In the opening weeks of 2020, Ireland’s bankers had reason to be optimistic. The country’s lenders were in a position of strength, most of them having cleaned up their balance sheets in the decade since the global financial crisis.
Capital ratios across the system were high: the five leading banks boasted an aggregate transitional common equity Tier 1 ratio of 19%, according to the central bank. In addition, the ratio of non-performing loans (NPLs) had fallen from 30% in 2014, to just 6% by the end of 2019. Though the hunt for higher profitability remained elusive, the post-global financial crisis (GFC) years of prudent stewardship had placed Irish banks at a developmental inflection point, ready for the next stage of their growth story.
“Capital levels were strong and NPLs were coming down to levels that were comparable with other markets in the euro area, having obviously been a significant outlier for many years. Irish banks were in a much better place. Even the profitability side was beginning to be addressed. There was quite a lot of restructuring that had either been announced or was being done,” says Diarmaid Sheridan, a research analyst at Davy Research.
[Irish] banks are being quite cautious because they were hit very hard during the global financial crisis
But the Covid-19 pandemic upended any notion that Ireland’s banks were set for a period of further transformation and growth. Social and commercial restrictions, including three national lockdowns, all dampened the country’s economic growth over 2020. Data from the central bank points to a contraction in underlying demand of about 7% over the period.
Joint support plan
Notably, however, Ireland’s leading banks, as well as the Central Bank of Ireland, acted decisively to support the economy from the outset. This included the central bank’s decision to drop the countercyclical capital buffer from 0% to 1% in the first half of the year, while the banks enacted a joint plan to support thousands of households and businesses.
“When the first lockdown was announced in March 2020, the banks very quickly agreed as a system to implement a significant forbearance scheme through payment holidays or payment breaks for customers who were impacted,” says Mr Sheridan.
These measures were instrumental in shielding the economy from the worst effects of the pandemic. Crucially, Ireland’s lenders were in a position to help to the extent that they did, thanks to their reform efforts in the preceding years. “We have a very strong capital position and are probably one of the best capitalised banks in Europe. That really shaped the way we were able to respond,” says Mary Whitelaw, director of corporate affairs, strategy and sustainability at Allied Irish Banks (AIB), Ireland’s largest lender by market capitalisation.
Mary Whitelaw, AIB
“We have invested a huge amount over the last number of years, particularly in upgrading to what we believe is a flexible, digital IT architecture. And having that digital architecture in place, coupled with a strong capital base, put us in a strong position from the start to deal with the crisis,” she says.
By the beginning of 2021, AIB had implemented more than 66,000 payment breaks for its customers. Similarly, the Bank of Ireland, the country’s second largest lender by market capitalisation, has adopted measures to support its customers and the wider economy. This includes, among other initiatives, a €1m Covid emergency fund for communities across Ireland experiencing urgent need as a result of the pandemic, in addition to an extensive degree of payment breaks.
“A major focus for Bank of Ireland was putting in place quick and accessible payment breaks for customers. In total we agreed 106,000 payment breaks for personal and business customers across Ireland and the UK,” according to a Bank of Ireland spokesperson in a written response.
Making provisions
Meanwhile, Irish banks have shouldered massive impairment provisions in response to the pressures of the pandemic. The scale of the charges stem, in part, from the degree to which the national economy has been hit by Covid-19. It also reflects the post-GFC prudence that has characterised Irish banking in recent years.
“The banks are being quite cautious because they were hit very hard during the [GFC]. Irish banks are among the top European banks in terms of their provision levels. Most have taken management overlays to increase their provisions above and beyond IFRS9 requirements. This conservative approach is also a function of their strong capital buffers. In other European markets, banks want to provision more than they are able, but they don’t have the capital to do so,” says Anastasia Turdyeva, director of financial services ratings at S&P Global Ratings.
In August 2020, AIB took a €1.2bn loan loss charge to cover potential losses for the year, while booking an additional €100m charge in the third quarter. Bank of Ireland, meanwhile, took a €937m impairment charge in August in response to the fallout from the health crisis.
As Ireland, along with the wider region, looks to a possible exit from the worst of the pandemic later in 2021, its banks are now eyeing a more uncertain future. For most top lenders, cost-cutting efforts are likely to increase over the coming months.
“Banks are really focused on cost controls. All of them have plans which they are trying to execute. They have high ambitions in terms of cost reductions. But again, the top-line story in terms of revenue remains a constraint,” says Ms Turdyeva.
Post-Brexit developments
The fallout from the Covid-19 pandemic is not the only dynamic shaping the fortunes of the country’s banks. The agreement reached between the EU and the UK, establishing a post-Brexit economic and trading arrangement, has provided some clarity for the sector and the businesses that it supports. While this relationship is likely to evolve, fears of a ‘no-deal’ Brexit have been allayed.
“We have some clarity around Brexit and that will allow businesses to determine whether it’s a good time to invest or not. Small and medium-sized enterprises (SMEs) have registered very low levels of investment into their businesses over the past few years. So clarity around Brexit and the reopening of the economy should also be quite beneficial from an SME perspective too,” says Mr Sheridan.
