The Irish debt crisis: lessons in lending

Quote

“A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain.”  Mark Twain.

News
The Euro has taken another knock this week as the Irish government is struggling to support its ailing banks, having promised to guarantee all their loans in 2008 during the credit crisis.  This has left the country with the highest public deficit in the eurozone this year, at 14.3% of GDP.

Politicians, bankers and journalists have been scurrying back and forth between Dublin, Brussels and other European capitals; Ireland says it does not need a bailout, some EU leaders think otherwise.  A relational perspective on the financial crisis over the last two years emphasizes one of its underlying causes. 

Despite attempts in recent years to treat debt as a commodity, in reality any loan is a relational transaction: one person lends some of his or her money to another person, who promises to repay it by a certain date.  The bank is the go between, acting in the interests of both parties (and their shareholders).  There is trust involved, and risk and uncertainty with any loan; these issues can be assessed and monitored provided there is genuine knowledge and relationship between the banks and their customers.

However, when loans are commoditised and sold on, the connection between borrower and lender becomes remote and accountability falls away.  The less relational lending becomes, the higher the default rate tends to be: banks are more likely to make loans that haven’t been properly evaluated, and borrowers can more easily get away with defaulting on their debts.

When the boom years came to an end in the Irish property market, the credit which financed it still had to be paid.  The Irish government decided at the time to protect bank depositors from any loss, so the banks turned to the state; the government has underwritten the banks but now has an unsustainable deficit.  Who will pay for the Irish bad debts?  It appears, ironically, that those at the furthest distance relationally from Ireland – taxpayers from across the EU – may ultimately end up paying for the remoteness between borrower and lender in the Emerald Isle.

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Dr Paul Mills is a senior economist in one of the international financial institutions; over the last 20 years he has studied alternatives to debt-based financial systems, including Islamic banking.  The following Cambridge Paper explores the reasons why interest was banned in Old Testament Israel, and what lessons can be drawn from this today. http://www.jubilee-centre.org/document.php?id=3

Walk the talk

The obligation to repay every debt should be taken very seriously, but so too the obligation to cancel a debt when the borrower is clearly unable to repay the loan.  Is there a debt which you need either to be more diligent in repaying, or else to be willing to forgive?

The last word

From the Bible, Proverbs 22 verse 7: “The rich rule over the poor, and the borrower is slave to the lender.”
Romans 13 verse 8: “Let no debt remain outstanding, except the continuing debt to love one another”.