Honohan: I was right to attack blanket bank guarantees
Central Bank governor Patrick Honohan this weekend defended a report he wrote in which he says blanket guarantees and open-ended cash injections into banks are wrong.
The report, which advises against the very course of action adopted by Finance Minister Brian Lenihan and Taoiseach Brian Cowen in September 2008, was based on a study of 40 banking crises and was published during his time at the World Bank.
Defending his work, Mr Honohan said through his spokesman this weekend: "The guarantee has indeed proved to be costly. However, given the situation that had developed by September 28, 2008, it was too late to avoid an extensive guarantee."
In a 2002 academic paper he co-authored during his time at the World Bank, Professor Honohan, along with Daniela Klingebiel, concluded "governments that provided open-ended liquidity support and blanket deposit guarantees incurred much higher costs in resolving financial crises."
The report continued: "We find that if the countries in our sample had not pursued any such policies, fiscal costs would have averaged about one per cent of GDP -- little more than one-10th of what was actually spent. The policy message from these results seems clear: open-ended liquidity support, regulatory forbearance, and a blanket guarantee for depositors and creditors all significantly contribute to the fiscal cost of banking crises."
In the summary of their report, the authors also questioned the merit of extending lines of credit to banks, saying such actions inevitably prolonged the road to recovery.
"Countries that used policies such as liquidity support, blanket guarantees, and regulatory forbearance did not recover faster. Rather, liquidity support appears to make recovery from a crisis longer and output losses larger. Thus it appears that the two most important policies during the containment phase are to limit liquidity support and not extend guarantees."
In response to a query from the Sunday Independent, the Central Bank said it was its firm policy to "avoid regulatory forbearance (which would allow banks to continue operating with insufficient capital). Instead we are requiring the banks to acknowledge loan losses promptly and insist on recapitalisation.
"Prof Honohan already pointed out the potential costs of Ireland's blanket guarantee approach in an October 2008 lecture at TCD," said the spokesman.
Last May, Prof Honohan produced a deeply critical report of the Government's decision to introduce the blanket nature of the guarantee in September 2008.
His main findings were that there was a major failure in terms of bank regulation and the maintenance of financial stability; the failure was of a systemic nature rather than related to any one individual and the weaknesses of Irish banks were not caused by the interruption in the flow of cheap money from abroad, with Anglo Irish Bank and Irish Nationwide Building Society "on the road towards insolvency" before the collapse of Lehman Brothers.