Category Archives: Central Banks

SME Credit and Deleveraging Targets

Posted on by

A number of people have asked me since I wrote this post about AIB and Bank of Ireland failing to meet their SME lending commitments whether we should have expected this outcome because of the deleveraging targets set in last year’s Financial Measures Programme (FMP) agreed with the Troika. The PLAR (Prudential Liquidity Assessment Review) element of this programme aimed at reducing the quantity of loans on the balance sheets of the domestic Irish banks. So isn’t the reduction in SME lending just a consequence of the agreement with the Troika?

The quick answers to these questions are:

1. There is no contradiction between the pillar banks meeting their SME lending commitments and also meeting the PLAR deleveraging targets agreed with the Troika.

2. AIB are going well beyond their PLAR commitments in tightening credit within Ireland and Bank of Ireland may also be but haven’t reported their loan book in a way that allows one to check.

For the longer answer, I’ll describe two aspects of this issue. First, the data from the Central Bank on stocks and flows of SME lending. Second, I’ll discus the deleveraging plans outlined in the FMP document and the evidence on the actual changes in loan books in 2011 provided in AIB and Bank of Ireland’s recent annual reports.

Stocks and Flows of SME Lending

When examining the question of whether or not banks are providing adequate amounts of lending, it is important to distinguish between stocks and flows. If you see the total stock of loans this year being the same as last year, that doesn’t mean that the bank has made no new loans. It just means that the amount of loans given out equalled the amount of loan repayments made by customers.

As I noted in the previous post, the language in AIB’s announcement of its commitment to SME loan targets made it clear that they were referring to a target for new loans.Whether a commitment to a given amount of new loans equates to an increase in the total outstanding stock of loans depends upon what fraction of existing loans are being repaid. SME loans have a relatively short average maturity, so agreeing to a given amount of new loans will be well short of agreeing to increase your balance sheet by that amount.

Thankfully, the Central Bank now provide figures to help us sift through the stocks and flows of SME lending in Ireland. They have also provided an explanatory note explaining the meaning of the various figures.

The Central Bank figures show three different “totals” for SME lending: Total SME lending, SME lending excluding financial intermediaries and SME lending excluding financial intermediaries and property-related sectors. I think the best guess as to what the €3 billion per year loan commitment likely referred to was SME lending excluding financial intermediaries.

The first tab in the spreadsheet reports outstanding amounts of Irish SME loans. In December 2011, total SME loans outstanding was €73.6 billion, SME lending excluding financial intermediaries was €61.5 billion and SME lending excluding financial intermediaries and property-related sectors was €27.3 billion.

Looking at changes in the outstanding amounts is not a good way of assessing what’s happening with SME credit. The totals can be affected by various re-classifications that change the total without new lending occurring, e.g. there was a big jump in June 2011 in property-related SME loans.

To deal with this problem, the Bank publishes a “Transactions” series which

are calculated from quarterly differences in outstanding amounts adjusted for reclassifications, other revaluations, exchange rate variations and any other changes which do not arise from transactions.

In other words, “Transactions” tells us the amount of new loans issued minus the amount of loans repaid. The Bank also publishes a “New Lending” series that does what it says on the tin. Using these two sets of figures, we can back out the amount of loan repayments that are occurring. Here are the figures for last year.

What these figures show is that the Irish banks could have made an additional €2.9 billion in loans, i.e. €6 billion in total, without increasing their total exposure to Irish SMEs. This is a market in which non-pillar banks (in particular Ulster) used to play some role but, by 2011, I suspect they would have had a fairly small involvement. So effectively these figures show that AIB and Bank of Ireland could have honoured their SME lending commitments without doing much to raise their balance sheet.

Domestic Deleveraging Targets and Outcomes

But what about the deleveraging plans? Wouldn’t even a small increase in SME loan balances have run counter to the PLAR plans? Well, no. It turns out these plans were based upon a very limited amount of deleveraging in the “core” activities of the banks such as domestic SME lending.  It is worth checking out the planned deleveraging and comparing it with what is actually happening.

Here are the three-year deleveraging targets set out in the PLAR.

Note that AIB were actually supposed to increase their core loans by €1.5 billion by the end of 2013. AIB have since been merged with EBS who were supposed to reduce core loans by €2.6 billion but this still amounts to a very small combined reduction of €1.1 billion over three years. Bank of Ireland were supposed to reduce core lending by €2.6 billion by 2013. There can be little doubt that the banks could have absorbed the small increase in SME lending required by their public commitments and still meet these deleveraging targets.

What is actually happening with core lending? AIB helpfully provided a table describing core and non-core lending on page 34 of their annual report. The table shows that, once you subtract off the additional €13.6 billion from taking over EBS, core loans at AIB have declined by €2 billion. You can also work out from information in the report and EBS’s 2010 annual report that the EBS total is €0.2 billion lower than their end 2010 figure, so the combined AIB-EBS reduction in core loans in 2011 is €2.2 billion, which is twice as large as was agreed to as part of the PLAR over the three-year period 2011-2013.

