Banks – where are we, how did weget here, where are we going?

Talk to Labour Party Economic Forum “The State of the Nation”, Cork City, March 2009

Professor Brian M Lucey

School of Business

Trinity College Dublin

• Causes of the Irish banking crisis– Local causes “cribbing and moaning”– International causes “dem lehman brudders”

• Where are we now?– Cleaning the stables– Cleaning the stables– NAMA– competition

• Where are we going– Banks– economy

A litany of woes…

• Unemployment, especially young male unemployment, at unacceptably high levels

• Tight credit conditions (but beware…)• Tight credit conditions (but beware…)• An unsustainable fiscal position• Growing problem of negative equity, esp

amongst recent FTB’s• Stormy international bond waters still

ahead

Brief Digression 1 - Fiscal

• Fiscal position is grossly unsustainable.

• A major part of the fiscal problem is structural deficit – this HAS to be closed

• Three ways of closing it• Three ways of closing it– Lower growth in state spend

– Higher growth in taxes

– Discovery of a pot of gold….

Brief Digression 2 - Bonds

• Good News – NTMA have proven successful at raising lots of debt, at increasingly cheaper

20%

25%

30%

increasingly cheaper rates

• Bad News – we have moved to a lower maturity profile –refunding issues loom

0%

5%

10%

15%

1 2 3 4 5 6 7 8 9 10

2010% 2008%

Source : NTMA

Causes of bank crisis

• Banks borrowed too much internationally

• They lent it out too much to property and related

• Credit fuelled a housing and related • Credit fuelled a housing and related bubble

• International banking competition wasn’t to blame

Banks borrowed disproportionallyabroad..

60%

70%

80%

90%

100%

Capital

Other Liabilities

Bonds - Irish

0%

10%

20%

30%

40%

50%

60%

'1999 '2008

Bonds - Irish

Bonds - Non Irish

Irish Customer Deposits

Foreign Customer Deposits

Irish Bank Deposits

Foreign Bank Deposits

Source : Central Bank

And lent disproportionally tohousing

60%

80%

100%

Other Business

Wholesale/Retail Trade

Other Personal

0%

20%

40%

60%

1999 2008

Other Personal

Mortgages

Real Estate

Financial Intermediation

construction

Source : Central Bank

And boy did they lend…

• Lending to private sector as % of GDP– ~50% 1995– ~100% 1998– ~150% 2005– ~300% 2009 !– ~300% 2009 !

• Vast increase in lending to developers– 2009 prices– 20b mortgages, 10b developers 1997 – 140b mortgages, 110b developers 2008– GDP rose by 75% for comparison

Private Sector Credit Q1/91 =100

1000

1200

1400

1600

1800

0

200

400

600

800

1000

Mar-91

Mar-93

Mar-95

Mar-97

Mar-99

Mar-01

Mar-03

Mar-05

Mar-07

Mar-09

Source : Central Bank

fuelling a massive, unaffordablebubble

300

400

500

600

0

100

200

300

Mar-9

1

Mar-9

2

Mar-9

3

Mar-9

4

Mar-9

5

Mar-9

6

Mar-9

7

Mar-9

8

Mar-9

9

Mar-0

0

Mar-0

1

Mar-0

2

Mar-0

3

Mar-0

4

Mar-0

5

Mar-0

6

Mar-0

7

Mar-0

8

Mar-0

9

New House Prices Price/Earnings

Source : DoE database, CSO

This was not driven by competition

3

3.5

4

4.5contributed to tighter credit for households

1.5

2

2.5

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Jan-

09

Jul-0

9

Jan-

10

Ireland - Competition Ireland - Prospects Ireland - LTV

contributed to looser credit for households

Source : Central Bank Credit Survey, ECB Herfindahl Index

Which was no worse thanelsewhere

1

1.1

1.2

1.3

1.4Relative to euro irish standards contributed to tighter credit for households

0.6

0.7

0.8

0.9

1

Jan-0

5

May-0

5

Sep-0

5

Jan-0

6

May-0

6

Sep-0

6

Jan-0

7

May-0

7

Sep-0

7

Jan-0

8

May-0

8

Sep-0

8

Jan-0

9

May-0

9

Sep-0

9

Jan-1

0

Competition Prospects LTV H Index

Relative to euro irish standards contributed to looser credit for households

Source : Central Bank Credit Survey, ECB Herfindahl Index

Or concentration…?

