I welcome Mr. Eugene Sheehy, chief executive officer of AIB; Mr. Dan O'Connor, chairman of AIB; and Mr. Robbie Henneberry, managing director of AIB, Republic of Ireland division. I congratulate Mr. O'Connor on his election as chairman, which has raised a few questions, not due to his being appointed but with regard to the executive chairman title.
Interest Premiums: Discussion with AIB.
I question his appointment.
I advise the meeting we will receive a presentation which will be followed by a question and answer session. I advise members, delegates and those in the Visitors' Gallery to switch their mobile phones back on when they leave the meeting.
I draw attention to the fact that members of the committee have absolute privilege but this same privilege does not apply to witnesses appearing before the committee. The committee cannot guarantee any level of privilege to witnesses appearing before it. Further, under the salient rules of the Chair, members should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable.
Mr. Dan O’Connor
Good afternoon. I will hand over to Mr. Sheehy for a detailed presentation about the very specific issue that was raised. A specific question of corporate governance was raised and I will deal with that at the end of the presentation. I will then throw the discussion open to any questions members may have.
Mr. Eugene Sheehy
I thank the Chairman and members of the committee. We will address the specific issue raised in the letter of 11 November.
Lending costs for commercial customers have increased over the course of 2009 for new borrowings and also where there is re-negotiation of existing facilities. This is a fact, and one we address in our presentation. The drivers of the increase relate directly to the increased costs to AIB in funding its loan book both from wholesale money markets and from its customer deposit book. Our pricing guidelines could lead to a customer being charged 4% to 5% over EURIBOR but, it is important to note that EURIBOR no longer represents the cost of funds, a point we will elaborate on in our presentation.
Implementation of NAMA is expected to have a positive effect on the cost of funding for AIB over time. Already, there is evidence that international providers of funds to Ireland have taken a positive view of the NAMA proposal. AIB is very conscious of the needs of businesses in Ireland, in particular SMEs. In this regard, a significant effort has gone into ensuring that the cost increases, to which I have already referred, and their justification are properly explained to customers.
On the drivers for increased costs, AIB funds its balance sheet, including its commercial loan book, through a combination of customer deposits — approximately 50% — and wholesale deposits — approximately 50%. The recent dislocation of the wholesale money market has had a significant impact on the cost to AIB of funding in its loan book. When AIB accesses funding in the wholesale money markets, the cost of raising these funds has risen significantly, particularly through the issuance of bonds. The table in appendix 1 illustrates the scale of this cost increase for AIB in regard to five-year bond issuance. The graph shows the cost moving from less than 20 basis points — in fact, ten basis points — in 2006-07 to 285 basis points in a recent unguaranteed five-year issue we did. There has, therefore, been a very dramatic increase in costs. As can be seen from the next table in the paper, this increase in costs is also being experienced by the Irish Government when raising sovereign debt through the bond issuance programme of the National Treasury Management Agency. AIB is now rated by international credit rating agencies as an A minus, and the price for borrowing by AIB is determined by the market in that context.
The three tables in the presentation broadly address three groups of borrowers in the international markets — banks, governments and corporates. The tables illustrate, in AIB's case, a move from ten basis points to 285 basis points in terms of the five-year bond issue. With regard to the Irish Government, we can see a move from minus 21 basis points to plus 53 basis points, which is very dramatic for a sovereign. Even when we consider some of the household names in the corporate bond issues — companies like British Telecom, Tesco and CRH — we see BT moving from 40 to 145 basis points and CRH from 50 to 170. We are giving this data to illustrate the universal nature of the change in the cost of funding for banks, governments and corporates.
In addition to the increase in the cost of wholesale money, over the past year uneconomic pricing levels have evolved in the deposit market in Ireland as banks have attempted to grow customer account balances to reduce the wholesale funding.
The table supplied shows clearly the reason the banks seek to reduce wholesale funding and this has led to intense competition in the deposit market. To attract and maintain customer deposits, banks are offering customers interest rates that are well above market rates. The tables supplied to members illustrate this by comparing typical AIB deposit interest rates in 2007 against those of 2009. In June 2007, which was the height of the deposit market in Ireland as the SSIAs had just matured, ECB rates were 4% and on average, for good size deposits, the bank was making approximately 30 basis points. There was a margin on deposits. Today, ECB rates are 1% and the bank is losing 102 basis points on its deposits. Consequently, the economics on which banks relied for years in respect of the liability side of their balance sheet have completely inverted. This factor, together with the major change in the wholesale market, is the driver of the increased cost that customers are seeing and that the banks must pass on to customers.