AIB’s report doesn’t split out SME lending in the same way as the Central Bank statistics. However, page 83 of their report does tells us that there has been a reduction of €1.3 billion, from €17.6 billion at end-2010 to €16.3 billion at end-2011, in a non-property-lending category labelled “SME\Commercial”. These figures suggest that AIB likely accounts for the majority of the €1.7 billion reduction in 2011 in non-financial-intermediary non-property SME lending recorded by the Central Bank. And remember this is a wholly state-owned financial institution.

What about Bank of Ireland? Unhelpfully, their preliminary statement for 2011 fails to report their loan book in a way that is compatible with the core\non-core targets set by the PLAR.  However, it does report a table (on page 49) that shows a small increase in 2011 in “Republic of Ireland non-property SME loans” of €342 million. Elsewhere though, a category labelled “non-property corporate” lending was reduced by €4.5 billion and “property and construction investment” was reduced by €3 billion.

From these figures, it also seems likely that Bank of Ireland is also over-shooting its PLAR target of fairly modest reduction in core lending and thus tightening domestic credit more than had been planned. It would be helpful if the Minister for Finance would request that Bank of Ireland provide an update on where they stood at the end of 2011 in relation to their core lending relative to the targets set in the PLAR.

Promissory Note Arrangement an Exercise in Political Optics

Posted on by

From a public relations point of view, the revised promissory note arrangement has been a great success for the Irish government. This editorial in the Sunday Independent declared

In the staring match between Ireland and the EU and the ECB, the other guys blinked first.

The Irish Times, only slightly more restrained, headlines the new promissory note arrangement as a “coup” for Michael Noonan.

What is supposed to have been achieved? Apparently, the Irish state has saved having to make a cash payment to IBRC with the burden of the payment being delayed until 2025.

In reality, a quick inspection of the announcement makes clear that neither of these claims are true.

The Irish state has not been saved making a cash payment: NAMA, an arm of the state, has provided €3.06 billion in cash to the IBRC, which IBRC is using to repay Emergency Liquidity Assistance loans, just as the ECB (the blinking guys) had always insisted.

In a separate arrangement, the government are planning to have Bank of Ireland provide a one-year loan to IBRC so that NAMA can be repaid and the state’s cash levels (including NAMA) can be restored to what they were prior to the ELA payment. IBRC will need to repay this loan next year.

Because the state is providing cash to IBRC to make its promissory note payment, the only thing added to what was already supposed to happen is that the state has arranged a one-year loan from Bank of Ireland.

Is arranging short-term loans from Bank of Ireland—a bank that has limited access to capital markets and is looking to shrink fast to meet troika-imposed deleveraging targets—a route to putting Ireland’s debt on a more sustainable path? Clearly not.

So the deal does literally nothing to improve debt sustainability. It also compromises the supposed operational independence of NAMA and raises questions about state intereference with the majority-private-owned Bank of Ireland.

For these reasons alone, this arrangement is an unwelcome development. However, in addition, it appears that the shenanigans surrounding this arrangement have seriously upset European officials who are better able to see what is going on than the Irish media.

This story from Arthur Beesley of the Irish Times likely illustrates the attitude of our EU colleagues.  In relation to Minister Noonan’s comments that he now wants a wider deal to replace the promissory notes altogether, the story reports:

“This risks further antagonising the ECB governing council,” said a euro zone source.

“His remarks were not helpful, particularly on the day after the bank agreed to facilitate an operation designed purely to give him an opportunity to make a statement saying that the payment of the promissory notes was settled with bonds.”

The Euro zone source is making clear that, as far as they are concerned, this deal was purely about optics.

I suspect that pennies may start to drop in Ireland about what has been arranged when Bank of Ireland have their shareholder meeting. For now, though, I’ll let it drop.

Promissory Note “Deal”: Not What Had Been, Em, Promised

Posted on by

Yesterday’s promissory note announcement was so complex that one might imagine that the government’s officials have been cooking up the various different elements for months. However, there is some fairly strong evidence that the additional elements (the role of NAMA and Bank of Ireland) reflect last-minute changes forced on the government by the ECB’s refusing to give any ground.

The reason I was surprised yesterday afternoon to hear of NAMA and Bank of Ireland’s involvement is that the shape of the deal that was supposed to be announced had been pretty well flagged beforehand and yet this deal was different.

What had been flagged in the moments leading up to the announcement was the IBRC were going to receive their cash payment from the promissory note but (and this is the crucial bit) rather than use it to repay ELA, they would use it to purchase a bond.  The actual announcement say them make an ELA repayment via incurring a debt to Bank of Ireland that must be repaid next year.

