ANALYSIS:Despite the massive sum involved, the State is stressing its €400 billion rescue is not a bailout but a move to instil market confidence, writes Simon Carswell
IN UNPRECEDENTED times it was going to require an unprecedented move by the Government to protect the banking system from the ever-growing storm in the global financial markets.
The crisis has spread from Wall Street to the mainstream US banking sector to Europe since the failure of US investment bank Lehman Brothers two weeks ago.
Ireland was seen as the next target of bloodied investors and the Government, the Financial Regulator, the Central Bank and senior executives all recognised the perils facing the Irish banks.
Contingency planning to stabilise the banking sector reached fever pitch on Monday as four major European financial institutions were rescued. Irish bank shares suffered their greatest falls in more than a quarter of a century.
The rejection of the proposed $700 billion (€485 billion) state bailout of the US financial system on Monday evening meant that the Irish banks were likely to face another day of large stock falls.
Anglo Irish Bank had lost 46 per cent of its value on Monday, its sharpest decline in more than two decades, as it was also hammered by a bailout for German lender Hypo Real Estate, which operates in the same space as the Irish bank - commercial property.
Concerns grew over Monday night that Anglo would take a further battering when the markets reopened. There was a sinking feeling within banking, regulatory and Government circles that something needed to be done - and fast.
Taoiseach Brian Cowen and Minister for Finance Brian Lenihan stepped in early yesterday - after intense negotiations with bankers and regulators that lasted through Monday night and into the early hours of yesterday morning - presenting a State guarantee that caused Irish bank shares to soar yesterday and injected much-needed confidence into the banking sector again.
The Government has agreed to guarantee, for two years, the deposits and debts of the four Irish publicly quoted banks and the country's two building societies to calm investors.
It is essentially charging the six institutions for State insurance on their deposits and debts so they can raise more money by encouraging reluctant investors to buy loans that look more attractive with a guarantee from the Government.
The move will also attract foreign deposits to the Irish banks at a time of turmoil when cash is king.
Mr Lenihan felt he had to act to protect the Irish banks amid the global freeze in the credit markets where banks raise their money. He said the financial crisis had created "a huge liquidity famine".
One bank official likened the guarantee to the temporary indemnity the Government gave Irish airlines against specific war risks after insurers refused cover following the 2001 terrorist attacks.
Mr Lenihan's bank guarantee exposes the taxpayer to liabilities of €400 billion (the combined liabilities of the six institutions that the Government is guaranteeing).
The State could hardly afford this as the Irish economy is worth about €190 billion and the national debt stands at €45 billion.
However, the guarantee would only be triggered if one of the six institutions defaulted on some of their debt, and this is regarded as unlikely.
The State will also be paid fees for the guarantee which could be offset against potential costs from possible calls on the guarantee.
Mr Lenihan insisted this was not a bailout - the State was providing a guarantee and would be charging the banks for it.
"We are not in the business here of bailing out banks or assisting those who have invested on a risk basis in a bank. The shareholders take the risks on the markets," he said.
"What we are guaranteeing is the lifeblood of the banking system - a system of lending and borrowing that is essential to the successful operation of any banking system."
The charge to the banks has yet to be decided on and will be determined by the Government on the advice of the Central Bank.
The Government's fear was based on the closure of the wholesale money markets, where Irish banks and building societies source the short-term funding that keeps them in business. This has brought them under intense and growing pressure.
Mr Lenihan was concerned that the "blood" flow in the Irish banking system could stop with potentially fatal results. He pointed out that it was also in the interest of taxpayers such as merchants, workers and farmers, to be protected by keeping cash flowing.
"We cannot afford to let the financial bloodstream of the country and the banking system dry up," he said.
Mr Lenihan's remedy certainly has helped. Irish bank shares more than recovered the ground lost on Monday.
Anglo Irish Bank bounced back a massive 67 per cent, Irish Life Permanent 35.8 per cent, Bank of Ireland 20.8 per cent and AIB 18 per cent.
The cost of insuring the debt of these four Irish banks against default, widely considered a proxy for gauging financial stress, fell sharply yesterday after the State's proposal was announced.
Credit rating agency Fitch, which measures financial strength, affirmed Ireland's debt rating (its ability to meet its borrowings) with a top "AAA" ranking, saying: "This proactive measure should help buttress confidence in the Irish financial system and limit the risks of a deeper-and-more prolonged-than necessary recession at a time of unusual stress in global banking markets."
The major concerns now lie with the large foreign-owned banks in Ireland which claim that this creates an uneven playing field as they will be competing for wholesale money and deposits in a cash-starved market with smaller rivals who have a highly rated guarantee from a sovereign state.