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.

The bailout specified that these deposits had to be repaid. Given the trouble banks have had in attracting deposits, the only way they could be replaced was out of the money coming in to the banks from their maturing loans and also through the sale of assets.

To date, some €45 billion of the ECB’s deposits have been returned to them. The repayment of the remaining €102 billion, comprising about €60 billion provided through the ECB and €42 billion through emergency lending via the Central Bank, remains a core condition of the bailout and a powerful disincentive for future lending.

Every day, people are repaying millions to the banks on their mortgages, loans etc under the deleveraging plans to de-risk the banks and make them self-sufficient again. But instead of lending this money out again, the banks are using it to repay the ECB.

An obvious solution is for the ECB to wait for its money and set some less stringent targets for repayment. This would be a good idea, but it does not fix the underlying problem which is that Irish banks still can’t raise the substantial corporate deposits they need at a cost that would allow them lend the money on. This is because their creditworthiness is poor. All of them, with the possible exception of Bank of Ireland, are only in business because the State stands behind them and thus their creditworthiness is the same as that of the State – and that hovers just above, or in the case of one credit rating agency, Moody’s, at junk level.

Corporate treasurers normally have very hard rules about the credit rating a bank must have before they put money on deposit. It follows that the banks creditworthiness can’t improve until the State’s does. The talks with the troika are aimed at lightening the debt load and are due to conclude next months.

According to a recent study by Pat McArdle for the Institute of International And European Affairs*, the best that could be expected would be a combination of measures that reduce Ireland’s debt to GDP ratio by 10 to 20 percentage points.

Substantial but not necessarily a “game changer” but what this means in term of the sovereign rating and, by extension, the ratings of the bank and their ability to raise deposits could be as important in the short term as any reduction in the annual interest bill on the national debt.

* The Euro Crisis: Refinancing the Irish bailout – the options post the June 2012 Summit.

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