Why do I say the original plan was a cash payment to be used to purchase a bond? Well, for starters, there’s the IBRC’s own annual report, released yesterday morning but presumably sent to press a few days beforehand. On page 168, it describes the proposed arrangement as follows:

Following an outline request, made on behalf of the Minister for Finance, the Bank is in discussions with the Department of Finance and the NTMA regarding a settlement proposal to utilise the funds due from the next instalment under the promissory notes on 2 April 2012 to acquire an Irish Government bond with an equivalent value.

“Utilise the funds … to acquire a bond” can’t really mean anything other than receiving a cash payment and using it to buy a bond rather than pay off ELA.

Then we had Governor Honohan’s appearance at the Oireachtas Finance committee on Tuesday. Honohan was given a number of chances to describe the deal in the offing and in each case chose to describe it as a cash payment that would then be used to buy a bond.

For example, here’s an excerpt from Deputy Michael McGrath’s questions

Deputy Michael McGrath: In the course of public disclosure, originally made early last week, of the shape of the deal on this month’s payment, it was stated the cash payment would be made by the State to Anglo Irish Bank but that in return the bank would buy an Irish Government bond.

Here’s the portion of Honohan’s answer relating to the cash payment.

Professor Patrick Honohan: With regard to cash payments, the detail is still not absolutely final. Assuming this arrangement works out, when it is complete – even if it takes a few more days – any cash payment would circle back. There will be no net cash outlay and any cash payment made by the Exchequer would come back.

Here’s Honohan replying to Deputy Pearse Doherty

Professor Patrick Honohan: That speaks to the issue of cash payment. A cash payment which is immediately extinguished by another transaction is still a cash payment which is valuable for communicating to markets that the Government does make its payments, even if the total effect of the transaction is to extinguish that cash payment and have the cash come right back to the Government in a prompt manner. I hope there is no tendency to get terribly excited about a cash payment which is rapidly extinguished.

Finally, when asked about Deputy Stephen Donnelly about IBRC’s cash needs, the Governor replied

Professor Patrick Honohan: The question I noted in particular related to how much cash IBRC needs. In fact, the objective of the plan is to eliminate the cash need by postponing it.

However, in actual fact, under the current plan the IBRC has a €3.1 billion cash need that it is honouring by means of a complex chain of transactions in which it borrows from NAMA and Bank of Ireland. There is no sense in which the IBRC’s cash needs have been postponed.

I can only assume that the “assuming this arrangement works out” element of Honohan’s reply to Michael McGrath didn’t actually work out. And the likely reason for this failure was that the ECB insisted, as it appears they had all along, that a €3.1 billion ELA repayment be made, something which required a cash payment.  That this cash has been temporarily sourced from NAMA and then Bank of Ireland doesn’t at all change the fact that this deal is not what had been flagged and does not have nearly the benefits of that deal.

Optimistic ministerial talk of “movement from the European authorities” seems highly misplaced.  (If the original proposal had gone through, there would have been some grounds for such a statement.) More accurate, I think, were junior minister Brian Hayes’s comments on Today FM to the effect that negotiating with the ECB was negotiating with bankers and you couldn’t get far with that, and that future negotiations needed to be with European politicians.

Promissory Note “Deal” Fails to Meet Low Expectations

Posted on by

Despite a lot of hype in recent weeks that the Irish government were going to arrive at a deal with the ECB that would reduce the burden imposed by promissory note payments to the IBRC, I had remained fairly skeptical that any announcement this week would represent significant progress.

In my last post on this issue, last Saturday, I had noted that any deal that was done was just in relation to the March 31 payment and did not affect future payments. I had written:

Is it likely that the ECB will agree at a later date to a more comprehensive restructuring of the promissory notes allowing for a systematic payment deferral? I would guess not. While you could argue that a deal on the current payment shows some flexibility on the part of the ECB, an alternative viewpoint is that six months of “discussions” failed to get anything other than a fairly meaningless one-off deferral.

My pessimism turned out to be too optimistic. In fact, it appears that the Irish government made essentially no progress with the ECB even regarding the current payment.

The arrangement arrived at today (ministerial announcement here) is so complex that it will bamboozle everyone and this confusion will provide plenty of cover for those who wish to claim that it represents useful progress. However, effectively what is happening is that the Irish government are providing the IBRC with a long-term bond, the IBRC are exchanging that bond with Bank of Ireland for one year in return for €3.1 billion in cash and this cash will be used to repay the IBRC’s Emergency Liquidity Assistance (ELA) loans.

What has been achieved? In essence, the government has delayed paying out the cash for this year’s €3.1 billion but the IBRC (and hence the state) now has to repay Bank of Ireland this amount next year. This is effectively a one-year deferral of this payment, which is far worse than the long-term deferral of the payment that I had already described on Saturday as “fairly meaningless”.  Because the ECB have fully achieved their goal — getting a full €3.1 billion ELA repayment — calling this “a deal” with the ECB is hardly appropriate. Rather, it represents an arrangement with a privately-owned Irish bank that maintains the appearance of some sort of deal having been agreed with the ECB.

