Tag Archives: banking

Cultural Learnings of Brexit for Make Benefit…

brexit-2So brexit will, or possibly wont, happen. And if it happens we might or might not see a significant change in how the UK interacts with the remaining EU that is if there is a UK and it has not splintered. But what will it really mean for Ireland? And how should we interrogate the issues? A purely economic lens wont really work. We need to look beyond politics, beyond economics.  Continue reading

20 Questions – Expert Group On University Funding Version

The Cassells report on future university funding, widely leaked (remember when government decisions were taken and then announced and when leaks were newsworthy not news?) has good and bad points in plenty. Continue reading

“theft by safety net” : Ed Kane on Irish Banks

If there is someone in the word who knows more about Zombie Bank(ing system)s  than Ed Kane of Boston College they have been very quiet. In fact,  Ed coined the term, and the analogy. Tomorrow he testifies at the Banking Inquiry and it should be entertaining, informative and provocative.

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Interrogating God, the Central Banking Version

Shield-Trinity-Scutum-Fidei-English.svgToday at the banking enquiry in the Irish parliament parliamentarians will get a unique opportunity, to interview and interrogate God.   I say God, but whom I really mean is Patrick Honohan.

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Hyperbolics, Banks and Elections

There is an interesting opinion piece in the Irish Times today, by Michael Noonan, the finance minister.   It is being spun as “were going to get our money back from the banks”.   This is not the first or second time of course we have heard that we are going to get the money back, and it will not be the last.  We need to take enormous caution when interpreting what politicians say, especially when they talk about banks, and especially when they talk about banks in the run-up to an election. Continue reading

An independent Scotland faces a banking crisis…what does HM Treasury do?

One of the arguments around the Scottish referendum on independence is centred on its banks. These are, simply, ginormous at around 1200% GDP. There is no way that an independent Scotland could, if push came to shove, bail them out. QED, don’t take the risk. Stick with the Treasury and the UK…

Hmm. Not quite as simple as it seems when you look at Ireland.

The Irish banking collapse of 2008 saw us borrow money hither and yon, from the IMF, the EU, and …the UK. The UK lent us money to defray this, as did the Danes and the Swedes. Why? Bilateral trade. These nations trade a lot with us and we with them. And its not good for your exports if the trading partner is utterly bankrupt, so best to lend a hand. A soft hand.

Ireland accounts for about €27b of uk exports, Scotland for about three times that from the rest of the UK. So, and independent Scotland would be a large and important trading partner with the rUK, and not one whom the Treasury would wish to see go under. Hence, were push to come to shove, despite all the warnings and threats, it would be in the best interest of the rUK to extend soft loans to Scottish banks and the government in the event of a rerun of 2008. Nothing political, just business.

Does An Irish Solution loom for European Banks (one way or the other) ?

brokenbankThis is a version of my column in the Irish Examiner of 25 Jan 2014 .Europe’s banks are broken. Very broken. We have always suspected that, but recent evidence in indications suggest that nearly six after the crisis first began to manifest itself seriously they are still grossly impaired. The drive towards meaningful banking union has stalled again amidst squabbling about whether or not there should be and if so how much of a common pot for resolution.  German banking giant Deutsche unveiled a billion euro loss just this week, underscoring how fragile both the banking system and the economy remain, even at the core. Without a working banking system the economy cannot prosper.

Recall what it is that banks do – despite the mystique and the bluster, its actually pretty simple. Some people have money and others need it. Banks act as a middleman to facilitate those that want it to get it from those that have it, in return for them taking a cut of the interest charged. This can be across space (savings flow from region to region) and/or time (mortgages and longer term loans) . Lending money out is risky. That is why banks charge an interest rate on loans that is greater than that which they pay on deposits – apart from needing to make a profit and cover costs, they need to put some money aside for the inevitable defaults and bad loans.  These retained profits, plus some other ‘safe’ assets, are the banks reserves, or its capital

There is a persistent fallacy that banks lend out reserves. They don’t. People such as Frances Coppola have been banging on about this fallacy for some time now (see here and here)  Its more complicated than that and revolves around the fact that banks can create credit (money) by issuing loans. However,  banks  do need, under prudential regulation, to hold a certain amount of capital, a proportion of the assets they have (loans made).  If banks have more capital they are in a position to expand. The problem for  European banks is that they are stymied by the fact that they have written down bad loans to an extent sufficient to impair their capital base but by no means enough to clean their balance sheet of the these bad loans. Caught in a double bind, they are unable to efficiently do their job as intermediaries and as credit creators.

