Big Brussels is watching
07 February 2010 By David Clerkin, Markets CorrespondentIreland’s banks are looking to Brussels for clues on what their future holds. The lenders that will soon take part in the National Asset Management Agency (Nama) scheme have already ceded much control over their destinies to Brian Lenihan, the Minister for Finance, having granted him sweeping powers in return for permission to sign up. These include the ability to force mergers between institutions, appoint directors to their boards and take whatever steps he deems necessary to maintain a stable banking system.
However, Lenihan will not be the only heavy-hitting outside influence that will be calling the shots in the coming months for AIB, Bank of Ireland, Anglo Irish Bank and building societies EBS and Irish Nationwide.
In the case of AIB, Bank of Ireland and Anglo, the European Commission has been taking a good look for several months at each bank’s restructuring plan. It was submitted to the commission last year as one of the many conditions attached to the multibillion euro state aid each has received so far.
The commission’s competition directorate is currently under Dutch commissioner Neelie Kroesbut is scheduled to be reallocated to Spain’s Joaquin Almunia (the current commissioner in charge of monetary affairs). It will soon decide what action to take with each bank.
The commission can attach whatever strings it likes to its approval of the €3.5 billion injected into both AIB and Bank of Ireland by the Irish government’s recapitalisation initiative last year. It can also impose conditions of its choice on Anglo, which has already received €4 billion from the state and is in line to receive billions more to shore up its devastated business.
In addition, it will not be long before building societies EBS and Irish Nationwide become more familiar with the subtle process of dealing with commission officials.
They are expected to merge in the coming months to help address Irish Nationwide’s chronic financial condition, They too will soon receive a massive capital injection, perhaps running into billions of euro, from the state. This will require them- or the merged entity that will take their place - to run the commission’s gauntlet. They will have to agree to whatever conditions it decides to impose in return for its approval for the deal.
But what shape will these conditions take? The commission has already demonstrated in spectacular fashion that its remit runs far beyond rubber-stamping whatever proposals are put before it.
Banks in Britain, Germany, the Netherlands and Belgium have found, to their cost, that the sob stories which have forced their governments to bail them out received little sympathy from the commission. It is determined to make banks pay for the misadventures that got them into their current mess.
At the root of their punishment is the commission’s insistence that state aid should be used only to prop up banks to the minimum extent possible.
While government intervention may have been necessary to save the banking system of an individual EU member state, the commission will seek to ensure that no bank will abuse the support.
Its conditions are aimed at preventing a beneficiary bank from distorting competition to the detriment of better-run institutions, whose policies kept them in business without government lifelines.
Based on the EU’s stance towards other European banks, the life-saving medicine that the government has administered to Ireland’s financial services sector is set to be accompanied by no-nonsense treatments. These could be far more difficult to swallow.
For banks which spent years pursuing aggressive growth strategies, the cure may leave them feeling under the weather for years to come.
Sale now on
Chief among the worries of the big two banks, AIB and Bank of Ireland, is that the commission may end their ambitions of maintaining a large presence outside their home market.
The extent of AIB’s international ambitions in the past leaves it extremely vulnerable to being forced to make radical changes. Its 70 per cent stake in Polish bank BZ-WBK and 24 per cent holding in US regional bank M&T are understood to be near the top of the commission’s hit-list.
Why, after all, should the commission approve Irish taxpayers bailing out Polish and American banks? Dan O’Connor, executive chairman, and Colm Doherty, managing director, of AIB, may argue that there are compelling strategic reasons for holding onto these assets. These are not least because they are profitable businesses that make the AIB group stronger than would otherwise be the case, but the decision is no longer theirs to make.
Instead, AIB and (to a lesser extent) Bank of Ireland face the prospect of forced divestments. They will have to put major overseas businesses in their shop window and sell them to the highest bidder, even if the current climate is far from ideal for extracting big prices. The commission’s track record in this area leaves AIB with much to ponder.
The commission has already ordered the sale of a number of Dutch bank ING’s external operations, including a US-based direct banking business. It has also told the bank to limit its focus to its home market and a limited number of other countries.
Belgian bank KBC also recently took orders from the commission to offload several non-core businesses at home and in emerging markets, although it was allowed to retain its Irish homeloan and corporate lending unit.
The commission may also target the significant lending businesses in Britain operated by both AIB and Bank of Ireland. AIB may make a case for retaining its US and Polish interests on the grounds that it has taken the bank about 20 years to build them up, but the arguments for both banks holding on to their British arms may be more convincing as they have even deeper roots.
They also provide a useful form of diversification and exposure to a major market that is experiencing far less stress than Ireland.
Anglo, meanwhile, has already signalled that its international activities - which included significant but highly troubled loan books in Britain and the US - are at an end. Any future it has will be confined, at best, to that of a limited niche player with an exclusive focus on Ireland.
