OPINION:Before the banks are recapitalised we need to know a lot more about their capacity to deal with - or not - their property-based debts, writes MICHAEL CASEY
THERE IS now a clear demarcation between those who believe the banks need to be recapitalised and those who think it is not necessary. This is a very important issue, and it is a pity there is no consensus.
The first group includes Opposition parties, notably Fine Gael, and a number of academic economists and journalists. They point to abandoned building sites and make predictions about falls in property and land values and assume that a significant proportion of bank loans to property speculators must be seriously impaired.
They argue that without an increase in capital the banks will not be able to lend to businesses and consumers and that this will worsen the recession and lead to much greater job losses. They cite the example of Japan where the collapse of the banking system contributed to a recession for 10 years - "the lost decade".
This group also believes that those on the other side of the argument are protecting their own reputations. In other words, if recapitalisation does become necessary then the Government, banks, Central Bank and Financial Regulator will have to admit they didn't do a very good job.
Statements by the non-recapitalisers have been very clear. The Central Bank and Financial Regulator have made definitive statements that three of the main banks have now indicated that there is no question of their capital being inadequate. It is not even necessary to go back to their own shareholders for a top-up. They are obviously most reluctant for the Government to take an equity stake in their businesses.
The Government is also on this side of the argument, though its pronouncements are slightly more guarded and hedged around with phrases like, "we will continue to monitor the situation" etc.
It probably seems strange to the lay person that there is no meeting of minds on this issue. If a person were ill most doctors would agree on the diagnosis and the remedy.
If there is one thing banks do well it is keeping good accounts. Surely it can be figured out fairly quickly whether their capital is adequate to cover bad debts? Banks have internal and external auditors; they are frequently examined by the Financial Regulator.
Oddly enough, these inspections - allied with frequent stress-testing exercises - do not seem to have done the job because 20 specialists from a firm of consultants have recently been sent into the banks. What if they come to different conclusions than those already made public by the CEOs of the banks and by the establishment? Whose view will prevail?
For those of us who do not have access to the books of the banks is there any evidence we can look at? There is some, though not a great deal.
It is true that credit extended to the private sector has slowed but it doesn't necessarily follow that this is because the banks are constrained by lack of capital. It could be that the problem lies on the demand side. Suppose, for example, that many businesses have reduced their demand for borrowed funds because of the recession; that would have nothing to do with whether the banks are constrained by capital shortage or not.
There is a Bank Lending Survey which throws some light on this. It suggests that demand for credit by enterprises tightened in April and July of this year. The same was broadly true of consumer credit. Banks did tighten the supply of credit in the same periods but again it doesn't necessarily follow that this was because of capital constraints.
It could be because the banks are (at last) becoming more prudent as recession bites. Having grown their balance sheets during the boom times, it is natural that they will now put a greater emphasis on quality, even if the capital base is ample.
The other point worth noting is that although total credit is not increasing by anything like the 25 per cent a year rate of boom times, it is still growing by 12-13 per cent which is actually quite high, especially when it is remembered that nominal GNP growth is around zero.
The pressure is growing for some form of recapitalisation and it may well be the right thing to do. But suppose, for the sake of argument, that it does not lead to a resumption of lending to firms? This could be because the firms themselves are wary of taking on more debt or because the banks would still be concerned about the credit-worthiness of the borrower in the face of recession.
There is no doubt that during the boom times many companies were lifted up on the rising tide. It is possible that a relatively high proportion of these are in trouble not so much because of difficulties about borrowing but because the recession has exposed fundamental weaknesses. The authorities will have to analyse the true situation in some detail.
In short, the jury is still out. It probably is not that easy to estimate the capital adequacy of the banks or to measure impaired loans. All banks make provisions for bad debts but this exercise is usually based on historical data - a no-brainer.
What we need in the present case is a forecast of what is likely to happen to the banks' property-based collateral as prices fall further. It is also necessary to estimate what additional capital the banks could raise by selling off assets at prices obtaining in six months or a year's time. Presumably all such calculations would have to be done on a mark-to-market basis. If alternative accounting conventions are adopted, the whole exercise will not be of much use.
Accountants prefer to work with actual historical figures and do not have much experience in forecasting or simulations. An example of the latter would be working out what would happen to capital ratios if land prices were to fall further by 40 per cent, 50 per cent, 60 per cent, etc. It is to be hoped the 20 specialists include seasoned economists with experience in forecasting and simulations.
Even if the consultants find that capital is problematic, is it likely that the establishment will admit this? To paraphrase Bernard Shaw, the establishment has nailed its colours to the mast and can't climb down. We know that when the Minister agreed to the €600 billion guarantee, the Central Bank, Financial Regulator and the main banks were in the room. It is likely that the Minister sought, and was given, assurances at that stage that there would be no question of the banks needing capital.
We live in such topsy-turvy times that we now regret not having those solid, pedestrian State-run banks - ACC and ICC. They were once the ugly sisters of the financial sector but by today's banking standards they would appear distinctly attractive.
Whether in the final analysis the banks are recapitalised, the lesson is abundantly clear. Prevention is infinitely better than cure. If only the authorities had curbed the ardour of the banks five years ago. It was all predictable - property price falls, economic recession, financial instability.
It is obvious that the US system needs a radical overhaul. So does ours. An important element of such an overhaul will be a special and continuing levy on banks for prudential reasons. A measure that could be taken immediately is the cessation of the long-standing practice whereby officials are parachuted on to the boards of the banks they once regulated.
• Michael Casey is a former economist with the Central Bank and member of the board of the International Monetary Fund