As the year progressed the problems facing Irish financial institutions continued to mount, forcing the Government to step in this week to recapilatise the three main banks to the tune of up to €7.5 billion, writes Simon Carswell, Finance Correspondent
THE WORD "credit" stems from credere, the Latin verb "to believe" and "to trust", and it is the foundation on which the global banking system was built. The first cracks appeared under Wall Street last year following the US subprime mortgage meltdown. They gradually spread into the mainstream US and European banking system. By September some banks, which many were thought too big to fall, collapsed or had to be rescued in state bailouts. As a result, the trust that kept all banks standing started to crumble, forcing governments to step in to support entire state banking systems.
At the start of the year no one could have foreseen such events unfolding. 2007 had been dominated by the international clean-up of the toxic subprime spillage. Early in 2008, Irish bankers were quick to show that their institutions had been largely immune from any material exposure to the US subprime mortgages. The banks believed that the property market was in for "slower, more sustainable growth" and predicted their profits would keep growing, albeit at lower levels, and that they would only see a marginal rise in losses on loans.
How wrong they were. The year started positively when builders started dropping prices in a bid to sell properties. From May the economy began to deteriorate rapidly.The banks were frantically working with their heavily indebted property developer customers to generate much-needed cash, while lenders were making life more difficult for possible house buyers, asking for larger deposits and setting higher interest rates. The global financial crisis had driven up the cost of money and banks were forced to pass this on to customers.
The difficulties didn't appear to faze the banks. In July, the State's largest bank, AIB, raised its dividend payout to shareholders by 10 per cent, despite increasing the amount of potentially bad loans on watch by more than 50 per cent to €10.4 billion from six months earlier. The move, aimed at instilling confidence, appeared reckless. The bank painted a worst-case scenario of its loan losses topping €1.3 billion a year for each of the next three years. AIB said it didn't believe this would happen, but wanted to illustrate how bad it thought the situation could become and still show that it could make profits.
Then the unthinkable happened. In mid-September, the 158-year-old Lehman Brothers, the fourth-largest investment bank on Wall Street, went bust. Many had thought Lehman was a businesses that was just "too big to fail", given that the US government had just bailed out the mortgage giants Freddie Mac and Fannie Mae and supported the rescue of another investment bank, Bear Stearns, six months earlier.
The Bush administration was also making every effort to save insurance giant AIG, and later took the company under its wing. Lehman's collapse shook the financial world. Investors fled the banks, depositors panicked, and at home, plummeting bank shares fast became a barometer for fear.
Concerned that fears about the imminent collapse of a bank could become self-fulfilling, the Financial Regulator said they were "well-capitalised" (meaning they have plenty of cash to cover unforeseen losses) and could withstand risks to their financial stability. No one believed that - least of all bank customers. Deposits were being withdrawn and placed in safe havens such as An Post, with reports of some depositors lodging seven-figure sums.
The Minister for Finance, Brian Lenihan, was forced to react announcing on September 20th an increase in the protection limit on deposits from €20,000 to €100,000. This covered about 97 per cent of deposits held by everyday customers, but failed to allay fears about the stability of the Irish banks.
On September 29th, four European banks and one US institution were rescued in state bailouts or shotgun marriages with stronger banks.Irish bank shares recorded their steepest falls in more than 25 years with Anglo Irish Bank falling the most, losing €4 billion in large corporate deposits at the end of September.
On September 30th, Brian Lenihan announced after all-night emergency talks that the Irish taxpayer would be guaranteeing all deposits at the four Irish-owned banks and two building societies in addition to their own borrowings from other banks and investors. The €440 billion exposure the State amounted to more than twice the value of the Irish economy and almost 10 times the national debt. Deposits flooded back in and bank shares rose. But the guarantee failed to solve the problem of capital and whether the banks had enough cash in reserve to cover higher losses on loans.
Other governments later went a step further by injecting vast amounts of cash into their institutions and by marrying institutions into bigger, stronger companies. Most notable was the UK, which injected £50 billion into its banking system. Two weeks ago the Governmetn announced it would make available a fund of up to €10 billion.
Then last week, the banking industry was rocked when Anglo Irish Bank chairman Sean FitzPatrick, a 33-year veteran of the company, resigned after admitting that he had concealed up to €87 million in directors' loans from the bank over an eight-year period to avoid disclosing the amount to shareholders. He transferred the secret loans to Irish Nationwide Building Society before the banks reporting year-end on September 30th, only to transfer them back shortly afterwards. Hours after his departure the banks chief executive David Drumm resigned.
The crisis at Anglo hastened the States plans to recapitalise the banks. Brian Lenihan announced that the Government was taking effective control of the bank with a €1.5 billion investment and would be clearing out most of the bank's board and management.
The Government also agreed to invest a further €2 billion each into AIB and Bank of Ireland, with the prospect of putting up to another €1 billion into each, if private investors dont buy new shares that are likely to be issued by both banks next year. Up to €7.5 billion will be invested in the three main banks.
The four Irish public banks have fallen from their peak valuation of €52.8 billion in February 2007 to less than €4 billion today, helping to wipe out the value of many Irish pensions.
The loss of trust in the banks has come at a massive cost. And the cost to the taxpayer is certain to mount.