Kenny's daunting task of keeping Ireland solvent

 

ANALYSIS:While some relief may be on the cards, the problems at the banks are enormous, writes ARTHUR BEESLEY

EUROPE’S EVOLVING approach to Ireland’s banking and fiscal hex is a little clearer after a double-bill of EU summits in a fortnight. While some relief is in prospect to lessen the load, Taoiseach Enda Kenny still faces enormous challenges to restore order to the wayward economy he leads.

As Kenny returned home on Friday from his second Brussels visit, it emerged that the European Central Bank was preparing to deepen its support for Irish banks by giving them medium-term liquidity loans. In addition, Ireland’s sponsors are now unlikely to push for an immediate “fire sale” of assets to shrink the unwieldy bank sector.

Such developments give the Government additional time to bring the banks to heel. On their own, however, they do not solve the core problem of the banks’ rampant indebtedness and the overbearing burden it places on the State. The Government wants to explore with its euro zone partners ways of using the European Financial Stability Facility temporary bailout fund to participate in bank recapitalisations, but that discussion has yet to begin.

There is more. From Kenny’s first visit to Brussels, we know that the other euro countries are willing in principle to cut the interest rate on bailout loans by one percentage point. This is significant in its own right, even if the asking price as regards corporate tax is not one Ireland will pay. This debate, however, has now been parked pending talks on the banks.

All of this underlines the daunting scale of the struggle the Taoiseach faces to ensure Ireland remains solvent. If Kenny cuts a dash as head of Government, in reality there are weights shackled around his ankles. What is more, the decision of EU leaders last year to finalise the mandate of a permanent bailout fund in 2013 greatly increases the stakes.

If the Government cannot get back to private market funding before its existing credit line expires that year, it would need to approach the new fund. Sovereign default is a specific condition of involvement in that scheme. The fund’s term sheet says aid recipients will be obliged “in all cases” to secure “a proportionate form of private sector involvement”. This cuts both ways. Default would for years compromise Ireland’s capacity to fund itself on markets. By the same token, Kenny’s EU counterparts might prefer to avoid testing the theory that default inevitably threatens contagion. This gives all sides an incentive to ensure that course is avoided.

Ireland’s crippled banks overshadow this entire scene. European officials say their heads become sore when they think about the vast sums of public money the banks continue to receive. Similar apprehension is evident in Dublin, where the rescue effort is the Government’s top priority. In Minister for Finance Michael Noonan’s view, the accumulation of bank debt when added to sovereign debt threatens to overwhelm the State.

So where are we now? Ongoing bank stress tests, a condition of the EU-IMF bailout, are designed to determine definitively how much more capital the banks need. Despite huge pressure from Ireland’s euro zone partners to ensure the tests miss nothing, the fact remains that they are essentially a notional exercise.

Thus the profile of projected bank losses, which will determine the requirement for new capital, can be akin to an ink stain advancing on blotting paper. Gauging where it stops is a very difficult thing.

Nevertheless, there is now some confidence in Brussels that the eventual requirement will not exceed the €35 billion for banks that was embraced in the bailout plan. That this represents a positive development illustrates the gravity of the crisis.

In the present malaise, however, the requirement for new capital is bound yet again to undermine any residual confidence in the banks. This helps explain the European Central Bank’s imminent move to take Ireland off short-term liquidity support – in which the banks must return for special funding every fortnight – into a tailor-made medium-term scheme.

While the move puts in place a key condition for the Kenny administration’s programme to finally resolve the banks, it also stands as a reflection of the banks’ precarious position. Far from being able to stand on their own, the banks need yet another crutch. Some 2½ years after the original guarantee, their plight continues to worsen.

Still, the Government believes a medium-term funding promise from the ECB is essential if the banks are to take the benefit from the abundant capital they receive from the State.

Whereas capital infusions boost their financial ratios, banks dependent on emergency funding every couple of weeks are a no-go zone for big depositors. This is all the more so given the ECB’s avowed determination to unwind emergency support for banks as part of its long-delayed exit strategy. New support over the medium-term – albeit with heavy conditionality – removes the implicit threat that Irish banks might suddenly find themselves without a funding lifeline.

This brings to the second element of the Government’s bank plan: to ensure a slower rate of deleveraging – or asset sales – than could be read into the strictures of the EU-IMF deal. This now seems to be in bag. Last Friday, Kenny said “the ECB now accepts that it would not be prudent to have immediate fire sales of assets which would lead to further recapitalisation at high interest rates.” This, too, represents progress, for the Government fears that rapid deleveraging would crystallise big financial losses immediately, puncturing yet more holes in bank balance sheets. The outwork of that, as Kenny implied, is a need for more capital. In a similar way, the realisation last year of big National Asset Management Agency losses led to massive capital infusions.

For all that, the ECB’s leeway on liquidity will come with strings attached. This is important from the perspective of the Government’s demand for unguaranteed senior bank bondholders to bear investment losses.

Whereas Kenny has signalled his willingness to step back from this demand, his Ministers have steadily held the line that this remains on the table and some have gone so far as to say guaranteed bondholders should also be touched.

That’s firmly against ECB dogma – and now, more than ever, it is keeping the banks afloat.

Noonan meets his counterparts in Budapest next Thursday week. Yet again the pressure mounts.


Arthur Beesley is European Correspondent

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