Banking system had assets worth nine times Ireland’s GDP before crash

Ireland's banking system had assets worth nine times the country's GDP just before the State went into financial meltdown in 2008, according to Central Bank governor Patrick Honohan.

However, he said it would be misleading to draw a simple conclusion about the financial collapse from this “headline fact”.

Prof Honohan was addressing a banking conference in Reykjavik, organised by the Central Bank of Iceland.

One of the chief similarities between the recent financial blowouts in Ireland, Iceland and Cyprus was that all three countries had big banking sectors relative to the size of their economies.

Having an undeveloped banking system - one that is small relative to the size of the economy - initially acts as a restraint on growth, Prof Honohan said.

This relationship held true until the bank-to-GDP ratio got to about 100 per cent.

However, beyond this point, he said there was little evidence of a “growth-enhancing function” from having a large banking system.

Equally, rapid growth in a banking system’s credit to the domestic economy had been “long-known as a risk factor for financial instability.”

The ultimate lesson of the crash was that if large banking systems with access to foreign finance became involved in providing credit to the local economy “they had the capacity to rapidly destabilise it”.

In Ireland’s case, Prof Honohan identified four different types of banks operating in the sector at the time of the crash.

Locally controlled banks, servicing the domestic economy, made up about 44 per cent of the system, he said.

A further 12 per cent comprised subsidiaries and branches of foreign-controlled banks dealing with the domestic economy.

There were also foreign-owned entities involved in exporting services, which accounted for about 19 per cent of the system, and which ultimately failed because of the subprime crisis.

Prof Honohan identified a final and fourth category of other foreign-owned concerns, which also used Ireland as an export base, but which remained “solid” after the crash.

While the first three categories got into trouble and “had to be rescued”, he said only the locally-controlled banks were implicated in the fiscal cost to the Government.

“The wider destabilisation of the Irish economy, including the boom and bust in property prices which has left a large section of the household sector under stress of over-indebtedness, was created by the first two categories of bank (and especially their ability to source foreign funding), but not by the third or fourth category.”