I move:
That Dáil Éireann notes the recent increases in Associated Bank interest rates.
As Deputies will be aware, the four associated banks on Friday, 11 April, announced increases in their lending and deposit rates with effect from close of business on that date. On the deposits side, the increases were 1.5 percentage points for all sums up to £25,000 and 2.5 percentage points on sums of £25,000 and more. Lending rates went up by 1 to 2.5 percentage points, depending on the category of borrower and the term of the loan.
The effect of these changes is that the lending rates now being charged by the associated banks range from 18 to 21 per cent. Because they affect the majority of borrowers in all walks of life, they have given rise to a good deal of comment. The Government, therefore, have decided it would be proper to afford the House the opportunity to consider these events.
I trust that Deputies will use the occasion to debate the matter calmly and with a due appreciation of its importance and, as regards some aspects, its sensitivity.
Interest rates are influenced by several factors, domestic and external. In our case, as a small open economy, the external factors loom large. Since June 1979, when the associated banks last changed their rates, the rise in rates abroad has continued unabated. Every member state of the EEC has increased rates at least once, and in some cases, more frequently, since June last. Even Germany, a country of low interest rates, has raised rates steadily so that they are now almost 50 per cent higher than in June last. In Belgium also the rate of increase has been 50 per cent and in the Netherlands 59 per cent. It may come as a surprise to hear that the increase in the associated banks' prime lending rate, after last week's move, is at 16 per cent, the lowest in the Community.
Countries outside the EEC have all been experiencing higher interest rates, notably the United States where the prime lending rate has reached an all-time record at 20 per cent. The litany in fact is almost endless. The main cause of this development is the increasing determination of the western world to bring down inflation. This is a big factor in the recent policy actions of the United States authorities, which have "spill over" effects through the international Eurodollar markets. Another important element is the problem of dealing with growing surpluses of the oil producers as rising oil prices eat at the economic stability of all our countries.
The question may be asked what have these events abroad to do with Ireland? More particularly, what have they to do with the domestic interest rates of the associated banks? For the record, let me remind the House that there are 45 banks licensed and carrying on business in the state. Four are the associated banks. Traditionally, they have operated agreed scales of charges and interest rates. With their long history and presence in every part of the country, they are not unaturally seen as "the banks". Indeed, for many they are the banking system. But let us not forget the other 40 or so banks. These are the non-associated banks, a category that scarcely existed 20 years ago but which now account for some 25 per cent of the total resources of the banking system. These banks include domestic and foreign institutions. They operate in a relatively free market where interest rates are determined according to the supply and demand for funds. This market is sensitive to economic developments at home and abroad.
The interest rates of the non-associated banks are not left solely to the vagaries of the market. The Central Bank helps to smooth the interest rates in the interbank market and prevent sharp seasonal variations in non-associated banks' rates. Generally not only non-associated banks, but all bank interest rates must inevitably reflect market forces. If not and if interest rates, important as they are, were made an end in themselves, some other policy aim, such as the maintenance of the exchange rate, would be seriously endangered.
For instance, only recently the German authorities have found it necessary to increase their interest rates in order to moderate the depreciation of their currency, perhaps the strongest in the world, against the US Dollar. Low interest rates here, at a time of high international rates, could produce outward capital flows endangering the exchange rate and leading to a devaluation-inflation spiral.
Capital outflows would deplete the reserves. It could also be that the banking system would simply contract in the face of a limitation on lending rates when market conditions suggested that rates should be higher. Moreover, low levels of deposit rates would be unfair to savers and would discourage savings. This would be an incentive to increased consumption, with adverse effects on the balance of payments.
If the Central Ban were to inject funds into the inter-bank market to reduce market interest rates the ultimate result would be capital outflows and loss of external reserves. In the longer run an injection of funds into the market need not succeed in keeping market interest rates down. The reserves' losses would themselves reduce liquidity in the economy and tend to push interest rates back up again. Ultimately, the external reserves would be exhausted with consequence that can readily be imagined.
