Open Dissent

by Mike Soden

  More than anything else the Government needs the banks to be independent and free from government support. The €400 billion worth of creditors’ guarantees needs to be erased in a short time span and not on the never-never. Ireland’s sovereign credit rating is affected severely by the guarantees, and the cost of borrowing by the state is accordingly higher than it should be. The price of this guarantee ought to be borne by those who are being protected – that is, all depositors. This group of creditors should be charged some twenty-five to fifty basis points per annum to cover this insurance. The banks need to stabilise and be able to attract deposits rather than being another burden on the Government or taxpayer. An active and aggressive plan has to be put in place to relieve the Government of the cost of the guarantee programme. These grand steps can only be taken when the loan-todeposit ratio is closer to 1:1 than it is at the moment. The wholesale element of the banks’ funding will continue to be guaranteed until the banks have regained satisfactory independent credit ratings. The dependence the country has on foreign debt and deposits should not be underestimated. Prevention of the loss of domestic deposits has to be high on each bank’s agenda.

  So, one way to restore health to the banking system in Ireland is through the resuscitation of the major banks by enabling them to continue operating as they have done for decades. We are looking at an uphill battle for the next several years to get the banks back on their feet and our sovereign credit rating restored to its preferred AAA status. Over the past twenty years, the banks have attracted more foreign capital into them than was available domestically. This was in both debt and equity. The shareholders’ register is a good place to start looking to see what percentage of the banks was owned by international investors. At our peak, in excess of 70 per cent of the value of our major banks was owned by foreign investors. As long as the institutions were managed domestically, we were happy to say they were Irish. In fact, they were foreign-owned, but rarely did one foreign entity exceed a 10 per cent shareholding.39

  On the debt side, when we examine the growth in lending over recent years we can see that the domestic retail deposit base of the banks did not grow in tandem with the growth of the loan portfolios of the banks. In fact, the massive growth of the banks was supported by foreign deposits from the international wholesale markets, which were at the heart of the credit bubble. There was no end to the availability of credit for lending into the property sector until the liquidity crisis occurred. Then we realised the error of our ways.

  This is the scenario we are looking at if we pursue what might be described as the ‘more of the same’ option. However, there is no getting away from the fact that the mould of traditional banking has been broken. Perhaps it is time to look at devising a national plan for financial services that enables us to erase the errors of the past while fulfilling the need to alleviate the Government of the massive contingent risks it has taken on as a consequence of the crisis. The thinking to date has been somewhat stifled with respect to the future activities of the banks being put ahead of the interests of the Government and the country.

  If we are to consider the development of a new banking model for the country then it is best that we initially identify the key imperatives that must be observed:

  • The plan must comply with EU directives on national banking.

  • The structure has to provide an attractive investment opportunity for both international and domestic investors.

  • The government guarantee and associated contingent liabilities should be reduced substantially and preferably erased.

  • The capital structure of the financial institutions should be maintained at the highest levels recommended by the ECB and the EU.

  • The sale of certain bank assets to provide capital should include a review of the potential sale of the Irish banks’ payments system.

  • Governance and risk management systems of world-class standards must be adopted and policed.

  • Competition must exist in the Irish market at acceptable levels in product choice and pricing.

  • Employment levels should be maintained but not without regard for efficiency.

  • Every business must become best in class, including retail banking, insurance, fund management and SME lending.

  • Reputational damage has to be repaired.

  Depending on what perspective one has, one can place a conscious hierarchy on the significance and importance of each of the ten imperatives. More emphasis can be given to one imperative over another, but in the end the balance between strong numerical analysis and attention to social effects has to be achieved.

  * The banks are Allied Irish Banks (AIB), Bank of Ireland, Anglo Irish Bank, Irish Life & Permanent, Irish Nationwide and EBS Building Society.

  ** Sources for numbers: Investor Relations and annual reports of banks.

  The table above depicts the current banking system in Ireland according to the business activities of the banks, as it stands at the end of the first quarter of 2010.

  If you consider this table in terms of the headings along the side, rather than the names of the individual banks across the top, a different picture of the banking landscape emerges. Instead of looking at the six banks and considering what we can achieve through recapitalisation, merger or closure, consideration ought to be given to examining a solution in terms of banking activities. There are many variables to this matrix, but it is worth looking at a solution that satisfies the majority of the above ten imperatives by grouping the listed banks into compatible activities.

  My suggestion would be the creation of three new financial services companies. Each of these companies would be viewed in the context of the ten imperatives. For ease of reference, we will name the three entities Bank 1, Bank 2 and Bank 3.

  BANK 1

  This institution would simply be the flagship of Irish retail banking. Of the seven hundred branches or so that form the collective network of the Irish banking system, let us for a moment select four hundred of these as the basis of Bank 1. The remainder of these branches would be moved into Bank 3.

