CONCURRENT MEETING OF THE COMMITTEE FOR FINANCE AND PERSONNEL AND COMMITTEE FOR ENTERPRISE, TRADE AND INVESTMENT

JOINT COMMITTEE PAPERS

Banking Focus Group

Banking practice in Northern Ireland in the aftermath of the banking crisis

September 2010

Background

The circumstances which lead to the global banking crisis have been well described and analysed in the financial press and elsewhere over the past three years. The interests of this focus group has not been with the reasons why, but rather the extensive and dire impact that the banking collapse has had on the vast number of small to medium sized businesses in Northern Ireland seeking to survive in what is now accepted by most economic commentators as being the worst recession in living memory.

The banking sector is crucial to the survival of those businesses. Without the provision of credit facilities from banks businesses could not conduct transactions on a scale necessary to sustain financial survival. This would have a devastating social impact on the community as a whole throughout Northern Ireland. Traditionally banks have in turn depended upon those businesses to provide their sustained profitability without which the financial loss to their shareholders in turn would also be devastating over the medium to longer term.

The outcome of the banking collapse has been the hugely reduced level of credit available through the banking system to those businesses. The reasons for this reduction in credit include:-

• Repayment failure on lending made prior to the collapse.
• Pressure from Government, FSA, Bank of England, etc for banks to rebuild balance sheets and create capital buffers to sustain the banking sector in future periods of stress.
• Impending reform to global financial regulation to introduce significant capital increases in capital requirements to above pre-crisis levels and beyond.

It is clear that the right balance must be struck between these measures to restore strength to the banking sector on the one hand and the survival of the underlying businesses essential to the banking sector in the medium to longer term for their own viability on the other.

This focus group came into being due to the extreme concern of the leaders of the four main Churches in Northern Ireland regarding the dire social impact on very many of their parishioners arising from pressures on small to medium sized businesses in particular as a direct consequence of the actions of the banking sector in the aftermath of the banking crisis. In extreme cases, the leaders were aware of fatal outcomes arising apparently from the depths of despair undergone by individuals.

With this latter comment in mind, the Church leaders made their concerns public earlier this year for a sole purpose, to give awareness to those in the community who might be under the most duress hope that change might come about through the involvement of the Churches which would aid them in their plight.

Since the media coverage at that time, the Church leaders have met with the senior representatives of the four main banks i.e. Northern Bank Limited, Bank of Ireland, Ulster Bank Limited and First Trust. The final meetings occurred on 7 th September 2010. The outcome of those meetings is that the Church leaders have undertaken to write to each of the banks who attended, summarising their concerns and inviting a considered response as to what specific actions will be taken by the banks in order to address the issues raised in the meetings and in the correspondence. It is expected this process will complete within the next four weeks.

A summary is set out below of the points made by the Church leaders in the meetings.

Strategic level

Several key strategic issues have been raised in the context of the banks striking the right balance in policy going forward:-

• To what extent should banks allocate their financial resources between retail and investment banking? The fact is banks are directing funds previously allocated to retail to investment banking presumably largely because of the potential for greater return on investment. The danger is this is entirely a financial decision and moral or social factors are not considered when reducing funding for the retail banking sector i.e. short term capital rebuilding and medium term shareholder returns come first and foremost.
• Over what period should banks rebuild their balance sheets? The danger is the pursuit of an “overnight fix” to the above financial objectives will shorten this period and so impact inequitably upon the underlying customers of the bank in the short term.
• Is sectoral quarantining happening? The outcome of the collapse in the property development sector in Northern Ireland has led to a widespread refusal of the banks to increase lending into the construction sector at large and in most cases this extends to an aggressive practice of debt reduction which is proving to be extremely damaging to the extensive number of small to medium sized businesses engaged in construction. All businesses, including those with long histories of prudent financial management, are being “tarred with the one brush”. Working capital is being highly curtailed in this sector by banks reducing working capital facilities leading to knock on impact on other businesses, not just in the construction sector.

The fact is banks currently are driving a highly aggressive pace to rebuild capital strength. It is a fact that banking margins have more than doubled on average over the past two years when compared with the period prior to the banking collapse. Average banking profit over the past three years has been strong, it has been the exceptional costs of bad debt write offs that has given rise to reported losses. These are largely due to the one off write offs associated with the banking write out of bad debt arising from the pre collapse period. The fact is many banks have now moved back to reporting profit, in fact banks in the UK had pre-tax profits of £23 billion in 2009 and with the level of charge and margin uplift, aligned with the underlying low cost of capital from investors, must mean ever stronger profit potential for banks going forward.

