OPINION:IN JOINING the Nama debate we all must consider what we need to put in place to help restore Ireland's prosperity. What does Ireland need to do to promote jobs and promote development? We have wasted opportunity. One resource we still have is intellectual capital. We need to start using it, writes DERMOT DESMOND
We need to consider what sort of banking system will facilitate growth and development. If we don’t, then we will all be fighting over an ever-shrinking cake. Ireland needs at least three competing banks, otherwise good businesses and good projects will be starved of funds with the consequential loss of jobs.
Asking the taxpayer to accept blind valuations of property or other loans is not a solution. No matter how well intended the valuers, the only certainty is that no one knows the future. Neither is starving the banks of funds a solution – in the absence of funds the banks cannot lend. Nationalisation is a great sound bite – but is equally not a solution. Creating an effective State banking sector monopoly will result in greater inefficiency and greater job losses. Creating a new quango, Nama, is not a solution. The public sector cost is already out of control; we do not need to bloat it further.
The problem in the Irish financial system is liquidity, not property. Without liquidity industry will not be funded, unemployment will continue to increase and the recovery period for Ireland Inc will be greatly delayed.
To fund their growth, all Irish institutions used money from overseas. The destruction of the credit image of Ireland together with the shortage of capital overseas has resulted in the Irish institutions having to repay this money. This has resulted in the banks being under pressure to reduce their loan books, restricting their ability to make new loans to industry and forcing them to borrow using the support of the Government guarantee.
In the absence of adequate liquidity banks are forced to reduce their lending, which in turn puts pressure on the businesses which create sustainable jobs. Currently all the Irish banks are struggling to survive. The only way they can survive in the absence of new sources of liquidity is to reduce their lending.
The primary source of liquidity in the current environment is the ECB/government. We would all wish it was otherwise but that is the reality. Nama is supposed to solve the liquidity problem. The concept was that the Government would swap a sizable portion of the property loans of the Irish institutions for Government bonds. This is supposed to enable the banks to shrink their balance sheets and raise new capital to fund lending.
In theory, Ireland Inc would be no worse off, because it would own the property loans and would have paid for them with Government bonds of the same value. However, the valuation risk is very high.
The suggestion is widespread that we can protect the taxpayer by paying for the property loans in stages. At one level this is correct. The difficulty is that it negates the primary objective which is to put liquidity back into the system. Reducing the amount of money available to the banks is completely counterproductive. It increases the pressure on the banks to reduce the amount of lending. Deferred payments may notionally protect the taxpayer but will actually result in a continuation of zombie banks, less funds for industry, and higher unemployment.
Given that the problem is liquidity, the emphasis should be on putting more money into the financial system, not less – what the economists call quantitative easing.
Setting up a quango to be Ireland’s primary property lender is a sleight of hand to distract from the real need, which is liquidity. It is an expensive and inefficient distraction. Does anyone really believe, no matter how well meaning the designers of Nama, that the most efficient way to manage an existing portfolio of property loans – bad or otherwise – is to transfer them into a new quango?
Each bank already has the personnel and the systems in place to manage the loans and is best positioned to make judgments on the likely performance of borrowers. If the Central Bank/Regulators/Civil Service believe co-ordination is required then a co-ordination framework can easily be put in place.
Everyone agrees that the banks (ie the shareholders) must be responsible for their own bad decisions and the losses which arise as a result. However, the new quango will increase those losses and is not in the interest of Ireland Inc. What incentive does Nama have to minimise losses and maximise efficiency? Absolutely none. In contrast to Nama, if we make the banks liable for their own losses, the banks have every incentive to minimise losses and costs and to nurture projects to a successful conclusion.
Nationalisation of the banks is widely advocated. It seems like a simple solution, but of course means that the taxpayer takes all the risks and all the upside, if there is any. The problem with this is that it does not deal with Ireland’s needs if it is to grow again.
If we want to take a pro-development route we need to have a competitive banking system. Does anyone believe that a nationalised group of banks, effectively controlled by the politicians/Civil Service, will provide a competitive banking landscape?
Nationalisation will result in less development and fewer jobs in the future. Nationalisation will result in less lending, excess risk aversion, slow decision making and lots of potential for political interference.
Legislation will be proposed to stop political interference but ultimately this becomes window-dressing as otherwise the institutions are not accountable to anyone.
