Two classes of Irish in deposit guarantee gamble

Commentators have woken up to the scale of what the Irish government is doing – already noted by shrewd Sugger contributors – of more than doubling its GDP to offer up to 400 billion euros to all bank deposits, liabilities including retail, commercial and interbank deposits in Irish-owned banks, to take effect immediately and expiring in September 2010.

My hero Peston says: “This has huge ramifications for us. Potentially it puts British banks at a massive competitive disadvantage – especially since other European governments are also taking urgent steps to reassure their citizens that their bank deposits are safe.” In other words, there could be a rush out of British banks and into the six named Irish banks covered by the scheme. The Irish authorities must be praying the guarantees are never called in or else they’d bust the State. They’ll be hoping their move is matched by other European countries pdq.

Meanwhile the Irish Times have a piece that makes the two classes of “Irish” clear. “Aside from the six Irish owned banks, ” other financial institutions, many of which are owned by foreign institutions are not covered under the new scheme. However, they can avail themselves of the Government’s previous Deposit Protection Scheme on sums up to €100,000 (i.e. not necessarily the full value), but the foreign-owned bank must make a request to the Financial Regulator to be covered to this amount.” What will the regulator say if they all come rushing? From the BBC story “The department said that the scheme would cover all UK branches of the financial institutions, but that negotiations were under way with the British authorities on safeguards that might be provided to any of the six banks’ subsidiary companies in the UK.” For example, ThisisMoney reports that “full compensation will not stretch to UK customers of Allied Irish Bank, as it says its UK branches are separately authorised to its Irish parent bank when it comes to compensation. These savings are therefore only covered up to the UK limit of £35,000 per individual. The move will increase pressure on Alistair Darling to increase the UK limit to £50,000 before the end of the year as he hinted during the summer.” “This is by any standards an extraordinary development that may result in an exposure of as much as €400bn for the Irish taxpayer,” said Joan Burton of the Irish Labour party. No wonder the Dail would like to discuss it.

  • DC

    This will give Gordon Brown some cover, given that Ireland’s socio-economic model has been held up across Europe as an inspiration of rejuvenation. It might help counter attack the Tories charges against him or perhaps might leave the Irish Government extremely vulnerable.

    Do you think underlying the American problem is a battle to sustain its prestige in that perhaps its own banking system could be saved by Chinese re-investment that would change the colour of the financial face of America?

    Instead of Chinese ownerage get the yank person on the ground to pay across the nation in a way that keeps the institutions under the red white and blue?

  • Suilven

    The real story here is not the deposit protection, but the protection of Irish banks’ covered bonds, senior debt and dated subordinated debt. In effect the Irish government is now an investment bank writing free credit default insurance on the entire financial sector. In short, they can only hope other European governments follow suit otherwise the EU will be forced to come down on them like a ton of bricks for illegal state aid.

  • That IT article could have pointed out that:

    a) Irish credit unions are not “foreign owned” – it took two journalists to write that article remember!
    b) The Irish credit unions are not only protected up to 100K by government as stated and have an additional Savings Protection Scheme of 110m Euro and covers CUs in both Northern Ireland and the Republic.

  • @Suilven – could EU governments decide instead to become insurers of last resort and charge premiums to get around that, as I seem to recall was done post 9/11 for the airlines?

    (I exempt France, Italy and Greece whose attitude to State aid is of a more “damn the torpedoes” variety.)

  • Suilven

    The EU problem, as I see it, Mark, is not the gratis nature of the guarantee (in the current quagmire anyway), but the favourable treatment being given to Irish-domiciled banks over the Irish subsidiaries of UK and continental banks. I can only believe the EU will view this as protectionism.

  • Comrade Stalin

    Surely the point here is that by increasing the amount of money the Irish banks have on deposit, the likelihood of an actual failure is substantially diminished, and hence the government is not likely to ever have to actually bail anyone out. Additionally the banks are also in a better position to lend to each other ?

    It’s brave but I think it could work.

