JOINT COMMITTEE ON FINANCE, PUBLIC EXPENDITURE AND REFORM debate -
Wednesday, 7 Mar 2012

Non-Financial Corporate Debt: Discussion

Chairman

I welcome, once again, from the Central Bank of Ireland Mr. Joe McNeill, head of statistics division, Mr. Martin O'Brien and Mr. Fergal McCann. I also welcome Mr. Michael Connolly, chief statistician, Central Statistics Office. The format of the meeting is that Mr. McNeill and Mr. Connolly will make opening remarks which will be followed by a question and answer session.

By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence they are to give to the committee. If a witness is directed by it to cease giving evidence on a particular matter and continues to so do, he or she is entitled thereafter only to qualified privilege in respect of his or her evidence. Witnesses are directed that only evidence connected with the subject matter of these proceedings is to be given and asked to respect the parliamentary practice to the effect that, where possible, they do not criticise or make charges against a person or persons or an entity by name or in such a way as to make him, her or it identifiable. Members are reminded of the long-standing parliamentary practice to the effect that they do not comment on, criticise or make charges against a person outside the Houses or an official by name or in such a way as to make him or her identifiable.

Mr. Joe McNeill

I thank the Chairman and members of the joint committee for inviting us to address them on the issue of non-financial corporate debt. As a copy of our opening remarks has been circulated to members, I propose to cover the main points. Our presentation will be split into two parts, in the first part of which the Central Statistics Office will describe the overall structure of the non-financial corporate sector in Ireland, including the multinational enterprises, while in the second the Central Bank of Ireland will deal with borrowings by the non-financial corporate sector from banks in Ireland. Mr. Connolly will make the presentation on behalf of the CSO.

Mr. Michael Connolly

I thank the Chairman and members of the joint committee. To clarify, I am not the chief statistician of the Central Statistics Office. My colleague, Mr. Gerard O'Hanlon, director general of the CSO, is also the chief statistician. I am head of the integration and large cases division in the national accounts department of the CSO. I am involved in the integration of sectoral information and also in dealing with the large multinational cases. I propose to run through the slides that have been distributed to members rather than reading from the text. Would that be acceptable?

Chairman

Of course.

Mr. Michael Connolly

I will deal, first, with the coverage and definitions relating to the non-financial corporations. The range of the companies involved is broad and I would like to be clear on exactly what we are discussing. The companies to which I refer operate in the industrial, construction, distribution and services - excluding financial services - sectors. We are not dealing with companies involved in agriculture or public services or sole traders which are included in the household sector. Members can see on the first slide that I have defined what constitutes small, medium and large.

The second slide relates to the number of active enterprises by size class. Approximately 74% of the total number of enterprises, 60,000, are small, 25%, or 15,000, are of medium size and 1%, or 708, are large. We, therefore, have a very large number of small companies and a very small number of large ones.

The third slide provides details on employment. Members can see that small companies are those which employ fewer than ten employees or between ten and 19 and 20 and 49, respectively. Am I going too fast?

Deputy Olivia Mitchell

I do not have a copy of the slides.

Chairman

They were circulated.

Mr. Michael Connolly

I will try to go more slowly.

Deputy Olivia Mitchell

Does Mr. Connolly have a presentation?

Mr. Michael Connolly

We do, but the technology which would enable us to show it is not available here.

Chairman

Unfortunately, our equipment cannot cope with it.

Mr. Michael Connolly

I was referring to employment, having briefly spoken about the very large number of small enterprises in the country. Small companies employ approximately 23% of people in the sector. The total number employed in the sector is close to 1 million. The quarterly national household survey estimates total employment at approximately 1.8 million. Medium-sized companies employ approximately 378,000 people, while the very small number of large companies employ in the region of 380,000.

The next two slides relate to turnover and gross value added in these corporations. Gross value added is the surplus left after companies have paid for the intermediate inputs in their production processes. It also includes salaries. For both turnover and gross value added, the large companies are responsible for approximately half, or 50%, of output. Medium-sized companies are responsible for 30%, while small companies account for the remainder. In the case of gross value added, the figure for small companies is 17%. The point I am making is that while a large number of the enterprises are small, the employment is dispersed. In the context of the value added contributed to the economy and GDP, it is really the large companies which count.

Deputy Peter Mathews

Do those large companies include the multinational corporations?

Mr. Michael Connolly

Yes. The next slide relates to debt by institutional sector. The context about which we are concerned is institutional sectors and reference has been made to the household and government sectors. The graph I have provided attempts to show the debt levels, as a percentage of GDP, across the four sectors for Ireland and then compares this with the position in other European countries which are involved in programmes with the troika and certain other states, namely, Germany, the United States and the United Kingdom. Members can see that the level of debt, as a percentage of GDP, for both the financial and non-financial sectors here is way in excess of that which obtains in the other countries - programme and non-programme - included in the comparison. It is probably worth pointing out that the other country listed which has a sizeable financial sector is the United Kingdom which, of course, has the city of London. That is the link: the International Financial Services Centre, IFSC, in Ireland and the city of London in the United Kingdom. Non-financial corporations in this country are responsible for 222% of debt in the context of GDP. There are very high debt levels there, too.

Having considered the statistics for debt, I will move to-----

Deputy Peter Mathews

Does the debt to which Mr. Connolly refers include debt owed to non-Irish banks?

Mr. Michael Connolly

Yes.

Chairman

If members have no objection, we will bank the remaining questions until Mr. Connolly has concluded.