Ireland needs a minimum of three vibrant, competing institutions which are incentivised and able to make sure that Ireland develops. Ireland must at all costs avoid a comfortable duopoly or, worse still, a group of nationalised banks which quickly become a monopoly. Competition from overseas banks is less likely to be a feature as many foreign banks are leaving to focus on their domestic economies.
A competitive and vibrant banking sector must be created with management focused on developing Irish business and with a set of rules that protect the borrower from any abuse of the relative power of the banks in a less competitive world.
Further overseas investments by the Irish banks cannot be justified in an environment where we need all our capital to deal with the problems in Ireland. The banks should be returning to their roots and selling off their overseas assets. Ireland Inc should provide all the necessary funding to meet the liquidity needs of the banks and should charge appropriately for the liquidity. Equally the funding provided by the Government should rank in priority to the existing equity and capital providers so that if there are losses then these will be the groups that suffer them.
Based on the widely rumoured figures, Ireland Inc intends to provide circa €60 billion of bonds to the banks as part of the Nama exercise. The Government could achieve exactly the same impact by guaranteeing €60 billion of bonds issued by the banks themselves. The Government can then charge a completely transparent fee for the use of this guarantee. This leaves all the risk of the existing loans with the existing capital providers and could be implemented in the morning without new quangos, complicated legislation, or additional risk. It should be noted that Ireland Inc is already showing significant profit on its preference share investment in the two main banks.
Each bank should set up its own delinquent asset management subsidiary (MgmtCo) which would hold all of the assets which would otherwise be transferred into Nama. This gives each existing bank two businesses which would be consolidated – the good bank and the bad. This is purely a book-keeping exercise and could be done overnight.
The Government should guarantee the funds to be raised by the banks to fund their delinquent asset management subsidiaries for, say, 10 years to match the property loan maturities and generate the necessary liquidity to meet their repayment obligations and to fund new lending. The Government should be paid a proper fee for providing this guarantee.
The following restrictive covenants would be imposed while any amount on the guarantee is outstanding:
- no dividends would be payable on the existing ordinary shares;
- no significant upward pay adjustments would be allowed;
- no overseas acquisitions would be allowed;
- lending margins and charges would be restricted (to a maximum of 4 per cent).
In the event that the Government guaranteed obligations are not fully repaid by a bank within 10 years, then the Government would have a right to acquire all the shares in that bank for €1 (the Damocles Warrant).
What are the implications of my recommendations?
1. More liquidity goes into the system without having to value the assets.
2. There is a saving in not establishing Nama. We should not be trying to grow the public sector; we should be trying to shrink it.
3. There is no argument over valuation. The banks remain responsible for their own loans and the banks will have to realise the value of their loans over time or else suffer the loss.
4. The loans continue to be managed by those who know them best and are already set up to manage and deal with the problems.
5. Any future desired restructuring or consolidation of the banking system by the Government can be readily undertaken as repayment obligations can be defined.
6. On an annual basis the good bank can contribute towards the likely deficit in the associated bad bank.
7. The Government/public sector, while having influence, is one step removed as is the risk of political and Civil Service interference.
8. At worst the taxpayer is no worse off than under the current proposal. The primary risk of bad loans rests with the equity and capital providers in the banks that made the loans.
9. The banks will only be able to avoid future nationalisation if they create a vibrant economy which enables them to redeem the Government-guaranteed funds within 10 years.
10. The banks will be incentivised to sell overseas assets which do not promote the Irish economy.
11. Fewer job losses and a more vibrant future.
12. And finally, the Government is compensated for providing the guarantee and has the Damocles Warrant to acquire the banks for free.
Nama as conceived will do untold long-term damage to Ireland Inc. It will result in paralysis for decades to come. Ireland’s key focus must be to get the economy moving again and start to promote the real economy. Without this tax revenues will continue at the current low levels and unemployment outside the public sector will continue to grow. Everything must be done to avoid ongoing stagnation. If the banks are capable of repaying all Government-guaranteed funds we have achieved everything we want as a country, because it would mean that the economy is functioning again. If they are not capable of making the repayment then Ireland Inc ends up as the owner of the banks at today’s value which is not desirable but is no worse than the position we are in today.
We need to think carefully about how we want Ireland to develop into the future. We owe it to our children’s children to find the best solution even if not politically expedient.
Dermot Desmond runs International Investment and Underwriting, a company in the International Financial Services Centre in Dublin. He founded NCB in 1981 and grew the business to become Ireland’s largest independent stockbroker. In 1994 he sold it to the National Westminster Bank (now The Royal Bank of Scotland). He was the original promoter of the IFSC, which now has 400 companies