    I cannot see the EU taking a hard line on this in the current economic circumstances. If there was an EU-wide agreement on this matter it might be a different situation.

  • Dave

    “Surely the point here is that by increasing the amount of money the Irish banks have on deposit, the likelihood of an actual failure is substantially diminished, and hence the government is not likely to ever have to actually bail anyone out. Additionally the banks are also in a better position to lend to each other ?”

    Deposits appear on a bank’s balance sheet as liabilities, not assets. Additional deposits, ergo, increase a bank’s debt, not decrease it. Why? Because a bank undertakes to pay a depositor (an investor) an annual return on the money that said depositor loans to the bank. To meet this undertaking, the bank must convert the deposit into earning assets, i.e. loans and investments. The average bank has around 2% of its net worth in cash. Cash is an unearning asset, and, ergo, a liability. In the current climate, a wise bank will not want cash deposits because investing it in order to earn the return it undertakes to pay the depositor will be highly problematical. So, although it may sound strange, an influx of cash will likely bankrupt a bank.

    Do Irish banks have a problem? That is for the Irish banks and the regulator to declare. This government is determined to create the impression, independently of the relevant evidence, that the Irish banking industry is on the verge of collapse. But then again, Brian “I didn’t read the Lisbon Treaty” Cowen is an utter moron who squandered the Nation’s wealth when he was Minister for Finance, so exposing the Irish taxpayer to the risk of penury by forcing them to act as guarantors for private enterprise and private investors, both foreign and domestic, is well within the remit of ineptitude that this dismal and unmitigated jackass is capable of.

    In addition, the 400 billion liabilities are not, contrary to idiotic claims by the Irish government, mitigated by assets. Assets are worth whatever the market will pay for them. Try disposing of the mythical 400 billion worth of assets and you’ll quickly discover that the bulk is unsalable, and, ergo, worthless. The government should be more concerned about where its own credit rating will end up rather than the credit rating of a few private companies.

  • “a wise bank will not want cash deposits because investing it in order to earn the return it undertakes to pay the depositor will be highly problematical.” – true, but that depends on the return offered. I note AIB’s website deposit rates were last updated in July – I expect another revision any second now…

    However, another inhibition to accepting large deposits could be the possible outflow if Broon bows to the clamour and raises the guarantee level for UK banks.

  • Dave

    If the annual interest was set at zero and the receiving bank did nothing with the deposits, it will still incur a loss on the transaction due to administrative and handing costs. What the banks should do is start charging depositors for holding their cash. They can offer this service because the Irish taxpayer is underwriting the insurance policy that the bank is selling to the depositor. This, of course, would make FF deeply unpopular with Irish depositors who will see their annual interest vanish and, instead, charges imposed on them by the banks for keeping their money in the bank.

    If the receiving bank loaned the money that floods into them from foreign investors (as a result of the Irish taxpayer guarantying to work for the next 30 years and pay rates of taxes at 70% to offer them a free insurance policy for their investment) to other banks, then it will still expose the Irish taxpayer to the risk of the business deal while the private company (the bank) earns a profit from it.

    If it offers an annual interest and then tries to convert the money into investments in order to earn a sum above the sum it undertakes to pay the depositor, then it will see those investments fall in value during the course of the recession, leaving the Irish taxpayer exposed to liability for the shortfall. In addition, all Irish banks are badly exposed to risky construction industry loans. AIB, to its credit, has been frank about this. So giving any of these banks large sums of money via money flooding into them from abroad will challenge their investment teams to find an area of investment other than the ones they are familiar with and exposed to. Believes in that happening only if you believe in fairytales.

    If this goes badly wrong (and the odds are that it will), then the Irish people have been sold into slavery in perpetuity. I’d support a revolution wherein we hang Cowen and his government from lamposts. Obviously, we’d have to reinforce the lampost before we could hang the fat fuck Biffo from it. 😉

  • Comrade Stalin

    (as a result of the Irish taxpayer guarantying to work for the next 30 years and pay rates of taxes at 70% to offer them a free insurance policy for their investment)

    I’d love to see how you derived these figures. I don’t expect I will, though.

