OPINION: THE BROAD shape of the Government's new plan for recapitalising the banks is now clear. It differs significantly from what was proposed last December and involves the Government putting up all the fresh equity, some €7 billion.
In return the State has been granted the right to buy up to 25 per cent of the bank at the current low share prices. It’s not entirely clear how this will work, but the indications are that it will be by way of warrants attached to preference shares.
This has two effects: it gives the State a big share in any upside, when and if the banks recover. It also encourages the banks to raise more equity from their own shareholders as this will dilute the amount of the banks that the Government will end up owning.
It’s a neat and innovative solution, particularly the use of warrants. Overall, it seems to meet two objectives. It causes the least possible pain to the bank’s existing shareholders at the least possible cost to the taxpayer. And if those were the Government’s sole objectives, then it should be adjudged a good outcome.
But by the same token, the plan, on the basis of what we know at this stage, seems to have forgotten what what should be its overriding objective: maximising the availability of credit in the economy.
Protecting the interests of the banks’ beaten-up shareholders and limiting the exposure of taxpayers is all very well, but it’s rather pointless if the €7 billion being spent by the State at this point in time does not contribute directly to reviving economic activity and, in the words of the Taoiseach, “jobs, jobs, jobs”.
There is now plenty of evidence that the banks have turned off the credit taps. Figures published two weeks ago by the Central Bank showed that lending to Irish businesses fell by €2.8 billion in December.
According to Ibec chief economist David Croughan, feedback from its members – apart from the banks themselves presumably – confirmed the credit squeeze.
“Our recent survey on lending conditions showed that about one-third of respondents indicated that the availability of working capital to their company had decreased in the past six months,” he said.
And last Friday the Central Bank published the Irish details from the ECB’s latest bank lending survey. It concludes the banks have tightened their credit standards on loans to businesses and households. The ECB also found that businesses faced higher loan margins and more restrictive collateral requirements in the final quarter of 2009.
The tougher credit conditions applied to enterprises of all sizes, and were caused by the banks’ cost of funds, balance sheet constraints and greater risk perception, the survey found.
The reference to balance sheets is telling and also very relevant in the context of the proposed recap. It’s no secret that the Irish banks are cutting back on lending to preserve capital in anticipation of bad debts. The more capital they can hoard, the less they have to find from elsewhere and the only show in town in that regard is the Government.
What is not clear about the new recapitalisation proposal is whether or not it amounts to a further incentive to the banks to preserve capital, which means cutting back further on lending.
Again it must be stressed that we don’t have the full details, but the recapitalisation scheme does seem to run the risk of being counter-productive.
It’s certainly hard to see how it incentivises them to lend more freely.
The priority for the banks is clearly going to be repaying the preference shares (with attached warrants) as soon as possible in order to avoid dilution. And while that might be a good idea from the point of view of limiting the amount of taxpayers’ money being put at risk, it is not necessarily compatible with freeing up credit for business.
There are a number of things the Government can do in tandem with the recapitalisation that would offset the problem, or potential problem. They range from something as straightforward as setting targets for lending that must be met before the preference shares can be redeemed, to something as dramatic as a counter-cyclical reduction in statutory capital levels.
The later approach has found some favour in the UK but the British government has intervened to a much greater extent in the banks, taking majority stakes in some and backstopping the loan losses of others with insurance schemes. Such measures appear to have been ruled out for the time being here.
However, the Government does seem to be alive to the issue and it’s reassuring then to see some comments attributed over the weekend to Government sources to the effect that more lending will be a condition of the deal. But it’s hard to escape the conclusion that the emphasis of the recapitalisation has fallen in the wrong place.
