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The landscape of the Irish banking market was poised to change beyond recognition as Dublin prepared to sign off on a €35bn rescue package to restore capital and liquidity to the country’s financial institutions.
The bail-out will include an immediate multibillion-euro capital injection as a quick fix for the banks’ tattered balance sheets and extra liquidity measures to ease paralysis in their funding markets.
The recapitalisation will fire the starting shot on a painful restructuring process that is expected to trigger a wave of building society mergers and push every large lender into government hands.
Allied Irish Banks will in effect be nationalised, while the state will also take a majority stake in Bank of Ireland.
The banks have already been forced to make considerable concessions for the state aid they have received during the financial crisis and people close to the latest bail-out talks believe the terms will be even tougher this time.
Both Bank of Ireland and Allied Irish are to be shrunk to a fraction of their former size, while smaller lenders, such as mutually owned EBS, Irish Nationwide Building Society and Irish Life and Permanent, could disappear altogether as they are merged or folded into larger organisations.
Analysts say the key to restoring confidence in the banks is to strip them of the billions of euros of risky loans that are clogging up their balance sheets.
However, people close to the bail-out talks say a big challenge is finding a way to clean up the banks without crystallising large losses, which would renew pressures on their capital levels.
Putting more assets into Nama [the National Asset Management Agency], the vehicle set up to buy toxic commercial assets, could be difficult as loans would be transferred at heavily discounted prices, triggering large upfront losses for the banks. Meanwhile, investors are unlikely to show interest at anything but rock-bottom prices.
One option under discussion is the creation of a giant state-owned bad bank that could sweep up all the institutions’ toxic loans. This would allow the government to take on banks’ remaining risky assets – largely residential mortgages and corporate loans – at book value and write them down over time.
Speculation has focused on whether the banks could force their senior, or most protected, bondholders to take losses as part of any recapitalisation. Cutting their debt would help shrink the banks’ balance sheets. However, the heavy reliance of the sector on government-guaranteed bonds and secured borrowing means that of the €46.2bn of bonds due to be repaid in the next three years by the three largest banks – Bank of Ireland, Allied Irish and Anglo Irish Bank – only 35 per cent is not already tied up in this way.
Bankers have warned too that a so-called “haircut” on senior bondholders, which only usually happens in bankruptcy, would risk upsetting other European banks’ access to the senior debt markets, where they have collectively raised more than €560bn this year.
Another big concern for the Irish authorities is the dramatic reduction of competition likely to come as a result of the bail-out. Bank of Ireland and Allied Irish, the two largest lenders, will be focused on deleveraging, while the wind-down of already nationalised Anglo Irish is expected to be accelerated.
Plans to merge the three smaller lenders – Permanent TSB, the banking arm of Irish Life and Permanent, EBS and Irish Nationwide – are also being discussed.
Two foreign providers – Danske Bank of Denmark and Ulster Bank, which is owned by Royal Bank of Scotland – say they are still committed to Ireland but both have drastically scaled back their lending operations.
With European competition regulators likely to take the axe to the branch networks and existing loan portfolios of the domestic banks, the government may be hoping these foreign banks will step up their activities.
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