    If this goes badly wrong (and the odds are that it will), then the Irish people have been sold into slavery in perpetuity.

    You do have a penchant for hyperbole that really undermines the minimal credibility your contributions have. Worst that’ll happen is a default. Russia did it, Argentina did it, they’re presently talking about the USA even doing it.

  • Dave

    Thanks for that, tulip. Have you learned what GSE means yet or are you still claiming that Fannie Mae and Freddie Mac are not ‘government-sponsored entities’ and that anyone who says otherwise is telling “lies.”

    I’m still laughing at that. 😉

  • Comrade Stalin

    Pretty stupid, I admit. At least I did something useful, though, by giving you an opportunity to ignore the argument, which you’re merrily doing right now.

  • Dave

    Really? Isn’t that what you are doing? You know your ‘argument’ above deposits are assets on a bank’s balance sheet and that the Irish government’s reckless move would lead to an influx of cash thereby boosting the bank’s balance sheet? I pointed out that you misunderstood how a bank’s balance sheet works, i.e. that cash is listed as a liability. That wrecked your argument, so you decided to ignore that post and focus on a issuing an unflattering review of my general ‘contributions.’

    “Surely the point here is that by increasing the amount of money the Irish banks have on deposit, the likelihood of an actual failure is substantially diminished, and hence the government is not likely to ever have to actually bail anyone out. Additionally the banks are also in a better position to lend to each other ?” – Comrade Stalin

    “Deposits appear on a bank’s balance sheet as liabilities, not assets. Additional deposits, ergo, increase a bank’s debt, not decrease it. Why? Because a bank undertakes to pay a depositor (an investor) an annual return on the money that said depositor loans to the bank. To meet this undertaking, the bank must convert the deposit into earning assets, i.e. loans and investments. The average bank has around 2% of its net worth in cash. Cash is an unearning asset, and, ergo, a liability. In the current climate, a wise bank will not want cash deposits because investing it in order to earn the return it undertakes to pay the depositor will be highly problematical. So, although it may sound strange, an influx of cash will likely bankrupt a bank.” – Dave

  • Brian Walker

    Dave and anybody else, On the above point – is treating deposits as liabilities one of the reasons why congress members are calling for new accounting rules? Can a deposit rich group of banks not restart the lending cycle themselves are so start to rebuild confidence? I only ask. As is obvious I’m no banker.

  • BfB

    Just make sure the deposits are in gold ingots….And look out for that money with ‘dead presidents’, non Obiewan looking bastards on them ;-0……

  • BfB

    Ruh Roh, may not make a difference where the uuurohs are……

    Euro Falls Most Since 2001 Against Dollar as Bailouts Spread
    Toxic assets….You guys are screwed! Better get the seedings planted for the long haul!! The sky is falling..

    ‘The euro fell the most against the dollar since 2001 after France and Belgium led a state-backed rescue of Dexia SA, as the widening financial crisis forces governments to prop up financial institutions across Europe.

    The cost of borrowing in dollars and euros reached record highs today as banks’ reluctance to lend at the end of the third quarter exacerbated the freeze in global credit markets. The dollar rose against the yen on speculation the U.S. Senate will salvage a $700 billion bank-bailout plan as early as tomorrow after Congress rejected it yesterday.

    “The consensus is the U.S. banking system is a little bit further along in its exposure of its toxic assets,” said Firas Askari, head currency trader at BMO Nesbitt Burns in Toronto. “It’s a case of which is relatively worse. The dollar’s going to benefit against the euro because Europe has more to expose.”’

