ela promissory notes and all that: fiscal costs of anglo irish bank

7/28/2019 ELA Promissory Notes and All That: Fiscal Costs of Anglo Irish Bank

1/28

UCD CENTRE FOR ECONOMIC RESEARCH

WORKING PAPER SERIES

2012

ELA, Promissory Notes and All That:

The Fiscal Costs of Anglo Irish Bank

Karl Whelan, University College Dublin

WP12/06

February 2012

UCD SCHOOL OF ECONOMICS

UNIVERSITY COLLEGE DUBLINBELFIELD DUBLIN 4


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1

ELA,PromissoryNotesandAllThat:TheFiscalCostsofAngloIrishBank

ProfessorKarlWhelanUniversityCollegeDublin

February 2012

Abstract: ThisisabriefingpapertheauthordistributedtotheIrishparliamentarycommittee

responsibleforfinanceandpublicexpenditure.ItdescribesthebalancesheetofIrishBank

ResolutionCorporation,theorganisationthatwasformedbycombiningAngloIrishBankandIrish

NationwideBuildingsSociety. ThenatureofthelongruncosttotheIrishstateoftakingoverthe

liabilitiesoftheseinstitutionsisoutlinedandsuggestionsaremadeforreducingthesecosts.


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2

1. IntroductionItiswellknownthattheIrishstatehastakenonhugedebtsbytakingoverliabilitiespreviouslyowed

by privatelyowned banks, with the majority of this cost related to Anglo Irish Bank and Irish

NationwideBuildingSociety,whichhavebeenmergedtoformtheIrishBankResolutionCorporation

(IBRC).

The total cost of taking on these liabilities has been about 35 billion or 22 per cent of Irelands

nominalgrossdomesticproductin2011. Withoutthiscost,IrelandsdebtGDPratio in2011could

havebeen85percent,roughlyinlinetheEurozoneaverage,ratherthanthe107percentthatwas

recorded. It is possible that without the cost of absorbing the IBRCs liabilities, Ireland may have

maintainedaccesstosovereignbondmarketsandthusavoidedanEUIMFprogramme.

It isalsowellknownthatasignificantfractionofthefundsprovidedbythestatetotheIBRChave

gone to pay off unsecured bondholders and, perhaps for this reason, much of the domestic and

international commentary has focused on the idea that the Irish government should change its

policyinrelationtopaymentofunsecuredIBRCbondholders.

It is worth stressing, however, that the amount of IBRC bondholders remaining is small when

comparedwiththetotalcostofbailingouttheseinstitutions.Instead,themajordebtburdendueto

the IBRC relates to promissory notes that the Irish government has provided, which in turn are

largelybeingusedtopayoffsocalledExceptionalLiquidityAssistance (ELA) loansthathavebeen

providedbytheCentralBankofIreland.

ThispaperdiscussesthefiscalcostsoftheIBRCbailout. Theissuescoveredareasfollows:

ThebalancesheetoftheIBRCandthecrucialroleplayedbyitsELAdebts. TheprocessofgrantingandrepaymentofELAandtheroleoftheECBinthisprocess. Thefunctionofthepromissorynotesandtheireffectonofficialdebtanddeficits.

Unfortunately, there are a lot of complex details associated with various aspects of the IBRCs

relationshipwiththe Irishgovernment, theCentralBankof IrelandandtheEurosystemofCentral

Banks,sothisnotefocusesatlengthonanumberoftechnicalities.However,Iwouldflaginadvance

thatthekeypolicyimplicationisasimpleone.

There are a number of ways that the burden of the debt incurred in the IBRC bailout could be

reduced,bothintermsofneartermfinancingdemandsandlongertermnetpresentvalue. Thekey

obstacletosucharestructuringisthatanyplanofthistypecanbeblockedbyatwothirdsmajority

oftheECBGoverningCouncil. Despitetheimpressionthatthisisacomplexissuerequiringtechnical

discussions,thekeyquestion iswhetherthemembersoftheECBGoverningCouncilarewillingto

lowertheburdenontheIrishpeopleduetheirgovernmentsdecisiontotakeoverthe liabilitiesof

AngloandIrishNationwideandensurethatitsdepositorsandseniorbondholderswererepaid.


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2. TheIBRCsBalanceSheetTounderstandthenatureofthefiscalburdenassociatedwiththeIBRC,thebeststartingpointisthe

institutionsbalancesheet. TheIBRCwasformedonJuly1st2011byamergerofAngloIrishBank

andIrishNationwideBuildingSocietybothofwhichwerebeingwounddownafterhorrificlosseson

propertyloans. Table1onthenextpageillustrateshowtheliabilitysideofAnglosbalancesheet

evolvedoverthepastfewyearsusinginformationfromthebanksannualandmidyearreports.