What further puzzles me about this transaction is that Governor Patrick Honohan described the plan to the Oireachtas Finance committee on Tuesday as follows:

The arrangement regarding this first tranche is very much in the direction in which I want us to go. It is a major step forward qualitatively in the approach.

I guess one could say it is “the direction we want to go” in the sense that this arrangement represents a deferral of the cash payment, however short-term. But the actual arrangement used to implement this deferral — borrowing the cash on a short-term basis from a privately-owned bank — is not at all a sustainable way to refinance a debt that amounts to almost 20 percent of GDP. So I fail to see how this is a major step forward, qualitative or otherwise (I had been puzzling about qualitative major steps ….)

Where does this leave us? In the same position as I reckoned we were last Saturday. No deal of any substance has been done with the ECB nor is one forthcoming. An arrangement to borrow long-term funds from EFSF or ESM to pay off IBRC’s debts and retire the promissory notes may happen. But it would require political approval across Europe, will not happen before Ireland passes the Fiscal Compact and would effectively amount to a second EU-IMF bailout with all the terms and conditions that this implies.

No, the ECB Has Not Hit a Limit

Posted on by

Last December, VoxEU published an article by Aaron Tornell of UCLA and Frank Westermann of University Osnabrueck titled “Eurozone Crisis, Act Two: Has the Bundesbank Reached its Limit?”.  The article claimed that the Bundesbank was selling securities to come up with the money for loans to peripheral central banks. They argued that the Bundesbank was about to run out of securities to sell and then … well, bad things would happen.

I responded with an article pointing out that no such process of security-selling to fund peripheral loans was actually taking place and so Tornell and Westermann were inventing a fake crisis. (Don’t rely on my word. Read the articles yourself and decide, if you’re interested.)  I’m guessing Tornell and Westermann read VoxEu every so often but, as of yet, I haven’t seen any reply defending their article.

Tornell and Westermann have a new VoxEU article today titled “Has the ECB Hit a Limit?”.  In it, they argue that the ECB has “lost its ability to implement anti-inflationary policy.” This is because the traditional tool for controlling inflation is adjustment of the short-term interest rate and, since the introduction of the LTRO, the ECB is no longer doing much short-term lending.

I’m afraid this argument simply doesn’t hold water. For a central bank to control inflation, what matters is that it can influence the marginal cost of funds for financial institutions, who can then pass on changes in their funding costs to firms and households.

Tornell and Westermann appear to believe that the large amount of long-term funding handed out in the LTRO means that the ECB can no longer affect the marginal cost of funds for the banks that have drawn down these loans. In fact, this is not the case. Here‘s the press release announcing the LTROs:

The operations will be conducted as fixed rate tender procedures with full allotment. The rate in these operations will be fixed at the average rate of the main refinancing operations over the life of the respective operation. Interest will be paid when the respective operation matures.

It is possible that Tornell and Westermann think the interest rate on the LTRO loans cannot be changed because the phrase “fixed rate tender” has been used in relation to these operations. However, that just means that the credit was not auctioned off via a bidding process. The terms of the loans were set by the ECB and all banks with sufficient eligible collateral can obtain funding at these terms.

And as the second sentence from the quotation above makes clear, the interest cost associated with these loans will rise as the interest rate on the short-term “main refinancing operation” goes up. So even if the numbers using the MROs remain low in the coming years, the MRO rate is still the marginal cost of central bank borrowing for banks that are using LTRO funds.

The ECB also has other tools at its disposal to control interest rates, such as the interest rate on its deposit facility. If it sets this rate to 5% then why would any bank make a loan to a firm or household at less than this rate?

Tornell and Westermann acknowledge the possible use of this instrument but dismiss it on the grounds that

high enough interest rates on deposits – without a higher lending rate – might generate losses at the ECB, which is a politically sensitive issue

But since standard ECB practice is to move the interest rates on deposits and the MRO rate by the same amount, the costs associated with a higher interest rate on deposits would be matched by the income associated with a corresponding increase in the LTRO rate. So there is no need to worry that an increase in the ECB deposit rate would generate losses for the Eurosystem.

As with the fake Bundesbank-running-out-of-securities crisis, the ECB losing control of inflation leading to a “risk of de-anchoring long-run inflationary expectations” is another thing that people don’t need to worry too much about right now.

Personally, I hope Tornell and Westermann have hit their limit on limit-hitting articles.

Standalone Deal on March 31 Payment Not Important

Posted on by

There has been a lot of media coverage in Ireland this week of a potential deal in the coming days involving the promissory notes issued by the government to the IBRC.

A comprehensive restructuring of these notes, worth about 20 percent of Irish GDP, would be beneficial to Irish debt sustainability. There have been various comments about this issue on Irish discussion boards and blog comments to the extent that a maturity extension would have no benefits as it does not change the debt-GDP ratio and “debt is debt”.  To that, I would ask people if they took out a €100,000 loan, which would they find easier: Paying the debt back over one year or over thirty years? “Debt is debt” is a fairly limited insight when thinking about the question of whether a particular debt burden is sustainable.