The Central Bank, in fact, has temporarily reduced the banks' primary liquidity ratios, which has released about £50 million into the market, keeping interest rates somewhat below the level, at which they would otherwise be. In addition, the Central Bank has short-term credit facilities in place for banks, to be used at their request, and has earlier this year released funds in some quantity into the financial market. The rates, nevertheless, have tended to rise because of the upward movement in world interest rates and the financing of the current balance-of-payments deficit this year.
The fact is that if the forces tending to push up interest rates were resisted too strongly there would be a tendency for the external reserves to fall as capital inflows are deterred and capital outflows encouraged. Once it is appreciated that the broad trend of interest rates cannot be frustrated, the difficulty of trying to control one set of financial institutions, in this case the associated banks, should become clearer. If one were to judge by the amendments put down by the Opposition, however, it is not appreciated. Perhaps, the Labour Party have some formula for controlling interest rates without unpleasant consequences for our economy? or perhaps they would be content to see the associated banks lose resources with a real reduction in banking business and a drying-up of credit facilities for the majority of people?
As the Central Bank indicated in its statement on Friday, large interest rate differentials have developed between the associated and non-associated banks. Their ability to attract funds was being impaired, while, at the same time, demand for their relatively cheaper credit was growing. A degree of conflict was developing between interest rates and monetary policy with its aim of ensuring adequate external reserves and an orderly, controlled expansion of domestic credit.
At this stage it is appropriate to refer to the EMS connection. Our link with our EMS partners is our commitment to keep the exchange rate for the Irish pound from devaluing or revaluing by more than a certain margin vis-á-vis other EMS currencies. Prime lending rates in the other EMS countries now range from 10.75 to 19.50 per cent. There is some flexibility for exchange rate movement and there is always the possibility of realignment of currencies within the EMS band.
The main Opposition party blame the Government for depriving the people of the possibility of cheaper credit opened up by membership of the EMS. "Possibility" is the key-word. Provided we accept the appropriate disciplines and the necessary measures to bring our inflation rate more into line with that of our partners, then, in time, we could aspire to lower interest rates. But even then we could not ignore international trends. I gave some examples earlier of the way rates have been moving in the EEC. They were nominal rates. It is also worth noting that some analyses indicate that, when account is taken of movements in prices, real interest rates in this country are among the lowest, if not the lowest, in the Community.
We cannot expect to be able to stand aside from these developments in EMS countries if we are to maintain the stability of our exchange rate in the EMS band. If we allow our rates to get out of line we stand to lose capital. Loss of funds in this way would, in turn, add to the pressures that are already on our external reserves as a result of our balance of payments deficit and would call into question the Government's ability to hold our exchange rate in the EMS.
This is an appropriate point to mention the exchange controls which, though they afford a degree of protection, cannot insulate us from external influences. Exchange controls relate to capital movements. Leads and lags in relation to payment for our trade, even in relation to one month's transactions could, on their own, exceed the total level of official external reserves.
As regards financial transactions, exchange controls do not and cannot relate to non-residents who have large balances and holdings of financial and other assets within the State, all of which could be run down at their wish.
As regards residents, they have large liabilities to abroad and could run them down without being restricted by exchange control, which must allow residents to pay their debts abroad. In addition, exchange control cannot force residents to borrow abroad and it may very well be that, as in this year, we need the private sector as well as the Government to effect significant capital inflows. All of these factors involve capital flows which add to or take from the liquidity of the financial markets here and so change interest rates.
There has been some comment in the press about the costs to the productive sectors of the rise in bank rates. Firstly, I should point out that lending to industry by banks other than the associated banks accounts for about 55 per cent of total lending. A substantial portion of industry therefore is already paying rates of interest which are even higher than those currently being charged by the associated banks. In the case of the latter the extra full-year costs are about £8 million for manufacturing industry, £10.5 million if building and construction is included as well and £14-15 million for agriculture. These figures compare with net output values of roughly £3 billion and £1.2 billion in industry and agriculture respectively. The costs quoted are gross and will of course be offset to the extent that these sectors benefit from the higher rates being paid on deposits. Some proportion of the increase will also be chargeable against tax. I would not however wish to suggest any lack of Government concern at the current level of rates or the fact that the effect on the productive sectors is not what we would wish it to be.
