Fixation on Nama obscures other serious bank problems

OPINION:Even if toxic debt gets scoured from balance sheets, many recession challenges still fester, writes JOHN McMANUS

THE MINISTER for Finance Brian Lenihan will soon deliver his much-anticipated speech on the future of banking.

The main focus will be on what he says about the haircut or discount applied to the first tranche of loans going into the National Asset Management Agency (Nama).

From that flows the best indication yet of how much capital the banks will need to raise in order to absorb these losses. That in turn will tell us how big a stake the Government will end up with, if they have to provide this capital.

The length of time that it has taken for us to get to this point – Nama was first mooted over a year ago – means that we have all had a time to get our heads around the Nama concept. And more importantly, to start to believe that once it is up and running this week the banks are pretty much fixed and life will start to get back to normal, credit will flow etc.

Part and parcel of this vision of sun-lit uplands that we are being offered is that we will have successfully avoided nationalising the banks which, in the round, is thought to be a good thing. The presumption is that the State will be a significant minority shareholder in Bank of Ireland and majority shareholder in AIB.

There is a danger that all this optimism might prove a bit premature. Sorting out the toxic land and development loans on their balance sheets was without a doubt the biggest and most urgent problem facing the banks, but it is far from the only one.

Once you have taken the Irish banks’ land and development loans off them, you have in effect put them in the situation they would have been in if they were merely dealing with the consequences of the worst recession in living memory, and not the combination of a bursting property bubble and a global recession.

And what has not really been acknowledged to date is that even the banks that have found themselves in the lucky position of only fighting a war on one front – ie the global recession – have all needed extra capital to absorb losses.

Not only that, they are also having to raise capital to bring their capital reserves up to levels that give regulators and investors confidence that they have the strength to face whatever else is coming down the track in the coming years.

This all means that Irish banks are going to have to raise very substantial additional capital on top of whatever they need to sustain their Nama losses. Nobody knows how much at this stage but, given the depth of the economic contraction we are experiencing and the knock-on effects of housing-bubble-related issues such as negative equity, it would be prudent to assume that the banks’ non-Nama write-offs are going to be big.

It is also prudent to assume that the amount of capital that regulators and investors are going to require is also going to be large given the state of the banking sector.

Last week, Goodbody Stockbrokers published some research that tried to get its arms around the problem. They looked at a range of scenarios – both in terms of loan losses and regulatory capital thresholds – and concluded that AIB could need between €4 billion and €6 billion of capital, while Bank of Ireland will need between €2.7 billion and €4.4 billion.

It would seem pretty obvious that capital requirements towards the top end of the spectrum would push the Irish banks into the arms of the State or some third party; they would need to be nationalised or taken over.

All of this presents the first real big challenge for our new tough-talking Financial Regulator Mathew Elderfield and his almost-as-new-boss, governor of the Central Bank Patrick Honohan.

They will have a very significant role in deciding how much non-Nama-related capital the banks will have to raise. They will set the regulatory threshold and also in their role as regulators have to satisfy themselves that the banks are not hiding non-Nama losses to preserve capital.

It is to be hoped they are clear-eyed, hard-headed and independent in this task. In theory they should not be influenced by wider consequences – such as forcing nationalisation or sales – of doing the right thing.

But if things come to such a pass, they are unlikely to be very popular with their political masters. The various arguments made by the Government for not taking over the banks lock, stock and barrel 12 months ago still hold.

Fundamentally they boil down to the impact on the sovereign debt rating and the cost of raising national debt. Things may have improved considerably on this front over the last year but the current ructions over Greece serve to show how fragile sentiment remains.

The problem with the Government effectively ruling out nationalisation is that it incentivises the banks not to face up to non-Nama losses and husband their remaining capital in the hope that they will somehow survive as independent entities. This in turn means they are reluctant to engage in new lending and are also pushing up lending rates despite the European Central Bank leaving its rate at a record low. Neither of these things aid recovery.

If nationalisation is still seen as the greater of two evils, then perhaps the Government should consider facilitating the sale of the banks to international partners as part of a process to allow them really clean up the rest of their loan books.