Sowing the seeds of the next banking crisis…

This is a extended version of a column in the Irish Examiner 29 June 2013.

The revelations of the attitude of the Anglo bankers –sociopathic is a word that comes to mind- should remind us of the need to stop and look at the governments banking policy.

15998338What was surprising to many  about the Anglo tapes was that the speakers come across as densely arrogant, cavalier in terms of both their language and their approach to business and having forgotten that they were being recorded. Perhaps  however it was not so much denseness as insouciance – after all, for these would be masters of the universe they were untouchable, playing a game with other peoples money and winning regardless of how the game progressed. They had succeeded (despite protestations now that that was not what they had intended) in misleading the state into a rescue based on illiquidity knowing that they would at best require multiples of the initially stated sum and at worst that they would end up insolvent and wards of the state. They even had managed to poke the Germans and the British in the eye. So perhaps they can be excused. But they wont and they shouldn’t be. They played fast and loose with the rules, won, scooped the (personal) pot and then got exposed. What is interesting is what other revelations lurk in other tapes from other banks.

What cant also so easily be excused is the way that the government, permanent and elected, is planning to allow a structure whereby such arrogance and insolence can flourish again. Indeed, they are encouraging it. The problem with Anglo, in essence, was that the bankers felt that they had become to big to fail. Linked closely with the ruling party, bankrolling the turbocharging of the economy feted as financial magicians they felt financially and politically invulnerable, and this presumption proved correct. Alas, when the magic went away the benefits went also

too-big-vs-too-smallRight now the government plan for banking is to create pillar banks. It is to reduce and consolidate Irish banks into two main banks. While this will make the job of regulating them easier it is also quite clear that it runs grave dangers. We have seen how Irish regulators in many many areas are easily captured. We have seen how these regulators tend to actually regulate only when the external forces become too powerful to ignore  forcing the policy porcupine to unroll and face the world.  With few exceptions and regardless of their nominal power most Irish regulators have proven to be toothless. Think elder care or creches or waste water or FAS or…you get the picture. Most meaningful changes have come about not from internal regulatory pressure but from outside judicial and economic pressure. If regulators were unable to regulate Anglo and AIB and the rest from running amok, why would we necessarily conclude that they will any more effectively regulate pillar banks? Maybe this time will be different but would we want to count on that?

pillarbankThe pillar banks will be by design too big to fail. Therefore they both will not and cannot, regardless of their transgressions, fail.  One of them will have embedded into its corporate culture a shocking degree of moral hazard, having been rescued by the taxpayer twice in the last few decades. Moral hazard in a corporate culture is likely intractable and incurable and must inevitably run the risk of the organization eventually slipping back to the old ways – after all if the state will bail you out what onus is there on you to behave responsibly? Add to this the too big to fail, and add a generous dose of regulatory capture, and we have a recipe for the 2030 banking crisis.

zbThe costs of the Anglo collapse in plain numbers are bad enough – 30b euro wasted on feeding a zombie. Zombies when fed do not lie down-  they demand more.  The more that Anglo has consumed consists of our international reputation (twice) and was, I contend, the straw that has broken the back of the fiscal state. It is undoubtedly the case that absent the 64b bank bailout we would still have faced a significant fiscal problem. Our tax base had eroded and the world economic crisis would have made things worse. absent the Anglo 30b we would face not 117% debt to GDP but below 100%.  We might be facing some 1.5b per annum less in debt service costs. It is arguable that we might not have even had to seek a bailout. With the economy flat lining in a quadruple dip recession and emigration soaring the collateral damage of the madness of saving Anglo is incalculable and worse yet the social damage is generational and ineradicable.

lossesThe new EU procedures on how to allocate losses in banking failures are good in principle – the rank the taxpayer last in line after capital, including those heretofore untouchables Senior Bondholders, and after large deposits. But the taxpayer is still on the hook in theory.  In any case there are lots of hurdles, at EU and various national levels, that will have to be overcome before any such resolution mechanism is in place. At the earliest we will not likely see this before 2017. Are we certain that before then we will not face additional capital calls from the banks? Even after, with an effective duopoly banking structure, what confidence do we have that should one of them run into trouble the letter of the law will be observed in relation to loss allocation? In other words – if banks are overlarge and untrustworthy we need to change.

behemothThe planned pillar banks therefore pose, in my view, a grave potential risk. We should consider a strategy whereby the banks are made smaller and less systemically important. Even now the liabilities of the covered banks amount to over twice GDP, and those of the domestic banks (in other words including banks such as Ulster and KBC etc) to over three times. This is too large. Absent a proper risk sharing approach a further bank failure would result in at best bail-ins of depositors (destroying confidence in irish banking, if such exists) and at worse more calls on the state.  Conversion of the majority of the covered banks to pillar banks will leave the state in an extremely vulnerable situation. The solution must be two fold; shrink the absolute size of the banking system and shrink the average size of the components.  Shrinking the size of the financial sector worldwide will come with costs, and so too in Ireland. We have gotten used to the idea of a very large financial sector, in other words we have gotten used to easy credit. This will have to change, both at a corporate and at a personal level. reduced credit will imply a slowdown in economic growth from the heady days of the middle noughties which is no bad thing. In terms of size we need to have many more competing banks, each individually more connected with local communities, each definitively not too big to fail, funded mainly by deposits and regulated assertively in terms of credit quality. These banks must be capped in terms of individual size and the enture system capped at a level below that of national income. Again this will mean an end to easy credit. There is an old saying ; when the elephants dance the ants get trampled. Its time to cull the elephants and break them into their component parts.


4 thoughts on “Sowing the seeds of the next banking crisis…

  1. analogue71

    Might be a path to more sustainable growth worldwide also but I don’t think we can go it alone. How will smaller banks compete for my custom against bigger euro banks?


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