As for addressing these changes, as a result of these changes the cost of the raw material, that is, the funds sourced to provide loans to our business customers has increased significantly. Like any other business, AIB needs to make commercial decisions to maintain its long-term financial strength. Some of these additional costs have been absorbed by the bank and it was necessary to pass on the balance to customers in the form of higher interest rates. Some customers are not experiencing such increases. For example, people who have tracker mortgages have contractual rights to a lower interest rate regime. In February 2009 it was decided to recover some of this cost through the introduction of a new but separately identifiable element of the lending interest rate called a funding premium. This variable informs customers and staff of the level of funding cost attributable to the lending facility. This new variable is reviewed quarterly with the intention that if and when market conditions improve, the funding cost will then reduce and this can be passed back to the customers. There is a degree of safety in the manner in which we are presenting this and are informing customers that were international conditions to change and were deposit prices to change, an opportunity would exist to reduce that funding premium.
In a time of historically low market interest rates in Europe, that is, with the ECB rate at 1%, and given that this is a significant increase in cost to customers, AIB has placed a priority on ensuring that in all customer interactions, the background and nature of this cost can be explained. To achieve this, AIB has conducted a significant training exercise with its staff across the country. As the funding charge increases with longer terms, that is, it will be more expensive to have a five-year term than a one-year term, customers are tending toward an annual pricing review and are charged the lower one-year funding premium in an attempt to minimise the cost. Increasingly, commercial customers do not want longer-term facilities which by definition are more expensive, as is evident from the bond market pricing contained in the other tables supplied to members.
AIB provides a standardised approach to pricing across the network whereby lenders in all branches are fully informed on the pricing to be applied to all individually negotiated facilities. The pricing process involves, in all cases, a meeting between the customer and the local relationship manager to discuss the requirements of the customer and to advise the pricing that the facility will attract. Once terms have been set, the customer receives a written contract which includes details of all elements of the pricing, including the funding premium.
In overall terms for AIB, the pricing of the deposit book tends to be short-term in nature, whereby customers' accounts are re-priced on a regular basis. However the pricing of the loan book is of a contractual nature and repricing occurs over a much longer period. In this situation, AIB carries the price differential, particularly where there is extreme market movement in the short term, as has occurred in the past year. To illustrate how much this has affected the bank's income, in the year to date in 2009, AIB's retail and commercial business in the Republic of Ireland has seen its overall loan margin increase by 7%. In terms of basis points, if the margin had been 100 basis points, it now is 107 basis points. This is not an interest rate of 7% but is a rate of increase in the margin of 7% on the asset or lending side. However, the margin on the deposit has fallen by 70% in the same period. On one side of the balance sheet, the economics are being unravelled while on the other, they are being improved, albeit slowly because of the contractual nature of the manner in which assets as distinct from liabilities perform.
The relevant graph supplied to members illustrates the recent decline in deposit margins in Ireland. It is quite telling and members can see a major drop in deposit margins from spring 2008 onwards. The difference between a bank and a retailer or a garage is that as wholesale prices move in some of those businesses, one can move prices quickly. However, we cannot do that. Our price of raw material moves much faster than our ability to re-price on the other side, which always will be a feature of banking. To take a broader perspective, appendix 2 of the presentation contains some additional statistics. We are using two sources, namely, reports from the European Central Bank and the IMF. While I acknowledge this is not a popular thing to say, the data prove that Ireland is a market with low net interest income, very low fee income and low operating expenses. This has been the case for many years.
In respect of credit risk and bank margin, another key component of our margin relates to the bank's view of the level of risk of default that a customer represents to the bank. The bank's margin will increase in line with the level of customer risk. In recent times, AIB has seen the level of risk associated with many of its commercial customers increase as their businesses have been affected by the downturn in the economy. As a result, some customers who seek new loans or whose existing facilities are out of contract and are being renegotiated, will observe an increase in the bank's margin that relates directly to the increased level of risk relevant to that customer. AIB, like all banks is required under international regulatory capital requirements, that is, the Basel accords, to have extensive risk rating systems to support the calculation of risk into customer margins. On NAMA, given the current economic outlook and as long as AIB's credit rating remains at A minus, liquidity costs are likely to remain a factor in the pricing of loans for the foreseeable future. However, a successful implementation of NAMA is expected to have a positive impact on liquidity costs over time.
