about banking 2
TRANSCRIPT
2 ABOUT BANKING
The Role of Pricing in Retail Banking in Ireland
Banking Changeand Consumer Expectations
International Financial Services in Ireland
From Macro to Micro Depfa’s Journey
NOVEMBER 2005EDITION 2
INSIDE
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CONTENTS
ABOUT BANKINGISSN 1649-6671
About Banking is a publication of the Irish Bankers Federation (IBF). Opinions expressed in the magazine are not necessarily those of the IBF, its Council, Committees or the Editor. Reproduction in whole or in part without written permission is strictly prohibited.
The Irish Bankers Federation is the leading representative body for the banking and financial services sector in Ireland. Membership of over 60 institutions includes licensed domestic and foreign banks and financial services institutions operating here. The Federation of International Banks in Ireland (FIBI) and the Irish Mortgage Council (IMC) are affiliates.
President: Diarmuid Bradley Chief Executive: Pat Farrell
Irish Bankers Federation,Nassau House,Nassau Street, Dublin 2Tel: +353 (0)1 6715311Email: [email protected]
EditorFelix O’Regan [email protected]
ProductionPatrick [email protected]
AdvertisingDeirdre [email protected]
DesignDcoy Design www.dcoy.ie
PrintingHudson Killeen
Cover ImageCourtesy of Tom McEnaney
8-10 Delivering a World-Class Electronic Payments Infrastructure in Ireland Anindya Roy
6-7 Banking Change and Consumer Expectations Dermot Jewell
2-4 Newsdesk The latest news from the Irish financial services sector
12-15 From Macro to Micro: Depfa’s Journey Patrick Hughes
16-17 International Financial Services in Ireland: The Next Phase of Development Sean Dorgan
18-20 The Role of Pricing in Retail Banking in Ireland Brian Gannon
22-24 Securing the Future of Covered Bonds Paul O’Connor
2 ABOUT BANKING
NEWSDESK
Ireland needs to build on success in international financial services
Senior international banking executives called for action to ensure that Ireland builds on its success as a centre for international financial services at the recent Global Finance Conference 2005 in Trinity College Dublin, which was sponsored by the Irish Bankers Federation (IBF).
“Ireland has established an impressive footprint in international financial services”, said Mike Ryan, Chairman of the Federation of International Banks in Ireland (FIBI) and Chief Executive, Merrill Lynch Ireland. “It is crucial that we build on the successes of the past and master innovation going forward. It is also essential that we have a legal, fiscal and regulatory environment that facilitates this.”
The central theme of the Global Finance Conference, which brought together over 400 academics and senior financial services executives from all over the world, was Globalisation of Finance and Europe. It also provided a unique opportunity to take stock of Ireland’s vaunted position in the international financial services sector and the contribution of the sector to Ireland’s economic success.
Pictured at the Global Finance Conference 2005 at Trinity College Dublin (TCD): Pat Farrell, Chief Executive, IBF; Mary Robinson, President, Ethical Globalisation Initiative and Former President of Ireland; and Colm Kearney, Professor of International Business and Dean, Faculty of Business, Economics and Social Studies, TCD.
Meade outlines vision for Ombudsman role
In one of his first engagements following his appointment as Financial Services Ombudsman, Joe Meade outlined his vision for the future role of the office at a seminar on complaints handling organised by the Irish Bankers Federation (IBF) and The Institute of Bankers in Ireland.
Pictured at the Complaints Handling Seminar: clockwise from top: Joe Meade, Financial Services Ombudsman; Pat Farrell, Chief Executive, IBF; Eimer O’Rourke, Head of Member Services - Retail, IBF; and George Treacy, Head of Consumer Protection & Codes, Financial Regulator.
Deirdre Lyons, Head of International Financial Services, IDA Ireland, Donal Forde, Managing Director, AIB Bank (RoI), and Mike Ryan, Chairman, FIBI, share a joke at the Global Finance Conference 2005.
ABOUT BANKING 3
IBF supports NALA financial literacy campaign
The National Adult Literacy Agency (NALA) launched a three-year campaign in 2004 to tackle financial literacy, which research suggests is a significant barrier to people accessing financial services. To support this campaign, the Irish Bankers Federation (IBF) has donated educational resources to promote financial literacy and foster an early understanding of money, saving and sensible money management.
These resources, which were originally designed for use in schools, will be adapted for use with adults with literacy and numeracy difficulties.
Speaking about receiving the Money Go Round packs from IBF, Tommy Byrne, PRO with the National Adult Literacy Agency (NALA), said “NALA are delighted to receive this tuition and learning resource on behalf of the thousands of adult literacy practitioners who will use it to support the family literacy development work”.
IMC engages Commission on mortgage market integration
The Irish Mortgage Council (IMC), which is affiliated to the Irish Bankers Federation, is working closely with its member institutions to develop a detailed response to the European Commission’s consultative Green Paper on European Mortgage Market Integration.
Harsha Shewaram, National Expert, Retail Financial Services & Payment Systems in the Commission’s Internal Market and Services Directorate General met with the Council of the IMC at its recent meeting to discuss the current stage of the Commission’s consultative process.
Diarmuid Bradley, President, IBF and Dermott Jewell, Chief Executive, Consumers’ Association of Ireland (CAI) join forces to fight card surcharges.
NALA Public Relations Officer Tommy Byrne receives donated educational resources from IBF Public Affairs Officer Deirdre Casey.
Banks and consumers jointly press for ban on card surcharges
The Irish Bankers Federation (IBF) and Consumers’ Association of Ireland (CAI) have jointly called for a Government review of card surcharges, which are imposed on payments made by consumers using credit or debit (Laser) cards.
The IBF and CAI believe that surcharging should be abolished, or at least more closely controlled, because it is an additional and unfair cost on consumers who pay by card - a cost estimated to be in the millions of euro each year. Also, it reduces consumer choice by discouraging consumers from paying by card. Support for this campaign is being sought of other key parties, including the Financial Regulator and the Office of the Director of Consumer Affairs.
“Banks here are concerned that surcharges on card payments may become even more widespread. We believe that the only effective solution lies in national legislation to specifically disallow surcharging”, said Diarmuid Bradley, IBF President. Describing surcharges as “regressive”, CAI’s Dermott Jewell is adamant that they must be resisted and outlawed.
Harsha Shewaram, Internal Market and Services DG, European Commission with IMC’s Chairman, Aidan Clarke and Secretary, Eimer O’Rourke.
Future of the IFSCElsewhere in this edition we have an interview with Gerhard Bruckermann, CEO of Depfa Bank, headquartered in Dublin since 2002. As one of the leading global providers of financial services to public sector clients, Depfa is part and parcel of the success story of international banking in the IFSC which now plays host to 25 of the world’s top global banks. The IFSC has been an outstanding success in the relatively short time since its establishment in 1987.
The original IFSC tax regime which underpinned much of the early success expires this year. This event serves as a timely
reminder that we now need fresh thinking and renewed commitment by all stakeholders to ensure continued success in bringing the centre to the next stage of development. The review of strategy for the development of international financial services recently initiated by Dermot McCarthy, Secretary General, Department of An Taoiseach, is most welcome. Following through on this important step, we now need early agreement on the way forward, clear accountability for delivery and built-in measures of success - all vital to the effective delivery of the new strategy.
