Government cannot have it every which way with banks

BUSINESS OPINION:The reputational repair achieved by the Bank of Ireland investor deal has been undone

THE LACK of joined-up thinking in Government has manifested itself most spectacularly in the current fuss around the banks’ reluctance to pass on the recent ECB interest rate cut.

On the one hand, you have the Government responding to public pressure and pressuring the banks to pass on the cut. On the other, you have them trying to present the Irish banking system as something other than one big State-owned money transfer operation.

Even those with short-term memories in the Cabinet will no doubt recall the self-satisfaction they enjoyed just before the summer when the Government sold a big stake in Bank of Ireland for very little to a group of blue-chip North American investors.

The deal could prove very lucrative indeed for the new investors, but it is justified on the basis that it sent a powerful signal abroad that the banking system – and, by extension, the Irish State – was not a complete basket case.

It would be surprising if, as part of the investment process, these North Americans had not asked Bank of Ireland about its plans to improve its lending margins and wean itself off emergency support from the ECB.

It would be equally surprising if the bank did not reply that it would try and avoid passing on rate cuts whilst remaining competitive in the market. This is how banks are supposed to make their money. Not by lending billions into a property bubble.

The biggest surprise – or perhaps not – would be if the Government was not aware of this discussion and its likely generation of some political heat.

But the Government’s actions over the last few days would seem to indicate otherwise. Indeed, much of the reputational repair done by the Bank of Ireland deal has probably been undone by the Government’s response to the banks’ reluctance to pass on the rate cut, and the administration of the rubber truncheon to the board of AIB in particular.

To all important outside eyes, it clearly looks as though the AIB board was forced into an about-turn by the Government which was feeling the heat as the banks acted in a fashion entirely consistent with the Government’s own banking policy. This policy’s central objective is to repair the banks’ balance sheets to a level where they can stand on their own and attract outside investors.

The paradox is that AIB probably had the best case for not passing on the rate cut, as it has been slow to pass on hikes. Bank of Ireland can also make a case for not passing on cuts because it is not the most expensive in the market, even after the other banks have cut.

Presumably at some point the Government will see the downside to ordering the banks around, or their new North American friends will enlighten them.

But the damage has been done at AIB and will not be easily undone.

One suspects the interim chairman, David Hodgkinson, has had – to paraphrase Bank of America’s Ken Lewis on investment banking – as much fun in Irish retail banking as he can stand.

The individual tipped to take over as chief executive, David Duffy, might also be tempted to think again because the situation will not improve anytime soon. It will take years to work through the factors contributing to the dysfunctional banking market in Ireland.

The banks – with the Government and the EU/IMF/ECB troika’s full support – are concentrating on repairing their balance sheets and not competing with each other to lend. As a result, the pressure to pass on rate cuts is not there.

The Government’s response to this self-created and utterly predictable problem has been to try and have its cake and eat it, which all sounds very like the Fianna Fáil approach to economics.

It’s not possible to strengthen the banks’ financial position and make them pass on rate cuts that are not necessarily justified. You can have one or the other, or, if you are very lucky, some balance.

The Central Bank has found itself caught up in the middle as the Government hoped it would volunteer to be the spear-carrier in this policy farrago.

It’s partly its own fault, as in a much publicised (but misinterpreted, it now seems) speech earlier this year, the Financial Regulator indicated he would seek powers to intervene if the banks continued to introduce unjustified rate hikes.

The Government now seems keen for the Central Bank to take on such powers, but the bank has stepped back from becoming the vehicle through which the Government plans to manipulate the banking system for short-term political gain.

On Friday, it informed the Government that it believes the issue would be better addressed as part of the regulator’s wider engagement with the banks, but ultimately some sort of competition remedy might be necessary.

As a result, the Government will be left to do its own dirty work when it comes to political interference in the banks. The boards of AIB, Irish Permanent and the Irish Bank Resolution Corporation can look forward to further humiliation and bullying whilst Bank of Ireland enjoys favoured child status.

Unless, that is, it sees sense and puts in place some sort of independent intermediary to oversee the banks that is mandated in the bailout agreement with the troika.