Mr. Michael Connolly

As a percentage of GDP, the debt figures are elements on the scoreboard for surveillance of macroeconomic imbalances. In other words, this is the basis for monitoring all EU countries. The agreed levels for private sector debt have a threshold of 160% of GDP. The figure for Ireland is something of the order of 605% of GDP; therefore, members can see that we are well ahead of the threshold. That said, no other country other than Greece is below the threshold for private sector debt. It is a very tough target and many countries will obviously have difficulty meeting it. For the net international investment position, a threshold of 35% of GDP is set. Members are well familiar with the position on government debt and the figure of 60% set down in the Maastricht treaty criteria.

Deputy Olivia Mitchell

Will Mr. Connolly repeat what he just said?

Deputy Peter Mathews

The target for government debt is 60%.

Deputy Olivia Mitchell

Mr. Connolly referred to Greece.

Mr. Michael Connolly

Yes. I mentioned three of the items on the scoreboard. There are about 11 such items in total. I have referred to three because they are tied up with debt levels. I have stated that in the context of private sector debt, the threshold is 160% of GDP. The combined figure should not be any higher than this. I have observed that for all the countries included in the comparison, those experiencing some difficulty and other such as the United States, Germany and so on, are all above that level.

Deputy Richard Boyd Barrett

Is that the threshold recommended by-----

Deputy Peter Mathews

It is recommended by the economists at the Bank of International Settlements.

Mr. Michael Connolly

No, by the European Union. This is an EU-based scorecard. The six pack, as it is referred to, is a legislative framework that will bring into play fines and controls for countries which deviate from the thresholds. As well as considering one period, it is also a case of examining how things are changing over periods also.

Given that I have illustrated the scale of debt in these sectors, I want to broaden matters out a little with the next slide in order to consider the gross assets and liabilities by sector. The slide shows that while the gross figures are extremely large, in effect, the assets and liabilities almost balance each other. That is an important feature of the data. When we consider the banks, we can see that, in the context of assets and liabilities, there is an imbalance of €4 billion in gross positions of €3.6 trillion. These are ginormous numbers, yet the balance is very fine.

When we consider the household sector, we see that there is a surplus of €117 billion of assets over liabilities. There is a deficit of €78 billion in the government sector. The figures for the four domestic sectors compare with the position for the rest of the world. In other words, to the extent to which Ireland has a deficit - a net asset or liability position - it is mirrored by the rest of the world. There are similarly large figures for the rest of the world and we have a net international investment position, IIP, of minus €158 billion. That is approximately 100% of GDP.

The next slide illustrates the importance of the IFSC in these numbers. It indicates that when we consider the gross external debt of Ireland, the IFSC explains 75% of this. All the time I am trying to underline the international context of these numbers and how much they relate to the international economy, not necessarily the real economy of Ireland. That is what I am trying to illustrate. I have given a chart of the non-financial corporate debt against which I charted GDP. What we see is that after 2007 GDP fell off. This is a current price measure but it is still falling off and flat-lining after 2009. This is the way our discussions go at our quarterly press releases of how the macro-economy is developing, but when we look at the levels of debt for these corporations, we see that they are still rising and doing so substantially. That is evidence of a two-speed economy. There are international financial services - aircraft leasing companies are included in that - and we have multinational corporations that are expanding their activities continuously. They are taking on additional debt all the time. That is why we have a duality in a sense with GDP going down yet the international side of the economy is going up. That does not imply that the domestic companies in the grouping are doing well.

I wished to compare the assets and liabilities under the category of loans for those companies. All that shows is that the companies have substantial loan assets, deposits and debt securities assets. When we net the two off we see a more meaningful position for the net debt of this group at approximately minus €100 billion, as opposed to the €340 billion mentioned earlier.

In the last slide of the presentation I wished to illustrate who is lending to those corporations. That is what is of interest. We referred to the numbers increasing dramatically after 2008. What we see is that the treasury companies in the IFSC are lending substantial amounts of money to their affiliates in the non-financial corporate area. They are managing the international cash management for the multinationals. The lending by the treasury companies to multinationals in this country is increasing each year, certainly after 2008. We also find that they are lending to each other. I refer to affiliate lending between affiliates in the same corporate group. We then also see that borrowing from abroad, which is listed on the top bars in the chart, is increasing too.

Deputy Richard Boyd Barrett

What does ROW stand for?

Mr. Michael Connolly

Rest of the world. The top bars relate to borrowing from the rest of the world. We have increases in that area, from the treasury affiliates and from other multinational companies that are in the same sector.

Deputy Richard Boyd Barrett

I am sorry, but what was NFC?

Mr. Michael Connolly

Non-financial corporations. That is really what we are talking about in this context. When we look at bank borrowing, we see that borrowing from banks has been decreasing since 2008. That is all I have to say. I am just trying to provide context and to shed light on the big macro numbers that come out for this sector. We have also produced a survey on access to credit. We can talk about that if required.

Deputy Olivia Mitchell

Could Mr. Connolly tell us what is his message? What should we be worried about? What is he telling us?

Mr. Michael Connolly

What I am telling the committee is that when one looks at the detail of the overall scale of debt for this sector, it is nowhere near as serious for the real economy of this country as one might imply at first sight. When one looks at the detail, it is really about a globalised, internationalised economy which has very large debt but also has very large assets. The two are off-setting one another when we take a net view on it. Of increasing importance is the interlinkage between some of the multinational corporations we have in the sector and their treasury affiliates in the financial sector. It is difficult to look at numbers in isolation because everything is intertwined.