That said, the recent reports (e.g. here and here) make it clear that the any deal done in the next week, if it occurs, will only involve the €3.1 billion payment due on March 31.  The Irish proposal appears to involve either making the March 31 payment with a long-term bond or else making the payment in cash and having IBRC immediately loan it back to government by purchasing a long-term sovereign bonds.

These proposals would make essentially no difference to Irish debt sustainability as they don’t have any impact on the burden of future payments. And to be fair, Minister Noonan appears to acknowledge this. This RTE story reports him as follows

He also said the deferral of the payment at the end of March was just one element, and that the bigger picture was to secure an easier way of paying the promissory note. He said this would be less onerous on the taxpayer and that the serious piece of negotiations would happen in the second part of the year.

Is it likely that the ECB will agree at a later date to a more comprehensive restructuring of the promissory notes allowing for a systematic payment deferral? I would guess not. While you could argue that a deal on the current payment shows some flexibility on the part of the ECB, an alternative viewpoint is that six months of “discussions” failed to get anything other than a fairly meaningless one-off deferral.

If a shorter-term deal is struck, my guess is that it will occur because the ECB are hoping that the EU will provide the funds before March 2013 to allow the promissory notes to be retired.  Such a deal would see EFSF or ESM providing a long-term low-interest loan to the Irish government, which would then provide the money to IBRC in return for the promissory notes, with the money then used to pay off ELA debts.

Of course, such a deal would require political approval of EU governments and, specifically, Germany, and thus would require passing the Fiscal Compact. As any such deal would require all the political manoeuvrings associated with a second bailout, it may well also involve additional funds to help deal with the ongoing problems in the rest of the Irish banking sector (very well documented in the Central Bank’s excellent and surprisingly frank Macro-Financial Review) as well as the provision of “standby” funds to cover future deficits.

Will the March 31 deal happen? The consistent briefings from Minister Noonan would point to the likelihood that it will, as he has now pushed things to the point where he will have some pretty serious egg on his face if it doesn’t happen. Alternatively, the same officials who have been briefing that a deal will happen have also been bringing up various red herrings like “we need to make sure we don’t have a technical default” or “there may be legal issues with payment via bonds”. This stuff hardly instils confidence and the brinksmanship suggests there are very strong forces on the other side who do not wish to see this deal happen.

Anyway, relative to the long-term issues of a permanent restructuring of the notes and the problems afflicting the Irish banking sector, the question of the March 31 payment is a side-show. As such, I hope the government has not wasted too much political capital on it. Noonan’s statements this week are likely to have been seen as megaphone diplomacy by some members of the ECB Governing Council and it would be a pity if they have caused longer-term damage in return for a limited short-term gain.

Micheal Noonan’s Statement on Promissory Notes: March 21, 2012

Posted on by

Dáil Éireann Private Members’ Business

Counter Motion Government Speech

Wednesday 22nd March

Check against Delivery

I move amendment No. 1:

To delete all words after “Dáil Éireann” and substitute the following:

“Notes that:

The European Stability Mechanism (ESM) Treaty is an important part of the significant number of initiatives which have been taken at EU level to ensure the economic and financial stability of the Euro Area and the EU as a whole which include 

–          The establishment of a temporary support facility – the European Financial Stability Facility and also the extension of the use of the EU’s European Financial Stabilisation Mechanism facility.

–          Agreement to enhance the effectiveness of the EFSF though increased lending capacity and additional flexibilities

–          Agreement to reduce the interest rates and lengthen the maturities for Programme countries

–        Agreement to establish a permanent support facility – the ESM – by July 2013 to replace the temporary EFSF and EFSM arrangements

–        Agreement to include the new EFSF flexibilities in the ESM

–        The agreement to accelerate the entry into force of the ESM Treaty to July 2012 (subject to ratification by Member States representing 90% of the capital commitments).

–        The agreement at EU level to provide significant  additional resources to the IMF

–        The agreement to reassess in March this year the adequacy of the overall ceiling of the EFSF/ESM of EUR 500 billion.

–        The agreement to provide substantial additional support to Greece and the enhancement of its debt sustainability

–        The enhancement of economic governance with the strengthening of the Stability and Growth Pact through, for example, the six pack of legislative measures and also the agreement on the Stability Treaty

–        the ECB’s significant initiative to provide liquidity of up to €1 trillion in support to the EU banking system

And that the Government has participated actively in the development of these initiatives, as appropriate, which are in Ireland’s and in Europe’s interests

And notes that the Government will decide on the appropriate timing for legislation to ratify the ESM Treaty in due course, with regard to the agreed timetable at European level for ratification”

Firstly, there is an issue that I wish to bring to the attention of the house as the Government has always committed that we would inform the Dáil about any development concerning the payment of the promissory note at the end of this month.