As part of the ongoing efforts to get to the root of the problem the ECB have initiated an asset quality review. This is in effect yet another stress test. Previous not-terribly-stressful tests have been greeted with derision as they in effect claimed that all was well when it was manifestly not. Thus this stress test, to be credible, needs to fail some banks – any banks.  It is reminiscent of Admiral Byng, who was shot not for failing at his task of taking Minorca, more or less impregnable and a rock on which others had foundered, but ‘pour encourage les autres’.  European banks all stand in danger of being the financial Admiral Byng of 2014. One or more large banks needs to fail to show the virility of the tests.

Recent research has looked at what holes might be lurking in the capital. As has been the case throughout this crisis while high level public data cannot give a precise amount it has been remarkable how using such data the gross magnitude and nature of the money sink de jure has been accurately estimated. Looking at the 109 largest banks with €22 tr in assets a hole of between 5b and 66b is found even assuming no further deterioration of any assets – an unstressed situation.  The biggest holes are in the core – French and German banks and the smallest in the periphery. Ireland, if things don’t get any worse, does not need any more capital in its banks.

But what if things do go south? They stress the banks rerunning a severe financial crisis, and further suggest that any residual bad loans are written off. Writing off bad loans of capital weak banks is the only way to kill zombie banks who crowd out and hinder the banking system.  In this stress situation the banks are woeful. Assuming reasonable levels of reserves to be held, European banks may need between 500b and 750b. Again the worst holes are in the core banks  especially French German and Belgian banks. Top of the list are the giant french banks – Credit Agricole, BNP and SocGen, and Deutsche Bank. Bank of Ireland and AIB are not immune, possibly requiring 6-13b euro more. But sure were good for that, havent we turned the corner and exited the bailout to a land of green shoots…

So what to do? Senior bondholders are sacrosanct and while depositors of unimportant nations such as Cyrus (whose banks are still bunched beyond reasonable hope of redemption) might be bailed-in that wont happen to real depositors, those of the core. So banks will limp along. But there is a potential solution – promissory notes. The notes were created to shore up the capital base of Anglo Irish Bank, and allowed it to access liquidity from the Central Bank of Ireland. Which it did. Ok, Anglo was a hopeless case but the principle is good. The problem with the notes was not per se their existence  – it was that they were required to be extinguished over a fairly swift timetable, placing unbearable strain on an already  strained exchequer and that it was done to put a figleaf on the notion that Anglo was a going concern.

Were these or national equivalents to be created by the national authorities of the core, we could well imagine much longer periods for extinguishing being placed in play.  If the Anglo ProNotes had been repaid over 300 years instead of 30 they would not have been an issue, except morally. While the numbers seem large, in the context of the (shrinking ) ECB balance sheet of 2.2b even the largest amount required is not unbearable. Part of the ECB objection to the notes was that the liquidity created was done so “outside its control”. A system of central banks cannot have individuals pursuing their own monetary policy in an uncoordinated and national focused way – that is what brought down the Rouble zone. But as a once off final fix for the banks? Its worth a shot.  In all probability the 750b would not be required in full. While the 40% fall over 6 months in equity values is high, this does not happen very often – but it does happen about 1 time in 25.   Doing this would ‘cure’ the banks, in so far as it would allow, in fact would have to be accompanied by,  a full write-down of impaired loans and thus position them for regrowth. It would allow a clean start to be made. Clean the mess up once and for all, and restart.

Alas, the inflation hawks and their fears  dominate the ECB, fears never more imaginary than now with deflation staring the Eurozone in the face, will not allow this. The consequence is that we flirt with a further crisis not merely knocking out the periphery but the core. As we have throughout the crisis we face a choice of unpalatable alternatives.  European banks will follow the irish lead – either via partial or full zombification with the odd twitch of life now and again while hoping that the economy does nothing remotely scary all the time barely functioning and taking a decade or more to get back to any health, or by the solution which worked, in that it allowed a bank to be cleansed and to br resolved.