The pace of restoration of banking capital value is the primary focus of this focus group. The contention of many in the business community in Northern Ireland is this pace is ruthlessly aggressive and will prove fatal to many sound businesses which may fail if policy cannot be changed through agreement between the banking policy setters, the regulators and Government.

Operational level

The following operational issues have been raised with the banks:-

• There is a culture in line managers that clients in default are “bad people” who are failed business people; approach is often aggressive and without respect.
• Additional funding is practically impossible to obtain
• Blue chip proposals can always be banked, so competition remains rife between the banks
• The group does not advocate more funding for failing businesses, but the problem cases are those “middling businesses” which are not clear performers, but equally are not about to fail, in a climate of credit squeeze there is a tangible limitation of money supply to these clients. A typical scenario could be:-
  1. Strong to very strong security cover. It is worthy of note that the value of this cover is often undermined by the distortions in the property market currently in which many valuations are on a forced sale basis as only those compelled to sell are doing so, often at the behest of the banks themselves i.e. the banks are contributing to an emergency sale market which is in turn spiralling down the value of security they hold, which leads to further penal responses by the banks.
  2. Sustained losses for a period
  3. Client doing everything to minimise costs
  4. But there is a need for more working capital
  5. Possible turnaround beyond 1 year, possibly into second yea
  The point is the bank’s capital should not be at risk if lending is permitted to continue in a planned and coordinated way

• The concept of reasonable and responsible withdrawal/reduction within the concept of treating customers fairly
1. If a loan total accumulated over a period of years, then it will likely also take a similar period of years to reverse
2. Banking elsewhere in current climate is impossible
3. Is it morally right to demand repayment when a bank knows their client cannot go elsewhere and repayment over a short period is impossible?
• Pressure to renew loans from previous lower rate deals into higher rate ones.     
• Significant inflation in facility renewal charges, transaction charges or interest rates from previous levels. It is accepted that the cost of capital in the past in Northern Ireland has arguably been too low and this cost going forward has to reflect the costs to banks of raising finance in the global money markets, however the application of highly penal rates of interest and charges by the banks in troubled cases is incomprehensible particularly when those businesses are seeking to survive and avoid insolvency with the resultant loss to others in the business community. Banks often blame risk for uplift in charges. The fact is the banking crisis in NI has arisen in the main because of local lending to property developers and the outside impact of global investment strategies in banks which have gone wrong; there is a compelling argument that the inherent risks posed by many “middling businesses” in Northern Ireland is no different today than it was 10 – 15 years ago when such penal rates of interest did not apply, the businesses will get through with sustained support from banks for working capital.
• Prolonged deliberation for facility renewal or project approval, at worst the “slow no” scenario. It appears the level of human resource available within the banks to deliver their processes has been cut so severely over the past 5 – 10 years that they are struggling in the current crisis to deliver timely decisions. These cut backs occurred in the aftermath of the various transfers of ownership of banks in Northern Ireland leading to cost cutting from the managerial levels within in order to sustain added value for new bank owners. One retired bank manager has referred to this policy as “dumbing down” delivery process i.e. staffing with lower paid, lesser experienced line managers with all credit decisions being made at senior level.
• Inaccessibility to decision makers. As mentioned above, decisions are now made by credit committees whose members refuse to become known to clients of the bank. The standard process in all banks is to insist on client contact occurring only at the level of those more junior line managers who no longer have adequate lending authority.
• Micro management of the client business affairs. Line managers are now engaged in detailed processes of management of the client’s financial affairs to the extent of daily decisions regarding which creditors may be paid or not. This is placing huge burden on this already over stretched bank resource and creating failures as the money supply fails to circulate from one business to another.
• Insistence upon costly third party reports to facilitate appraisal.  

Summary

It is the view of the focus group that action is needed urgently to address these “bad behaviours” by banks.

The group note several of the banks have very recently launched customer service charters in the national media. These appear high level and aspirational in nature e.g. retention of branches, Saturday opening, etc. This group remains focused on the need for change in bank delivery at operational level for small to medium sized businesses in Northern Ireland where lending decisions remain overbearing and there is a severe need for working capital. Several questions are pertinent:-

1. Is there an objective and transparent code of practice for banks in Northern Ireland?
2. Is there a need for a comprehensive “Treating Customers Fairly” code of practice, as rigorously applied by the FSA to the financial services sector, to be introduced to the banking sector in respect of delivery of routine banking services to its own customers?
3. Is there a need for a Business Banking Ombudsman in Northern Ireland, as is the case in the Republic of Ireland? Banking in the island of Ireland is so integrated nowadays, this would seem to provide strong argument for such an office regardless of the position within GB.