THE RECAPITALISATION of the banking system has been allowed to become an all-consuming sideshow to the much bigger drama playing out in the economy.
That it has taken the Government so long to begin the task in earnest - almost three months after the intensification of the credit squeeze - only serves to confirm the perception that the Taoiseach and his Ministers are floundering in a sea of economic trouble. Nor does the delay reflect any credit on our banks which have put what little chance there is of preserving shareholder value ahead of the vital national interest of having the banking system functioning normally.
The two-step process announced on Sunday by the Government will merely delay the process further. It will put €2 billion each into AIB and Bank of Ireland and then support them as they strive to raise another €1 billion each from private investors, dragging the process out into the middle of next year. The incremental approach also runs the risk of appearing to be inadequate and thus failing in its purpose, which is to reassure the financial markets that the Irish banks are now strong enough to take whatever losses may come their way and thus remain open for business.
The Government is presumably of the view that the amount of money it has committed to the banking system is sufficient to ensure the banks can deal with their losses. The problem is that many in the market - other banks and investors - believe the Irish banks are underestimating their losses and substantially more cash may be required before the problem is fixed. And if there is one truism that has been confirmed by recent events, it is that market sentiment can matter more than the facts.
That said, the State's resources are finite and every euro invested in the banks is a euro that will not be spent on essential services. The decision as to exactly how much taxpayer money should be put into the banks was always going to involve a compromise. In that regard, the decision to use preference shares - which may earn the State up to €500 million a year - as the vehicle by which to inject capital is correct.
What is important now is that taxpayers get the return they really want from their €7.5 billion investment: a functioning banking system. Recapitalisation does not of itself fix the problem. However, it removes one of the biggest impediments, which is the pressure on banks to reduce lending in order to preserve capital. In the current climate, even recapitalised banks will be risk-averse and will seek to avoid the areas which the Government really needs them to lend into: small- and medium-sized business.
The Government has attached various conditions aimed at ensuring the banks lend to business and house buyers, but in truth they don't amount to much. The commitments all come with riders attached that ultimately allow the banks to refuse to lend.
Based on their records there is no reason to believe the banks will act in any fashion other than their own self-interest. Further pressure will have to be applied.