I refer to AIB's ongoing commitment to the SME sector in Ireland. Our key focus is on supporting our 170,000 SME customers through the current economic and trading cycle, while seeking to meet their individual financial needs and helping them to overcome their key business challenges. We are doing this in several ways. For example, we are providing more than €15 billion in working capital and investment loan facilities to the SME sector. Between January and October this year, we have approved more than 42,000 facilities for business customers totalling €1.85 billion. We have launched several credit initiatives this year, including the EIB loan fund and our revamped invoice discounting offer. In addition, we will announce shortly details of a new €23 million seed capital fund with Enterprise Ireland.
The EIB loan fund has attracted a great deal of attention. It is a €100 million fund, of which the most up-to-date figures reveal that €14 million has been drawn down, €4 million has been sanctioned and €50 million is under discussion or advanced discussion. In other words, this hopefully constitutes €68 million that is on the way to being drawn down out of a fund of €100 million. The total fund contains €350 million, of which AIB has €100 million. It is at a margin of 2% and no funding premium applies to that business. While heretofore, it primarily has been availed of by the agriculture-related, fishing and hospitality industries, it is available to all SMEs.
We have realigned our business model to support the changing needs of our customers, which included the launch of 15 new business centres nationwide. We are communicating our commitment to the SME market via an extensive communication campaign targeted at SME owners and managers, as well as industry groups, State agencies and key media influencers. We are determined to play a leading role in supporting and enabling the SME agenda. The SME market is key to the recovery of the economy and we recognise our role in helping to achieve this. Our commitment to business customers, including SMEs, remains strong. Where we write lending business, the interest rates we charge will continue to reflect the costs we encounter.
Mr. Dan O’Connor
I will address the governance issue and then throw it open to questions. The past 18 months have seen unprecedented economic turmoil. While some of AIB's problems were due to global issues, we fully accept that many were self-inflicted. Like other financial institutions, AIB became embroiled in the property bubble, which was instrumental in bringing this situation about. Our viability and, more importantly, credibility as an organisation has been damaged.
Unfortunately, I cannot change the past, but I guarantee that I will do everything within my power to ensure that we do not repeat our errors. In recent months, significant time and effort at board level and throughout the bank have been spent ensuring that our preparatory work for NAMA is delivered in a timely and efficient way. The new management team's key objective is to return AIB to profitability and restore its reputation. The team announced last week will have the right combination of internal and external experience and perspective to deliver these objectives.
We owe it to our customers and the taxpayers who have supported us in this difficult period to play a role in revitalising the country and helping the economy to recover as quickly as possible. An executive chairman post is not in keeping with corporate governance best practice and we have no intention of keeping it for longer than necessary. I am taking it on temporarily to help with three specific issues, namely, NAMA, the EU restructuring plan, which will be vital for the bank, and capital raising. The new group MD, Mr. Colm Doherty, will hold day-to-day responsibility for the group's running and for establishing the new management team, parts of which are already in place. For example, Mr. Robbie Henneberry is responsible for the Republic of Ireland, the UK and Poland, but we will shortly be appointing a new finance director and a chief risk officer externally. At board level, the appointment of Dr. Michael Somers as deputy chairman illustrates our determination to assemble a team at board and executive levels with the necessary skills to effect real progress in the months ahead.
Progress will be reviewed regularly at board level. When the work on NAMA and the EU restructuring plan is completed in mid-2010, the managing director, the Minister for Finance, all other stakeholders and I will review the management structure to ensure that the format remains relevant. I expect to return to non-executive status following that review.
AIB has been shaken by recent events, but has a firm base from which to rebuild. It has some great businesses, but we have considerable work to do in the Republic, where we have significant property exposures. Everyone is determined to deliver a better future for the organisation. No one believes it will be easy, but we know it must be done for the sake of our customers, employees and the public, whose support we have an absolute obligation to repay.
I thank Mr. O'Connor. Before moving to the general questions, I wish to ask a question. Does AIB intend to participate in NAMA? Would it need an extraordinary general meeting to make that decision and, if so, when is it likely to be held?
Mr. Dan O’Connor
In recent months, we have been working extensively on preparing for NAMA. We are readying a circular for shareholders that we hope will be distributed imminently. We require a shareholder vote before we can opt into NAMA.
Must a minimum percentage agree or must it only be more than 50%?
Mr. Dan O’Connor
A simple majority.
Other banks require 75%.
Mr. Dan O’Connor
The NPRF cannot vote because it is deemed to be a connected party.