4 ABOUT BANKING
Delivering what consumers wantThis edition of About Banking includes some forthright views from one of our key stakeholders, the Consumers’ Association of Ireland. It is important that we listen at all times to the views of our stakeholders, obtain their insights into the challenges facing our industry and commit to change where we recognise its inherent validity and necessity.
This approach has served us well in recent times as we have promoted important pro-consumer initiatives in a sector that is delivering increased choice for consumers. The competitive landscape for banking here has been transformed in recent years and we now need an appropriate light touch regulatory framework to allow the full benefits of this to accrue to consumers.
Consumers can look back over the last few years and find many things to be critical of in our sector but equally recognise many more positive developments which have delivered significant gains. Customers now benefit from increased choice and access coupled with good and fair value as independently measured against our European and global peers. Bread and butter items such as personal current account transaction banking and mortgages are just two examples of where the sector offers excellent value.
Maintaining competitiveness is the key driver of success for businesses in this economy. It’s important therefore that banking plays its part in supporting and enabling that success. We now have more than 10 business banking providers of core services in this market together with additional specialist
service providers, all offering significantly increased competition and choice. Not surprisingly, a survey last year by Amárach Consulting confirmed that transaction charges for business banking in this market are considerably lower than in the UK. The planned introduction of an IBF Business Switching Code will act as a further spur to competition. A Project Manager and Working Group are already in place and consultation with the various business representative interests has commenced, all with a view to having an agreed Code by the end of this year and full implementation by the middle of 2006.
Since our last edition we have seen publication of the Competition Authority’s study of the sector. We welcome publication because, while we have been proactive in delivering on a number of initiatives to enhance competition, other developments have inevitably had to await the final report. A substantial body of work has already been completed by the sector aimed directly at removing any perceived obstacles to increased competition in both the personal and business banking markets. IBF Personal Switching Code launched earlier this year has considerably raised awareness in this area with some 10,000 customers having already switched using the Code. None of this reflects any complacency within the sector regarding our current state. We clearly recognise that being true to our mission statement - to foster the development of a dynamic, innovative and stable banking and financial services industry which contributes to the economic and social wellbeing
of the country - calls for a journey, not an event; an inclusive rather than an exclusive view of the world. Perhaps, most importantly of all, it’s a call to action which demands a real commitment to change; change that is already well underway.
Pat Farrell, IBF Chief Executive
Change, almost without exception, meets resistance. ‘If it’s not broken, don’t fix it’ invariably comes hot on the heels of an announced decision for change. And this is closely followed by the reality that those who uttered this advice have now been ‘dragged kicking and screaming’ into the now - the future.
This is how the majority ofconsumers view the banking industry, and that is the nice version!
Trust, respect and support have been withdrawn by those consumers who have been made, through years of entrenched immobility, to suffer a serious lack of competition, the absence of choice, and the consequences of a loss of values and ethics. More importantly, and the one which many will never forgive, they were submitted to the ultimate abuse - overcharging to their personal loss and the gain of not one but a number of these financial
monoliths that had posed as their opinionated protector.
Competition The first sign of change now is one of attitude. The sector has gone into a serious damage limitation and correction mode and is trying hard to manage the unforgivable. No tears - but there has been apology, handholding and the promise of more change. Those days, they assure us, of oversights, glitches, computer errors, mistakes, technical faults, serious lack of communication, an internal failure or the result of an unfortunate series of events - are over!
The kicking and screaming part now comes mostly due to the emergence of that long elusive element of competition I referred to earlier. The Danes are invading again and, through their acquisition of National Irish Bank (NIB), are promising aggressive campaigning and value to woo new customers. Bank of Scotland (Ireland) already has
6 ABOUT BANKING
Banking Change and Consumer Expectations
Dermott Jewell, Chief Executive, Consumers’ Association of Ireland
ABOUT BANKING 7
a strong consumer goodwill factor and will undoubtedly receive attention to their offers as soon as they convert their former ESB branch network. Add to this the new RaboDirect offers and the permanent tsb move to get in the game with a challenging ‘free banking’ slap in the face to the existing NIB offer and we are starting to see the marketing techniques actually beginning to emerge that are geared to deliver long awaited benefits to customers - not just shareholders. Clearly, one of the most intense signs of a change of direction is the reduction by Bank of Ireland of almost 20% of its workforce. With real change clearly demanded, the level of screaming from here is deafening.
So, let me strike some more positive notes. The moves by some providers towards free personal banking are welcome. They are long overdue because those ‘valued customers’ who have for years maintained their accounts in credit without receipt of any benefit deserve some reward for letting the banks use their money. The ‘valued customers’ also deserve some significant monetary relief or reward due to the fact that they now use their telephones and computers, at no cost to the bank, for maintaining their accounts. The massive reduction in usage of cheques alone provides massive savings in office space and storage and in staff resource costs.
The move by the Irish Bankers Federation (IBF), willingly supported by the Consumers’ Association of Ireland (CAI), in lobbying the Minister for Finance to remove the double taxation of stamp duty on credit and ATM cards on second accounts was a highly significant one. Specifically so because it brought the two bodies together, singularly focused upon removing an unfair tax on consumers of the service, customers of the banks and already overcharged citizens of the State - well, in this area at any rate!
The CAI and the IBF have lobbied jointly before and will do so again. This, I believe, indicates perhaps one of the most important elements of the change that has come about. This is because we can see in it a willingness and determination to restore some of the quality of the appreciation of the customer that was lost. It also begins to re-establish some of the quality that has been eroded over the years of change, closures, overcharging and denial.
Of course, that said, the business of banking goes on. If consumers fail to make their payments due to oversight, error or internal failure they will continue to be ‘strongly urged to rectify the matter as a matter of urgency’ and also advised that ‘penalties will (and shall) apply’. That is fair enough, but the entire landscape does stand on the brink of more change. A change of attitude and what will be for many a restoration of the quality of service but to a very high level of demand. This level will be compared against the new entrants who will undoubtedly raise the bar from the outset and be poised to raise it even further as the competition, expectedly, heats up.
This ‘quality’ will bring a focus on charges, fees, commissions and penalties. The ‘value’ to the customer will be twofold in that consumers will look to how much they can save, not simply without incurring any loss of quality of service or outlay, but more through continual reward for their custom and a personal form of attention to their banking needs. Any marketing executive will confirm that retention of a customer is far more economically viable than recruitment of one. That form of ‘spend’ - in real terms that actually is visible to the customer - is what will dictate the level of change here and the initial limit of switching loss or retention.
Switching and consumer choiceThis brings me to perhaps one of the
most significant of long overdue changes recently introduced into the Irish banking system - the facility, thanks to the IBF Personal Switching Code, to switch personal bank accounts with a limited delay, red tape or cost for the ‘switcher’. This is hugely significant because it allows the market to really work and lifts old and deeply- set barriers to competition that had dissuaded so many for so long. This has not so much been a case of biting the bullet but rather a very unique form of disarmament.
