Banks facing a €1bn charge and stringent controls

ANALYSIS:The State stands to earn €1 billion over the life of the two-year banking guarantee

SO THE draft terms and conditions of the State bank guarantee have been set out, more than two weeks after it was announced.

The State will earn €500 million a year - or €1 billion over the life of the two-year guarantee - for insuring deposits and the banks' own debts, worth €485 billion, at 11 Irish institutions (six Irish-owned and five foreign-owned).

The Government is setting the charge on the basis that it expects to pay between 0.15 per cent and 0.3 per cent more to borrow for the exchequer because, by guaranteeing the banks, the State is taking on greater risk and investors buying Government bonds will price that risk accordingly.

Under the guarantee, the Government will recover the difference from the banks so that the taxpayer is not left out of pocket.

While the scheme's terms and conditions do not specify the exact charge, the Department of Finance is expected to set it at €500 million a year. This is in line with the banks' expectations.

Minister for Finance Brian Lenihan said on Wednesday night that the charge of the guarantee would amount to at least 10 per cent of the banks' annual profits.

The draft scheme, released yesterday evening, does not reveal how much each institution will pay for the guarantee, if indeed each bank uses the guarantee and a payment is made.

The Department of Finance has only said the charge to each bank using the scheme will be based on "long-term credit ratings which reflect the risk profile of individual covered institutions".

In plain English, this means the higher-risk banks will pay a higher charge for the privilege of using the guarantee. By not revealing each bank's charge, the Government will not single out the higher-risk banks, ensuring that the guarantee provides the comfort of blanket support across the sector.

"Commercial sensitivity" is the reason cited by the department.

A higher loan exposure to construction, development and commercial property, which are suffering the most and showing the highest arrears in the downturn, means those banks will pay more.

Anglo Irish Bank and Irish Nationwide are likely to face a higher charge as these sectors account for 80 per cent of their loan books, compared with 35 per cent at AIB, 26 per cent at Bank of Ireland and 11 per cent at EBS.

Irish Life Permanent does not lend to developers or builders but relies more heavily on the turbulent wholesale markets for its funding than the other lenders.

The banks' debt ratings and credit default swaps (a type of insurance product used by the market to gauge risk) will also help dictate charges to each bank.

The State will not just be earning money in return for its guarantee.

The Minister for Finance has wide-ranging powers to monitor the banks during the two-year guarantee, curtail any excessive lending or deposit growth, and have a say on how much senior executives will be paid.

Under the scheme, at least one but not more than two board members from a panel approved by the Minister must be appointedto the board of each bank using the guarantee during the two-year period.

The Minister can also install individuals to "observe" meetings of the remuneration, audit, credit and risk committees at each bank.

They can attend all meetings and access any committee papers.

These measures will ensure the banks do not take on any additional risks at the taxpayers' expense.

The Minister will also appoint an independent three-person committee to oversee salaries, bonuses (including share options) and pensions payments for senior executives at the guaranteed banks.

While senior bankers earned bonuses on profit and share performance in the past, bonuses will - under the guarantee - be "measurably linked" to reductions in guarantee charges and "excessive risk-taking" and will be based on encouraging "long-term sustainability" of each guaranteed bank.

The Minister can, in consultation with the Financial Regulator, also limit banks lending to certain sectors or customers if it is "in the public interest" and in the "interests of financial stability".

The draft scheme also gives the Minister the authority to stop dividend payouts to shareholders and share buy-backs which could reduce the amount of capital that the banks hold. This will enable the Minister to build up greater capital reserves at the banks to protect them against future losses.

All told, the scheme gives the Minister stringent controls over any banks using the guarantee.

Bank guarantee scheme

COST:

• The taxpayer will receive €500 million a year for guaranteeing banks availing of the scheme over the two years.

• The charge to each bank depends on its long-term debt rating, which reflects if the bank is seen as high or low risk.

• The Government expects to pay 0.15 per cent to 0.3 per cent more for State debt as a result of the guarantee, which it intends to pass on to the banks.

TERMS AND CONDITIONS:

• Banks will be prohibited from passing on the cost to customers "in an unwarranted manner".

• Banks outside the scheme can buy or merge with a guaranteed bank at the Minister for Finance's discretion.

• An independent committee will oversee salaries, bonuses, pension payments and other benefits for senior executives at the guaranteed banks.

• At least one but no more than two board members must be appointed by a bank from a Minister-approved panel.

• The Minister can appoint individuals to attend meetings at the covered banks.

• The Minister can limit new lending and deposit growth, and reliance on wholesale funding.

• The Minister can cap the maximum loan-to-value on mortgages and other loans.

• Loan exposures to particular sectors can be limited.

• The Minister can set rules on dividends and share buybacks.

• A bank's ability to grow loans, deposits or capital can be limited.