2.1. AngloIrishBankAttheendof2007,priortothefinancialcrisisthatrockedIrelandfromlate2008onwards,Anglo

had58.4billionindepositsand23.6infundingfromdebtsecurities. Thesubsequentyears,amid

financialcrisisandnationalisationofthebank,sawthevastmajorityofthesedepositspulledfrom

thebankandasubstantialreductioninfundingfromdebtsecuritiesasinvestorsviewedthebankas

toobigarisk.Combinedfundingfromdepositsanddebtsecuritiesfellfrom82billionattheendof

2007to19billionattheendof2010.

Someofthefundstopayoffdepositorsandbondholderscamefromsellingsomeofthebanks

assetsandfromloanrepayments,whichsawthetotalsizeofthebalancesheetfallfrom92.6

billionattheendof2007to68.6billionattheendof2010.Butmostofthefundscamefrom

borrowingfromcentralbanks. Atfirst,mostofAngloscentralbankborrowingtooktheformof

participationinstandardEurosystemrefinancingoperations.However,theseoperationsrequire

counterpartiestopledgeparticulartypesofcollateralinreturnforborrowingmoneyandAnglo

begantorunoutofeligiblecollateralastheIrishbankingcrisisbeganinlate2008.

InMarch2009,theCentralBankofIrelandagreedaMasterLoanRepurchaseAgreementwith

AngloIrish

Bank,

lending

11.5

billion

against

collateral

that

did

not

qualify

for

standard

Eurosystem

monetaryoperations.1ThiswasthefirstofaseriesofsocalledExceptionalLiquidityAssistance

loansthatweremadetothebank.(Themechanicsandlegalitiesoftheseloanswillbediscussedin

thenextsection.) Asthebankingcrisisintensifiedthrough2010,ELAborrowingsrampedup

significantly. Bytheendof2010,Angloowed16.9billioninEurosystemborrowingsandhad28.1

billioninELAdebtstotheCentralBankofIreland.

InFebruary2011,AnglowasinstructedtotransfermostofitsremainingdepositstoAlliedIrish

BanksalongwiththeBanksholdingsofabout12billioninseniorbondsissuedtoitbytheNational

AssetManagementAgency(NAMA)inreturnformostofitsportfolioofcommercialpropertyloans.

Becausethe

NAMA

bonds

had

been

used

as

collateral

for

Eurosystem

borrowings,

Anglo

had

to

pay

offmostofitsECBloans,whichfurtherincreaseditsdependenceonELAfromtheCentralBankof

Ireland.BytheendofJune2011,Angloowed38.4billioninELAandhadEurosystemborrowingsof

only2.4billion.

1Seepage102ofAnglos2009annualreport.


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Table1:AngloIrishBanksLiabilities(BillionsofEuros)

End2007 End2010 Mid2011

TotalLiabilities 92.6 68.6 50.7

OfWhich:

Deposits 58.4 12.1 1.2

DebtSecurities 23.6 6.9 5.7

SubordinatedDebt 5.3 0.5 0.5

OtherLiabilities 5.3 3.6 2.6

EurosystemBorrowings 0.0 16.9 2.4

ELADebtstoCBI 0.0 28.1 38.4

2.2. IrishNationwideBuildingSociety(INBS)The

smaller

Irish

Nationwide

experienced

asimilar

collapse

to

Anglo.

As

with

Anglo,

an

aggressive

approachtopropertylendingcombinedwithdubiouscorporategovernancepracticescombinedto

produceenormouslossesonpropertyloans,mostofwhichwerecrystallisedbythetransferofits

commercialpropertyloanstoNAMA. From2008onwards,thebanksawacollapseinitsfunding

fromdepositsandbondmarketsandahugeincreaseinitsrelianceoncentralbankborrowing.Table

2onthenextpageshowsthatthebuildingsocietylosthalfofitsdepositfundingbetweentheendof

2007andtheendof2010andalsopaidoffalmostallofitsoutstandingdebtsecurities.Bytheendof

2010,Eurosystemborrowingsaccountedformorethanhalfofitsliabilities.

INBSdidnotpublishahalfyearreportin2011,sothereisnopubliclyavailableinformationabout

howitsbalancesheetchangedinitsfinalsixmonths. However,its2010annualreport,publishedin

May2011,reportedthatthebuildingsocietytransferredsubstantiallyallofitscustomerdeposits

toIrishLifeandPermanent,aswellasNAMAseniorbondsworth2.9bnandotherbondsworth

790m. ThetransferoftheseECBeligibleassetsmeantthatIrishNationwidealsoneededtoapply

forELA,soitlikelythatthebankhadELAdebtsofapproximately3.7billionwhenitwasmerged

withAngloonJuly1,2011toformtheIBRC.


