The uncertainties generated by Brexit have cast a long shadow over economic activity in Britain and, to a lesser extent, in Ireland. Last week the International Monetary Fund (IMF) lowered its growth forecast for the Irish economy for this year and 2017 and warned that the UK economy will be weakened by Britain's departure from the European Union.
That in turn, the IMF suggests, will have an adverse impact on the earnings of the major Irish banks, especially those with UK operations. The warning came as the domestic banks announced half-year results; and as the results of stress tests carried out by the European Banking Authority (EBA) – and announced late on Friday evening – delivered unexpectedly disappointing outcomes for Bank of Ireland and AIB.
The EBA examined how well the EU’s top 51 banks might withstand a severe and prolonged economic downturn. It found that both Irish banks were poorly placed to do so – among the worst of those surveyed. While AIB and Bank of Ireland are adequately capitalised at present, they are less well placed to withstand a doomsday scenario as envisaged by the EBA.
The IMF warning and the questions raised by the EBA stress tests present challenges for both banks. Bank of Ireland – where the State has a 14 per cent shareholding – relies on the UK for one quarter of its profits. A slowing UK economy – with a recession forecast by some – leaves the bank facing a potential downturn in that key market. Last week Bank of Ireland reported pre-tax profits of €560 million for the six months to end June. AIB announced pre- tax profits of €1 billion over the same period. For both banks, profits were lower than in the same period of 2015, reflecting lower income as interest rates fell further, fewer write-backs on bad loans, and increased provision for rising deficits in staff pension schemes.
The financial health of the domestic banks matters. They are a vital part of the financial system and have a key role in mobilising savings and in lending for productive investments. Their profitability also determines how quickly AIB and Permanent TSB – in effective State ownership – and Bank of Ireland can repay taxpayers some of the €64 billion cost of the bank bailout.
Both Bank of Ireland and AIB hope to resume dividend payments to shareholders, suspended since 2008. But Brexit and other economic uncertainties have depressed bank shares on global stock markets and dividend policy remains under review. As does the Government’s planned sale – in 2017 – of some AIB shares via a public flotation. That too has become more difficult given the results of the EBA stress tests, weak equity markets and the low market valuation of bank shares. Recouping part of the cost of the bank bailout may take far longer than anticipated.