Anglo Irish Bank should have been allowed to fail in September 2008, Central Bank governor Patrick Honohan has said.

Speaking at the Oireachtas Banking Inquiry, Prof Honohan said it should have been clear to the State's financial authorities that the bank was in danger of going bust.

Asked by Fianna Fáil’s Michael McGrath if Anglo should have been allowed to fail in September 2008, Prof Honohan replied “Yes, certainly”.

He said there should have been an intervention and the management of Anglo should have been removed.

“That would have been more clear had they known what the size of the problem was but all the investment banks that looked at it saw that Anglo’s business model was not credible in the market,” he said.

“It had run out of cash and there was a big problem with its portfolio which would have eaten through its capital.”

Prof Honohan, who was not Central Bank governor at the time, said it should have been clear then that allowing Anglo to fail was the right move.

Lenihan overruled

He said the then minister for finance Brian Lenihan agreed with the bank guarantee and also thought Anglo and Irish Nationwide Building Society should also be nationalised but was overruled. He said Mr Lenihan told him he argued strongly not to cover the subordinated debt linked to the institutions.

Asked by Fine Gael Senator Michael D’Arcy as to who had the authority to overrule the minister for finance, he replied “we’re not meant to talk about individuals but he (Mr Lenihan) was not the senior politician and it was probably the weight of advice around him as well.”

Mr Honohan added that he did not want to name names but the taoiseach and attorney general were the only other political people present.

Mr Lenihan, he said, backed down on the matter with expectation the two institutions would be nationalised by end of week the guarantee was given. The measure led to an inflow of funds into the banks and the pressure to do so eased off for some time, he added.

Bad rap

Prof Honohan said Ireland got a “bad rap” for introducing a guarantee. He said the State would have been viewed even more poorly internationally for saying “to hell with the bondholders” and liquidating Anglo but this did not make it the wrong call.

“It would have been seen as the European Lehmans and the government would have been pilloried. That doesn’t mean they shouldn’t have done it but they would have been pariahs in international circles.”

Other banks were close to the edge at the time and would have required Emergency Liquidity Assistance (ELA) if Anglo had been allowed to fail but they ultimately needed to access ELA a few years later anyway, he added.

The decisions taken by government at the time were understandable given the advice they were receiving, he said.

Prof Honohan said the Central Bank and Financial Regulator appeared to be in the backseat when many of the decisions were taken in 2008.

“They weren’t pushed into the backseat, it just seemed de facto to be the situation,” he said, adding that some of the decisions had to be taken by the government as they involved committing State money or needed legislation.

Prof Honohan went before the inquiry to discuss a report he wrote, The Irish Banking Crisis Regulatory and Financial Stability Policy 2003-2008, prior to taking up his position at the Central Bank.

His report followed a request by Mr Lenihan and examined the performance of the Central Bank and Financial Regulator in the period 2003-08. It was based on internal files and interviews with relevant officials.

Lehman collapse

Prof Honohan said the collapse of Lehman’s was a catalyst for but not the cause of Ireland’s financial crisis. The development had an effect on others but Ireland was already in a bind and one shock or another would eventually have caused the crisis, he said.

“Our vulnerability meant that the collapse - in terms of activity, construction activity, overall tax revenues, imbalance in the public finances as well as paying for the losses built up over a number of years - was much more severe. We would have ridden out Lehman’s with a much milder situation if we had managed to avoid all those errors.”

Asked by committee chairman Ciarán Lynch how much the guarantee and rescue of the banks would ultimately cost, Prof Honohan replied that the “best estimate is around €40 billon”.

He said this figure took into account of the recoverable amounts such as what might be received when the Government sells the shares that were taken in the banks.

“So the €64 billion whittled down eventually to around €40 billion but there are so many ifs and buts you could spend the whole morning on them.”

Asked where that €40 billion had gone, Prof Honohan replied that it went “up in smoke” on property. He said “it went on buildings nobody wants to live in” and on wages to those who built them.

Guarantee mistake

He said a decision by the Fianna Fáil-Green Party government to guarantee subordinated debt linked to the banks in 2008 was a mistake.

“The guaranteeing of subordinated debt of the banks was clearly a mistake and the formal guarantee, backed by legislation, of all long dated debt was also unnecessary and bound to strain the authorities ability to restructure or wind down failed banks before the expiry of the initial guarantee,” he said.

Prof Honohan said a move to put Anglo Irish Bank and Irish Nationwide Building Society into liquidation should have been “more favourably” considered.

“Given how resistant external authorities subsequently proved to be to the imposition of losses on unguaranteed senior debt of failed banks, external partners might at that moment have responded to such an idea with compromise proposals that might have alleviated subsequent pressures on the Irish exchequer,” he said.

Greater consultation with Ireland’s EU partners at that stage could have ensured Ireland was “less on the back foot” in future negotiations on bank debt, he added.

Tyres kicked

On regulation, Prof Honohan said not just the government but whole regime didn’t want to interfere with the banks. He said the government would have been in favour of having a welcoming environment for banks coming to IFSC but that big banks like to have the tyres kicked every now and then.

He said there was a excessive reliance on philosophy that banks could be relied upon to be safe and sound in the period he examined.

Prof Honohan queried why were dangers of excessive lending were not identified more clearly and earlier and headed off, and why better containment measures were not adopted when the crisis began to break.

He said the supervisors of the time did not accumulate enough relevant information and noted deficiencies in skills and staff resources.

There should have been “a less deferential approach to the bank industry”, he said, adding that officials were too optimistic about the strength of the Irish economy and banks.

ECB view

Asked about the European Central Bank’s refusal to send a representative to the inquiry, Prof Honohan replied that the bank did not want to put itself in a position of being accountable to a national parliament ahead of the European Parliament.

He said the ECB was not resistant to sharing its views and that there was a possibility that the information and an understanding of the ECB position would be communicated in some way to the committee.

Prof Honohan said he did not believe the ECB told the government to guarantee the banks in 2008 but rather it had said countries were responsible for looking after their own banks.