I thank the AIB delegation for its presentation and attendance. I recognise that AIB is undergoing restructuring, but the appointment of an internal person from the risk committee of the old days does not give a general signal that everything is changing. AIB has handicapped its presentation of a clean break, which it claims is important.
I wish to ask about the envisaged restructuring. Many people claim that governments must move away from banks that are too big to fail. The Irish situation in which two banks are dominant is a risk that we must address.
Before Deputy Bruton continues, we must vacate this room at 1.30 p.m. Perhaps we could keep the questions and answers session brief.
I will deal briefly with it, but there is an ongoing concern from the point of view of public policy. As discussed by others, do we need to reconfigure and clearly separate banks' public utility dimensions? In connection with this, what of living wills and so on, dealing with which is not often discussed in Ireland?
What negotiations have been held with the Department of Finance regarding new credit guidelines that might emerge after NAMA is in place? The delegation's presentation is refreshing, in that it seems more realistic and reflective of what we have been seeing on the ground, namely, tough times for small businesses. Does AIB envisage the premium falling away after it gets access to NAMA's funds and the implicit lower cost of funds?
Our guests claim there will be a drawdown on the European Investment Bank, EIB, which is positive, but none of the data supplied regarding SMEs is as informative as the data offered by the Bank of Ireland or as we would like. Is adequate money available to fund SMEs? As with working capital, is AIB's provision up or down? Is it turning working capital away and forcing working capital requirements off overdrafts and onto invoice discounting? Is AIB taking high margins on the new products that will replace the established products? According to what we have been told, these elements are crippling businesses that are already finding the situation difficult.
Bank of Ireland seemed to indicate that it was able to absorb any impact on its lending activity by disposing of overseas assets. What is AIB's ability to shelter lending in the domestic market and focus on the business sector by disposing of assets? It would be catastrophic if viable businesses went to the wall for want of banking. Can AIB create the scope for this?
Mr. Eugene Sheehy
There were a few questions. As to whether our funding premium is likely to reduce, the honest answer is "No", at least in the short term. Central banks, which have supported markets with quantitative easing of various types in the past year, have indicated that they want to start retightening. It would be disingenuous to lead people to believe that the premium will reduce. It could only decrease if there was a dramatic resetting of the deposit market involving a drop in deposit rates to something closer to the ECB rate.
The ECB is at 1.5%. Would this not form a larger proportion of AIB's deposit base, which our guests assert comprises 50% of its funding?
Mr. Eugene Sheehy
No, 50% of our funding is deposit-based, but the deposit book reprices quickly. In this competitive market, customers on lower rates want higher rates. In the past year, there has been a 70% decline in our margin on deposits. The liability or deposit side of banking is over. It may return, but it will put pressure on the asset side while it remains in its current state. People must fund loans with high-priced deposits or high-priced wholesale funds. At this point in the cycle, it is difficult to see how——
Will Mr. Sheehy explain something? Is the underpinning of the asset activity or lending a percentage of ECB money, a percentage of open market money and a percentage of customer deposits? If the ECB proportion rises as a result of NAMA activities, surely the overall average is coming down.
Mr. Eugene Sheehy
The central banks, the banks and the rating agencies want the banks to have less and less reliance on ECB support.
One rate is at 1.5%, the other is that 4.5%.
Mr. Eugene Sheehy
We have a large tracker mortgage population in this economy. The assets one can repo with the ECB are generally mortgages. Only the mortgage book is out by that amount; it does not help the SME book. The question was whether prices would reduce in the short term. We do not think so.
The EIB got off to a slow start because some of the original conditions were onerous. There was a great deal of paperwork required but there has been much improvement following discussions between the banks, Enterprise Ireland and industry associations. That is moving well but it is a small amount. We have exposure of €15 billion to the SME sector and there is €100 million in our EIB pot. It is helpful but it will not change the world.
Regarding pricing of new products, our presentation focused on why rates are going up because we have tried to identify the funding premium. The margins are influenced by the elevated cost. There is no effort to charge customers more, we are passing on the cost. We have much data on SMEs and I ask my colleague, Mr. Henneberry, to provide a flavour of that. I know the Bank of Ireland presentation contained more data than ours.
Mr. Robbie Henneberry
I will address our overall approach in the SME market. I took on the responsibility for the Republic of Ireland business at the end of May. We worked very hard over the first weeks to assemble a new divisional management team for the Republic of Ireland. Some had overseas experience and were brought back to the Republic of Ireland division. Like me, a number of them spent much of their career in the network and have a strong empathy with what is happening with the economy, the strain on personal and business customers and the strain on our staff in trying to cope with the crisis in the economy in recent times.
