Sins of the Father

by Conor McCabe

  THE SECOND BANKING COMMISSION AND THE ESTABLISHMENT OF THE CENTRAL BANK

  In 1931, less than four years after the Banking Commission had tied the Irish pound to ‘The most sound and stable nation’ in Europe, the UK broke from the gold standard and devalued its currency. It was not the only country to undertake such a measure during this period – Sweden, Norway, Denmark and India all abandoned the gold standard around this time. However, because of the parity link, the Free State was forced to follow sterling to its new value, regardless of the financial realities in Ireland at the time.

  The leader of the Irish government, William Cosgrave, responded to the financial crisis not by disentangling the Irish pound from sterling, but by appealing to patriotism and calling on the Irish people to purchase Irish goods. ‘Let us see to it that our courage and our energy are not wanting in the time of national necessity,’ he told a civic carnival banquet in Limerick in October 1931, ‘to keep the name of our country in the forefront for being able to meet whatever demands may be made on us in difficult times.’11 The increase in tariffs undertaken by the government at this time was in direct response to similar moves by Britain. In order to avoid the Free State becoming a dumping ground for British goods, it needed to put a marker on imports. In 1933 the World Monetary and Economic Conference in London passed a resolution which called on the establishment of independent central banks with powers to carry out currency and credit policy in developed countries where they did not already exist. It was becoming clear that the Free State’s avoidance of a central bank was out of step with the rest of the developed world.

  On 26 October 1934, the Minister for Finance, Sean McEntee, announced the appointment of a commission to inquire into banking, currency, and related matters in the Irish Free State. Its personnel represented a wide range of Irish society, ‘There were five university professors, five civil servants, three bankers, two trade unionists, two agriculturists, two representatives of general business and trade interests, one Roman Catholic bishop and one foreign expert.’12 It held over 200 meetings and took four years to produce its report. It was finally released in October 1938 and found that while a central bank should be established, parity with sterling should also be maintained, and government borrowing should be curtailed. It also rejected the suggestion that a nationalised bank should be established to provide credit for the expansion of the economy. The commission took four years to conclude that the status quo offered the best solution to the problems facing the Irish economy.

  The commission also produced a minority report, which was signed by Professor O’Rahilly and the two trade union representatives, William O’Brien and Sean Campbell. They stated that they could not:

  … acquiesce in the extraordinary view that this country, alone amongst the responsible entities of the world, should not ever have the power to make decisions, and that no apparatus or mechanism for controlling the volume and direction of credit should ever be brought into existence … We need an organ for the issue and control of developmental credit … That is our fundamental conclusion, and the only thing startling about it is that it was not accepted sixteen years ago.13

  It was testimony to the power of the banks in the Free State that, after sixteen years, two commissions, and one international financial crisis, their ability to dictate the pace and direction of Irish economic growth to suit their own business agenda to the detriment of almost all other aspects of Irish economic and social life remained undaunted.

  One of the main recommendations of the Second Banking Commission – the establishment of a central bank – was not implemented until 1943. A central bank, the commissioners said, ‘has to ensure the maintenance of external stability, to take care of the monetary reserves of gold and foreign exchange, and have certain means of influencing the currency and credit position within the country’.14 It undertakes these responsibilities in order to assist the development of the economy, and to act as a stabiliser between the right of banks to sell credit, and the right of businesses to trade. As far as the developed world was concerned, a central bank was not seen as a luxury but as an essential element of monetary policy. The failure of Fianna Fáil to establish a central bank led to accusations that the banks, rather than the government, were setting economic policy. ‘It is all nonsense to say that we are merely creatures of the banks,’ said de Valera in 1939. ‘We can pass a law at any time to control the banks or to sever parity with sterling. We can do all these things. It is merely a question of whether it is wise or unwise to do them.’15 Three years and the outbreak of a world war later, the Central Bank Bill was brought before the Dáil.

