OPINION:The Government and the banks need to find sustainable alternatives to ECB funding, writes SIMON CARSWELL
FIGURES TO be published by the Central Bank will reveal what effect market fears around the financial position of the Government and its almost fully nationalised banks had on the liquidity in the financial system.
The banks, including the Irish operations of international banks, had drawn a total of €165 billion at the end of October – €130 billion from the European Central Bank (ECB) and almost €35 billion from the Central Bank.
The Government’s agreement with the European Union and the International Monetary Fund (IMF) on an emergency package of €85 billion is likely to have driven further deposits out of the system.
The big three – AIB, Bank of Ireland and Anglo Irish Bank – had lost more than €35 billion in deposits this year up to last month. Borrowing by Anglo, the most heavily reliant of the three on central bank funding, may soon hit €50 billion as it fills the hole left by lost deposits.
The attraction of being funded by the Central Bank is obvious – the Irish banks can borrow at a discount rate of 1 per cent, funding that would cost them considerably more if the debt markets were willing to lend to the lenders. The ECB became alarmed in late October-early November not at the scale of drawings by the banks from Frankfurt but that the level of emergency lending assistance (ELA) from the Central Bank had jumped from €14 billion to almost €35 billion in just two months.
This was mostly down to Anglo as the bank has little or no eligible collateral that it can use to borrow from the ECB discount counter. It is relying on the drip of heavy cash flowing from Dame Street.
A basic rule of central banking – and one followed closely by Frankfurt – is not to provide liquidity to insolvent banks because there is a very good chance you won’t get your money back. The Irish Central Bank has taken assets as collateral from Anglo which would not be accepted by the ECB to support Anglo, a bank with no future.
Bankers point out that central bank funding is like a drug – it’s easy to get hooked and difficult to come off, particularly when the lenders who could help wean you off are aware of your addiction.
The ECB has signalled that it is willing to continue funding the Irish banks if they have sufficient eligible collateral and will sanction continued ELA lending to the banks as long as there is a plan to repair them so they can stand on their own at some point in future. However, the monetary authorities are currently looking at other ways of funding the Irish banks.
The EU-IMF €85 billion bailout – €17.5 billion of which is coming from the State’s reserves – covers the capital hole at the banks and Government borrowing for up to three years, but not bank funding.
A fund of €35 billion has been earmarked for the banks under the plan. Some €10 billion will go to overcapitalise them up front and to slap guarantees on assets and loans to attract buyers. In addition, €25 billion is being put aside in “a just-in-case” fund for more asset sales and to cover losses rising above and beyond a worst-case scenario to try to reassure markets further.
The plan involves a sharp restructuring of the banks, making them smaller and better capitalised – to international standards – so they can go out and borrow to wean themselves off ECB/Central Bank cash.
But the markets’ view is that international investors and depositors won’t touch Ireland until they see a quick execution on shrinking the size of the banks and a line – a very final one – being drawn under losses. This could take some time. The EU-IMF plan does not contain details of how the banks will fund themselves in the short term.
Four measures need to be considered to properly fix the problem:
The full scale of loan losses at the banks needs to be determined and a plan agreed to finance these losses over a much longer period, potentially over more than 30 years. The longer the better to keep the interest rate or the cost of funding these bad assets down.
All bad assets – beyond the toxic property loans taken out of the banks by the National Asset Management Agency – need to be warehoused in a bad bank and run down over a long period. This will fund repayments on the funding of the bad assets in the first part.
Banks deemed viable must be recapitalised to the emerging international standards so that investors and depositors will lend to them and they can fund themselves. Selling these banks back into private hands much later will pay for this.
Finally, the viable banks must be funded properly and interest rates on the cost of funding them based on long-term timescales.
The EU-IMF rescue plan estimated that banks could require an additional €15 billion – on top of the latest €60 billion bailout total – as a contingency against potentially horrific losses, well above stress case scenarios.
Minister for Finance Brian Lenihan said in his Budget speech this week that it was estimated the banks would incur losses of €70 billion to €80 billion in the years from 2008 to 2012. A fund of about €75 billion should therefore be sufficient to protect against losses and raise capital at the viable banks to levels that will satisfy financial markets.
This is on top of the banks’ own efforts to boost their reserves.
Then comes the funding part. Running off bad assets will require financing of €70 billion, banking sources estimate, while viable banks will require at least €50 billion to fund themselves back to full health over the medium term.
The sum of these figures is not the net cost of saving the banks – some cash could be recouped as the economy recovers – and funding will be provided by way of loans to be repaid over time.
ECB and Central Bank funding is currently keeping the banks upright but central bank funding should not, by definition or design, be applied during a period of intensive care but to healthy banks that are struggling in difficult times. The low cost of ECB lending and the easy availability of support from Frankfurt has been a disincentive to the Government and the banks to consider more fundamental solutions – this was one of the reasons why the ECB called time on the Government’s plan.
If a market rate was applied to the ECB/Central Bank funding, the banks – in effect, the Government – would have to pay a rate of more than 5 per cent on loans of €165 billion or €8.25 billion a year compared to the current cost of €1.65 billion.
The ECB is effectively being used as a back door lender for the financial needs of the State – making this arrangement permanent would compromise the independence of the European bank.
While Frankfurt creates a safety value for euro zone-wide monetary pressures, there is no such mechanism for a state’s financial system, which lumps the funding of the banks back on to the state. In other words, the ECB is funding liabilities that are ultimately due by the Government. If the banks are to kick the habit, another way must be found to fund them. This could be by way of the European bailout fund, the €440 billion European Financial Stability Facility which is providing €17.5 billion to the State under the EU-IMF rescue plan.
This would involve the Government borrowing more heavily from the fund – solely for the long-term benefit of the banks – to take the ECB out of the equation. This is a long road, but you just can’t keep kicking a can down it.