Irish Banks - Knee deep in the brown stuff and all alone

This is a really interesting chart from the European Banking Association Transparency exercise report published yesterday

RWA are risk weighted assets (loans) and Capital Effect is the trend in the core capital of the banks
From the report (my emphasis and comments in brackets)

13. An analysis has been carried out to further investigate the driver of the Core Tier 1 capital ratio  evolution and to decompose its variation into capital and RWA components. Chart 5 illustrates the  relative importance of the Core Tier 1 (numerator) and RWA (denominator) effects on the EBA  Core Tier 1 ratio by jurisdiction, which helps to explain whether capital increases have been driven  by injections of new capital or by de-risking and deleveraging. The main results of this analysis are:
a. The improvement of 170 bp (from 10.0 to 11.7%) recorded over the 18 months ending in June 2013 has been the result of both an increase in the EBA Core Tier 1 capital (80 bp)  and a reduction of RWAs (90 bp). [overall banks are healing]
b. In one country (IE, area Q4-b) there has been a reduction of EBA Core Tier 1 capital ratio, due to a decrease of capital, partially offset by a reduction of RWAs. [irish banks shrinking but capital shrinking faster than assets. this is not good…]
c. In eight countries (Q4-a and Q1-a – AT, BE, DE, DK, GB, IT, NL, SI), whose banks account for around 56% of the total, the improvement in the EBA Core Tier 1 ratio has been mainly  driven by a reduction of RWAs. [in the main the improvement comes from deleveraging – smaller banks]
d. In six countries (Q1-b – CY, ES, FR, HU, NO, PT, 35% of the total) the impact of higher  EBA Core Tier 1 capital has been larger than the impact of the decline in RWAs. [these are in effect recapitalising]
e. In six countries (GR, FI, MT, PL, SE and LU – area Q2-a, 7% of the total) the increase in the EBA Core Tier 1 capital has been partially offset by an increase of RWAs.

Irish Banks : Arrears, Deposits, Bail-in and Interest Rate Editon

This is an edited and extended version of a column in The Irish Examiner 26 October 2013

There is a great book on marketing titled “the long tail” , which stresses that instead of trying to hit millions of customers at once its perhaps better to do millions of niches. Replete with examples it was and remains a deserved hit. The long tail refers to the distribution of something – a large bulk at one end quickly trailing off to smaller numbers but which go on for a long time. Another word for this is skewness. In very many skewed distributions it is common for the total amount in the long tail to be equal to or greater than the amount in the bulk. Another way of thinking of this is a power law. Many many things have been found to follow power laws – terrorism, population of cities, bibliometrics, income distribution… theres no reason to think Irish bank losses are different.

download (1)The long tail approach is worth considering as we move into the sixth year of this crisis.  Having dealt with the massive mess of the commercial property and developers loans via hiving them off to NAMA (which has yet to “get credit flowing” as its cheerleaders in the then government and some still prominent stockbrokers trumpeted) , the long tail of the mortgage and SME loans continue to erode the banks. We are moving down the tail with the average loss getting smaller but there are an awful lot of them. Today I spoke to a SME owner who runs a small distribution business. He had settled with a bank for a loan taken out in 2006 which resulted in the bank taking a loss of just under €1m. The business is still going, much reduced but “ticking over nicely”. This is as good as it gets – a viable business remains. Many many SME loans are for larger amounts and the banks will take a larger hit as there is nothing left. I think of someone  I know who purchased a house in 2006 for €450k, interest only of course, in a  not very fashionable holiday area, where similar homes are selling at €150k on a good day. These are the long tail and they are wagging the dogs of our banks as the banks chase them round in a circle.

