Irish bank guarantee scheme: now the devil is in the detail

As far as I can make out the Irish bank guarantee saga has reached somewhere between Pete’s disapproval and my earlier optimism. Finance Minister Brian Lenihan has been explaining himself to the Financial Times:

“Mr Lenihan insists Ireland did not want to strike out on its own, but needed to act quickly. “Our government and I would have preferred a European approach to guaranteeing confidence and stability of the banking sector,” he says in an interview with the Financial Times. “But in the absence of a European approach, a small sovereign state like Ireland is obliged to ensure the stability of the banks that are orphaned with us.”

After the Dail’s all-night sitting to pass the measure a wider political defence includes the admission:

“For the Government, the sobering reality is that no matter how necessary the legislation was in the national interest, it will take some explaining to the public. The fact that unpopular bankers have been let off the hook is easy to grasp, while the unknown impact of an averted banking failure is an abstract concept”.

The British seem to have cooled down. Now the cost, already debated in Slugger, is being counted… Extracts from Irish Times report:

“Aside from straining relations with Britain, the move could be very costly. If the Irish government had to honour its guarantee, the national debt would balloon from 25 per cent of gross domestic product to 242 per cent, according to analysts at Collins Stewart. It is also far from clear how Irish banks will be prevented from abusing the guarantee, which runs for two years. Mr Lenihan says they will be charged for it, but would not be drawn on how this will work in practice.

Now that the Irish have agreed to extend the guarantee to the Irish subsidiaries of RBS and HBOS, the British authorities do not see the threat as too serious. Nevertheless, it has intensified calls for Downing Street to introduce a similar guarantee.

Analysts estimate that bad debts at the four guaranteed banks will top between €8 billion and €10 billion this year and over the next two years – with AIB, Bank of Ireland and Anglo Irish Bank accounting for most of the debt.”

  • Pete Baker

    I had aimed at sceptical rather than “disapproval”, Brian.

  • Greagoir O’ Frainclin

    The Greeks have followed the Irish example now!

    Some old English chap was on BBC Question Time last night and was all hot and bothered about the Irish move, saying it was totally ‘anti-European’ and ‘nationalistic’ etc…!

    …this encapsulating the attitude of perhaps the most Euro-sceptical and nationalist member of the EU!

  • Greagoir O’ Frainclin

    Richard Lambert was the old bean in question…

    (Director-General of the CBI, and the present Chancellor of the University of Warwick)

  • econokensei

    Analysts estimate that bad debts at the four guaranteed banks will top between €8 billion and €10 billion this year and over the next two years – with AIB, Bank of Ireland and Anglo Irish Bank accounting for most of the debt.

    So say €8 billion, to account for the other banks. 8/3 = €2.67 billion each.

    The bank of Ireland made a pre tax profit of almost €2 billion last year:

    http://www.finfacts.ie/irishfinancenews/article_1013653.shtml

    This is a bit old, but gives total assets at €162 billion and market capitalisation at €16 billion

    http://portal.cbre.eu/portal/page/portal/bank_of_ireland/covenant

    I freely admit I’m an idiot that knows nothing, but does that translate as a crisis, or just nasty losses? Are these losses to be nationalised?

  • Glencoppagagh

    The Irish government is not underwriting losses from bad assets (i.e. loans). It is guaranteeing liabilities (i.e. deposits). So only if loan write-offs escalate to the point where a bank is unable to meet its liabilities when they fall due will the Irish government’s guarantee be invoked. The beauty of the guarantee is that this must happen in reality, the mere apprehension of it should not provoke a run on a bank because of the guarantee.

  • John East Belfast

    Glenc

    “So only if loan write-offs escalate to the point where a bank is unable to meet its liabilities when they fall due will the Irish government’s guarantee be invoked.”

    Exactly – the real question is how much of the Loans on Irish Books are bad ?

    Those of us in Construction, Property and Wealth Management know personally of situations and also anecdotedly a lot more about people who have taken a serious beating on property deals – especially land banks – and are up to their necks in debt – with Irish banks.

    The question is more than one about the liquidity of Banks and more the liquidity of the Banks’ borrowers.
    ie can they continue to make the interest calls.

    I think if the Assets backing the loans were marked to market and the personal liquidity of the Borrowers were reviewed I think Eur 10billion of Bad Debts is on the shy side.

