Irish model of handling bad debt isn’t working

BBC’s Panorama recently revealed new evidence about the banking crisis. It suggested that the UK regulator was complicit in manipulating Libor, the main UK benchmark interest rate from which millions of financial products are priced.

The scandal has already led to banks being fined hundreds of millions of pounds while a number of traders have been jailed.

The BBC said its investigations added to evidence the Bank of England had pressured commercial banks to push their Libor rates down and that the transcript of a phone conversation at Barclays called into question evidence previously provided to the UK’s Treasury select committee.

In the recording, a senior Barclays manager, Mark Dearlove, is heard instructing a Libor submitter, Peter Johnson, to lower his rates.

Regulators applying pressure to banks is nothing new. Here, evidence at the Anglo trials revealed the so-called “Green Jersey Agenda” where bankers came under pressure to give a positive impression of the financial system.

Whatever the reasons for the regulators actions, both cases provide a rare insight into the real world power of the Central Bank to influence the actions of commercial banks. The opportunity for regulators to bring pressure on banks goes well beyond issuing formal directives.

In this context, one of the more remarkable features of the post-crash period has been the apparent impotence of the European regulators to make material inroads into the mammoth problem of non-performing loans (NPLs) facing Europe’s lenders.

Large institutions across the euro area have a combined total of nearly €1tn of non-performing loans that have the corrosive effect of reducing profitability, consuming capital, tying up resources, and negatively impacting the cost and supply of credit. The EC’s latest quarterly eurozone report highlights that elevated NPLs constitute a brake on economic growth.

Late last year Gary Cohn, who was then president of Goldman Sachs prior to his appointment as Donald Trump’s economic adviser, hit out at eurozone banks for failing to clean up their balance sheets after the financial crisis.

He noted that the US banking sector was “in the best shape ever” while other parts of the world provided cheap financing to their banks to allow them to earn their way out of the crisis.

The European Parliament published evidence that supported Mr Cohn’s point of view last week. It noted that in the EU the average rate of non-performing loans amounts to 5.1% remaining higher than in other major developed countries. The World Bank reported NPL ratios of about 1.5% for the US and Japan at the end of 2016.

The recognition of losses has been slower in Europe and the subsequent reduction in NPLs is also more gradual. What should be of particular concern for the Irish authorities is that the level of NPLs in Irish banks is unsustainably higher than the above data, at 13.6%, and — as noted recently by the European Commission — there is a strong correlation between high NPL levels and weak economic performance.

Bad debt is a real, serious problem and our approach isn’t working when compared to other countries. With Brexit looming, one would have expected the Irish regulators to have been more assertive in resolving the overhang from the last financial crisis before facing into fresh challenges.

  • Eugene McErlean is an expert on banking and corporate governance

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