Last Thursday, I announced the Government’s radical and wide-ranging plans to restructure the state supported banking sector. When we published our plan the Government had a number of objectives: to restore confidence in the banking system and in the economy of the country; to recapitalize and restructure the Banks; to restore credit to the economy so that growth will rebound and jobs can be recreated.
All three objectives are being fulfilled.
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Our plan set out to restore the confidence in our banks and economy lost by the aimless and indecisive plans of the last government. The reaction at home and abroad to our policies shows that confidence is being restored.
Since our announcement last week: Bank of Ireland shares have advanced for three consecutive days of trading, increasing 45% since our plan was announced; Allied Irish Banks likewise advanced significantly.
The total amount of deposits withdrawn from the pillar banks has been very significantly reduced. Since Thursday’s announcements, the net deposit position of the Pillar Banks has improved significantly. Irish 10 year bond rates peaked on the 31 March at 10.322% and have since fallen back by close of business last night to finish below 10%
Standard and Poor’s has removed Ireland from CreditWatch, noting that “the outlook is now stable ». Their statement reiterates their opinion that “the assumptions underlying the stress test conducted by the Central Bank of Ireland - in conjunction with the IMF, European Central Bank (ECB), and European Commission - are robust and that the expected €18-€19 billion net cost to the Irish state of additional recapitalisation, plus the contingency buffer for the banking system, is within our range of expectations, albeit at the upper end.” S&P also noted that they “believe that the Irish economy has stronger growth prospects than the Portuguese and Greek economies considering its openness, its flexibility, and its competitiveness."
Moody’s stated that they “view the plans to deleverage the system as credit positive, as they will reduce the high reliance on central bank funding.” They did however acknowledge as we know ourselves that the plans to deleverage “will be a challenging process”.
Fitch described the stress tests as “an important step” in restoring confidence in the banking system.
Market Participants have also responded well. In a report on Monday entitled “Ireland – Time to Buy” Morgan Stanley encouraged investors to buy Irish sovereign debt. The investment bank says that Ireland is still facing major challenges. 'But if there is one economy in the euro area than could meet these challenges, it is probably the Irish economy, we think” They went on to say that “The stabilization of the Irish banking system that we expect the stress test to facilitate should allow the economic turnaround already underway to boost investor confidence in Ireland’s medium-term debt sustainability.”
While this response is very positive and will help build up confidence, I appreciate confidence is a fragile flower that can fade under the stress of international events. The initial response is however very positive and this is to be warmly welcomed.
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The
reorganisation and recapitalisation of the banks we announced has received wide-spread approval and involved a number of steps: In essence, our banks are to become smaller, more focused on core operations, better funded and better capitalised.
Firstly, the Irish banking system is being reduced to a size appropriate to our economy. This involves the sale or run-off of in excess of €70 billion of non-core assets. It will be accomplished in line with detailed plans submitted by the banks and reviewed by the Central Bank and the Government.
The system is in parallel being reorganised so as to create a banking system that has two universal full-service domestic banks as its core pillars and a radically restructured Irish Life and Permanent. The first Pillar bank is being created from the already strong franchise of Bank of Ireland and it is our intention to combine the businesses and strengthen the franchises of Allied Irish Bank and the EBS Building Society to form the second Pillar bank. Overseas banks operating in Ireland will help maintain the competitive fabric of the market.
Each of these banks has already begun to reorganise their operations into core and non-core functions and to implement a carefully managed programme of deleveraging.
As the non-core assets which do not serve growth on the island of Ireland disappear, the Pillar banks will become even better able to serve the economy as functioning banks rather than the oversized, overleveraged banks they now are.
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A key element to a successful plan for reorganisation is funding. Shortly after we presented our radical plans to resize and reorganise the banks, the ECB issued a number of very important announcements related to the continued availability of Euro system funding for our banks:-
Firstly, and of most importance, they confirmed that against the background of our decision to recapitalise the banks in line with the Central Bank’s “rigorous assessment of the capital needs of the Irish banks”, the Eurosystem (or ECB) will continue to provide liquidity to banks in Ireland and also “supports the Irish banks plans to deleverage and downsize their balance sheets”.
Secondly, they confirmed that all marketable debt instruments issued or guaranteed by the Irish government will be deemed as fulfilling the credit standards required for collateral in Eurosystem credit operations irrespective of rating. In the absence of such a statement, the risk was that the banks access to ECB funding would have been restricted were there downgrades of the sovereign.
By confirming the availability of liquidity for the Irish banks, this allows the banks and the banking sector to avoid all too speedy deleveraging in currently difficult markets. This means the Irish taxpayers avoids upfront losses from system wide firesales which would have cost the exchequer €45 billion.
