How Ireland Guaranteed the Shadow Banking System


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There is a tendency these days in articles by right-wing TDs and libertarian economists in particular to talk up how the Troika bailout was not provided for the Irish people to pay for schools and hospitals during a financial crisis but was provided simply to pay back French and German banks for the money they lent Irish banks during the credit bubble. Further that by the unwillingness of the ECB to reduce that debt we are forced to pay in full for mistakes that are not the responsibility of the Irish people. For example, Mario Dragi’s response to Gay Mitchell’s question in the European Parliament:

“It’s too easy to think that the ECB can replace governments’ action or lack of it, printing money. That’s not going to happen”.

Now, while there is a great deal of truth in the injustice of the matter, it neglects one important aspect as far as I can see. It follows the narrative that the Irish political establishment has no hand or part in this dreadful imposition. Ultimately it suggests that the pressure we are being put under comes exclusively from an external authoritarian source – the IMF/ECB/EU Troika. There is no mention of the fact that the imposition of the bailout in order to pay back French and German bank losses in full was imposed on Ireland because of the nature of Ireland’s blanket bank guarantee.

To begin with its clear that there is no way that Ireland could have put in place such an incredibly broad guarantee unless Ireland was part of the Euro. Such a guarantee would have been useless if we had our own currency. Now the history of the Euro currency tells us that it was created with all its magnificent flaws to provide competitive advantage to principally the French and German economies that required a larger ‘domestic’ market without the additional costs and risks of currency exchange. So, the Irish bank guarantee took an almighty dump on a currency that the core surplus countries had worked so hard to create, and which they needed to remain in its over-valued (ie strong) state.

The main problem, however, with the guarantee was the inclusion in it of Anglo Irish Bank. Now, I realize that the details of this have been poured over a thousand times, but it strikes me that very little is understood about what the guarantee, and the inclusion of Anglo Irish Bank actually amounted to. I am not in a position to explain it expect to point out that the inclusion of Anglo meant that, unexpectedly and against all sense, Ireland guaranteed not retail banking, as other countries did and would do, but the shadow banking system.

In order to understand this it’s worth reading (again?) Patrick Honohan’s report on the banking crisis which includes lots of fascinating detail on the guarantee (see pages 128 – 134). Ultimately I don’t agree with Honohan’s argument that in the circumstances the Irish government did the right thing to include Anglo. But as is often the case with reading Honohan his analysis is thorough, he presents all the facts and even gives a decent snapshot of the literature, which allows you to ask the right questions.

“No other country had introduced a blanket, system-wide, guarantee, though this has been a relatively frequent tool in previous systemic crises (Box 8.3). As such, the Irish guarantee caused considerable waves, upped the ante for other governments struggling to maintain confidence in their own banking systems, and placed some direct competitive funding pressure on banks in the UK, where the liquidity position of some leading banks was much more critical than was known to the Irish authorities at the time.

The scope of the Irish guarantee was exceptionally broad.  Not only did it cover all deposits, including corporate and even interbank deposits, as well as certain asset backed bonds (?covered bonds) and senior debt it also included, as noted already, certain subordinated debt. The inclusion of existing long-term bonds and some subordinated debt (which, as part of the capital structure of a bank is intended to act as a buffer against losses) was not necessary in order to protect the immediate liquidity position. These investments were in effect locked-in. Their inclusion complicated eventual loss allocation and resolution options. Arguments voiced in favour of this decision, namely, that many holders of these instruments were also holders of Irish bonds and that a guarantee in respect of them would help banks raise new bonds are open to question: after all, extending a Government guarantee to non-Government bonds has the effect of stressing the sovereign to the disadvantage of existing holders of Government bonds; besides, new bonds could have been guaranteed separately. The argument for simplicity also is weakened significantly by the fact that an actual dividing line between covered and non-covered liabilities was drawn at as least an equally arbitrary point; moreover, such instruments were held only by sophisticated investors.”

Which begs the question, why then was the guarantee broad enough to include them? After all, not everything was included, and as Honohan points out elsewhere ELA funding for the pillar banks would have solved their liquidity problem in weeks after the decision ultimately to guarantee everything was taken.

The notes and boxes are worth reading too. This one is from the comparison of the Northern Rock guarantee, which was refereed to constantly as the template for the Irish action at the time, and the Irish Guarantee

“Unlike in the case of the Irish guarantee of September 2008, the Northern Rock guarantee extended only to existing and renewed wholesale deposits; and uncollateralised wholesale borrowing. It did not include other debt instruments such as covered bonds, securitized loans and subordinated and other hybrid capital instruments.”

