Nationalised banks would find it harder to get international funds

 

OPINION:REPAIRING THE balance sheets of our banks is arguably the most significant financial challenge ever faced by the State. It is fundamental to getting credit flowing again to support economic recovery and jobs, writes ALAN AHEARNE

As pointed out this week by the head of the International Monetary Fund Dominique Strauss-Kahn, the experience of past banking crises is that economies do not recover until after the cleaning up of banks’ balance sheets.

A robust debate on all of the options available to Government is very welcome. All of the international experience confirms that a national consensus can maximise the prospects of resolving a banking crisis.

For that reason, the commentary ( Nationalising the banks is the best option) in The Irish TimesOpinion and Analysis pages on April 17th signed by a group of academics is an important contribution. The article makes some valid points, but the analysis is incomplete and the authors end up drawing the wrong conclusions.

The recommendation that nationalisation of the entire Irish banking system is the only way we can extricate the banks and the economy from the serious difficulties we are experiencing risks diverting the debate away from issues that are much more central to the success of the National Asset Management Agency (Nama) proposal. As in other advanced economies, bank nationalisation is seen very much as a last resort.

It is important to recall that there is an overwhelming international consensus that the so-called good-bank/bad-bank model on which Nama is strongly based presents the opportunity for achieving an enduring long-term solution to the banking crisis.

One of the main issues identified in the article is the need to restore bank lending. This is a central objective of the Nama initiative. Nationalisation, on the other hand, creates a significant risk of undermining the capacity of the banks to raise funds internationally for domestic lending.

As recently pointed out in the New York Times by the eminent US economist and former Federal Reserve vice-chairman Alan Blinder, nationalisation may seem an attractive approach in theory but in practice there are several intractable and dangerous pitfalls. These downsides are just as relevant to the Irish situation as to the US and other developed economies.

First, would international confidence in Ireland be sustained in circumstances where the whole of the banking sector was under the wing of the State? Investors would surely give the Irish market a wide berth in the future – not just in the banking sector – if the State undertook such an extreme step.

It is difficult to see a credible exit strategy from wholesale bank nationalisation. The article talks about “temporary” nationalisation but what does that mean in practice? I suspect that the banking sector would remain under State control much longer than advocates of system-wide nationalisation have in mind.

Second, would wholesale international money markets be prepared to fund a nationalised banking sector? Banks in Ireland, as elsewhere, remain very dependent on their continuing ability to raise funds from abroad to finance their activities and meet the economy’s needs. Banks with a continuing market presence and operating subject to market disciplines and constraints are best equipped to compete for funds in the international marketplace.

It is true that the deposits and some of the debts of our banks are guaranteed by the State. But it is naïve to think that providers of funds do not differentiate between banks with a market presence and nationalised banks.

Third, as far as the successful implementation of Nama is concerned, what matters is the State’s ability to achieve an outcome that is good for the economy and good for the taxpayer. It is not at all clear why nationalisation of the entire banking system is believed to better secure these goals.

Under the Nama initiative the taxpayer is protected from unforeseen losses through the Government’s commitment to levy the banks for any losses incurred.

The State has already, under the recapitalisation programme, potential for benefiting from the upside in terms of the recovery in the share prices of the two main banks. The State has an option to purchase at a very low price 25 per cent of the existing ordinary shares in Bank of Ireland, and will soon have a similar claim on AIB.

In addition, as banks’ share prices rise the taxpayer will gain through the equity injection that the Minister for Finance has said the State will make, if necessary, into the cleansed banks following loan transfers.

The valuation issues related to impaired assets highlighted in the article exist irrespective of the ownership structure of the banks. There needs to be a detailed and comprehensive process for assessing asset quality and determining capital needs prior to asset transfer. This approach will be inherent to the execution of Nama by Government.

It is also important to note that, contrary to some popular perceptions, Nama is not a bailout for developers. Nama will acquire loans at an appropriate discount from the face value of the loans held on the banks’ balance sheets. Developers whose loans are transferred to Nama, however, will continue to be liable for the entire face value of their loan obligations.

In conclusion, Nama is designed to achieve the restructuring of the banks’ balance sheets so they can play their appropriate commercial role in meeting the financial needs of our community. Would a nationalised industry effectively meet these needs?

Empirical evidence strongly suggests that private banks perform better than nationalised banks. International studies have shown that too much “policy-directed” lending by wholly state-owned banks has retarded economic growth. The simple truth is that nationalisation creates a significant risk of a political rather than a commercial allocation of credit. This would be bad for the banks but even worse for the country.

Nationalisation of the whole of the Irish banking system would send out the inaccurate and unwarranted message internationally that the whole of the banking system was non-viable; this would be a very damaging message at a time that the Government is working to rebuild international confidence in Ireland and its banks.