Is consolidation of bank sector the best option?

Fewer players in the banking market-place will mean less competition and less choice for consumers

PLANS TO create a “third force” in Irish banking are gaining steam, with Irish Nationwide and the Educational Building Society (EBS) in merger talks and Irish Life Permanent restructuring potentially to facilitate joining them.

While such consolidation may be necessary to stabilise the beleaguered banking market, fewer players in the market-place will mean less competition and less choice for consumers.

Moreover, given the problems encountered because the Irish banks were deemed “too big to fail”, is bundling institutions together really the best option?

Consumers are already bearing the brunt of the banking crisis, as foreign banks pull back on their activities in Ireland and the remaining players restrict their capacities. Consolidation will mark a further reduction in competition.

Already, First Active’s operations have been merged with those of Ulster Bank, while Irish Nationwide’s planned merger with the EBS, for example, will mean an additional reduction in the number of banking products available to Irish consumers.

While the building society may have over- extended itself to big-name property developers, it was a viable alternative for consumers looking for lending and saving services.

Although less competition will mean that consumers will be worse off, it may be a necessary evil consumers will have to endure to get the banking sector back into shape.

After all, “you have to bear in mind that competition got us into the mess we’re in,” says Philip Bourke, Irish Banks professor of banking and finance and dean of the School of Business at UCD, adding that it was aggressive competition by Anglo which is at the core of the problem in the banking sector.

Indeed, Anna Lalor, financial analyst with Goodbody Stockbrokers, says the real issue for consumers is not consolidation and the associated reduction in competition, but the structural changes which are needed in the banking sector.

While the arrival of foreign players such as Bank of Scotland (Ireland) provided a welcome shake-up in the banking market for consumers, the level of aggressive competition it heralded pushed down margins to very low levels. “The overriding issue is that banks are going to have to make a reasonable return to encourage people to invest in them again, so that they can lend again,” she says.

What this means for the consumer is that banking products will get more expensive – regardless of whether or not there is consolidation.

The one anomaly in terms of competitive forces at work may be seen in the deposits market, where banks are intensely competing for customers as they look to lower loan-to-deposit ratios. As such, deposit rates are very high across the board.

However, some of the best rates are coming from institutions which may no longer be here in 12 months – Irish Nationwide will most likely have merged with EBS, while the outlook of Anglo Irish Bank remains uncertain.

Moreover, even if high deposit rates stay where they are, it may be at the expense of borrowers.

Consolidation in the banking sector also raises the issue of whether creating additional institutions, which will become “too big to fail”, is a sensible strategy.

Ireland is not alone in facing this particular challenge, as a wave of consolidation ripped through the global financial services market in order to save institutions following the collapse of Lehman Brothers.

Many of these deals would have previously been disallowed on competitive grounds, but were allowed in the circumstances and have resulted in financial behemoths bigger than those which led to the crisis.

In the massive US market, it has been estimated that just four banks – JP Morgan Chase, Bank of America Merrill Lynch, Wells Fargo and Citigroup – issue one of every two mortgages and about two of every three credit cards. Now, the US authorities are looking to limit their size, with the “too big to fail, too big to exist act”, which proposes that the US treasury would have 90 days to identify financial institutions and insurance companies that are “too big to fail”, and would have to break them up after a year.

In Britain, the government has started to act on such an approach, recently announcing that three of its biggest banks – Lloyds, Royal Bank of Scotland and Northern Rock, all of which received state support last year – will be either downsized or split up.

Chancellor of the exchequer Alistair Darling says that the restructuring will be undertaken in order to ensure “proper competition and choice” and that having just “half a dozen big providers was not acceptable”. However, such an approach may just not be realistic in an Irish context. While Lalor acknowledges that the Irish banking sector will continue to pose systemic risk, hinged as it will be on larger players, she says the British market is very different, with more niches, more opportunities and a much bigger market.

“There’s no right answer. The alternative is that [Irish] banks are broken up into something tiny but there would be a lot of risk with a change of that magnitude,” she says.

One way of keeping a lid on the size of banks is to limit their regulatory capital ratios, which would force them out of risky business. However, as Burke says, “perversely it might force them into risky business, as it pays higher margins”.

In any case, there is little political appetite for such restructuring. In October, in the heat of discussions on the National Asset Management Agency (Nama), Minister for Finance Brian Lenihan said that Ireland was “over-banked”.

Burke adds that the concept of being “too big to fail” is a bit of a red herring. Pointing to the example of EBS and Irish Nationwide, which are both covered under the Government guarantee, it shows that any bank which is moderately big will still be rescued.

What needs to be discussed, he says, is the extent to which Ireland needs a utility banking system, whereby you have a low-risk utility bank, which is implicitly State guaranteed, and other banks which are risk taking, but which would be allowed to fail.

“This debate needs to happen in an informed community, which isn’t happening,” Burke says.

In the meantime, beleaguered consumers always have their local credit union, which Bourke describes as being the “fourth force” in Irish banking, suggesting that they should consider coming together to set up a type of co-operative bank, as seen in other countries in Europe.

And, if Irish banks go back to earning fat profits, it may attract new institutions into the marketplace once more, increasing options for consumers. “If the market becomes too uncompetitive again, leading to bigger profits, it may attract foreign players to come back in,” says Lalor.