  So, Bank 1, created out of four hundred of the existing seven hundred branches, would have the mandate to perform all the traditional retail banking activities, including, but not limited to, mortgage lending, personal loans, SME lending, credit cards, payments system, sale of insurance products and private wealth management. The geographic footprint for this flagship Irish bank could be the Republic of Ireland or it could be an all-island bank. All treasury and wholesale activities would be performed within this entity as it would be a stand-alone financial entity.

  You can hear the cries of lack of competition emanating from Dublin to Brussels to Berlin. But we must look at all options and the consequences of these. This should be viewed as a first step in a long-term solution.

  BANK 2

  This entity would be comprised of all the insurance and fund management activities that would lead to the creation of a major Irish insurance company. All the activities of risk management, distribution, manufacturing and marketing would exist in this company. Bank 1 would be a distributor of this entity’s products along with a wide range of competing products from other manufacturers. This bank, insurance and fund management company would include, but not be limited to, Irish Life, Permanent TSB, New Ireland Assurance, Quinn Insurance, Bank of Ireland Asset Management, AIB Fund Management, and all other associated entities in the fields of fund management and insurance in Ireland.

  BANK 3

  This entity would be made up of the extended retail banking network that is left independent from Bank 1, which would be rebranded at some future date and would have close to three hundred branches. Together with the wholesale banking activities of the system and all the international banking activities and investments of the six current banks, this institution would be viewed as a diversified financial services company, something akin to either Bank of Ireland or AIB today. This company would have clear objectives and time frames for divestm
ents to ensure that the capitalisation of the institution reached the highest standards demanded by the EU.

  With this proposed structure, the country would have three new financial entities: a flagship retail bank, a major fund management and insurance company, and a diversified financial services company.

  Having looked at the measures taken in Sweden in the 1990s, if we examine the imperatives associated with the proposed change to the Irish financial infrastructure and consider these in the context of the long-term survival of the banks, we may glean a better understanding of the advantages of such change. In summary, if we were to accept the vision of three new financial entities being created out of the remains of the six banks, we would manage to achieve the following:

  • Two well-capitalised entities – Bank 1 and Bank 2 – that could be packaged for sale in the event that there was not sufficient domestic equity available.

  • The release of the government guarantee in whole or in part would be facilitated through these measures.

  • Through the sale of surplus assets from Bank 3, additional capital would be freed up and could be used to capitalise Bank 3 partially.

  • Employment is a serious concern for the industry and the country. Seeking levels of efficiency for the industry would have to be carried out with an eye on the preservation of jobs – a careful balancing act.

  • The whole area of governance and risk management has taken on substantive meaning since the arrival of the new Regulator. The management of risks and not just processes would be normal practice. Skill bases in all areas of risk management would be honed. Boards and subcommittees of boards would be populated with skilled and experienced directors.

  • The reputational damage that has been incurred by the country as a result of weak regulation and governance needs to be repaired. The benefit of this strategy is that the villain in the financial crisis (Anglo Irish Bank) would simply disappear, and its assets, liabilities and people would be absorbed into one of the three new entities. The new banks may or may not retain their respective names (AIB and Bank of Ireland).

  • Reducing the cost of borrowing for the country and the individual banks will be achieved when our sovereign rating is upgraded. This is more likely to occur when international approval is given to a national financial services plan and international investors see that our recovery is taking hold. The savings generated from the improved pricing would be measured in billions per annum.

  • Finally, compliance with any ECB or EU directive would be essential. Exactly what the EU sees as the plan for European financial services and the role of each sovereign state therein is a mystery. We await its disclosure. No one imperative should be put ahead of a total solution that works for the country within an agreed time horizon.

  • Competition would exist in the form of foreign banks, but if these disappear (as they have started doing) then we would miss the value of their presence in the market.

  We have a relatively open market for foreign banks to enter and compete in this country. Some of these have developed strong retail networks that compete daily in the marketplace. The decision to remain in this country will be made at the respective head offices in England, Scotland, Denmark or wherever. Halifax Bank of Scotland (HBOS) has recently made the decision to close its small retail network and end its wholesale activities in Ireland, based on the size of the market, future prospects and possibly guidance from Europe that might have suggested a UK footprint (for Lloyds TSB) would serve their shareholders better. Consideration to stay or leave at this time will be high on the agendas of foreign banks, based on variations of the reasons for HBOS’s decision. The withdrawal of many of these institutions in whole or in part will lead to both liquidity and credit challenges for the domestic banking system, along with the real concern of pricing competition being reduced.

