This Is a version of a column which appears in the Irish examiner, Saturday 14 September 2012
The last few weeks have seen an economic clarity beginning to appear, as the dust of the bank collapse begins to settle. We see at the European level that there is an acceptance of the role Ireland played (willingly or no) in preventing contagion by means of the bank guarantee and the decision (again, willing or no) to obtain a bailout. We see that there are the glimmers of hope that this will be somehow, by someone , at some time d own the road, rewarded by other than a gold star for our copybooks. We see at the macroeconomic level a much greater clarity, with the government grimly setting out to repair the hole in the state finances left by decades of porkbarreling and special interest trough wallowing (its always amusing to hear private sector representatives of industries which made out like bandits on the back of public largesse decrying public sector wages while calling for special extra grants for their unique capitalism) We see at a micro level that the credit allocation and distribution system of the Irish banks is broken. And that is perhaps the most stark problem we face.
Banks are, in essence, simple creatures. They take money, and lend it out. From the profits they make on lending they run their operations and pay a modest sum in interest to the depositors. Sometimes they want to expand faster than the available deposits will aloow and then they themselves borrow money from others and onlend. The credit intermediation system – transforming deposits into loans – is the basic plumbing of modern finance and has been since the middle ages.
Where it gets problematic in Ireland is that we have a threefold crunch on the banks. First, they are obliged to shrink both because they have grown too fast and that in doing so they became a (realized ) threat to the state. Second, they need to rebuild their capital base. Third, they are sitting on large unrealized losses in the form of residential mortgages – some of this is ever deteriorating mortgage lending situation with close to 1/5 of all mortgages now in some degree of trouble. More is the ongoing drain from the losses being sustained on a daily basis from the tracker mortgages (where the mortgage rate is tied to the very low ECB rate while the financing of these is market rate). A third element is the tail of property related loans that were not swept into NAMA. All of these conspire to reduce credit flow. As Irish banks became more and more dependent on foreign bond holders to lend to domestic construction, a dangerous gap opened. The bond holders having been repaid by the generosity of successive governments, the banks are now funded by (slowly increasing) deposits and (slowly decreasing) ECB money.
Credit to households has fallen by over 50b euro, 1/3 of GDP, since its peak in 2008. Credit to non-financial corporations has fallen by 80b. With deposits falling only by 20b or so, the clear evidence is that the collapse in credit is associated with a shrinking back of Irish banks to a much more conservative deposit led banking system. In the very long term this is good, as such a system is less exposed to international credit cycles. But in the short-term it is a source of massive dislocation. And the SME sector is taking a huge hit. IMF reports suggest that the SME sector accounts for some 70% of employment and generates about 50% of GNP. Historically Irish SMEs were not highly leveraged and they have of course reduced their leverage during the crisis. While some of this reflects no doubt a normal prudence, there is also an exogenous forcing, as they find it hard to obtain finance.
The most comprehensive European data are those of the ECB which surveys every 6 months. 17% of Irish SME’s (as opposed to 13% Euro area) were refused (having applied) loan approval. A further 16% did not apply due to possible rejection, the second highest after Greece. Demand conditions do not help with Irish SME’s rating demand for products as the most pressing issue. This is a classic recession SME finance squeeze – as demand falls the quality of available loans demanded falls, rendering banks less likely to lend. Combine this with an absolute credit crunch, as we have with de-levering banks, and we have recipe for throttling the SME sector.
What is also astonishing is that despite the property slump, lending to SME property sector has increased, massively, since 2010 when the Central Bank began to make sectoral breakdowns of SME lending available. Lending to real estate is up 44%, while lending to primary industry and manufacturing is down 12%, transport and logistics is down 54%, to retail and wholesale SMEs down 22% and hotels and restaurants down 44%. Irish banks are supposed to lend nearly 3b to the SME sector this year, but in fact lending is falling. Stripping out the property and finance sectors lending to SME’s has increased by just over 800m in 2012. There is not a hope that the banks will meet the target. Nor can we expect them to when delevering and when faced with an SME sector struggling to find customers. Government can do little on either – the deleverage targets are set in the final instance by the terms of the bailout and the demand for goods is a function in the main of the domestic economy. Facing a government sector going to take billions more out of the economy in the next budget and the one thereafter SME’s seeking credit would be well advised not to expect a favorable response from the bank. Nor should we expect the broken banks to be able to do their job.
The time must be coming soon when a clean look needs to be taken at whether or not the pillar banks are capable of doing the credit allocation role required. If they cannot, as many suspect, then every step to create new clean banks, whether state or private, must be taken. But that will take courage.