Irish State looked at bank guarantee options in early 2008

A scoping paper produced in the Department of Finance in January 2008 considered potential guarantee options, nationalisation and letters of comfort from the minister for finance as potential mechanisms to deal with a banking crisis.

The paper, released by the Oireachtas banking inquiry this week, considered in detail three scenarios that officials thought might occur: an institution that was illiquid but solvent; an institution that was insolvent or approaching insolvency; and a position where it was unclear if an institution was illiquid or insolvent.

It was prepared some nine months before the government's blanket bank guarantee decision, and also considered the potential for the Central Bank to provide emergency liquidity to Irish banks.

It was noted that such assistance would have to be reported to the European Central Bank if it exceeded €500 million and that the Central Bank was legally prohibited from providing emergency liquidity to an insolvent institution.

Pressured

It was determined that the Central Bank could lend to an insolvent institution if it was given a “guarantee or letter of comfort” by the Government.

The paper said that in the event of a bank becoming illiquid or insolvent, the State would be pressured to give assurances that it would support the institution or “provide guarantees to its depositors”.

“Other guarantees which the minister might consider . . . include a guarantee to banks regarding interbank lending to pre-empt overall withdrawal of market liquidity and a guarantee to CBFSAI [Central Bank] regarding losses that may occur on ELA [emergency liquidity assistance].”

Moral hazard

The paper said legislation would be required for the minister to provide a guarantee and highlighted how this could cause moral hazard, as “institutions would know when and how the State would intervene if they were in difficulty”.

It stated that the existence of such powers on the statute book could compel the minister to save a bank that would “otherwise not be saved and reduce the flexibility available” to the State to deal with a particular institution.

The paper also considered provisions for the appointment of liquidators, receivers and examiners, or the appointment of court inspectors, and the implications of state aid rules in assisting an insolvent bank. It listed five “urgent next steps” that needed to be taken. These included seeking advice from the attorney general on various legal issues, completing preparations for a deposit guarantee scheme and completing a simulation exercise, and preparing a “crisis management manual”.

It said the “failure of any bank could have negative impacts on critical banking services” such as ATMs and direct debits.