Banking system remains greatest risk to economy

The rising number of bad loans – both mortgage loans and those to businesses – and the reconfiguring of the banks so that they can lend profitably to support growth are the two main challenges to the Irish economy, according to the Central Bank’s second annual Macro-Financial Review.

The report, which assesses the strengths and weaknesses of all areas of the Irish financial system, states that the greatest single risk to the domestic economy is “the health of banking system and its ability to support the real economy”.

International investor confidence in the Irish soverign remains subject to “a rapid reappraisal by financial markets” which could reverse recent positive developments and “hinder continued market access and debt sustainability in the medium term” according to the review.

The long term viability of the banking system will depend on boosting net interest margins, which have been in decline for more than a decade, and the weaning off of the banks’ still-heavy dependence on central bank funding.

The woes of the banking system have caused financing conditions for companies to worsen since the last review, “especially for Irish-owned, small- and medium sized enterprises” the studies notes.

“Bank lending is lower, and interest costs remain high” it goes on to say and that this has happened despite cuts in the European Central Bank’s base rates.

Also hindering the supply of credit to business is the riskiness of lending to many companies, often owing to debts run up during the construction bubble and invested in property.

The report observes that the “rate of liquidations of potentially-insolvent companies is over twice the average of the past 20 years”.

In contrast to the corporate sector, households in the aggregate recorded an improvement in their balance sheet position last year for the first time since 2008. Despite this the report stresses the slow pace of balance sheet repair and the risks to that process from a “fragile” residential property market.

The report notes that while investor confidence in Irish sovereign debt and domestic banks has improved since last year’s assessment, the international picture has darkened with weaker than anticipated economic growth in the main export markets.