And how the huge cost out the banking crisis, and subsequently the requirement of the bailout itself, came about:

“Studies have shown that blanket guarantees have typically been associated with crises that resulted in larger fiscal costs which in turn reflected the underlying gravity of the situation that called for such a drastic step. However, there are indications that a regime that is prone to introducing a blanket guarantee is also more likely to have been associated with less adequate regulation that can result in large banking and fiscal losses.”

So, while its fun to characterize the ECB and the IMF as the bad guys in all this we have to realise that, given how there has been absolutely no systemic change since the guarantee, that its the lads and lassies who are running the show here that we should be going after.

Update from Conor McCabe over on Dublin Opinion


It’s one thing for the Irish moneyed class to say that the ECB forced them into the 2008 bank guarantee, it’s another for progressives/leftists to fall for it. From Der Spiegel, 2 October 2008:

“Mention of the plan infuriated many across the EU who feel that the action will unfairly draw money away from other banks and toward the presumably safer Irish institutions.

As an alternative to such unilateral responses, French Finance Minister Christine Lagarde suggested the creation of a “European safety net.” Fearing that it would be forced to make the biggest contributions to any such mechanism, Germany responded harshly to the suggestion, with Chancellor Angela Merkel saying that Germany “cannot and will not issue a blank check for all banks, regardless of whether they behave in a responsible manner or not.”


3 Responses

  1. Joe O'Reilly

    November 6, 2012 6:41 pm

    I’m delighted to see someone dismiss a regularly made claim for which there is no evidence – that the ECB were involved in the 2008 blanket guarantee – but somewhat disappointed to see that you uncritically repeat another claim with equally little evidence to support it – that the bailout was provided to pay off French and German bondholders.

    Early journalistic reports on who Ireland’s banks owed money to did indeed show large figures “owed” to eurozone banks – but those figures were BIS figures which included the entirety of the IFSC offshore banking hub, whose ‘balance sheet’ is somewhat larger in itself than the Irish domestic banking sector which received the bailout. The majority of the large sums apparently owed by “Irish banks” to French and German banks have nothing to do with the Irish bailed-out banks, and are instead ‘owed’ by IFSC subsidiaries to their parent banks in their home countries.

    The extent of eurozone bank involvement in the Irish covered banks is indicated both in the Central Bank’s aggregate balance sheets for the covered banks, and through the various stress tests conducted on European banks, and it is surprisingly small. At its peak, funding visibly originating in the eurozone accounted for about 9-10% of the funding in the subsequently bailed out banks (and had already fallen to about 7% by the time of the guarantee), compared to about 50% from Ireland and 40-44% from “rest of world” sources, which in this case is most probably the UK and US, jurisdictions in which the Irish banks traditionally and demonstrably do the majority of their business.

    While it is still possible to claim, even in the light of such evidence, that the involvement of French, German, and other eurozone banks was somehow hidden in the “rest of world” figure, it’s worth pointing out that nobody has demonstrated such concealment, and that one is rather visibly, at that point, engaged in special pleading to rescue one’s original, and unsupported, theory.

    Is mise

  2. Donagh Brennan

    November 7, 2012 11:01 am

    Thanks for the comment Joe, and while it pleases me to get a compliment I can’t say that I entirely agree with your analysis. First, before I say more I am not a researcher, nor to I have experience in analyzing financial markets, banks or economic trends and indicators. The post was written quickly, and the simplistic enough point which I didn’t flesh out admittedly, about the relation between the bailout and the exposure of Irish bank debt to the European inter-bank market I think still remains in some form.

    Also, I’m not wedded to a theory or precious about my conclusions, so let’s have a discussion. I’d be interested if you could walk me through the aggregate balance sheets for covered institutions which suggest that exposure to the Euro area market was small. I also thought that the stress tests were not given much credibility, but again I didn’t look at them.

    I agree that the issue with the IFSC has distorted the understanding of “European” banking as it relates to Ireland, and that the BIS data may have not taken this into account. That is why I was saying that Ireland’s relationship with German banks was complicated.

    However, perhaps an IMF Working paper written in 2007 which examined the External Linkages and Contagion Risk in Irish Banks, based on data from 1994 to 2005 might be useful here.

    It provides lots of information on the inter-dependedness of the Irish banking system to the European securities market, as well as UK and US banks.

    Second, Irish banks have large loan-book exposures abroad. The two largest banks, AIB and BOI, are geographically diversified—each with almost equal share of domestic and foreign assets. Nearly 28 percent of AIB, 44 percent of BoI, and 41 percent of Anglo IB loan book exposures were in the United Kingdom. Although AIB held over 20 percent stake in a U.S. bank, U.S. operations were only 2 percent of its loan book. Anglo IB, on the other hand has about 5 percent of its loan book exposed to the U.S., without having equity exposures in the U.S., but operates through a representative office. Table 2 shows the overseas exposures of AIB, BoI and Anglo IB as percent of their total loan books.

