Independence and Interest Rate Setting – The Irish Banks 1952-1970
Dr. Ella Kavanagh[1]
Department of Economics
University College Cork
Abstract
Between 1922 (when the Irish Free State was founded) and 1979, the Irish pound was linked one for one and was freely convertible into sterling. Consequently the impetus for changing Irish interest rates came from changes in the (Bank of England) Bank Rate. The Irish Banks Standing Committee (IBSC) was formed in March 1920 “to fix rates for Overdrafts, Loans and Discounts for all banks” (IBSC Minutes, March 16th, 1920). In the 1920s and 1930s, the Irish banks adopted a fixed schedule, which they followed for each change in the Bank Rate. By the beginning of the 1950s the schedule was abandoned as it was no longer deemed to be relevant and it was decided by the IBSC that any change in Irish interest rates, following a change in the Bank Rate, would no longer be automatic but would be a decided by the IBSC.
This paper analyses the reasons behind the changing relationship between Irish interest rates and the (Bank of England) Bank Rate during the 1950s and 1960s. The independence that the IBSC had previously enjoyed in setting their retail rates began to be eroded as a number of other players, the Central Bank and the Irish Government, started to influence the way that interest rates were set while other factors, besides purely banking considerations, entered into the interest rate decisions. The contents of the Minutes of the meetings of the Irish Bank Standing Committee for the 1950s and 1960s are used to analyse the role of the three agents, the Irish Banks Standing Committee (Irish banks), the Central Bank and the Irish Government in setting retail interest rates.
The paper analyses the economic and political reasons for the Irish government’s interference in setting interest rates. The mid 1950s was characterised by economic stagnation. This was followed by the emergence of economic planning in 1958 to combat problems of high unemployment and emigration. The paper examines the emerging and evolving relationship between the Irish Central Bank and the banks. While initially the Central Bank played a minor role as mediator between the banks and the government, during the 1960s the commercial banks began to recognise its potential role as a protector against government interference. The paper highlights the “threats” that were invoked by different governments, at different times, to get the banks to behave more in line with their wishes and why government was willing to incur the cost of interference in banking activities, in order to achieve their objectives. It also documents how the banks responded to these threats. It demonstrates how the banks used their role as lenders to the government to try to retain their independence in setting retail interest rates according to their own banking criteria.
1. Introduction
Between 1922 (when the Irish Free State was founded) and 1979, the Irish pound was linked one for one and was freely convertible into sterling. Consequently the impetus for changing Irish interest rates came from changes in the (Bank of England) Bank Rate. The Irish Banks Standing Committee (IBSC) was formed in March 1920 “to fix rates for Overdrafts, Loans and Discounts for all banks” (IBSC Minutes of March 16 1920). In the 1920s and 1930s, the Irish banks adopted a fixed schedule, which they followed for each change in the Bank Rate. By the beginning of the 1950s the schedule was abandoned as it was no longer deemed to be relevant and it was decided by the IBSC that any change in Irish interest rates, following a change in the Bank Rate, would no longer be automatic but would be a decided by the IBSC.
This paper analyses the reasons behind the changing relationship between Irish interest rates and the (Bank of England) Bank Rate during the 1950s and 1960s. The autonomy that the IBSC had previously enjoyed in setting their retail rates began to be eroded as two other parties, the Central Bank, which had been established in 1943, and the Irish Government, started to influence the way that interest rates were set. We examine the evolving and rather volatile relationship between the Central Bank and the IBSC and document the impact that it had on interest rate decisions. We also investigate the role of the Irish Government and the Department of Finance in affecting interest rates at different times during these two decades. The contents of the Minutes of the meetings of the IBSC for the 1950s and 1960s are used to analyse the role of the three agents, the Irish Banks Standing Committee (Irish banks), the Central Bank and the Irish Government in setting retail interest rates.
This paper is divided according to particular time periods. Section 2 deals with the period from 1952-1954, the beginning of government involvement. Section 3 examines the period from 1955-1957 when the government effectively dictated interest rates to the IBSC with negative consequences for the economy. Section 4 is the period of the First Programme for Economic Expansion, 1958-1962 and an increasing role for the Central Bank. Section 5 reviews the period 1963-1967, which matches the early years of the Second Programme for Economic Expansion. Section 6 examines the latter years of the 1960s. Section 7 concludes.