    The thing that the Irish taxpayer should be worried about is how much is the Market capitalisation (Equity) of these Banks less than the Bad Debt write off – that is the figure they have underwritten.

    The Irish Govt took an understandable action to stop a run by Depositors wanting their money back on Tuesday – and that has worked. However it in no way helps banks deal with the Bad Debt situation.

  • Harry Flashman

    Anglo-Irish Bank is currently offering 7% on some deposit accounts, given that those deposits are now guaranteed by the Irish government would it be too simplistic for me to say that in effect the Irish treasury is now effectively offering 7% interest to borrowers without accruing any profit to itself?

    In the current economic climate is this wise? Would allowing the badly managed Anglo-Irish Bank go under not be a much better option for Ireland than to see such a devaluation of their government bonds?

  • econokensei

    Harry

    A 7% interest rate on deposits would point to me to a lack of capital. The bank offers high interest rates to increase deposits, and thus their capital base. That would be worrying.

    The Irish Government is not offering 7% any more than my unemployment insurance means that my insurer is paying my wages every month. Payout only happens in the event of failure. This should really cost though — I thought there was some talk that there would be some payment to the Irish Government, but no specifics.

    If only the Anglo-Irish guarantee was protected, then there would be an issue as the Anglo-Irish bank would have a competitive advantage in terms of being a much safer bet. That’s why Northern Rock is limited to 1.5% of the market and had to refuse business this week. But the Irish Government guarantee is much wider than that, thus mitgating those sorts of competition issues.

  • John East Belfast

    econo

    “The bank offers high interest rates to increase deposits, and thus their capital base”

    Without boring you with Double Entry Book Keeping I am afraid it doesnt.

    The only way to increase a Bank’s Capital is for shareholders to stump up and/or retain any profits earned.

    That is a Bank’s Market Capitalisation or equity – eg in the BOI example you quoted above you would have to increase the Eur 16billion.

    However what this influx of Deposits does is increase a company’s Asset base and simultaneously increase its Liabilities. The latter is what the Irish Govt are now guaranteeing.

    What the Anglo does with this extra cash will convert it from one safe but poorly returning asset (cash) into another less safe but better returning asset – a loan.
    The Irish Govt is guaranteeing what the Banks have done with all these Deposits.

    The influx into the Banks of Deposits increases a Bank’s liquidity and means it doesnt have to go to the credit crunch dried up Bank wholesale market and borrow what they have loaned out in excess of their own money (capital) and retail Depositors.

    Remember how Banks work – their shareholders put in £2, Depositors put in £8 and then the banks go an lend out £20. They go to other banks to borrow the other £10 they have loaned out.
    The Irish Govt are now guaranteeing the £18 of Depositors and other Bank money in the hope that the Bad Loans among the £20 are less than the Bank’s own money of £2. If they are their guarantee will never be called upon but if they are £8 or £10 then the Bank is insolvent and the Govt makes up the difference.
    Multilpy these numbers by tens of Billions of Euros of course.

  • econokensei

    JEB

    Thanks for the explanation, the double entry bit makes sense in terms of capital. As I explained previously I’m talking out of my hat on a lot of this 🙂

    I’m still a little unsure about a few things though. I thought the guarantee was for depositors only — that if the bank went bust only the people that put in their £8 deposits would get their money back. How do the loans end up guaranteed?

  • John East Belfast

    econokensei

    The Irish Govt have guaranteed all the people and Institutions that have loaned money to Irish Banks.

    Remember a Depositor is simply somebody who has given the bank its money to look after but will want it back again someday – ie they are a Bank’s liabilitity.

    The Bank has then taken that money (plus some) and loaned it on to somebody else – to balance their books each night the bank have to make up that shortfall – between their own money(equity/capital) plus Depositors against what they have loaned out – by going to the Interbank market (as well as the Govt)and borrowing of them.
    The Credit Crunch has hit that latter Inter Bank Market – ie banks wont lend to each other because they dont trust each other.

    The Irish Govt has stepped in to bridge that trust by saying they will guarantee all deposits and all Inter Bank Lending.
    This then stops Depositors taking their money out (as well as encouraging others to put money in and hence reducing the need to go to the Inter Bank market)and also encourages other Banks to lend to the Irish Banks.

    Hence this all solves the Liquidity problem that all Banks and especially Irish Banks were facing.

    However the big question is how bad are the Loans and is the Bank Equity enough to cover them – if its isnt then that is where the Irish Govt’s Guarantee gets called on.