Analysis: lessons from Ireland and Europe show the importance of discernibly different bank types
The news about Bank Of Ireland branch closures and the recent Ulster Bank announcement have raised concerns about the competitiveness of Ireland's banking market. Market competition may well be best served in the short term by the entrance of a so called third force, but longer-term sustainable development and system resilience would be better served by fostering the development of a diverse bank types with discernibly different behaviour and focus.
Ulster Bank's own history is illustrative of this. It was founded in 1836 as a bank to serve local businesses, an era in which financial diversity grew. Its merger with demutualised building society First Active in 2009 took place as diversity declined rapidly.
The value of biodiversity is well established in science, but are societies better served by banks with diverse and discernibly different behaviour or a single dominant banking model? By emphasising the question of in whose interest a bank is run, the argument for diversity departs from the narrow view of competition, which tends to be less concerned with ownership. In fact, diversity can improve competitive market outcomes, while a lack of diversity can hasten concentration.
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From RTÉ Radio 1's Saturday with Katie Hannon, the implications of the Ulster Bank decision to leave the Irish market
Central Bank data show a consistent trend of increasing market concentration in Ireland since the late 1990s. This trend has been amplified by the mergers and exits following the financial crisis. Concealed in growing concentration has been a decline in the diversity of bank types.
Yet, the history of banking has been characterised by a wide diversity of ownership types including governments, mutual societies, families, and religious orders. The present-day Bank of America (originally known as the Bank of Italy), was founded with the objective of extending finance and banking services to small Italian businesses. Closer to home, Cork University Business School's Centre for Executive Education now occupies the former Cork Savings Bank buildling on Lapp's Quay. Savings banks were part of a policy in the 19th century to extend banking services to low-income households. More recently in the 1970s, savings banks, a type of not-for-profit financial institution came to dominate European markets, especially in France and Italy.
How, then, did we arrive at a situation where large parts of the banking sector are dominated by a single model? The history of the European savings banks is instructive in answering this. Legal reforms and deregulation of markets and interest rates led to an increase in market concentration and a subsequent decline in organisational diversity.
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From RTÉ Radio 1's in August 2020, RTÉ Economics Correspondent Robert Shortt on how Bank Of Ireland plans to reduce its workforce by around 1,400 over the coming years
In the US, deregulation allowed different banks perform similar functions, reducing discernible differences in behaviour by lifting restrictions on the lending side of their operations. The developments led to the creation of large multi-state banking corporations and contributed to the problem lending in the run up to the 2007/2008 financial crisis.
These developments were mirrored in Ireland, albeit on a smaller scale. Savings banks disappeared while demutualisation turned building society members into shareholders and incentivised their management to compete head on with commercial banks. While some of these changes temporarily reduced market concentration and led to the entrance of overseas banks, they ultimately set the scene for greater consolidation and the exit of different banking types.
Academic literature provides two main answers for why diversity matters in banking. First, a more diverse range of financial institutions provides greater channels for generating employment via loans to different sectors of the economy. For example, publicly listed banks which operate in the interests their shareholders might have less interest in extending credit to smaller businesses or green projects, if such loans do not align with the objective of maximising shareholder value.
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From RTÉ Radio 1's Drivetime in 2014, Fergal Keane reports on the opening evidence in the Banking Enquiry given by Peter Nyberg, author of a report on the Irish banking collapse
The second reason is increased financial resilience. Greater concentration reduces the resilience of a system by increasing the risk of contagion. The dangers of this were alluded to in the 2011 Nyberg report which described how demutualisation empowered building societies to provide finance for housing developments, competing head on with the major commercial banks for higher margin business. Access to wholesale funding allowed demutualised societies fund a much faster expansion in loan assets than their traditional mutual-based funding model. However, the strategy of mimicking the commercial banks, ultimately led to their collapse when wholesale funding dried up, as all bank types depending on this funding channel were vulnerable to contagion.
Research on financial diversity conducted for the Building Societies Association in the UK paints a similar picture, showing a decline in diversity and a widening of banks’ funding gap in the run up to the 2007-2008 credit crunch. Other systems with more diverse banking types have shown themselves better placed to deal with funding crises. Hong Kong's banking system, which survived the global financial crisis relatively unscathed, benefits from a mix of international, regional and local-level banks.
The lessons from Ireland and other European markets indicate that policy should focus more on sustaining different ownership types
The evolution of the banking industry shows that competition does not always deliver the most sustainable outcomes for society. From this perspective, the question concerning policy makers should not so much be the exit of a bank that is similar in type to the remaining banks, but rather the lack of discernibly different bank types in the market.
The lessons from Ireland and other European banking markets indicate that policy should focus more on sustaining different ownership types. There needs to be a broader discussion on the post-pandemic future of banking in Ireland, including how best to simulate activities on the asset side, including what type of institutions are best placed to finance a green transition, job creation and a resilient financial system.
The views expressed here are those of the author and do not represent or reflect the views of RTÉ
