ECB rate cut may turn up heat on banks
THE BOTTOM LINE:THERE IS something very wrong in banking when you could borrow a mortgage from one State-controlled bank, AIB, for as low an interest rate as 2.9 per cent, choose to go into arrears on the loan and use your cash instead to make money by depositing it with another State bank, Permanent TSB, for 3.9 per cent.
In fact, at these rates AIB would be better off not lending on mortgages at all and just putting its capital (ie the State’s) on deposit with Permanent TSB to improve its net interest margin – the difference between what it pays for deposits and charges for loans.
AIB got hammered last year for not passing on a European Central Bank interest rate cut when many had missed the fact that the bank had not actually passed on Frankfurt’s interest rate increases earlier in the year.
Now with talk of another ECB rate cut at tomorrow’s meeting – to a record low of 0.75 per cent – Irish banks will come under renewed pressure from the public and politicians to pass this on to borrowers.
Last week’s supposed “game-changer” deal means that the EU bailout funds can, following a climb-down by Germany, directly recapitalise European banks and member states can avoid lumping further bank debt on already stressed-out sovereign balance sheets.
The Government expects the one-line insertion in that political agreement drafted in the wee small hours of last Friday to give Ireland the opportunity to re-engineer the costly recapitalisation of the Irish banks.
But why would those masters holding the strings of the EU bailout purse want to pick up the State’s almost €30 billion tab for AIB, Bank of Ireland and Permanent TSB when they are worth nothing near this amount and are struggling to return to profitability?
This graph shows how the net interest margins have been squeezed by excessive competition during the boom years and, latterly, by the hefty bank guarantee fees.
The Government would point to Prem Watsa of Canadian firm Fairfax, New York billionaire Wilbur Ross and their fellow investors in Bank of Ireland as some who see profits to be made from Irish banks but these are the contrarians of the investment world and are among a minority brave enough to climb into the front of the roller coaster.
The lines in this graph will have to start rising sharply if other new risk investors are to appear on the share registers of the banks.
If the ECB moves tomorrow and reduces its rate, as the market expects, the Irish banks will feel the heat and likely be forced to cut the cost of lending on variable rate mortgages.
The rate on tracker mortgages, which account for more than half of all Irish mortgages, will automatically reduce so that would put an instant squeeze on the banks.
Reducing deposit rates is the least politically sensitive option given the continuing criticism of the banks’ failure to lend in any meaningful way. Permanent TSB, ESB and Ulster Bank have already trimmed deposit rates in recent times so a trend is already starting to emerge.
The unintended consequence of the targets set by the troika to bring bank loans closer in line with deposits is a war for retail and small business deposits as they are easier to gather than reducing the size of loan books. The targets reflect the contradictory commitments that the Irish banks are being forced to meet.
It really comes down to the troika and the Government joining up their thinking and agreeing on the best way to fix the banks. Do they want stable banks operating on profitable models that will attract outside investment and reduce the burden on the State? Or does the ECB want its €65 billion in cheap loans back by the end of next year regardless of the dysfunctional effect this has on the banks?
The banks can only borrow at sustainable levels if the country can, and borrowing large amounts at affordable levels is still some way off, regardless of the State’s efforts tomorrow with the auction of treasury bills aimed at raising €500 million in three-month loans.
In the meantime, the rates the banks pay customers for deposits has to go one way – down. If the ECB moves tomorrow, it would timely for the banks to move too. Relaxing a troika target or two would also help.