I will give an idea of the tone we are trying to set in our divisional team. One of the first items of correspondence I sent to our people in June 2009 referred to the importance of the SME business relative to sustainment, recovery and refloating of the economy and how our future closely correlates to this, particularly with the future of the SME business. I stated that we are committed to supporting the SME business customers, that we need to be open for business and that people are empowered to use their discretion to reflect their expertise and experience in lending. I asked the divisional teams to use their discretion and expertise to support our customers through this difficult economic cycle. I told them I had every confidence in their ability to continue in their professional assessment of management of credit. I continued by asking all staff, directly and indirectly involved in supporting customers, to demonstrate real credit leadership in the weeks and months ahead, in prioritising customer engagement with the overarching mandate to agree individual credit strategies for customers impacted that can best accommodate their needs. If we are doubtful about the creditworthiness of a proposal, I told them we should ensure that the proposal is reviewed by a second pair of eyes and on the occasion that we refuse a customer, we should do it honestly and directly, giving clear rationale for our decision and taking personal ownership of the decision. That is the tone I tried to set in the new divisional team since last June. We followed up this week by messaging staff about flood victims and the importance of showing empathy and engaging directly with the SME, farming and consumer sectors that are directly impacted. We sought to offer flexibility and temporary credit facilities to facilitate them nurturing their businesses or houses.
Mr. Sheehy commented on the fact that our exposure to the SME sector is €15 billion. Accusations have been made that we have reduced our exposure to that sector. I brought along the Central Bank statistics covering the period up to September and I can provide the committee with a copy. It shows a contraction in private sector credit in the economy, even from September 2008 to September 2009. The contraction in that period was €7 billion. Our exposure in the same period has increased. In relative terms, we have taken market share in the business market over that period. It is the same in the mortgage market. We have reduced our exposure in personal lending, which is a small market in the overall context. It is a good thing if consumers are using the opportunity of interest levels at historic lows to reduce their debt levels. It is good for the economy and will help the economy to recover in the medium term.
Breaking down the SME figure of €15 billion, €3 billion concerns working capital. That level persisted in 2008. We have given a commitment to retain that level of €3 billion. Some 55% of that figure is being utilised at the moment so there is headroom of 45% on the €3 billion figure. We continue to engage with customers on a daily and weekly basis where there is significant restructuring taking place. There is flexibility on the term of facilities, interest only or some level of moratorium where required.
In the tone we set, we are trying to get our people to make an economic assessment through the cycle of viability of businesses, not just focusing on what is happening in the immediate period. Mr. Sheehy has mentioned our invoice discounting, which supplements this. Several customers have not been able to avail of invoice discounting. We have reduced the level to an average of debt level of €100,000. One of the issues is that suppliers' payment terms have stretched out and the normal consumer invoice discounting has precluded funding invoices over 90 days. We have extended this to 120 days. Under normal criteria, one would expect the business to be profitable but provided we are confident the business is profitable over the economic cycle, we should consider risk as appropriate.
We have also been involved in the social finance fund. Our contribution is 25% and it is doing very good work. The pay down and draw down in local communities and SMEs has been very good. In conjunction with Enterprise Ireland we have an existing seed capital fund of €30 million, which is being added to by €23 million, bringing the total to €53 million. We recognise that we have some way to go in terms of our national coverage of the SME sector. This is particularly true in respect of expertise in some of the emerging areas such as clean technology and IT security. We have set up 15 business centres nationally, with 250 people. They will front up with regard to our overall engagement of the more sizeable SMEs to persist throughout the economy. In addition, we have 200 SMEs specialists in the retail network.
I do not want to cut across Mr. Henneberry but I had specific questions on whether there have been negotiations with the Department of Finance on new guidelines as a result of NAMA. Can we expect AIB to unwind its position elsewhere to protect lending in the Irish market?
Mr. Eugene Sheehy
Discussions are ongoing through the Irish Banking Federation with the Department on ways we can continue to support the SME sector. The Department is anxious to build greater oversight processes, particularly in the post-NAMA world, regarding how the bank is supporting the sector. We do not have any fears about these oversights being put in place as extra criteria because it is a core part of our business. If the SME sector does not do well, we will not do well. There will not be conflict about us embracing new criteria.
With regard to withdrawing from other businesses, we have lending businesses in Poland, the UK, the US, Canada, Australia, the three Baltic countries and Hungary. They all make money other than in the Baltic countries, which are very small businesses but are loss-making. These businesses are funded locally. In some cases, they provide net liquidity to the group overall. Poland has more deposits than loans. The worst thing we could possibly do would be to withdraw support from a market that is helping Ireland because it is providing liquidity for the overall group.