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Table2:IrishNationwidesLiabilities(BillionsofEuro)

End2007 End2010

TotalLiabilities 14.6 12.2

OfWhich:

Deposits 7.3 3.7

DebtSecurities 6.7 0.6

SubordinatedDebt 0.4 0.4

OtherLiabilities 0.1 0.2

EurosystemBorrowings

0.0

7.4

ELADebtstoCBI 0.0 0.0

2.3. TheIBRCsBalanceSheetThe

IBRC

has

not

yet

published

abalance

sheet

but

Table

3below

provides

my

estimate

of

how

their

balancesheetwouldhavelookedonitsdateofbirth,July1st2011.Thishasbeencalculatedby

combiningthemid2011balancesheetofAnglowiththeend2010balancesheetofINBSand

accountingfortheshiftofdepositsandbondsfromINBStoIrishLifeandPermanent.

Asofmid2011,depositswereonlyaverysmallpartoftheorganisationsliabilities,whiledebt

securitiesoutstandingweredownto6.3billion,abouttenpercentoftotalliabilities.Thevast

majorityoftheIBRCsdebts48.2billionofatotalof58.6billionareowedtocentralbanksand

thevastmajorityofthese(42.2billionbymyestimate)taketheformofELA.

Therehasbeenaconsiderablefocusinthemediaandpopulardiscussionsonpaymentsto

unguaranteedseniorIBRCbondholders.However,asofJune2011,only2.9billionoftheIBRCs

debtsecuritieswereunguaranteedandunsecuredseniorbonds.SinceJune2011,therehavebeena

seriesofpaymentsonthesebonds,includinga$1billionbondthatwaspaidoutinOctober2011

anda1.25billionbondthatwaspaidoutinJanuary2012.Asaresultofthesepayments,

unguaranteedunsecuredseniorbondnowaccountforlessthan1billionoftheIBRCsdebts. So,at

thispoint,ifthereistobeasignificantreductionintheburdenimposedbytheIBRContheIrish

public,itwillneedtocomefromsomewhereelsethandefaultingontheremainingunguaranteed


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seniorbonds.Specifically,itwillrequireanewapproachtodealingwiththeIBRCsdebtstocentral

banks.

ThelefthandsideofTable3explainswheretheIBRCistogettheresourcestopayoffitsliabilities

asitwindsdown.Ithastwoprincipaltypesofassets.First,thereareloanstocustomers.Second,

there

are

a

series

of

promissory

notes

from

the

Irish

government

that

were

provided

to

Anglo

and

INBSduring2010.ThesepromissorynotesarecurrentlyvaluedontheIBRCsbalancesheetat28.1

and(aswillbediscussedlater)arecurrentlyscheduledtoprovideaseriesofpaymentsoverthenext

20years.

Animportantaspectofthisbalancesheetisthatwithoutthepromissorynotes,theIBRCwouldhave

sufficientassetstopayoffallofitsdeposits,itsbondholders,itsEurosystemborrowingsandallofits

otherdebtsapartfromELA.Only14.1billionofthe42.2billionELAdebtscouldbepaidoffifthe

bankdidnothavethepromissorynotes. Thus,akeypointtounderstandaboutthefuturecostof

IBRCtotheIrishpublicisthat,effectively,thepromissorynotesonlyexisttopayofftheELAdebtsto

theCentralBankofIreland.

Table3:EstimatedIBRCBalanceSheetatMid2011(BillionsofEuros)

Assets Liabilities

PromissoryNotes 28.1 Deposits 1.1

Loans 27.5 DebtSecurities 6.3

Other 3.0 SubordinatedDebt 0.7

OtherLiabilities 2.3

Eurosystemborrowings 6.0

ELADebtstoCentralBank 42.2

Total 58.6 Total 58.6


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3. TheABCsofELAThissectiondiscussestheprocessbywhichExceptionalLiquidityAssistanceisissuedandmoveson

tothevariouslegalandaccountingissuerelatedtotheissuanceandrepaymentofELA.

3.1.

Money

Creation

and

Central

Bank

Balance

Sheets

BeforedescribingthespecifictopicofELA,itisworthclarifyinghowtheprocessofmoneycreation

worksintheEurosystem.ItiscommontoseemediareportsstatingthattheEuropeanCentralBank

isprovidingfundstothebankingsystem.Technically,however,thisisnttrue.TheECBitselfdoesnot

lendmoneydirectlytobanks. Rather,theEurosystemsrefinancingoperationsinwhichitsupplies

liquiditytoEurosystembanksareconductedonadecentralisedbasisbythenationalcentralbanks

oftheEurosystem.

Wheredothenationalcentralbanks(NCBs)getthismoneyfrom?Theansweristhattheydontget

itfromanywhere. Theprocessworksasfollows.EverybankintheEurosystemkeepsasocalled

reserveaccountwithitscentralbankandthisaccountcanbeusedtowritechequestocreditorsor

torequestcashfromthenationalcentralbanktouseinATMmachines. Whenabankobtainsaloan

aspartoftheEurosystemrefinancingoperations,itreceivesthefundsviaitsNCBcreditingits

reserveaccount.Thisistextbookmoneycreationinwhichmoneyisconjuredoutofthinair.

