Why is Ireland seen as unattractive by banks?
Ulster Bank, Bank of Scotland Ireland, Rabobank, Danske Bank, and more.
There have been plenty of lenders who have dipped their toes in the Irish banking sector, only to discover in recent years that the temperature of the water is not to their liking, and disappear.
And now it seems one more may be about to join the list, with the shock news that KBC Bank Ireland is in talks with Bank of Ireland about offloading its performing loan portfolio and liabilities.
So what exactly is it about Ireland that currently makes it so unattractive to banks, particularly foreign-owned ones?
Interest rates internationally are currently at record low levels.
And they have been so for some time because of the fallout from the last financial crisis and now the impact of Covid-19.
The interest rates are low in order to try to stimulate demand in the economy.
But the flip side effect for banks and other lenders is that it means they are not able to make as much margin or profit as they may have in the past.
The Irish situation is made more difficult by the legacy of tracker mortgages that are uneconomic in a low-interest rate environment, and of which Irish banks still hold large quantities.
Another bugbear of the Irish banks is the level of capital they have to hold compared to their international peers.
This is another legacy of the crash and requires them to put aside more money to cover potential losses that might arise from so-called risk weighted assets if borrowers for some reason aren’t able to pay back their loans.
More than a decade on, the fallout from the last financial crisis continues to wash through, and although they have made progress on reducing them, the Irish banks still have higher levels of bad loans on their balance sheets than most European peers.
This has led to a situation where, at 19.1%, Ireland has the fourth highest Core Equity Tier 1 ratio (the highest quality of regulatory capital) across the eurozone countries, compared with the average of 14.4%.
This additional tied up capital is, in effect, money that can’t be used to make more money through lending or returned to shareholders.
As a result, the banks don’t like it. Indeed, it is one of the reasons why NatWest is winding down Ulster Bank at the moment.
In order for a banking system to be able to function properly, they need to be able to retrieve money they lend from borrowers if it is not being paid back.
However, for many years, bankers have complained that the Irish legal system makes it extremely difficult to repossess properties from defaulting customers.
This has led to a situation where the level of home repossessions here is very low by international standards.
Research by ratings agency Standard & Poor’s a few years ago found that the full legal process for repossessions in Ireland can take as long as 42 months, compared to 18 in the UK, Denmark, Norway and Sweden.
It is a costly and frustrating situation for banks operating here.
The Irish market is also seen by lenders as being costly to operate in.
In recent years, the industry claims the cost of doing business from a regulatory perspective has increased significantly here.
This is due to supervisory fees and other levies charged by the Central Bank, the European Central Bank and the State, to cover the costs of financial regulation.
In 2019, AIB, Bank of Ireland and Permanent TSB collectively paid €268m in such fees.
The retail banks also pay a financial institution levy to the Revenue Commissioners which brings in €150m a year.
All added up, it amounts to significant costs for those operating in the sector which ultimately eat into profits and shareholder returns.
In recent years demand for lending in Ireland has been relatively weak, owing to the gradual recovery of the Irish economy and the reluctance to take on debt.
Add to that the fact that relative to other economies, Ireland is small and less capable of sustaining many large players in the banking market.
Traditionally, the market has been dominated by two large banks – AIB and Bank of Ireland – with a number of other smaller lenders trying to compete.
That situation has been made even more challenging in recent times by the Covid-19 pandemic with households and businesses choosing to save rather than borrow and spend.
Although we are starting to see light at the end of the tunnel as vaccines are rolled out, the scarring effects of the pandemic are going to be deep and long-lasting in certain sectors.
That means that while Irish banks returned to profit in the second half of last year and should be profitable this year, they do still face a challenging few years as the effects of the pandemic wear off.
Putting all of the above factors together, it quickly becomes clear that the Irish banking landscape is tricky to say the least and not overly attractive to new entrants.
As of the end of September last year, Return on Equity – a key measure of profitability – was -5.23% for banks in Ireland, the lowest in the EU, compared to an EU average of 2.19%, continuing a trend seen since 2014.
Of course, some of these challenges are not unique to Ireland.
That’s why we’ve seen increasing retrenchment and consolidation in banking not only here, but across Europe and beyond over the past few years.
That has been spurred on by regulators like the European Central Bank who are keen to see fewer small and potentially vulnerable lenders and more large robust institutions into the future.
All that said, while the focus is inevitably on those that leave, there have been some new entrants into Ireland in recent times, including Dilosk, Avant Money and Finance Ireland.
However, the worry now is that the sight of Ulster Bank and perhaps KBC exiting will serve to put off any other lenders thinking of entering the market.
And that spells bad news for consumers, businesses and the economy at large.