In more recent months, we have been involved in technical discussions on reducing the burden of debt associated with the recapitalization of the banks.   In particular our focus has been on the Promissory note arrangement that was put in place to fund the Irish Bank Resolution Corporation – formerly Anglo Irish Bank and Irish Nationwide. This is an arrangement, which requires the State to make cash payments of €3.06 billion each year to IBRC. There have been some developments on this issue during the day.

The discussions with the European authorities on the general issue continue but we are now negotiating with the EU authorities, and principally with the ECB, on the basis that the €3.06 billion cash installment due from the Minister to IBRC on 31 March 2012 under the terms of the IBRC promissory note could be settled by the delivery of a long term Irish Government Bond.  The details of the arrangement have still to be worked out.

This allows me now to turn to the core of the motion before the House – The Government’s extremely constructive engagement with the EU and whether or not we want to put in place appropriate support mechanisms at European level.  We all know that these are needed.  So I want to recap on how Europe has reached its current position.

Europe, and indeed the broader global economy has been in the throes of an economic and financial crisis for a number of years now.  The approach of providing support mechanisms started with the Greek Loan Facility in early 2010.  That was a specific measure for Greece.  It was followed quickly by action to put in place a more general support facility – the EFSF – which could be used for any Euro Area Member State.  This was a temporary mechanism which will expire in 2013.  It turned out that Ireland was the next country to require assistance – in late 2010.   By that time it was clear also that a permanent mechanism would be needed, and the discussion started on the ESM.   At the same time, there was a clear understanding that these types of support measures for countries in difficulty needed to be complemented by measures to promote more sustainable public finances.  The six pack is the new set of rules on enhanced EU economic governance which entered into force on 13 December 2011. The Six-Pack has four main aims:

  • To strengthen the rules of the Stability and Growth Pact (SGP) which was designed to limit budget deficits and government debts, by introducing a much greater and stronger degree of surveillance at an early stage and to make it easier to initiate the excessive deficit procedure. The new rules will also give a greater importance to debt (and not only deficit) reduction and sustainable growth,
  • To introduce new controls on macro-economic imbalances across the EU, such as housing bubbles and growing divergences in competitiveness between Member States,
  • To set standards to ensure the correct and independent compilation of statistics as this data is crucial to sound budgetary policy-making and monitoring of budgets, and
  • To enhance the transparency of the decision-making processes and the accountability of decision-makers.

So it will be clear that the direction in Europe was always towards providing support to deal with countries in difficulty but also to put in place measures to ensure that this would not happen again.

It is important to recognise that we are in uncharted waters here.  That is why the approach is being adapted as it develops.  I have been pointing out for some time that when the Euro was put in place – the architecture to support it was not adequate.  I stated clearly some of the elements that were required – lower interest rates for the programme countries and a substantial firewall among them.  These, and other proposals I have made, have gained traction in Europe and are now part of mainstream thinking.

This resulted in some amendment to the interest rates for the programmes in March 2011.

At the same time, the discussions on the ESM continued and in early July 2011, Finance Ministers signed the Treaty as it then stood.

However, in parallel with this discussion, it became increasingly clear that the existing mechanisms needed to be greatly enhanced.  This culminated in the decisions of the Euro Area Heads of State and Government on 21 July 2011 which agreed significant changes for the Greek Loan Facility and more importantly for the broader European Agenda to – the EFSF.   Most notable among these was reduction in the interest rates and the other costs associated with the EFSF, and the change in its structure, while the maturities were lengthened.  All of these measures aimed to enhance debt sustainability in Programme countries.  In addition, the EFSF was also granted additional flexibilities allowing it to act on the basis of a precautionary programme, finance recapitalisation of financial institutions through loans to Governments and intervene in primary and secondary sovereign bond markets on the basis of ECB analysis.

It was agreed at the same time that these flexibilities would also be included in the ESM.

In order to do that, there was a need to reconsider the draft ESM Treaty.  These additional flexibilities, and the establishment of a permanent support mechanism, are clearly in our interest, and the reopening of the ESM discussions clearly brought potential benefits for us.

While that was taking place, discussions continued on the 2nd Greek Programme involving substantial additional funding and also private sector involvement which is strictly limited to Greece.  We have discussed those measures recently when we considered the legislation on the 2nd amendment to the Greek loan facility.

Of course, thinking was developing as to how to further underpin the EU’s support programmes.   The outcome was that, as part of the agreement to these broader measures, discussion started on a broader fiscal compact, with the aim of ensuring that the level of fiscal irresponsibility which brought about the current crisis could not be repeated.  This represents a development of the approach underlying the six pack, in the same way that the enhancement to the EFSF and the ESM represented a significant and important development in the approach to support mechanisms.

I should also point out that the measures in the fiscal arena have been complemented by the actions of the ECB.  The low interest rates currently in place will help to offset the economic slowdown which is affecting not just Europe but also the world economy.  In addition, the ECB’s longer term refinancing operation or LTRO, has provided some €1 trillion in liquidity to the European Banking system.

