Irish banks are poised to put the squeeze on customers to maintain their profits, writes David Clerkin.

Anyone who had hoped the credit crunch would be a short-term and relatively painless phenomenon got the answer they did not want on Friday. News that the Bank of England had stepped in to prop up British mortgage lender Northern Rock sparked fresh panic and saw bank shares take yet another hit.

Shares in the main Irish banks, which had already suffered so much pain - even before the liquidity squeeze took centre stage last month - tumbled even further.

Special punishment was meted out to Anglo Irish Bank on Friday, as its shares fell 7 per cent. This was largely down to fears directed at banks that do not have large-scale deposit bases of their own and which are perceived as being more reliant on inter-bank funding to meet their cash requirements.

Despite Friday’s events, however, Anglo remained one of the better-performing Irish financials since the market peaked earlier this year, with its cumulative share price fall 29 per cent off its highs.

By contrast, it is Bank of Ireland that has slid most of all among the four main Irish financials this year. Its 5 per cent drop on Friday brought the share price to a low not seen in three years and its aggregate decline to 38 per cent since its all-time high in February.

The news has been little better at AIB and Irish Life and Permanent, whose prices are now down 29 per cent and 31 per cent from their peaks. The falls have dragged the Iseq down by 20 per cent since peaking in February. The Dublin index slipped below the 8,000 barrier last week for the first time in more than a year.

While Northern Rock’s problems represented more bad news for bank shareholders, they also spell major trouble for bank customers too.

Hundreds of Northern Rock’s Irish customers, who have collectively deposited €2.5 billion with the bank through its online and phone operation here, queued at its Dublin offices on Friday to get their hands on their money, despite assurances from the bank and the British financial regulator that their funds were safe.

But Northern Rock’s underlying difficulties, detailed in a stock-exchange statement issued by the bank on Friday, have further-reaching implications for customers of all banks, who face significantly higher borrowing rates as a result of the credit squeeze.

Although the European Central Bank (ECB) failed to pull the trigger on higher interest rates earlier this month, the crunch has resulted in soaring borrowing costs in the interbank market and bankers expect this rise to be passed on to customers.

Northern Rock said it was not expecting inter-bank borrowing costs to return to their historical norms in the short to medium-term. Chief executive Adam Applegarth spoke of ‘‘extreme conditions in global liquidity’’, and revised profit forecasts downwards by more than 20 per cent.

The bank did not expect to see markets return to normal until next year at the earliest, and also suspended its attempts to raise cash through a fire sale of what it called ‘‘capital-inefficient assets’’, saying it would only sell these if and when the prices on offer for these assets improved.

At the root of the higher borrowing costs is a problem on the supply side, as banks with surplus cash are no longer as willing to lend because they place a premium on having sufficient cash at their disposal in the event they need it to plug a funding gap of their own.

With less money on offer from suppliers, the price of money has shot up - in some cases as high as 1 per cent over the base rates.

Even with the ECB holding its rates steady, bankers are now finding themselves forced to pay far more for their money than in the past. Irish Life & Permanent chief executive Denis Casey was the first mainstream banker in the Irish market last week to warn of a looming threat to lending margins caused by the credit crunch.

If the cost of money goes up, the only way to preserve margins is to hike the rates that banks charge to their customers. Several high-profile British banks, such as Abbey and Halifax, have already begun to do this but senior bankers in Ireland have said it is only a matter of time before the experience is repeated here.

But the banks are prevented from raising rates across the board. Many mortgage holders are already immune to higher rates after signing up to fixed-rate deals, which have set their monthly repayments at agreed levels, or tracker products, where the rate charged is a fixed margin of between 0.6 per cent and 1.3 per cent over the ECB rate. These customers can only be forced to pay more if the ECB raises its rate.

Instead, the focus is likely to be on customers who have taken out standard variable rate (SVR) mortgages, where banks are free to change the applicable rate as they please, and new tracker mortgage customers, w ho may be faced with higher margins over the ECB rate. Others in the firing line include businesses and customers with floating rate overdrafts and personal loans.

While higher rates may ease some of the banks’ pain, however, they will also have a negative effect on lending volumes as they will curtail the borrowing power of individual customers.

Just as the ECB’s series of rate hikes has dampened demand in the Irish mortgage market, with some banks reporting a fall-off of 20 per cent in new lending, higher margins will act as a further brake on lending activity.

The spectacular fall in Irish financials has resulted in their dividend yields - an often-forgotten measure that tracks the relationship between dividends paid and a company’s share price - soaring.

Investors who take a punt on Bank of Ireland at current prices, for example, can expect to receive a dividend worth €4.68 for every €100 they put on the table - a far higher return than is available by putting the money on deposit with the same bank. But shareholders are not taking the bait and fear that pr ices have further to fall before the current horror show ends.

One senior banker described the liquidity collapse as unprecedented and said the return of confidence necessary to restore the old order remained a long way off. ‘‘This could run and run,” he said.

For a property market where confidence is already dwindling, t he shot in the arm provided in recent years by cheap and freely available credit may have ended up delivering a shot in the head instead. Borrowers face a future of tighter credit conditions and higher margins. But the news for shareholders could be even worse.