Fresh capital may strengthen banks but they will still curb lending to rely less on wholesale funding, writes Simon Carswell, Finance Correspondent
THE FURORE over whether the Government, possibly with private investors, should inject fresh capital into the banks suggests that recapitalisation is the magic pill needed to kick-start lending to cash-starved businesses. The Government and the banks think not.
Taoiseach Brian Cowen told the Dáil on Wednesday that recapitalisation was not a "panacea for the solving of all ills" and that "the idea that bank recapitalisation is the solution to that problem is not the full picture". The banks and financial commentators agree.
On one hand, the Government is coming under pressure from Opposition parties, businesses and lobby groups such as the Small Firms Association, which claim that credit to businesses is drying up and that thousands of jobs are at risk. They are calling for urgent action to force the banks to lend more to struggling companies.
On the other hand, the Department of Finance is pressing the six covered banks and building societies to "de-risk", which means forcing them to cut their loans-to-deposits ratios by de-leveraging during the two-year guarantee.
"This point has been lost in all the drama of the last few weeks and months," said analyst Scott Rankin at Davy stockbrokers.
"Capital will help the banks take the hits that need to be taken and help the process of marking off bad loans, but tighter credit won't be resolved by capital raising."
A senior executive at one bank said: "It doesn't matter if we were to raise up to €20 billion in capital, we still have to reduce our loans-to-deposits ratio and our reliance on wholesale funding."
A bank's loans-to-deposits ratio reflects how heavily it relies on the turbulent wholesale funding markets for their lending. These markets have remained very costly over the 15-month credit crisis, squeezing bank profits and effectively closed down altogether when US investment bank Lehman Brothers failed in September, terrifying investors.
The Irish banks rely far too heavily on the wholesale markets.
Irish Life Permanent shopped for money in these markets more than its rivals in recent years as it aggressively sold mortgages to become the largest player in the market.
The bancassurer has a loan-to-deposit ratio of more than 280 per cent. This means that for every €1 it has on deposit, it has lent €2.80 to customers.
AIB had a ratio of 157 per cent last year and Bank of Ireland 179 per cent. Anglo Irish Bank has a lower, more manageable ratio, standing at about 125 per cent.
The Government has indicated that it wants the banks to reduce these ratios to 125 - 130 per cent, which is roughly the European average, over the two-year life of the bank guarantee.
The banks can achieve this in two ways - curb lending or grow deposits. They are doing both. Bank of Ireland has said that its ratio fell to 140 per cent at one point last week from 174 per cent at September 2007.
"It's falling because our lending growth has slowed but also our deposit-gathering activities are very active. It is the future for banks to have a strong core deposit base," said the bank's finance director John O'Donovan.
AIB says its ratio will fall from 157 per cent last year to about 150 per cent at the end of this year. The bank told Davy on Tuesday that it wanted to be nearer to 130 per cent two years from now when the bank guarantee expires.
"The only way to do this, given strong and increasing competition for customer deposits, is to constrain loan growth to a minimum," said Davy in a research note.
"This objective, which is held by all the banks, is obviously at odds with what politicians want."
The new business plans submitted by the six guaranteed institutions to the financial regulator yesterday will show how they intend to reduce their risks - in other words, how they will cut loans-to-deposits ratios further.
AIB, Bank of Ireland and particularly Irish Life Permanent still have some way to go to bring their ratios down to desired levels.
Credit growth is undoubtedly slowing. However, the Central Bank said underlying private-sector credit actually grew in September by 11.1 per cent year-on-year.
The economy has deteriorated significantly since then and credit figures for October and November will likely confirm the anecdotal tightening in lending that has been claimed so publicly in recent days.
Scott Rankin of Davy said the Government could, through the State's money manager the National Treasury Management Agency, buy securitised loans from the banks, affording them greater flexibility to lend more.
Other countries are experiencing similar credit difficulties.
The UK is placing fresh obligations on British banks to increase help for small businesses following criticisms that the state £50 billion (€59 billion) bank recapitalisation scheme had failed to unfreeze the flow of credit into the economy.
British prime minister Gordon Brown has also called on the European Investment Bank to boost lending to small businesses that are suffering in the recession.
One senior Irish bank executive said the Government needed to create a fund for businesses that the banks could distribute to feed credit to the small and medium-sized enterprise (SME) sector.
"There isn't the loan capability within the banking system to satisfy the SME sector. The whole thing is stuck at the moment. The only way to make it happen is for the Government to create a fund for small businesses," he said.
Pressure is mounting on the Government to provide a remedy.