Mr. Joe McNeill

As Mr. Connolly has said, the Irish economy is a complex structure. We have large multinationals, the macro picture, where the economy is dominated by multinationals in the Irish financial services sector. When we were invited to make the presentation we agreed that we would take a two-track approach. We would try to give a broad overview, which includes the large multinationals in the overall economy, but our focus is more from a micro level; it is really lending by the Irish banks to non-financial corporates in the economy.

We have a separate set of slides which I hope have been distributed. As we said at our household presentation a few weeks ago, the data we compile are compiled according to international standards. They are compiled as part of our monetary aggregates for the ECB. Basically, they cover lending by banks licensed to operate in the State lending to non-financial corporations. Bank lending is much more important for indigenous firms, as large multinationals - as Mr. Connolly said - have access to other sources of funding through capital markets and international treasuries due to their sheer size and influence.

The first slide we presented shows that credit by the banks resident in this country fell from €171.3 billion in August 2008 to €87.7 billion at the end of January 2012. That is a huge fall but it is significantly impacted by transfers to NAMA and other non-transaction effects such as write-down of loans. The underlying fall, based on transactions only, is 6.2% per annum from the peak. Annual rates of growth on transactions peaked at 37.1% in July 2006. That is year-on-year growth and it has been falling since. That is in sharp contrast to the euro area where growth peaked at 14.9%, fell to minus 2.4% on an annual basis and is back in positive territory since 2010.

The following slide looks at a maturity breakdown of the loans to Irish non-financial corporates. There is quite an interesting picture here as the trends are different for different maturity products. Longer maturity loans for Irish non-financial corporates grew more rapidly than for the euro area before the crisis and have fallen much more sharply since the crisis, with annual contraction falling to 13.4% by February 2010, before moderating. The latest year-on-year data show little change. I believe it is up until January 2012. In contrast, shorter loans, that is loans up to one year maturity, including overdraft facilities, followed a much different path and have generally been above the euro area levels and in positive territory. This message would seem to indicate the importance of short-term funding to Irish non-financial corporates, most likely for working capital purposes. The sharp fall in longer term funding, which is normally associated with investment-type expenditure, shows that this type of activity by the multinationals remains weak.

The next slide shows the cost of credit. This shows a similar pattern for both short-term and longer term loans when we compare Irish and euro area figures. Irish rates were higher before the crisis and they were lower after the crisis. Both rates have converged in recent months. Irish rates have declined more than for the euro area since the crisis, in particular for short-term loans.

We also have data for lending by sector of economic activity. Mr. Connolly referred to definitions. By economic activity we go beyond the multinational corporates. This is based on enterprises. "Enterprise" includes sole traders and others. It is defined by functional category. The data show the dominance of lending to construction-type activities, which peaked at 66% of all lending to non-financial corporates in mid-2009 and still represents 60% in the latest data.

The bank has also recently started collecting data on lending to small and medium-sized enterprises, including gross new lending by quarter. This gross new lending excludes restructures or renegotiations, so it is effectively new lending that was not principal outstanding in the previous quarter or the previous return. It is noticeable that in the year up to Q3 2011, the last year for which we have data, that construction still accounts for the largest component of new lending, with agriculture next in line. However, the most noteworthy feature in the chart is that year-on-year growth for all of the sectors we have listed in the chart is negative, which means in reality that repayments are outstripping new loans.

Our last slide shows interest rates paid-----

Senator Thomas Byrne

Will Mr. McNeill explain each row on lending to Irish small and medium businesses? I am not clear on it.

Mr. Joe McNeill

The 11 September figure is the stock amount, as a percentage of total credit - the amount outstanding on the books of the bank in terms of total non-financial corporate lending.

In terms of the annual net flow, in the statistics we find that flows are a much more meaningful way of looking at the data. Effectively, they are transactions during a period. If, say, there are 100 repayments and 50 items of new lending, the flow for the period is minus 50. That is the annual percentage change. It is the year on year difference in percentage terms.

Annual new lending is the volume of new lending by the banks, as distinct from renegotiations and restructures. I should have used the words "drawn down"; that is an important point.

Senator Thomas Byrne

Does Mr. McNeill have figures for approvals?

Mr. Joe McNeill

No, we do not have them. We collect information on what is on the balance sheet of the banks at a point in time.

The last slide shows the interest rates for new non-financial corporate, NFC, loans by size of loan. We do not collect data for the interest rates for small and medium enterprises directly, but we do collect data for loans up to and over €1 million. This size criterion is a good proxy for the rates charged to SMEs. Our data show that rates charged to Irish NFCs, for loans up to and over €1 million, are higher than in the euro area as a whole, as the graph clearly illustrates. That is in line with research presented by Central Bank economists at a conference we held last Friday in which Mr. McCann was involved.

Chairman

Mr. McNeill referred to the part over-reliance on short-term funds in Irish SMEs and said that that appeared to be the pattern. He is concluding that this is striking. It appears to be significant.

Mr. Joe McNeill

If the Chairman looks at the chart, we are saying there is a very different trend for longer and shorter term loans. We are saying that if one is borrowing for investment purposes etc., it is more likely to be a longer maturity loan, whereas this means Irish banks are more reliant on short-term funding, including overdraft facilities, etc., which may mean they are largely funding working or day to day capital. That is the conclusion we draw.

Chairman

Is there any way of distinguishing between push and pull factors? Is it that Irish NFCs are not seeking such funding or, if they are, they are not getting it? Which is it? Mr. McNeill has presented it as being their preference, although he does not use that word, but it is suggested what he has discovered is that is their preference for the shorter term funding. Do the figures allow us to establish whether they sought longer term funding but could not get it?

