Bank on it: Challenging times ahead for sector

One can only imagine the exchanges between Bank of Ireland chief executive, Richie Boucher, and the Central Bank last weekend.

The Central Bank had just completed its balance sheet assessment. The good news was that the three domestic banks — Bank of Ireland, AIB and Permanent TSB — were not required to raise any further capital as they met the regulatory standards.

But Bank of Ireland was just about to go to the markets to raise €1.8bn or thereabouts in order to redeem the Government’s preference share.

It was forced to disclose to the markets that on foot of the balance sheet assessment, it had to increase bad debt provisions by €1.1bn. The Central Bank did not release any further information. There was no clarity on its methodology and how it compared to Bank of Ireland’s own methodology.

If there is one thing the markets hate it’s uncertainty. This initially raised concerns that Bank of Ireland would have to delay its preference share redemption. In the end, investors felt comfortable enough with Bank of Ireland’s balance sheet to take part in its capital raise.

But the situation is far from ideal. The full details of the comprehensive assessment of the banks will not be known until next November. But banks will want to raise capital before then. Take AIB for example. It is understood it will look to refinance its contingent convertible notes as well as the Government owned preference shares sometime in 2014.

How will the markets react to the lack of transparency? Senior figures at the Central Bank acknowledge that there are serious drawbacks to the way the comprehensive review of the banks is being carried out. But they point out there is very little they can do as the Central Bank is legally obliged not to disclose the details of the balance sheet assessment.

And not only is the lack of transparency about the banks’ balance sheet a problem, there is also uncertainty over the future resolution of banks as part of EU banking union. As of 2018, if a bank has a capital shortfall, the first leg of remedial action will be a bail-in of investors starting with ordinary shareholders, then junior bondholders; senior bondholders and finally unguaranteed depositors.

The German government wants a shorter timeframe for the introduction of these bail-in rules in 2016. With a lack of clarity about the health of banks and the new resolution regime, it is hardly the most benign backdrop for potential investors.

But it isn’t just the handling of the balance sheet assessment results that has caused tensions between the Central Bank and the banks. The handling of the mortgage arrears crisis also prompted a bout of mutual recriminations.

The Central Bank publicly reprimanded the banks for not tackling mortgage arrears with more urgency.

The banks claim that under the old code of conduct on mortgage arrears, which only allowed contacted with a customer three times in a calendar month, it effectively tied one hand behind their back in this respect. The CCMA was reformed over the summer.

When this newspaper recently asked a senior bank executive what he thought of the Central Bank, he said: “A lot better now that most of its functions are being transferred to the ECB.”

When the ECB takes over the supervision of the banks system, the Central Bank faces an obvious diminution of its responsibilities. This may explain the recent exodus of personnel from the Dame Street institution.

But it will still retain a number of important functions — not least the macro-prudential supervision of the banks.

This will include determining the banks’ counter cyclical capital buffers and loan-to-value ratios among other things. Both of these tools will be essential in ensuring the country does not experience a bank collapse in the future.

For example a counter- cyclical capital buffer will determine how much extra capital the banks will have to put aside in a rising market. Loan to value ratios will be used to take the froth out of rising property values.

To discharge its duties effectively, the Central Bank will have to be independent; have the requisite expertise and above all a thorough knowledge of the banks. The Central Bank will play an important role in the future and that is why it is vital that it is fit for purpose.