PIECE ON IRISH BANKING

Examiner Piece on July 31st by Jim Power

On Thursday the European Central Bank (ECB) delivered the latest rate increase, a year to the day since it commenced taking rates up in the face of an evolving inflation crisis. In the past year, the ECB’s key interest rates have been increased by 4.25 per cent, which is a dramatic tightening of monetary policy in a relatively short period of time.  Ahead of the next meeting in September, the ECB clearly has an open mind at this juncture and another 0.25 per cent increase is certainly not a certainty. In the statement following the increase, the ECB said that it would ensure that interest rates ‘will be set at sufficiently restrictive levels for as long as necessary.’ This represents a noteworthy change in the tone of language from the prior meeting, when the ECB said that it would ensure interest rates would be brought to levels that were ‘sufficiently restrictive’ to bring inflation down to the 2 per cent target.

The ECB will be engaged in data watching ahead of the September meeting. Economic activity, particularly activity in the services sector; the labour market; and core and headline inflation; will be the key focus of attention. While headline inflation is falling quite sharply, the core rate, which excludes volatile food and energy is proving very stubborn. The fear now is that energy and food prices could start to accelerate again, for global reasons relating to China, Russia and India to varying degrees.

The reason why central banks increase interest rates is to make borrowing more expensive and make savings more attractive, with the net result that money is basically taken out of circulation. The transmission mechanism is basically through the banking system, and the policy does appear to be working, in the Euro Zone at least. The ECB’s quarterly survey of bank lending this week shoes that loan demand from business is at the lowest level in 20 years, and that loan demand from households is also weaker. No surprises there and the results will not displease the central bankers in Frankfurt.

Here in Ireland the face of banking has changed immeasurably over the past 15 years. We have seen a dramatic concentration in the market as a few players exit and the two- and a-bit incumbents are now becoming more and more powerful, and competition is suffering. Competition, if regulated properly, is good for consumers in that banks must compete for our business. One gets the distinct impression today that the banks are not particularly interested in most of our business. Customer service in the branch system is dire and is reminiscent of the post offices back in the dreadful 1980s. The IT offering of the banks is not of a very high standard, with one of the big two particularly lamentable.

Last week the Financial Times reported on a study by S&P measuring the extent to which banks have passed on official rate increases to depositors. Of the 22 countries considered, UK banks are top of the table, passing on 43 per cent of rate increases to depositors. Guess what, Irish banks are bottom of the table, passing on just 7 per cent of rate increases to depositors. Consequently, it should come as no surprise that AIB announced bumper profits in the first half of the year. If a bank is operating in a strong economy; is passing on such a low percentage of rate increases to depositors; is increasing rates to its customers; and has a strategy of cost cutting; then it certainly does not take a genius management team to deliver strong profits. The arguments about the salary cap are utter rubbish, given the lack of competition in Irish banking. This poses the question about the point and purpose of banks in the modern Irish economy. At a basic level the role of a bank is basic, namely, to act as an intermediary between savers and borrowers, and to do so in a trustworthy manner. This intermediation is crucial to the functioning of an economy. The SME sector is not well served by the Irish banking sector, and indeed as a personal customer, I now find that contacting my bank is as big a nightmare as contacting Eir Evo, that is of course if one doesn’t mind hanging on the line for an hour.

More competition is needed in Irish banking, but it seems clear that the State will have to be very involved. I have believed for a long time that a State-owned bank that supports SMEs and start-ups is essential, along the lines of the old ICC. It must be properly managed of course and cannot be run along the lines of RTE or Bord Pleanála, to name just two. I also believe that the credit union movement needs to be upskilled, properly resourced, and enabled to provide real competition.