Mr. Joe McNeill

The data would not tell us that. I am aware Mazars carried out a survey recently. Mr. O'Brien might know if it dealt with the issue of maturity, but I do not think it did.

Mr. Martin O’Brien

The Mazars survey asked about the purpose for which the loan had been sought, but it was focused on SMEs, not NFCs in total. The results were that most firms asking for credit wanted it for working capital purposes.

On the Chairman's question, there are demand and supply issues that when they come together, they result in the aggregate developments presented in the chart. There is nothing in the aggregate data that will allow us to disentangle the information necessarily, but looking at the longer term loans, the development of investments, on which Mr. Connolly would have information to hand, as a share of economic output, etc., collapsed from 2008 onwards. That feeds into the developments one sees on the long-term loans side.

Mr. Joe McNeill

The data are collected as they appear on the balance sheet at a point in time. There are changes to particular maturity categories, but we do not have data on the demand side - applications for loan approvals, etc.

Chairman

I take it that international comparisons are possible. The figure that always appears to be extraordinary - Mr. McNeill touched on it - is the proportion of all credit related to construction or construction related activities during the period of the boom. I presume it is possible to compare these figures like with like in other countries.

Mr. Joe McNeill

We do not have the data with us-----

Chairman

I did not think Mr. McNeill would have it.

Mr. Joe McNeill

-----but we can look at what is available and supply it to the committee.

Senator Thomas Byrne

We are being given fascinating information and it is hoped the new information will lead to some changes at policy level. Am I right in saying 30% of all new lending is related to construction and real estate? There is a figure of €984 million in new lending for construction and real estate. Does Mr. McNeill know off-hand the percentage to which this equates in the economy? I presume it is significantly lower at this stage.

Mr. Joe McNeill

We can give the Senator the figure for total lending. It is €984 million over-----

Senator Thomas Byrne

I am referring to the figure of 30%.

Mr. Joe McNeill

It is actually more than that.

Senator Thomas Byrne

I am referring to the figure of €3,346 million.

Mr. Joe McNeill

A total of 59.7% is related to construction.

Senator Thomas Byrne

Yes.

Mr. Joe McNeill

The total amount outstanding is still in the region of €35 billion. It is the top figure indicated.

Senator Thomas Byrne

New lending activity is dominated by construction.

Mr. Joe McNeill

It is dominated by construction related activities, yes.

Senator Thomas Byrne

That is extraordinary because in any of the surveys carried out the construction sector appears to be the one lagging behind the rest of the economy, yet it seems the banks are lending disproportionately to that sector. I wish those involved in the industry all the best, but am I missing something?

Mr. Joe McNeill

There are a couple of interesting features, one of which could be interest roll-overs, etc. which are being capitalised. That represents new financing. There are many ongoing projects, but interest roll-overs-----

Senator Thomas Byrne

Some of it is rolled over?

Mr. Joe McNeill

Yes, some of it would be.

Senator Thomas Byrne

How is Mr. McNeill able to classify it as new lending?

Mr. Martin O’Brien

In this context, new lending is any increase in the principal amount outstanding to the borrower. If interest is being capitalised by the bank, that increases the principal amount the borrower must repay. This relates to the principal amount outstanding to the borrower. It is not necessarily the case that the cash is physically changing hands in terms of a builder going into his or her local branch and getting the money over the counter. In their account they are seeing that what was classified as interest being incorporated into the principal amount outstanding. It is extending the availability of funds to the borrower.

Senator Thomas Byrne

Therefore, what Mr. O'Brien describes as new lending includes old lending and old charges on it.

Mr. Martin O’Brien

Yes.

Senator Thomas Byrne

Therefore, it is not new lending.

Mr. Martin O’Brien

It is from the perspective of the bank's balance sheet. It is increasing the funding available to the borrower.

Senator Thomas Byrne

I had understood from the presentation that this was money the banks were giving out, but it turns out that that is not the case.

Mr. Martin O’Brien

It is making funds available to the borrower. That is the context in which it is considered to be new lending; it is increasing the principal amount on the bank's balance sheet.

Chairman

Is it possible, given the information provided, to strip out the material about Senator Thomas Byrne is talking? The point he is making is that it is old money; old lending.

Senator Thomas Byrne

It does not represent real economic activity.

Chairman

Can it be stripped out? Is it possible to obtain figures for genuine new lending?

Mr. Michael Connolly

One could consider examining the figures for capital formation or investment in the macro-economic statistics. That would give one the figure for new investment which, by definition, must be funded in some way. That is one way of looking at it.

Mr. Joe McNeill

It is possible to do so. However, one must bear in mind a big problem that we face. New lending is a very difficult concept and renegotiation, restructuring and the rolling over of existing facilities must be considered. We tried to collect the data by taking the principal amount outstanding at a particular end period and determining the changes in that figure from period to period. I take the point that if there is a roll-over of interest that is capitalised, it does not constitute what we might call actual new lending to the economy. We could try to determine whether we could make estimates, but our new lending figure is defined as a change in the principal amount outstanding from period to period.

Senator Thomas Byrne

I accept what the delegates are saying statistically, but in holding the Government and the banking sector to account in terms of their obligations and promises - sums of €3 billion were referred to in respect of Bank of Ireland and the AIB - the information is not very helpful. Is it helpful? Can it be explained better?

