As we all know, we are in a difficult economic climate. When the Governor of the Central Bank launched the annual report last week, he indicated that we could expect a fall in gross domestic product this year of some 8.3%, with a cumulative fall for last year, this year and next year of between 13% and 14%. In conjunction with this, employment is falling away and unemployment is rising and we expect the figure to peak at beyond 15% in 2010.
As the Governor of the Central Bank and the Minister for Finance said recently, we need to look at three big areas of economic and financial policy. We need to stabilise the banking system, get our fiscal position back into balance and restore the competitiveness of the economy which has been eroded in recent times. Various measures are in the course of being implemented to enable us to make progress in these three areas.
Since the primary interest of this meeting is in credit developments and the flow of credit to businesses, I will spend some time on that subject. Prior to joining the euro area, our interest rates had been historically high but, after joining, they came down. Both the household and business sectors were, arguably, underborrowed at the time; therefore, there was scope for borrowing to increase. In addition, affordability had improved, given the falling interest rates. In the event, there were rapid increases in credit of the order of 20% or 25% for several years, which most would now accept represented an unsustainable rate of growth. More recently, in the first half of this year, household borrowings, for example, from the banks have declined slightly. The very large increase in credit and indebtedness of both households and the corporate sector suggested, coming into this more difficult period, we could expect some de-leveraging or running down of borrowings. However, a balance must be struck because if it is overdone, it will impinge on demand in the economy which will give rise to further contractions in output that will reverberate on the banks. The bad loan experience could get worse which, in turn, could inhibit the banks from lending. Thus, we want to avoid getting into such a negative downward spiral.
With regard to the current position, over the first five or six months of the year credit outstanding to the household sector has fallen slightly, mostly as a result of a fall in consumer credit. In fact, if one considers non-mortgage borrowing by households, one can see there has been a fair element of net repayment. People are tightening their belts and repaying. With regard to the companies sector, we are talking about broad stability or a modest decline in lending.
With regard to sectoral developments, most of the increase in private credit in recent times, as we know, has gone to the property sector — too much of it, in retrospect. That has been split roughly evenly between residential mortgages and other forms of property lending, that is, construction activity in the commercial, industrial and office sector. While the outstanding amount of total corporate lending has declined in more recent months, the proportion accounted for by property-related lending has remained fairly static.
If we are concerned about the credit situation, we must recognise there are two factors at work, representing both demand and supply. The financial market turmoil we have experienced for some time has impinged on the banks which, as we all know, has led to a challenging funding position for banks across the globe, as well as in Ireland. This has been exacerbated, as members know, by what happened with Lehman Brothers last September. Together with the pressure on their capital positions, this has acted to inhibit banks' capacity to supply credit. As members may know, every quarter the European Central Bank and the national central banks of eurozone members conduct a bank lending survey. In the survey of Irish banks in recent times the banks have reported some tightening of credit standards on their part but also a falling demand for loans from businesses, which is no surprise in the current economic climate.
On the issue of funding, as members may know, total bank deposits have been volatile since Lehman Brothers went bankrupt last autumn. Total deposits with Irish banks in the first five months of the year were down about 8% relative to the same period last year, which reflects the difficult funding position they are facing. Domestic deposits have held up better than non-resident deposits which have been substantially drained from banks based here. There has been an even bigger drain by depositors at overseas branches of Irish banks, which mostly means branches of Irish banks in the United Kingdom, due to the lack of confidence in the Irish banking system. A compensating factor in this regard has been that with the drain in liquidity the banks have had to have greater recourse to the European Central Bank; as members will see from the balance sheet of the Central Bank and commentary in the press, there has been extensive recourse by Irish banks to the Central Bank. The most recent figure showed about €130 billion outstanding. Much of this is in connection with IFSC banks; we are not talking only about Irish banks. However, it shows the scale of the pressure on funding.
The impact of supply and demand factors on outstanding credit growth has been highlighted in the Mazars report commissioned recently by the Department of Finance. The results of that study accord with the picture we have gathered from the statistics for lending reported to us by the banks. The main messages are summarised in the opening statement and I will reiterate them. Total SME, small and medium-sized enterprise, lending has remained static for the past year. The data also indicate that to some extent there has been renegotiation of credit facilities and that, in fact, banks have been pushing out the terms of repayments for some borrowers. We are aware this is taking place in the mortgage sector too and that there are some concessions to be made in this area.
Most SME loan applications are for working capital. It is no surprise but the bank lending surveys reported to us indicate there is very little demand for investment. Businesses are not in expansionary mode and seek credit for working capital purposes or, in some cases, because business revenues are falling away.
The rejection rate of loan applications quoted by SMEs in the Mazars survey is somewhat higher than that reported by the banks. A 24% rejection rate was reported, whereas the banks have indicated they are rejecting only 14% of applications. The Mazars experts explain the difference in terms of the banks' view that some applications are not regarded as full scale, serious applications but rather tentative applications. Let us consider the obverse: the banks report that they approve 86% of applications, but businesses maintain 76% of applications are being accepted. Not surprisingly, the quality of the SME loan book of the banks is declining somewhat and we are all aware of the property aspect.
In broad terms the two main Irish banks conform to the terms of the Government recapitalisation programme on lending to SMEs and first-time borrowers. The committee may recollect the recapitalisation deal was agreed only three or four months ago in February. As part of it the banks agreed to increase their lending to SMEs by 10% a year and stated they would increase mortgage lending to first-time borrowers by approximately 30% a year. These facilities are in place and proceeding and broadly compatible with what they have signed up to.
The final part of the opening statement refers to the interest rate pass-through from the market rates or the official ECB interest rates. Since the first cut or reduction in the ECB interest rates last October the cumulative fall has been 325 basis points or 3.25 percentage points. The actual fall in lending rates to businesses has been more than this. For smaller loans which would include SME type loans, we have ascertained the fall has been approximately 3.4 %. There has been a fall in the case of larger loans to larger businesses of approximately 3.7%. The difference may be put down to a differential degree of risk attaching to SME loans as opposed to large company loans. Initially, the cuts in interest rates on deposits were not pushed back and the perception was the banks, given the liquidity or funding problems, were reluctant to do so. Since January deposit rates have been pushed back somewhat. On the other hand, banks have been constrained in reducing deposit rates further because rates are already quite low. That is a fact.
Let us consider the longer perspective. Over five or six years the net interest margins of the banks have been in secular decline. The real reason is that over time they have become more reliant on wholesale or market-type funding, whereas ten or 15 years ago there was a large number of non-interest bearing current accounts or very low interest retail deposit accounts. A more recent vulnerability of the banks has been due to the fact that during the period in which they expanded loans greatly they were financing this expansion by recourse to market or wholesale funding for which they had to pay more money. As a result, net interest margins have been declining.
In summary, credit flows to businesses and households are broadly flat. New loans are being extended but are more or less offsetting the repayments; therefore, there is no massive change in outstanding loans. Supply and demand factors are at play. The banks are slightly reluctant to increase their lending, given the funding difficulties they have and the increased riskiness of the environment. On the other hand, demand is in no way buoyant, as one would expect. With that summary, we are available to try to answer any questions the committee might have.