In the UK we have a commitment, particularly in Northern Ireland where we are a high street operation. We do not really see any difference between our customers in Newry and our customers in Dundalk, and so we should not because we have been there since 1825. It is the same approach. We do not see any opportunity to close down a business somewhere and pump extra money into Ireland. Mr. Henneberry's team has no restriction in terms of liquidity. If he has business propositions that meet the criteria, there is no constraint on him.
Mr. Robbie Henneberry
At present, AIB has quite substantial qualifying liquid assets and we could access the markets for additional liquidity. There is absolutely no constraint on the Republic of Ireland business with regard to lending. At present, we open 1,000 accounts a month in the SME sector. Of those, 40% generally do not have any borrowing requirement as they operate on credit. To maintain the same level of funding to the SME sector, there is approximately an 18% pay down on an annual basis into that sector. We would have to lend at a level of 18% just to stand still with regard to the size of our balance sheet.
I welcome the delegation. Reference was made to the collapse of AIB's margins on deposits and it seems to be a critical issue. Does AIB think Anglo Irish Bank is paying too much on deposits and is that distorting competition in the Irish market given that AIB, Anglo Irish Bank and Irish Nationwide are covered institutions and in receipt of significant amounts of Government support?
I accept what Mr Henneberry stated and I know from speaking with business people that AIB is restructuring much of its business models to have what I believe is called relationship management with customers. I understand that, but I want to ask Mr. O'Connor in particular about the future of the bank itself. According to the Minister for Finance, AIB will transfer a target of €24 billion in loans to NAMA and expects to receive €16 billion or €17 billion in NAMA bonds between now and next July.
I will allow a question but not too much discussion.
It relates to the future of the bank. The bank is restructuring its lending side. The more important issue is whether it has a funding side to keep the lending going. What does AIB propose to do with the €16 billion or €17 billion in NAMA bonds? Will it hold on to them and use them at the ECB window or does it envisage selling them on the market? As Mr. O'Connor stated, the ECB is beginning to close the window. It seems that by January or February AIB will need a very large injection of further Government funding to square the circle which he was discussing.
Mr. Eugene Sheehy
Public policy and the taxpayer would be better served if deposit rates were much lower. Virtually all Irish institutions are covered institutions and if the economics of the deposit taking part of their business, which also attracts costs because it is linked to money transmission. By and large, there are no fees for bank accounts in Ireland as 55% of people pay nothing and there are no charges for using ATMs. If the economics of money transmission and deposits are damaged for a long period, it will be very bad for the country.
Does Mr Sheehy see them as damaged?
Mr. Eugene Sheehy
The economics have unravelled not by anybody's design, but because of the international constraint on liquidity. It has happened in other countries also and persisted there. It is not just here. In the longer term, the economics of deposits will have to return to somewhere close to normal and the country would be better off if that happened. However, it is not something in which authorities can interfere because there are covered and non-covered institutions and as long as there is competition and the marketplace is operating, I cannot see a ready-made solution to interfere in that market. It has defied other countries also. Over the past year, we had an example of this in Poland, which had very elevated deposit rates in a market with more deposits than loans. It has taken quite a long time to come down. The country, customers and banks would be better off if the rates were lower overall, and in the long term the risk to the economy would be lower but I cannot see how it can be changed in the short term.
With regard to the funding and what will happen the day after one receives a bond from NAMA, nothing will happen other than that a bond from NAMA will replace the assets one had on one's balance sheet, many of which were earning marginally. However, the quality of the bank's balance sheet will be vastly improved because it will have a bond which is recognised domestically and internationally as a repossessable asset. However, one will not generate any additional liquidity by repossessing it. It is not a supply problem; it is a matter of the banks being able to find risks that are appropriate to the amount of risk they can take with their capital.
At present, how much does AIB have from the ECB?
Mr. Eugene Sheehy
A very low amount, approximately 6% of our balance sheet. Our policy is to maintain it as low as possible. International policy is that commercial banks should be de minimis in their reliance on central banks.
What is it in monetary terms?
Mr. Eugene Sheehy
It is approximately €10 billion. Our business model is not about running to the ECB to get money. It is to raise as much deposits as we can as effectively as we can and fund the wholesale side of the balance sheet as appropriately as we can. That involves taking three or five year term positions. People might think that the day after NAMA the country will be awash with money but that will not happen. The banks' balance sheets will be stronger and that will help them make long-term funding cheaper and there will be a trickle-down effect.
