Irish Economy Conference, Dublin, Jan 31st 2014
A Banking System for Economic
Recovery
Colm McCarthy
Signs of Recovery
 Employment
data is improving
 External
environment, especially outside
the Eurozone, is better
 But
there is still no hard evidence of a
broad-based recovery.
The L-Shaped ‘Recovery’
Macro Prospects……..

Sharp decline in activity seems to be over

Fiscal stance remains deflationary, credit
availability weak

Through 2014 and 2015, nominal GDP unlikely
to grow more than 4% per annum (CB Forecast)

While a recovery from 2014 is plausible, there is
a clear debt sustainability problem
Domestic Demand Prospects
 Since
Ireland must run a BOP surplus for
many years to come, domestic demand
must be restrained.
 This
means consumption and fixed capital
formation cannot grow too quickly.
 Growth
needs to be mainly export-driven.
What Infrastructure Deficit?
The Banking System
 Domestic
banks have closed, foreign
banks have withdrawn
 Balance
 But
sheet contraction continues
the three ‘guaranteed’ banks still had
consolidated assets > 200% of GNP in
mid-2013
Housing Finance
 At
bubble peak in 2006, mortgage lending
for house purchase reached €28 billion.
 In
2013 below €3 billion.
 25
 At
- 30K houses needs €8 billion, or more
the end of a bust, credit requirements
for asset transfers are additional.
The Contingent Liability
 There
will be no centralised Eurozone
backstop for bank resolution, so the
liability remains national.
 No centralised deposit insurance means
national liability for deposits in foreignowned banks too?
 Does sovereign sustainability require
further bank balance sheet contraction?
Other Credit Demands
 Finance
also needed for inventory re-build,
trade credit, working capital, dairy herd
expansion.
 Multinationals,
large Irish companies,
semi-states, have external credit access
 Households
and SMEs are captive.
Bank of Ireland
 Assets
98% of GNP
 Leverage 17
 If further 5% of loans lost, leverage = 42
 Price-to-Book 105%
 Mortgages + property = 73% of all loans,
52% of all assets
 Loan to deposits = 121%
AIB
 Assets
88% of GNP
 Leverage 11
 If further 5% of loans lost, leverage = 16
 Price-to-Book 684%!!!!!!
 Mortgages + Property = 73% of all loans,
42% of all assets
 Loan to deposits 106%
PTSB
 Assets
28% of GNP
 Leverage 15
 If further 5% of loans lost, leverage = 37
 Price-to-Book 127%
 Mortgages + Property = 99% of all loans,
78% of all assets
 Loan to deposits 157%
Not a New Problem….
 ‘The
banking system is heavily exposed:
the big Irish banks, such as Bank of
Ireland and Allied Irish, are in effect
mortgage banks, observes Colm McCarthy
of DKM Economic Consultants. A property
crash would badly hit their balance
sheets.’
 The Economist, October 2004
Clearing or Mortgage Banks?
 Until
the mid-1980s, the Irish clearing
banks did not carry large mortgage books.
The asset duration mismatch was seen as
unsuitable for deposit-funded institutions.
 Mortgages were extended by specialist
and tax-privileged building societies.
 There are no more building societies, and
credit unions are not a replacement
How to Fund Housing?
 Bank
balance sheets need less, not more,
long-duration mismatches.
 Covered bonds are not the answer, since
they leave the liability with the bank,
whatever the accounting treatment.
 If a major increase in mortgage lending is
needed, mortgage-backed securities in an
originate-and-distribute model is better.
Banks and SMEs
 Deposit-funded
banks are a suitable
vehicle for SME finance (not for equity!).
 And
paradoxically for builders/developers.
 Bigger
firms, and some medium-sized
firms, will increasingly be accommodated
via securities markets, and foreign banks.