The £8 million gross cost to industry on an annual basis will have some impact on production and employment. However, if the main banks, which serve the economy countrywide, were not as a result of pressure from the interest rate differentials to have credit to give the effect on the economy could be much more damaging and, moreover, failure to act now could lead to crisis measures later on which might have considerably more serious implications for output and employment.
The reality of the situation is that the increases are unavoidable and not out of line with the experience in other countries in recent times. They should be seen as part of the deteriorating international economic environment from which we cannot escape. Naturally, there have been renewed calls for the Government to introduce an exchange risk guarantee scheme under which Irish companies could borrow abroad at low interest rates. This of course would involve a contingent commitment of Exchequer funds and for practical purposes is tantamount to a subsidy.
In passing, I would like to mention that substantial assistance of this kind is already provided for both the industrial and agricultural sectors and is freely available to qualifying firms and enterprises. Loans for investment by small and medium-sized industries are available from the European Investment Bank through the Industrial Credit Company at attractive rates of interest and with the Exchequer carrying the exchange risk. Almost 90 per cent of Irish industry fulfils the criteria for eligibility and to date over 300 applications have been approved and financing of over £30 million has been arranged. A similar scheme for agri-business is available through the Agricultural Credit Corporation.
In addition, I have authorised the Industrial Credit Company to borrow up to the equivalent of £50 million in foreign currencies on the capital markets for onlending to industry at keenest going rates, again without exchange risk to the final borrower. Deputies will recall that towards the end of last year the ACC were authorised to engage in a similar operation amounting to £25 million on behalf of the farming community I am happy to report that this was such a success that I have recently authorised the corporation to engage in a further £25 million foreign borrowing on similar terms. The Government do not see this as the limit of their commitment to support industry and agriculture. If the demand is there the Government will be more than willing to ensure that it can be satisfied. I have drawn attention to these scheme because I want to underline the fact that the Government are not denying the productive sectors access to credit at keenest rates nor exposing them to exchange risk. What I am not prepared to concede are subsidies which must be paid for by all taxpayers.
One of the amendments before the House states that there is an obvious conflict between national economic objectives and the commercial and profit levels of the banks. The interest rates problem is a symptom of the difficult international environment in which we strive to pursue prudently our economic policies. I want to refute unreservedly the suggestion that the determination of those rates is subordinated to the profit objectives of the banks. In view of the approximate equality of lending by and deposits with the associated banks the profitability implications of the changes in interest rates are not significant. The result will be to augment associated banks' profits in the aggregate, but to a relatively small extent; the net effect on each associated bank will depend on its structure of lending and deposits. The Central Bank is satisfied that associated banks' profits are not excessive.
Given that the increases in lending rates were judged to be the minimum necessary in the circumstances, the only way to achieve a contraction in profits would be to increase deposit rates further. Moreover, given the structure of associated banks' recources—with the bulk of their deposits falling within a range that is directly competitive with the building societies—the effect would have been to put even greater upward pressure on building societies' rates. This suggestion, in fact, is nothing more than an attack on the role and competence of the Central Bank. The Central Bank is an institution set up by Act of the Oireachtas and endowed by the Oireachtas with a wide measure of autonomy and specific powers and responsibilities in relation to the currency, credit and the supervision of the banking system.
The bank has on more than one occasion publicly affirmed its overriding role in relation to bank profits, namely, to try to see on the one hand that the banks earn sufficient profits to enable them to remain secure repositories of the public's savings and, on the other, that their profitability is not so great as to reflect an excessive high net cost of their services to the Irish economy. The Bank is and has been as concerned that the banks do not earn excessive profits as that they earn sufficient profits. However, it has advised me that in its judgment, based on the objective criteria it has applied since 1973, taking one year with another the banks have not earned excessive profits. The two major groups in fact experienced a fall in pre-tax profits in the six months to September last.
