Here are the views of a former banker now based in Dubai. Dave McGee regularly comments on a number of issues through his http://www.homethoughtsfromdubai.com blog.
Some of you have asked me WHY I think the Irish Banking system will not be able to lend money for many years. Let me try to simplify the situation.
Let us take a fictitious country where there is £100 million of borrowings from banks across the personal and business sectors. Additionally there is another £30 million of unutilised credit approved by banks (in overdrafts and other ‘fall back’ credit). The numbers are far far greater than this (nearly 5,000 times larger) but let us work with these numbers.
The financial crisis hits the economy. The banks realise that much of their loans are not capable of being repaid by the borrowers – hence the £100m has to be reduced and the economically crucial unutilised credit lines immediately cancelled. Driving this response is the banking system’s balance sheet capital (this is the key number in bank balance sheets which determines how much each bank can lend to the market and is usually set by the Financial Services Regulator or Central Bank). So if a bank previously had £1 million of ‘capital’ and the Rules were that it could lend £10 for every £1 of capital, this bank could lend up to £10 million. So let’s assume it does (and probably had many undrawn commitments including overdrafts to customers which would technically have brought it over its maximum allowable/regulatory limit) and that £3 million of these loans were not capable of being repaid. Now the lending bank has ‘negative capital’ and must restore this and more to ‘put it back in the lending game’.
Let’s assume our bank raises £3 million of new capital (with enormous dilutive impacts on its existing shareholders – but that is not relevant in the point I wish to make) and in doing so restores its £1m of capital. So it can now lend up to £10 m again.
Well not really. The Regulator has now responded to the crisis by only allowing banks lend £7 against every £1 of capital. So the bank has £1 million of capital and it can now lend £7 million – which is exactly what the current written down value of its loan assets are (ie £10 m minus the write down of £ 3m). So no room for new lending – except if there is still further new capital or the current loans get repaid.
BUT we need to negatively adjust the Irish bank numbers by some other factors;
a) the loans that are being ‘bought’ by ‘bad bank’ (NAMA) exclude smaller corporate and personal loans/credit cards etc. –where with unemployment at 13% + the losses here could be as high as the current market valuations of Irelands two largest quoted banks – remember the capital/lending impact of such write off’s
b) a number of foreign banks based in Ireland are now withdrawing. Much of their loan books will, after being adjusted for sizeable write-downs, find themselves refinanced in some way in Ireland
c) so many of the companies/individuals who would like access to borrowing, will have been too weakened by the last 18 months of financial meltdown, that they will not meet the credit approval standards of the banks that will now be even more cautious not to repeat the lending mistakes of the past and finally
d) overdrafts and short working capital loans will be a product of the past.
So Ireland will be without a working banking system for many years to come. Trust me. This is my profession. My area of knowledge. The country is screaming out for a new bank. A new lending source. But the Government is not listening. Again.