Mr. Martin O’Brien

This information is not designed to hold the Government or the banks to account in whatever target is set. That job is being done by Mr. Trethowan in the Credit Review Office. This is not fresh cash being handed over by a bank to builders. Taken in the context of the existing stock of credits for construction and real estate activity, the amount is very small. Based on some of the results of Mr. McCann and other colleagues who presented work on Friday and on which Mr. McCann might like to elaborate, one can see that in reorienting the flows of new lending the sectors that are performing relatively well in the wider economy by comparison with others such as the agriculture sector are the ones in which there is new lending. This contrasts with what these sectors received in the past by comparison with the construction and real estate sectors.

Senator Thomas Byrne

Does Mr. Trethowan have the appropriate information? We have plenty of information from the banks and press releases on how much new lending there is. When I see the figures which make me both delighted and concerned about construction, I discover the results are not as I interpreted them initially. I am not criticising the delegation, I am just trying to obtain information. Does anybody have the information on new lending promised by the Government and the banks and which the people expect, given all the money they have put into the banks?

Mr. Joe McNeill

One of the big problem is presented by definitions, on which one must be very clear. If someone needs new money for working capital purposes and a loan is rolled over or a debt is restructured, this essentially constitutes new lending for the business. The Credit Review Office includes sanctions in regard to the renewal of lending facilities. What we are collecting is information on a change in the balance sheet pertaining to the principal from period to period. What the Senator is asking for involves a narrower concept that would remove capital or interest roll-overs. We can, however, try to obtain an estimate. Having said that, if somebody needs funding for working capital purposes and agrees to restructure, that constitutes new lending in his or her book. It is a question of defining exactly what is required and providing the appropriate data.

Senator Thomas Byrne

I would like to make one further point which is really just an observation. The interest rates applicable to new businesses in Ireland are higher than those elsewhere in the eurozone area. In fact, they are significantly higher, in the order of one percentage point or more. What is the reason for this? Is it the roll-over? Are the delegates aware of the reasons Irish banks are charging more? We all know why they have higher costs, but banking sectors throughout Europe have had to restructure.

Mr. Martin O’Brien

There has not been any such analysis in recent times. We brought to the attention of the committee a paper on variable rate mortgages that colleagues in the bank had analysed. This raised the funding costs issue the Senator rightly mentioned. In previous analyses from a number of years ago of the more structural issues that determined the reasons interest rates in Ireland were as they were relative to those charged elsewhere in Europe, general issues such as bank competition and other such structural issues emerged. In general, there are fewer banks operating in Ireland than in Germany, for example. Structural issues potentially have an effect, although I am not sure about the extent to which they result in the difference referred to by the Senator.

There are potentially some definitional issues in product categories. The last time we were present Deputy Mathews made the valid point that the use of credit card facilities was an alien concept in Germany. We consider their use common in Ireland. We try to harmonise the products offered in various member states as much as possible, but there remain residual issues that can lead to differences. Apart from the wider funding cost circumstances, the more embedded structural issues may well be having an effect.

Mr. Joe McNeill

One other important point is that the volumes of new business have been very small in recent times.

Deputy Pearse Doherty

I thank the delegation for its presentation which, with the charts provided, was very interesting. I want to pick up on a couple of points, particularly based on graph 6. My first point is on lending to SMEs, in regard to which I am trying to get my head around the facts. The statistics pertain to the period from the third quarter of 2010 to 2011. Does the delegation have the total figure for new lending committed to in 2011?

Mr. Joe McNeill

We will have the figures shortly. We have not published the fourth quarter data as yet, but will have them within the next two to three weeks.

Deputy Pearse Doherty

The annual figure is from the third quarter of 2010.

Mr. Joe McNeill

Yes.

Deputy Pearse Doherty

Accounting for the period from the start of the year to the end of the year, does Mr. McNeill expect the overall figure will have increased, decreased or remained roughly the same? Was there a considerable increase in lending in the last quarter?

Mr. Joe McNeill

It is hard to say definitively, but I would not expect much change. However, we will not know until we process the data. I would be surprised if there was a major change.

Deputy Pearse Doherty

That is based on examining the trends. Which banks are we covering in terms of lending to SMEs?

Mr. Joe McNeill

We are covering all the banks resident in Ireland. We collect monetary statistics which cover every bank with a licence to operate in the Republic of Ireland. Obviously, all banks do not lend to SMEs. There are different structures, but we cover all banks.

Deputy Pearse Doherty

Roughly how many banks are covered by the figures?

Mr. Martin O’Brien

Of the almost 80 banks licensed in Ireland, approximately 15 to 20 are operational in the SME space.

Deputy Pearse Doherty

What proportion of the moneys committed to SMEs is attributable to Allied Irish Banks and Bank of Ireland?

Mr. Martin O’Brien

I cannot actually say. I am not at liberty to give the figures for specific banks, given the nature of the data involved. However, they would be significant.

Mr. Joe McNeill

Very strict confidentiality criteria apply to our statistics. We cannot comment on fewer than three entities.

Deputy Pearse Doherty

The reason I am asking is that I have looked at the Government report card published today. It states the restructuring of the banks has allowed adequate provision to be made for SMEs. It is stated that in 2011 Allied Irish Banks and Bank of Ireland met the required targets and sanctioned €3 billion in lending to SMEs. The figures before us show the total sanctioned by the 18 banks as being roughly €3.3 billion, with one third devoted to construction. We have heard that a lot of this money was not associated with what we would regard as new lending. Based on this, Allied Irish Banks and Bank of Ireland would have to have lent well over 90% of all the money made available to SMEs if the Government statistics are to be believed.

Mr. Joe McNeill

As Mr. O'Brien said, we cannot compare the figures directly because there are very significant differences in the definitions used. As stated, the figures included for the purposes of achieving the target cover sanctions, renegotiations and restructuring. We collected this for a specific purpose because we thought that it was important to know what was actual new lending, if I can use that term, or changes in principle from quarter to quarter. We cannot compare both sets of figures directly because the definition, for the purposes of the targets, is much broader than the definition we apply here.

