AIB, Bank of Ireland and Permanent TSB have all made sizeable provisions against future loan losses in their first-half accounts just published. This is a change of tack by banks, in Ireland and internationally. After the 2008 financial crash, banks were in denial and the regulatory regime at the time allowed them to provide only for loan losses which had already crystallised.

Banks which were clearly going bust made inadequate provisions and some even paid out dividends and bonuses to the bitter end. The result was taxpayer bailouts in many countries.

In Ireland, the cost helped push the country out of the sovereign bond market and into an IMF rescue programme.

Had the banks, and their auditors, been making realistic provisions, some of the bubble-period lending mistakes might not have been made.

Lessons have been learnt – the worst banks have been closed, the survivors have smaller balance sheets and they have raised additional risk capital. The rule-makers now permit banks to make prudent provision against expected loan losses instead of pretending that all will be well.

Despite all this, banks whose shares are listed on stock exchanges have had a dismal time.

Against the best price over the last year, AIB is down 68%, Bank of Ireland is down 63% and Permanent TSB is down 61%.

The Government has been better at selling bank shares than it was at buying them – it nationalised Anglo and all the funds injected have been lost.

But the current price of AIB is just one-quarter of the price at which the Government sold 29% of the bank in 2017, while the much smaller Permanent TSB has been an even worse buy for investors – the Government sold shares at €4.50 which have recently traded around €0.50.

The State was always a minority investor in Bank of Ireland and has sold in stages, always at prices well ahead of today’s quotation.

The critical question is whether the provisions made against loan losses are adequate, and whether the three banks can expect an early return to decent operating margins. If both answers were positive, the market valuation of the shares would be a lot stronger.

A bank able to earn normal profits and whose assets (mostly loans) exceed its liabilities (mostly deposits) will have a share price roughly in line with net assets, in the jargon a price-to-book ratio of about 1.0.

Valuation of loan assets

For AIB and Bank of Ireland, price-to-book has recently been around one-quarter, for Permanent TSB even lower. This means that the market is not convinced about the valuation of loan assets or does not expect an early return to profits and dividends, or both.

The current discount to net asset value for the Irish banks is not unique – European banks trade at only about 50% of book value, American banks at about 90%.

The Irish discount is simply much bigger and evidence that the market is not convinced that loan accounts have been marked down aggressively enough. They must think that more loan loss provisions will be needed in future financial statements and they may also be worried that operating profits will be hard to restore.

The main Irish banks are heavily reliant on lending for residential mortgages.

Numerous borrowers have availed of repayment holidays and the big question is whether they will resume steady monthly repayments once the Covid-19 crisis has passed.

The banks have been lending up to 90% to mortgage borrowers in recent years, house prices are headed south and some people may not get their jobs back.

Many business borrowers, including farmers, are struggling too. Not all will be in the clear even if the Irish economy recovers strongly – there will be permanent damage in the travel and hospitality sectors, for example. And there is no guarantee of an early end to the crisis.

The medical experts are not sure that a vaccine will become widely available for another year and there is a risk that the efforts to create one will come up short.

After the rescues and bailouts following the 2008 financial crash, the new management teams at European banks had little choice but to play the nice cop when COVID-19 struck.

Some of their lending exposure has been supported indirectly by governments, which have run up big budget deficits quickly to maintain household incomes and have also written state guarantees against business lending.

If there is a serious second wave around Europe more businesses will go to the wall, more mortgage borrowers will get into arrears and the fiscal capacity of governments to sustain this indirect support to the banks will weaken.

Banks will have to become less accommodative to customers in arrears.

But if you feel that the COVID-19 crisis will be over fairly soon, the banks will recover and bank shares are cheap.