Irish banks less exposed to risk


Panicked depositors are unlikely to be forming queues outside Irish banks any time soon - thanks to the ECB, writes Simon Carswell, Finance Correspondent.

The sight of panicked Irish depositors lining up outside a Dublin branch of an English bank this week frantically trying to withdraw their money had one major effect - it prompted more panicked Irish depositors to join the queue.

The scenes at Northern Rock were sparked by the so-called credit crunch and liquidity crisis in the international money markets and compounded by the failure of the British banking system to have in place credible guarantees to protect customer deposits.

This has in recent days led to much soul-searching on this side of the Irish Sea about whether Irish banks could find themselves in a similar predicament.

Northern Rock, Britain's fifth largest mortgage lender, has grown largely on funding generated in the wholesale lending market, in which banks lend money to other banks.

Within this market, Northern Rock relied heavily - about two-thirds of its wholesale funding - on selling on asset-backed securities, predominantly its mortgages, to raise money to fund its expansion.

Northern Rock effectively traded in debt. By packaging its mortgages and selling them on as collateral, Northern Rock removed debt from its balance sheet. This allowed it to raise more money in the wholesale market that it could use to underwrite more mortgage business. The more loans it sold to customers, the more its market share and profits grew.

The US subprime mortgage crisis, in which high-risk borrowers with poor credit histories defaulted on home loans, has thrown the wholesale funding and debt securitisation market into disarray.

Banks and investors have become suspicious of mortgage-backed assets, fearing some exposure to the high-risk subprime loans. This has made banks reluctant to lend to each other in the money markets, driving up the price of money in the inter-bank market and creating the liquidity crisis.

The rising cost of short-term inter-bank rates and the reluctance of investors and banks to buy its mortgage-backed securities, dried up Northern Rock's reservoir of funds, forcing it to go to the Bank of England for emergency rations eight days ago.

"Northern Rock was very heavily dependent on loans coming through the door and going out to investors and into the market," notes Eamonn Hughes, banking analyst with Goodbody.

Irish banks have grown rapidly in recent years and they have relied in part on inter-bank borrowing to fund the massive increase in mortgage lending they have underwritten, as loans provided to customers have far outstripped deposits taken in.

For many Irish banks, however, the reliance on costly wholesale lending and the now dormant securitisation market to fund their operations is nowhere near as great as at Northern Rock.

The British bank sourced about 72 per cent of its funding from the wholesale banking market, compared to between 36 per cent and 65 per cent for Irish banks, according to the credit ratings agency, DBRS.

Anglo Irish Bank relies on the wholesale market for 36 per cent of its funding, AIB 44 per cent and Bank of Ireland 46 per cent.

Permanent TSB, the State's second-largest lender, which relies on the wholesale market for 65 per cent of its funding, would appear to have the greatest exposure in this market. However, a senior Permanent TSB banker said that higher-risk securitisation operations accounted for just 8 per cent of its total funding.

Permanent TSB is also part of a much larger financial services group. The bank contributes about a third of the profits within the Irish Life & Permanent group; the rest comes from Irish Life.

Northern Rock also borrowed heavily in the short-term wholesale market, in some cases pricing its fixed rate mortgages on expensive short-term inter-bank borrowing.

As the price of short-term borrowing increased, Northern Rock's profits were eroded because it could not pass on these costs to customers.

The Irish banks have largely plumped for longer-term borrowing, obtaining more secure and less costly funding. Permanent TSB has had little difficulty in raising funds in the money markets in recent weeks.

"We have a €10 billion facility available to us from the ECB - the supply of money is not a problem," said the senior Permanent TSB official.

"The nature of what happened at Northern Rock, given its business model, is unique," said Sebastian Orsi, banking analyst with Merrion Capital.

"The scale of the reliance on wholesale funding and the nature of what went on in the inter-bank market is of a scale that is unprecedented."

Ratings agency Standard & Poor's said in a note yesterday that Irish banks were "comfortably managing their liquidity requirements while their loan growth is expected to slow from recent high levels".

The agency said that, while term wholesale funding remained scarce, access to inter-bank deposit markets appeared sound and there was still some access to most commercial paper markets.

It noted that IIB Bank had also relied heavily on wholesale funding but Standard & Poor's took comfort from the fact that the Irish bank was part of the large Belgian group, KBC.

It found that Anglo Irish Bank had a large number of corporate and institutional depositors, who were "proving to be resilient despite usual assumptions that these are typically less sticky than retail deposits".

Standard & Poor's acknowledged that the use of securitisation by the Irish banks has been more modest than at some of its British counterparts.

Northern Rock's failure to diversify its funding with government bonds, for example, also left it exposed. "It was a one-trick pony," said Stuart Draper, head of research at Dolmen Stockbrokers. "Its mortgages were the only earnings stream for the business and its funding was outside its own control."

Irish banks have the luxury of having access to greater levels of everyday lending within the European Central Bank (ECB) system than their counterparts in Britain. The ECB was quick to inject funds into the banking market in early August when the liquidity crisis was still in its infancy, pumping more than €130 billion in the system over the last six weeks. More than €400 billion is available to Europe's banks from the ECB to improve liquidity in the market.

"The big safety net for the Irish banking system has been the ECB. Irish banks pledge assets as security and we can borrow from the ECB against those assets," said the senior Permanent TSB banker.

Northern Rock was unable to use its mortgage book to borrow from the Bank of England, so European banks have in effect access to money that Northern Rock can only tap into in an emergency.

The continuing high cost of the inter-bank lending is likely to lead to some hardship for Irish customers, if the price of money traded among banks does not fall.

The Euribor inter-bank rate - which has been hovering around the 4.7 per cent mark for three-month money (0.7 of a percentage point above the ECB rate) - will affect profit margins at Irish banks if it remains high.

Customers could have to pay more on new tracker mortgages or on variable rate mortgages, as Irish banks strive to maintain their profit margins with these higher costs.

However, panicked depositors are unlikely to be forming queues outside Irish banks any time soon.

How reliant are European banks on wholesale funding?

* Irish banks 45 per cent

* UK banks 45 per cent

* Spanish banks 49 per cent

* French banks 50 per cent

* Italian banks 50 per cent

* Nordic banks 55 per cent

* Benelux banks 55 per cent

* German banks 66 per cent

How reliant are Irish banks on wholesale funding?

* Irish Life & Permanent 65 per cent

* Bank of Ireland 46 per cent

* AIB 44 per cent

* Anglo Irish Bank 36 per cent