Downsizing
Overseas cutbacks will not be the only options identified by the commission. It has also administered stiff punishment to other European banks. Those included severe restrictions on their domestic activities, forcing widespread branch closures and even divestments of domestic businesses.
British banks Royal Bank of Scotland (RBS), the parent of Ulster Bank, and Lloyds Banking Group, which owns Halifax, recently signed up to hard-hitting restructuring plans that will see their domestic footprints dramatically reduced, with hundreds of branches closed or sold to other players.
Most Irish banks are already reviewing their branch footprints in response to steep declines in new business and pressure to cut costs aggressively and repair damaged profits.
As a number of foreign-owned players such as National Irish Bank (NIB), owned by Denmark’s Danske, and Ulster Bank have already announced significant branch closures, staff of Irish-headquartered banks are also beginning to brace themselves for major cost overhauls.
The commission is expected to seek detailed explanations from banks that do not propose to initiate significant reductions to their domestic cost bases. It is likely to insist that banks in receipt of state aid do not abuse the competitive advantage that this may confer.
If foreign banks are closing branches, AIB and Bank of Ireland offices are unlikely to escape. The commission may veto any attempts to retain an extensive presence in prime locations in every major city and town and pick up business from other banks that have taken a commercially-driven decision to retrench.
While Lloyds and RBS undertook to sell branches, AIB and Bank of Ireland may argue that a buyer for any parts of their networks may be difficult to find, as potential new entrants to the Irish market concentrate their fire on managing their existing businesses.
But it is the commission that will decide whether promoting competition takes precedence over the desire of state-aided banks to maintain a business as-usual approach to their existing activities.
Deleveraging
Notwithstanding branch closures, the main banks also face the prospect of the commission imposing stringent targets for so-called ‘deleveraging’, or reducing the size of their loan books.
A chronic shortage of funding has afflicted all of the Nama participants, as well as mortgage lender Permanent TSB. Each institution is heavily reliant on expensive wholesale funding from the interbank market, so the EU is expected to prioritise deleveraging.
Such a move would, over time, restore Irish institutions to a more stable footing. They would manage to align their lending volumes more closely with their deposit-gathering. In essence, only lending money that they had managed to source from their deposit customers.
The commission may follow the example it set in other markets and set targets for each bank to reduce their total loans by a specified percentage within three to five years.
But this would not come without its costs. When banks are already under fire for a perceived credit famine, the Irish government may seek to persuade the commission that forcing bank balance sheets to shrink would be counterproductive.
A forced reduction in credit would mean that local banks would lend at a slower rate than they were receiving loan repayments, sucking cash out of the economy. This would be in stark contrast to the effect witnessed during the construction bubble, when easy credit fuelled increased economic activity as consumers and businesses borrowed and spent.
Thou shalt not . . .
The commission is also free to impose restrictions on specific activities by forcing each bank to reduce its share of individual markets, such as those for personal loans, current accounts, credit cards or deposits.
The EU may fear that the retrenchment of foreign-owned banks could spell bad news for consumers as the remaining Irish institutions pick up business they left behind. It could impose ceilings to prevent state-aided banks from growing their market share beyond set levels.
Among the options open to the commission are preventing AIB or Bank of Ireland from having a market share of, for example, 25 per cent or more for selected products. This could force each bank to withdraw from seeking new business and leave the way clear for other players to mop up the remaining elements of each market not open to the main players.
The commission could insist that AIB or Bank of Ireland refrain from signing up new customers, restrict marketing campaigns or even limit the rates that they can charge for loans or offer on deposits.
Either bank may be prevented from lending below a certain rate or paying more than other banks for deposit business.
Such moves would open the way for rival institutions to sweep up business and prevent the emergence of a duopoly.
Ireland: a special case?
Despite the harsh medicine administered in other EU markets, however, the commission’s task of approving state aid for AIB, Bank of Ireland, Anglo, EBS and Irish Nationwide is more complicated than was the case elsewhere.
Between them, the five institutions represent an enormous chunk of the entire banking sector.
In other countries, state aid cases have involved a relatively small number of banks in each jurisdiction. Ireland, however, has distinguished itself with its requirement that almost all of its locally headquartered institutions will require a government bailout.
This may be a feature in the commission’s thinking that works to the advantage of local institutions. If the commission seeks to restrict each bank or building society’s activities in Ireland, it is not clear that their foreign owned rivals would be motivated to increase their presence here.
Handicapping state aid recipients to level the playing field for banks that have not received a bailout may have worked to boost competition in other markets, but the commission will be mindful that imposing restrictions on all Irish-headquartered institutions may not have the same desired effects.
The local banks would be unwise to place too much reliance on this potential escape route, however.