The bank is aware that a determination of profit adequacy on the basis of its, or any other, approach does not offer an assurance, when there is an absence of price competition, that the banks are keeping their level of costs under adequate observation and control. The bank is also aware of its own responsibility in this regard. It has consistently endeavoured over the years to exert pressure on the banks to improve efficiency in terms of cost and the service offered to the public. This has been done in the context of the rationalisation of the two major groups, control of their branch networks, the controlled admission of competing institutions from overseas, control of the margin between deposit and lending rates in the context of changes in the level of interest rates, and detailed examination of costings in connection with requests for increases in charges, with approval withheld in major instances.
There are of course aspects of bank profits which are of concern to me, as I indicated in my budget statement. I have asked the Commission on Taxation to look into these matters urgently. As regards the Central Bank, however, I am satisfied that it is discharging responsibly its duty to oversee bank profits in such a manner as to ensure the integrity of the banking system and the widest interests of the community in general. At this point I might mention that I have been advised that the banks in fact originally put proposals which would have ensured no increase in their profits. This would have been achieved by increasing deposit rates by a greater amount. The Central Bank, however, mindful of its wider public responsibilities, appreciated the adverse effects that would have ensued for building societies and other savings institutions. In the event therefore it was agreed to limit the increase on smaller deposits to 1.5 percentage points.
The Labour Party's solution for the ills of the system as it sees them is to take the financial institutions under effective public control. The public will have its own views on that recipe—even during bank strikes it was notable how little demand there was for such action. The proponents of effective public control—whatever that may mean—do not say whether all banks would be included or only the four associated banks. Nor do they say how the institutions, once under public control, could be subjected to some form of cheap money policy without running the attendant economic risks. The experience of some other countries is relevant in this regard. In France and Italy, for example, where there is significant public ownership or control of banking, the minimum commercial lending rates are 14.50 and 19.50 per cent respectively. In these countries the banks compete for funds and interest rates reflect domestic conditions and international trends.
I now come to the role of the Government. The Government did not approve the increases. In accordance with normal protocol in these matters, as Minister for Finance I was informed of the proposed changes shortly before the announcement and of the reasons why the Central Bank considered the changes to be essential. But no Government approval was sought or given. This was in line with the usual procedure. As then Minister for Finance, Deputy Richie Ryan, indicated in reply to a question in this House on 31 October 1973, "the level of interest rates is a matter primarily for the Central Bank". I mentioned earlier that when the Central Bank was set up in 1942 it was given considerable autonomy. I would like to recall here some remarks of the Minister for Finance of the day, and I quote:
It is intended that there should be the fullest co-operation between the Government and the Central Bank. The Government does not, however, propose to interfere with the administration of the Bank which will be independent in the carrying out of its functions. This independence is possessed by almost every Central Bank throughout the world and is a very desirable provision.
These words summarise the relationship that has existed between the Central Bank and every Government.
The Government readily appreciate that the interest rate increases are unwelcome. They realise that they will add to the problems of many firms and farmers faced with unfavourable trading conditions. They are aware that house purchasers are concerned about their position. Neither do they welcome the possible effects on other savings media or the increased costs that may fall on the Exchequer.
We should not delude ourselves that inflation is not the real enemy. If I may revert here to my budget statement, the Government have initiated the action necessary to bring order into the public finances and reduce our balance of payments deficit. We cannot compensate ourselves for the rising cost of oil. Equally we cannot divorce ourselves from the unsettled world economy, with its tighter trading conditions, uneasy financial markets and rising interest rates.
Despite the current increases in interest rates I believe that investment and exports will continue to expand. The Government will be watching the situation closely and will engage in direct and continuing consultations at home and abroad. In the course of these consultations we will be exploring the possibility of the rates being reduced having regard to the effect of their present levels on general economic activity. I shall be raising with my fellow Finance Ministers, at the informal meeting of the Council of EEC Finance Ministers this weekend, the question of the level of international interest rates and the problems being caused by the apparent competition that is developing between certain countries. I shall be emphasising to them that it would be of little solace to any of us to conquer inflation if in doing so our economies or those of our neighbours were forced into deep recession.
