Time to cull these elephant banks

We need smaller banks that are not ‘too big to fail’, writes Brian Lucey

WE need to take a close look at the Government’s plan to create two pillar banks. While this will make the job of regulating them easier, it is also clear that it runs grave dangers.

We have seen how regulators in many, many areas are easily captured. With few exceptions, and regardless of their nominal power, regulators are toothless.

If regulators were unable to regulate Anglo and AIB and the rest from running amok, why would we conclude that they will any more effectively regulate pillar banks?

What was surprising about the Anglo tapes was that the speakers come across as densely arrogant, cavalier in their language and their approach to business.

Perhaps, however, it was not so much denseness, as insouciance. They were untouchable, playing a game with other people’s money. They had succeeded (despite protestations now that that was not what they had intended) in misleading the State into a rescue based on illiquidity, knowing that they would at best require multiples of the initially stated sum and at worst that they would end up insolvent and wards of the State.

Even harder to excuse is the way that the Government, permanent and elected, is planning to allow a structure whereby such arrogance and insolence can flourish again.

The problem with Anglo, in essence, was that the bankers felt they had become too big to fail. They were linked with the ruling party, bankrolling the turbocharging economy, and feted as financial magicians. They felt financially and politically invulnerable.

Similarly, the pillar banks will be, by design, too big to fail. One of them will have embedded into its corporate culture a shocking degree of moral hazard, having been rescued by the taxpayer twice in the last few decades.

Moral hazard in a corporate culture is likely intractable and incurable and must inevitably run the risk of the organisation eventually slipping back to the old ways.

After all, if the State will bail you out, what onus is there on you to behave responsibly? Add to this the too big to fail, and add a generous dose of regulatory capture, and we have a recipe for the 2030 banking crisis.

The costs of the Anglo collapse in plain numbers are bad enough — €30bn wasted on feeding a zombie.

Zombies when fed do not lie down — they demand more. The more that Anglo has consumed consists of our international reputation (twice) and was, I contend, the straw that has broken the back of the fiscal state.

It is undoubtedly the case that absent the €64bn bank bailout, we would still have faced a significant fiscal problem. Our tax base had eroded and the world economic crisis would have made things worse. Absent the Anglo €30bn, we would face not 117% debt to GDP but below 100%.

We might be facing some €1.5bn per annum less in debt service costs. It is arguable that we might not have even had to seek a bailout. With the economy flatlining and emigration soaring, the collateral damage of saving Anglo is incalculable and worse yet the social damage is generational and ineradicable.

The new EU procedures on how to allocate losses in banking failures are good in principle — taxpayers rank last in line after capital, including those heretofore untouchables senior bondholders, and after large deposits. But the taxpayer is still on the hook in theory.

In any case, there are lots of hurdles, at EU and various national levels, that will have to be overcome before any such resolution mechanism is in place. At the earliest we will not likely see this before 2017.

ARE we certain that before then, we will not face additional capital calls from the banks? Even after, with an effective duopoly, what confidence do we have that should one of them run into trouble, the letter of the law will be observed in relation to loss allocation?

The planned pillar banks therefore pose, in my view, a grave potential risk.

We should consider a strategy whereby the banks are made smaller and less systemically important. Even now the liabilities of the covered banks amount to over twice GDP, and those of the domestic banks (including banks such as Ulster and KBC) to over three times.

This is too large. Conversion of the majority of the covered banks to pillar banks will leave the State in an extremely vulnerable situation. The solution must be two fold; shrink the absolute size of the banking system and shrink the average size of the components.

Shrinking the size of the financial sector worldwide will come with costs. We have gotten used to the idea of a very large financial sector, in other words we have gotten used to easy credit.

This will have to change, both at a corporate and personal level. Reduced credit will imply a slowdown in economic growth from the heady days of the middle noughties which is no bad thing.

In terms of size, we need to have many more competing banks, each individually more connected with local communities, each definitively not too big to fail, funded mainly by deposits and regulated assertively in terms of credit quality. These banks must be capped in terms of individual size and the entire system capped at a level below that of national income. Again this will mean an end to easy credit.

There is an old saying “when the elephants dance the ants get trampled”.

It is time to cull the elephants.