Banks acting like teenagers?

I smiled when I heard that Central Bank director Fiona Muldoon had described dealing with the banks as ‘like dealing with troublesome teenagers‘. This was referring to their resistance to resolving their loan book issues for the last five years.

The thing that wasn’t mentioned was ‘why’, and as always, it’s the ‘why’ that plagues many of us the most. The ‘delay and pray’ response is a standard tactic deployed by lenders when they have a crisis, this has occurred in Japan in the past, is currently an issue in Vietnam and also in the USA. Banking is one of the industries where honesty is not the point, survival is. At any time a bank could unwind if everybody made their claims against them and the same broadly holds true for dealing with bad debts.

If a bank started to deal with one bad debt (at a time when there is a pent up mass of them in the system) it would quickly eat through both their capital and provisions, their preference is therefore to extend out losses over as long a period as possible and to meet those losses with incoming operating profit. The issue here is that it doesn’t work because it creates zombie banks (which is what Japan has proven).

This ties in with why they will start to look for more ways to get more from their customers, be it charging for current accounts, higher loan rates, jacking up rates on existing borrowers or less favourable terms on other credit products. The rationale is simple, bring in as much money as you can and put it aside (rather than lend it) so that one day you can deal with the problem, again, this delay tactic is a stock response to their financial problems.

State ownership (which was cited by many as a ‘solution’) hasn’t made much of a difference in this respect, the only thing that would have solved this would have been to shut down errant lenders in the first place, force losses onto investors in the order for which they signed up for them (namely, equity gets wiped out first, then preference shares, and then down into all of the bondholders).

Not dealing with problems and not lending are intricately linked issues in banking. Loan repayments and operating profit would normally be lent out to some degree, but instead now it is being used to deleverage and in order to provide for future problems. Banks have been provisioning for bad debts for many years but not actually using those provisions actively – this is effectively a form of tax dodge.

I jokingly describe their plans as a ‘three point plan’ which is 1. delay, 2. deny, 3. delay some more. The non-funny part is that maturity transformation (what banks actually do as intermediaries) doesn’t occur. The credit cycle in Ireland will not resolve until banks are lending and deleveraged, personally I think they want this, but getting there is the impossible part.

Technical insolvency is another issue, if your assets are rapidly written down then your liabilities are larger, these liabilities are deposits, bonds etc. and also represent a claim on the bank, so they suffer from a double balance sheet challenge, and once more, not writing down loans is part of the answer. If they can keep valuations as high as technically possible on paper it is better than actualizing the values when securities are sold (where true market value then becomes the benchmark rather than the modelled value).

It isn’t so much that banks are ‘hiding’ these loans, they simply have a preference for doing what is in their best interest, stop credit, increase prices, reduce the size of assets and liabilities and deal with the bigger issues further down the road. The frustration the Central Bank director was getting at was that this was not what we paid for, we didn’t give them €64bn in order to do what a regular zombie bank would do without that help.

Annoying to say the least! The answer though is to perhaps get more banks lending, or start a new bank that has some capital and a need for lending in order to create assets, this bank could then be sold for a profit in years to come. Single problem, we don’t have the cash to do that!

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