Ronan Lyons | Personal Website
Ronan Lyons | Personal Website

An unwanted experiment: a modern economy without banking

Physics and the natural sciences explore questions of truly enormous significance. I’m fresh from reading the Existential Issue of New Scientist magazine, which tackled such questions as “Why is there a universe?” and “Am I a hologram?”. Economics and the social sciences in all reality have “science envy” but do their best to tackle questions that, if not so profound for the life of a dog, an atom or an alien on Alpha Centauri, certainly matter for the lives we live today.

In particular, economists focus a lot on the Industrial Revolution, as before that time there had never been a society where prosperity had risen steadily. Instead, prosperity and the wages of the common labourer tended to be inversely related to population. When population crises occurred, those who survived were able to reap the rewards of the scarcity of human labour. Since the Industrial Revolution, though, a growing number of people – now the majority of the world’s population – have enjoyed steadily increasing incomes, generation after generation, all while the human population grows and grows.

Growth and banking

Understandably, given such a shift change, every economist – indeed probably every social scientist – has their own pet theory for the answer to social science’s Big Question. And perhaps predictably, most tend to think that the most important factor was something they have spent their lives working on. As I develop my research career, I won’t have that option, as the intriguing economic force I hope to understand better (urban agglomeration – what happens when people come together and live in cities) clearly only dates from the Industrial Revolution and thus cannot have caused it!

There is general agreement, though, on the necessity – if not the sufficiency – of a number of conditions an economy needs for people to enjoy increasing incomes, generation after generation. Property rights and the enforceability of contracts is one: if you can’t prove you own something, it’s harder both to trust the system you work in and to motivate yourself to generate wealth. Extreme temperatures have, at least until now, proven a block to human industry: a brief pause to consider the role of air conditioning in the development of the US South will surely convince people of that.

Another factor that no economy has growth without is banking. This is the process of turning savings into investments, i.e. of turning current production into future consumption. Much of modern macroeconomics has tended to ignore the fractional reserve system of banking that we all depend on: this is probably part of a broader issue with modern macro, which is less concerned with why incomes grow over the long run and more concerned with why incomes bobble up and down around that trend in the short run.

However, the power of banking is undeniable. Even if I were writing before the tumultuous economic events of the last few years, history is replete with examples. For instance, one of the main reasons the mighty Spanish empire was defeated by the United Dutch provinces in the early 1600s was because, for all Spain’s New World silver, its Genoese bankers just couldn’t mask the empire’s lack of creditworthiness. The Dutch, on the other hand, could borrow at will.

A banking-free Ireland

My worry is that Ireland is adding itself to the list of powerful examples of the importance of banking. Not only what happened in the run-up to 2008 – and the effect of the Anglo-Irish Bank model of banking – but also in what’s happened since. Currently, banks are worried solely about day-to-day, month-to-month survival. They are not in the slightest bit interested in generation-long mortgages. The result? Two friends of mine, recently married, decided to buy. They were told that even though they currently pay a monthly rent of €1,300, his job “doesn’t really count” and she “could get pregnant” and thus they would only be eligible for a loan whose monthly repayment would be €600. I’ve argued before that current asking prices look high relative to long-term averages… but it shouldn’t be rocket science for banks lend based on ability to pay and according to standard valuation methods for properties.

An economy without mortgage credit will muddle on with falling house prices and widespread negative equity. House prices will probably overshoot on the way down. But ultimately, people will survive. The even greater worry is an economy without business credit, because an economy without business credit will never be able to create jobs. And Ireland is not just an economy without business credit. It’s an economy where there are no banks interested in business banking whatsoever.

That’s a strong statement. For evidence, though, I need look no further than my fiancée and her friend, who run a very successful online wedding magazine, One Fab Day. The site has over 30,000 readers a month, making it one of the most popular wedding websites in the world on a per capita basis. Audience is one thing, revenue another and it has a lot of paying clients and some excellent ideas for how to generate new revenue streams. However, like any modern business, it requires a bank account. What amazed me was just how long Irish banks were able to drag their heels, no matter how many client cheques were waved in front of them, before they would even open a bank account!

SMEs, banks and jobs

In any ordinary developed economy, with their track record over recent months, One Fab Day would now be taking out a working capital loan, hiring staff and expanding. Instead, in the modern Irish economy, they realise that they will have to grow without credit and thus significantly more slowly. There are lots of things they could be doing but without the credit, they just can’t.

One thing they could certainly do without credit, though, is start selling their services online and reach international markets. (In fact, as proof of concept, they’ve already had paying clients from both North America and Europe!) However, to trade online properly (i.e. beyond PayPal), you need an online merchant account. And guess what? Irish banks are just not interested.

To even consider approving your business for online trading, they do the whole chicken-and-egg thing: they expect you to have two years of online trading behind you and audited accounts to prove it! They are prepared to make an exception and accept a business plan, but only if you can produce three years of forecasts for online trading that they will then judge to be realistic or not. If you haven’t traded online yet, this of course gives them ample room to refuse. And lastly, even if you do meet the above conditions, it will take at least four months to process!