Deputy Pearse Doherty

Is there no way to have an idea? It is really important for us as policy makers to know what is going out to the economy. It is nice to know that the banks are sanctioning money, but the drawdown is more important. That is why it is important to know where the pillar banks are this year, but I understand if Mr. McNeill cannot provide that information because it is reduced to two banks.

I also have a question on the non-financial debt. The table is quite startling.

Mr. Michael Connolly

Which table?

Deputy Pearse Doherty

Table 7, which shows that we are nearly up at 700% when one combines everything. I understand Mr. McNeill's point that this is backed up with assets and the table must be read in conjunction with the assets. As regards personal and household debt, we know that a lot of loans are not performing. Do we have any information regarding non-financial corporate debt? From the figures provided, we know the scale of the debt, which is quite startling, and we see it is backed up by assets. However, in terms of the performance of those loans, is there any indication what proportion or value of it is non-performing?

Mr. Michael Connolly

From our CSO data, there is no indication that these assets are impaired. We are saying that the internationalised debt is performing. There is no indication at all that we need to reconsider the valuation of it, unlike the domestic situation which is quite different.

Mr. Fergal McCann

We have separate work at the Central Bank, which came from last year's recapitalisation and stress-testing of the banks. We had access to data, loan by loan, for SME lending in Ireland, including hundreds of thousands of loans. We recently published that work, which was presented last Friday. The share of loans in default from that whole SME segment was 12%, with another 18% on a watchlist or past due in arrears. As of December 2010, some 30% of all domestic loans in the Republic were in trouble, either past due or in default.

Deputy Pearse Doherty

Has the Central Bank seen a trend from that information and, if so, is it more or less concerned about that tranche of loans at this stage?

Mr. Fergal McCann

Does Deputy Doherty mean relative to 2010?

Deputy Pearse Doherty

Yes.

Mr. Fergal McCann

The December 2011 data drop is happening at the moment, so that information will be released over the summer. Offhand it would be difficult to speculate, but the domestic economy has not performed particularly strongly in 2011. There is, therefore, no reason to believe it would have hugely improved, but I could not say for sure.

Mr. Joe McNeill

The chart presented by Mr. Connolly covers all that, including non-national and treasuries. Mr. McCann is talking specifically about the Irish banks.

Mr. Fergal McCann

Yes, specifically the two pillar banks.

Deputy Pearse Doherty

I have a question on interest rates that are being charged to SMEs by the banks. The graph shows they are high compared with European averages. We can conclude from the previous discussion that the pillar banks are the major lenders to SMEs in the Irish economy. The CSO collects data and presents them. The Central Bank talks about competition but, given the amount of recapitalisation the pillar banks have been subject to over the past year to 18 months, has any analysis been done on why these rates are not being reduced? Earlier on in private session, I mentioned a lobby I received concerning a person from Permanent TSB business being charged a 6.25% variable interest rate. Despite the fact that the ECB has continuously dropped its interest rates, these have not been passed on. Has any analysis been done by the Central Bank of the impact on the banks' books of not passing on the ECB's reduction, like Permanent TSB, for example? I understand that every time the ECB cuts its interest rate and the bank refuses to pass it on, the bank makes a profit as a result, or is in a better financial position than before. Has any analysis been done on that? There used to be talk about the powers that were required to try to bring this into line, so has there been any further discussion on that?

Mr. Fergal McCann

No work has been done on SME interest rates in particular, as of yet. It is something that is on the agenda. As Mr. O'Brien said, the only paper we have that looks at price setting is the one on standard variable rates. The main issue that came up was that of funding costs, which is a causal factor in the lack of competition.

Mr. Martin O’Brien

That concerned funding costs on variable rate mortgage payments. In terms of the general condition or performance of the underlying loan book, if there were significant levels of arrears, there were typically higher interest rates prevailing on that loan book. Issues like that would potentially feed into the kind of interest rate structures we are seeing here. As Mr. McCann said, however, they have not yet been examined systematically.

Deputy Pearse Doherty

One of the questions that is asked of me by business people, not just those connected with SMEs but also those who have loans with the likes of Permanent TSB - I am using it as an example - is that we have had the stress tests and have seen the performance of their loan books. There was a commitment to recapitalise the banks and they have been recapitalised, bar Irish Life and Permanent whose recapitalisation will be completed in June. They have all been brought up to the base in terms of capital requirement to cover losses. However, that State owned bank, in comparison with the other State owned bank, AIB, is charging a huge difference in terms of its variable costs. I can understand if Mr. McNeill is talking about the non-performance of the loan book, but the recapitalisation has dealt with the losses that would be incurred by that. Therefore, have we not created an equal playing field both for AIB and Permanent TSB, because they are recapitalised to a level that takes the losses into account? People do not understand why they are still applying two significantly different variable interest rates.

Mr. Joe McNeill

That is a fair point, but the Central Bank collates and compiles data. I think I made it clear the last day that we are not policy people. We are very much moving into the policy field now, so I think other people are better qualified to tease out policy issues than we are. Having said that, however, there is a clear difference between the new business loans in the last chart. If we go back to one of the earlier charts, it shows that when one looks at the average wait on the outstanding amounts, they are not that different for Ireland and the rest of the euro area. That shows how small the volume of new lending is. It is not impacting hugely on outstanding amounts. That is one point that is worth making. We collect, analyse and compile the data, but we are not qualified to get into the policy issues.

