The economic crisis in Ireland gave rise to, and ultimately became over dependant on, the property sector. The initial investment in property was based on solid demand and supply fundamentals, such as rising population, strong income growth and low unemployment. However, after the successful recovery of the Irish economy in 2002, individuals underestimated the risk involved in entering the property market. However, the real estate boom that swept the United States also swept the world, including Ireland. The nation had survived a housing bubble in the late 1990s, but the banking sector, emboldened by the global boom, doubled its assets in just three years, lending to Irish and non-Irish alike. When the global bubble burst, the banks were in a severe crisis. The government feared that institutional providers of funds to the banks would withdraw, leading to a collapse of the banking sector. To prevent such a run, the government guaranteed the senior debt of the banks.
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From 2004, the property market displayed the signs of an asset price bubble. Many international commentators highlighted the dangers of Ireland’s over reliance on the construction and property sectors. The IMF (2006) observed that growth in Ireland had become increasingly unbalanced since 2002, with a “heavy reliance on building investment, sharp increases in house prices, and rapid credit growth, especially to property-related sectors”. Economist’s (2004) survey of Ireland indicated that the Irish banking system was heavily exposed to the property sector and a crash would “badly hit the balance sheets of the two big Irish banks, Allied Irish Bank (AIB) and Bank of Ireland”. However, these warning went unheeded by policy makers, the regulator and banking institutions and Ireland’s monetary and public policy initiatives reflected this ignorance.
The correction in the housing market commenced in early 2007, as interest rates started to increase and the economy became affected by the shock of the sub-prime crisis. In 2008, property prices declined nationally by 9.1 per cent, compared with a fall of 7.3 per cent, the previous year (Permanent TSB/ESRI, 2009). According to Friends First (2008), house prices have dropped by 25 per cent since the height of the housing booming 2006 and are set to drop within a range of between 20 and 30 per cent over the course of the next three years. Recent indications are that the reductions are closer to 40-50 per cent. Construction output has contracted each month since June 2007, resulting in 40 per cent reduction in house unit completions in 2008 (Department of the Environment, Heritage and Local Government, 2009). The impact of the adjustment in the housing market has spread to other sectors of the economy including non-housing investment and consumption. The commercial building sector further contracted in 2010 with substantial declines in both output and capital values also expected. Following the falloff in property prices, customers are now facing the possibility of negative equity and banks are left with loan books which are heavily exposed to the declining property market. The failure of IFSRA to limit these consequences is a product of its laissez-faire approach to supervision. The Irish Central Bank (2008) had clearly identified strong credit growth and rising indebtedness as major systemic vulnerabilities. This is especially true in relation to the latter stages of the property cycle where the loan books of Irish banks increased from e166 billion in 2004 to 275 billion by 2007. The majority of the expansion in credit was funded through “disproportionately high” borrowing from the ECB (Morgan, 2008; Goodbody, 2008), as “banks leveraged their deposits with sizeable borrowings from abroad” (Honohan, 2010).
The rapid deterioration in the Irish economy is reflected in the financial results of the main Irish banks. In May 2009, recently nationalised Anglo Irish Bank, posted a loss of over 4.1 billion, the largest in Irish corporate history, and expects loss to be 7.5 million by the end of the year. In 2008, AIB reported pre-tax profits of e1 billion, a 60 per cent reduction from the previous year. It announced a 4.3 billion bad debt charge in 2009, due to an increase this year in its loans in difficulty by 9 billion to 24.3 billion. The Bank of Ireland, in the year ended 31 March 2009, recorded a loss before tax of 7 million vs a 1.93 billion profit in 2008. It has raised its expected bad debt charge for the three years to March 2011 to 6 billion. In relation to foreign players, Bank of Scotland (Ireland) has reported a “significant increase in impairments” because of falling asset values in 2008 and described the severe deterioration in the property market as “unprecedented”. As of February 2010, in light of difficult market conditions, the bank closed its retail arm, Halifax, with the loss of over 750 jobs. Therefore, it is clear that the Irish banking sector will have to deal with the consequences of the imprudent and high risk lending practices that fuelled the property bubble and resulted in short-term super profits. Its capital base has been destroyed and years of steady progress and integrity have been eroded in a few short months.
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The disaster was mainly caused by the inadequate risk management practices of the Irish financial institutions and the failure of the regulator to supervise these practices effectively. The situation was occurred by the pro-cyclical monetary and public policy initiatives enacted by the Irish Government at that time and amplified by the international financial sub-prime crisis in 2008. The decline in the Irish property market has been the prime reason why the capital structures of the Irish banks have been significantly eroded with the prevailing global creditâ€‰crisis compounding liquidity concerns. The Irish banking sector has effectively lost the confidence of international markets and the public in general.