The European Central Bank (ECB) implemented its latest rate increase last Thursday, marking a year since it began raising rates in response to the inflation crisis. The key interest rates have now risen by 4.25%, a significant tightening measure. The ECB’s upcoming meeting in September remains uncertain, with another 0.25% increase not guaranteed. The central bank will closely monitor economic activity, focusing on the services sector, labor market, and core and headline inflation rates. While headline inflation is decreasing, the core rate, which excludes volatile food and energy prices, remains stubbornly high. Concerns have arisen that energy and food prices may accelerate due to global factors involving China, Russia, and India.
Central banks increase interest rates to make borrowing more expensive and savings more attractive, effectively reducing the circulation of money. This policy appears to be working in the eurozone. The ECB’s quarterly survey of bank lending reveals that loan demand from businesses is at its lowest level in 20 years, and loan demand from households is also weaker. These results are unlikely to displease the central bankers in Frankfurt.
Over the past 15 years, the banking landscape in Ireland has undergone significant changes. The market has seen a concentration of players as some exit and a small number of incumbents become increasingly dominant. Competition has suffered as a result. There is a clear impression that banks are not particularly interested in most Irish businesses. Customer service in the branch system is poor, reminiscent of the 1980s post offices. The banks’ IT offerings are also subpar, with one of the major lenders providing a lamentable service.
A study by S&P, reported on by the Financial Times, measured the extent to which banks passed on official rate increases to depositors. Among the 22 countries analyzed, UK banks topped the table by passing on 43% of rate increases to depositors. In contrast, Irish banks were at the bottom, passing on just 7% of rate increases. As a result, it is unsurprising that AIB announced significant profits in the first half of the year. When a bank operates in a strong economy, passes on a low percentage of rate increases to depositors, raises rates for customers, and implements cost-cutting strategies, it does not require a genius management team to deliver strong profits.
Given the lack of competition in the Irish banking sector, arguments about the salary cap are baseless. This raises questions about the role and purpose of banks in the modern Irish economy. At its core, a bank’s role is to act as an intermediary between savers and borrowers, doing so in a trustworthy manner. This intermediation is crucial for the functioning of an economy, particularly for small firms that are not well served in the current system. Increased competition is necessary, but it is evident that the State will need to be heavily involved. I have long believed that a State-owned bank, similar to the old ICC, is essential to support SMEs and start-ups. However, it must be properly managed and not run like RTÉ or Bord Pleanála. Additionally, the credit union movement must be up-skilled, properly resourced, and empowered to provide genuine competition.