1

1.1

1.2

1.3

1.4

Irish banks more concentrated (less competition) than EU5

0.5

0.6

0.7

0.8

0.9

Dec-97

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-03

Dec-04

Dec-05

Dec-06

Dec-07

Dec-08

Source : ECB Herfindahl Index, ratio of Ireland to “big5” ;

Irish banks less concentrated (more competition) than EU5

General consensus1. House prices are significantly determined by credit availability ;

“inflation is always and everywhere a monetary phenomena”…this we lost sight of

2. This is a function in the first instance of the supply of credit and the ability to pass this through

3. Easy money …” • Effectively the Irish economy segued from one driven by • Effectively the Irish economy segued from one driven by

competitiveness in the 1990s to one driven by a credit fuelled bubble in the 2000s” (Kelly “the irish credit bubble” 2009)

4. Lax regulation – “In addition to ignoring, or even condoning, fraudulent accounting, the

financial regulator made strategic errors in not responding to the build-up of systemic risk to the banking system” (Flavin et al 2010)

– “Irish problems relate to a very old-fashioned credit boom and not to financial innovation. The failure was one of insufficient scepticism on the part of the Regulator.” (Honohan 2009)

Context Now

• Banks –– Bankrupt beyond redemption if had to take losses on

the chin– Losses could be as high as 50-60% of transferred

value based on commercial court cases and property value based on commercial court cases and property drops

• NAMA– Maybe the EU will save us from worst overpricing– The crash is over! : Nov 30 2009 Judgement Day– NAMA magic beans , sorry bonds still unclear.– Micawbernomics rules…

What to expect

• This time / Ireland is NOT different – many other countries have had banking + fiscal crises

• A good starting point to what we can • A good starting point to what we can expect is to look at studies of systemic banking crises

IMF Analyses show the way forward

• “Banking crises are also often preceded by credit booms,”• “Fiscal costs, net of recoveries, associated with crisis management

can be substantial, averaging about 13.3 % GDP on average, and can be as high as 55.1 % GDP. Recoveries of fiscal outlays vary widely as well, with the average recovery rate reaching 18.2 percent of gross fiscal costs. While countries that used asset management companies seem to achieve slightly higher recovery rates, the correlation is very small, at about 10 percent” correlation is very small, at about 10 percent”

• “The effectiveness of government-run AMCs has been quite mixed: better where the assets to be disposed have been primarily real estate, less good where loans to large politically-connected firms dominated”

• “Nonperforming loans tend to be high during the onset of a banking crisis, running as high as 75 percent of total loans and averaging about 25 percent of loan”.

• “Crisis-affected countries often suffer from weak legal institutions, rendering a speedy resolution of distressed assets hard to accomplish”

• “. blanket guarantees are used in 29 percent of crisis episodes….they tend to be in place for a long period as well, about 53 months on average… Laeven and Valencia (2008) … find that they are often successful in the sense that they restore depositor confidence. However, they also find that outflows by foreign creditors are virtually unresponsive to the announcement of such guarantees, despite of being covered in most cases. Regarding the fiscal cost of using guarantees, they find that such Regarding the fiscal cost of using guarantees, they find that such guarantees tend to be costly” - median cost is 30% GDP

• “On average, the net recapitalization cost to the government (after deducting recovery proceeds from the sale of assets) amounts to 6.0 percent of GDP across crisis countries in the sample, though in the case of Indonesia it reaches as high as 37.3 percent of GDP”.

• Working Paper 08/224 Systemic Banking Crises: A New Database

• “Severe regulatory measures increase both the likelihood of recovery and its duration while weak measures are insignificant.” IMF WP10/27 Recovery Determinants of Distressed Banks: Regulators, Market Discipline, or the Environment?

• “Our findings raise the question of why crisis response policies that are risky for taxpayers might also be costly to the economy. One possibility is that readiness to deploy fiscal resources may hinder private efforts to carry out financial sector restructuring, thereby private efforts to carry out financial sector restructuring, thereby delaying crisis resolution. Also, these measures may give politicians too much influence over credit allocation, causing scarce financial resources to be channeled to politically favored enterprises or sectors, and thereby undermining efficient economic restructuring “ IMF WP 10/27 Responding to Banking Crises: Lessons from Cross-Country Evidence

What do we have?

• Banks– Asset divestitures (hollowing out)– Financial engineering (swapping T2 for T1)– Margin squeezing and revenue generation– Entrenchment and consolidation– Entrenchment and consolidation– Persistent unwillingness to face reality

• Govt– Maximal unwillingness of Govt to recap– Incrementialism 11b to get 100% of worthless bank,

15% of 2b bank, 0% of 1.5b bank….– Persistent unwillingness to face reality

AIB

AIB

Bank of Ire

AIB

INBS