So, we see the way clear for new entrants, new products, transparency within charging structures and the possibility for real value and innovation across the spectrum of products and service offers. How innovative, how transparent, how strong in value and how realistic these will be in their level of charge to the consumer only time will tell. Suffice it to say that many are keeping a beady eye on progress - especially on the rates and charges. Innovation also has its potential for problems and the offers of 100% mortgages, easy access to credit and debt management must all, of necessity, form an integral part of this fast moving factor of change. Otherwise it will be futile. That path of future progress will be significantly improved if a structure of clear and understandable criteria is adopted for every customer required to operate and move within the banking system. Consumers have the power to dictate how rapidly that takes real shape. However, two considerations need to be borne in mind. First, consumers must be proactive - having demanded it they must avail of the change, use it and mould it into their preferred state. And, lastly, notwithstanding Caveat Emptor, they should always be mindful that, unless they do so, the odds will move against them and dictate that, as far as they are concerned, the house always wins!
“The CAI and the IBF have lobbied jointly before and will do so again. This, I believe, indicates perhaps one of the most important
elements of change that has come about.”
8 ABOUT BANKING
Delivering a World-Class Electronic Payments Infrastructure in Ireland
Anindya Roy, Senior Manager, Financial Services, Accenture
Developing our electronic payments infrastructure can help address some of the strategic challenges facing the economy, argues Anindya Roy.
The key message from the Information Society Commission’s 2003 report, “Delivering A World Class Payment Environment”, is as relevant today as it was two years back. This is that the use of cash and cheque payments in Ireland remains one of the highest in Europe and this constitutes a substantial cost to the Irish economy. In particular, the relatively high prevalence of cash payments has been linked to the fact that a sizeable segment of the adult population in Ireland does not have
access, for whatever reason, to the payments system. As Figure 1 shows, the relatively low number of total cashless payment instruments per capita in Ireland (76 per annum), compared to the EU average (150 per annum), reflects relatively high use of cash payments. Ireland also has the fourth highest usage of cheque payments in the EU.
Armed robberies of cash-in-transit vehicles, for example, have highlighted the cost to society at large of a continuing high level of cash payments. This is reflected not only in the increased cost to businesses and banks of handling cash, but also the impact of criminal activities on society at large. Conversely, greater adoption of electronic payments can lead to significant benefits to Irish businesses and consumers, not just in financial terms but also in broader socio-economic terms.
ABOUT BANKING 9
Lower cost, wider choice, greater social inclusivenessThe most obvious financial benefit of cashless payments is the cost saving arising from a reduced need to handle cash or process cheque payments. According to the Information Society Commission report, just these savings, on a gross basis, could potentially amount to between €200 million to €500 million per annum, or around 0.3% of GNP. While there are a number of assumptions behind these estimates, they clearly show the very significant potential for savings.A pervasive, multi-channel electronic payments environment, enabling quicker migration from cash and cheque to electronic payments, could significantly reduce the cost of providing electronic payment products and services and create opportunities for innovation. This would create a “virtuous cycle” that, in the longer term, would benefit consumers in many ways. For example, access to cost-efficient banking, and ultimately to a wider range of financial services, could be provided to traditionally underserved segments of the population by leveraging a pervasive and low-cost electronic payments environment.
Such universal access to the payments system could therefore help to contribute to increased social inclusiveness. Also, consumers could have more choice and convenience in carrying out commercial transactions and availing of public service delivery using electronic channels, such as the internet or mobile phones.
However, all of this can only be achieved through development of a world-class electronic payments infrastructure which offers inter-operability to payment services providers and convenience and choice to consumers. Such an infrastructure is, in fact, a critical component of the overall technology infrastructure of any country and helps to contribute towards sustaining economic growth and global competitiveness.
The World Economic Forum, for example, measures the development of electronic payments infrastructure as part of its evaluation of the “network readiness” of a country - that is, its technology infrastructure and environment, which is a key leading indicator of global competitiveness.
In many ways, Ireland is well positioned to become one of the “best practice” countries globally in the area of electronic payments. Our demographics - age, education, income profile - are highly favourable for greater acceptance of electronic commerce and increased sophistication in the use of technology. Over the last decade, there has been significant growth in electronic payment volumes and many of the infrastructure elements of electronic payments. For example, the number of credit cards has more than doubled, while debit cards have grown from zero to over one million in a relatively short period of time. The number of ATMs and merchant point-of-sale devices in Ireland, on a per capita basis, is now comparable to or better than many other EU countries including Sweden, Germany and the Netherlands.
Alignment of stakeholder interestsSustaining this growth in electronic payments into the future and transforming the electronic payment infrastructure in Ireland presents a significant challenge for the many stakeholders involved, including banks, businesses, retailers, consumers, transport operators, telecommunication companies and public sector agencies. Many of these challenges are of a global nature and it would be difficult to come up with an Ireland-specific solution. In this regard, there is a lack of clarity around common standards and inter-operability in many emerging electronic payments channels such as mobile payments or smart cards.
On the other hand, within Ireland there are potential opportunities for the stakeholders to align, integrate and/or leverage current and planned broader infrastructure initiatives that could transform the future shape of electronic payments here. Some of these opportunities lie in the potential synergies between initiatives such as integrated public transport ticketing, Chip and PIN roll-out of bank cards, use of smart cards for identity, rollout of broadband internet access and of 3G mobile network access.
Figure 1: Use of Cashless Payment Instruments(Number of transactions per inhabitant) Credit Credit & Direct Cheques Card Total transfers debit card debits based payments e-money
Belgium 67 60 19 2.3 10.3 158Denmark 45 105 28 6.8 1.3 186Germany 69 27 64 1.6 0.5 162Greece 1 5 1 2.4 nap 10Spain 15 27 34 4.3 0.03 80France 42 71 38 64 0.29 215Ireland 10 38 10 18.7 nap 76Italy 18 17 12 8.7 neg 56Luxembourg 29 81 11 0.6 6.7 129Netherlands 78 74 61 neg 6.7 219Austria 109 24 80 0.8 2.2 216Portugal 10 65 14 23.2 0.1 111Finland 109 106 12 0.2 0.2 227Sweden 48 84 15 0 0 147United Kingdom 37 87 41 37.9 nav 203EU 43 49 38 20.2 1.2 150
Source: European Central Bank, Blue Book Addendum, August 2005
10 ABOUT BANKING
Delivering a World-Class Electronic Payments Infrastructure in Ireland
Recent experience in Asia has demonstrated how different stakeholders (including, for example, banks, mobile operators, device manufacturers and transport operators) can come together to create value-added mobile payment services for consumers, which are also economically viable for the stakeholders. Increasingly, the net result is that mobile phones are used to pay for an expanding range of products and services, from train tickets to theatre tickets, thereby substituting the use of cash. Other examples exist of stakeholder collaboration that create economically viable alternatives to cash usage, without necessarily requiring huge investment in new technology. Pre-paid cards have been extensively used in the United States and in many emerging economies to provide payroll services and social benefit transfers for people without bank accounts. This has involved collaboration between banks, private sector businesses and government agencies. Although such stakeholder collaboration is by no means easy to execute, it could be argued that, given Ireland’s market size, a substantial level of industry collaboration is a prerequisite for progress with the payments agenda; based, that is, on the experience of other countries with comparable population and economic size.
