Credit Availability: Capital Scarcity is not the whole story

Oliver O’Shea writes on credit availability in Ireland (originally published in Irish Times on June 22nd but not available online):

OSHEAcreditjune22

10 thoughts on “Credit Availability: Capital Scarcity is not the whole story”

  1. The Net Lending figures (Mortgage and Other) for the years from 2004 to 2007 are mind boggling. Private sector borrowers took on an additional €81 billion in mortgages and €149 billion in other loans in the four years from 2004 to 2007. This created a debt-financed speculative bubble which generated illusory wealth as it grew, but its collapse has now left us (taxpayers/citizens) with a mountain of private sector debt -€429 billion as of the end of December 2008. This is over 2 ½ times the outstanding private debt ( €165 billion)in the country at the end of 2003.
    Whether this crazy level of debt remains in private hands or is converted to public debt it is going to be a severe drag on the economy for a considerable time. While the debt-financed speculative bubble generated illusory wealth as it grew, there will be real pain in increased taxes ,reduced public services and reduced economic growth ,while this debt is paid off.
    The present FF government are too closely connected to that speculative period to maintain a credible and ongoing mandate to steer the country out of the mess which is going to be painful and prolonged.

  2. This sounds to me like a very strong argument for a new bank. The capital issue for the current banks will continue until it is resolved to some satisfaction. The longer the resolution takes (in whatever form it takes) the longer we will not have regular credit flow the parts of the economy that need it.

    I understand that the amount of capital required for new lending a relatively small (strange times we live in when several hundreds of millions is a relatively small amount of money) but in a situation where the current bank’s capital growth is negative the extra amount required is pretty meaningless.

    There is no shortage of liquidity to fund lending (thanks to the ECB), there is probably not even much of a shortage of new capital. What there is a shortage of is banks that deserve the new capital and banks that are able to lend.

  3. @ Lorcan
    Agreed, but without liquidations, how does the new bank get access to ATM’s? Short term, I guess they pay per transaction to the host.

    @Aidan C
    Thanks, now I am really depressed. On the bright side, some people got their equity out to some degree, as part of that bubble. Possibly they will migrate, if there is no foreseeable future in Ireland in view of the rest of what you have said. A way of avoiding the deflation trap for some individuals. I would hope someone, possibly a newly redundant economist, could make a fist of quantifying the extraction as it will obviously play a role in the recovery. Maybe it went into bonds issued by AngIB et al? Wasted if that is so.

  4. @ Lorcan
    Agreed, but without liquidations, how does the new bank get access to ATM’s? Short term, I guess they pay per transaction to the host.

    @Aidan C
    Thanks, now I am really depressed. On the bright side, some people got their equity out to some degree, as part of that bubble. Possibly they will migrate, if there is no foreseeable future in Ireland in view of the rest of what you have said. A way of avoiding the deflation trap for some individuals. I would hope someone, possibly a newly redundant economist, could make a fist of quantifying the extraction as it will obviously play a role in the recovery. Maybe it went into bonds issued by AngIB et al? Wasted if that is so.
    Oops…forgot to say great post! Looking forward to your next one.

  5. Re starting a bank – Getting access to the ATM’s ought not to be a big problem compared to the other problems.

    In summary, the main issue is scale. In order to cover overheads and profits (including customer acquisition, cost to serve, various head office costs like regulatory and IT, and to provide a return on capital to shareholders) of EUR 10m your lending activities would need to make a contribution of around that amount. To do that, assuming you had a 2-point spread (profit margin on your loans), you would need to have loans of 10m/.02 = 500m in issue. It’s not easy to get that number of decent loans in a short time, especially when property borrowing is at a standstill. You would also need capital adequacy. This would need about 50m of equity to begin with. To provide a return on this equity of 10 percent, you would need to be adding EUR 5m to shareholders’ funds every year. This amount of capital would not be enough to support continued rapid growth. Consideration would also have to be given to your startup costs, which I estimate would be 20m-50m, which for a modern day bank would go mainly on the IT side.

  6. Too rapid growth was the cause of the problem, but as there is to be reconstruction of the economy, with fewer franchises, restaurants, car dealers etc, the niche is in providing working capital for businesses that are expanding as their over leveraged competitors fail. Given the continuing collapse of property, it could only be counted as an asset for loan purposes to 20% of cost at most. The entire sector is likely to continue to contract for more than two years. More likely a decade. Short term loans only.
    The clearing bank would likely be an extention of the bulk of the credit unions, relatively over capitalized but perhaps sound. Possibly the easiest way in is via the British/Dutch banks withdrawal? They might even fund part of it. They are undoubtedly being told to get out of the next Iceland!

  7. The way of doing this is relatively simple, if implemented by the government.

    One simply turns the existing banks (or some, perhaps 2 or maybe 3 small banks or 1 big bank would be OK) into agents of the State. You can make the scheme open to all banks to avoid competition concerns but you don’t need everyone to participate.

    You pay them a fee for their services (they instantly sell/factor all their loans to the State but retain risk sharing up to the level of the aggregate fees they charged the State) and take the balance sheet on at State level (where, as pointed out above, it would be minuscule).

    All it takes is the courage to genuinely tell bankers what to do (as Mr. Putin’s did this morning by cancelling their holidays, though this may be a digression).

    This courage will not be found before we default on our national debt (just because it’s “impossible” does not mean that it’s not going to happen) or, perhaps, organize a coup d’etat .

  8. I think the European investment bank tried this or something very like it. I have heard that the fee offered was to small to be attractive but I am not certain of this.

    Itmay be that banks need structural reform as much as they need an injection of capital.

  9. The BOI website is very interesting Antoin. That should be working.

    I think that the key problem (apart from an possible unwillingness to lend in any case) is the lack of a genuine control/feedback mechanism.

    In France a “Credit Mediator” position has been established where an accountant reports almost directly to Sarkozy as to whether loans are being made by the banks.

    This accountant has a network is each French “departement” (using officers of the French State, the French IBEC, etc). Usually problems can be solved locally but difficult cases go up to Paris to be solved with the banks head offices.

    This type of external control mechanism is close on non existent in Ireland (I believe there is a “consultative body” of the type in which we specialise but am not sure if it is achieving anything except discussion).

    The banks need to be audited and constantly challenged nationally and in every branch in every town by the State and by IBEC/ISME. They clearly won’t act without compulsion.

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