Eachofthenationalcentralbanksreportsonamonthlybasishowmuchmoneytheyhavecreatedin

thisfashionwhentheyreleasetheirbalancesheet.Ahighlystylisedcentralbankbalancesheetis

producedbelow.

StylizedCentralBankBalanceSheet

Assets Liabilities

Assetsacquiredbymakingloansandbuying

securities

Moneycreatedbymakingloansandbuying

securities

Someotherassets CentralBankCapital

Onthelefthandside,thebalancesheetdescribestheassetsthatthecentralbankhasacquiredvia

moneycreationinadditiontoasmallamountofadditionalassetsthatitmayhaveacquiredover

timeindependentofitsmoneycreationactivities(e.g.transfersfromthefiscalauthority). While

centralbankswillhaveholdingsofgoldandothersecurities,formostcentralbanksthelargest

categoryofassetsistheloansthatithasmadetobanks.


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Therighthandsideofthebalancesheetshowsthetotalamountofmoneythatthecentralbankhas

createdovertimeaswellastheresidualvaluebywhichthebanksassetsexceedthemoney

created,whichisusuallytermedthecentralbankscapital. Notethatiftheassetsacquiredvia

moneycreationriseorfallovertimerelativetotheiroriginalvaluewhenacquired,thencentralbank

capitalneednotcorrespondtothevalueofassetsacquiredindependentofmoneycreation.

Therighthandsideofthebalancesheetisoftendescribedasillustratingthecentralbanks

liabilities.However,itisworthstressingthatacentralbanksliabilitiesarequitedifferentfromthose

ofanyprivateentity. Acentralbankthatprintsafiatcurrencythatpeoplewishtousefor

transactionscannevergooutofbusiness.

Suppose,forexample,thatacentralbankprintsoffmoneytoacquiregoldandthepriceofgoldthen

plunges. Inthiscase,thevalueofthecentralbanksassetsmaywellfallbelowtheamountofmoney

thatithascreated,sotheentryforCentralBankcapitalwouldbenegative. Onecouldinthiscase

labelthecentralbankasbeinginsolventinsometechnicalsense.However,thisisnotan

insolvencythatcorrespondstoanyprivatesectorversionofthisconcept.Aslongasthebankcan

createmoneythatpeoplewishtouse,itcanpayoffanydebtsthatfalldueandhonourallofits

obligations.

3.2. CollateralandRiskSharingforEurosystemOperationsBythesecommentsaboutthelackofimportanceofcentralbankcapital,Iamnotintendingtoargue

thatcentralbanksshouldbeabletoprintmoneyforwhatevertasktheywishandnotworryabout

the consequences. The ability to create money is an extremely powerful tool and needs to be

carefullymonitored. Inparticular,withinacommoncurrencyarea, it isparticularly importantthat

eachparticipating memberstate isnotseen tobeparticularly responsible for fuelling inflation by

abusingits

power

to

create

money.

Forexample,forcountriesfacedwiththeproblemoffailingbankssufferingadepositrun,itmaybe

tempting to provide such banks with loans from the central bank so that private creditors and

depositorscanbepaidoffandthenallowforslow(orno)repaymentoftheseloans.However,such

a policy could be inflationary and would be open to accusations of corruption and abuse of the

moneycreationpower.

To prevent such abuses, the Eurosystems refinancing operations take the form of repurchase

agreements that are handled in a way that is designed to prevent losses on money creating

operationsofthetypejustdescribedabove.

The Eurosystems repurchase agreements involve banks temporarily supplying financial assets to

their local NCB as collateral in return for loans, with the terms of these loans set by the ECBs

GoverningCouncil(consistingoftheseventeennationalcountrygovernorsandthesixmembersof

the ECB Executive Board) at its monthly monetary policy meeting. Haircuts are applied to the

collateralsothattheamountthatisloanedtotheborrowingbankislessthanthevalueoftheasset,


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with the amount that can be loaned increasing with the quality of the collateral.2 Should a bank

defaultonitsloansfromanNCB,thecollateralframeworkis intendedtoseetheNCBstill leftwith

anassetthathasthesamevalueastheloan.

Thatsaid,noriskcontrolframeworkcancompletelyruleoutthepossibilityof lossesonmonetary

operations.Forexample,LehmanBrothershadborrowed8.5billionfromEurosystemcentralbanks

whenit

entered

bankruptcy

and

it

was

thought

at

first

that

there

could

be

large

losses

on

these

loans. (In fact, recent media reports suggest the gradual sale of the pledged collateral will come

close to recouping the full amount of money loaned.)3 More seriously, the Eurosystem has now

loanedlargeamountstobanksthathaveusedEuropeansovereignbondswithlowcreditratingsas

collateralandhasalsoengagedinlargedirectpurchasesofthesebondsonthesecondarymarket.

