For many Irish investors, the banks have long been the mainstay of their share portfolios - solid, sensible and safe. Well before the rash of new high-tech companies arrived on the scene, even before the rush into exploration shares in the 1980s, banking shares were firm favourites with those who dabbled in the stock market.
In recent years, the shareholder base in the sector has expanded considerably as Irish Permanent's 1994 flotation, followed by Norwich Union and First Active, introduced a whole new set of investors to the joys of owning financial shares. And the performance of the Irish banking and financial sector in recent years has, on the whole, been a cause for celebration.
AIB's shares have gained around 240 per cent since the end of 1993 while Bank of Ireland shares are up by an even greater 340 per cent over the last five years.
Even investors in smaller stocks such as Hibernian and Anglo Irish Bank have cause to be happy given the significant gains made across the sector.
But if Irish banking and financial shares have delivered well in the past, they face a challenging future as the environment in which they operate is transformed by the introduction of the single European currency.
The strength of the financial sector has been fuelled in recent years by the phenomenally strong performance of the Irish economy. Lending volumes have surged to double digit levels as consumer demand has soared. Although most economists predict that the Irish economy will continue to grow strongly, success breeds its own problems.
In a recent review of the sector, international credit ratings agency Moodys warned that a key challenge facing the Irish banks will be to preserve acceptable asset quality, particularly in the mortgage market which has been showing signs of overheating.
In addition, financial institutions have had to come to terms with slimmer margins as interest rates fall to historic lows against a background of intense competition. In recent years, banks have crossed over from their traditional business into other areas such as life assurance, making life tougher for older players like Irish Life and Hibernian.
Meanwhile, the pressure on the banks from non-profit institutions like building societies and credit unions has grown. The drive to win market share - particularly in the residential mortgage lending market - has put downward pressure on prices, forcing the banks to cut the slice of the business they take for themselves.
Figures from the Irish Banks' Information Services show that the net interest margin - or the difference between the average interest rate on loans charged by a financial institution and the average interest it pays on deposits - at the retail banks has been under sustained downward pressure in recent years. It has fallen from a range of 3.1 to 4.4 per cent in 1996 to a 2.6 to 4.3 per cent range in 1997 and looks set to fall further as financial institutions try to ensure some sort of a return for depositors while slashing lending rates.
The introduction of the single European currency has already proved costly for the financial sector. In addition to the costs of preparing to deal with the euro, the banking sector will suffer from the loss of lucrative foreign exchange business. Analysts estimate the two big banks will lose £20 million to £30 million as a result of this each year.
But provided the Irish economy remains strong and interest rates stay low, the banks should remain highly profitable, analysts say.
"What's saving them is good volume growth in Ireland. Without that earnings would be on a flat to downward trend," says Mr Shane Nolan, banking analyst with NCB Stockbrokers. He predicts lending volumes will remain in the low to mid-teens over the next three years while all the financial institutions will continue to benefit from falling corporation tax which is scheduled to drop to 12.5 per cent by 2003.
But if the home market remains in good shape, the landscape in which the financial institutions operate will be greatly changed from the beginning of next year. The introduction of the euro opens the way for institutions across the continent to enter the Irish market - and most analysts agree that the easiest way for them to do this is by buying an Irish company.
Smaller companies are seen as the most vulnerable to begin with. Commercial General Union (CGU), a 28 per cent shareholder, has already been sniffing around Hibernian, FBD has had its name linked with a number of continental European firms while Anglo Irish Bank, with its niche in the small business sector, could be of interest to one of the English or Scottish banks focusing on that area. "The smaller the bank in market capitalisation terms, the more vulnerable it will be," says Mr Nolan of NCB.
But analysts concede that it is possible that a large European institution, or a British company eager to establish a toe-hold in the euro zone, could, in the not too distant future, look at acquiring AIB, Bank of Ireland or even a combined Irish Life and Irish Permanent if the merger goes ahead. While the big financial institutions dominate the Stock Exchange here - AIB and Bank of Ireland account for some 35 per cent of the ISEQ index of shares - they are small in overall European terms. However, they have strong local franchises, exposure to a booming domestic economy and look cheap relative to their European and British peers. Analysts say the Irish banks are trading on a 10 to 15 per cent discount to their peers.
But even if merger and takeover activity does not materialise to boost share prices in the sector in the short-term, there should be no shortage of interest in the Irish financial stocks. This is especially true of the larger ones whose importance in the ISEQ makes them a natural choice for investors in the euro zone who want to own Irish shares.
"AIB will have the edge in this regard owing to its inclusion in the Stoxx 50 index, which the less experienced international equity investor in Europe will be tempted to use, at least initially," Goodbody Stockbrokers says.