Single European Payments Area (SEPA)Of course, regulatory demand is another key determinant of the future electronic payments infrastructure in Ireland. The biggest regulatory challenge in payments for all eurozone countries over the next few years is to realise the vision of a Single European Payments Area (SEPA). According to the European Central Bank (“Towards A Single Euro Payments Area - Third Progress Report”, December
2004) the progress towards SEPA is to be marked by three phases/milestones:
1. January 1st, 2008: Payment infrastructure in all eurozone countries to meet target service levels required by SEPA. Consumers and businesses will have access to both SEPA-compliant and existing/legacy payments products and services
from banks;
2. January 1st, 2010: Convergence of all eurozone payment systems and full migration of all payments back-office infrastructure to SEPA. All payments products and services offered by banks will be SEPA compliant;
3. Post-conversion period, beyond 2010, when most/all volumes should have migrated to SEPA.
While it is still unclear how the pan-eurozone payments landscape will be configured during 2008-2010 to realise SEPA, some of the likely implications are quite clear and significant. Since businesses and consumers will be provided with the same efficient service standards at the lowest cost anywhere within the eurozone, every country will have to move towards a more efficient domestic payments infrastructure if that infrastructure is to remain economically viable and relevant after SEPA conversion. It is therefore in the interests of all stakeholders in Ireland to work towards a step change in the efficiency and competitiveness of the electronic payments infrastructure. This would also have the additional benefit of enabling multinationals and Irish businesses to utilise their existing links into the Irish electronic payments infrastructure in order to process transactions across the eurozone.
All of this points to the strategic imperative of developing the electronic payments infrastructure in Ireland over the next few years in order to create a more pervasive and efficient electronic payments environment. It would address a number of strategic challenges in the medium term that are faced by the economy as a whole: namely, reducing use of cash, reducing paper processing costs in the economy, creating wider banking access to underserved segments of the population and creating more consumer choice and convenience for electronic multi-channel access to commercial transactions and public service. It would also make Ireland’s domestic payments infrastructure economically viable and relevant in the context of SEPA.
The National Payments Strategy is the best means of delivering an electronic payments infrastructure in Ireland that is used and shared by all stakeholders in a transparent way, ensuring competition as well as opportunities for innovation and growth. For this to be effective, it is critical to have the right engagement model with all of the key stakeholders - including government - so that there is a shared strategic vision, a realistic road-map and a clear commitment to make this happen. A collaborative effort in this direction is already underway, involving the Government, regulators and the Irish Payment Services Organisation, to provide a framework for delivery of the National Payments Strategy and to develop a protocol for wider engagement with all stakeholders. It is imperative that there is strong support and commitment from all stakeholders to sustain and further develop this process, so that the transformation of Ireland’s electronic payments infrastructure becomes a reality.
“The biggest regulatory challenge in payments for all eurozone countries over the next few years is to realise the vision of
a Single European Payments Area.”
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12 ABOUT BANKING
From Macro to Micro:Depfa’s Journey
The state sized bank with a fresh view on development
Gerhard Bruckermann must be a happy man.The bank of which he is Chairman and Chief Executive, the IFSC-based Depfa, has had yet another successful business year. Yet to perceive the bank as solely a vehicle for making large profits would be to misconstrue its unquestionable ethos. Patrick Hughes met Gerhard Bruckermann to find out more.
Depfa: The BackgroundFounded in 1922, Depfa was established by the German government to use long-term bonds to alleviate pressures in the social housing sector. It was privatised in 1991, just two years after the fall of the Berlin Wall.
By the time Gerhard Bruckermann was on the board of Depfa, the bank had widened its gaze to public sector financing and other countries in the European Community. It had a particular desire to develop business in the English-speaking world. “We chose to open an office in Ireland for simple reasons”, says Bruckermann, “the language, the people, the IT infrastructure and the cost of doing business here were paramount, especially the low tax regime”.
Originally, the Irish office was established as a subsidiary to deal with non-German business. As this business grew and
grew, the bank turned the Irish office into its global headquarters.
Microfinance Compare and contrast. A global bank engaged in state finance, with not a single account holder. A local co-operative operation, providing loans of tens of dollars to rice farmers in remote Cambodia. The two could not be further apart in conceptual terms, and yet the latter is at the heart of Depfa’s ethos.
“For many years, Depfa didn’t have a formulated policy on social responsibility”, explains Gerhard Bruckermann, “though we funded a school for the blind in Germany since the 1950s, and have been involved in educational projects like Erasmus and sponsoring initiatives around languages and mathematics - core missions for the bank itself”.
ABOUT BANKING 13
“Microfinance refers to small scale finance which provides loans on a very local level to economically active people”
14 ABOUT BANKING
The needs of local farmers in developing nations are not an expected core constituency for a bank like Depfa. “I attended an event that we sponsored at which Tom Arnold of Concern spoke” explains Bruckermann. “I was hugely impressed by his message, and decided to find out if there was anything we could do to help”.
The result? Depfa’s involvement with Concern’s microfinance operations in Cambodia. “Microfinance refers to small scale finance”, says Concern’s Chief Executive, Tom Arnold, “which provides loans on a very local level to economically active people who wish to develop a small business or objective to increase their livelihood options”.
Concern was already involved in microfinance institutions (MFIs) before Depfa’s participation, and Concern still fully owns its microfinance facility. “MFIs have a great impact on the communities where they are available”, says Tom Arnold. “For example, AMK Cambodia grew out of community development work, and became fully licensed by the Cambodian Central Bank in 2004”.
How Microfinance Works“Loan officers travel at regular dates to communities where Concern offers MFI facilities” explains Gerhard Bruckermann, “and they extend small finance to those who present themselves, collect payments and move on to the next community. AMK, for example, has a Board that licenses individual loan officers, who apply well thought out lending criteria. The loan facility itself is an extremely sophisticated, and flexible, product”. “The debt repayment ratio is much higher than in Western societies at around 98%. Interestingly, women make up around 80% of applicants in some
regions, and that might be for a variety of sociological reasons, including that they are seen as being economically more active”.
Depfa’s input to such projects combines funding of €50,000 per month with other important assets. “This kind of finance has nothing to do with Depfa’s business model”, states Bruckermann, “but I wanted Depfa people to be really involved in Concern’s projects”. He himself has recently returned from a trip to Mozambique to see other projects. “This is now an integral part of the work of the bank, not just in providing financial advice, but also through our people providing expertise like legal, IT and audit services. This is now part of our corporate culture.”
Concern and Depfa are involved in developing nations such as Cambodia and Mozambique. “In Mozambique, the population has been utterly ravaged by HIV/AIDS: facilitating people to develop their own small businesses is one step in the building blocks of education that will alleviate their situation.” New initiatives are underway in Eritrea and Ethiopia.
