Address by Director Credit Institutions & Insurance Supervision, Fiona Muldoon to Cantillon Economy & Entrepreneurship Forum

11 April 2013 Speech

The feedback loop: Ireland’s retail banks, regulation & real economy supply and demand


Good afternoon, ladies and gentlemen, thank you for inviting me here today to speak to you on this important topic. I suppose that there is a working assumption inherent and given the title of our afternoon session today that banking has broken away from the real economy. But I believe that what has happened in Ireland in recent years, is in fact more that, their very inter-connectedness with each other has created a negative feedback loop of ‘ever decreasing circles’ as it were. I further believe that re-establishing a positive feedback loop is difficult but possible and will +be brought about through good governance of our banks, intervention where necessary and effective regulation. Changing this feedback loop or re-establishing a virtuous circle, will in turn fund the growth and stability of the critical SME sector and other aspects of the so called real economy in Ireland. I would like to take some moments of your time to discuss why I think this is so and to highlight what the Central Bank of Ireland is doing to help bring about that positive change.

There are 73 banks including branches regulated by the Central Bank of Ireland. Taken in aggregate at 40,000 feet the sector is very large at just under €1tn in gross assets. It also appears well capitalised if we accept that all such assets (loans in the main) are fairly valued and fully provided against.

However as the title of our session implies the relative size of the sector in Ireland bears little true relationship to the current domestic economy and only five of those 73 institutions are lending into the SME sector in Ireland today. Indeed, referring to the Department of Finance survey, lending to the SME sector in Ireland was approx. €2.7bn in 2012 representing a very small fraction of the overall lending balance sheet of the banks operating in this jurisdiction. I would like to explore this a little and discuss what if anything, can or should be done about it.

In 2012 the Aggregate Domestic Bank Balance sheet shows €98bn non-performing assets and an impairment coverage ratio of just over half. The figures show the sheer scale of both the International Banking Balance Sheet operating from the IFSC with minimal lending impact on the domestic economy as well as demonstrating the domestic banking sector and how bloated it remains as at 31 December 2012, four and a half years after the crash. And indeed, these figures are after the many deleveraging efforts of those four years.

As critically, and turning to take a snapshot of profitability: the impairments taken for poor lending or the provisions for loan losses in the domestic sector mean that the current domestic banks profit and loss account continues to make for fairly grim reading. And even before those provisions and impairments, the current business model viability is troublesome, as the retail institutions return an operating loss in aggregate again in 2012. The on-going challenge for the banks is the need to return to active lending and deposit taking at a healthy margin with a right-sized cost base.

So how will the banks do this?

  • In the first instance the existing balance sheet and the loans already made must be dealt with. There are 3 parts to this: firstly, it involves continuing to safeguard the performing loan book, that includes for example, the approximately 82% of PDH mortgage holders who continue to pay on time, every month, often in very difficult circumstances. Secondly, they must stem the flow of new arrears. And finally, it requires working out and dealing with their distressed credits.
  • In that regard certain slow but steady progress has been made in the not insignificant task of building operational capability in the domestic retail banks so that they are now in a position to process and deal with the significant numbers of both new and existing arrears.
  • That done, now the banks must deal with those cases: this will mean crystallising some losses through work out and eroding their capital base in the process.
  • They also need to improve their interest margin – as difficult as this is for their customers, it means (as we have already seen), that consumers and businesses pay more for loans and services and receive less for money left on deposit. Tracker mortgages are already a major loss maker for the banks as they can no longer fund these loans at the rates they have lent. Restoring net interest margin (the difference between their cost of money and their lending rate) is critical and so new lending and existing standard variable rates are now at significantly higher rates than two years ago despite intervening cuts in official interest rates.
  • In addition, there remains further difficult work on cost cutting, reducing employee numbers and overheads to reflect the new realities of domestic demand and local business models post the property crash.
  • In the process, they are required to hold significantly higher capital levels as they transition to Basel III, resetting perhaps forever the expected Return on Earnings in this business, and thus thereby altering the market dynamics for new capital /new entrants and future sales/acquisitions

So I do not highlight all of this to show how difficult the banks’ operating environment is. Most certainly it is difficult for anyone in business right now. Nor surely, is it done to elicit sympathy for the many issues bankers now face, more it is intended to highlight that those self-same challenges are having a real and tangible consequence for SME customers and ordinary consumers.

The importance of the SME group cannot be underestimated to the Irish economy and to the wider Irish recovery narrative. This group represents more than 99% of enterprises by number in the private sector and employs more than 70% of all people who are employed in the private sector. It is dominated by four sectors, hotel & restaurants, wholesale & retail, agriculture and manufacturing. Like all other parts of the Irish economy, the sector has undergone significant challenges. It is also heavily indebted. SME arrears throw up complex issues and there is a high-level of property related borrowing. In effect, in Ireland, literally and figuratively, all roads lead to property.

Given 70% of people in private sector employment are employed by SMEs there is a further direct knock-on for these employees (& past employees) into the whole area of household debt and mortgage arrears in particular.