TheofficiallegalstatutegoverningtheEurosystemisquitevagueabouttheimplicationsforanNCB

of losses incurred in monetary operations. Article 32.4 simply states The Governing Council may

decidethatnationalcentralbanksshallbeindemnifiedagainstcostsincurredinconnectionwiththe

issue of banknotes or in exceptional circumstancesfor specific losses arisingfrom monetarypolicy

operationsundertakenfortheESCB. Inpractice,theGoverningCounciloftheECBusedthedefaults

byLehmans

and

other

banks

in

2008

to

clarify

in

astatement

in

March

2009

that

losses

should

be

sharedinfullbytheEurosystemNCBsinproportiontotheirECBcapitalkeyshares.4

NotethatdespiteregularcommentarypointingtotherelativelysmallsizeoftheECBscapitalbase

oflessthan10billion,theactualamountavailabletotheEurosystemtoabsorblossesonmonetary

operationsissignificantlylarger:AsofFebruary2012,theEurosystemhasacombined81billionin

capitalandreservesandanadditional394billioninrevaluationaccountsthatcanalsobeusedto

absorblosses.

Still, this does raise the question of what would happen should one or more Eurosystem central

bankshavetheircapitaleliminatedbylossesonoperations.Perhapssurprisingly,asfarasIcantell,

thelegal

structures

underpinning

the

Eurosystem

dont

discuss

this

eventuality.

Article

27.1

of

the

ECB Statute requires each NCB to have its accounts audited by independent external auditors

recommended by the Governing Council and approved by the Council but it does not state what

should happen if the Governing Council is unhappy with the accounts. Still, it is generally

understood that NCBs would need to be recapitalised by fiscal transfers from their national

government.

3.3. ELA,MonetaryFinancingProhibitionandtheECBGoverningCouncilThe

Eurosystem

allows

for

abroad

range

of

assets

to

be

pledged

as

collateral

in

its

refinancing

operations. However,from2009onwards,eachoftheIrishbankscoveredbystateguarantees

exhaustedtheirstockofeligiblecollateralandwouldhavedefaultedonbondsorfailedtohonour

2SeeEuropeanCentralBank(2011)foradetaileddiscussionoftheoperationalframeworkformonetarypolicy

intheEuroarea.3SeethisreportfromtheFinancialTimes,datedJanuary20,2012.

www.ft.com/cms/s/0/30d1a26e 42b811e193ea00144feab49a.html.4Seepressreleaseherewww.ecb.int/press/pr/date/2009/html/pr090305_2.en.html .


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depositwithdrawalswithoutadditionalhelp.ThathelptooktheformofsomethingtheCentralBank

ofIrelandtermsExceptionalLiquidityAssistancebutwhichtherestoftheworldcallsEmergency

LiquidityAssistanceeitherwayitsELA. Thisassistancetakestheformofloansthatareprovided

tobankswhopledgecollateralthatitisnotacceptableforEurosystemoperations.

TounderstandthelegalbasisforELA,onehastostartwiththeobservationthatallofthenational

centralbanks

in

the

Euro

area

were

founded

prior

to

the

start

of

EMU

and

thus

each

have

pre

existinglegalpowersandobligations. Somearegivenvariousregulatoryandsupervisorypowers

whilesomearenot.Moreimportantly, itiscommonfornationalcentralbankstobegivenanexplicit

setofpowersrelatedtofinancialstability.

TheActcurrentlygoverningtheCentralBankofIrelandgivesitageneralpowertolendagainst

securitytocreditinstitutionsandalsoprovidesitwithanexplicitfinancialsecurityobjective.Thus,

theoriginallegalbasisfortheBankspowertoprovidebankswithELAtopreventabankfromfailing

andtriggeringfinancialstabilityproblemscomesfromIrishlaw.

Thisdoesnotmean,however,thattheBankhascompletefreedomtooperateitsELAprograms

howeverit

wishes.

A

number

of

different

layers

of

Eurosystem

involvement

are

worth

flagging.

First,in2005,thebankingsupervisoryauthorities,thecentralbanksandtheFinanceMinistriesof

theEuropeanUnion(EU)haveagreedonaMemorandumofUnderstandingoncooperationin

financialcrisissituations.ThisMoU,whichisnotapublicdocumentnorlegallybinding,consistsofa

setofprinciplesandproceduresforcrossbordercooperationandlikelyincludesagreementabout

theuseofELA.

Second,the2008ECBConvergenceReportofferstheopinionthatNationallegislationforeseeing

thefinancingbyNCBsofcreditinstitutionsotherthaninconnectionwithcentralbankingtasks(such

asmonetarypolicy,paymentsystemsortemporaryliquiditysupportoperations),inparticularto

supportinsolvent

credit

and/or

other

financial

institutions,

is

incompatible

with

the

monetary

financingprohibition.5HowexactlytheECBsdefinesoftemporaryoperationsisunclear.