“Such finance initiatives are unlike any sense of banking as we know it,” says Bruckermann. “They go into areas that are fairly inaccessible, and where the only previous facility was usurers or money lenders, charging huge interest rates.” Did this previously exacerbate problems in those regions? “Without question. MFIs offer a real alternative to people, and the beneficial impact that I have witnessed in those societies is simply huge.”
“One of the goals of the MFI is to recover its money, not to make a profit”, says Bruckermann. Previously, the only source of funding in such areas was
from moneylenders, who charged interest rates of between 100 and 200%. Bruckermann explains “MFIs charge a much more reasonable rate of a little over 30%, which fully covers all the costs of loan officers travelling hundreds of miles across inhospitable terrain to get to a local community. Though such a rate might seem high to Western minds, in these circumstances it allows MFIs to survive”.
The relationship between Depfa and Concern runs deep. Mr Bruckermann explains that when he got to know more about Concern “I could see that, as an NGO, it was fairly non-political, and that matched with the ethos of the bank. Other NGOs stimulate political debate, and very effectively too, but that is not the stated goal of Concern”.
Social ResponsibilityDepfa works with almost 6,000 local authorities around the world, and its board system is centred on the CEO. This means that the bank can make decisions quickly, certainly a key to its ongoing success. And yet it is not well known in Ireland.
Placed against the work with Concern, the billions this bank handles and its international state profile remains seemingly incongruous. “Increasingly, the expertise of Depfa as a state project-funding bank can be brought to bear in developing nations”, says Bruckermann. “We are working with the World Bank to see how we can help to manage country funds. In projects like this, we can see how our two seemingly disconnected worlds merge: we have expertise in helping governments to fund and develop major infrastructure initiatives, and in our work with Concern in developing small initiatives in developing nations. If we put these
From Macro to Micro: Depfa’s Journey
“We can facilitate communities to take an element of their future back into their own control, and the impact
on societies of that is and will be huge.”
ABOUT BANKING 15
two things together, we might be able to help such nations at a macro, as well as a micro level.”
Gerhard Bruckermann and Depfa do not blow their own trumpet about their work under the heading of social responsibility. “From our work with Concern, we accrue no benefits. However, for our people, the work really functions at the level of a motivational objective, but we’re not trying to make any PR capital out of this. We are extremely lucky, we are at a phase in history where we could financially and technically eradicate absolute poverty. Of course governments have a genuine responsibility, but personally we do too: as corporations and individually. Our generation has that responsibility right now”.
“ I’m very interested in ensuring the correct balance of regulation: too much stifles growth, too little creates a difficult working environment”
PPPs in IrelandThe experience of Depfa in providing public sector finance must also have some relevance closer to home. “The scope for Public Private Partnerships (PPPs) in Ireland is huge,” says Bruckermann, “because the high growth rate of this economy is matched by a lagging infrastructure. PPPs help to speed things up hugely in sectors like health, education and transport. With careful consideration, there are combinations of public and private funding that can produce real results for the nation”. In recent times, Ireland has seen a very public debate on the lasting value of PPPs, particularly with the ongoing debate about the Westlink. Bruckermann’s view? “A PPP gets an initiative going that wouldn’t otherwise be budgeted for. The private sector needs some incentives to be involved. Not every project ends up being as lucrative as Dublin’s Westlink toll bridge seems to have been. But there are methodologies that help avoid such
controversies: for example, sharing revenue when the project achieves more than a specified return”.
The View from the IFSCContinuing on the theme of success, Bruckermann sees the role of the IFSC as being central to the ongoing socio-economic development of the country. “Over the years, the IFSC has developed into a vibrant business district in its own right within the city of Dublin through the conglomeration of offices. It has attracted its own ancillary legal and accounting practices and has an important role to play in the creation of cutting-edge professional jobs.”
It is fair to say that most commentators see that the ongoing development of the IFSC must be continued in a wider context. Bruckermann contributes to this debate: “I’m happy overall with governmental policy in the sector, but I’m very interested in ensuring the correct balance of regulation: too much stifles growth, too little creates a difficult working environment.”And moving forward? “The elements that will continue to drive the growth of the IFSC include a general positive political climate to support business development, along with the creation of an infrastructure that facilitates non-nationals in areas such as schooling and housing. Further, a fair and efficient visa policy is necessary to attract top professionals and add to the pool of expertise in Ireland.” Finally, can the IFSC stay ahead of the game, should other economies attempt to replicate its success? Bruckermann answers that question with one word: “Flexibility”.
Microfinance in ActionTwo stories of how microfinance has helped change lives in Cambodia.
Ith Ya, 40, is widowed and trades in stone goods in the Banteay Meanchey province of Cambodia. Her shop is located in her village, but she also sells her items (including sharpening stones, sculptures, mortars and pestles, and rice mills) in other areas. She began by selling her goods from in front of her house in 1999 when she received her first loan from AMK Cambodia. Now she has many clients, and hires between 10 and 20 skilled and unskilled workers every day. It is a family business: her son looks after the workers, while she and her mother take care of trading. In the future, she would like to hire more workers to meet demand.
Phuon Siek is 49 and married, and raises livestock in Pursat, Cambodia. He trained as a vet, and currently owns 5 cows, 1 ox, 6 buffalo and a pig. He started out by investing his own savings with a loan from AMK to buy three piglets. With the profit, and a further loan, he bought a rice field and two more piglets. With his new profit, and a third loan, he bought a cow. His fourth loan bought him another piglet and some fertilizer. In the future he intends to rent his cows and buffalo to his neighbours.
Adapted with the kind permission of Concern.
International Financial Services in Ireland:The Next Phase of Development
Sean Dorgan, Chief Executive, IDA Ireland
Following years of tremendous growth and success, Ireland’s international financial services industry now needs to move beyond transaction processing to focus more on activities that are revenue and profit based, writes Sean Dorgan.
Since the formation of the IFSC in 1987, Ireland’s position in the international financial services industry has undergone a complete transformation, evolving from an industry serving local market needs into one of the world’s leading financial hubs. It has also contributed to and mirrored Ireland’s economic development, particularly over the last decade.
Dublin is now internationally recognised as a first choice location for the international financial services industry, ranging from banking and treasury to insurance and funds. This is largely due to Ireland’s reputation for highly-skilled and experienced people, our ‘can do’ business attitude, responsive legislation and flexible, speedy regulatory procedures. Identifying the challenges aheadNotwithstanding the success achieved to date (see the side panel on page 17), the industry in Ireland is constantly facing new challenges. New competitors are emerging, both from within the EU and worldwide, all eager to replicate Ireland’s achievements. The world of financial services is changing; there are new pressures on various sectors of the industry. We must constantly evolve and build on our strengths and develop new areas where Ireland can achieve the lead position.
IDA Ireland has undertaken several new measures specific to the international financial services area to ensure that Ireland is prepared for the next phase of development in the industry. IDA Ireland’s International Financial Services team has been expanded and a renewed emphasis has been placed on promoting the new potential business in the industry. In order to examine potential areas of
opportunity, IDA Ireland commissioned international consultants, Deloitte, to undertake a study to examine the current position of the industry and to identify areas for future development.
