19 Nov 2010

Ireland’s risky bank strategy

Today the news from Dublin has strong echoes of the situation in the UK in October 2008. There’s some rather clear statistical evidence of why the Irish Government needs to act decisively over the weekend.

Ireland’s second biggest bank – AIB – put a rather candid trading update out late this afternoon, which showed that €13 billion has been withdrawn since the beginning of the year, mainly from corporate and institutional deposits. That is a 17% shrinkage in its deposit base.

Last Friday, Bank of Ireland, the nation’s biggest lender reported a €10bn deposit exodus, again mainly from corporate deposits. Yesterday Citi, the global banking giant put out a note pointing to the sharp fall in deposit balances in Irish banks.

This explains two things. Firstly the words yesterday from both the Irish Central Bank Governor and the Finance Minister seeking to reassure depositors about the deposit guarantee schemes. Secondly this is the delicate, real story of what is going wrong in the Irish financial sector.

As AIB said today, it has replaced this deposit slump with reliance on central bank funding, basically the European Central Bank. In October this had already surged to €130bn for Irish banking, 25% of all ECB funding for a nation that is less than 2% of the Eurozone economy. That was October, what will it be this month?

That is the parallel with October 2008 or even September 2007 in the UK.

The banks can of course continue ticking along, provided they increase their addiction to central bank money. But the Central Bank in question, in Frankfurt, is clearly, demonstrably, and understandably unhappy.

The answer, as it was in Britain two years ago, is surely recapitalisation. But in creating extra time for their negotiation with the IMF/EU/ECB troika over keeping their fiscal sovereignty and 12.5% corporation tax rate, the Irish government is risking a calamity.