When it comes to SME arrears within the banks, there are complex issues and high levels of inter-connectedness. In many cases family businesses borrowed to expand the business, invest in their premises and maybe a buy-to-let property for their pension. Some cases include personal guarantees or drawdowns on the family home. That same SME is now the only source of cash flow in servicing both direct and indirect debt. Where that SME is consumer facing, they are facing restricted demand brought about by unemployment, reduced consumer confidence and the resultant increased savings levels we have seen over the last several years. In effect households are de-leveraging alongside the banks.

It is a Central Bank focus in 2013 to ensure that the governance and execution framework of the SME support unit in our banks is adequate. We have worked to ensure that each bank has a practical thought through plan and that they have the operational capability to implement it. We receive regular updates from the banks management on their progress against plan. In this way, restructuring and re-underwriting will continue to take place throughout the year. Like MARS, we view it as essential that the banks have segmented their loan books so that they have a clearer picture of the viability of various cohorts of customers and therefore the types of outcomes that are likely to be sustainable for each. Thereafter, banks are required to adopt appropriate restructuring or re-underwriting where possible on an individual case basis and identify appropriate debt resolution strategies that provide sufficient incentives to viable borrowers to work through the debt overhang. In this way, to both the individual business and bank’s advantage, over the medium-term loan losses can be minimised through improved management of the situation.

We believe that the banks now have credible credit assessment tools. We have overseen that operational skills and resources are improved and that appropriate external help is engaged where necessary.

Policies and Key Performance Indicators (KPIs) are in use in the banks to measure their success. The banks’ management teams must now be accountable for the implementation of the strategy and measured in terms of their success in that implementation.

With regard to mortgage arrears our policy is already public and the implementation of targets, follow up audits, capital implications and potential changes to provisioning rules, as well as the introduction of legislation to restore the pre-2009 legal status quo following the Justice Dunne ruling in Gunne v Start Mortgages, should see substantial progress in this area during the next year or so. In that regard, the Central Bank continues to urge all borrowers to engage with their credit institutions in order to be afforded the full protection of the Consumer Code on Mortgage Arrears.

In addition we are facilitating work on the problematic issue of burden sharing between multi-borrowed personal customers (where there is secured and unsecured debt). It is clear that any unsecured creditor can expect to receive very little in bankruptcy and that an secured creditor will realise only the value of their collateral. It is also clear from our analysis based on the voluntary disclosure of Standard Financial Statements data supplied by the banks, that many cases can be resolved by mutual effort before that difficult end-stage is reached. Whilst requiring compromise and pragmatism from all creditors, an agreed framework would reduce costs and time for the lender and provide peace of mind, sustainability and certainty to the borrower. This creditor framework would facilitate burden-sharing arrangements that work sensibly for both secured and unsecured creditors as well as for the individual consumer without the need to proceed to a full PIA or bankruptcy. Despite the difficulties and sometimes competing interests, I have been impressed by the commitment and constructive engagement shown by the various creditor groups and their representative bodies in working through the issues with us and I remain hopeful that we are moving towards a workable practical outcome.

In terms of new lending, it appears that the level has been low but reasonably constant since 2010 and that, unsurprisingly perhaps, new lending is realigning away from property – however the share of stock underscores the earlier point with approximately 50% of stock still real-estate related.

Net increases in share of new lending perhaps also unsurprisingly are evident in those sectors currently performing reasonably well namely, agriculture, manufacturing and business administration. In addition the sectors seeing the most reduction in share of new lending are also those with the highest current levels of default.


So the case for inter-dependency and the need to break the current negative loop to turn it into something more positive is very real. In the big picture, EU efforts and banking union should ultimately break the currently self-defeating link between sovereign and the banking sector. Once operational, the resolution of insolvent banks and the rules required to regulate will all be handled centrally. Until then, the Central Bank will navigate the current post-crisis painful clean up by forcing both the pace on new standards of governance and risk management and by ensuring work out is balanced and careful. None of this is easy or speedy either in terms of the solution or the execution. For the ordinary person or business, access to credit to start a business or for working capital, to buy a machine or put a deposit on a home requires a functioning normal profit-making credit market where monies borrowed are repaid in the normal course. There is a very real inter-relationship and indeed co-dependency in any modern economy between the health of the credit-providing industry and the economy it participates in and services. That this banking market in Ireland is not yet fully functional is obvious, much is yet to be done particularly in the arrears space (for both mortgage & SME borrowers). The sooner normal market conditions can prevail (for lending, borrowing and repaying) the better for businesses, households and the economy collectively. The measures taken by the Central Bank to date have set us on that path but much remains to be done in a process that is fraught with complexity and with difficult sometimes unpalatable decisions. It will take some time to complete that journey, frustratingly more time than many would like. It is critical that we remain resolute in the face of these challenges so that we can progress down this path as efficiently and quickly as a difficult complex task allows. We must move towards sustainability at both individual borrower level and at the level of the Irish domestic banking sector as a whole. In effect, and whether we like it or not, the health, stability and profitability of one feeds, sustains, and nurtures the other.