I want to get Mr. Sheehy's view on this. Irish banks owe the ECB approximately €100 billion. The ECB stated it will reduce this. That must affect AIB and other banks. I presume most of it is with Anglo Irish Bank but I do not know the exact composition. Once the ECB starts to do this, AIB will have to go to the deposit market or the international funding markets at very expensive prices.
Mr. Eugene Sheehy
We have a very large pool of qualifying liquid assets. We do not need to run away with the bond to re-finance it. Our funding is well diversified, albeit more expensive than heretofore. I cannot answer for the overall system but I do not think the ECB will be dramatic in retracting support for the markets.
In regard to whether the banks will offer more money to a customer who enters one of our branches the day after NAMA is established, that will not happen. Over time, we have a good prospect of reducing what we referred to in our paper as the funding premium. We deliberately identified this separately because we see it as a new lexicon which we and our customers have to understand. We left it as a cost so that customers can clearly see why it should be variable and demand that it be reduced as funding becomes cheaper.
Is AIB proposing to hold or sell the NAMA bonds?
Mr. Eugene Sheehy
Our funding position, which is strong and diverse at present, will depend on the overall liquidity of the bank.
Mr. Sheehy does not see a need for additional Government funding in the new year.
Mr. Eugene Sheehy
The fact is that we would not be able to repo the assets which are going into NAMA because of their quality and the uncertainty that surrounds them. The big advantage of NAMA is in its removal of uncertainty by replacing the assets with bonds. It thereby strengthens the perception and the reality of the bank's funding position.
I thank Mr. Sheehy and his colleagues for attending. Mr. Sheehy stated that the only assets on the AIB's books that could be subject to repos through the ECB are mortgages. Is the bank restricted to using the funding for mortgages or could it also be used to support SMEs given that it would reduce the overall cost of funding?
The Government has sold NAMA to the public on the basis that the banks would be able to repo Government bonds with the ECB to get funding at 1% which they could lend at a lower cost to small businesses and mortgage holders. Mr. Sheehy is saying quite the opposite, however. I do not believe the public bought into NAMA but that is the basis on which it was sold.
What is the funding premium for business customers at present? Mr. Henneberry stated that his bank agreed to hold to €3 billion in working capital, but he also noted that lending would have to be increased by 18% to retain the existing level of facilities for customers. I do not want to rehash old ground because I have no doubt the witnesses are familiar with Bank of Ireland's submission to the committee. Small businesses are starving. Am I correct in saying that AIB provides just under 50% of business lending to the Irish market?
Mr. Dan O’Connor
Yes.
As the biggest provider of funds for small businesses, AIB plays a critical role in the market. It is not good enough merely to maintain working capital at existing levels. Small business people are seeking our help because their credit facilities have been curtailed or withdrawn. How can they function on a day-to-day basis? The model is simple. If they have sound businesses proposition but are experiencing rough times, they need to be given time to recover.
Assuming that the banks have to adhere to market demands rather than regulations for core tier 1 capital requirements, how much more funding will be needed by AIB to meet a core tier 1 capital ratio of 7% to 8%? Can such funding be found in private markets and how much will the Government be required to contribute?
I mean nothing personal when I raise the issue of changing management in all the banks. I ask Mr. O'Connor the process followed in searching for an external CEO. How many recruitment agencies were employed and were they international? Regardless of the merits of the individuals concerned, the appointments are being made from within the institutions. We need clarity on that issue.
Mr. Eugene Sheehy
The Deputy asked questions on three themes. I will address his questions on the ECB, NAMA and pricing, and Mr. O'Connor will speak about the CEO recruitment process. In regard to the ECB, one can easily repo mortgages and other types of assets.
My question was whether the funding can be used for other purposes.
Mr. Eugene Sheehy
As the Deputy will be aware, the rates charged on Irish mortgages are very low. In addition, a high proportion of mortgages are trackers. That represents a significant bonus to consumers, who are also benefiting from the repo of their assets.
The Irish banking system would be in terrible trouble if not for NAMA because we have a lot of poor quality assets about which considerable uncertainty has arisen.
What is AIB's expected haircut?
Mr. Eugene Sheehy
We accept the Minister's statement that he expects the average to be 30%.
What does Mr. Sheehy expect for AIB?