2. 1952 - 1954
At the beginning of the 1950s, the IBSC abolished the schedule that had previously been used to set interest rates, which allowed for change in the relationship that had existed between the Bank Rate and Irish interest rates. They wanted greater flexibility in the rate structure “so that one rate could be changed without all others” (IBSC Minutes of 22 February 1952). More significantly, they made the decision that “no changes in the Irish bank rate structure will in future operate automatically on a change in the Bank of England rate” (IBSC Minutes of 18 February 1952). Loan rates were set as a mark-up over deposit rates. The Irish banks (both in the North and in the Republic) were in competition with the British banks and the Trustee Savings Banks (TSBs) and the Post Office Savings Banks (POSBs) in Ireland for deposits. As we will see this was a significant factor affecting interest rate decisions.
During this period, the independence that the banking sector had previously enjoyed in setting interest rates was eroded. The Minister for Finance began to directly intervene in interest rate setting, which meant that other factors, besides purely banking considerations, became important in interest rate decisions. The Governor of the Central Bank acted as a mediator between both parties and appears to have had very little direct influence.
2.1 Direct Government Interference
On 11th March 1952, the Bank Rate was increased from 2½% to 4%[2] while the London Banks Deposit Rate was raised to 2%. The IBSC proposed, at the 13th March meeting, that the deposit rate should be set at the same rate as the London Banks Deposit Rate. The overdraft rate was set at 6½%, a margin of 4½%.
The Governor of the Central Bank had no active role in the setting of interest rates. The Chairman of the IBSC informed him of their decision and he in turn informed the Minister for Finance[3]. The Governor of the Central Bank, Mr. Brennan acted as a conduit between the IBSC and the government. He informed the IBSC that the Government had requested the banks not to change rates “until such time as several Ministers had an opportunity of examining the matter in more detail and if necessary to discuss the proposal with the representatives of the banks” (IBSC Minutes of 14 March 1952). The banks agreed to this although not indefinitely and set a deadline for the publishing of the new schedule. The Governor also stated his willingness to convey to the Minister for Finance any views the banks might wish to express. Although the Chairman did meet the Minister, a meeting was still requested by the government with the IBSC. Prior to this meeting, and presumably in deference to the government request, the IBSC proposed an adjustment in deposit rates – a 1½% deposit rate on deposits of less than £25,000 and 2% on deposits of £25,000 or more. This would enable a maximum overdraft rate of 6%.
The importance that the government attached to this meeting can be gauged by the personnel who attended - the Taoiseach, Mr. Eamonn De Valera, the Taniste and Minister for Industry and Commerce, Mr. Sean Lemass, Mr. Sean McEntee (Minister for Finance) and Mr. Frank Aiken (Minister for External Affairs) along with Mr. Mc Elligott (Secretary to the Dept. of Finance) and M. Moynihan (Assistant Secretary to the Dept. of Finance). There was no representative of the Central Bank.
Three reasons explain the high level involvement by the government and the absence of the Central bank. Firstly, the Central Bank had published a highly critical report on the Irish economy on 25th September 1951. In it the Governor, had expressed concern about the underlying forces causing the increase in the balance of payments deficit from £9.5m in 1949 to £30m in 1950. “The present economic situation is one of high consumption, high investment and low savings” (Central Bank of Ireland, 1951:16). The factors that he identified as responsible were: “the constantly increasing scale of the expenditure of the State and local authorities and the continuing rise in general levels of remuneration” (Central Bank of Ireland, 1951:10). While most of the discussion was on the need for fiscal correction, “rigorous restriction of bank credit for non-essential and less urgent purposes” was also considered to be imperative (Central Bank of Ireland, 1951:16). Moynihan (1975) discusses in some detail, the outcry that followed its publication. Secondly the government was opposed to the report. According to the Minister for Industry and Commerce (Seán Lemass), although the analysis by the Central Bank of the financial and monetary situation is done “with reasonable accuracy”, the “line which the Government tends to follow in the solution of these problems is diametrically opposite to that which the Central Bank suggests”[4] “The Central Bank says that the solution is to cut down consumption. The Government believes that the solution is to increase the level of production……In our efforts we expect to obtain the co-operation of the Central Bank and the commercial banks. If necessary we are prepared to take steps to ensure that we will get that co-operation”[5]. Thirdly the Minister for Finance was planning to introduce a contractionary budget[6], in response to the deteriorating balance of payments (Fanning, 1978:483).
