Jim Stewart: Banks are a vital part of any modern economy. They perform a number of key functions (1) a repository and access to liquid assets; (2) transferring funds; (3) provision of short term credit and lending; (4) provision of financial services and retention of records. Policy actions to date has ensured banks continue to survive and can perform three of the four functions, but expecting banks to start lending is unrealistic. This has not happened in other countries nor is it likely to happen here. Rather than lending to enterprises, eurozone banks have increased their purchase of government bonds. One estimate is that banks bought 75% of the total of €77 billion of eurozone Government bonds issued in January (F.T. 4/3/09). The implications for Ireland is that is that a substantial proportion of recent issues of Irish Government debt was bought by banks and in particular Irish banks. The ECB cannot lend directly to governments but can lend to banks at low interest rates in exchange for many types of collateral including government debt. Banks are then in a position in turn to purchase government debt. This is how the government deficit can be financed. The ECB has recently announced further measures to in crease liquidity which will again support both the banking sector and large borrowers such as Governments.
It is most unlikely that the NAMA will succeed in its stated objective of ensuring households can access credit and that funding will be provided to small and medium sized enterprises (Budget statement April, 2009). This is a similar objective to those stated in the plan to guarantee all the debts of banks last September (the stated aim was to ensure financial stability and “protect the real economy” (Minister for Finance 22nd October, 2008). In the announcement of the government recapitalization plan (11th February, 2009) it was stated that the “recapitalisation package will “reinforce the stability of our financial system, increase confidence in the banking system here, and facilitate the banks involved in lending to the economy”.
The reason this stated aim will be unsuccessful is that it is irrational to expect banks to provide funds to firms or individuals in the context of falling personal incomes, rising unemployment and a rising level of insolvencies in the corporate sector. This is a feature not just of the Irish economy but of all the Eurozone economies. Table 1 below shows that the annual rate of increase in loans to the private sector and in particular the two targeted sectors, Households and Non-financial corporations, have fallen consistently every month since May 2008. This in spite of all the State guarantees, arranged mergers, equity injections, and nationalisations. Much of the increase in lending could be ‘rolled up’ interest as in the case of the Irish Nationwide Building Society.
This is particularly serious for small and medium sized enterprise because bank lending is the main source of finance in the euro zone area.
The most recent bank Lending survey, 2009, reported higher loan margins and more restrictive collateral requirements for five Irish banks participating in the survey. The same survey also reports a decline in demand for loans due to a “reduction in the financing needs of enterprises”.
Current policies have been successful in ensuring banks have survived and continue to perform many valuable services. But it is unlikely that either NAMA or nationalization of the banks would result in additional lending to small business because it is irrational for them to do so, given the overall objective of behaving in a commercial (for profit way). NAMA or nationalization will be extremely costly. Changing ownership does not change the size of the deficit between the value of assets financed by borrowing and the amount borrowed and the likely required State contribution. It is doubtful that changing ownership would result in efficiency gains, for example in realising higher values for assets that are sold. It is also unlikely that a change in ownership would result in losses (transfers in value), other than those already incurred, to bondholders or preference share owners. This did not happen in the Anglo-Irish case (see statement issued by the Government on 30th January, 2009, to the effect that nationalisation would have no effect on Tier 1 hybrid instruments (See: http://www.angloirishbank.ie). It is better to proceed cautiously now than pursue policies that pre-empt all other options because of their cost and size. An early example of delay being the best option was the proposal to seek mergers amongst banks. It was clear to some then but to all now that any bank that merged with either Anglo-Irish Bank or the Irish Nationwide Building Society would reduce the chances of the merged entity remaining viable.
But there is one area in which it is vital that immediate action is taken, and that is to ensure that credit and loans flow to small and medium sized enterprises and not just those involved in exporting. Large corporate entities and the multinational corporate sector have other sources of finance. Some large firms have no need for additional borrowing. What is needed is a new entity designed to lend funds to the SME sector. Such an entity cannot be “for profit”. It cannot be run on strictly commercial lines, because in the current crisis lending to SMEs is certain to result in losses. This new entity could be funded on the basis that 20% of loans would fail. Lending is thus made with the knowledge that there is an explicit subsidy. The return to the State (and the economy) is indirect in terms of job preservation, so that when the economy recovers there is an existing base which is a potential source of growth and job creation. Such a policy could also act as a certification device to other banks. It would reduce risk to other banks provided claims on collateral were ranked below that of additional funding from other banks.
Dr Jim Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.
He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).