A banking lesson Europe can learn from Ireland


BUSINESS OPINION:IT IS A measure of how much things have changed that we consider it progress when Irish banks can borrow from the European Central Bank at 1 per cent and lend to the Government at 4 per cent.

This we all now know is in what happened last month when Ireland “re-entered” the bond market with much public jubilation. And our ability to do so again, following last week’s further liquidity exercise by the ECB, will be seen as another step towards exiting fiscal rehab.

Italian and Spanish banks have been doing something similar, which has allowed both those countries to avoid being forced out of the bond markets and into bailouts. Indeed, it’s not unreasonable at this point to conclude that this was the real purpose of the whole €1 trillion exercise.

But according to the ECB, the reason it has offered European banks unlimited three-year loans at 1 per cent is to keep the wheels of European commerce turning. Banks are supposed to be lending the money to one another and crucially to companies and people across the euro zone.

But they haven’t been. Figures reported this weekend show that European banks have almost €800 billion back on deposit with the ECB. It is clear that rather than doing what the ECB says it wants them to do with the money – lend it to credit starved business and so on – they are hoarding it and paying the ECB to mind it for them.

For the time being, nobody is going to be getting too worried about this. Creating some breathing space for the euro zone to get its house in order is the over-riding priority.

But the ECB is unlikely to provide this sort of quantitative easing (QE) by the back door for ever. It will eventually come under pressure to compel banks to use the €1 trillion for the purpose for which it is nominally intended. This pressure will be internal and external.

The source of internal pressure is obvious. Representatives of Germany and its fiscal acolytes on the bank’s governing council are not going to sit back and allow QE by stealth to continue. The external pressures are equally obvious. If Europe’s banks don’t use the money for the purpose intended, then Europe will not grow, and governments, including those of Spain and Italy, will want to see the money used for its avowed purpose.

But putting the the QE genie back in the bottle and getting banks lending will not be easy. Experience in Ireland has shown that getting banks to do what you want them to do – even when you own them – is very difficult.

Ireland has pumped well in excess of €60 billion into its banks over the past four years. The proximate reason was to avoid the collapse of the banking system and keep credit flowing in the economy. In truth it has nearly all been about saving the banks from insolvency, and, thanks to the September 2008 guarantee, the State itself.

It is only now that the Government is getting serious about making the banks use the money for its intended purpose: lending to business, meeting mortgage losses and other productive activities. But progress is tortuously slow and the banks have yet to demonstrate they are really on board. John Trethowan, head of the credit review office – which monitors lending to business – said last week that the banks only met business lending targets last year after “robust” meetings with the Department of Finance and his office.

Deputy governor of the Central Bank Matthew Elderfield expressed similar sentiments last Friday when noting the lack of enthusiasm by banks to use capital provided by the exchequer to sort out mortgage books. He said the bank was increasingly concerned last year “over the progress that the banks were making on working through their arrears cases in terms of their operational capacity but also more fundamentally the approach that they were taking to unsustainable mortgages”.

Irish banks’ behaviour – and that of their European peers – is understandable. Paradoxically, it is to be welcomed after a fashion because it constitutes a return to the sort of risk aversion and conservatism noticeably absent during the previous decade.

But that is a heavy price to pay for the sort of trench warfare over credit that has been going on in Ireland between banks and government for the last four years. And it will be repeated across the euro zone once the peak of the crisis has passed and the banks come under pressure to use the €1 trillion lent to them by the ECB to get the economy moving.

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