Mr. Eugene Sheehy
It is too early to say because every loan will be individually assessed. We would not be able to survive without NAMA given the amount of property lending in the system overall. NAMA has had a hugely positive impact in terms of stabilising the system and, in time, helping to reduce funding costs. It is not a panacea, however.
The Minister has stated on numerous occasions that one of the main benefits of NAMA is that it allowed the banks to access the cheapest funding from the ECB. Is Mr. Sheehy telling me that AIB will not avail of that facility?
Mr. Eugene Sheehy
The system has already benefited hugely from NAMA.
I asked a direct question. Will AIB take the NAMA bonds to the ECB to get funding at 1% or will the bonds sit on its balance sheets to earn 1.5% annual interest from the Government?
Mr. Eugene Sheehy
Currently we do not expect any shortage in our ability to meet the lending requirements of our customers.
Mr. Sheehy told me that one of the reasons for higher rates is because the funding requirement for his bank has increased significantly.
Mr. Eugene Sheehy
It is a cost issue, not a volume one. We can get the funds but they cost more.
Why not go to the ECB with the NAMA bonds to get the funds at a reduced cost? When we looked at it, one of the main ideas was to provide a flow of credit. One of the reasons credit is not flowing is the cost to banks and customers. Banks were to function in an environment and pass credit to small and medium-size enterprises, in particular, at a reduced cost. Will AIB not go to the ECB with the NAMA bonds to get funds at 1%?
Mr. Eugene Sheehy
We have adequate funding available to meet the demands of our customers. The NAMA bond will be part of the bank's overall liquidity management position.
It will not go to the ECB.
What will the bank do with them? That is the question I asked as well.
They are being taken on the balance sheet of the banks, with the interest from Government bonds from the taxpayer, but they will not be used with regard to one of the main issues, getting cheap credit flowing again.
Mr. Eugene Sheehy
We want the credit to be as cheap as possible.
Why is the bank not going to the ECB?
Mr. Eugene Sheehy
The NAMA bond will be part of the bank's overall liquidity position. It will help us get money.
Mr. Sheehy is not answering the question.
Will Mr. Sheehy explain that? I asked the similar question of what the bank proposes to do with the NAMA bonds. Will it hold, use or sell them?
From Mr. Sheehy's statement, the bank will effectively sit them on its balance sheet. He is not answering the question. Does AIB intend to go to the ECB with the NAMA bonds to access to funds at 1%? Have the banks discussed the matter with the Minister for Finance? I would love to know his views on what the banks are saying today. This is the bank which is providing over 40% of lending to small and medium-size enterprises in the Irish economy. There is disconnect.
Mr. Eugene Sheehy
I do not see the disconnect. We are exchanging assets with the State for the bond and that bond will improve the funding position of the bank. It will improve our ability to fund money more cheaply.
Why will the bank not go to the ECB?
Mr. Eugene Sheehy
It is one of the options.
Is the witness saying the bank will consider going to the ECB?
Mr. Eugene Sheehy
We will consider everything. The important factor is that removing the uncertainty around these assets improves the overall funding position of both the bank and the country.
Nobody disagrees with that. We are making a very simple point.
Mr. Eugene Sheehy
I accept that point.
Is Mr. Sheehy stating that AIB will look to access funds through the ECB by effectively repoing NAMA bonds?
Mr. Eugene Sheehy
We will use the NAMA bond to improve our overall funding position.
What of the cost of funding implicit in that?
Mr. Eugene Sheehy
If our funding position is better, the cost of funding will be better.
Okay.
Mr. Eugene Sheehy
We have structured our repricing in a way that has a funding premium which is variable. If our funding position improves, that will be passed to the customer.
I am glad to hear that. Will Mr. Sheehy deal with the other issue, the cost of the fund premium, as well as the NAMA matter?
There is a vote in the Dáil so we will have to suspend. Having discussed the matter with the clerk and bearing in mind that we must vacate the room in ten minutes or a quarter of an hour, we might arrange another time to continue the discussion for an hour or two. The clerk will discuss the matter to see if we can get agreement on a time.
Mr. Sheehy may not be back before us. I did not have a chance to come in but I thank him for coming before us today. I hope we get a chance to see him again and I appreciate the input today.
I thank Mr. O'Connor, Mr. Sheehy and Mr. Henneberry for coming before us. It is "for whom the bell tolls" and we have no choice. If Mr. Sheehy will not be back, I thank him for coming. I do not know when he is to vacate his position but I wish him all the best for the future.
The joint committee adjourned at 1.25 p.m. until 11 a.m. on Thursday, 3 December 2009.