This is critical to minimise the losses in the banking system. Selling assets in a rush where the world knows you would have to sell them to repay a bank demanding its cash immediately is never a way to maximise the sales price.
Equally importantly, the banks continue to access the cheaper interest rates of this funding to transition to less difficult times as compared to the 5.8% interest payable on alternative EFSF funding amounts
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Positive market reaction is one thing and certainly more than just a nice to have. More critical, however, to our plans is having a new approach to system design so as to provide the necessary credit to spearhead economic recovery. Economies cannot function without access to credit. Certainly, they cannot grow without access to the credit required to permit such growth.
As consumer and business certainty recovers, credit demand improves. Householders feel less insecure about income and employment prospects and businesses feel more comfortable about making investment decisions.
If improvement in credit conditions helps to stabilise asset prices, credit demand will then increase further. But without access to lending and credit none of this can occur.
The wise shop-owner who cuts his costs and gets his business running even in recessionary times needs to be able to invest in new equipment to make things work even more efficiently. He may want to open up a second shop across town and employ three more people. Nothing is possible without a reasonably priced loan permitting the investment.
And it is not just a problem for SME’s. You cannot buy the house down the road for which you have the deposit unless the bank is willing to grant a mortgage to fund the rest of the purchase price. So the house-buyer cannot move to buy, the house seller panics, reduces the price even more and still the buyer cannot buy. The floor falls from under the price at even unreasonably low levels simply as no one can get a mortgage.
Everything stagnates as we have seen without credit supply. The scale of the drop in activity has been noted in the recent Home Bond announcement that only 87 new homes were registered last month.
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In recent years, excessive attention has been focused by bank management on the need to recapitalize and repair broken balance sheets under the previous governments failed policies.
With banks under pressure to deleverage quickly, new lending suffered very considerable downward pressure. Despite the efforts by the Credit Review Office, business and retail confidence in the availability of credit got completely eroded.
Our decisive plan will provide a powerful support to encourage investment and help get people back to work. We must break the vicious cycle whereby limited access to credit hurts economic growth by restricting investment and consumer spending which in turn causes further job losses which even further limits spending.
Our plan will provide credit to encourage investment and consumer spending, thereby instilling in the economy a confidence which will lead to increased employment and even further consumer spending and confidence.
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As I have said, for the past three years and up until last Thursday, banks were under extreme pressure to delever and restructure their balance sheets. It is impossible to consider new lending as a priority when you have capital and funding problems. With inadequate capital, the pressure came first from a need to avoid new lending activities which would have used up scarce capital resources.
We have solved that by committing to properly capitalise the banks to deal with losses in their legacy books and also to withstand all foreseeable shocks to their businesses even in the extreme pessimistic scenarios. With funding difficulties, the banks were under pressure to delever assets in order to repay the funding due to the ECB and our own Central Bank.
We have solved that by working with the ECB and the Central Bank to provide for liquidity coverage for the deleveraging plans while at the same time accommodating in those plans more than €30 billion of new lending between now and 2013.
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The key to creating the potential for new lending is to be found in a full understanding of the deleveraging process. It is that dynamic which presents the catalyst for new lending and a clear change of direction from failed past policies.
The Central Bank has estimated for me that SME and mortgage credit of €11 to €16.5 billion of gross new lending will be required in total over the next three years. Our plan creates capacity for the Pillar Banks to lend in excess of €30 billion over the same three year period.
Over the period to 2013, to resize their balance sheets and achieve acceptable loan to deposit ratios, the Pillar Banks need to delever their balance sheets by in excess of €55 billion of loans. Each year, on average, €10 billion of existing loans get repaid in the Pillar Banks’ core businesses – that is more than €30 billion over three years. If the banks restrict new lending in their core banks, achieving the plan could have required an identification of just €25 billion or more of additional non-core assets to be sold off or run-off.
New lending would be zero but the banks would delever to the desired size and could commence new lending in 2014.
The Government might have stopped there. That would have just continued the failed policies of the past. We could not wait until 2014 to see the banks working again for the economy. The €30 billion or more of expiring lending over the three years had to be saved for the Irish economy system. The banks could not come under pressure to pocket the cash and use it to repay the ECB. It had to be recycled into the economy.
So, we are overcompensating on the deleveraging of non-core assets. We have identified a full €57 billion of assets which were not required to rebuild the economic growth of the country. These are the assets to be wound down or sold.
By taking out or deleveraging extra assets, the reorganization plan retains a clear capacity across the two pillar banks to recycle the expiring core lending to create new lending in activities which would spur economic growth.
“Down fifty-seven, up thirty”, giving the same net reduction of €27 billion or more, but critically a key target of more than €30 billion for new lending now is part of the system.
