The main impediment to bank profitability – apart from ongoing loan losses – is low margins.
Irish banks in particular are in a tough situation. On the one hand they have to pay a lot for deposits and wholesale funding due to their relatively risky profiles. On the other they can't really charge a lot for loans because ECB rates are at record lows. In fact, when banks have raised lending rates – as Permanent TSB, EBS, AIB and Bank of Ireland have done – they have faced criticism from borrowers and government alike.
If you can't raise lending rates high enough, why not cut deposit rates and raise margins that way?
A little more than a month ago, Bank of Ireland slashed its corporate deposit rates in half, following AIB's lead from April and widening the margin between what it pays for funding and what it earns on lending. Bank of Ireland now has the lowest corporate deposit rates in the market for every term under one year. This is possible because Nama has begun to shrink the banks' balance sheets, meaning they need less in deposits.
The move is also part of the bank's strategy to increase net interest margin from today's 1.59% to 1.75% by 2013. The newly recapitalised, smaller and 'de-risked' bank is betting it can attract enough deposits at lower rates to support new 'core' lending while it runs off the bad loan legacy of the boom, which was funded by issuing debt.
The question is: will depositors be willing to give up the higher (and guaranteed) deposit rates for a more long-term play on stability?