Challenge for banks

Allied Irish Banks produced its final results on Wednesday, matching market expectations in reporting a €2

Allied Irish Banks produced its final results on Wednesday, matching market expectations in reporting a €2.5 billion pre-tax profit for 2007. That was a four per cent drop on the 2006 figure but the bank's results contained few surprises and were broadly in line with earlier guidance on earnings that AIB management had provided.

The writedowns for the bank's investment losses in the US subprime market dented its financial performance somewhat. Those writedowns, however, amounted to relatively small losses and reflected AIB's limited exposure to the high-risk subprime sector. In this regard AIB's investment caution remains in sharp contrast to the reckless enthusiasm shown by some of its European and US peers for these toxic investments.

Credit Suisse, one of Europe's largest banks, shocked investors on Tuesday when it announced a further €1.9 billion write down, arising out of subprime losses incurred last year. The surprise revision came less than two weeks after the Swiss investment bank had released its full year results for 2007, but had failed to take these losses into account. The bank's results were signed off by accountants, involved detailed disclosure of its subprime exposure, and were assumed to reflect an accurate and up-to-date account of Credit Suisse's financial position. Once again, public confidence in the competence of banks to manage their own risks, already diminished by the huge trading losses at Societe Generale and the mismanagement at Northern Rock, has been further weakened.

AIB, to judge by its 2007 results, hopes to reassure investors that it can manage its own loan risks successfully. In its accounts and briefings, the bank has provided a detailed disclosure of its activities and outlined how it hopes to minimise the risk of major loans losses in vulnerable sectors, such as housing, given the downturn in the property market. There, AIB has started to closely monitor some €700 million in loans to property developers, which amounts to some eight per cent of its Republic of Ireland property and construction loan book. This is a pre-emptive move by the bank to minimise potential losses to borrowers at risk of default.

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AIB chief executive Eugene Sheehy has conceded that some mortgage holders are now experiencing negative equity. Nevertheless, he said, their loan repayments were not affected. He has also admitted that: "Banks have destroyed their credibility to a very significant degree over the last six months and investors will be slow to forgive them." The slump in bank shares, not least the low ratings for Irish banks, provides evidence of that and the scale of the challenge ahead.