The findings of the Deloitte report, “The Future of the International Services Sector in Ireland”, identified emerging global trends in the industry and pointed to key areas of opportunity where leadership could be achieved and key competitive advantages could be developed in the future. Areas highlighted in the report include:• Specialist debt/financing products and securitisation• Managing global/regional banking products• Funds servicing• Asset Management• Pan European mass risk/retail insurance products
Meeting these challenges The industry in Ireland is now at a crossroads. The majority of the activity, and therefore the employment, is centred around transaction processing. This needs to change if international financial services are to remain and develop in line with Ireland’s ongoing economic growth.
Ireland needs to move from this phase of transaction processing to one which is revenue generating and profit motivated. A number of companies have already made this transition - for example, Merrill Lynch and KBC - and there are others whose activities were and are revenue and profit based. This basis of operation is not new to Ireland and the majority of multinational companies who operate here across other sectors such as life sciences, ICT, and engineering are focused on revenue and profits.
16 ABOUT BANKING
ABOUT BANKING 17
In line with this step change in the activity base IDA proposes that Ireland’s international financial services companies should become actually involved in creating knowledge within their companies. Such knowledge will lead to creativity, innovation and product development. It will help companies to win corporate mandates, deepen relationships with the customer and increase sales and marketing activity. A good example is Citigroup, who recently announced the establishment of a Research and Development (R&D) Centre of Excellence at its Dublin offices in the IFSC. This is the first dedicated R&D Centre established by Citigroup worldwide and the first ever R&D investment by a financial services company in Ireland.
The infrastructure required for this transition is fundamentally in place. However, step changes always require refinements and the international financial services sector is no different.
As recommended by Deloitte, the education inputs could be enhanced by creating a “chair of financial services”, increasing the number and scope of academic courses in the areas of risk management and computational finance together with more collaboration with internationally recognised schools. In this regard, the recent development and launch by the Irish Bankers Federation (IBF) and The Institute of Bankers in Ireland of the Executive Masters Degree in Risk Management is particularly welcome. Now underway in University College Dublin, this MSc course should help meet the need for more well-qualified risk management professionals.
It is important that Ireland’s taxation environment is “capital friendly” and that there is an ongoing development of our extensive double taxation agreements. Equally, it will be important to ensure sufficient regulatory measures are available to support the Financial Regulator’s stated role of facilitating innovation, competitiveness and growth in the sector through effective and responsive regulation.
A key factor in the success and growth of the IFSC has been the team effort that has gone into achieving this. The partnerships that have formed over the years between the various government departments and agencies, the industry itself and the supporting professional services have been key to the success story. It is crucial that this cooperation continues as we move into the next phase of development for the industry.
The industry in Ireland is reinventing itself at accelerating rates and we must work to ensure that Ireland keeps pace with these changes in order to maintain our position as a world leading location for the industry at the forefront of developments. IDA Ireland will continue to work with companies and representative bodies, such as IBF, to ensure that Ireland offers the most attractive package to the industry in terms of business knowledge, skills and responsive legislation. However, we face the challenges with confidence that Ireland can continue to meet the needs of the international financial services industry based on our ongoing success and the responsiveness Ireland has displayed since 1987.
Making Ireland a Global PlayerThe listing of IFSC companies reads like a “who’s who” of top global financial institutions with companies such as Citigroup, State Street, Depfa Bank, JP Morgan, HSBC, Merrill Lynch, XL, Hartford and ABN AMRO managing European and global functions from the IFSC. Dublin is now home to half of the world’s top fifty banks and one of the main European locations for insurance (both life and general) and an internationally recognised hub for the funds industry. Up to 16,000 professionals work directly in the industry today, with as many again employed indirectly in support services (legal, tax, accounting etc.)
Some highlights, which give an idea of the scale of operations in the IFSC, are:
• Bank assets of international banks are now worth over €337 billion; • Net asset values of domiciled investment funds are €498 billion; • Cross-border life assurance premiums are €5.6 billion; • Some €700 million paid by IFSC companies
in corporation tax to the exchequer in 2002, which accounted for 15% of the total take for the year.
The success of the IFSC has led to the growth of non-regulated financial services activities, expanding into locations nationwide. A key element of IDA’s strategy is to continue to encourage and support the development of financial services activities beyond the greater Dublin area, ensuring Ireland and not the IFSC alone is internationally recognised as a first-class location for the industry. A growing number of companies are already doing this by adding operations centres and back office and administrative activities, with strong clusters of these activities being developed in several regional areas across Ireland.
The year 2005 alone has seen companies such as IFS and Bisys expand with new regional operations in Drogheda, Naas and Waterford, while PFPC has built on its positive experiences in Wexford and is expanding its existing facility and opening a new office in Navan. Other companies that have found success outside the IFSC include Sun Life in Waterford, State Street in Kilkenny, GMAC in Mullingar, MBNA in Carrick-on-Shannon, Cigna in Galway and Pramerica and Pacificare in Letterkenny.
The Role of Pricing in Retail Bankingin Ireland
Brian Gannon, Head of Financial Services UK and Ireland
Brian Gannon believes that, with little scope left to compete on price for basic services, retail banks in Ireland need to intensify the drive for service improvement with technology and innovation askey drivers.
It is only in recent years that consumers have become more aware of the costs associated with the financial products and services they buy. This is partly because the levels of financial literacy among the public at large are low, but
also because the charges for services have not been as transparent as they might be from country to country. Although banks generally publicise charges for their core products, it is difficult to compare the cost of the basic services across national boundaries, since not all services and products are directly comparable.
The Capgemini World Retail Banking Report sheds some light on this. Its goal is to provide people in financial services around the world with a clearer view of the dynamics of today’s retail banking industry. The report presents an annual index of prices of banking services across national markets. However, because of the difficulty in direct comparison, the pricing indices are restricted to day-to-day banking products and services, and do not represent an all-encompassing benchmark of retail banking prices.
18 ABOUT BANKING
Source: Capgemini Analysis 2005, World Retail Banking Report 2005
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Figure 1: Annual weighted prices of core banking services by country using global usage profile, 2005 (€)
ABOUT BANKING 19
Earlier this year, the Irish Bankers Federation commissioned Capgemini to include Ireland in its international survey, measuring the same services in the same way as it did for other countries. The original research, which covered 130 banks in 15 European states, the US, Canada, China and Australia concluded that the average cost of basic banking services was €108 annually, ranging from a low of €34 to a high of €252. This wide range shows how independent each country is when it comes to setting basic prices, although the report notes that usage and customs vary substantially between countries.
Cost of banking well below global averageSo how did Ireland measure up? In fact, as Figure 1 shows, Ireland fared extremely well in its pricing, coming in as the third lowest pricing regime out of all the 20 countries surveyed. Only the Netherlands and China provide basic services at lower prices. Ireland’s cost of banking is €59, against the average of €108 across all of the countries surveyed. However, a number of anomalies are noteworthy: the Irish government charges stamp duty for cheques, and this is not standard practice in other countries. Also, an annual government duty applies to ATM, debit and credit cards (again not standard practice elsewhere) and these were excluded from the analysis.
