There is a great book on marketing titled The Long Tail, which stresses that instead of trying to hit millions of customers at once, it’s perhaps better to do millions of niches. Replete with examples, it was and remains a deserved hit. The “long tail” refers to the distribution of something — a large bulk at one end, quickly trailing off to smaller numbers but which go on for a long time.
Another word for this is skewness. In many skewed distributions, it is common for the total amount in the long tail to be equal to or greater than in the bulk.
The long tail approach is worth considering as we move into the sixth year of this crisis. Having dealt with the massive mess of the commercial property and developers loans via hiving them off to Nama (which has yet to “get credit flowing”), the long tail of mortgage and SME loans continue to erode the banks.
At present, Irish banks are well capitalised. Some might say they are overcapitalised. The ECB recently stated that it will conduct another round of stress tests. These are required, so the final set of capital injections will be made prior to the ECB taking over full control of regulation. The political reality is that this step, a necessary requirement for a proper banking union, will require that individual states make or supervise any capital injections. In a banking union this will be the responsibility of the union, and so the German taxpayer might be on the hook. But not this last time.
We have known for some time that the Irish banks will require additional capital. The state of the mortgage book is bad but the state of the SME loan book is also dire. Earlier this year, we found out that 50% of the SME loan book was in distress. There is a total of €70bn in SME lending, of which an astounding €30bn is still outstanding to real estate. A multi-billion loss is a certainty. On the mortgages we have similar. And who bears these losses?
Traditionally, the order of losses was deemed to be shareholders > junior bondholders > deposits and senior bonds. The taxpayer might then step in and recapitalise if the bank was deemed to be needed. We saw in Cyrpus, and indeed have seen in the liquidation of IBRC that depositors can and in future will be “bailed in”. This is fine and dandy if all other sources of capital have been burned through. The problem is that recent statements by Mario Draghi suggest that bondholders might be spared in future, for fear that once burned they might not return. In other words the sovereign would be required to decide whether they would absorb losses or instead force bail- ins on depositors. There is zero willingness for the Irish state to add more taxpayer money into the banks. Thus the question becomes: do the banks have sufficient buffers to absorb losses before the question of depositors comes into play?
On a macro level they are good. AIB has shareholders funds of around €10bn, BOI of €8bn and PTSB €2.4bn. The problem is that they are required to hold funds at a certain level. This level is higher than the European requirements. Thus, as losses get booked the banks will have to either raise additional funds. This, in sufficient amounts, is unlikely.
Bank of Ireland will need to roll over or pay off bonds of €9.5bn in 2014-2015, AIB €7.5bn and PTSB €5bn in the same period. This will tax them significantly. If they face a requirement to otherwise increase capital from losses, that will make the job that much more difficult.
Bank of Ireland has the largest “burnable” buffer but is the one least likely to require it. AIB has very little unsecured debt and less than €4bn senior debt. We have seen that even the mention of senior debt being burned, has caused significant negative market reaction. Thus, where there is no taxpayer backstop and either no bondholders or no willingness to burn them, inevitably deposits must come into play.
In that context depositors should seek a higher rate than they are at present getting. Deposits that were 10 years ago as close to riskless as it is possible to be are no longer so. It is time that the banks begun to remunerate them appropriately for the risk, small that it is, that they are being asked to bear.
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