The shares of the two main banking groups have suffered from heavy selling in the early weeks of the year, falling yesterday to their lowest levels in three years. It is a trend which is difficult to reconcile with the strong performance of the economy. Irish banking shares are now trading very cheaply when compared to other European banks; the market value of AIB is now just half what it was at its peak last year, when unwarranted takeover speculation surrounded Ireland's largest banking group.
One reason for the fall in banking share prices has been fears of higher interest rates, which has weighed on banking shares in most major markets in recent weeks. Higher interest rates tend to hit bank shares as they increase the return available from Government bonds, traditionally seen as a competing investment for those looking for long-term stability and a steady return.
Late yesterday evidence of this rising interest rate trend came as the US Federal Reserve Board increased US rates by 0.25 of a percentage point. The European Central Bank meets today to consider whether to follow suit.
Irish bank shares have suffered more heavily than most in recent weeks, suggesting that other factors have also depressed their performance. One of these is the new competition in the market here, spurred by the entry of British groups into the mortgage and savings markets.
Fears overseas about the sustainability of the Republic's economic performance has also contributed to the weakness of the banking shares and to the lacklustre performance of the Dublin market in general. Many of the London investment houses, in particular, believe that the economy here is heading for the kind of crash seen in Britain in the late 1980s. This view is, in many cases, built on a simplistic view of recent economic developments and is not generally shared in Dublin. However, following the advent of the euro the major domestic investing institutions have also been diversifying their portfolios away from Irish shares. This has been another factor behind the poor performance of the market and of banking shares in particular.
There is little the banks themselves can do to arrest this trend in the short term, beyond demonstrating that they have a clear strategic view of their business priorities and showing that they implement this vision. If they can successfully grow their businesses both at home and abroad - and do so as successfully as their international peers - then inevitably their share prices will recover in time. All provided, of course, that the economy here can remain on a steady growth course.
However, the pressure on bank shares also highlights a policy issue for the Government. The Minister for Finance, Mr McCreevy, has signalled that he is undertaking a review of the banking sector. This review should look at how competition rules would apply in the case of proposed banking mergers here.
The trend in Europe is for banks to consolidate within their national boundaries; when this process is complete, cross-border takeovers will become more common as major institutions look to build a business across the euro zone. If Irish banks are to play a role in this process - as opposed to eventually being purchased by bigger players - then the Government may need to consider allowing larger institutions to develop in the Irish market through mergers and acquisitions than would be permitted under current competition rules.