  The board of the Central Bank of Ireland met for the first time on 1 February 1943. The chairman was Joseph Brennan, who was the chairman of the Currency Commission prior to its disbandment. One of the few surprises was the appointment of William O’Brien to the board. O’Brien, who had signed the minority report in 1937, was also a member of the Labour Party, which had been severely critical of the legislation which established the Central Bank. Within the year, O’Brien left the Labour Party and helped form the breakaway National Labour Party – the resulting split a boon to Fianna Fáil’s electoral fortunes in 1944.

  The Central Bank was given the responsibility of protecting the purchasing power of the Irish pound and regulating the issue of credit in the interests of the nation. The board made it clear that there would be no change in monetary policy. On 18 September 1949, sterling was devalued by 30 per cent. In 1951 the Ibec Report, which had provided such a succinct and devastating analysis of Irish trade, also looked at the State’s monetary policy. As with the cattle trade, it found the practices of the Central Bank difficult to fathom.

  The decision by the Central Bank in 1943 to continue with the policy of investing the State’s currency ‘primarily in British exchequer bills, with the rest of the 100 per cent coverage provided by gold bullion’ was heavily criticised by Ibec.16 It said that ‘The fact that the Central Bank has made no use of its statutory power to invest its legal tender reserves in Irish government securities has handicapped the development of an active domestic capital market in Ireland which is one of the country’s primary needs.’ This emphasis on the purchase of sterling notes didn’t make any commercial sense. Ibec noted that were the Central Bank to purchase British government securities as opposed to exchequer bills, the higher yield in interest payments afforded by the former would yield at least £500,000 a year in revenue. ‘The commercial banking system of Ireland, as well, has shown a similar tendency to operate in a fashion that channels Irish deposit funds into the British market rather than retaining them in Ireland for domestic use.’17 Ireland needed to boost its means of increasing its volume of physical capital formation. ‘Unless this is done,’ wrote Ibec, ‘it is difficult to see how any development of Irish industry and agriculture sufficiently vigorous to keep pace with outside competition can take place.’ Not only did Ireland need to increase capital formation, it had to ensure that such capital went on productive enterprises. (It may be recalled that Ireland had spent the bulk of its grants and loans from the Marshall Plan on land reclamation, rather than on specialist cattle breeding, or an expansion of indigenous export-led industry. More grazing for Shorthorns. That was the essence of the plan.)

  As far as Irish banking was concerned, the move to bring foreign industry to Ireland helped to kill two birds with one stone. It would allow the economy to expand, but without any need to change monetary policy. This was because the much-needed capital formation would not come from the Irish pound. Any move to expand Irish credit on a level needed to develop the economy would put pressure on the parity link, as such capital formation would weaken the ‘value’ of the Irish pound. This is a necessary procedure in order to expand an economy; credit is used to develop productive enterprises which in turn will create more value than that initially provided by the credit. However, such a move would mean the end of an expensive, and groggy, Irish pound – a sluggish currency that creaked u
nder the weight of its sterling link.

  Ibec also found that of the capital formation which did occur in Ireland, between one third and one half went towards construction, ‘The major part of [the capital formation] does not flow to uses that have a direct and immediate impact upon the production of goods for the Irish market or for export.’ It also found that ‘shockingly low’ levels of capital formation went towards agriculture, and that ‘an unusually high degree’ of capital formation in Ireland was ‘marshalled under the auspices of government agencies’.

  The role of private banks in the creation and distribution of credit in Ireland was quite limited, ‘[This] cannot be explained in terms of a comparative dearth of personal savings,’ wrote Ibec, ‘since Ireland’s 1949 personal savings represent about twice as large a proportion of gross capital formation as in the United Kingdom’. Instead, it concluded that ‘The disparity is clearly chargeable to the fact that an active capital market for domestic issues has never been developed in Ireland’ and that ‘this failure is immediately influenced by the example of government and private commercial banking agencies which consistently have channelled a very large proportion of their assets into British securities rather than securities of the home market’. Irish commercial banks were seen as directly responsible, along with government, with stymieing Irish economic growth. A reform of monetary and banking policy was needed, and as so often in Ireland when an economic power bloc was challenged, the concerns were duly noted and filed away.