    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)

    Lots more in there of relevance but I don’t have the time to go through it at the moment.

  3. Joe O\'Reilly

    November 8, 2012 1:36 pm

    Thanks for the IMF working paper link – I’ll have a look through that as well, it’s all grist to the mill!

    The Central Bank’s aggregate balance sheets for the bailed out banks (Table A.4.2) are available here:
    – along with those for “Irish domestic banks” (Table A.4.1) and “Irish banks” (Table A.4).

    A.4.2 there allows us to look directly at the credit institutions that have been bailed out by the state. The Liabilities sheet gives us the details of the money that went into the covered banks, back to 2003, so it covers the period of the Celtic Tiger. The liabilities are broken out into several categories, and the ones of most interest are Deposits (customer deposits, obviously) and Debt Securities (aka “bonds”). These are further broken down by the area of the purchasers of the bonds, or holders of the deposits, into three main categories – Ireland, Eurozone, and Rest of World. Note that from the perspective of a bank balance sheet, deposits, like bonds, are liabilities. We can track the sums under each heading month by month through the Tiger and on through the subsequent crash.

    The popular claim is that the banks were stuffed with eurozone bank money during the Tiger, which was then loaned into the Irish market. We should therefore find that the balance sheets show us that, with large sums from the two Eurozone as Deposits and/or Bonds – again, popularly, this should be Bonds.

    That’s not what we find, though. The Eurozone liabilities amount, at their peak in 2006, to 10% of the balance sheet. By the time of the guarantee in 2008, they are down to 7.7%, and by the time of the bailout in November 2010, they form only 4.35% of the banks’ liabilities, while eurozone bonds form only 2.3% of the banks’ total bond liabilities, for a grand sum of €8.2 billion.

    The idea, therefore, that the bailout was aimed at eurozone bondholders doesn’t stack up. Not only was the ‘eurozone exposure’ to the guaranteed banks only about €10 billion in bonds at the time of the bailout (and about €8 billion in deposits), but it has since fallen only to €7 billion now, which means that only €3 billion in eurozone bonds has been paid back since the bailout. In comparison, the fall in “Rest of World” bonds over the same period has been rather larger, falling from €21 billion at the time of the bailout to €7.6 billion now, while even Irish bondholdings have fallen from €34.5 billion to €24.5 billion over the same period.

    So, again, the idea that “the imposition of the bailout [was] in order to pay back French and German bank losses in full” has very little to recommend it based on the holdings of such potential losses in the bailed out banks. Spread over the eurozone banks, €3 billion is a very small sum. Even if we include all the eurozone deposits as being those of eurozone banks, then the exposure of eurozone banks to the bailed out banks in Nov 2010 can be maximised at €18 billion, and the amount paid off since then as €9 billion. That is a sum that could comfortably have been covered by the Irish government from, say, the NPRF and Exchequer cash without a bailout and corresponding IMF programme.

    And that is a conclusion which is backed up both by the statements of the German banks, who publicly rejected the claim that they had large exposures to Ireland at the time – I believe Deutsche reckoned its own exposure as €400 million – and by the European bank stress tests, which show also relatively small amounts per bank in exposures to the bailed out Irish banks, summing to roughly the same total figure as the corresponding exposure in the Central Bank figures (€16.4 billion). While the stress tests are, as you say, regarded as not hugely credible, that’s because they didn’t stress the banks very heavily, not because they recorded the exposures incorrectly, so for our purposes, their credibility isn’t an issue.

    Had the covered banks’ liabilities really consisted of the sums they owed to eurozone banks, there would have been no IMF bailout, and indeed no bank crisis. The Irish banks could have covered their entire eurozone exposure without even requiring government intervention.

    What they could not cover, though, was a massive loss of deposits and bonds in Ireland and the rest of the world. Irish deposits and bondholdings in the covered banks fell from €288 billion just before the end of the 2008-2010 guarantee to €273 billion by that November 2010, while the ‘rest of world’ deposits and bondholdings fell from €183 billion to €130 billion over the same period. Those repayment requirements total €68 billion over the space of a couple of months, and they have gone on falling since, to €181 billion for Irish, and €67.5 billion for ‘rest of world’ in August this year (losses of €109 billion and €115.5 billion respectively).

    So the final sums paid back since the end of the guarantee look like this:

    Eurozone: €9 billion (4%)
    Ireland: €109 billion (47%)
    Rest of World: €115.5 billion (49%)

    We have not been paying off eurozone creditors through “our” state-owned banks since the end of the guarantee – we never required a bank bailout to pay back the small sums involved there. We have been paying off Irish and “rest of world” creditors – and all the evidence, including the IMF working paper you cite, point to the US and UK as that “rest of world”.