OPINION:THE CONTROVERSY over publicly funded banks not passing on interest rate reductions announced by the European Central Bank (ECB) raises a wider concern over the Government's restructuring plan for the banking sector.
While the plan to create the so-called “pillar banks” is understandable from a financial stability perspective, it unintentionally risks weakening competition even further, meaning the main losers will be personal consumers and small business customers of the banks.
As to what to do about the retail banks passing on interest rate reductions, this should be the result of competition rather than through order by the Central Bank or the Government, even if practically all domestic banks are under public ownership.
Competition in the banking sector has been under threat since the banking guarantee and is set to come under even more pressure, not by design, as a result of the bank restructuring plan. The challenge is how to restore competition to the troubled banking sector.
Generally speaking, effective banking is based on striking a balance between competition and regulation. Ireland has never had such a balance.
Before the crisis, the Irish banking sector was characterised by improving competition but poor regulation, both by design and in terms of enforcement. Since the crisis, the knee-jerk response of the authorities, including the International Monetary Fund and the EU, has been to reverse direction. We’re now heading rapidly towards an over-regulated and highly uncompetitive banking sector.
To be fair to the authorities, the emergency response taken to create the pillar banks is understandable in the interests of bank survival – it’s better to have a monopoly or duopoly banking structure than no banks at all. But the risk is that the new structure is sacrificing users – small businesses and personal consumers – in the interests of financial stability.
Without appropriate remedial action, the situation will get worse, with even more negative consequences for the economy in terms of reduced spending and investment.
One of the biggest fallacies to have emerged from the crisis is that it was caused by “too much competition”. Competition is always beneficial. If not, there is some other issue with the market – what economists call “market failure”. This necessitates regulation to help competition do its job.
In the presence of market failure, effective economic policy should aim to strike a balance between competition and regulation. As a general principle, competition is always preferable to regulation – “competition where possible, regulation where necessary”, as the oft-quoted maxim goes.
In the lead-up to the crisis central bankers and regulators took great pride in their efforts to control inflation, and even proclaimed they had conquered inflation. That was the easy bit. But as their efforts were focused on the macroeconomic issue of inflation, they missed the more subtle and challenging microeconomic issue of credit control in the context of capital mobility and cheap money.
To this economist at least, the most telling story of the Irish banking crisis is not Anglo, but Bank of Scotland (Ireland).
When this bank entered the market in the late 1990s, it shook it up and injected fresh competition. Having built a strong position in mortgages and business banking, it entered the personal current account market and, in a few years, rolled out a physical branch network – which had seemed an impossible feat in a small market such as Ireland.
This aggressive strategy triggered escalating competition, with Anglo behaving similarly in the property development market.
While all this was going on, the regulator was asleep at the wheel and there was no one to guard against side-effects of escalating competition. In other words, there was no strong regulatory hand to balance the growing competition and keep the banking sector on a sustainable track.
What might therefore be done to protect competition – the interests of personal consumers and small businesses – in the brave new world of the pillar banks?
It should not be the role of the Central Bank to force the retail banks to pass on interest rate reductions, not even in the theoretical situation where the euro ends and Ireland finds itself back with the punt and control over its own interest rates. Telling banks what interest rates to charge is not the job of a central bank or government or any public authority; rather, it’s the job of sustainable competition among banks, under the supervision of a central bank.
To help achieve such competition, the Competition Authority and the National Consumer Agency – which are to merge – need to be included in the planning of the banking sector to ensure competition and consumer interests are appropriately voiced and balanced against the regulatory tendencies of the Central Bank, Financial Regulator and Department of Finance.
The request by the Financial Services Ombudsman to be given the power to name both good and bad practitioner banks should be implemented as a matter of priority to enhance openness and accountability and to mitigate the recidivism that the ombudsman is reporting.
There should be an ongoing review of barriers to entry into the banking sector (involving the Competition Authority and Financial Regulator) because there is no competitive challenge to the sector.
Any further mergers should be subject to independent scrutiny under the merger control provisions of the Competition Act.
The situation in which the Minister for Finance is both promoting and assessing (on competition grounds) the future structure of the banking sector is a potentially very dangerous one for personal consumers and small businesses.
A competition-based remedy for the banking sector is therefore possible and practical – but must avoid the regulatory failures of the past.
Dr Pat McCloughan is managing director of PMCA Economic Consulting. The views expressed in the article are his own and do not necessarily reflect PMCA’s views.