  • Dave

    Brian, deposits are liabilities, so I don’t see where you are going with “new accounting rules.” It’s true that the bank takes legal title to the funds of the depositor, so it becomes an ‘asset’ of the bank. However, they can’t add it to the balance sheet as an asset without also adding it as a liability: it is the [i]liability[/i] that the bank owes to its depositor. So, if a bank gets a billion in deposits in one week, it also becomes one billion deeper in debt in that week. The particular problem faced by the banks is that they enter into an agreement with the depositor to invest the money that he lends to them and to offer him a return on his investment (his deposit) out of their return on their investment of his money – which must be greater than the return offered to the depositor. In essence, the bank converts the unearning ‘asset’ into an earning asset. That’s the basic business model of banking. It works well when the banks can earn a satisfactory return on their investment, but rather obviously fails when the bank converts the deposit into assets that are worth less than they paid for them. In the current environment of rapidly falling market values, just about everything the banks have invested in is worth less than they paid for them. Many of these banks are bankrupt, but they just don’t know it yet.

    Banks are lending money. They’re just being careful about who they lend it to. Indeed, the stronger banks are snapping up the weaker banks. It’s only the banks who have question marks over their solvency that can’t get loans from other banks, and rightly so. There is uncertainty about the quality of their credit-scoring models; uncertainty about what form the impending recession will take, and uncertainty about the extent of their bad debts, present and contingent, etc.

    In the US, 700 billion is a lot of money, but it is a mere fraction of the liabilities that the US banks have outstanding. The whole may be far bigger than imagined. This measure, and the Irish measure, doesn’t do anything about the uncertainty pertaining to solvency. Only the free market can answer those questions by letting the weaker banks fail, sans any form of government intervention. Leave the market alone and it’ll sort itself out. Yes, a lot of people will have to assume responsibility for their own mistakes but that is how it should be. It is an outrage that a PAYE worker who probably has no more than a few thousand in a bank should be asked to assume liability for someone like Michael Smurfit who has tens of millions in it. Worse, Fannie Mae and Freddie Mac happened because it was always assumed by the market that the US taxpayer would accept liability for the debts of those GSEs, thereby freeing the private companies involved from assuming responsibility for their own lending practices. And so it came to pass. The market that is ‘corrected’ by government intervention still has its fundamental problems in situ, whereas a market that corrects itself will recover fully – and won’t allow itself to take reckless risks when it alone is responsible for them.

    In regard to the US, do you really expect government to accept responsibility for its role in allowing the GSEs to assume massive debts or for exhorting the Federal Reserve to set interests rates at insanely low levels? No, they’ll pretend that the cause of the problem wasn’t bad government, and that their proposed solution isn’t more of the same.

  • pfhl

    Surely this promise from the Irish goverment is a preventative measure in order to bolster confidence in deposits made in irish banks. This will persuade people their money is safe in the bank and there is no need to withdraw it. Meaning the bank does not have to raise cash to pay all the deposits which would be withdrawn if confidence failed. This scramble for cash among banks would lead to a serious drop in prices in capital markets further buggering us all. Dave I do get your point of them not wanting more deposits but this action will decrease the chances of people demanding their money back straight away.

    Dave you also talk of how the market will decide. What about those hundreds of thousands of people who could loose most of what they have if banks did fail and nobody was there to pick up the pieces? All the current situation shows is past economic practices were not in the interest of most people but for a few greedy pricks at the top who wanted a new car when their bonus came in. The main word in this whole situation being confidence.

  • Suilven

    I have to say I feel Dave is only partially right here. While in normal circumstances, a glut of deposits with their investment and admin costs would be bad news for a bank, at the moment with the interbank rates (LIBOR and EURIBOR) trading way above central bank rates, it’s actually cheaper for banks to fund themselves via deposits than in via the interbank or money markets. That’s the reason Santander were so eager to pay £600m to the UK govt to get their hands on Bradford & Bingley’s £20bn deposit business last Monday.

  • Dave

    It just comes down to how the bank can generate the yield required to may the depositor his interest in the present investment climate, i.e. recession, loan defaults, falling property values, shares in freefall, etc. Invest a billon via the usual routes now and the odds are you’ll have 600 million in 4-years time (if you’re lucky). Do nothing with the deposit and you’ll have paid the depositor over 150 million during the course of the recession, leaving you with a handsome loss for not investing.