  There were nine joint-stock banks in Ireland in the 1950s, compared to only five in the UK. The added numbers did not lead to any competition regarding credit and charges. ‘To all intents and purposes,’ wrote The Irish Times, ‘[the banks] work hand in glove, and their activities are coordinated by the Joint Banks Standing Committee.’18 There was a cartel in operation, ‘and entry into retail banking was inhibited other than by way of a takeover’.19 In 1958, the Bank of Ireland acquired the Hibernian Bank, which led The Irish Times to wish that the move would ‘contribute, even in small measure, towards a narrowing of the gap between deposit and overdraft rates, at present so much wider here than across the Channel’.20 There was no change in costs to bank customers, but the merger was the first of a series of such moves which took place over the following decade. In 1965, Bank of Ireland took over the Irish branches of the UK-based National Bank. Ireland was opening up its financial world to foreign investors, and the mergers could be seen as a pre-emptive move to ensure that retail banking stayed under the control of the cartel.

  The largest merger, however, was that which formed Allied Irish Banks. On 22 August 1966, the Munster and Leinster Bank, the Provincial Bank of Ireland and the Royal Bank of Ireland announced their decision to amalgamate and form a new bank with total resources of £225 million. The move received much praise, as it was seen to ensure ‘that control of these banks [would] remain within Ireland’.21 It was thought that the size of the new bank – ninth largest in the British clearing bank system – would enable it to compete both internationally and within the Common Market, Ireland’s membership of which was seen as all but inevitable. And in international banking, The Irish Times noted, ‘it is size that displays fertility’.22 The newspaper voiced its concerns over the name of the new bank. ‘The directors are open to suggestions from the public,’ it wrote, adding that with the title, Allied Irish Banks, ‘it is unfortunate that such a deplorable name has been chosen’. In December 1966, AIB announced the formation of a merchant bank subsidiary, the Allied Irish Investment Corporation, which was a joint operation with Hambros, the London-based merchant bankers, and the State-owned Irish Life Assurance. It gave AIB a foothold in the area of Irish banking that had been opened up to foreign investment.

  The increase in foreign investment in the 1960s brought with it an increase in demand for bank services, especially wholesale banking. Companies needed capital, and banks, especially American banks, were credit rich and constantly on the look-out for new markets. Ireland provided such an opportunity for expansion. At the time of the Irish bank mergers, ‘there was virtually no control over the establishment of branches or subsidiaries of foreign banks that wished to concentrate on non-clearing or wholesale banking’.23 North American banks were the first to arrive, and by the 1970s they accounted for over 5 per cent of the Irish banking market. These were followed by European banks in the aftermath of Ireland’s entry to the Common Market in 1973.

  On 28 September 1965, the Irish branch of the First National City Bank of New York (FNCB) was officially opened at a ceremony which was held at its Dawson Street office in Dublin. The FNCB had been in Ireland since June and employed twenty-five people. It was ‘The smallest branch of the largest international bank in the world’ and any credit note issued in Ireland had the full backing of the bank’s $12.5 billion reserves in New York.24 In June 1967 the bank moved to new premises at 71 St Stephen’s Green, the occasion of which was marked by an appearance and speech by the Minister for Finance, Charles J. Haughey. The expansion of the FNCB took place alongside the opening of Ireland to the eurodollar market and to the opportunities such a market afforded with regard to international financial speculation. ‘In developing the range of their services the Irish banks may be able to benefit from the experience of their American counterparts’, Haughey told the audience. ‘Such facilities as the purchase and leasing of expensive industrial equipment, long-term financing of business and residential properties and term loans are provided directly to customers by American banks.’25

  The commercial and residential property boom which Ireland was going through was financed, in part at least, by the American banks – a boom which was assisted by government tax incentives, and which led to tens of thousands of square feet of empty premises, with more absorbed by government departments under a policy of rent rather than ownership. The government was using taxpayers’ money to create a demand which didn’t exist, and taxpayers’ money to absorb a surplus which shouldn’t have been built. American banks provided a boost to finance, allowing Irish banks to keep parity with sterling, as they did not have to produce Irish-pound-based credit to fund these loans. The banks, along with the builders, contractors and their political friends, reaped the benefits.

