Experts have just one chance to get rescue right

RECAPITALISING BANKS:GETTING A grasp on how much more the banks will need to calm the nervous financial markets is like trying to catch a falling knife.

It is difficult to know how much the banks will lose on loans when their borrowers have to deal with the effect of €15 billion of spending cuts and tax increases over four years.

This is why experts from the International Monetary Fund have been poring over figures since last Thursday – they only have one chance to get the bailout right.

The bank bailout bill reached €45 billion in September. This covers the expected losses so far and brings the reserves at five banks to levels now regarded internationally as the bare minimum.

The market has moved on, and where the Financial Regulator last March thought a ratio of €8 in capital reserves to cover every €100 on loan was enough, the market now wants €12 for every €100.

Yesterday, the regulator, Matthew Elderfield, said “overcapitalising” the banks was being actively considered. Plans were already laid to bring the banks up to these levels over the coming years, but the market is not waiting.

Unless the banks get more capital to reach them, no investor will lend or place deposits with them.

Credit rating agency Moody’s estimated that the four banks left standing – AIB, Bank of Ireland, EBS and Irish Life and Permanent – will require up to €12 billion more to hit these new standards.

Investors have an added fear about Ireland – they are concerned more borrowers will struggle to repay their mortgages given the severity of the upcoming budgets, leading to bigger bank losses.

Mortgages are different to property development loans, which are the most toxic in the Irish banks.

Most are secured on homes, so it is widely held that borrowers will typically stretch themselves to repay them. For this reason, mortgage losses tend to be far lower.

The regulator tested the banks in March to ensure they had enough to cover losses of 5 per cent of their mortgages, when 4.6 per cent is the worst case metric.

For losses to rise above 5 per cent – regarded as a doomsday scenario by regulators – mortgage arrears would have to hit 18-19 per cent; they are at 5 per cent now.

Elderfield said the banks would need “standby contingent capital” to be drawn on as needed. This could increase the next banking bailout to as high as €30 billion.

So, out of a mooted IMF-EU bailout of €80 billion to €95 billion, it is suggested that about €30 billion would cover the banks, and the remainder Government borrowing over three years.

Shrinking the size and number of banks by selling off loans at discount with a State or EU guarantee over time would also raise their capital levels, as they would not have to put aside as much, given they would hold fewer loans.

IMF officials are trying to strike a balance between all these elements to get the figures right.