Belfast Telegraph

Monday 14 July 2014

Banks in need of real cash

If you are of that cast of mind, your reaction to last week’s extraordinary global rate cut will be, "Wow, I didn't know things were that bad!" You would probably be right.

Clearly, it is a welcome development that the major central banks of the world agreed to a co-ordinated rate cut of half a point. But to get such an agreement, it is equally clear that they thought they were peering over the edge of the abyss.

This is particularly the case with the European Central Bank. Not only does it not answer directly to any government, but its mandate deals only with inflation.

Prices across the euro area are rising more than twice as fast as the ECB's target. It had already raised rates once and threatened that it might do so again.

Those threats came mainly from German and Austrian governors and executives in the ECB. It is not too fanciful to think that the serious difficulties in the German banking industry prompted this remarkable change of heart.

One of the many reasons to worry about the present crisis is that all the insider elites — governments, central bankers and the banks themselves — seem totally to have underestimated its scope, severity and the path it would take.

Last Tuesday, the Financial Times' German edition carried a scathing article about Ireland's unilateral bank guarantee, and the Irish financial system in general.

There seemed little doubt that this was a reflection of the official attitude in Berlin. Yet even as it went to press, Chancellor Merkel was offering guarantees and capital to the German banks, and in a pretty haphazard, panicky way.

Most governments on the Continent began by thinking that the banking crisis would have little effect on them.

Germany in particular had no property boom at all (as some Irish investors found to their cost) and limited exposure to fancy, dangerous financial products.

Official forecasts saw the German economy as untroubled by the problems of those irresponsible "Anglo Saxons."

They were all terribly wrong. Banks are in difficulty everywhere, because the free flow of funds between them and to them has dried up.

Business is being starved of ordinary credit. If that happens, business grinds to a halt.

Consumers and investors, looking at the wreckage, are closing their wallets and purses. The financial crisis has turned into an economic crisis.

"Who are you telling?" we Irish may say, as we face into the deepest recession, worst government deficit and nastiest Budget in 25 years.

But at least we can see that most of that came from the collapse of the house building industry and the drying-up of tax revenues in a stagnant property market.

What we may not yet have noticed, until the central banks' actions told us so, is the developing global economic crisis which, if it is not contained, will add to the huge problems we already face.

The rate cuts are intended both to make life easier for the banking system, and to encourage economic activity.

If one wants a crumb of comfort, it is that a highly indebted economy like Ireland's will benefit more from rate cuts than most; mainly in the help it will give ordinary folk to pay off their mortgages.

Unfortunately, the gains to income and confidence are likely to be undermined, if not overcome, by the losses from Tuesday's Budget.

Also, if the cut is to achieve its first purpose - helping the banking system — the banks will have to take a share of the interest saving, by not passing it on in full.

Yesterday, Halifax Ireland passed on the full cut, thereby neatly illustrating some of the problems posed by a global financial market.

Halifax has been a successful, aggressive entrant to the Irish market, offering good terms to both savers and borrowers.

It's been good for customers and competition, but it also ate into the profits of Irish banks with bigger overheads, which increased their temptation to incur more risk to seek higher returns.

Halifax Ireland is probably as sound as a bell, and is, quite reasonably, seeking the same guarantees for its depositors as the Irish-owned banks are getting.

But, in another twist, its UK parent, HBOS, is in deep trouble and the subject of a risky takeover by Lloyds TSB.

None of that matters in the great scheme of things, but it does illustrate how difficult it will be to fix the great scheme of things.

Few think rate cuts are enough on their own. Opinion at home and abroad has shifted to the need to put real money, not guarantees, into the banks — "re-capitalisation," as it is called.

Taxpayers might get their money back in the end and even make a profit but, if they are small countries with big banking systems, they may not have enough to put into the banks in the first place. Iceland certainly doesn't. The smaller euro states would have to pool their resources.

A full re-capitalisation of the Irish banks might cost €20bn. Ireland could borrow that amount, although it would double a national debt already expanding by over €12bn a year.

It may come to that in the end, or something above €10bn, but this time we should make sure we do not go it alone.

Every type of bank rescue has now been tried by somebody, somewhere. But only the central banks have acted in a co-ordinated way. Governments need to start doing the same.

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