Looking now to our own position. We are in receipt of substantial support from the EU mechanisms under our EU-IMF programme of financial support.  This provides funding at rates well below those which would be available if we had to fund ourselves in the financial markets.  In addition, the ECB continues to provide substantial liquidity support to the Irish banking system.  It should therefore be clear that European solidarity is in our interests and to our benefit.

Our Programme is working;  we have met all our targets to date – over 90 in all.  We have met the quantitative fiscal targets.  We have implemented financial sector restructuring.  We achieved banking recapitalisation at a significantly lower cost than initially envisaged.  We imposed burden sharing on junior debt holders.  We are implementing structural reforms with a view to enhancing the growth potential of the economy.  We are introducing fiscal reforms to improve the management and control of our public finances.

The success of our programme implementation has been recognised by the financial markets.  Our 10 year bond yields have remained below 7% for a number of weeks now.  In addition, the NTMA has successfully re-engaged with the markets through the recent bond swap.  These are all positive indications.  They reflect our resolve to emerge successfully from our programme at the end of 2013, and to resume financing ourselves in the financial markets.

It is in Ireland’s, and in Europe’s interest, that there should be a strong firewall, or safety net available to all Euro Area Member states.  I have argued for this consistently.  The ESM provides this firewall.  It provides reassurance to the financial markets, and to all of us, thereby underpinning the confidence that is essential to healthy economic activity. It will also help to protect Euro Area Member States who are in economic difficulty from market speculation.

Now turning to the content of the ESM Treaty, there is no basis for the assertions made in the private members motion in relation to the inclusion of the cross reference to each other in the ESM and Stability Treaties.

The linkage between the ESM and the ratification of the Stability Treaty was accepted in the context of the acceleration into force of the ESM by July 2012. It was of particular importance to a number of countries. It is entirely logical and reasonable that a country receiving the support of its partners under the ESM should be prepared to run sensible budgetary policies as required under the new Treaty. That is the position, and the attempt to put any other gloss on it is both inaccurate and misleading.

Further I have clarified that the linkage of both the ESM Treaty and the Stability Treaty refers to new applications for assistance under the ESM and will not affect the transfer to the ESM of undisbursed amounts under the European Financial Stability Facility (EFSF) for Ireland and other programme countries. The funding approved under the existing Programme of Financial Support for Ireland is not therefore conditional on Ireland ratifying the fiscal compact but, as is currently the case, on Ireland successfully implementing our programme.

The ESM treaty will have to be ratified by the 17 Euro Area member states; it will enter into force and the ESM will become operational as soon as possible. The target date is July 2012, a year earlier than originally planned. As a permanent mechanism, the ESM will take over the tasks currently fulfilled by the European Financial Stability Facility and the European Financial Stabilisation Mechanism.  The ESM’s lending capacity is currently set at €500 billion, and this will be subject to reassessment later this month. This again reflects the continuing development of EU policy to which I referred earlier.

Sinn Fein tabled a motion to try to cast the Government’s actions in a bad light. The Government has consistently acted to support the financial stability of both Ireland and the Euro Area. We have contributed constructively to efforts at European level to ensure the economic stability of the Euro Area, the financial stability of the European Union and the safeguarding of the financial stability of the Euro Area as a whole. While the underlying economic and fiscal situations differ across Europe, it is imperative that countries restore their respective economies to health and their public finances to a sustainable position.

In relation to the legislation, as our amendment to tonight’s motion makes clear, the decision on the timing of legislation for the ESM Treaty, and also for the Article 136 amendment has yet to be taken.  However, it is clear that we will bring forward this legislation at the appropriate time.  This will have regard to the target date for entry into force of the ESM Treaty on 1 July.

The motion before the house tonight seeks to sow confusion and doubt where none should exist.  The Government’s amendment places the ESM in its proper positive context of a series of developing EU measures to address the current crisis, and to seek to avoid a future repetition.  The Government has played a constructive role in these discussions.

I commend the Government’s amendment to the House.

Promissory Notes: No Magic Required

Posted on by

Here‘s an interesting article on promissory notes by Dan O’Brien of the Irish Times. Dan defends the ECB’s approach to this issue:

The ECB has been subject to criticism in this country for not letting Ireland off this portion of its debts. Difficult and all as it is for a taxpaying citizen of this State to concede, Frankfurt is entirely correct to refuse to magic away Ireland’s promissory notes.

Dan’s key argument is as follows

If the ECB was to delete some of Ireland’s debts at the click of a button, as some people advocate, it would not be long before other governments started issuing promissory notes and looking to Frankfurt for some monetising magic. Having the ECB make an exception for Ireland may seem appealing, but it could never be justified by a central bank serious about preserving the currency.

Thus, Dan sees the lightening of any debt burden as needing to be done via fiscal transfers of some sort

The monetary authority in Frankfurt has always insisted that any relief on Ireland’s bank debt is done by the fiscal authorities – i.e. other euro area governments collectively.

