BUSINESS OPINION:Four banks are better than two in the Irish market – even if one is an Anglo hybrid, writes JOHN McMANUS

THE IRISH bank bailout enjoys the dubious distinction of being the most expensive in Europe – if not the world – in per capita terms.

Much of the focus has been on the direct costs, the capital injections into the banks and the debt issued by the National Asset Management Agency. The longer-term hidden costs are really only now becoming apparent and discussed.

Central to the rescue plan – if that is not too strong a word – is ensuring the Irish banks are strongly profitable as soon as possible.

This has two beneficial consequences from the perspective of the overall economic and fiscal strategy. The most obvious is that profits can be used to rebuild capital and, as a result, reduce the amount that has to be raised from other sources, either new investors or, more pertinently, the State. Given that any State money invested in the banks has to be borrowed and diverted from other spending, it would seem axiomatic that this is a good thing.

The other advantage of profitable banks is that they can afford the rather tasty fees being charged by the Government for the various guarantees as well as the dividends associated with the preference shares through which the State investment has been made.

So far, so sensible. The difficulty lies with the preferred route to increased profitability of the Irish banks.

The simplest way for the banks to increase profits in the current market is to put up prices for existing customers.

All the banks have been ratcheting up interest rates on unsecured lending over the last 18 months, but the big two have finally bitten the bullet on residential mortgages.

Bank of Ireland has put up variable rates by half of a percentage point and AIB has said it will follow suit.

The Government – a significant shareholder in both banks and represented by public interest directors on their boards – has acquiesced.

One would like to think that it has thought long and hard about this and decided that, on balance, it feels the public good is better served by allowing the banks to rebuild their capital at the expense of householders and economic growth.

There is no evidence, however, of any such debate, which is worrying, but some external observers have started thinking about where all this is going.

One of these is Crédit Suisse, which last week issued a report on the Irish banks and identified AIB and Bank of Ireland as two likely to outperform their peers.

The reason is not the potential for the Irish economy to recover more strongly than expected. Instead, Crédit Suisse has identified that the medium-term consequences of the Government’s desire to see AIB and Bank of Ireland churning out profits means that it has little desire to encourage competition in the Irish banking market.

The Swiss estimate that AIB and Bank of Ireland will have up to 60 per cent of the market in the post-Nama landscape. Overall competition – as measured by something called the Herfindahl index – will be lower.

The main factor will be the exiting from the Irish market by foreign banks or else a substantial scaling back of their activities.

AIB and Bank of Ireland look set to clean up under this scenario, and the really perturbing thing about the Crédit Suisse assessment is that they will do so pretty much regardless of the strength of the recovery.

Even if the economy does not grow, AIB and Bank of Ireland will prosper by taking a bigger slice of a shrinking pie, with the tacit support of the Government.

Taking this line of thinking to its extremes, you have the potential for some sort of perverse short-term incentive for the Government to stifle competition and hamper the recovery in the process.

There is clearly a need for some sort of balance to be struck between the short-term benefit to the exchequer of reducing the cash cost of rescuing the banks and the longer-term cost of reduced competition. It represents a considerable challenge to the Irish policymaking system which has traditionally been poor at this sort of thing.

There are, however, some signs that the issue is going to be addressed, but once again the impetus may have to come from Europe.

As part of its efforts to justify to the European Commission why it should be allowed to stay in business, Anglo Irish Bank has put a deal of time and effort into divining the sort of banking system most suited to Ireland’s needs.

Mike Aynsley, the chief executive of Anglo Irish Bank, and his team have looked at 26 countries similar in size and economic development to Ireland. The most stable systems “often have few domestic banks with a fairly high market share across most product sets of the banking sector”, according to a briefing document.

The magic number for Ireland would appear to be three to four, according to Anglo Irish Bank. This does of course fit neatly with Anglo’s aspiration to combine with other smaller entities to form part of a fourth pillar alongside AIB, Bank of Ireland and Ulster. But even allowing for that, four sounds better than two.