November 2, 2008
Irish banks must tell the truth if they are to regain our trustPosted in Banks · 71 comments ·
Banks are paying for the abuse of belief and trust with the loss of credibility in the fiduciary system.
Today, thousands of us will go to Mass or church service. For Irish Catholics and Protestants, the central pillar of both ceremonies is the Creed. In the Creed, which in the Catholic Church and Church of Ireland is exactly the same, we profess our belief in something. In both faiths, the Creed begins with the words, ‘‘I believe in one God’’. The word Creed comes from the Latin verb credo, which means I believe or I trust. This is what we believe; this is what we find credible.
A favourite expression of my granny, when she heard something unusual on the wireless that intrigued her, was always ‘‘Would you credit that, DathaÃ Lacha?” This meant not only would you believe it, but would you trust that piece of information. Do you think yer man on Radio Eireann might be pulling your leg? Would you give that any credence?
Credo is also the root of the modern financial term, credit. To accept credit meant that you trusted the person you were dealing with.
In Roman times, people associated credit with belief and trust. Gradually, the expression found its way into medieval English. The basis of the fiduciary system comes from the Roman custom of trusting or believing the person you are dealing with. Indeed, the word fiduciary comes from the Latin word fides, meaning faith.
Today, although the financial system has become increasingly complicated, the basic bedrocks of trust and faith remain immutable. The central problem with the Irish banking system at the moment is that they have been abused.
Never mind the indecipherable chatter about CDSs, CFDs and CDOs, the problem is that people lied to each other and trust has been shattered. Without trust, there is no credibility in the fiduciary system.
For Ireland, the main task ahead is rebuilding this trust because, without credit, the recession will give way to a depression. But to get credit going again, we have to recapitalise our banks because, if we don’t inject fresh money into these institutions, they will contract their lending further.
Here is the rub. Whatever recapitalisation route we choose, we have to contend with the issue of trust. And here the picture is not pretty. ] The international financial markets do not trust the management of the Irish banks – any of them. At the moment, behind the scenes, the executives of the two big banks are working away in an effort to show they are okay. They are insisting they can sell international businesses if they need to raise capital. Their body language sends the following message: ‘‘We – AIB and Bank of Ireland – are respectable, whereas there are real delinquents.”
The subtext is that the big banks were ‘‘simply caught up in a global frenzy’’ and they insist they have the capital and the networks to survive.
This is an affectation at best, misinformation at worst. If you look at the loan-to-deposits ratio of the big banks, you see that they were all at the same game. The strategy was borrowing short from the wholesale market and lending long to property.
The bet was predicated economically on Germany remaining in recession for years and the euro offering Ireland a free lunch. As long as this was the case, the management of the Irish banks believed that the property market could go only one way.
The Irish bank bonanza wasn’t limited to Ireland. The banks were confident that this ‘cross-country credit subsidisation’ involving German subvention to Ireland, would last indefinitely, so they expanded into countries without having a commensurate deposit base.
About three years ago, I became aware of this procedure when a friend in London told me about a new concept in international banking called ‘‘Irish pricing’’. By this, he meant that the Irish banks were so keen to get business and build up their loan books that they were offering much better prices to clients on deals than the big international banks could do or were prepared to do. All this money was borrowed either from shareholders or from the market.
When it all came tumbling down, shareholders lost most of their money, and the trust and faith in the system was shattered. One thing investors in the Irish banks will remember for a long time to come was that the management of the banks was doing road shows as recently as early 2008 telling investors there was nothing to worry about.
Logic suggests that the management must have had at least an inkling that loans were going sour by that stage.
To make matters worse, the investors we now need in order to recapitalise our banks are probably the same people who have lost out. Their credo and fides have been abused, and rebuilding these precious commodities will come at a price.
Perhaps an easy way to understand this is to think of a simple personal situation that involves trust, faith and credibility.
Imagine you lent â‚¬100 to someone and you were promised not only your money back, but that you’d get a capital gain of at least 10 per cent. Instead of getting â‚¬110 back, you are now looking at â‚¬10 return because the share price is down by 90 per cent.
Would you be quick to give that character money again? Not unless he had changed his ways. The only clear signal that the Irish banks have changed their ways is to admit that the problem, is not so much liquidity, but the underlying price of property.
Irish property prices need to fall by close to 40 per cent from here before we are back to our long-run average level. Until that happens, foreigners will not be keen to put new money into the Irish banks.
Evidently, the major problem facing Irish banks in their efforts to recapitalise is that no one believes them. The state naturally wants to get them lending again but, as money is tight, the state wants its own exposure to any recapitalisation to be at a minimum.
Minister Brian Lenihan’s objective must be to get the minimum investment the state can make and the maximum return for that investment.
There is still plenty of money in Ireland that could participate in this venture. Indeed, the world is full of money waiting to be committed. However, the world is also full of bargains, and a battered and bruised Ireland is by no means the best opportunity.
Therefore, whatever structure we decide on for the great Irish bank recapitalisation, that structure must be right. We won’t get a second chance to do this. If we undertake a half-baked recapitalisation, the state’s credibility and its credit will go up in smoke.
If that came to pass, expect churches to be full again with people who swapped God for Mammon in 1999, back inside, belting out the Creed as if the boom had never happened.