The simple truth is that Irish banks need more capital

Troika visits are becoming increasingly low-key affairs as we head towards the end of the Irish bailout. The most recent was particularly anodyne, with no briefings or press conferences and the release of short and unremarkable press statements by all concerned some days after the visit concluded.

We will only get a real sense of what was discussed during the visit when the European Commission and IMF staff reports are released in the next few weeks. The reports have to be signed off on by the IMF board and Ecofin before we get our next tranche of money, and they usually highlight the bad as well as the good.

The European Commission report is usually helpfully leaked by German parliamentarians and it will be interesting to see what the staff reports say about stress-testing the banks. The subject was not mentioned in any of the press releases issued last week but has become an issue of some friction between the Government and the troika.

The Government's position is pretty clear: it wants the next round of tests, which are due by the end of the year, kicked forward into next year when the Europe-wide bank supervisor – the European Banking Authority – will scrutinise the systemically important banks in Europe to see if they have sufficient capital to absorb expected losses.

The attractiveness of this option for the Government is that it allows it sidestep one big potential stumbling block on the way to full market access and bailout exit.

Nobody can say with any certainty how the markets would react in the autumn to the news – if it came to it – that the Irish banks would need additional Government cash. It could derail the bailout exit. Thus it is prudent not to take the risk of stress-testing them unless you have to and it looks like we don’t have to.

The bond market seems to think the banks are adequately capitalised or that any further calls on the taxpayer will be manageable. A lot of store is being put on buffers of €2 billion and €4 billion respectively at Bank of Ireland and AIB that arose because the losses associated with deleveraging (selling loans) have been smaller than expected.

Troika position
The troika position is apparently a little more straightforward.

It takes the view that the Irish bailout was essentially a bailout of the Irish financial system and thus it would be scarcely credible to declare it a success without running the slide rule over the banking system one more time.

It is a good point and one the Government seems to have found hard to rebut, given that its own narrative has as a central point the claim that Ireland would never have required external assistance were it not for the weakness of the banking system.

It would appear from recent comments that the troika won the day and the banks will be stress-tested in the autumn.

The game, however, is far from over, with one Irish official pointing out privately that there is still a lot to play for in terms of what sort of stress test we might have.

A lot of assumptions will have to be made about things such as growth and mortgage arrears which will have a direct bearing on the outcome of the test.

Given the Government’s position, we can assume it will push hard for a fairly light test that will not give the bond market too much cause for concern.

Minister for Finance Michael Noonan has already apparently won one concession, which is that the minimum capital threshold will fall from 10.5 per cent to 9 per cent of loans.

What the Government is doing may seem expedient, but it is also dangerous. Exiting the the bailout without fixing the banks could be a pyrrhic victory.

It really is a glass-half-full, glass-half- empty moment. Politicians by their nature tend to be optimists, but without functioning banks it is hard to see how we can have growth. Eventually the bond markets will find us out and punish us.

From this perspective there is a very simple rubric to discern if the Irish banks are fixed or need to be rigorously stress-tested and recapitalised further.

It is to ask the question: are they lending normally or likely to do so in the near future?

The answer would be no and thus they need more capital.