As Figure 2 shows (p.20), the cost of banking services in Ireland is also low on a GDP per capita basis compared to other mature markets. At 0.13% of GDP, Ireland’s cost is half that of the UK and only the Netherlands
and Sweden among the 20 countries surveyed are comparable.
Some other conclusions are worthy of note. Banks in Ireland have adopted a mix of pricing strategies, with transactional-based pricing on payment and cash utilisation products, like cheque books, debit card cash deposits at desk and withdrawals at banks’ ATMs. The report noted that there is little variation in usage patterns between those Irish banks which charge for both ATM withdrawals at their bank and others, and those which do not charge at all. And in Ireland, as elsewhere, banks are using pricing to persuade consumers to use certain products and services and not use others.
Where can Irish banks compete?If the pricing for core banking services in Ireland is comparatively low, what scope does this give the banks to compete? The Capgemini report poses this question differently but raises the same issue: how can retail banks in mature banking markets increase their share of wallet from high-potential, mass-affluent customers? Based on interviews with banking executives across the survey locations, Capgemini found that most institutions are attempting to establish or refresh a relationship approach with their clients. Their objective is to meet customers’ needs more effectively and increase the perceived value of the banks’ services and retail solutions. However, the report found that very few financial institutions have set up a fully structured approach to client relationships, or attempted to align the critical elements required to produce
results, such as understanding and segmenting customers, product and service offerings, organisation, structure, IT and tools, and performance management.
Another recent report, ‘Powerful Pricing Processes’, by Georg Wuebker and Jens Baumgarten of Simon-Kucher & Partners, also looks at this issue. The report notes: “After rounds of heavy cost cutting, companies have nearly exhausted the potential to reduce costs any further. Now management must concentrate more on revenue and price.” This mirrors a Capgemini conclusion from its study in Ireland: that banks do not have much scope left in competing on price for basic services. If this is so, banks need to compete in other areas - most notably in intensifying the drive for service improvement. Wuebker and Baumgarten conclude that management should concentrate more on ‘intelligent’ price increases than on other measures such as cost cutting, especially in situations with low unit margins.
The key to success for banks, say the authors, is to apply innovative price strategies that focus on the customer’s needs and implement these strategies using an effective pricing process.
In Ireland, as in many other countries surveyed in the Capgemini report, the financial services sector is regulated - although regulation of prices per se is unique to Ireland. While there is increasing clarity (and some concern) about the increasingly onerous regulatory burden borne by financial services institutions, there is less discussion about the role of the regulator in pricing of basic services.
“...as Figure 1 shows, Ireland fared extremely well in its pricing, coming in as the third lowest pricing regime out of all
the 20 countries surveyed.”
20 ABOUT BANKING
In the UK, for example, the Financial Services Authority champions consumer rights, but does not see itself as a regulator of competition, leaving that to the Office of Fair Trading. In Ireland it is difficult to assess the impact of price controls on competition. Who could say whether the abolition of price controls and introduction of freer market forces would help consumers get a better deal - although the launch of various free account offerings shows that banks are prepared to be very innovative in pricing when it comes to acquiring customers.
The role of technology and innovationOne further important question arises from the Capgemini study: why is pricing in the Netherlands the lowest of all the countries surveyed, and significantly lower than the average price of core services? The answer is that Dutch banks have invested heavily in technology to reduce the
cost of processing, and have passed a proportion of these cost savings to customers. Capgemini research shows that the average number of cheques written by a person in the Netherlands is two per annum, which compares to almost 48 in Ireland. Many of the processes associated with basic banking services are heavily automated in the Netherlands, and this reduces the cost of providing these services.
There is certainly scope in Ireland and the UK to follow this technological lead. Most of the major banks have initiatives in place to automate front and back office processes - and many are well advanced in implementing technology-enabled services to their customers. Other EU-sponsored initiatives, like the Single European Payments Area, will lead to further investment in technology in the coming years, speeding up an inevitable process.
A final point relates to banks’ profitability. Both in Ireland and in the
UK, financial institutions have been accused of earning excessive profits. The Economist noted that, last year, Britain’s four biggest banks between them made £6.7 billion profit from their retail banking operations in Britain - a profit of about £126 per customer. It asked whether this points to a market inefficiency - in other words, is there some reason why competitors have failed to provide cheaper services? Que Choisir, the French equivalent of Britain’s consumer magazine, Which?, calculated that French banks charge a margin of between 35% and 100% above the costs of technical banking services such as payments by cheque. Even then, as our World Retail Banking Report shows, a number of countries leave France and the UK well behind when it comes to charging for core banking services. Whatever grounds for complaint bank customers in Ireland may have, they cannot point the finger at excessive charging for such services.
Chin
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Figure 2: Local profile prices of core banking services versus GDP per inhabitant (%)
Source: Capgemini Analysis 2005, World Retail Banking Report 2005
The Role of Pricing in Retail Banking in Ireland
Concern works with poor communitiesso they can protect themselves fromthe uncertainties of the future – byhelping build the resources peopleneed to make their lives more secure.
In Ethiopia, we are helping familiesbuy new stoves to bake and sell bread.These stoves will continue providingfamilies with a secure source ofincome for many years to come.
In Laos, our ‘Farmer Fields Group’teaches local people new techniquesto increase their rice production andhow to make natural remedies whichkill off pests. As a result, families cangain extra income by selling surplusrice seed.
Please help us provide the long-termsupport that makes a real difference to
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• €30 could help buy 100 kilos of seed in Ethiopia.
• €100 could help towards a'Farmer Fields Group' to helplocal people increase agriculturalproduction in Laos.
Khamla, Photo by: Justin White, Laos 2003
Fighting poverty throughimproving livelihoods.With Concern’s help, Khamlaand his family have enoughfood for the year and to savefor planting next year.
With Concern’s help, Khamla hasbecome self sufficient and cannow grow enough rice to feed hisfamily for the entire year.
How you can help families fight poverty
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I enclose a cheque made payable to Concern OR Please debit my Amex/Laser/Mastercard/Visa (delete as appropriate)
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Please check the information and return this form to:Livelihood Appeal, Concern, Camden Street, Freepost, Dublin 2. Thank you. ARAD05-03/006
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22 ABOUT BANKING
Securing the Future of Covered Bonds
Paul O’Connor, Head of Prudential Supervision and Risk, Irish Bankers Federation
The interests of Ireland, and a competitive European Union market, are well served in new measures adopted at EU level for the rapidly-developing covered bonds sector, writes Paul O’Connor.
Rapidly-developing with huge potential for further growth, the covered bonds market is now the second largest bonds market in Europe, after government bonds. New legislation and continuous product innovation have established covered bonds as the most important segment of privately-issued bonds on Europe’s capital markets. With some 23 European countries active in this market, the volume of covered bonds outstanding exceeded €1.6 trillion by the end of 2004.
