitude next year - and many argue they should - then the nightmare scenario outlined by Kelly starts to look much less outlandish.

The real likelihood of this coming about is difficult to calculate, but it is the sort of thing that the Central Bank and the Department of Finance are paid to worry about.

One cannot but suspect it did play its part in the decision to revisit the stamp duty regime in such a decisive fashion last week.