News Analysis

Wednesday 27 August 2014

Fears over future of Central Bank as emergency lending takes a toll

Laura Noonan

Published 01/02/2011 | 05:00

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FIRST our banks went bust, then our sovereign went bust, now some are speculating that our Central Bank could round off the grim trilogy.

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New figures out later today are likely to show that the Central Bank of Ireland (CBI) has well over €50bn of cash tied up in our battered banks through emergency lending.

The scale of the injection has sent eyebrows shooting up, since even small percentage losses on a portfolio that big could wipe out the CBI's capital and reserves of just €1.5bn.

London-based experts at investment bank Citi have been particularly vocal. In a recent a research note, they claimed the very solvency of the CBI could be threatened by the emergency lending.

Like the rest of us, they cannot be certain because of the infinite unknowns surrounding what is a highly secretive operation.

Citi reckons that the €50bn is likely to have been loaned to very weak banks, including those who solvency was "in question" when the cash was handed over.

This is reasonable, since stronger banks would use the more traditional route of going directly to the European Central Bank where interest rates are kinder.

The fact that the banks the CBI is lending to are those who've exhausted all other avenues and already pledged their best collateral, means the risks look higher.

Citi also makes much of the scale of the CBI's activities since the €50bn dwarfs both the reserves/capital cushion of the central bank.

The CBI also owns 1.6pc of the equity of the European Central Bank, an asset theoretically worth about €32bn, but Citi sees little chance of this being cashed in since the ECB is unlikely to allow for it to be unwound.

The growing belief is that losses on the CBI's investment would ultimately be passed onto the State, since the Government is likely to be guaranteeing the scheme.

But, as Citi says, that merely leads to another problem -- "the solvency and the liquidity of the Irish sovereign is itself not beyond doubt". So even if a government guarantee is there, the CBI still runs "some risk of insolvency" because the losses may be too big for the State to cover.

What Citi, or anyone else, doesn't know, is whether such a government guarantee is actually in place.

We also don't know whether the CBI has managed to insure out any of the risk for the €50bn, either with other banks or with the ECB itself.

So the CBI may, or may not, have to backstop all of the potential losses on its own.

The biggest knowledge vacuum, though, surrounds the scale of potential losses.

Citi and the rest of the analyst world don't know much about the collateral that the CBI accepts, beyond the fact that it's likely to be of a lower quality than that accepted by the ECB.

They know equally little about the haircuts, or discounts, imposed by the CBI on any of that weaker collateral -- so they can't know if higher haircuts mitigate for lower-quality collateral.

Without that piece of the puzzle, it's impossible to answer the most pertinent question of all -- if a bank went bust, could the CBI recover its cash by selling off the collateral?

Discover the answer to that, and you'll discover whether our Central Bank truly is at risk of ruin.

Irish Independent

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