Third,anarticleintheECBsFebruary2007MonthlyBulletinstatesthattheEurosystemalsohas

proceduresinplaceregardingtheprovisionofELAtoindividualcreditinstitutionsintheeuroarea,

whichareundertheresponsibilityofthenationalcentralbanks(NCBs).Theseproceduresareaimed

atensuringanadequateflowofinformationwithintheEurosystemtothedecisionmakingbodiesof

theECB.Inthisway,theimpactofanELAinterventiononaggregateliquidityconditionsintheeuro

areacanbemanagedinamannerconsistentwiththemaintenanceoftheappropriatesingle

monetarypolicystance.6

Finally,andmostcrucially,Article14.4oftheProtocolontheStatuteoftheEuropeanSystemof

CentralBanksandoftheEuropeanCentralBankstatesNationalcentralbanksmayperform

functionsotherthanthosespecifiedinthisStatuteunlesstheGoverningCouncilfinds,byamajority

oftwothirdsofthevotescast,thattheseinterferewiththeobjectivesandtasksoftheESCB.7

5Seewww.ecb.int/pub/pdf/conrep/cr200805en.pdf

6Seewww.ecb.int/pub/pdf/mobu/mb200702en.pdf

7Seewww.ecb.int/ecb/legal/pdf/en_statute_2.pdf


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11

Tosummarise,theECBmustbeconsultedwhenELAisissuedanditwillassesswhethertheissuance

ofELAinterfereswithitsmonetarypolicystance.TheECBalsoviewsloanstoinsolventcredit

institutionsandnontemporaryliquiditysupportprogrammesasillegal.AndtheGoverningCouncil

canvoteatanytimebyatwothirdsmajoritytostopanyELAprogramme.

Forthesereasons,theECBhasbeenheavilyinvolvedinthedesignoftheELAprogrammefromthe

start.For

example,

it

is

likely

that

the

ECB

approval

was

required

in

relation

to

the

payment

structureofthepromissorynotesthatIBRCisusingascollateralforELAloansandwhichprovides

thefundswithwhichELAwillberepaid.Inaddition,theECBlikelysoughtvariousassurancesthat

ELAwouldberepaidsuchasthe(apparentlylegallynonbinding)lettersofcomfortsentfromthe

MinisterforFinancetotheGovernoroftheCentralBankoneachoccasionanewELAprogramme

wasinitiatedindicatingtheintentionthattheELAwouldberepaidandtheprovisionofsocalled

facilitydeedswhichtheCentralBankannualreportasprovidingagovernmentguaranteein

relationtorepaymentofELA.8

Inpractice,itappearsthatELAcreditisprovidedtobanksforaveryshortperiodoftime(acoupleof

weeks)andtheECBsGoverningCouncilregularlyconsiderswhethertostoptheprogramme.In

addition,the

ECBs

view

on

the

need

for

solvency

of

institutions

in

receipt

of

ELA

means

that

most

likelytheymustapproveofanyrestructuringoftheassetsofsuchabank,suchasachangeinthe

termsoftheIBRCspromissorynote.

3.4. Target2andIntraEurosystemAssetsandLiabilitiesBeforedescribingthemechanicsofhowexactlyELAworksandhowitaffectsthebalancesheetof

theCentralBankofIreland,ithelpstodescribeoneaspectitsbalancesheetinabitmoredetail.

IntraEurosystemBalances

Onthenextpage,Iveproducedaslightlylessstylisedcentralbankbalancesheetthantheone

describedbefore.Itislessstylisedinthatititemisesthedifferentsubcomponentsthatcorrespond

towherethemoneycreatedbyacentralbankendsup.

Thethreesubcomponentslistedhereare:Reserveaccounts,banknotesandIntraEurosystem

liabilities. Thefirsttwoofthesecomponentsaresimpleenough;thelastone,unfortunately,isoften

misunderstood.

When

a

central

bank

creates

money

via

a

loan

to

a

financial

institution,

it

credits

that

banks

reserveaccount.Thisshowsupasincreasedliabilitiesonthecentralbanksbalancesheet,

withtheloanshowingupasacorrespondingentryontheassetside.

Iftheborrowingfinancialinstitutionrequestsadeliveryofbanknotes,theirreserveaccountisdeductedbytheamountdeliveredandthebanknotesentryonliabilitysideofthe

8Copiesofmostofthelettersofcomfort,whichwereobtainedviaaFreedomofInformationrequestbyRTE,

areavailableatwww.rte.ie/news/2011/0718/centralbank business.htm.


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12

centralbankbalancesheetiscredited.Thereisnochangetotheassetsideofthecentral

bankbalancesheet.

