An awful warning for banks

BANK shares have had a terrific run on the stock market over the last five years. But as the Allied Irish Banks fraud demonstrates, the sector is as vulnerable to banana skins as ever.

Investors in AIB, including Irish pension funds, have had a huge shock with the shares down more than 20% in a day.

Shares in the UK banking sector have had two tumbles in five years. The first came in 1998 after banks around the world were forced to absorb losses from the collapse of the American hedge fund Long Term Capital Management and the implosion of the Russian economy. A further dip occurred early in 2000 as cash poured out of more traditional stocks, like the banks, into the technology and dotcom bubble.

We may just be at the start of another setback for the sector. AIB looks like one of those freak events, like Barings. The Dublin-based bank should remain intact as most of the losses can be covered without eating into its capital cushion.

There should be little doubt that it has been seriously wounded and could become a takeover candidate for a European bank seeking to test the waters for a transcontinental deal. ABN Amro is being mentioned in this context.

But although the AIB affair may be an aberration, it comes at a moment when the difficulties for our banks are mounting. Northern Rock, largely a mortgage bank, has hoisted a question mark over the consumer credit and housing boom by doubling its provisions.

Given the scale of the personal lending and mortgage and indications that unemployment in manufacturing is picking up, it may be wise for others with big domestic portfolios to follow Northern Rock's lead.

Then there is the growing list of bigger problems. The Bank of England's stability review in December mentioned commercial property. Since then even greater worries have surfaced.

Banks with exposure to Argentina, most notably HSBC and Lloyds TSB, will need to consider some write-downs.

If they are cautious, they might be looking at their broader Latin American loan books - even though there has been no contagion so far.

After all this comes the Enron effect. This manifests itself both directly as a result of write-offs on loans to Enron, with the American banks the biggest losers so far, and indirectly through the impact on audit practices.

There is some evidence from the UK banks, as they put the final touches to their full-year results, that a more cautious line is being taken. As the current imbroglio over the restatement of Deutsche Bank's results makes clear, a

change in accounting convention can make a fantastic difference. In DB's case a profit of £9bn in 2000 became one of just £100m in 2001.

Add to this the 'banana skins' detailed by the Centre for the Study of Financial Innovation in a report released today.

Credit risk tops the CSFI table, followed by problems arising from the worldwide slowdown, falling share markets and complex instruments such as credit derivatives. It may be time to switch out of banking shares.

Pension disgrace
BILL Grimsey's stewardship at Iceland is looking increasingly unfortunate. First there were the disgraceful payments made to a raft of former directors and hangers on. Now the retailer is reneging on its pension obligations to the workforce.

Iceland has the dubious honour of being the first major public company to push employers out of a final salary pension scheme (with the promise of retirement at two-thirds of salary) into an inferior stakeholder scheme.

At other firms, the switch has been made with the consent of the staff after a ballot, or imposed on new staff, leaving the pension rights of existing employees intact.

Whatever the state of the stock market and however bad the deterioration in Iceland's prospects, the behaviour of its management is deplorable. This must be a case for the FSA and the pensions ombudsman.