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In any economy, the job of a banking system is to hold deposits of savers and recycle those savings into the hands of those who want to spend or invest. It’s that basic. The way a bank makes money is by charging more to borrowers than it pays out to the people who want to save. The gap between both of these interest rates is called the “spread”. For an economy to operate efficiently, its banking system must be lending money, or as they say in the jargon, “extending credit”. If it is not extending credit, then the money that is deposited gets stuck in the banking system leading to a situation where the economy has lots of money, but no credit.

Ireland is one such economy – the banking system is little more than a safe for savers. This has been the case for some time. In 2009, Ireland’s “domestic credit to private sector” (bank lending) was at 169.3 per cent of GDP. By 2021, this had declined to 27.9 per cent of GDP according to the World Bank’s calculations. This figure of domestic credit, accounting for only 27.9 per cent of national income, puts Ireland on a par with places such as sub Saharan African countries, the Dominican Republic and Moldova. These are countries without a developed financial system, lacking banking infrastructure and a stable currency, characterised by capital flight and chronic current account deficits.

Ireland, in contrast, is one of the world’s most profitable financial centres, the IFSC, home to a vast and developed banking infrastructure (although the ATMs this week may be slightly problematic). Ireland is also in the Euro and is running a large current account surplus. To put the bank credit picture into a rich nations’ context, we can see that in most western countries, bank credit hovers around 100 per cent of income, a little bit less in countries that are not investing and are growing slowly and a little bit more in countries that are spending and growing more quickly.

According to the Global Innovation Index, in 2022, Ireland ranks 90th in the world when it comes to domestic credit to private sector as a percentage of GDP, with a score of 32.4. The amount of credit being extended to Irish-resident SMEs has been declining for well over a decade, with outstanding credit falling from €57.7 billion in 2010 to just €18.3 billion earlier this year. Ireland’s banks are simply not lending. They are afraid to lend and therefore large parts of the economy are strapped for cash. This means that there is a huge overhang of potential credit that could be lent but is being hoarded. Did you ever ask yourself why those small builders, for example, who used to build a dozen houses here and there in your locality don’t seem to be around any more? They can’t get credit at reasonable rates – despite interest rates being so low. Credit is part of the reason. During a period when Irish interest rates were as low as they’ve ever been, Irish bank credit to small businesses has collapsed. Does that not strike you as strange?

It is not only strange, it is profoundly dysfunctional and should be the number one concern of our Central Bank because if the banks are not lending, monetary policy is not working – and monetary policy is the Central Bank’s mandate. Put simply, when the ECB cuts interest rates or raises interest rates, the banks should either pass on the increased interest rate hike to the customer (which they are not doing in Ireland as we saw in last week’s column ) and, when interest rates are reduced, the banks should encourage small businesses to avail of cheaper credit (which they are not doing as evidenced by the collapse in lending). As a result, monetary policy in Ireland is not working.

This means that the economy becomes lopsided, dominated by large multinational companies that have no need for bank credit because they have lots of other means of finance. Meanwhile, there is an expanding public sector because it is financed by the State. In contrast, the small- and medium-sized sector, the entrepreneurial heartbeat of the economy, is squeezed for lack of credit. It is quite clear that the existing Irish small business sector gave up on the banks quite some time ago. A recent government survey (2021-2022), found that 16 per cent of SMEs applied for bank finance up to March 2022, a decline from 20 per cent the year prior. It is the lowest level of demand for bank finance since the survey began in March 2012. The pandemic will have affected that figure but the picture that emerges is one where small businesses are financing themselves out of their own cash flow. This sounds prudent but implies a lack of ambition and scale and it also means that only existing businesses with strong cash flows can trade while start-ups and young business people wanting to set up shop on their own can’t get credit. Entrepreneurial spirits are crushed and we become a nation of employees. The dilemma with this scenario is that without entrepreneurs creating new products, a nation of employees will be an economy that stagnates. Such an economy might seem secure but, in truth, it is extremely vulnerable because it is static. In contrast, the entrepreneurial economy is dynamic and better able to roll with the punches.

The core of the banking problem in Ireland is a lack of competition. We need more banks competing with each other to finance the growing economy. The reason the banks “cheat” customers out of income interest is because they can. The reason they don’t lend is because they don’t have to lend to make the money which they are robbing from the savers. The chief executive of a bank can suppress lending and take profits by cheating savers. The banking system is broken, yet banks make huge profits. If that is not the definition of a stitched up market, what is? Savers’ money is captured and borrowers have nowhere else to go.

The Central Bank must make it more attractive for other banks to come into Ireland. This means less not more red tape, regulation and paperwork. Talk to anyone in the retail banking business in Ireland and they will tell you that the Central Bank is strangling competition. They would say that of course but nonetheless we have ended up with the least competitive banking environment in Europe. The economy booms here because of a small number of huge companies in most sectors rather than many smaller companies fighting for market share. The customer gets shafted, paying through the nose for everything, most notably housing. The saver sees his or her income trousered by the banks, while the prospective small business borrower doesn’t even go looking for a loan. All the while, working capital in an economy with an abundance of actual capital, disappears.

As a policymaker, you’d have to try hard to make that counterintuitive outcome a reality but the Department of Finance and Central Bank together have made it happen. Ireland has the credit reality of a third-world country side by side with a financial sector that competes with the world’s best. Is it any wonder the punters are clamouring for change?