Basel-IIIAt present Irish banks are well capitalized. Some might say that in a classic overreaction to the lack of adequate capital buffers in the past they are over capitalized. Bank capital is a two edged sword. On the one hand the more capital they have the greater a buffer exists to absorb losses. On the other, as capital is measured as a percentage of assets the more capital is required then all things considered the smaller will be the assets. A bank that has a 10% capital ratio will be able to make more loans (assets) than one that is required to hold a 15% ratio. The ECB has recently announced that it will conduct another round of stress tests. These are required, in essence, so that the final set of capital injections will be made prior to the ECB taking over full control of regulation. The political reality is that this step, a necessary requirement for a proper banking union, will require that individual states make or supervise any capital injections. In a banking union this will be the responsibility of the union, and thus the German taxpayer might be on the hook. But not this last time.

gpyugoWe have known for some time that the Irish banks will require additional capital. The state of the mortgage book is bad but the state of the SME loan book is also dire. Earlier this year we found out that  50% of the SME loan book was in distress.  There is a total of €70b in SME lending, of which an astounding €30b is still outstanding to real estate. A multibillion loss is an absolute certainty.   On the mortgages we have similar. The question that should raise its head is : who bears these losses. Traditionally the order of losses was deemed to be shareholders -> junior bondholders -> deposits and senior bonds. The taxpayer might then step in and recapitalize if the bank was deemed to be needed.  So in the Irish case 2008 saw some but not all junior bondholders and almost all equity destroyed, but the system balked at that and so in stepped Paddy with his chequebook. And we know how that ended. We saw in Cyrpus, and indeed have seen in the liquidation of IBRC that depositors can and in future will be “bailed in”. This is fine and dandy if all other sources of capital have been burned through. The problem is that recent statements by Mario Draghi suggest that bondholders might be spared in future, for fear that once burned they might not return. In other words the sovereign would be required to make a decision as to whether they would absorb losses or instead force bailins on depositors. There is zero willingness for the Irish state to add more taxpayer money into the banks. Thus the question becomes: do the banks hae sufficient buffers in place to absorb losses before the question of depositors comes into play?

hqdefaultOn a macro level they are good. AIB has shareholders funds of c 10b, BOI of 8b and PTSB 2.4b.  In the case of PTSB and AIB much of these shareholder funds are in fact state funds, so any erosion of these is an erosion of taxpayer funds. The problem is that as we noted they are required to hold funds at a certain level. This level is higher than the European requirements. Thus as losses get booked the banks will have to either raise additional funds. This, in sufficient amounts, is I submit unlikely. While they have had some success in raising limited amounts these have either been expensive or have required significant security. In addition, the banks face rollovers of existing issued debt. Bank of Ireland will need to roll over or pay off bonds of 9.5b in 2014-2015, AIB 7.5b and PTSB 5b n the same period. This will tax them significantly. If they face a requirement to otherwise increase capital from losses that will make the job that much more difficult. A large part of the outstanding bonds are senior notes, some 7b. A large part of the remaining is covered or asset backed. Only some 5b or so across the banks, mainly in Bank of Ireland, are unsecured or subordinated. Bank of Ireland has the largest “burnable” buffer but is the one least likely to require it. AIB has very little unsecured debt and less than 4b senior debt. We have seen that even the mention of senior debt being burned, where legally possible, has caused significant negative market reaction. Thus where there is no taxpayer backstop and either no bondholders or no willingness to burn them, inevitably deposits must come into play. In that context depositors should seek a higher rate than they are at present getting.

browseChartThe chart shows the deposit rate on new deposits for an agreed maturity, Ireland v Germany. Deposits that were ten years ago seen as close to riskless as it is possible to be are no longer so perceived. The difference between Irish and German deposits is not, I suggest, sufficient to reward for the relative risk differential. Although small, the risk of depositor bailin in Ireland is many many times larger than that in Germany. These risks are the worst sort- small probability large outcome risk. It is time that the banks begun to remunerate depositors  appropriately for the risk, small that it is, that they are being asked to bear.  We need to move away from a banking system that is dependent in large part on loan capital towards one that is dependent on deposits. In fact, in the last week we have seen the situation worsen. The increase in DIRT means that deposits are now paying less than the already paltry levels. Combined with the loss of ACC , closing after 86 years, this further erodes competition, even if ACC was a small player. Expect pressure on interest rates to be downward, relatively speaking, on deposits. Which are now risk capital and in the firing line.

