Time for thrift

The financial services regulator has teeth after all, which must come as a surprise to the people running the country's main banks.

 For some time it has seemed the banks operating in Ireland could lend almost willy-nilly, aware of public "concerns" expressed by the authorities about the incipient risks, but in no way inhibited in their actions. But now, to the consternation of the banks, the regulator has made it somewhat harder for banks to lend, especially those dubious 100 per cent mortgages they have become fond of issuing in recent months.

Last week the Irish Financial Services Regulatory Authority ordered banks to put more capital reserves aside to provide for potential mortgage defaults. In particular they will have to do so to cover mortgages where the size of the loan is more than 80 per cent of the "value" of the property.

And with good reason too. The private sector credit binge is a recipe for economic disaster. The level of credit advanced by financial institutions in the 12 months to the end of February was 29.4 per cent, according to the latest figures from the Central Bank, the highest level recorded in five years.

Borrowers took out an additional €5.6 billion in loans last month, bringing total debt outstanding to €268 billion. Households account for almost half of this debt. The trend is not moderating despite recent interest rate increases and the strong probability of more, possibly by as much as 1 per cent over the next 12 months.

It can be expected that the cost of setting aside extra capital could be passed on to borrowers in the form of higher interest rates, although competition means that some lenders might accept reduced profit margins instead.

Banks can argue of course that they will not take undue risks, that they are not going to damage their balance sheets by making loans that will not be repaid. If only that were true. Those with a long enough memory know that banks consistently make loans that borrowers are unable to repay in full, even if they make their repayments in the initial stages. They get lucky in cycles where bad debts and what are called "non-performing" loans make up only a very small portion of their overall "book" of money advanced. Many bankers can't remember when the cycle last turned against them, but they would be stupid to think that it won't again.

The banks have more reason than most to pretend that the property bubble and the consumption binge can continue on the basis of borrowed money. Banks are under pressure from shareholders to continue increasing profits and they have to lend money to do so. They also have a vested interested in protecting the value of the property upon which many mortgages are secured, so they will do nothing to talk the market down.

Which is what makes the emergence of the credit unions in the mortgage market ominous: about a dozen of the biggest are seeking regulatory approval for this expansion of their businesses along with a couple who have already done so as agents of banks and building societies.

Credit unions should not be offering mortgages at any time, but most certainly not now, at what is increasingly likely the top of an inflated property market – no matter what the vested interests would have you believe. Instead, this is the time for them to be advocating thrift and to be dissuading people from borrowing big to buy expensive properties.

The credit unions getting into this game so late in the day may be the equivalent of the shoe shine boys operating stock market tips just before the 1929 crash.

Balancing bank profits

With an exquisite sense of timing (later the same day the regulator tried to clamp down on reckless bank lending), Taoiseach Bertie Ahern last Friday attacked those who criticise excessive bank profits. Ahern said there was a need for "balance" in the public view of banks' profits. He argued that the banks made an important contribution to the Irish economy. Would he not agree that it works both ways?

He could also have recalled his own comments to the Dáil in late February when he pondered how "you can go to the bank to cash a cheque and end up being offered a car loan", which is something the regulator would probably agree with. There is a sales culture dominant in Irish banks these days, where its staff are encouraged to be sales people, pushing loans, insurance products, shares and the like on customers.

Ahern also said then how banks must be "fair" to their customers, while maintaining their profitability. Customers who have been overcharged for services would agree with that, as would depositors who have been rewarded with tiny interest rates for giving their money to the banks.

But on Friday 31 March, Ahern pointed out that when businesses in other sectors reported good profits they were "justly" praised for their achievements. "But a bank with a similar headline profit is assumed to be doing it at an adverse cost to its customers", he said. And remember that in the Dáil back in February Ahern said that he took great pride in AIB's €1.7 billion profits, particularly as half of it was made abroad.

This means there was nothing tongue-in-cheek about Ahern's comments, notwithstanding that they were made to an audience of international bankers operating out of Ireland (many of whom do little business in this country but use it as a tax-efficient location to do business back in their home markets).

Ahern may have been impressed by predictions that the Republic's international banking sector – much of which operates out of the IFSC – could create at least 8,000 new jobs over the next five years, bringing the figure employed to in excess of 26,000. And he is right to recognise the employment issues and the need for banks to provide loans when times are tougher than they are at present.

The banks have known that Ahern is their friend for some time anyway. Four budgets ago Charlie McCreevy introduced a bank levy of an additional 1 per cent tax on their profits, on top of the standard 12.5 per cent corporation tax that all businesses pay, to be paid for three years. Brian Cowen dropped the levy in the last budget when he could have extended it, saving them the Irish banks over €100 million each year on their profits in the process. Lucky banks.

The Last Word with Matt Cooper is broadcast on 100-102 Today FM, Monday to Friday, 4.30pm to 7pm