Trichet: emergency funding

A return to profitability is still a long way off for Irish banks as margins continue to shrink under pressure from the high cost of funding and the withdrawal of cheap money from the European Central Bank (ECB).

Pressure on margins is forcing the banks to reconsider their pricing and sources expect rate rises across the board in the new year, which will hit borrowers with variable rate mortgages hard.

Interim management statements from both Irish Life & Permanent and AIB last week showed both institutions were expecting significant drops in net interest margins in their end-of-year figures, meaning it will be harder to rebuild profits from basic lending.

IL&P said its margin could drop as low as 0.8% from 0.9% in June, while AIB was expecting a 0.25 percentage-point fall from 2.21% over the same period. Likewise Bank of Ireland recently reported a 10 basis-point decline to 1.61% in its half-year results to the end of September, which it said contributed to an 18% fall in pre-provision profit.

According to banks and analysts, two factors are driving the margin attrition: the continued high cost of funding in a very competitive deposit market, and the reduced dependence on cheap ECB funding. So even though the banks are improving their deposit levels and sourcing funds on the open market, the interest they have to pay is causing problems for the bottom line. And there is no relief in sight.

Last week the ECB ann­ounced it would tighten rules for the collateral it accepts for loans as it tries to restore the "proper functioning" of markets and prepares the ground to unwind emergency liquidity measures next year. The news came just a week after the ECB said it would pull in the maturity on funding lines from a year to nine months. The 12-month auctions of unlimited cash, a key plank of the ECB's ­crisis response plan, will stop next month after a third tranche is handed out.

ECB president Jean-Claude Trichet said last Friday the bank would gradually withdraw the emergency cash to ensure it wouldn't fuel inflation.