No real recovery until vicious cycle of credit cost is broken

THE Central Bank survey which shows loan application rejections are twice the eurozone average throws the spotlight on a crucial area of the economy.

If the SME sector is starved of credit, then the domestic economy will remain stagnant at best, which will ultimately lead to a vicious circle that could undermine the viability of the banking system.

Exports have held up well during the worst downturn in the history of the State. But there has to be a recovery in the domestic economy before unemployment can be brought down to manageable levels. Banks will not be able to return to full health until there is a stabilisation of the economy. This then becomes a chicken and egg scenario. As long at unemployment remains where it is, the housing market is likely to remain in a prolonged slump and there will be concerns over mortgage arrears and other forms of personal debt on the balance sheets of the banks.

But as long as banks starve the economy of credit, the prospects of a sustained recovery are slim. And as the Central Bank report starkly points out, the SME sector faces the some of the most challenging credit conditions in the eurozone.

There is very little public sympathy for the banks. After all, they played a central role in the cause of the crash. But there is a compelling reason why they are not lending.

The problem is that banks grew too big during the boom. Mortgage and property lending ballooned to unsustainable levels. When the credit crisis erupted in 2008, Irish banks were left dangerously exposed. The State has so far pumped €64bn into a nationalised banking system. But, as part of the EU-IMF bailout in Nov 2010, the troika imposed deleveraging targets for the domestic banks.

The banks have to downsize if they are to become fit for purpose. Irish banks are selling assets in an effort to meet their deleveraging targets. With roughly static deposit books, there is no incentive to increase their loan books.

One corporate financier said banks may say they are in business but in reality, what is happening is that most new lending is a rollover of existing loan facilities. And, as the Central Bank report finds, these rollover facilities are generally on more onerous terms — more stringent collateral requirements, shorter loan terms, lower loan amounts, and higher interest rates.

In a way this just reflects the new reality of Irish banking. During the boom years, there was a global supply of cheap capital. Irish banks took full advantage. That is why they were, in turn, able to dole out cheap credit to the SME sector.

But now Irish banks do not find it so easy to raise capital. They have to pay more for deposits than peer countries, and wholesale markets are much less buoyant and much more expensive than they were in the past. In other words, the cost of funding for Irish banks is expensive. They have to charge higher rates on what they lend out in order to make a profit. This is not going to change until the Government has made a full return to the sovereign debt markets and the economy has fully normalised.

There is also the uncomfortable reality that many SMEs reflect the underlying weakness of the economy, which means they very often lack creditworthiness. The focus of Irish banks is to purge bad debts from the books — not add to them.

The obvious solution would be for a State investment bank to fill the void. But the Government is using any bit of spare revenue to plug the yawning chasm between what it spends and what it gets in taxes. There is nothing left in the coffers to fund a State bank.

Unfortunately, Ireland is also hit by another whammy. In other mature western economies, private sector wealth can provide a much needed source of liquidity through venture capital funds and angel investors. In this country, the property bust has wreaked havoc across this sector, removing a potentially lucrative alternative source of capital.

Ensuring that the SME sector gets sufficient levels of credit is one of the biggest challenges facing this Government. There is a huge amount riding on the outcome.

Read more:

Firms call for probe into bailed-out banks’ loan books

Businesses back Central Bank report

Credit study contradicts itself, say bankers


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