“A blueprint for a new, working, banking system for Ireland” By James Deeny

James Deeny is a Director of a number of major IFSC companies and a retired Country Manager of HSBC Ireland

Finance Dublin

“A blueprint for a new, working, banking system for Ireland”

It is a basic reality that the domestic banking sector in any country is only as good as the local economy and Ireland is no exception. Until such time as Ireland demonstrates the capacity to manage to the EU/IMF budgetary targets and the local economy ceases to deflate it is unrealistic to expect that the Government or the domestic banks will have material access to international capital markets. Other than the EU/IMF funding package we are on our own for the next few years. The flow of credit within the economy has become a real problem and if not addressed will hinder economic recovery. There is an urgent need to find ways to recycling domestic savings into productive investment. It is sad to hear professional advisors and “smart” investors talk about how they have placed their funds in overseas depositories.

As of now local enterprise is faced with a situation where there is little if any competition in the domestic banking market. The number of banks and finance houses active in the market has shrunk dramatically.  The main Irish banks are deleveraging rapidly and the remaining banks are in large part subsidiaries of foreign banks with little appetite for Irish risk.

At the core it can be said that Ireland has an operational banking system with a pool of experienced financial service personnel who were not involved with the catastrophic property lending debacle. This combined with our enhanced regulatory capability means we have the capacity to build whatever “fit for purpose” domestic banking platform we contemplate.

As we address the question of an appropriate future landscape for Irish Banking there are a number of major issues that need attention:

• The absence of competition in the market
• The financing of local enterprise and  SME’s
• Whether ultimately free market ownership of the main Irish banks is the right model.

 

The domestic banking scene in recent years has been private sector, centralist and monolithic. There are many international examples of alternative structures. In Germany there are three banking pillars involving the public sector, the cooperative sector and the private sector with the latter, the smaller player. It has been a highly regulated market. The situation in Germany is changing; however, what was put in place after WWII has served them well. We need to contemplate what is right for Ireland. It can be argued that the lack of public confidence in our banking sector is in part due to our monolithic and centralised approach and the absence of local structures.

Government policy should aggressively seek competition in the market through the encouragement of what has been called the third banking force and at the same time localise part of our domestic banking infrastructure.

There appears to be a general acceptance that Bank of Ireland and AIB should be scaled down and domestically focused. To re-establish credibility they are to be capitalised at a level twice that of five years ago.  The term utility bank with a return to a conservative lending ethos has been used and well defines what is proposed. There is general agreement that this is the right way forward; however, there are resulting implications.   It will create enterprises with an upside cap on potential return on equity. As utilities we are defining financial institutions with the likelihood of a steady state ROE of the order of 12%. This is the kind of return you expect from a cooperative / public sector bank.  Will such returns attract institutional investors? Will individual investors find the prospect of a stable dividend flow attractive and return as investors having been blown away over the last few years? Will a major international bank see either Bank of Ireland or AIB as an attractive investment?  I think the jury is out especially in the context of a domestic economy and national budgetary scenario that has yet to turn around.

In the past, capital markets drove the management of the main Irish banks to seek returns on capital in excess of 20% which they did through prolific property lending.  This is space we never want to revisit. In this context the free market has not served Ireland well.

It does beg the question whether in the context of “a blueprint for a new, working, banking system for Ireland” and a banking system more closely aligned to the financing of local enterprise there is merit in seeking to reconfigure AIB into regional full service savings banks under public / cooperative control using a version of the German model. It certainly would be a more stable operation and a balance to a private sector Bank of Ireland if such it should remain.

In the past local enterprise had the option to finance capital goods with finance houses such as Woodchester, Lombard & Ulster and Capital Leasing to name a few examples of the many players historically in the market. This facility has largely disappeared from the landscape.  However, it is just the kind of financing vehicle that is needed at present by the SME sector. One would expect we will see the re-emergence of small ticket finance houses. They should be encouraged. There is a definite need for it in the SME market. Could the credit union movement establish such a central finance vehicle?  From a regulatory perspective with credit quality a priority a well run finance company with consistently applied credit standards and a widely spread small ticket hire purchase / leasing portfolio will demonstrate an acceptable risk profile.

The voluntary credit union movement is very much part of this debate. It is a curious fact that the Irish credit union movement has what is a high degree of local identity and credibility but many individual credit unions fail in terms of governance and lending standards. It is the case there are well run and badly run credit unions. The former need to be supported and the latter merged into stronger operations.  The movement is the custodian of €15billion in domestic savings. The movement is a natural conduit to fund community and local micro enterprise. This can be achieved by working with; for example, Enterprise Boards and EnterpriseIreland. If combined with enhanced credit management in credit unions this would result in a new funding source for local enterprise. There is a major strategic review of credit unions currently being undertaken by Grant Thornton. While retaining their voluntary ethos there is a need to create overarching regional supervisory board structures which have the legal power to force necessary change. The Regulatory Authority has worked hard to raise standards; however, there is a need for Government and the movement to look to new regional credit and investment management structures to get to where they need to go. The historic practice of individual credit unions making their own credit judgements and investment decisions is not an option. The recommendations flowing from the Grant Thornton study will be vital and will need to be taken on board. The sector is too important systemically both in terms of the deposit pool involved and the potential to support local enterprise not to do so.

EnterpriseIreland is the largest venture capital house in the State in terms of its client base. Its mandate is to grow domestic enterprise capable of competing internationally. In this it is hugely effective. Where I see a gap is in the availability of seed capital at the local community and micro enterprise level, for businesses focusing on the domestic market.  We need more initiatives like the existing highly successful “First Step” business start programme which operates at this level.

There is a growing national mood to move on and start to rebuild. To do this we need the tentacles of finance for enterprise to be seen to spread throughout the community.

It is indeed a conundrum that while the IFSC is one of the greatest enterprises ever created by Ireland our domestic banking system has become such a national disaster.

January 2011

 James Deeny is a Director of a number of major IFSC companies and a retired Country Manager of HSBC Ireland.