Crucial details of how the banks can survive on their own not in plan

ANALYSIS:The memorandum backing up the EU and IMF plan is short on detail but long on sweeping statements about change and deadlines for action

THE AGREEMENT – or memorandum of understanding – on the Government’s €85 billion rescue plan with the EU and IMF revealed little new on how the banking sector would change.

Once again, the crucial detail of how the banks would be carved up and slices of their businesses removed to ensure they survive on their own was again missing.

We know that the country’s two biggest banks, Allied Irish Banks and Bank of Ireland, are going to be slimmed down. We know that Anglo Irish Bank and Irish Nationwide Building Society have no future and are going to be closed.

We know that the banks are going to have split their businesses into core and non-core – or good and bad operations – and show how they plan to run down or sell off non-core assets and loans to investors in securitisation deals with State- backed guarantees that will cost further billions of euro “once the market stabilises”.

But there was little in this latest action plan on what shape the banking sector would take – will the six banks be three in two years’ time and what parts of the banks will attempt to be sold off?

It emerged last night that some of the agreements reached on the planned changes to the banks is contained in a side letter between the Government and the EU-IMF, which has not yet been made public for reasons of confidentiality and market sensitivity.

One of the more interesting disclosures and immediate actions to be taken is that the Government will determine the expected size of each bank in 2013 by setting targets for loans-to- deposits ratios at each by the end of the month.

The Central Bank – in conjunction with the European Central Bank, the European Commission and the IMF – will agree “ambitious” ratios for each lender.

It has been quickly realised – by recognising the banks’ growing and heavy reliance on European Central Bank and Central Bank funding – that liquidity is the immediate crisis facing the banks.

A bank can stumble on with low reserves of capital but a shortage of funding or liquidity can knock a bank over quickly. The surge in Central Bank borrowing by the banks triggered the EU-IMF plan.

Loans-to-deposits ratios are the measures to be tweaked that will determine the repair of the banks.

Ratios vary across the banks. At Irish Life Permanent, the biggest mortgage lender during the boom, it stands at well over 200 per cent.

This means it has more than €200 out on loan for every €100 on deposit, leaving it heavily reliant on cheap Central Bank loans. The industry average is about 165 per cent and must be brought closer to between 100 and 120 per cent.

The bigger banks, such as AIB and Bank of Ireland, can survive near 120 per cent, while the small banks, such as EBS, must get their ratios closer to 100 per cent.

Pumping €10 billion in capital up front into the banks – and leaving a further €25 billion in a just-in-case fund – will help but reducing the size of the banks is the key to repairing them and reducing the strain on the State.

The banks became too big to fail and then too big to bail – yesterday’s agreement puts only a little flesh on the bones of the plan to show how they will shrink in size.