What's that rising in the (Y)east?

The Great British Bake-off (GBB) was a celebration of quintessential Britishness; was gripping; elegant and drew a nation together in a crescendo of drama, which climaxed in the final episode, in which somebody won. I wouldn’t know to be honest as I didn’t watch a single second of it, being Irish contrasts somewhat with the quintessential Britishness I described above.

What I have been watching is the other British obsession that is rising like yeast to the East of Ireland. It may not have the same attributes as the GBB but it does or will have all of the drama and will almost certainly end in a climax (probably not a good one). I am talking about the rise of property prices in London; and by extension the UK.

If you are still with me, let me assure you that this will not be another property bubble blog. However the UK property market is a very important aspect of what I will discuss….. and it allowed me create a dramatic opening.

This blog is going to come as a series; I will deal with a number of topics under the same umbrella. By the end of this I hope to have covered, the Irish banking sector, the national debt, the role of Germany in the Eurozone and of course the story in Britain.

The first issue I want to look at is the Irish banking sector.

There are many debates around this sector, specifically regarding how healthy the banks really are - or aren't, as the case may be. Seamus Coffey has taken a detailed look at this on his blog and if you want the detailed number crunching analysis, then you can visit his blog (after reading mine of course) here. For those who chose not to read it let me synopsise.

He says that the current value of loans on the books of the Irish banks is circa 214 billion. This by the way happens to be slightly larger than the Irish national debt, which itself is about 120% of the Irish economy.... a sobering thought. Of these loans about ¼ are loans made to the UK and the rest are loans made in Ireland. Economists have estimated that in a boom such as Ireland experienced it is typical to write off about half of the debt as bad debt. So what does that mean in numbers?

Irish loans are ¾ of 214 billion, which weighs in at 160 billion. Of this approx half will probably never be paid back. So the Irish banks stand to lose in the region of 75-80 billion. As we have already injected 65 billion into the banks - via the government bailout – there is the potential for another 10-15 billion of capital to be provisioned for. Capital by the way is another word for a reserve; a bank needs money to survive as does any business. When I say capital, I mean how much money does the bank have in reserve to pay for any future losses. The government can do some financial trickery to reduce this figure (the 10-15 bn) without actually injecting any more cash. So lets say for now that there is no more capital required, for the next few years at least.

You may wonder why no provision has been made for the UK loans. The reason is that these are largely preforming – getting paid back essentially. At this point one can assume that there will be little or no loss on these...... Watch this space!

So the fact of the matter is that the Irish banks are largely capitalised to a level where they probably can survive. Add to this that the banks are close – or so we are told – to generating a profit again. Therefore one can assume that the, level of capital should right itself over time or, the banks will be able to get any further capital requirements from the markets. Again this is assuming that the status quo remains the same or improves.

But there is a twist in the tail, over the coming year the ECB are going to carry out stress testing of the systematically important banks – banks that can make the whole system go kaput if they go under basically – and as luck would have it, the Irish banks have been included in this assessment. Once the stress tests have taken place, and any capital shortfalls have been identified and dealt with (I’ll come back to this later), the ECB will begin to supervise the banks. This in theory, means that any future bank failures would be paid for by all of Europe and not only the local government. Although this is strongly opposed by the Germans, more on this later.

Seamus Coffey believes that all of the skeletons in the Irish banking closet have been revealed, and does not believe that any further re-capitalisation will be needed following the stress tests.

Of course the best case scenario would be that the status quo gets better, house prices have stabilised and may rise - they already are in Dublin - which may reduce the levels of negative equity, and lead to less of a write down for banks. That in turn would mean less losses and more remaining capital. Banks have also avoided engaging with borrowers to any great extent so far in the crisis, but I feel they will be gradually forced to do so over the coming quarters. By doing so they may be able to work out a payment system where more than 50% is recovered. Some suggestions are that some buyers may be forced to sell and then pay off a pre-agreed amount, which would bring the loss for the bank down to perhaps 35-40%. I am simplifying things somewhat by concentrating only on property - banks of course made loans to consumers, business etc as well - but as this by far makes up the biggest portion of the Irish debt at 117 bn, it is a good barometer for losses.

If we take a more pessimistic look however, there are 2 issues to deal with here.    

1. What if the status quo takes a turn for the worse?

2. Who will pay for any shortfall in capital?

The answers to these questions will be revealed in tomorrow’s blog