‘Credit unions must consolidate and banks tackle arrears’

Further consolidation among credit unions combined with banks working their way through the backlog of loan arrears as well as a possible solution for loss-making tracker mortgages are all needed for the financial sector to return to profitability, Central Bank governor Patrick Honohan has said.

“If the banks can manage to accelerate their processing of the large backlog of troubled legacy debt into sustainable solutions, much of what is needed to restore their health will have been achieved.

“If in addition the funding of their low-yielding tracker portfolio could be enhanced — something for which technical solutions have been devised, but require wider official European agreement that does not seem likely to be forthcoming in the short-run — then, when combined with the credit union restructuring framework being implemented by the Credit Union Restructuring Board, the foundations would be well laid for the long-term rehabilitation and repositioning of the banking sector,” he told the IIEA conference on the ‘Future of Banking in Europe’.

Mr Honohan was speaking about how the banking system was likely to unfold. Noting the many causes of the crisis, possibly the biggest contributing factor was the breakdown in traditional banking relationships where there was a deep understanding of a client’s risk profile and funding needs. This had to change, he said.

He said Irish banks became too internationally focused. They acquired subsidiaries in many countries, including the UK. Most of these international assets — apart from the UK — have not been divested.

An Irish bank could theoretically become pan-European in presence and because of banking union, its balance sheet could be effectively separated from the sovereign.

“After all, that is consistent with the logic of the single market. But I feel that such a prospect lacks the ring of authenticity. This is probably not a path to seek out in the immediate future. While recognising the UK links, the main focus of Irish banks should now be on Ireland,” said Mr Honohan.

Most of the foreign banks have exited the Irish market, but when the economy normalises, foreign banks will return, he noted. However, most foreign-owned entities tend to concentrate on large companies and wealthy individuals.

“The international literature notes the tendency for foreign-owned banks to serve mainly large companies and wealthy individuals when they enter a banking market; but it also emphasises that their entry can drive the incumbent banks to refocusing on SMEs and middle-income households, with a beneficial effect on availability and pricing of services to this clientele.”

“Perhaps then the best mix is to rely on foreign-owned concerns for those services that require large scale, while not neglecting the importance of the local relationship banking that is necessary for supporting the SME sector.”

What is the right size of a bank is another important issue that has to be addressed, he said. Bank of Ireland and AIB reached roughly €200bn in assets while Anglo Irish Bank grew to €100bn. This caused huge problems for the State when they ran into trouble.