The restructuring of the Irish banking sector

Lest anyone think otherwise, we should be clear that the bailout now being negotiated is aimed squarely at our banking system. The funding needs for the day-to-day running of the State for the next four years (to the end of 2014) will be some €43bn and we start out with over €10bn on hand, some €14bn in our pension reserve (€24bn less €10bn earmarked for AIB/BoI) and a cornucopia of State-owned assets that can be privatised – we can fund the day-to-day running of the State for the next two, possibly three years. And practically everyone in Ireland accepts that we must rebalance our books which today reflect a level of national expenditure commensurate with a tax-take that collapsed two years ago with the implosion of our property sector – political parties representing 80% of the nation want to reduce the deficit to 3% by 2014 and the other main political party representing 11% wants it reduced to that level by 2016. Nothing extraordinary to see here – many other countries are also rebalancing their books which suffered from the fail-out from events in 2007/8.  In truth there is also the €38bn scheduled repayment of debt but banking crisis aside, our debt levels would simply be rolled over under normal circumstances.

The problem is our banking sector and this entry explores the restructuring presently being considered.  To begin, earlier this year when the EU was granting approval to the NAMA project, they included in their Decision an overview of the State’s banking sector.

The above omits the extensive credit union and post office networks which also provide some financial services. And in addition to the above banks and building societies that serve the usual banking needs in Ireland, there are some 430 financial institutions located in Ireland’s Irish Financial Services Centre (IFSC) including Citibank, Commerzbank and Sumitomo. These financial institutions do not serve Irish society with traditional banking services – they are located in a small section of Dublin (dubbed “Liechtenstein on the Liffey” by its many detractors) because of our tax and regulatory advantages.

So of the above banks active in Irish society in 2008, there has already been some “restructuring” with Anglo, INBS and Bank of Scotland effectively ceasing new operations and winding down. So our banking sector today looks like this

Of the above banks, 100% State-owned EBS is presently being sold with the sale at an advanced stage to one of two bidders – Irish Life and Permanent (parent to Permanent TSB above) and a group dubbed the Cardinal Consortium. Four of the other banks are foreign controlled (Danish, Dutch, Belgian and British). Statements from these banks confirm the negative view they take on the Irish economy in the immediate future and there is risk that these banks may choose to retrench or exit Irish market altogether.

And that leaves Allied Irish Banks (AIB – 18.6% State-owned with the imminent prospect of 94% State-ownership) and Bank of Ireland (BoI – 36.5% State-owned but if the share price stays at the €0.30 level recorded this morning and the next dividend due to the State in February 2011 on the State’s residual €1.8bn preference share investment is paid in ordinary shares then it will be 51% State-owned) and of course Permanent TSB (and its parent Irish Life and Permanent). With respect to BoI it seems a record that the EC approved a restructuring of BoI on 15^th July, 2010 and yet more than four months later the decision has not been published. There seems to be some consensus now that AIB will be 100% nationalised by Christmas 2010.  The latest accounts for Irish Life and Permanent (six months to June 2010) show that group having assets of €80bn, liabilities of €78bn and capital of less than €2bn – hardly a strong position and possibly just about able to absorb EBS.

The only “structural” question now seems to be whether AIB will be merged with BoI or will some rump financial institution be cobbled together from AIB and what is lefy of INBS and Anglo and offered for sale to the likes of Deutsche Bank, Santander or BBVA. Alan Dukes, our former Minister for Finance and currently chairman of Anglo yesterday called for the maintenance of “at least two viable banks”. Could we manage with one major “Irish” bank centred around Bank of Ireland with a second-class player in Permanent TSB? Given that our Financial Regulator is reported to now employ 520 people, you might have thought that competition issues with an effective monopolistic operator could be countered.

The other key issues in our banks relate to the accuracy of loss-provisioning and capital adequacy. Our new-ish Financial Regulator, Matthew Elderfield, gave another speech which touched on these issues yesterday. He referred to “overcapitalising” banks so that there could be no challenge to capital adequacy and he proposed that future Prudential Capital Assessment Reviews might have independent third party oversight and that the non-NAMA loans would be subjected to more “granular” reviews. I found this speech disappointing – there seems to have been no independent assessment of non-NAMA losses at a “granular” level – in the case of NAMA loans, once the legal due diligence was undertaken banks were exposed to have had shoddy unenforceable documentation yet there seems not to have been any comparable exercise undertaken in establishing existing non-NAMA loss levels or consequent capital requirements. The Regulator points to the recent mortgage arrears (5.13% of the 790,000 mortgages in the State in arrears for more than 90 days) as being within their stress testing, yet there is no reference to the estimated 45-60,000 restructured mortgages where payment holidays, interest-only payments and other reductions in repayment are standard. Nor to the 16,700 mortgages in receipt of some State assistance. The fear must be that any “overcapitalisation” will simply be swallowed up by new losses. It seems shameful that after a PCAR in March 2010, updated in September 2010 and a European stress test of AIB/BoI that there is still such uncertainty and suspicion about the level of bank losses and capital requirements.

And to repeat, this bailout is really about addressing these bank losses and capital requirements.