At the meeting the banks were requested to adjourn the increase in interest rates. In their introduction, the banks focussed on the danger of losing deposits and the effect that this would have on the supply of industrial loans. The Taoiseach stressed, “the anxiety of the government at the effect the increased interest rates would have on the economy” (IBSC Minutes of May, 1952). McElligott (Secretary to the Department of Finance) contrasted the much smaller increases in English lending rates with Irish rates[7]. The Tániste and Minister for Industry and Commerce, Mr. Lemass pointed to the high profits of banks and argued that the banks should be reducing their cost base (by reducing branches). “The banks appeared to incline to the opinion that they must be protected no matter to what extent other sections of the community suffered” (IBSC Minutes of March 18th, 1952). The Minister for External Affairs, Mr. Aiken argued that the banks should be able to distinguish between loans for productive and non-productive purposes, charging a different rate to each. The Chairman of the IBSC said that the banks were “discouraging advances for unproductive purposes” and the bill system was enabling cheaper rates to be charged for loans for productive purposes. Despite a further appeal from the Taoiseach to the banks to adopt a wait and see approach, the banks made it clear that the proposals, which they had already amended, would be introduced on the 20th March. On the 20th March, they were introduced[8][9].
2.2 Disagreements
The Bank Rate was reduced twice during the remainder of this period - on the 17th September 1953 to 3½% and on 13th May 1954, to 3%. In line with the movements in the Bank Rate, the London Banks Deposit rate was reduced to 1¾% and then to 1¼%. The IBSC discussed a ¼% reduction in deposit and lending rates in response to the September change.
The new Governor of the Central Bank (Mr. JJ. McElligott formerly of the Department of Finance) conveyed to the Banks a request by the Minister that no decision should be announced before the Government had been given an opportunity of considering it (Moynihan, 1975:415). On the 21st September the Minister discussed the possible change in interest rates with the Governor. McElligott supported the banks in his discussion with the Minister – He pointed out that the banks had not increased their interest rates in line with the British Bank Rate in March 1952 (Moynihan, 1975:415). At their meeting on the 22nd September, the IBSC proposed that the deposit rate on amounts of £25,000 or over would match the London Banks Deposit Rate while the deposit rate on amounts less than £25,000 was reduced by ¼% to 1¼%. The margins were maintained by reducing the overdraft rate (and some other lending rates) by ¼% only to 5¾%. In the expectation of potential government interference the IBSC wished to “make the proposal attractive to government”. So for the loan categories E2, E3 and E4, (i.e. those applying to government related loans) it was agreed that a ½% reduction should be applied (IBSC Minutes of September 22 1953).
On the 25th September, the Acting Minister for Finance, Mr. Aiken, met with the banks. He wanted more flexibility and experimentation in the way that interest rates were set. Specifically he wanted the banks to reduce the rate charged on loans for productive purposes to 5% and to reduce their deposit rates by more than originally specified to accommodate this. The banks outlined their own banking considerations in response: the danger of losing deposits if Irish rates were below British rates[10] and the need to improve reserves which had been greatly affected by the fall in the value of securities. The profitability of banks, already mentioned by Lemass in 1952, continued to be an issue with the banks pointing out that the reduction in rates would not give the banks the bonus of increased profits (as it was, profits were negatively affected by the reduction in call money rates). Despite the request by the Acting Minister for Finance, the banks held to their original decision and the new rates were introduced from the close of business on 30th September 1953. Again as before an agreement was made with the British Bankers Association in relation to deposit rates.