Enough, already, just pull the plug on Anglo before its too late ; September 2 2010

Id had it with the arguments that Anglo could be saved. Here is my oped in the Irish Times on 2 September 2010. Enough already…

OPINION:Ordinary folk have paid enough. Subordinated and senior debt holders should cover the rest

THE HORRENDOUS losses of Anglo Irish Bank come as no great surprise to informed analysts of the banking catastrophe. The Government s solutions amount to no more than insisting the taxpayer must, under all circumstances, bear all the losses Anglo will continue to create. This cannot be borne.

That there are significant additional losses to come from Anglo is undoubted. The Government and its proxies continue to assert, without placing in the public domain any detailed analyses, that the losses will be capped at EUR 25 billion. This is the same process that has successively asserted that the losses will be EUR 4.5 billion, EUR 12 billion, etc. Why are we expected to believe them now, when they have proven to be wildly inaccurate in the past? Analysts inside and outside Ireland believe Anglo s losses will be at least EUR 35 billion with potential for EUR 40 billion-plus.

Anglo, like all banks, is funded in five ways: deposits; borrowings /deposits of a short-term nature from other banks and central banks; longer-term borrowing (senior debt); longer-term borrowing with less protection (subordinated debt), and by shareholders. The question that arises is simple: which of these should be protected in full, and which in part? It is startling that, as of now, only the most junior party, the shareholders, have been asked to take the full consequences.

Some subordinated debt has been (voluntarily) renegotiated, but there remains some EUR 2.5 billion of subordinated debt in Anglo. This should now absorb the next EUR 2.5 billion of losses. It is unfortunate that the Government has guaranteed some of this, but this is a legislative act and can be unwound.

Beyond that, we are into the realm of senior debt holders. Anglo has borrowed some EUR 14 billion from such investors, of which some EUR 7 billion is repayable in September. It is now beyond time that these investors be informed that their investment is not fully payable. There is more than enough in the subordinated and senior bondholders to absorb even the most pessimistic estimates of losses to emerge from Anglo. We can, and I say we should, consider this.

We are told by the Government that to do so would be a sovereign default. This is palpable nonsense. Anglo Irish is a private institution, which has some elements of its capital structure guaranteed by the Government. It is not the State. The reason the guarantee was given was the fear that allowing Anglo to be wound down in 2008 would have precipitated a cascade of Irish bank failures. While this is debatable, we are now in 2010. The taxpayer has paid enough.

Governments have a genuine concern that if a state defaults, it may not be able to re-access bond markets. But even if we allow the fantasy that Anglo is the same as the State, assertions that this chimera would be locked out of the international bond markets are false, and are pedalled as a scare story to frighten the taxpayers and citizens into ponying up sovereign money to bail out private investors.

Bond investors look forward what they are interested in is the risk that they will not be repaid. A history of default will of course impact on the amount of money they will lend, and the price they will charge. But the evidence is that even serial defaulters can gain funds on an ongoing basis.

Academic evidence, including papers from the International Monetary Fund, indicates absolutely no evidence that sovereign investors are permanently excluded from the international capital markets after a default. Even in the rare cases of temporary exclusions, in the sense of not being able to issue bonds, this rarely lasts for more than two years. In addition, the evidence is that any increase in sovereign debt costs is short-lived and transitory. We have to decide: is the price for the taxpayer of any increased cost of lending if we discontinue support to Anglo, less than the cost of continued support?

There is in my mind no question now but that there is a moral, political, economic and social need for the subordinated and senior debt holders of Anglo Irish Bank to bear the remaining costs. There is a timing problem, however any announcement of the intention to force these losses on the senior bondholders would have to come prior to the renewal of the guarantee at the end of September. Thus, the next three weeks are critical.

There is an argument that this decision to withdraw the guarantee should be taken in conjunction with another. The State is now paying more for money than it would if it were to access the EU stability fund. The judgment of the bond markets is that the combined banking and fiscal crises are such that Ireland is no longer a sound bet. A very large part of this is the increasing concern that there is not the political will to deal with either of these problems, never mind both.

Pulling the plug on further taxpayer involvement in Anglo may best be done at the same time as announcing that we are to seek the assistance of the EU in restructuring our fiscal position.

It is time to seek to place ourselves in the hands of people who can run the State effectively and in the long-term interests of the citizens. Political or indeed national pride should not stand in the way of this.

Brian Lucey is associate professor of finance at Trinity College Dublin