Government took far too long to repair the banks

BACKGROUND: The US and UK took quick action at the start of the recession, while we procrastinated, writes SIMON CARSWELL Finance…

BACKGROUND:The US and UK took quick action at the start of the recession, while we procrastinated, writes SIMON CARSWELLFinance Correspondent

IT WAS 18 months ago yesterday that the Government introduced a blanket guarantee for the domestic banks, enabling the six institutions to fund themselves. While this restored vital oxygen to the suffocating banking sector, the underlying condition of the patients is only now being fully diagnosed and treated.

Banks in the US and UK are well on the road to recovery because they have either repaid their state aid or are in advanced planning to do so.

The Irish Government is still pumping money into banks. So why has it taken so long?

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The Government’s two previous attempts to recapitalise our two main banks, Allied Irish Banks (AIB) and Bank of Ireland – in December 2008 and February 2009 – proved inadequate, failing to address the realistic scale of the losses due to the property crash and the worst recession since the foundation of the State in 1922.

Delays in designing and building the complex National Asset Management Agency (Nama) – devised to purge the banks of their toxic loans – stalled progress. The plan to transfer about €81 billion in loans – at a discount – was aimed to call losses at the banks, who had refused to acknowledge them. But Nama has missed repeated deadlines.

Yesterday’s announcements from Minister for Finance Brian Lenihan and the Financial Regulator that the five Nama participating lenders would need an additional €21.8 billion in cash will effectively bring the Government to a point many feel it should have reached a year ago.

While some of this cash may be generated by the lenders, much of it will come from the State.

Mr Lenihan said that it was “probable” that the State would take a majority stake in AIB and expects to remain a minority shareholder in Bank of Ireland by converting more of its existing €3.5 billion investment in the bank into a direct stake.

This is similar to the position the UK has found itself in but which it reached in almost half the time – majority ownership of one of its largest banks, RBS, and a minority stake in another, Lloyds.

The €2.6 billion required at Irish Nationwide and €875 million at EBS effectively brings the building societies into State ownership, joining Anglo Irish Bank as nationalised lenders.

This has been a slippery slope for the Government to this point. Part, majority or full nationalisation of the country’s three biggest banks – AIB, Bank of Ireland and Anglo Irish Bank – was always on the cards given their collective €45 billion exposure to the toxic development sector, never mind mounting losses on loans to other faltering sectors of the economy.

The three had a core of just €19 billion in reserve this time last year to cover their massive losses.

The Government’s decision in February 2009 to pump cash into AIB and Bank of Ireland, by way of preference shares on a €3.5 billion investment in each (and not by direct ownership), was curious given that losses should have been borne by shareholders.

Mr Lenihan sought to avoid greater nationalisation of the banking sector after taking over Anglo in January 2009. He gave banks the chance to raise more cash on their own, to avoid majority or full nationalisation.

Inevitably, this plan failed and given the €7.4 billion required at AIB, majority State ownership looks inevitable as the sale of its UK, US and Polish interests will only raise about €4 billion.

Bank of Ireland is in better shape but will try to keep State ownership below 40 per cent.

Prof Patrick Honohan, an expert in banking crises, warned against using Nama to recapitalise the banks last May, four months before he took over as governor of the Central Bank. His arrival in Dame Street, followed by the appointment of a new regulator Matthew Elderfield in January, brought fresh momentum.

Both chose not just to consider the impact of the Nama losses, but stress-tested the non-Nama loans and set the capital bar higher for the banks in preparation for yesterday’s recapitalisation plan.

AIB’s foot-dragging in the run-up to the announcement – where once again the recalcitrant bank sought to resist Government plans for its rescue – is understandable given how much it is set to lose following yesterday’s announcement.

Now the bank looks like it will have to cede a majority stake to the State. This is not surprising given that AIB had a higher level of exposure to the noxious development sector than Anglo.

The prolonged repairs at AIB and Bank of Ireland contrast with the relatively speedy changes and realistic, but difficult, loss assessments taken by the new management at Anglo, in situ for just over three months.

This point could have been reached far sooner had Mr Lenihan installed his own managers across the other banks – or at AIB at the very least – 18 months ago after the guaratee.

One benefit of this drawn-out process is that Mr Lenihan has bought time and stabilised public finances, enabling him to write a far bigger cheque than the €11 billion already written to bail out the banks and lower the risk of spooking the omnipotent bond markets he so fears. But this “shock and awe” bank recapitalisation plan has come many months too late.