This might be understandable prudence on the part of Irish banks but for two facts. The first is that there is almost no marginal cost for the banks in helping SMEs trade online. They are not exposing themselves to huge risk – as they might with mortgage lending – by enabling transactions from which they take a cut. Effectively, they are only interested in online trading if you are a large company and thus there are large amounts of euro on the table for them, risk-free, Day 1.

The second is the bigger picture (lest you think this was all written out of a sense of nuptial duty!). Information & communication technology have done a huge amount to flatten the playing field between large and small firms. Things that had been prohibitive fixed costs (like buying a supercomputer) have been turned into utilities that can be tapped on demand. However, if you literally cannot take the money in, it’s all for naught.

Percentage of enterprises selling over the Internet (by number of employees), 2010

The graph above shows the percentage of enterprises trading online. In Ireland, one in three companies with more than 50 employees is selling online, while for those with 10-50 employees, it’s one in six. There are only a handful of countries that produce statistics for micro enterprises (1-4 workers) or mini ones (5-9 workers) [not shown above]. Portugal is one and its profile is similar enough to Ireland’s that it’s fair to say probably no more than 5% of micro enterprises in Ireland are selling online. The figure in Germany is 18%.

It’s a truism to say that SMEs provide the bulk of jobs in Ireland, a cliché to say that there is no recession online, and a mantra that export-led growth will lead Ireland out of recession. Sitting in the middle of all three of these statements is an obvious point for the new Government, if it’s truly serious about turning the SME sector into an engine of jobs growth through online exports. The Government, as key shareholder in practically the entire Irish banking system, must make bank management, who are only there to execute the wishes of shareholders, set ambitious but deliverable targets in relation to SME online trading. The first step is giving AIB and Bank of Ireland targets for new online merchant accounts by the end of this year, say 2,000 each.

With the will and the support systems in place, across banks, Enterprise Ireland, the county enterprise boards and Irish companies such as Realex, it should be entirely possible to have one in four Irish SMEs trading online in less than five years. As you may have guessed, I know a business that will do it tomorrow, if only they got the chance!

 

  • Sean Murphy ,

    • Gerard O'Neill ,

      I come across a lot of cases Ronan like your fiancée in One Fine Day.

      If it’s any consolation (and I know it isn’t), the banks might be doing her a favour: almost all businesses fail (half in the first five years on average, 80% within ten years). Business survivourship rates are even lower for IT related companies and for partnerships.

      Why are they doing her a favour? Because even when the banks do lend money to start ups/SMEs it has to be personally guaranteed. Net net: when the business fails (as most do) the entrepreneur doesn’t go back to square one, he/she goes back to square minus one as the debts have to be repaid even after the business is gone.

      Like I said, it’s no consolation…

      • Ronan Lyons ,

        @Sean
        Thanks for that link – interesting to see similar stories in the UK, but not in the US or – indeed – Portugal (in the comments).

        @Gerard
        I can understand your point in relation to credit. But One Fab Day isn’t even daring to dream of a loan, all it wants is a merchant account so it can trade! No risk to either the enterprise or to the bank, but banks seems to perceive this to be “hassle”.

        • Sabrina Dent ,

          Two relevant stories: We could not get a highstreet mortgage BEFORE the bust as two self-employed freelancers. We were paying €1100 a month in rent. We had 50% down, cash. It was insanity. We ended up getting a sub-prime mortgage and self-certifying. Our payments are €474 per month. It is sheer dumb luck our rate is ECB +1.

          Second of all, as part of my unreliable and financially unsound freelance work, I create ecommerce websites for Irish businesses. I always try to get people setup with an Irish bank. I *routinely* end up sending people to the US despite heroic efforts because it is virtually impossible for a new business to get a merchant account for CNP sales here. It is a serious, serious problem.

          • Antoin O Lachtnain ,

            An independent, well-functioning banking system is at the heart of a modern market economy. What you are proposing (in a small way) is that the operation of the banking system be dictated by politicians. It is hard to understate how wrong a direction this is to go in.

            I do not see how the government could give a diktat like that to a privately controlled bank (Bank of Ireland).

            I agree that the banking system is not functioning well in a number of respects. If the government wants to intervene in the banking system, they should do so by establishing a new regulatory regime, then selling part or all of AIB/pTSB to a new player. If the government wants to solve the specific credit-card transaction processing problem, they should do so by other means, i.e., encourage, entice or goad Paypal into providing a more upmarket service.

            You are also proposing easy answers to difficult (but not insurmountable) problems. The real difference between Ireland and the UK and Germany over the next few years wil be that their banks have developed far superior transaction systems over the last ten years. At the same time IPSO and the Irish banks have failed to deliver any progress or to align us with the UK or German systems. This is a big problem for Irish banking (but not one that the government can micromanage to a solution).

