2004 Report: Interbank Borrowing at the Heart of Irish Bank Funding Stream

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This is from an IMF working paper – WP/07/44 – written in 2004 by Elena Duggar and Srobona Mitra, entitled, External Linkages and Contagion Risk in Irish Banks, (link here).

It lists the exposed areas for Irish banks – areas where contagion could become a factor.

Here it talks about the banks’ exposure to the wholesale funding markets – the very markets which started to dry up late 2007 onwards, hitting full crisis in September 2008 in the wake of the collapse of Lehman Brothers:

Third, the increased reliance on wholesale funding in recent years, including interbank borrowing and capital market issues, is another potential source of international interdependencies. The average loan-to-deposit ratio for Ireland exceeds 150 percent, one of the highest for industrial countries. All of the major Irish banks are dependent for funds on the interbank and securities markets—AIB and BoI fund about 40 percent of lending in the market, while the market funding requirement for the Anglo IB is at about 35 percent. The overwhelming bulk of both nonresident interbank borrowing (83 percent) and debt securities issued and held by nonresidents (83 percent) in 2004 were vis-à-vis non-Euro area residents.” (p.7)

The paper also notes that Bank of Ireland had securitized its mortgage book:

BoI has transferred the bulk of its domestic residential mortgage assets to a designated mortgage credit institution, which has a banking license to issue mortgage-covered securities—these are used both for hedging interest risk and for generating additional funding. Almost 60 percent of these securities were held by other Euro Area members, while 25 percent was held in USD by other countries.

Bank of Ireland was able to issue more loans based on its actual held capital by moving its mortgage loans ‘off-books’. What’s interesting here is the amount of these securities that were (are?) held in the Euro area and US dollars. Last year Bank of Ireland moved to buy back about €4.5 billion of these securities which were issued in 2007 – all of which adds to the argument that the Irish bank guarantee was also a defacto guarantee of the European securities market.

I’m still going through the paper but just to highlight again that the actual trigger in September 2008 for the bank guarantee was not Irish mortgage default due to a collapse in the property market but the freezing of the interbank and securities markets – and that eurozone financial institutions were quite exposed to Ireland’s loan book, not just in terms of actual short-term loans but also in terms of securities purchased on the back of the Irish bank sector mortgage book at least, and in all probability its commercial loan book as well.

It also goes some way to explaining why the Irish State and the banks have been so reluctant to move in any way to protect households from the burden of negative equity and actual default.

One last point, the above paper cites another that was carried out for the ECB.

Entitled, Measurement Of Contagion In Banks´ Equity Prices, it was written by Reint Gropp and Gerard Moerman and published in December 2003 as ECB Working Paper no. 297.

Here it talks about banks of EU-wide systemic importance:

we identify banks, which appear to have been of systemic importance within individual countries and across countries. Overall, the results suggest that there may be relatively few banks with EU-wide systemic importance. The banks consistently identified as systemically important in the EU are Deutsche Bank, Dresdner Bank, Danske Bank, Allied Irish Bank, Bank of Ireland, ING, ABN Amro, HSBC and National Westminster Bank. BNP Paribas, Natexis, BBVA, Banco Santander and a number of large UK banks seem to have some systemic importance, but the evidence is weaker.” (p.6)

So, as early as 2003, both AIB and Bank of Ireland were identified by the ECB as being of systemic importance in the EU.

As to how two banks in a country with 0.78 per cent of households in the EU, ended up as having systemic importance to the EU, well, that’s a story worth exploring.