  With the Pay As You Earn (PAYE) tax scheme introduced in 1960, the government had gained a captive, and constant, supply of income. The government’s policy of funding speculation with tax breaks and absorbing speculation via office rent was in effect the wholesale transfer of wealth from the working population to builders, banks and speculators, with government as the conduit. It seems incredible that something so blatant could exist so freely, but it is only so strange when seen in isolation. Given the pattern of Ireland’s economic history, from the 1920s currency commission to the 2008 bank guarantee and the creation of NAMA, the 1960s speculation boom fits securely in place.

  The role of the banks in facilitating and sustaining property speculation was underlined in a 1977 study of Irish banking by N.J. Gibson. In it, he noted that while ‘both the merchant banks and the North American banks have been active participants in the inter-bank money market that has developed in recent years in Dublin,’ the development of this money market ‘is partly a consequence of their arrival and their particular methods of operation in that they … often seek out lending business and then find the funds to finance it’.26 He found that with the Irish merchant and North American banks, ‘their liabilities within Ireland tend to be less than their assets, and so they tend to be net external borrowers’. Ireland’s industrial banks dealt with hire-purchase loans for consumer goods, ‘industrial loans, the finance of foreign trade and company finance’, and foreign banks such as the Algemene Bank Netherland (Ireland) Ltd and Banque Nationale de Paris (Ireland) Ltd.27

  The liberalisation of the Irish banking system also had an affect on the once-conservative building societies. In 1965 they accounted for around 7 per cent of all deposit and current accounts in the State; by 1985 that share had risen to
almost 50 per cent.28 Ostensibly concerned with the provision of affordable mortgages to members, by the late 1960s, Irish building societies had turned into full-blown property developers and speculators, overseeing the construction of office blocks and suburban estates. By 1985 the societies had total assets of £2.5 billion, around 20 per cent of the liquid assets in the State. Ten years previously, total assets stood at £250 million. It was a phenomenal growth, virtually all of it based on commercial and residential property.

  The banks were bringing credit into Ireland, finding buyers, and selling it to them. With a famously ‘hands-off’ Central Bank and government, the purpose of this credit, and its function within the wider economy, was rarely challenged or even discussed. The Irish economy was being sold credit, and this credit was ending up in land speculation, construction and mortgages. It was not long before Ireland had a major banking crisis on its hands.

  ‘[IT] SHOOK THE FOUNDATIONS OF THE BANKING SYSTEM IN IRELAND’

  Edward Collins, Minister of State at the Department of Trade. Commerce and Tourism, 6 November 1985.

  On 8 March 1985, the Taoiseach, Garret Fitzgerald, was visited at his home in Rathmines by two of his cabinet colleagues and informed of an impending banking crisis which had the potential to bring down the bank and fatally undermine the economy. His Minister for Finance, Alan Dukes, and Minister for Trade, Commerce and Tourism, John Bruton, told him that the Insurance Corporation of Ireland (ICI), which had been bought by AIB the previous year, ‘had racked up massive but as of yet unknown losses by wildly underwriting high-risk businesses in the insurance market’.29 AIB had tried to cover the losses but could no longer afford to do so. However, it made sure to tell the government that if ICI’s liabilities were not met, AIB itself could fold, and the effect on the Irish economy of the collapse of the largest bank in the State would be devastating. Fitzgerald, Dukes and Bruton decided that the State would have to step in and take responsibility for ICI’s liabilities, even though it had absolutely no idea as to the scale of those liabilities except that they were of such a scale as to threaten the existence of AIB. The government gave AIB a blanket guarantee. It covered everything, absolving AIB of its financial commitments to the broken insurance company. ‘Clearly the bank was playing a game of who blinks first?’ said a former AIB banker. ‘and Fitzgerald and his ministers blinked first.’30