BANKING:With trust in banking at an all-time low, it's time to turn our attention to how the banks should be run and whose interests they should serve
'I ENTERED A profession and ended up working in an industry." The words of David Lomax, former chief economic advisor to Nat West Bank, in a speech to his peers in Belfast some years ago resonate with bankers of a certain generation.
The move from a relatively simple and generally well-respected profession to a complex high-pressure sales-driven environment characterised banking in Ireland over the last decade or so. In this, it was mirroring some of the worst aspects of global banking practice, unsurprising given the increasing networking of global financial institutions. Greed, reckless speculation and the absence of rigorous governance are all charges that can be fairly levelled at the sector. The fallout from the financial crisis of the last two years is a profession in disrepute. Public respect for banking is at all-time low.
Government recapitalisation and the removal of toxic debts through the setting up of Nama have heightened public anger, notwithstanding the acceptance of many that there is no alternative. Those lucky enough to have held onto their jobs are enduring higher taxes while seeing bankers bailed out. In the public mind, banks, casino-playing property developers and a Government asleep at the wheel merge at some point as malignant forces that squandered our boom.
The damage is done but, more to the point, the process of rescuing our financial institutions is now well underway. Time then to turn attention to how our banks should be run, whose interests they should serve and how the banking landscape might look a few years from now.
Prof Ray Kinsella of UCD, a seasoned banking observer, is among those who would like to see a return to some of the traditional ethos of banking. "The credit unions provide a good example of a very appropriate model of banking with their emphasis on the individual, the community and the general good. Vocationalism has been hijacked by a malign corporate model. The erosion of the power of the branch manager in recent years is a manifestation of the problem. Centralisation simply hasn't worked. There is a lot to be said for devolving power back down the branches."
There is now a general acceptance of the argument that our banks need to be protected as to allow them to fail would represent a systemic threat to economic activity in the country. As Kinsella suggests, this implies banks are not merely shareholder interest-driven corporations, as they have often argued in defence of some of their narrow self-serving actions, but rather utilities that form part of the fabric of economic and social life in the country.
"Banks are the central nervous system of the economy and their model has been shown to be flawed. Given that the Government is now engaged in a massively expensive rescue operation, we are entitled to reconfigure the banking sector. The Minister for Finance has sweeping powers now and should use them. Banking has been fixated on the interests of stockholders rather than the broader stakeholder community that includes customers, employees and the national interest.
Part of that reconfiguration involves regulation. The recent selection of Prof Patrick Honohan as the new governor of the Central Bank is seen as a good starting point, breaking the cycle of appointing former secretaries general from the Department of Finance to the post. Even the opposition was fulsome in its praise for this move with Fine Gael finance spokesperson Richard Bruton suggesting his appointment could mark a new era in regulation for the Irish financial sector.
Honohan, whose most recent position was professor of international financial economics and development at Trinity College, Dublin has vast experience in both Ireland and internationally having worked in the Central Bank, World Bank and London School of Economics. He is a heavyweight. Better regulation is important in the context of rebuilding trust generally and specifically should have positive effects on investor sentiment towards Irish banks.
Assuming nothing gets in the way of the Nama process as outlined, the task of fixing the banks will gather pace over the coming months. Regardless of the distaste many have for the need to establish it, there is growing acceptance that Nama is the only game in town. International experience also suggests it works. Unpalatable as it may seem to many, the recent upward movement in the share price of Irish banks reflects the market's realisation that risk has transferred from the banks to the taxpayer.
Asset management companies such as Nama allow banks to focus on their core business of financial intermediation instead of dealing extensively with the management of bad loans. All going well, once confidence returns to the financial system through the removal of troubled loans, this should allow banks to raise new capital, mainly in the form of private funding, as investors will now get a more transparent view of the potential earnings of the remaining good banks. With existing tied capital also freed up, in theory this should allow banks to restart their normal lending activities.
Cynics suggest banks will merely use this as an opportunity to shore up their balance sheets. It remains to be seen what pressures or incentives the Government can use to ensure funds flow to areas such as the SME community but banks have no long-term interest in maintaining the current hiatus.
