Banks in the bad books?
The average post-Second World War economic cycle lasts around seven years, meaning the events of 2007-8 should be long behind us. However, Dan White believes that until the Irish and other Eurozone banks come clean on the full extent of their bad loans, a true recovery in lending will remain elusive
18 October 2017
More than a decade on from the original financial crash, the Irish banks, along with most of those in the rest of the eurozone, remain broken. Unless and until Europe’s banks come clean about the true state of their loan books, businesses and individuals will find it extremely difficult to borrow and economic growth will suffer.
Remember the “credit crunch”? It all sounds so terribly quaint now. The first signs that the global financial system might be little more than a gigantic Ponzi scheme came in July 2007 when US investment bank Bear Stearns, which went bust eight months later, warned investors in two of its hedge funds that they were unlikely to get much of their money back.
Entering common discourse
This was followed less than a month later by French bank BNP Paribas suspending withdrawals from two of its funds because it could no longer accurately value their assets. Suddenly, what had previously been arcane topics such as sub-prime mortgages and toxic assets entered common discourse.
Anyone who might have thought that the credit crunch was purely for financial anoraks was rudely disabused when in September 2007 nervous depositors of British mortgage bank Northern Rock queued around the block. They were anxiously seeking to withdraw their money when word leaked out that it was unable to roll over short term loans from other banks. This was the first “run“ on a British or Irish bank since the Munster Bank closed its doors in 1885.
While it took another year for the financial crisis to go nuclear, when in September 2008 US investment bank Lehman Brothers went bust and the Irish government was forced to unconditionally guarantee the deposits and bonds of the domestic banks, we can now see that the events of the Summer and early Autumn of 2007 marked the beginning of the worst financial and economic crisis since the Great Depression of the 1930s.
Under “normal” circumstances, a decade is an infinity on the financial markets. With the average post-Second World War economic cycle lasting about seven years, we should have put the event of 2007-8 long behind us.
But we haven’t. Earlier this month the ECB unveiled plans to force eurozone banks to set aside more capital against bad loans. Under the terms of the draft document, banks will have two years to set aside 100% of the value of loans against newly-classified bad debts and seven years to set aside 100% against their €1 trillion (that’s €1,000 billion) of legacy bad loans.
The idea behind the new rules is to make it prohibitively expensive for eurozone banks to sit on legacy bad loans, which are clogging up their balance sheets and preventing them from making new loans.
That’s the theory anyway. The reality is that there is virtually no secondary market for these new loans and, with eurozone bank share prices so low, forcing them to raise fresh capital to cover losses on legacy bad loans will be prohibitively expensive.
Immune from wider Eurozone?
But surely, with the Irish taxpayer having spent a gross €64bn bailing out the Irish-owned banks – a move that effectively bankrupted the Irish state and threw us on the tender mercies of the Troika in November 2010 – we in this country will be immune from the problems of the wider Eurozone banking system?
Think again. The great Irish bank bailout may have prevented the Irish banks from going bust but it hasn’t restored them to full health. The latest Central Bank figures show that overall Irish bank lending is still falling, with loans to Irish non-financial companies down by 2.3% and loans to Irish households down by 1.7% in the 12 months to the end of August. Total Irish bank lending has now more than halved since the crash.
Indeed, we are now in the unprecedented position of Irish households having more on deposit with the banks than they have borrowed from those banks; about €3.5bn at the end of June.
Still not lending
So why, after having received €64bn of our money, are the Irish banks still not lending? Could it possibly be that, despite having written off close to 20% of their pre-crash loans books, the Irish banks are, like those elsewhere in the eurozone, still sitting on large piles of unacknowledged bad loans?
A close examination of the Central Bank’s mortgage arrears statistics would certainly seem to lead one towards this conclusion. While the headline mortgage arrears figure has been falling steadily since September 2013, unfortunately there is less to this apparent fall than meets the eye.
At the end of June, almost €13.6bn of mortgages on principal private dwellings and a further €6.2bn of buy-to-let mortgages were in arrears, a total of €19.8bn. The mortgage arrears statistics also categorised €16.6bn of mortgages on principal private dwellings and €5.5bn of buy-to-let mortgages, a total of €22.1bn, as having been restructured.
According to the Central Bank, the vast bulk of these restructured mortgages, 74% of those on principal private dwellings and 78% of those on buy-to-lets, are not now in arrears. So, if one takes the Central Bank statistics at face value, there are restructured mortgages with a total value of €16.6bn not in arrears.
Extend and pretend
However, when one looks at the composition of these restructured mortgages, it quickly becomes apparent that there is much less to most of them than meets the eye. At least 61% of restructured mortgages on principal private dwellings and 74% of those on buy-to-lets are short-term expedients such as interest only, arrears capitalisation, term extension and payment moratoriums.
Extend and pretend in other words.
Throw on the fact that approximately 55% of all mortgages are trackers linked to the ECB’s official interest rate and one can only wonder how many mortgages will turn bad when interest rates start to increase once again. Are there similar problems lurking elsewhere in the Irish banks’ loan books?
Some things never change
Could this possibly explain why a decade after the crash, the Irish banks are still effectively so-called “zombie banks”, almost exclusively focused on recovering legacy loans rather than advancing new ones? Unfortunately, as the latest proposals from the ECB make clear, they are not alone.
Unless and until the Irish and other eurozone banks come clean on the full extent of their bad loans, there will be no recovery in lending and economic growth will remain below what it would otherwise be.
And as for the Munster Bank, it was reconstituted as the Munster & Leinster Bank and re-opened for business in 1886. In 1966 the Munster & Leinster was by far the largest of the three banks that came together to form AIB. Some things it seems never change.