How State's bailout discourages banks from lending
BUSINESS OPINION:LAST WEEK this column attempted to answer a letter from a reader struggling to understand why the banks are not lending. Answering the question was hard enough; coming up with a solution proved impossible.
However, the events of last Thursday do give some grounds for optimism. If the belief that the European Central Bank has made a decisive move prove grounded, the way is open for some sort of restructuring of the debt Ireland has taken on to support its banks.
Discussions of what might or might not be possible tend to see this process – and will judge it – in terms of what it will mean for national debt dynamics. But it is also an opportunity to try and free up credit, particularly for business.
If you accept – as was proposed last week – that the banks are not lending because the terms of Ireland’s bailout incentivise them to reduce lending, the obvious solution is to change the bailout. In order to figure out what needs to be done, it’s worth looking a bit more closely as to how the bailout disincentives the banks from lending.
In theory the bailout was supposed to do the opposite. A massive amount of money, €64 billion, has been set aside for the banks to allow them fix their balance sheets. This cash is supposed to allow the banks face up to the losses lurking on their balance sheets and meet losses on future lending, with the emphasis on the future – ie they can make fresh loans. With hindsight this was never going to work because banks don’t lend capital. What they actually lend is other people’s deposits and one thing the Irish banks still don’t have is deposits. The main source of deposits are retail customer and corporate deposits. Corporate deposits left the country in the run-up to the bail out and have not returned, despite recapitalisation.
In total, Irish banks lost some €146 billion in deposits which had to be replaced with – in effect – emergency deposits from the ECB. The problem is that the ECB has no interest in having money on deposits with Irish banks. Their deposits are meant to be stop-gap until the Irish banks could once again attract commercial deposits.
In fact, it was their concern about the amount they had in the Irish banks, and particularly the sharp increase in emergency loans provided through the ECB’s outpost in Dublin, the Central Bank, that led then ECB governor Jean-Claude Trichet to play his part in pushing Ireland into a bailout.