Why should we believe a word the banks tell us about their ability to carry on
business? The three biggest lenders — AIB, Bank of Ireland and Irish Life &
Permanent — all insisted in the past fortnight that they’re not short of the
capital required to issue new loans. But only the most naive would believe
this latest confidence trick.
Put simply, the banks have form when it comes to understating their problems.
For years they denied lending recklessly, despite being the prime players in
a pyramid scheme where they lent massively to property developers. The
developers then flogged over-priced houses, apartments and commercial
buildings to people who borrowed far more than their income warranted. The
buyers got that money from the same banks who had funded the developers in
the first place.
As their share prices collapsed earlier this year, the banks insisted they
were happy that most customers could meet their repayments. They even
insisted that the security given for loans — usually property — had retained
sufficient value if they had to be sold. They boasted that they were flush
enough to continue paying out dividends to shareholders.
The technical term for all this guff is “maintaining confidence”. In reality
it was an attempt to fool the investors who traded their shares. It didn’t
work. Most investors ignored the spin and sold Irish bank shares, to the
extent that they are now worth just a small fraction of their value 12
months ago.
Now those same banks are being forced to confront reality. They are finally
admitting that some customers can’t repay loans and that the assets securing
those loans have fallen in value. Money is now being put aside to meet bad
debts. That’s eating into profits, but it’s not enough to cope with the
coming crisis.
The banks are still looking after their biggest customers, particularly the
property developers who have massive debts. They are giving them a holiday
from repayments, or if the interest cannot be paid they are adding it to the
loan. In cases where banks address the reality of falling asset values, they
are forcing some borrowers to make sudden repayments to cover the reduced
value. Shareholders won’t be getting dividends for the foreseeable future
but that won’t be enough to protect the banks’ capital bases.
Given their parlous condition, you’d imagine all donors bearing fresh capital
would be welcomed. An injection of funds would allow the banks to get on
with business, using rebuilt profits to cover the losses on bad loans. It’s
happening all over the world.
For some reason our own banks believe they are different. They insist they
don’t need new capital, and certainly not from the state. AIB boss Eugene
Sheehy told investors recently that he’d “rather die” than allow the
government to become an investor in his bank.
This is an extraordinary statement. AIB had to be rescued by the government in
the mid-1980s from the near fatal consequences of its purchase of an
insurance company. Just six weeks ago AIB chairman Dermot Gleeson and his
Bank of Ireland counterpart Richard Burrows went to the Department of
Finance on bended knee pleading for government action to stop a potentially
ruinous run on their banks.
The government acquiesced, and that was the correct decision. It didn’t want
to bail out the banks, but ministers couldn’t risk the economic carnage that
would have developed if a bank had collapsed. The banks may have exaggerated
the crisis, but the government had little time to assess the situation and
acted decisively, guaranteeing the deposits and liabilities of seven
domestically owned lenders at a potential cost of ¤440 billion.
But that is not enough. The government needs to do more to reform the banks
and that means going beyond the populist stuff such as curbing salaries and
bonuses for top executives. It needs to find a way to ensure that the banks
continue lending for non-property related activities, particularly to
businesses.
The mounting anecdotal evidence is that they are failing in this basic
function. Many companies with cash flow problems, exacerbated by difficulty
in getting payments from customers, are facing ruin. Ironically, the banks
have been given two years’ comfort courtesy of the taxpayers, but are not
reciprocating where their customers are concerned.
They have no interest in new business and seem content to take in repayments
on good loans and squeeze what they can from bad ones. They have turned into
“zombie banks”. Even though their liquidity is no longer a problem (¤25
billion in deposits has come from abroad in just six weeks), they are
keeping all the benefits of this cash themselves.
But the game is now up. Bank shares have continued to fall in the wake of the
government guarantee because you can’t fool the investment community. They
know new capital has to be raised. Hundreds of millions of new shares will
have to be issued in exchange for money, which will dilute further the value
of shares already in existence. It’s in the interests of existing
shareholders to prevent this.
Directors and senior managers in all the banks have large shareholdings and
they are now worth a fraction of what they paid for them. Some holdings were
paid for with borrowed money. So while an injection of capital would improve
a bank’s ability to do business, it could undermine further the financial
positions of those who operate the banks, especially as any new owners would
want to remove those responsible for creating the mess.
Despite their own problems — and their moral debt to taxpayers — the banks are
cynically exploiting the government’s own weakness, refusing not just to
raise new capital but also resisting mergers with weaker competitors or
lending for anything but the safest of ventures. The banks can get away with
this safe in the knowledge that the government is skint and doesn’t want to
bear the cost of recapitalisation unless absolutely forced to do so.
Worryingly, there is no sign of private investors lining up to plug the gap.
Price Waterhouse Coopers is in the second phase of an investigation into bank
debts and that will put the government in a better position to decide how
much, if anything, it should invest. The government has little time in which
to act but should have no fears if it decides it must take control of the
banks. This would allow it to get a fair return on its investment while
ensuring that financial institutions play their essential role in the proper
functioning of the economy. In time, it might even be able to sell on its
investment at a profit.
In taking this step the government must be able to show that any purchase is
in the best interests of the state and not the bankers who created the mess.
That would require the wholesale firing of directors and senior managers to
avoid the perception that they are being rewarded for failure.
Of course, if the same criteria was to be applied to the civil servants and
politicians who have destroyed public finances over the past few years,
there could be a lot of blood-letting by the time this crisis has run its
course.
matt.cooper@sunday-times.ie