Ultimately, good banking is at heart a simple business of taking a margin from prudent lending activity and, with access to cheap funding, they have plenty of scope for making money doing just that.
Pat Farrell, chief executive of the Irish Banking Federation, acknowledges banks need to work hard now to restore public confidence and that part of this is an acceptance that mistakes were made in risk assessment and moving into complex global financial instruments.
"People have generally lost trust in the sector. The major currency of banks is trust, not money. What people are looking for now is simpler, more transparent business models," he says.
Farrell says, however, there is a danger that in the desire to return to basics, there may be less appetite for innovation. Innovation by its nature often requires an element of risk taking. "Without innovation in financial services, you wouldn't have products such as fixed-rate mortgages. No one is arguing that they are a bad thing, yet they are hedged. All derivatives are getting a bad name."
Looking to the players in the market, some consolidation in the banking sector seems inevitable. The creation of a super mutual centred on EBS Building Society and the Irish Permanent element of Irish Life & Permanent, is now a distinct possibility. There may yet be a shake-out in jobs in the sector but for the moment employment has been remarkably resilient. Non-replacement of departing staff and incentivised leave have played their part in trimming payroll as part of overall cost reduction strategies.
The real damage has occurred in the intermediary market with major layoffs in mortgage brokerages dotted around the country. Around 40 per cent of mortgages are sourced through these intermediaries.
Pressure at EU-level to withdraw state aids and restore more normal market conditions when difficulties ease is likely to drive further consolidation at the banks in the years ahead, according to Farrell. In this it is mirroring what is happening globally.
Kinsella says consolidation will help produce a better sector. Getting an appropriate level of scale is important, he says. "The contestability of banking from non-domestic players will act as an important check on market dominance by bigger banks."
A recent PwC report - The Future of Banking: returning stability to the banks and banking system - underlines another fundamental change that must occur: getting back to focusing on client relationships. The report states: "In a world with less liquidity, banks need to focus their scarce resources on clients and markets where they have distinct capabilities. They need to focus effort and capital on where they can win . . . This is a major mindset shift from the previous era where balance sheet expansion almost always resulted in apparent profitability, driving banks to enter a variety of new client relationships and markets, which were not ultimately value-creating. Investing in the right client relationships with a view to the longer-term will boost organic growth and pay dividends in the future."
While the domestic banking market is going through a painful adjustment, by contrast the stellar performance of the International Financial Services Centre (IFSC) is a beacon of hope for the sector. Total employment at the IFSC is holding up well overall, with 25,058 people still employed there at the end of 2008, down just 152 on the previous year, according to the Finance Dublin Yearbook.
Notwithstanding the fact the figures are helped by net gains in funding and insurance, the fallout in banking employment has been relatively modest given the scale of the global banking crisis. "A different set of dynamics drive the IFSC to the domestic market," says Brendan Kelly, director of Financial Services Ireland, the Ibec group that represents the sector. "We are seeing a rapid recovery in the sector globally at the moment."
The Government is hoping financial services will play a key part in economic recovery and plans are being finalised now by the IDA for a high-profile trip to the US in mid-November by executives of the agency, the Minister for Finance and banking industry figures to sell Ireland's story to potential investors. This will be part of a wider trip involving other sectors but it is believed financial services are being given major emphasis in the drive.
Innovation is likely to be a key element in the sector. Farrell notes while Ireland has done well in attracting US multinational operations, much potential still exists to attract banking operations from the Middle East and Asia.
Appropriately enough, Sharia banking, the instrument for compliant finance under Islamic law with its strong emphasis on morality and the common good, could be one of the key growth areas in Irish financial services in the years ahead.
SEPT 2008: Lehman Brothers SEPT 2008:Night of the Long Knives DEC 2008:Sean Fitzpatrick resigns from Anglo Irish Bank FEB 2009:National protest against cutbacks SEPT 2009:Zoe developments SEPT 2009:Green changes to Nama APR 2009: Bacon report on Nama AUG 2009:John O'Donnell retires from AIB SEPT 2009:Lenihan briefs Dáil on Nama