ASlightlyLessStylizedEurosystemCentralBankBalanceSheet

Assets Liabilities

Assetsacquiredbymakingloansandbuying

securities

CentralBankCapital

Someotherassets Moneycreatedbymakingloansandbuying

securities

Ofwhich:

Reserve

Accounts

BankNotes

IntraEurosystemLiabilities

ThatbringsustoIntraEurosystemliabilities.Thisitemisbestexplainedviaatransactioninwhicha

depositor(callhimJean)withanIrishbank(callthemAnglo)requeststhat100betransferred

fromtheiraccounttoadepositaccountwithaFrenchbank(callthemSocGen).Thisworksas

follows:

Jeansbankaccountisdeducted,reducingAnglosliabilitiesby100. Atthesametime,AngloinstructstheCentralBankofIrelandtodeduct100fromitsreserve

accounttosendthefundstoSocGen.

ThereductioninAnglosdepositaccountwiththeCentralBankofIrelandreducesthiscomponentoftheBanksliabilitiesby100.However,theCentralBankofIreland

immediatelyincreasesanentrylabelledIntraEurosystemLiabilities.

ViatheEurosystemsrealtimepaymentssystem,Target2,theBanquedeFrancethenreceiveseithera100credittoitsIntraEurosystemAssetsora100reductioninits

IntraEurosystemLiabilitiesdependingonwhetheritisanIntraEurosystemcreditoror

debtor.

Offsettingthis100improvementinitsbalancesheet,theBanquedeFrancecreditsSocGensreserveaccount,thusincreasingSocGensassets.

SocGenthencreditsJeansdepositaccountwiththatbank.NotethatfromJeanspointofview,allthathashappenedisthathis100hasgonefromhisIrish

bankaccounttohisFrenchbankaccount. However,thewaypaymentssystemsactuallyoperate,

therehavebeensixdifferentoffsettingtransactionsthathaveoccurredalongtheway. Most


14/28

13

importantlyforthepurposesofthispaper,theassetsideoftheCentralBankofIrelandsbalance

sheethasnotchangedbuttheliabilitysideshows100lessinreserveaccountsand100morein

IntraEurosystemliabilities.AsimilarchangewouldhaveoccurredifAnglohadwrittenachequeto

payoffabondholderwithadepositaccountoutsideIreland.

TheseIntraEurosystembalancesaveragetozero.ThosecountrieswithIntraEurosystemliabilities

payinterest

on

these

liabilities

at

the

rate

of

the

Eurosystems

main

refinancing

rate

(currently

1per

cent). ThisinterestisaccumulatedattheECBandredistributedtothosecountrieswithIntra

Eurosystemcredits.

AnAside:TheTarget2Debate

Ashasnowbeenwelldocumented(e.g.pages34and35oftheBundesbanksMarch2011Monthly

report)themovementsofdepositsassociatedwiththebankingandsovereigncrisesofrecentyears

havegeneratedverylargeIntraEurosystemliabilitiesincountriessuchasIrelandandaparticularly

large

Intra

Eurosystem

credit

for

the

Bundesbank.

Itisbeyondthescopeofthispapertodiscussthevarioustechnicalissuesthathaveariseninrelation

totheIntraEurosystemflowsthathavebeengeneratedbythecapitalflightfromtheperipheryto

thecore.However,Iwouldnotethatanumberofeconomistshavereceivedsubstantialmedia

attentionformisleadingclaimsrelatingtotheBundesbanksIntraEurosystemcredits.

Inanumberofcontributions(ofwhichSinnandWollmershuser,2011,isthemostcomprehensive)

HansWernerSinnoftheIfoInstitutehascharacterisedtheBundesbanksIntraEurosystemcredits

asTargetLoans. Thischaracterisationisunhelpfulinrelationtobothwordsemployed.

Asdescribedabove,thepurposeoftheTargetsystemistoseethatJeancantransferhis100

from

his

Irish

account

to

his

French

account.

Sinn

has

proposed

anumber

of

ways

to

restricttheoperationoftheTargetsystem.Byrestrictingthefreemovementofcapitalwith

theEurozone,theseproposalsareeffectivelyacalltoendthecommoncurrency.

Thesecreditshavenoneofthecharacteristicsofloans.TheyarenotinstigatedbytheBundesbanksupplyingitsownfundstotheCentralBankofIreland.Rather,theyrepresenta

transferoffundsoutofIrelandtowardsGermany.

Morerecently,anumberofmediacommentatorshavefocusedontheideathatGermanyissubject

toanenormouscreditriskinrelationtoapossibledefaultonitsIntraEurosystemcreditsinthe

eventofaEurobreakupandconsequentlargefiscalcostsofaBundesbankinsolvency.Thesefears

areunfoundedfortworeasons.First,thevariousEurosystemcentralbanksretainsufficientassetsto

allowfor

afull

and

final

settlement

of

the

Intra

Eurosystem

balances

ifsuch

were

required.