Deputy Pearse Doherty

It was worth a try.

Chairman

Are there any further questions?

Senator Thomas Byrne

I would like to make a point to which Deputy Doherty has alluded. We have had commitments to and promises by the Government and the pillar banks of approvals of €6 billion. I think the figure is €3 billion for each. That is an important distinction because the Government is promising sanctions. If the figure of €6 billion in sanctions between both banks is correct, about half of that is being drawn down, including roll-overs. Some €3.3 billion has been drawn down in new lending, which includes roll-overs and interest put onto capital. It is not all new lending. There is a significant discrepancy between the perception as to what the banks are supposed to be doing and what is happening in practice. In practice, the banks are lending only a small percentage of the headline figure which they and the Government claim. It would be worth getting the exact information from the Central Bank or the Central Statistics Office on lending by the two pillar banks. I accept confidentiality and all of that but not so much when it comes to Bank of Ireland and AIB which we have bailed out. We need to know as much as possible about them to hold them to account in the best way we can. We need to know the exact figures so we can ask what are they doing. The economy is badly stuck for investment. It seems promises and commitments have been made that do not measure up.

Chairman

These are very legitimate political questions but ones we cannot ask the delegation.

Senator Thomas Byrne

I am encouraging the gentlemen before us and their colleagues to get the information that will allow us to make the choices.

Mr. Joe McNeill

We made the point that it is changes in the principal figure from period to period, renegotiations and restructuring which are not included in our figures but are included in the targets. The same goes for sanctions. We do not have the data to hand but it could be quite significant.

Deputy Peter Mathews

I commend the delegation on this new direction in getting statistics in management information form which is on time, relevant and allows policy decisions to follow.

The aggregate figure for non-financial business debt from the Irish-owned institutions is approximately €160 billion. In the non-Irish owned institutions, such as Ulster Bank, NIB, ACC and KBC, the figure comes to another €100 billion. We need to get the feel of the relationship between debt overhang in the non-FDI, MNCs, non-foreign direct investment, multinational corporations. Some MNCs are Irish-owned which hold their moneys and profits in Ireland. The FDI ones create the blur between the gross domestic product, GDP, and gross national product, GNP.

We all know that household debt and business debt is crushing us at the moment. One of the pillar banks, AIB, is talking about new mortgages in the region of 4,000 a year whereas 30,000 plus existing customers are creased along with small and medium-sized enterprises, SMEs. SMEs employ 1.3 million people while the MNCs, both Irish and foreign-owned, employ only 130,000 people. We need to cut that Gordian knot by examining the restructuring and writing down of business debts.

I have been 20 years in banking and I know these unsustainable loans have to be written off. It is like the bad stock in a retailer's; he has got to get rid of it. There is no point in saying that over the next five years the pink and purple dress will sell. It will not. In the same way, an existing business or a household cannot pay back what it thought it could at the outset. It behoves the institutions with those assets to sharpen them down to what is recoverable in the foreseeable future.

That invites the question as to what sort of funding reserves the banks need to make these write-downs. I do not claim to be the know-all in this but my experience and instincts say the PCAR, prudential capital assessment review, and the BlackRock assessment, which is model based, are not correct. We will have a slow death by a thousand cuts over the next eight years unless we get competent teams into the institutions to deal with it. We need them to do the triage and then the surgery. That is what the country needs motivationally too.

However, it also means Patrick Honohan, Governor of the Central Bank, tells tomorrow's ECB governing council meeting that there is €75 billion out of €100 billion not for the account of the people of Ireland. I pray he tells them to get real and start talking about the credit restructuring of our banks. If we had held on to our majority shareholding of Bank of Ireland rather than letting it go outside the State, we could be driving this negotiation to get creditor restructuring right down, as any business does when it has a viable operation but legacy debts that are too much for it to carry.

We have to do this no matter what one's political ideology or membership of a political party. This is the challenge for us and for Patrick Honohan. It is lonely because the Germans have six people on that governing council and minutes are not taken. It is a shocking situation in which to find oneself. We should be clamouring with graciousness but insist that we are not going to be put into that quasi-reparations class. Greece is in a reparations mode just as in 1920 Germany was.

Chairman

We have an agenda for today's meeting. Does Deputy Mathews have a question?

Deputy Peter Mathews

I apologise. These statistics will help these arguments.

Chairman

I call on Senator Barrett whom I should have called before Deputy Mathews.

Senator Sean D. Barrett

In 2009, up to 66% of lending went to construction. One would have to look askance at that as construction is what got us into our problems in the first place. A minuscule amount of the borrowing stream between 2000 and 2008 went to either industry or agriculture. Have Irish banks got the message yet? Are they still addicted to construction? We all remember the articles about a house built on sand in The Economist and by Anthony Downs and the Brookings Institute. Do Irish banks have the expertise to know anything about industry or SMEs? Do they have the economic expertise to deal with these sectors? As an economist, I recall those economists in the commercial banks put out front as public relations people telling us to get on the housing ladder.

The old rule on mortgages was that it was based on 2.5 times the first income, 1.5 times the second income plus what people had saved. This means the average house price was €140,000. If it heats up more than that, we have to switch it off as we are not going for a second bubble. The Seanad was unanimous this morning in supporting the Governor of the Central Bank on the promissory notes issue. He and the late Brian Lenihan said we were running a banking system that was five times the size of the economy and it must be shrunk. It looks like it might be shrinking in the wrong places if it is still wedded to the construction industry. People say it is time for the Government to renew confidence in the construction industry. Confidence meant the price of a house in Dublin went up fivefold in a ten-year period. I am sure no one will want to do that again. We conducted the experiment which destroyed the banking system and the public finances.

