The banking crash post 2008 was followed by a large bank bailout costing around €60 billion.
The cost might have been slightly lower if the government had decided to amalgamate PTSB with AIB or Bank of Ireland, both of which already needed huge cash injections from the State.
Instead, the government opted for a three-bank solution, as it offered better long-term prospects of competition in the banking sector.
However, the subsequent exodus of foreign-owned retail banks like Ulster Bank has left a domestic banking market characterised by weak competition. This is costly for bank customers and bad for the wider economy.
In the run-up to the 2008 crash, Irish and foreign banks competed to provide mortgage finance to Irish households. This intense competition saw rock-bottom average mortgage interest rates in Ireland, which were a quarter of a percentage point below other euro zone rates, and three quarters of a point below German rates. This proved unfortunate as it encouraged the disastrous property market binge that ended in tears.
Over the past decade, with just three retail banks here, our mortgage interest position was reversed, with rates almost 1.25 percentage points above the euro zone average.
Some of this adverse differential was because investing in home loans in Ireland is riskier for banks than in other countries. In the event of mortgage default, it is difficult for financial institutions to repossess the house. But the absence of competition has also been important.
Irish households built up exceptional savings during the pandemic at a time when they couldn’t spend – household deposits in Irish banks are around €40 billion above pre-lockdown levels.
At present, Irish banks pay almost no interest on these deposits while they are able to lend the money to the European Central Bank at no risk and earn around 4 per cent, a very profitable opportunity.
In other euro zone countries, banks are paying more to attract deposits; for funds left on deposit for at least three months, euro-zone banks pay on average 0.7 percentage points more than in Ireland, and still make good profits.
Normally, if banks in one country were making exceptional profits, foreign banks would move in to get a share of the action. However, despite the current profitability of the Irish banks, there are serious structural reasons why foreign banks are unwilling to invest to establish here.
For all banks it is important to have as diverse as possible a range of customers. Lending only for housing, or to a particular industry, runs the risk that a bank could go bust if their restricted clientele encountered major difficulties. We saw this with the property market collapse in Ireland.
While AIB and Bank of Ireland had begun trying to diversify outside Ireland in the 2000s, they were too late, and then very unsuccessful with some of their investments.
By contrast, Spain’s two biggest banks rode out the Spanish property crash successfully because they were lending into diversified markets. Banco Santander is a large Spain-based international bank, with most of its lending taking place outside Spain, and not a lot of that in property. This meant that its losses on Spanish property-related business were more than offset by gains elsewhere.
Today, most of the Irish banks’ business is still lending on property. The big multinational companies in Ireland either don’t need to borrow from them, or else source their funding internationally. This means that, unlike in countries such as France and Germany, banks in Ireland do not have many other profitable opportunities to lend domestically to companies operating in industry or services.
Because of the distinctive nature of the Irish property market, foreign banks are unwilling to open up for mortgage business here. As ECB interest rates fall, the bonanza for banks in lending cheaply-sourced household deposits to the ECB will disappear. That means the chances of new entry by banks from outside Ireland seeking a share of Irish banks’ profits are low.
It would probably be easier for an incoming firm to buy one of the existing banks rather than establish themselves in competition. It remains to be seen what further inroads Revolut will make on the traditional Irish banking model.
In the short term, the lack of competition for Irish deposits is hurting households here. If EU regulations made it easier to open bank accounts in countries like Germany, it could allow Irish savers to enjoy the higher interest rates there.
However, in the long term, we need more banks in the Irish market wanting to take our money on deposit, and lending it to domestic households and businesses.
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