Customers to suffer if foreign banks exit

International banks are likely to play a more passive role in Irish banking in future rather than offering full service

IRELAND WAS once seen as a money-making location for international banks, as the relative lack of price-based competition in most product markets meant that Irish banks had some of the highest deposit and lending margins in Europe, while the booming property market meant business was brisk.

Now, however, margins are on the floor, the property market has collapsed and foreign banks are looking for an escape route. But where will this retrenchment end and what will the impact be on consumers?

Back in the 1990s, the Irish banking market was dominated by the two major Irish banks, and the lack of competition meant a poor deal for consumers. The arrival then of international players such as Halifax, Danske Bank and Rabobank heralded a new competitive era for Irish banking.

National Irish Bank, for example, introduced its loan-to-value mortgage, which promised a cheaper cost of borrowing for home-owners, while Halifax offered the lowest variable rate mortgage, brought in tracker mortgages and paid interest on current accounts.

And, despite the country’s small population, other banks were also said to be considering Irish retail operations. For example, a foray into the Irish retail market by HSBC, one of the world’s largest banks, was thought to have been on the cards, as it ramped up its Irish banking activities, setting up a corporate banking operation in 2006, and a private bank aimed at high-net-worth clients in 2007.

Similarly, Landsbanki’s purchase of Merrion Stockbrokers in 2005 was thought to have been a precursor to offering wider services, and before it went belly-up due to the financial crisis last year, the introduction of new savings and mortgage products here was being looked at.

Now international banks based in Ireland are running scared.

Anna Lalor, a banking analyst with Goodbody, sees the political pressure, along with the pressure from taxpayers and the media in foreign banks’ home countries, as being critical factors in the retrenchment. “Banks need to be seen to be supporting their home market,” she says, adding that because of the credit crisis, banks are hoarding capital and not lending to the same extent, “so if they’re going to lend, they will do so in their home market”.

As Tom O’Connell, assistant director general at the Central Bank recently remarked, “Foreign banks, here and elsewhere . . . are tending to focus primarily on promoting credit flows in their home markets”.

This pressure has apparently led Halifax/Bank of Scotland, which was the first foreign bank to set up a branch network in Ireland in 100 years, to put its Irish operations under review, with a decision expected as to its future viability by the end of the month. Given that its parent group Lloyds is now 43 per cent owned by the British government, the trend towards “economic nationalism”, which has also come into play amongst Irish banks who have pulled back their services in the UK, means that its priority is the UK market.

And Halifax is not the only foreign bank reconsidering its role in Ireland. ACC Bank, owned by conservative Dutch institution Rabobank, has considerably downsized its Irish operations, closing 16 of its 25 branches and making a third of its workforce redundant. Moreover, its determination to get some money back from developer Liam Carroll indicates that it is not willing to sit tight until the long term and risk damaging its AAA credit rating.

Over at Ulster Bank, the job cuts are still coming, while it is to withdraw the First Active brand, and merge its activities with those of Ulster Bank. Moreover, its parent Royal Bank of Scotland is 70 per cent owned by the UK government following its bail-out, and is facing its own political pressures to concentrate its lending on the UK market.

In addition to political pressure, the collapse in the Irish economy is also a significant factor in the banks’ decision to batten down the hatches of their Irish operations. As Philip Bourke, professor of banking and finance at UCD, points out, “There is a huge adjustment of Icelandic proportions going on in the Irish economy. Given that the economy has lost 10 per cent in gross national product, you’d expect the banks to leave”.

And, while the Irish market may have once been attractive for international players, profitability has declined significantly in recent years, compounding the problems faced by the banks with regards to property loans.

In some respects, the foreign banks have been a victim of their own success in bringing competition to the Irish market, as this resulted in lower margins. Net interest margins are now very low in Irish retail banking. Given the current capital crisis, Lalor notes that they are at “unsustainable” levels, and so lending margins must increase.

Moreover, as Bourke points out, the domestic banks have an informational advantage over their international rivals, with better knowledge of the local market. While this may not have served them well to date, it may help the Irish banks get out of the current mess quicker.

Whether or not Halifax/Bank of Scotland exits the Irish market completely, its recent rate hikes suggests that it has closed the doors to its mortgage business, at least in the short-term. For example, new customers have the option of either a variable rate of 6.06 per cent, or a fixed rate, starting at 6.21 per cent for one year. Considering that the ECB rate is just 1.5 per cent, and variable rates start at 2.28 per cent at AIB, and fixed at 2.39 per cent for new customers, it is a clear signal that the bank is not open for new business.

And Halifax is not the only bank to effectively shut down new lending. While the other foreign banks have publicly declared their commitment to the Irish market – earlier this month for example, National Irish Bank’s Danish parent Danske Bank – said it had “no plans to abandon the Irish market” – similar moves in their interest rates suggest lending to new clients is not on the agenda.

For example, although Bank of Ireland offers a variable rate of 2.6 per cent for people trading up, Belgian-owned KBC Homeloans’ variable rate is almost 200 basis points higher, at 4.38 per cent, while its three-year fixed stands at 5.01, compared to 2.9 per cent at BOI. Similarly, National Irish Bank’s three-year fixed rate stands at 4.79 per cent, and its standard variable is 4.23 per cent.

So what role will international banks play in the Irish retail banking market in the future?

Lalor says it’s likely that they will play a more passive role, at least in the medium-term. Already, Canadian bank CIBC is said to be considering taking a stake in AIB, and this is the likely future route for banks, rather than establishing their own branch network in Ireland.

There is also likely to be a role for “commodity” players, says Burke, who will come in and offer specialist services. Deposit-taking for example, has attracted the likes of Northern Rock, Nationwide and Rabodirect, while it has been suggested that if Halifax moves out of Ireland, it will retain its deposits business.

However, the prospect of a new entrant applying a full service banking model here is unlikely.

What this means for the Irish consumer is a lack of choice. With the dearth of competition in the market, no bank is going to buck the upward pressure on rates. Already the domestic banks have increased their market share, with AIB doubling its take of first-time buyers in the first half of this year for example. With Government now accepting the “commercial market realities” facing the banks, as evidenced by its almost equanimous response to Permanent TSB’s decision to increase its variable rates, the only brake on banks driving up margins will be competitors. But they may have all gone home.