            Gerard: it is true that it most businesses do shut down within a few years, but it is not quite true to say they all ‘fail’. Many fulfill their purpose to a greater or lesser extent and then shut down.

            On a practical note, did One Fine Day try Worldpay?

            • Ronan Lyons ,

              @Antoin,
              Thanks for the comment. Unfortunately, Worldpay is even more expensive (and less flexible) than Paypal and the Irish banks (if they do give you an account). Also, it doesn’t integrate well on to websites and, according to those who deal with these things, has significant customer trust issues and so would hamper export volumes. Even if One Fab Day did go that route, the argument above in relation to banks would still remain.

              Regarding your more substantive point, this is capitalism. Shareholders set the agenda, not management. If the taxpayer is the shareholder – and even leave aside that this is for reasons for which the banks should be extremely grateful – then the taxpayer calls the shots. Simple as. If the taxpayer does not impose its will, you have a direction-less company that is only out to tread water or serve its management. To turn your point on its head, “it is hard to understate how wrong a direction this is to go in.”

              If we had an independent, well-functioning banking system (which to be fair you note yourself we don’t), it would spot this opportunity for significant sustainable low-risk profits and seize it. The fact that we don’t speaks volumes. There is no appetite at the moment among banks internationally to come into Ireland, so we need to look to the banks that we in large part own. As Ireland already has a home-grown world-leading online payments service provider in Realex, so we don’t need to ask PayPal to change for “little ol’ Ireland”. All we need is a banking system that works!

              I’m not asking for crony capitalism (Johnny TD’s nephew gets fast-tracked up the queue because of who he knows), I’m asking for targets. If the country were to put in place a goal of 100,000 extra companies trading online by 2020, and owns some banks, it’s obvious how these connect. The government has already done this – and will be doing it again – in relation to mortgage provision. Why not SMEs?

              • Antoin O Lachtnain ,

                It is the obvious but wrong answer. It is also the obvious but wrong answer in relation to mortgage lending.

                This is not capitalism. This is state-controlled allocation of capital.

                The reason foreign banks have no appetite to enter the Irish market (and to a greater or lesser extent the reason why Fortis and BoSI have exited the Irish banking market) is that the market is all tied up by banks the government owns or has a large position in and which the government’s interest is to support.

                Unfortunately it looks like the lack of well-run privately owned banking in Ireland is driving customers off-shore (according to tweets which suggest that Citibank US has taken an interest). There is a lesson here, but imposing targets is not it.

                • Martin Harrigan ,

                  Great post.

                  I think there is a real danger that small Irish websites wishing to trade online will start using products offered by US-based companies like Stripe (stripe.com) and Noca (noca.com) and pay them a premium just to avoid the hassle of setting up merchant accounts with Irish banks.

                  • Ronan Lyons ,

                    @Martin
                    Thanks for the comment. As it happens, someone working with Citi based in Texas actually got in touch with One Fab Day yesterday upon hearing about this – it was, apparently, a shock to talk to a bank where the focus was on solutions, not barriers. From One Fab Day’s point of view, fingers crossed it all works out but the broader point remains: how ridiculous is it that a US bank, not an Irish bank, picked up on this and acted on it?! Other start-ups are saying it’s actually just easier to set up in Delaware and go from there (without moving physically at all).

                    While Antoin disagrees, and I see where he’s coming from re diktat, I firmly believe that the combination of national (non-bank specific) policy targets and shareholder prerogative must be used to overcome the spectre of zombie banks refusing profit and stifling jobs growth.

                    R

                    • Tyrone Slothrop ,

                      Ehhh, Mr.Lyons, Alpha Centauri is a binary star system with a combined magnitude of -0.27 and therefore not a planet. No life can exist in or on a star, let alone a binary system. Are we to believe these are some kind of magical aliens??

                      • Richarrd ,

                        Ronan. Very similar story, my company is an EI HSPU and we had to get them to intervene to get a merchant account. Even then there were strings attached. Looks like there is an opportunity for someone to bypass the banks on this – see Realex Ciara Pay

                        • Help! ,

                          HOw do you set up a merchant account in the US/where do you go to do it? Help appreciated please email applecore@ireland.com

                          • Antoin O Lachtnain ,

                            What about looking for a lower rate from Worldpay for Irish startups? That would seem much more viable than trying to get these banks to do business they just don’t want to do.

                            • Ronan Lyons ,

                              • Laura ,

                                Excellent piece Ronan, I think a lot of the problem is that IRish banks in general have underinvested in IT services in recent years, preferring instead to spend it outsourcing to a narrowing circle of providers who themselves are not spending either. As a result the level of innovation in terms of business services are low.

                                The suggestions about basing offshore are probably – sadly – your finances only real options at the moment, but remember there is the whole of Europe if you are able to manage the various languages.

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