The moral case for doing this is very strong. In terms of the collective interest of the euro zone, the case is almost as strong – ensuring Ireland exits its bailout will benefit everyone. Easing the repayment terms on the promissory notes will help to achieve that.

In the event that an easing is not granted, criticism should be directed at those who deserve it. That would be other euro area countries, not the ECB.

The article is well argued but I don’t think the conclusions it arrives at are necessarily correct.

The point about magicking away the promissory notes is a straw man and it’s easy to win arguments with straw men. But it is a logical leap to go from accepting the notes won’t be magicked away to arguing that a restructuring of the notes within the current ELA arrangement is somehow impossible.

One can wave away arguments about a special deal as simply Irish exceptionalism that would set a precedent for everyone else to get such a deal. However, that misses the key fact that the IBRC promissory notes are an exceptional deal. Nowhere else in Europe has a country taken on debts of 20 percent of GDP to bail out an insolvent bank. Indeed, bank resolution proposal documents such as this one from the European Commission are partly premised on the idea that what happened in Ireland with Anglo is unacceptable and should not be repeated.

So the reality is that the promissory note\ELA deal involving IBRC is an exceptional one and one that the ECB Governing Council has agreed to. The ECB has taken a number of bold steps in recent months including radical changes to its collateral framework. Against this background, it should not be considered unimaginable that the collateral for IBRC’s ELA could have its payment structured altered.

The slippery slope on this issue is also a bit overplayed. The ECB’s mandate allows it to pursue a wide range of policies in support of the goals of the EU provided they do not “prejudice” its goal of price stability. Reworking the collateral on €28 billion of Eurosystem loans at a time when the system has just printed off €1 trillion hardly smacks of a systemic threat to price stability. But if other larger countries wished to print of large amounts of ELA in support of their banking systems, then clearly any decision on such proposals would have to keep price stability in mind.

I’m not saying that a final resolution of the promissory note issue won’t involve, for example, the government taking on a long-term loan from EFSF to allow the ELA loans to be repaid and the promissory notes retired. But it is not necessarily the only change from the current situation that would represent an improvement.

ELA is Printed, Not Borrowed

Posted on by

A member of the fourth estate passed on to me a “Background Briefing” from the government on promissory notes.

It contains the following sentence: “The Central Banks (sic) had to borrow this Cash to give to Anglo and has a resultant liability that it must repay.”

This is not true. ELA funds were not borrowed by the Central Bank from the ECB or the rest of the Eurosystem. They were created by the Central Bank of Ireland and provided as a credit to Anglo’s reserve account. To the extent that Anglo used this money to pay off people with foreign bank accounts, the liability will have switched from being a reserve liability to an Intra-Eurosystem (i.e. Target2) liability.

Furthermore, as central bank economists throughout Europe have been saying time and again over the past year (e.g. this piece by two Bundesbank economists) Target2 balances simply reflect the outcome of private decentralised transactions and there is no system whereby a Target2 creditor is under an obligation to “repay” the Target2 liabilities under any particular time-frame.

The long-winded version of this point is on page 14 of my recent briefing paper:

The reason I have described Intra-Eurosystem transactions in such detail is that there has been some confusion in media and political circles in relation to the nature of the ELA issuance.  A number of media stories have reported that “the ELA money was borrowed from the ECB”. This is not the case. The ECB does not issue money at all as this task is delegated in the Eurosystem to national central banks.

A more subtle version of the “ELA was borrowed from the ECB” claim was provided in an answer to a parliamentary question by the Irish Minister for Finance, Michael Noonan, on January 31, 2012. Mr. Noonan stated that “ELA is itself funded by the CBI through Intra-Eurosystem liabilities”.

The word “funded” can have an elastic meaning. However, this answer suggests an interpretation in which the appearance of an ELA asset on the Central Bank of Ireland’s balance sheet is accompanied by an increase in Intra-Eurosystem liabilities. It is my understanding that this is not the case. At the moment of “conception”, so to speak, of the ELA, the corresponding increase in liabilities is a credit to the reserve account of the bank receiving the ELA loans.  Only if that bank then uses its ELA funds to transfer money to bank accounts outside Ireland does the Central Bank of Ireland’s balance sheet start to show an increase in Intra-Eurosystem liabilities.

Because the IBRC appears to have used the vast majority of its ELA loans to pay off foreign bondholders and people moving their deposits outside of Ireland, there is little doubt that the issuance of ELA has led to a significant increase in the Central Bank’s Intra-Eurosystem liabilities. However, it is not accurate to describe the ELA as having been either “borrowed from the ECB” or to describe an increase in “Intra-Eurosystem Liabilities” as the source of the funds.

There are lots of reasons why the ELA needs to be repaid, so why persevere with this false one? As far as I can see, there are two possible explanations for the continued use of  this talking point. Either the officials who draft these briefing notes don’t understand how ELA works or else they do understand but feel that the “money was borrowed from the ECB” line will provide a good excuse on March 31.