Ir­ish bank­ing sec­tor faces five chal­lenges

The Pak Banker - - Front Page -

CORK

Mr Matthew Elder­field, Deputy Gover­nor of the Cen­tral Bank of Ire­land ad­dress­ing the As­so­ci­a­tion of Com­pli­ance Of­fi­cers in Ire­land, Univer­sity Col­lege Cork said it is es­sen­tial for break­ing the dam­ag­ing link be­tween a dis­tressed bank­ing sys­tem and weak pub­lic fi­nances.

And it is im­por­tant for eco­nomic re­cov­ery that the banks are once again in a po­si­tion to lend to small busi­nesses and home­own­ers. But de­spite the con­sid­er­able ef­fort that has gone in to re­cap­i­tal­is­ing, shrink­ing, re­struc­tur­ing and oth­er­wise re­form­ing the bank­ing sys­tem, the process is by no means com­plete and sig­nif­i­cant chal­lenges re­main.

While the banks have trans­ferred their trou­bled com­mer­cial prop­erty loans to NAMA (and are sell­ing down their non-core port­fo­lios), they re­tain their legacy port­fo­lio of mort­gage, SME and other as­sets which have a high level of ar­rears, im­pair­ment and em­bed­ded losses. A lot of work has been un­der­taken to as­sess the qual­ity of these as­sets and to en­sure both that ad­e­quate cap­i­tal is held against them and that ad­e­quate ac­count­ing pro­vi­sions are held (fol­low­ing new guid­ance from the Cen­tral Bank). So, a much greater level of cap­i­tal has been set aside against the risk of loss and higher lev­els of pru­dent pro­vi­sions are now in place.

How­ever, more work re­mains to be done in or­der to de­velop a more pre­cise and clear pic­ture of the per­for­mance and de­gree of em­bed­ded losses in these port­fo­lios. This is the first chal­lenge. Ef­forts to date have in­volved, in the first in­stance, a top down es­ti­mate of port­fo­lio losses and, more re­cently with the as­sis­tance of Blackrock (a con­sul­tant used by the Cen­tral

Bank), a bot­tom-up loan by loan loss fore­cast ex­er­cise based on con­ser­va­tive mod­el­ing as­sump­tions. But there is a re­main­ing task: a case-by­case re-un­der­writ­ing, in­volv­ing where pos­si­ble re­cov­ery and where nec­es­sary re­struc­tur­ing, of trou­bled loans.

This is cru­cially im­por­tant for a num­ber of rea­sons. While the banks still have un­cer­tainty about the gran­u­lar per­for­mance of their loan port­fo­lios, they will be un­sure of the ex­act cap­i­tal buf­fer that is in place and the ex­tent to which they have ad­e­quate cap­i­tal for ex­treme loss developments. To my mind, this en­cour­ages an at­ti­tude of hoard­ing cap­i­tal and pro­vides dis­in­cen­tives to lend­ing. At the end of the sum­mer, there was much de­bate around a widely re­ported Cen­tral Bank anal­y­sis of lend­ing to the small busi­ness sec­tor, where we found that loan re­jec­tion rates were sig­nif­i­cantly higher than other EU ju­ris­dic­tions, ex­cept­ing Greece, and which to our mind pointed to sup­ply con­straints in the bank­ing sec­tor (in ad­di­tion to prob­lems over credit qual­ity). Un­cer­tainty about the cur­rent loan book and the ex­act losses that will crys­tallise (and there­fore con­sume cap­i­tal) are likely a fac­tor in con­strain­ing lend­ing.

Ab­sent an ex­er­cise of even fur­ther re­cap­i­tal­i­sa­tion, the best op­tion is more speci­ficity and un­der­stand­ing of the per­for­mance of the legacy loan port­fo­lios - and an ex­er­cise in fac­ing up to losses and mod­i­fy­ing loans as nec­es­sary.

The banks' mort­gage port­fo­lios are a case in point and have in­volved close at­ten­tion by the Cen­tral Bank. At this event last year, I ex­plained how we were ini­ti­at­ing a project to re­quire mort­gage ar­rears res­o­lu­tion strate­gies from all lenders in Ire­land. We re­ceived these in Novem­ber of last year and pro­vided feed­back to the banks, high­light­ing the need for more ef­fort on a num­ber of fronts. One ma­jor area of con­cern was the lack of op­er­a­tional ca­pac­ity in the banks to deal with cus­tomers in ar­rears so we re­quired se­nior man­age­ment to com­mit to a step change im­prove­ment in that ca­pac­ity. The plans we re­ceived showed sig­nif­i­cant im­prove­ment and we are con­tin­u­ing to mon­i­tor progress closely.

We also pressed the banks to work harder to de­velop spe­cial­ist strate­gies for their buy to let port­fo­lios. And, cru­cially, we in­sisted that the banks de­velop a broader range of tech­niques to deal with loans in ar­rears, draw­ing on the ideas of the so-called Keane group. In a slight sim­pli­fi­ca­tion of the po­si­tion, the banks were re­ly­ing heav­ily on the pro­vi­sion of in­ter­est only ar­range­ments or the cap­i­tal­i­sa­tion of in­ter­est ar­rears, even though these tech­niques were clearly un­suit­able for a size­able group of cus­tomers with un­sus­tain­able mort­gages as a re­sult of a se­vere re­duc­tion in in­come. The banks were re­quired to iden­tify a broader range of tech­niques, in­clud­ing loan mod­i­fi­ca­tion ar­range­ments such a split mort­gages and the in­tro­duc­tion of mort­gage to rent schemes, and to pi­lot these dur­ing Q3 of this year.

These pi­lots are now mostly con­cluded (al­though are drag­ging on in one or two cases) and the banks are now in start­ing the process of rolling out the new ar­range­ments more widely.

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