Time to fix mortgage crisis while sun shines

The most direct casualty of Brexit so far appears to be the UK’s property investment funds industry, with six funds worth over £15bn (€17.5bn) now refusing to allow savers access to their cash.

With vestiges of Northern Rock and Bear Stearns, it may be too early to determine whether this development represents a financial canary in the coalmine or an overreaction to a short-term market dysfunction.

Problems in the UK have been mirrored by banking issues inside the eurozone where a failure to repair the legacy bad loans following the 2008 crisis has left many European banks in a difficult position when it comes to absorbing further shocks such as Brexit.

Italian banks are the current focus of attention with falls of around 40% in the market values of the largest banks since April, a decrease that has been accelerated by the Brexit vote.

Ironically the world’s oldest surviving bank, Monte dei Paschi di Siena, is at the eye of the storm with a market capitalisation that has plummeted by over 75% since the start of the year.

The announcement last week by Consob, Italy’s financial regulator, that short selling in shares of Monte dei Paschi di Siena has been banned for three months has a familiar resonance for Irish bank investors.

In contrast to the case of Anglo Irish Bank, the ban was not accompanied by an attempt to blame the bank’s woes on the black arts of the ruthless short sellers.

The non-performing loans at the heart of the Italian banking crisis have been well known for a long time with regulators having attempted to contain the issue with what now appear to be inadequate recapitalisations.

However, the capacity to resolve the non-performing loans in Italian banks has now become that much more constrained with Italy’s preferred approach of avoiding bail-ins coming up against the eurozone’s new rules agreed after the last crisis.

The pressure on eurozone leaders to bend the rules will in all likelihood intensify with the prospect of contagion hanging in the air.

Authorities have reassured the public that, although it may take sometime, solutions will be reached with Matteo Renzi, the Italian prime minister, stating that the situation is much less serious than the market thinks.

The question then arises, if Mr Renzi is correct, how can a relatively small number of non-performing loans, when viewed in the context of such a large economy as Italy, have such a disproportionate impact on markets and cause such financial turmoil?

The ripple effects of this market turmoil and focus of attention on the level of non-performing loans in the banking system should not be lost on Ireland.

The European Banking Authority rankings placed Ireland at the wrong end of the European league table with around 20% of the Irish bank loan book classified as non-performing.

Shares in Irish banks have suffered; Bank of Ireland’s stock price is down 50% from the start of 2016.

The underperformance of Irish bank stocks is in marked contrast to the performance of the Irish economy, which is at the top end of the European growth league.

One would expect some positive correlation between bank stocks and national economic performance instead of this abnormal bifurcation.

The negative impact of the continuing failure to resolve the non-performing loans in Irish banks has already been evidenced in the housing crisis and the excessive rates charged for variable rate mortgages and small business loans.

The re-emergence of unresolved banking problems at this late stage in the cycle is clear evidence that too few steps have been taken to sort the issue within a reasonable timeframe.

Mortgage arrears appear to be particularly intractable with only slow progress being made in determining what outcomes are feasible for the 40,000 cases that have been threatened with repossession.

The level of arrears capitalisations and loan resolutions falling back into default are not positive indicators. As Lorcan O’Connor, director of the Insolvency Service remarked, it is difficult to solve a debt problem with more debt.

It is clear that the arrears problem is solvable if there is a political will to take the necessary steps, however uncomfortable they may be in the short run.

Resolving arrears cases quickly is the prudent and conservative thing to do as well as being the essential prerequisite of returning to a normal banking market.

It was encouraging that the new administration’s programme for government set out a range of measures that, on the face of it, appeared to represent a step change in the priority given to solving this problem.

As George Osborne is fond of remarking, you have to fix the roof when the sun is shining. Let’s hope there is still some sunshine left.

  • Eugene McErlean is an expert on the banking industry and corporate governance.

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