At long last, an endgame for our shattered banks

ANALYSIS:Doubts about relying on the views of deluded bankers have been definitively addressed

AS THE banking bill reaches an eye-watering €70 billion, it would appear that in the third year of the crisis, this may finally be the endgame for the shattered banks.

Central Bank governor Patrick Honohan said, without a hint of hyperbole, that this was “one of the costliest banking crises in history”. The figures support this.

He said the losses at the Irish banks and the foreign lenders in Ireland have topped €100 billion.

For a banking system with a balance sheet of about €500 billion at peak, this is an extraordinary hit.

Property accounted for about 60 per cent of loans at the banks.

This has been one of the worst property crashes globally, so the staggering losses are understandable given the collapse in the value of the vast number of houses, apartments and office blocks built over the past decade.

Honohan said the scale of the latest bailout, the fifth since December 2008 – and the €24 billion in cash required – will lead all six institutions into majority State ownership. “That is only realistic,” he said.

This marks the virtual nationalisation of the Irish banking system.

But have these latest stress tests gone far enough? They should have, given the severity of the tests and the unanticipated shocks considered. They were described as “apocalyptic” stress tests by the chief executive of the National Treasury Management Agency, John Corrigan.

The Central Bank, using outside consultants BlackRock Solutions to value the loans, have ripped up the floorboards of the Irish banks to examine every bad loan.

BlackRock fed every mortgage, about 700,000, through its models and considered how they would perform over the lifetime of the loans, stretching out to 2040. The Central Bank considered losses to 2013 and beyond.

Previous stress tests failed to go far enough to reassure international investors that the banks had been purged of their problems and that the Government had finally grappled with the true extent of the problem.

These tests should finally address any lingering doubts about relying on the views of deluded bankers.

The €27.7 billion in loan losses estimated across the banks under the stress tests were €5.5 billion above the banks’ own estimates.

The Central Bank has also directed the banks take not just €18.7 billion to meet these losses but a further €2.3 billion for “additional conservatism” and €3 billion of contingent capital to cover losses beyond 2013, giving us the latest capital bill of €24 billion.

This is in addition to capital already raised and loans already written down, as well as profits to be made up until the end of 2013.

Where the previous government failed to go, new Minister for Finance Michael Noonan is not only overseeing onerous stress tests to expose the true extent of the losses in the banks but undertaking an overhaul of the system.

Where once there were six banks, there will soon be two – Bank of Ireland and AIB – in an attempt to create two strong financial institutions and restore confidence in Irish banking.

Noonan described them as “two new strong universal pillar banks”.

His predecessor toyed with the idea of mergers to strengthen the system in November 2008 but quickly dropped it.

Honohan said that the “two pillar approach” would mean that the banks can actually start lending into the economy again.

You would certainly hope so, once they are stuffed with this vast amount of cash to be injected, recapitalised to levels that are higher than some of the Swiss banks.

“We are pretty much starting from scratch,” said Matthew Elderfield, the head of financial regulation at the Central Bank.

Having only two banks and both being in public ownership wasn’t ideal, said Honohan, but the system has to restart somewhere.

The other banks have no futures as standalone banking entities.

Anglo Irish Bank and Irish Nationwide Building Society – the two “baddest” banks – are being consigned to the scrap heap.

The building society EBS will be merged into the larger AIB.

Irish Life and Permanent, the biggest mortgage lender during the boom, will be broken up, and its profitable pensions and investments business Irish Life sold to help cover the cost of its bank, Permanent TSB.

The bank may still be merged into Bank of Ireland but Irish Life must first be sold.

In general, it will be back to the future for Irish banking – the sector will be reshaped around the old Bank of Ireland-AIB duopoly.

Competition concerns must hardly matter at this stage, given the dysfunctional state of the banks and how they are surviving on the life support of €140 billion in funding from the Irish and European central banks.

Besides, aggressive and unchecked competition between the banks was one of the factors that brought us to this point.

In this new world, Honohan said he would be more concerned about the pricing of bank products than the availability of loans.

The Government will rely on the foreign-owned lenders, most notably Ulster Bank, to become a natural “third force” to keep the two main banks honest in competitive terms.

Those banks also have their own problems.

The effective nationalisation of the lenders allows the Government to move quickly to reshape the banking system.

The capital holes to be filled – relative to the value of the remaining publicly quoted banks – makes the Government the only source of cash, pushing the last two - Bank of Ireland and Irish Life and Permanent – into State control.

Not only was the Irish system overbanked but each bank overlent, forcing them to borrow heavily internationally to fuel their property lending and bridge the gap between loans and deposits.

“The banks were too big for the economy,” Noonan told the Dáil.

The Minister described the day in September 2008 when the last government guaranteed the banks so they could continue borrowing as “the blackest day in Ireland since the Civil War broke out”.

Now he will not only reform the banking system but is forcing the reduction in the size of each bank, bringing them back to banking basics where they rely on deposits.

Their loan books will be split into core

and non-core, with non-core loans (almost all overseas) run off or sold gradually to the end of 2013 so as to avoid fire-sales and further capital holes to be filled.

Some €72.6 billion of loans must be run off before the end of 2013. Bank of Ireland accounts for most of this, having to offload €32.6 billion, followed by AIB with €19.4 billion and Irish Life and Permanent with €15.7 billion.

The Central Bank has factored in a total loss of €13.2 billion on selling off these non-core assets.

This is covered by the €24 billion bill, most of which is coming from what has become the State’s banking resolution war chest, the National Pension Reserve Fund.

The Government and Central Bank has ruled out any sharing of bank losses with senior bondholders. The EU is “hostile” to such a move, said Honohan.

Up to €5 billion of subordinated debt – loans that pay investors a risk premium – will be written off to cover some losses. The banks’ own sale of profitable parts should also help meet some of the banking bill.

Anything to reduce a €70 billion bill for a banking system that will be largely owned by taxpayers must be welcome.

The new Government should be applauded for taking such a once-and-for-all approach in tackling the full extent of our banking woes.

The other positive is that Anglo Irish Bank said yesterday that it doesn’t need more than €29.3 billion already committed to the bank.

Simon Carswell is Finance Correspondent