McCarthy laments lack of bank buyouts

THE author of the controversial Bord Snip Nua report Colm McCarthy laments the fact that the Irish banks have not been bought out by larger European banks less exposed to banking meltdowns.

Given the problems faced by the state in having to refund the banks, McCarthy says its a “shame the Irish banks weren’t bought out in a European consolidation”.

Commenting on The Irish Economy blog he said this country needs a functioning banking system that is adequately capitalised.

It is also important it does not impose “excess costs on the productive economy, and does not enjoy any free insurance on its liabilities. The exit strategy from the guarantee is critical”, he said.

He went on to say the banking problems for countries like Ireland are not addressed by the separation of commercial from investment banking.

Irish banks did not fail as a result of “casino losses, but through explosive balance sheet growth and huge loan write-offs, a very old-fashioned commercial banking failure”, he wrote.

It is not clear either that “having 10 commercial banks rather than three helps either. If all 10 were to behave in the same way, you are in the soup anyway”, he said.

In the end the state ends up as the lender of last resort in the euro system as it is currently operated, he said.

In small economies like Ireland the state is simply not big enough “to credibly underwrite the next failure”. That’s the case for several EU countries with the state in Iceland “clearly not big enough to underwrite the last one”, he said.

Unless full-blown EMU emerges soon with all commercial banks covered by European financial support the size of the domestic banking system which the state can stand behind “must be constrained by the fiscal capacity of that state”, he said.

Ireland got it wrong by permitting domestic bank balance sheets to expand beyond what could comfortably be supported by the state, which it then failed to supervise adequately.

“Iceland made the same mistake multiplied by three or four,” he said.

The implication is that the contraction of Irish bank balance sheets is not just an important component of de-leveraging, it is necessary in order to match the state’s capacity to its responsibilities, he said.