Seamus Coffey: What makes us think that Spain will get a deal that we would want any part of ?
THE days after the referendum have been dominated by talk of a deal on bank debt for Ireland. Although the bank debt was not a live issue in the campaign, both the Taoiseach and Tánaiste were quick to introduce it in the aftermath. It still not clear what exactly is meant by a deal on bank debt.
Ireland has pumped €64 billion in recapitalisation funds into the banks. Of this, €20 billion came from the savings we had built up in the National Pension Reserve Fund during the good times. As things now stand there is around €25 billion of the Promissory Notes remaining which were provided to Anglo Irish Bank and the Irish Nationwide Building Society, which were subsequently merged to form the Irish Bank Resolution Corporation (IBRC).
The remainder of the money came from some of our other resources and loans agreed as part of the EU/IMF programme. The State has also received about €6 billion in return through sales, guarantee fees, dividends, Central Bank profits and other revenues.
The changes that have discussed intermittently since the start of the year relate solely to the remaining €25 billion of Promissory Notes. There have been repeated references from government ministers to technical discussions about technical issues but we are no nearer knowing exactly what is proposed.
The Promissory Notes were created in 2010 when Anglo and Irish Nationwide required massive recapitalisation in order to ensure that their creditors could be repaid. Much of the focus has been on the repayment of bonds in these defunct institutions but it must also be remembered that their depositors were also repaid in full.
The requirement that all deposits and senior bonds be repaid in full was part of the European Central Bank’s strategy to prevent contagion spreading from the periphery to the core of the eurozone’s banking system. The ECB’s strategy has failed and the eurozone is suffering under the consequences of a malfunctioning banking system.
The bailing-out of bank creditors has not worked and there are now slow moves to a European bank resolution regime that will require the bailing-in of bank creditors. At first, this will involve write-downs on senior bank bonds, but it may creep as far as depositors above certain limits if a eurozone deposit insurance scheme can be put in place.
These changes will come too late for Ireland but there can be little doubt that moves to ensure that senior bondholders, and maybe large depositors, contribute to the resolution of failed banks would be broadly accepted here. It is entirely correct that those who put in the money should lose that money when they give it to banks that lend imprudently and can’t get it back.
The bailing-out of bank creditors has meant those with the money could provide funding to banks safe in the knowledge that public funds would be provided to make good any losses incurred. A move to the bailing-in of bank creditors may actually lead to the more stable banking environment that the original misguided policy of the ECB was trying to effect.
The move may make bank failures less likely as investors and depositors will be more cautious about where they put their money and therefore will be less likely to provide funding to risky banks whose operations are concentrated in sectors such as property development and construction. These banks will have to pay more for funding which may curb their more reckless actions.
Developments in Spain over the past few months are like watching a re-run of those in Ireland from three years ago, albeit on a much larger scale. There has been some suggestions that Ireland should strive to get the same deal on bank debt that Spain may get. It is actually not clear that Spain will get anything that Ireland will want.
Although the Irish case has proved it to be wrong, it does seem that the creditors of the Spanish banking system will also be bailed out. From an Irish perspective, we will be observing where the money comes from to recapitalise the Spanish banks. Although it has been a part of the discussion there is no official avenue to provide these funds while keeping them off the public debt. If private banking losses are to be made good in Spain it will only be through an increase in public debt.
The European Stability Mechanism (ESM) will be formally set up at the start of July. The ESM cannot provide funds directly to banks and any provision to do could only be introduced via a treaty change agreed by the 17 members of the eurozone. The ESM can, however, provide loans to countries with the explicit purpose of using that money to recapitalise banks.
If Spain needs official assistance to recapitalise its banking system it may turn to the European Financial Stability Facility (EFSF), or if they can wait two months to do so, they can apply to the ESM for the funding. However, in both cases the funds will be added to the Spanish government’s debt and the ultimate responsibility for repaying the loan will lie with the Spanish government and not the banks who will be the recipient of the money. As it is currently constituted the ESM does not sever the link between banking debt and government debt.
Although we can’t be certain, if Spain does get money from the ESM it is likely it would come with an interest rate of around four per cent. One option for Ireland is to look to transfer our Promissory Note liabilities to the ESM at the same terms. This would not be a good move.
Due to the nature of the funding arrangements put in place for the IBRC with the Central Bank of Ireland the final cost to the State of the money provided to via the Promissory Notes is equal to the ECB’s main refinancing rate. At present, this is just one per cent and there is little possibility of that increasing anytime soon. A deal linked to the ESM would not be a good switch for the Promissory Notes that remain. Rather than Ireland looking for what Spain might get, it is possible that Spain will look for the arrangement that Ireland got.
Ireland can gain if we ignore the ESM and hold on to the Promissory Notes, but delay their repayment over an extended period than set out with the current €3.1 billion annual payments. This would provide access to cheap funding for a longer period, reduce the real costs of the repayments and would have significant funding benefits in the medium term. The ECB would be vehemently opposed to this but this would not be the first time that the ECB holds opposition to a proposal in error.
According to the standard ECB line, a change to the Promissory Notes would be a precedent that it does not want to set and argues that “the commitments of the Irish state are met”. However, the Irish precedent is one that has to be repeated.
With slow moves to the bailing-in of bank creditors there should be less need for public bailouts of failed banks. It is also the case that the ECB’s governing council can block the use of Promissory Note type instruments to recapitalise banks. The ECB allowed Ireland to do so because there really was no other way to ensure that bondholders and depositors in Anglo and Irish Nationwide were repaid. Ireland was not in a position to issue government bonds to raise the money.
Countries can now turn to the EFSF and, from July, to the permanent ESM if they need funds to support their banks. This money should come from the bank’s creditors but if it has to come from public sources it can done without replicating what has happened in Ireland.
Therefore the ECB can allow a precedent in Ireland and not face a repetition elsewhere. The Promissory Notes should be allowed to continue but the repayment schedule should be extended. This is what should happen but there is nothing to suggest that this is what will happen. A lower-value alternative would be to continue with the existing repayment schedule but to guarantee Ireland access to low-cost funding via the ESM to make the payments.
Ireland is in an EU/IMF rescue programme and forcing the government to use money from that programme to repay money that was used to bailout bank bondholders and depositors in defunct banks, while at the same time seeing perceived risk of a default on normal government bonds increase, is not a sensible policy. This is an ECB policy. They have been wrong before and it looks like they’re wrong again.
Ireland can repay the money. What we need is for the ECB to wait until we are in a position to do so. Some of the costs of banking mistakes in the future will be covered by senior bondholders and possibly depositors. Ireland needs to allowed time for growth and inflation to help reduce the real cost of banking mistakes from the past.
Seamus Coffey is lecturer in economics at UCC