Meanwhile, the decision by Britain’s NatWest to sell its in-country unit, Ulster Bank, as part of a wider strategic review of its business will have a profound impact on the banking sector. This is largely due to Ulster Bank’s market position as the country’s third largest lender by total assets. “There could be a substantial change in the market. [Ulster Bank] has about 15% of the mortgage market, about the same in terms of current accounts and about 20% of the SME market. So they are a reasonable player in an Irish context,” says Mr Sheridan.
NatWest’s decision offers Ireland’s remaining banks a strong opportunity to grow their businesses, as Ulster Bank’s €20bn in assets are likely to be split up. Notably, NatWest’s leadership has made it clear that the bank is keen to carve up its Irish business to sell to existing and active lenders in the market. A memorandum of understanding has been signed with Allied Irish Banks concerning the potential sale of a €4 billion commercial loan portfolio, according to the Financial Times. Nevertheless, whatever form the sale of Ulster Bank takes, it could lead to further concentration within a banking system that is relatively small and highly competitive.
In a sign of how seriously the Irish authorities are taking this scenario, finance minister Paschal Donohoe revealed to the Irish parliament’s budgetary committee in February 2020 that he was in discussions with NatWest leadership and UK chancellor of the exchequer Rishi Sunak over the bank’s future.
Faster digital uptake
As the landscape of Irish banking changes, so too are the ways in which the banks are operating and engaging with their customers. In particular, the trend towards digitalisation, which has been accelerated by the Covid-19 pandemic, is sweeping through the Irish banking sector at pace.
“Covid-19 has accelerated this changing behaviour, and we’ve seen a seismic shift towards digital banking in the past year. In this context, Bank of Ireland is now accelerating its pivot to become a digital relationship bank, providing customers with a digital-first proposition, digital-only for simple products and services, and relationship management advice for complex and high-value products,” says the Bank of Ireland spokesperson.
Covid-19 has accelerated [an already changing] behaviour, and we’ve seen a seismic shift towards digital banking in the past year
In 2020, Bank of Ireland launched a new mobile app; customers can also open a current account online and complete the mortgage process to draw down entirely online. “In 2020 we delivered some key milestones on our transformation journey, despite the disruption caused by the pandemic,” adds the spokesperson.
The ambitious drive towards digital transformation can be seen in every corner of Ireland’s banking landscape. “Broadly speaking, we obviously can see that the pandemic has accelerated the trend towards digital. AIB has invested in our operational infrastructure, and that has paid dividends and allowed us to provide really strong support to our customers. We see that our customers are engaging with our app more than 1.5 million times a day. That compares with 40,000 branch visits per day. Our app is really well used and popular,” says Ms Whitelaw.
“We have seen huge uptake across all categories on the digital side. It really has been quite a transformative change, and I think a lot of the changes are probably here to stay. It’s amazing how quickly that transaction has taken place. We talk about 10 years of change happening in 10 months,” she adds.
Sustainability strategies
Beyond this digital transformation, Ireland’s banks are now at the vanguard of national efforts to transition the national economy to a low-carbon economy and society. In doing so, they are pursuing market-shaping product and service innovations, generating long-term growth opportunities and invigorating new sectors of the economy. Though it will take time for the full impact of their sustainable finance strategies to bear fruit, it remains a vital endeavour.
In December 2020, AIB published the outcome of its strategic review, providing an update to its long-term strategy published before the onset of Covid-19. In it, the bank noted: “Tackling climate change by lending to support lower carbon projects remains central to AIB’s sustainability strategy. Green lending has been the fastest-growing part of the bank’s loan book. Despite the economic shock caused by Covid-19, AIB has exceeded its target of €1bn in new green lending this year.”
The seriousness with which AIB is taking its commitments to sustainability is clear. “We believe that, as a bank, we have a really important role to play in supporting the economy in the transition to a low carbon economy. We believe that where the money goes, carbon emissions will follow. So if we help to fund business to transition, that, in turn, will help to reduce greenhouse gas emissions,” says Ms Whitelaw.
AIB was the first Irish bank, in November 2020, to pledge to be carbon neutral by 2030 by adopting a net-zero approach. Beyond this, the lender has also set itself the target of ensuring that 70% of its total loan book will be either green or transition finance by 2030, while the overall loan book will be green by 2040. “We want to lead this and we want to make sure that the pace is robust and will have an impact. And we want to [do this] in all sectors; I suppose we are trying to deliver that as best we can by 2040,” says Ms Whitelaw.
“Last year we were the first Irish bank to complete a green bond issuance. We raised €1bn in a well-subscribed issuance. The bond represented a major vote of confidence by investors, who recognised that we are obviously very serious about this agenda,” she adds.
The Covid-19 pandemic may have dented the sense of optimism that prevailed over Ireland’s banks a little over 12 months ago, but it has also underscored the resilience of the wider system. Today, Irish lenders benefit from both balance sheet strength and strategic prudence. These have been vital ingredients in helping the wider sector to shoulder the strain of an unprecedented global health crisis.
Although the challenge of securing higher profitability remains, lenders prioritising digital transformation and transitioning to a low carbon economy points to the possibility of a brighter long-term outlook.