How are we slimming down the banking sector? How can we get banks to take an interest in SMEs, as Senator Byrne my colleague asked? Are the banks competent or qualified to invest in those sectors which all Members are trying to tie to job creation? An economy which is 60% based on construction is certainly not the way forward.

I wrote to the Governor after our last meeting to express my appreciation for what our witnesses had to say. How can we design a banking regulatory system so that we never again experience the current appalling situation? Should there be another tsunami of cheap money such as that which came from Germany and France in the early part of the decade, can it be neutralised in any way? Preservation of an overall macroeconomic balance would have required an incredible fiscal surplus to compensate for the monetary excesses. Has the Central Bank given any thought to this issue? I understand the IMF is concerned that small economies like Ireland are particularly vulnerable and is trying to get the ECB and the EU to recognise the special problems that arise as a result the huge capital flows which seem negligible in Germany but become a veritable tsunami when they arrive in Ireland. There are 42 new Senators out of 60 in the Seanad, as well as 77 new Deputies out of 166 in the Dáil. We want to put the banking system under stricter control so that we never again experience this mess. Have the witnesses any views on how we can deal with these massive flows?

I am concerned that some of the agricultural lending to which they referred is being used for land speculation rather than genuinely productive agricultural activities. The recent signs of an increase in land prices are worrisome. Are the prices justified by the underlying productive value of the land or do they merely signal another bubble which we must endeavour to avoid?

I hope my questions are not rambling. We are trying to find the direction toward better macroeconomic management of banks and the economy. I am indebted to our colleagues in the Central Bank and would be interested in hearing their opinions. I ask them to tell me if I strayed away from their territory so that we can discuss these matters elsewhere.

Chairman

Before I invite speakers to conclude, I suggest that the committee needs to find a way of discussing the issues raised by Senator Barrett and Deputy Mathews among ourselves. We have held a series of hearings and hope to prepare a report but we do not appear to allow ourselves sufficient opportunities to debate the issues arising. While it is good to have the support and advice of outside experts, perhaps we need to make time for our own debate.

The witnesses are naturally constrained in what they can say on questions of policy because these are principally matters for Government and the Parliament. This is where the Oireachtas has been lax in recent years, however. It would not be fair to press the statisticians and economists before us to stray into that area because they came here to respond to a particular request. I thank them for providing us with extremely useful information and they are free to add anything they wish.

Deputy Peter Mathews

They can volunteer.

Chairman

As a courtesy to them we should be fair in our expectations. They have done highly valuable work for us and we are not going to press them to stray outside their remit. They may do so if they wish, however.

Mr. Fergal McCann

I will respond to one of the points raised by Senator Barrett. I will not speculate about the skills of bankers but we have a certain amount of information on the sectoral allocation of new lending versus the stock of lending. We touched on this issue last Friday. The share of new lending in the sectors most associated with the boom is much smaller than their stock of lending. The share of new lending to the real estate sector, the hotel and restaurant sector and the wholesale and retail sector is disproportionately lower than their share of the stock of lending. The credit market and volume of lending for SMEs are quite small but the market appears to allocating away from those sectors relative to their share during the boom. On the flip-side, the sectors which are receiving more new lending than their share of the stock of lending are primary production, including agriculture, industry and business services. These are core sectors in a productive modern economy. Regardless of how skilful a banker may be, there is evidence of reallocation towards these sectors. The question of whether we are at an optimal level or closer to the position of the 1990s is policy related but we are definitely moving in that direction.

Deputy Peter Mathews

The tsunami of money that came from surpluses in Germany and France to what they saw as a superbly managed and fighting fit economy in the Ireland of the 1990s subsequently turned into an equally large outflow. The bankers piled in with too much money and we exploded into a turbo-charged credit bubble but they got out on the reflux while we were left with the debris.

Mr. Joe McNeill

As Mr. McCann noted in regard to the preponderance of construction debt in the overall share of lending, its share is falling but it will take some time, especially when volumes of new lending are small, for a major compositional change to take effect. We are seeing some evidence of this change but the statistic to which we would draw members' attention is that every sector is making net repayments and the amount of new lending is relatively small. The compositional change which all of us would like to see will take some time to manifest.

Mr. Martin O’Brien

It should also be borne in mind that the Irish owned banks have undergone significant transfers of assets to NAMA. While one can estimate overall real estate and construction lending at 60%, one cannot indicate whether that is necessarily the case for covered banks versus foreign banks. Different approaches have, obviously, been taken by Irish and other banks. However, the sheer scale of the issue implies that it will take a long time to resolve from an economy-wide perspective, as opposed to a banking perspective.

Deputy Peter Mathews

I forgot to add that the non-financial corporate debt also includes the NAMA balances because it came off the banks' balance sheets and into NAMA.

Chairman

I thank Mr. O'Brien, Mr. McNeill, Mr. Connolly and Mr. McCann.

Mr. Joe McNeill

If the committee wishes to receive further information, I invite it to communicate with us and we will see what we can do.

Chairman

It may be useful to maintain contact in that context. I realise there are apples and oranges and things do not necessarily fit together but our interest is in building a picture of the debt in all its manifestations on behalf of the people we represent. The witnesses have assisted us enormously in that regard. This may be an issue to which we shall return on an annual basis but we will not press them to respond at that level for the moment. They will certainly hear from us again and I thank them for their assistance in answering our questions.

The joint committee adjourned at 5.50 p.m. until 2 p.m. on Wednesday, 14 March 2012.