  In 2003, as CEO of Bank of Ireland, I made the suggestion of a merger between Bank of Ireland and AIB. I had assumed that the strategy of increasing the banks’ capitalisation for financial services companies globally was well understood in Ireland. At this time, the combined market capitalisation of the banks was in the region of €25 billion. If the entities had merged, it would have been likely for a variety of reasons that this figure would have jumped to €35 billion and, with the subsequent acquisition of an English bank, the combined market capitalisation could have reached €60 billion. Complaints of lack of competition would have faded if we had achieved a top-ten status in European banking and, in hindsight, the portfolio concentration in property would not have occurred. This would have been an unintended consequence and not a premeditated attempt to reduce property exposure. I am revisiting this vision with the above model. However, judging from the reaction to my proposal in 2003, the different cultures of the banks might prove a genuine obstacle.

  It would have been very valuable if, at Farmleigh in December 2008, the Government and the Department of Finance had requested the banks to put a national plan together, jointly. This plan would have been the blueprint for the financial services industry for the next decade. Instead, each of the entities under the government guarantee was requested to submit within a given time frame a plan for their respective institution. Following these six submissions would result in the aspirations of individual entities being fulfilled and would not result in the implementation of a plan for the country that would put the greater good ahead of individual preferences.

  It is my belief that the Government has the power to accept and press ahead with a proposal such as that outlined in this chapter. State ownership is not a prerequisite. The Government might have the power to achieve what is considered best for the future of Irish financial services but whether it has the vision remains to be seen.

  CHAPTER 9

  Misery Loves Company –

  Ireland and the European Union

  The headquarters of Citicorp/Citibank NA was 399 Park Avenue in New York on the south-west corner of 54th Street and Park. In 1977, the bank closed a retail branch on the opposite corner of 54th St and Park. Shortly thereafter, Allied Irish Banks took occupancy of this property as their flagship for US operations. At the opening of the AIB branch, Walter Wriston, chairman and CEO of Citicorp/Citibank, was asked if he was concerned about the arrival of new competition in America. Wriston was the doyen of banking in America, if not the world, at the time. His response was suitably measured: ‘It’s nice to welcome Allied Irish Banks to New York as it is good to have someone to share the losses with in this business.’40

  Misery loves company. We are an island but we are economically attached to other members of the EU. The historical roots of the EU lie in World War II. Europeans were determined to prevent such killing and bloodshed ever happening again. Europe was split into East and West at the end of the war, setting the scene for the beginning of the forty-year Cold War. Western European nations created the Council of Europe in 1949. This was the first step towards Western cooperation. In 1951, six countries signed the Treaty of Paris with regard to the running of their heavy industries – coal and steel – under a common management. The six countries and founding members of the European Coal and Steel Community (ECSC) were West Germany, France, Italy, the Netherlands, Belgium and Luxembourg.

  On 25 March 1957, building on the success of the Treaty of Paris, the six countries expanded cooperation to other economic sectors to strengthen their ties. Thus, the Treaty of Rome was signed, creating the European Economic Community (EEC) or Common Market. The idea was for people, goods and services to move freely across borders. Over the next sixteen years, a period of economic growth was experienced in Europe. In 1973, the six became nine with Denmark, Ireland and the UK formally entering the EU. As a member of the EU, Ireland has benefited over the years from EU Structural Funds, funds allocated to less developed countries in the union to help with regional and economic development.

  Over the next thirty years, the EU opened its borders and membership to eighteen more countries, culminating in the signing of t
he Treaty of Lisbon in 2007, which came into force in December 2009. This treaty amended previous treaties and was designed to make the EU more democratic and transparent. This transparency and democracy are surely being tested as the financial crisis impinges on many EU states that are unable to live up to the economic standards that were the requirements of admission to the EU in the first place.

  If we are to take guidance from the experiences of other countries, we should hope that comparing ourselves with the most developed countries in the world would be suitable. However, considering how the current economic and financial crisis has affected Ireland, we may find comparisons with Latvia more useful.

  In 2008, after years of economic success, the Latvian economy took one of the sharpest downturns of the global crisis, which saw GDP contracting by 10.5 per cent. In January 2009, Latvia experienced its worst riots since the collapse of the Soviet Union when thousands took to the streets to demonstrate their dissatisfaction about the Government’s handling of the economic crisis. The Government called in the IMF and requested a bailout of €7.5 billion. Some weeks later, after a local bank, Parex Bank, was nationalised, the country’s credit rating was downgraded to BB+ (junk) and shortly thereafter the Coalition Government collapsed. In December 2008, the Latvian unemployment rate stood at 7 per cent. Twelve months later the figure had risen to 22.8 per cent. This was the highest unemployment growth rate in the EU. The forecast of a further contraction of 12 per cent in the economy at the beginning of 2009 proved to be an underestimate as the economy contracted by 18 per cent in 2009.41