It is vital that the fundamentals of the business of banking receive a fair hearing and are subject to an honest debate by all who will participate in this review.
The Review of the Banking Sector in Ireland is firmly under way with the recent publication of the terms of reference by the Minister for Finance, Paschal Donohoe. It will enable stakeholders to voice what they believe to be necessary for a stable, progressive, viable and sustainable banking sector in Ireland.
We are all agreed that a solid, well-capitalised banking system is at the heart of our economy. Past experience taught us the hard lessons of the impact of an excessive risk-taking banking system on an economy and a society, and the past 10 years has seen policymakers, regulators and banks adopt a swathe of banking regulation and legislation. It has been the most prolific regulatory period in banking history, encompassing every aspect of banking from capital quality and adequacy, corporate governance and conduct, to culture and individual accountability.
Strong governance and higher capital requirements are now firm pillars of the EU-wide banking system, and the Government is right to list financial stability, in its review, as the priority issue in looking towards the future.
But it is also vital that the business fundamentals of retail banking in Ireland get a balanced hearing by all stakeholders and that the place of profitability and return on equity in creating a strong and attractive industry that can grow, innovate and reinvest in its future has its place in the discourse.
Low profitability
We should not forget that it was the departure of two retail banks in quick succession earlier this year, and subsequent questions regarding the hard-core financials of retail banking in Ireland that led us to this review. We welcome the fact “the business model for retail banking” is listed as a central issue in the terms of reference. Without viability, there simply is no bank.
The profitability of the Irish retail banking sector, measured in terms of return on equity, is among the lowest in Europe – 2.6 per cent in Ireland versus circa 7.6 per cent for the European average for the first quarter of 2021. Profitability is, whether all stakeholders want to acknowledge or not, a central tenet of the future sustainability of our retail banking sector.
Ireland needs a profitable retail banking sector that can fulfil its core mission of providing a wide breadth of credit, deposit and payments services to customers and society, an increasingly unique feature of the retail banks in the midst of fragmentation of the financial services market here.
The retail banks provide loans to businesses and households totalling €127 billion, including 822,500 mortgages. They hold €270 billion in deposits, process about five million transactions worth €3.7 billion every day, and are already playing a crucial role in financing Ireland’s green transition.
But the retail banking sector is undergoing a period of unprecedented disruption, with accelerated digitalisation, changing customer trends and increasing competition from fintech and non-bank competitors who have entered select segments of the banking market.
Supervision of banks
Chair of the European Central Bank Single Supervisory Mechanism (SSM) Andrea Enria, who is responsible for the supervision of banks across the euro zone and has a detailed view of their operations, cost base and profits, put it clearly this year when he said banks would have to adapt to shifting customer preferences and competition from fintech and big tech market entrants.
“If banks pass up these opportunities, their business models will become more and more vulnerable,” he stated.
Research shows that Irish retail banks have been reorienting their business models and strategically investing to transform their businesses while managing their costs. They have collectively spent over €3 billion in the past five years on technology and innovation in response to a rapidly changing market environment and increasing regulatory demands. The Minister for Finance just last week emphasised the importance of investing in technology when he spoke of how “fundamental information technology now is to the delivery of banking services in our country”.
There are a range of complex issues impacting the retail banking sector in Ireland and this review is to be welcomed in terms of offering a full analysis of them. Under the ECB, there is now an EU-wide single rule book for financial services, to which Ireland subscribes, and in this context the operating environment for banks in Ireland should not be significantly different from the operating environment for banks in other euro zone countries.
Yet, banks in Ireland have one of the highest capital requirements, face the most stringent corporate governance and consumer-protection rules, and the most restrictive renumeration framework. A more level playing pitch would be in order, if Ireland is to create a stronger banking environment. Some issues in particular warrant discussion.
Skills composition
The Irish retail banking sector is an outlier in the EU on capital requirements, with our banks required to hold about three times more capital for their mortgage loans books when compared to the European average.
The rapid digitalisation of banking means the skills composition within banks is evolving, with retail banks requiring top-class IT and digital skills to meet consumer and regulatory demands. Yet Irish retail bank employees are subject to some of the most restrictive variable pay remuneration conditions in the EU and are clearly disadvantaged when compared with graduates and employees in other sectors including global big tech and fintech, which have a major presence in Ireland.
Irish policy dictates that variable pay, including benefits such as health insurance and childcare, cannot be paid to any staff members at any level from the most junior upwards. Such policies must be reviewed, with a view to aligning with existing EU rules on variable pay, if retail banks are to compete for the skills necessary for their future transformation.
Given the scale of disruption and competition in banking, and the degree to which new entrants are unshackled from legacy banking issues, it is crucial that retail banks can operate in an environment where innovation, skills, efficient use of capital, and profitability are regarded as key to their future sustainability. As we embark on this review we need a debate that is informed, by the past of course, but is firmly focused on the future role that the sector can play and is playing.
Brian Hayes is chief executive of Banking and Payments Federation Ireland