Ireland enacted legislation enabling the issuance of covered bonds in 2001 and the first issues took place the following year. By 2004, Ireland represented almost 5% of the total outstanding balances of the larger covered bonds, called jumbo covered bonds, and accounted for over 12% of new issues of jumbo covered bonds during that year. Banks such as Depfa Bank and WestLB are highly active in the public loan covered bond arena through their Irish operations whereas Bank of Ireland
is active in the area of mortgage credit covered bonds.
Covered bonds secured with mortgage credit are a major source of funding for the European mortgage market, which stood at €4.7 trillion at the end of 2004. There is likely to be further significant growth in all areas of the covered bond market over the coming years, driven in part by the continued expansion of the mortgage market.
Already, the mortgage market has expanded at an average annual rate of over 8% for each of the past ten years, with 9.7% recorded in 2004. In the enlarged European Union of 25 Member States, the fastest growing national markets are the Central and Eastern European countries. Ireland, Spain and Greece are the fastest growing markets amongst the EU15.
European mortgage debt amounts to 45% of EU GDP compared with a US figure of 65%. While the two markets are not directly comparable, there remains significant room for growth in Europe.
ABOUT BANKING 23
Addressing shortcomings in EU legislationThe European Commission’s Capital Requirements Directive (CRD) defines the rules for capital adequacy of banks for the next generation of banking. This is the level of capital required by institutions to ensure that they maintain the appropriate level of capital to reflect the risk profile of their assets. This is essential to protect banks from insolvency and to protect their customers’ interests.
With regard to covered bonds, the CRD defines the minimum regulatory capital requirements for covered bonds and specifies a range of eligibility criteria which must be fulfilled if the bond is to receive capital treatment as a covered bond. A covered bond meeting the criteria laid out in the CRD can achieve a lower risk weighting of 10%.
The original proposal by the Commission contained a number of restrictive measures which would have seriously reduced the ability of Ireland and other EU countries to compete with the traditional providers of covered bonds – Germany, Austria and Denmark. Given that all covered bonds issued in Ireland have achieved an AAA rating from the major rating agencies and that there is no history of default in the EU covered bond market, these restrictions appeared unnecessary and regressive.
The proposal contained three major restrictions as follows:• less ability to incorporate a broad range
of international (non-EU) assets in a
pool, favouring markets which have a large availability of domestic assets;
• lower limits applying to the substitution of assets within a pool, thereby reducing operational flexibility. Assets need to be replaced from time to time as the loans are repaid. This favoured markets where long-term, fixed rates are the norm and loans are generally not switched from one lender to another;
• stricter rules on the valuation levels applying to residential mortgages whereby only loans of a lower loan-to-value (LTV) level could be included in the pool of assets. For any marketplace with a rapidly growing property market - such as Ireland, UK, Spain and the Netherlands - higher LTVs are commonplace.
The EU legislative process requires consideration by the European Council - representing the relevant government ministries of the 25 Member States - and parallel consideration by the European Parliament and its elected members. A negotiated agreement is ultimately put to a final vote in a full plenary session of Parliament. The Commission remains influential throughout the process, attending all meetings of Council.
Promoting Ireland’s interestsTo influence the European agenda, it is important to have a European position. In Ireland a national position was developed through dialogue between the industry, the Department of Finance
and the Financial Regulator. This was taken forward at a European level through the various industry associations. These included the European Banking Federation representing 29 countries and over 4,000 banks, the European Mortgage Federation representing over 75% of the EU mortgage lending industry and the European Covered Bond Council (ECBC).
Considerable differences of opinion existed amongst Member States, ranging from the extremely conservative through progressive to wildly ambitious. At each of the industry fora, the Irish position was presented and a European position negotiated which accommodated the views of various Member States, and importantly for us, accommodated the Irish national interest. This established a clear and unified European position which was then taken to the Commission, Council and Parliament.
The outcome ultimately proved positive, persuading the Commission and the Council that the restrictive measures were unnecessary. The Council agreement negotiated under the Luxembourg Presidency at the end of June 2005 represented a good outcome.
The consideration by Parliament proved to be equally challenging, as new proposals surfaced including one to remove the full eligibility of EU assets. EU Member States are governed by common treaty and rules on financial stability and it is accepted that EU assets carry less risk than non-EU assets.
Gay Mitchell, TD, MEP, tabled a number of amendments to secure a favourable outcome. © Photo European Parliament
24 ABOUT BANKING
Further restrictions to international asset eligibility were proposed along with other measures that would have impacted negatively on the ability of Ireland and others to compete successfully in the European marketplace.
Within the European Parliament, both Gay Mitchell TD, MEP and Eoin Ryan TD, MEP used their positions as members of the European Committee on Economic Affairs (ECON) to alter the course of the debate and restore the key measures required by Ireland, Luxembourg, France, UK and others. Gay Mitchell led the campaign within the EPP political grouping, the largest in Parliament, to win the support of members for the Irish position. The debate ultimately went to the day of the final ECON committee vote in July with an oral amendment tabled during the vote by Gay Mitchell to secure the eligibility of international assets.
The outcome was the adoption by Parliament of the more progressive approach that had been widely favoured.
This incorporated measures that will benefit all European jurisdictions and represents a highly successful outcome.The final round lay in the closing negotiations between Council and Parliament, which focused on the correct level of the Loss Given Default (LGD) parameter to be applied to covered bonds. While highly technical, this was very important to the traditional and larger players in the marketplace, especially Germany. Other Member States were keen to ensure that a level playing field would prevail and a compromise was reached in the lowering of LGD from 12.5% to 11.25% for all AAA-rated covered bonds.
While much has been achieved at the European level, Ireland cannot afford to stand still. In the past year, there have been many legislative developments in various Member States - Germany and Italy introduced new legislation while Portugal is currently reviewing its legislation. The challenge to the Irish industry and authorities is to maintain a competitive level of legislation while preserving the quality of the covered bond product.
As Chairman of the European Covered Bond Council’s CRD group, Paul O’Connor has been at the centre of representations at EU level on the covered bonds issue.
What is a covered bond?A covered bond is a bond issued by a bank secured by a pool of high quality assets on the balance sheet of the issuer. These assets may be mortgage loans, both residential and commercial, or alternatively public sector loans.
Public sector covered bonds account for over 55% of the total amount of covered bonds in issue.
Benefits of covered bondsCovered bonds are a low-risk product and are of major interest to international investors. Key benefits for both issuers and investors include the following.
For issuers• Lower funding costs• Flexible alternative to deposits and
senior bonds• Possibility of extending the
maturity profile of banks’ liability side to make it match with mortgage loans maturity
• Generally better returns on regulatory capital
For investors• Alternative to government bonds• Secure instrument in case of issuer insolvency • High liquidity due to large
issue sizes and market maker commitments in the jumbo market
• Geographic and asset class diversification
“By 2004, Ireland represented almost 5% of the total outstanding balances of the larger covered bonds…and accounted for over 12% of new issues…”
Securing the Future of Covered Bonds
Eoin Ryan, TD, MEP helped restore key measures required by Ireland. © Photo European Parliament
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