Other systemwide deleveraging occurs separately in other banks like Anglo Irish without disrupting this. Even better, this exercise results in €30 billion of legacy core assets being replaced with new lending in the core banks free from the problems of the past.
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The second key feature is that lending in the core banks does not need to be increased to service the economic needs of Ireland it just needs to be redirected. We know that the Irish banks have lent excessively to their clients in recent years especially for foreign real estate purchases. The credit allocation has become skewed towards real estate lending and genuine borrowers in for example manufacturing and agriculture have seen their percentage share of the lending pie reduce annually over time since the end of the 1990’s.
Loans like mortgage lending to families in Donegal, to small manufacturing businesses in Dundalk, to hotels in Galway, to small shops in Mullingar, or just credit card spending taking a family to Sunday lunch in Limerick will repay in the next three years.
But equally other loans from excessive credit lending to real estate activities will also repay over this period. My Department published last Thursday some statistics which show how real estate lending became disproportionately large. Lending to trigger economic development in other areas like agriculture and manufacturing was squeezed out of the system by the rush to lend to real estate developers – and even to farmers, shop-keepers and solicitors wanting to become real estate developers.
It is now necessary to reverse this trend. Putting back more than €10 billion of lending per annum into the economy is a good thing but it could easily be a bad thing if we repeat the mistakes of the past and allow the lending to take place in the wrong parts of the economy. Working with the Central Bank, the Banking Policy Division of the department will develop safe monitoring tools to prevent excessive concentration of lending in undesirable sectors.
We will proactively encourage lending in the sectors where we need to see additional growth such as agriculture, manufacturing, the green economy and to allow people to once more buy new homes.
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The Credit Review Office commenced operations on 1st April 2010 to ensure that Allied Irish Banks and Bank of Ireland achieved their objectives of making €3bn new lending available each year to SME’s over the period from 2010 to 2012.
While this process has worked to improve the previous wholly unsatisfactory situation, problems remain. The most recent quarterly report of the Credit Review Office, itself notes that the “perception of bank borrowing being difficult to access” has led to some businesses engaging in the “risky strategy” of investing working capital into fixed asset projects. This puts these businesses in a more perilous situation unable to trade through difficult trading periods and also dampens their investment in improvements or expansion of the businesses.
But there are some positive signs. In the words of John Trethowan, Credit Reviewer, the potential of a borrower to appeal to the Credit Review Office against their treatment and credit decision, has “in itself had a positive influence on the behaviour of these two banks”. It is a step in the right direction but it is not sufficient. We will build on the work of the Credit Review Office to ensure the most effective access to enlarged credit lending from the pillar banks.
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The total capital required for the Central Bank stress test exercise is €24 billion. The net impact of this to gross debt is significantly reduced by measures we are taking.
In total, the total impact on gross debt may not exceed c€2 billion in total (less than 1.5% of GDP). Of the total amount of €24 billion, €3 billion will be a contingent buffer or COCO contingent capital instrument paying a market coupon to the state which will reduce the cost to the exchequer of financing this investment.
The agreement with the external authorities provided that the State would provide €17.5 billion of funding towards the programme of support for Ireland. It is proposed therefore that the NPRF will provide an additional €10billion and that the state will fund a further €7 billion from cash resources. This will reduce the additional debt service cost to the State associated with new capital injections.
Additionally, as we have already announced, the Government will require burden sharing from subordinated bond holders, will require capital generating asset disposals by banks and will endeavour to raise capital from private investors to alleviate the burden on the domestic taxpayer.
We expect, therefore, as I have said, that the impact on gross debt will not exceed more c.€2bn in total (less than 1.5% of GDP).
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Since the banking crisis commenced, many statements have been made in this House in the past. Many good policies were outlined after the mistakes of the 30th September 2008 but they were never implemented. We will not make the same mistakes. We have already started to implement the policies we outlined last Thursday. Already, my staff have met with the CEO’s of the banks to explain what will be required in the upcoming weeks and months.
Details of how the implementation of these policies will be effected are being finalised by the Banking Policy Division of my Department, working with officials from the NTMA and the Central Bank. I hope to shortly provide further details to the House of these arrangements.
Banks are only one aspect of the restoration of economic growth in Ireland. We understand that we must do more to build up of confidence in industry and consumers so that they feel confident in the future again and feel that they can spend for the future.
At the moment, the households savings rate is extraordinarily high. In large part because families and individuals are worried about the employment prospects. We must do what we can therefore to stimulate growth in output and to make what output growth which materializes more jobs rich than it would otherwise be.
To this end the next key part of the Government’s programme will be the jobs initiative that we plan to announce before the end of May. Amongst other things it will start to tilt the taxation system in a jobs friendly fashion and will begin to alleviate the problem of long term employment by greatly increasing participation in training and education programmes.