Second,

asnotedabove,concernsaboutinsolvencyofcentralbanksareunfoundedprovideditprintsafiat

currencythatpeoplewishtohold.OnecanbesurethatintheeventofacompleteEurobreakup,

theBundesbankwillfindplentyofdemandforitscurrency.


15/28

14

3.5. IssuanceandRepaymentofELAHereIwanttodescribethemechanicsofhowELAissuanceworksaswellaswhathappens

afterwardsinrelationtointerestandprincipalrepaymentsonELA.

Issuance

ThereasonIhavedescribedIntraEurosystemtransactionsinsuchdetailisthattherehasbeensome

confusioninmediaandpoliticalcirclesinrelationtothenatureoftheELAissuance. Anumberof

mediastorieshavereportedthattheELAmoneywasborrowedfromtheECB.Thisisnotthecase.

TheECBdoesnotissuemoneyatallasthistaskisdelegatedintheEurosystemtonationalcentral

banks.

AmoresubtleversionoftheELAwasborrowedfromtheECBclaimwasprovidedinananswertoa

parliamentaryquestionbytheIrishMinisterforFinance,MichaelNoonan,onJanuary31,2012.9Mr.

NoonanstatedthatELAisitselffundedbytheCBIthroughIntraEurosystemliabilities.

Thewordfundedcanhaveanelasticmeaning.However,thisanswersuggestsaninterpretationin

whichtheappearanceofanELAassetontheCentralBankofIrelandsbalancesheetisaccompanied

byanincreaseinIntraEurosystemliabilities.Itismyunderstandingthatthisisnotthecase.Atthe

momentofconception,sotospeak,oftheELA,thecorrespondingincreaseinliabilitiesisacredit

tothereserveaccountofthebankreceivingtheELAloans. OnlyifthatbankthenusesitsELAfunds

totransfermoneytobankaccountsoutsideIrelanddoestheCentralBankofIrelandsbalancesheet

starttoshowanincreaseinIntraEurosystemliabilities.

BecausetheIBRCappearstohaveusedthevastmajorityofitsELAloanstopayoffforeign

bondholdersandpeoplemovingtheirdepositsoutsideofIreland,thereislittledoubtthatthe

issuanceof

ELA

has

led

to

asignificant

increase

in

the

Central

Banks

Intra

Eurosystem

liabilities.

However,itisnotaccuratetodescribetheELAashavingbeeneitherborrowedfromtheECBorto

describeanincreaseinIntraEurosystemLiabilitiesasthesourceofthefunds.

IshouldemphasisethatinpointingoutthatELAfundswerenotborrowedfromtheECBortherest

oftheEurosystem,itremainsthecasethattheECBGoverningCouncilcaninsistonanendtothe

ELAprogrammeatanypointandisalsolikelytorequireconsultationinrelationtoanyproposals

thatwouldinvolvechangestothenatureoftheIBRCsassets.

InterestPaymentsonELA

TurningfromELAissuance,toitsrepayment,afirstquestionrelatestotheinterestratesthatthe

CentralBankofIrelandchargesonitsELAloans.TheBankhasnevercommentedpubliclyonthis

interestrate.GiventhatELAisnormallyissuedattimesoffinancialcrisisanditsmereexistencemay

beaverysensitivematter,itislikelythattheyarefollowingEurosystemguidelinestoadoptthe

FightClubapproachtocommunicationsonELA(ThefirstruleofELAis:YoudonottalkaboutELA).

9Seewww.kildarestreet.com/wrans/?id=2012 0131.767.0&s=mathews#g774.0.q


16/28

15

Despitethisofficialapproach,AngloIrishBanksrecentreportshavenotedthattheinterestrateon

itsELAloansislinkedtotheECBmarginallendingfacility,whichiscurrently1.75percent. In

addition,theCentralBankofIrelandreported510millioninELAinterestin2010initsannual

report,whiletheentryforOtherassetsaveraged21.3billionin2010. Dividingtheinterestbythe

averagevalueofotherassetssuggestsaninterestrateof2.4percent.Giventhatthemarginal

lendingfacilityratewas1.75percentthroughout2010,myguessisthattheformulausedto

determinetheELAinterestrateissomethinglikemarginallendingfacilityplus75basispoints.

GiventhattheCentralBankiscurrentlypayingoutinterestof1percentonbothmoneyheldin

reserveaccountsandonIntraEurosystemliabilities,thisraisesthequestionofwhathappenstothe

profitsincurredviatheestimated75basispointspreadchargedonELA.

ProfitsrelatingtoEurosystemmonetarypolicyoperationsaresharedamongthevariousnational

centralbanks.However,asfarasIcantell,thisisnotthecaseforprofitsassociatedwithELA

operations.Ifthisiscase,thenthe75basispointmargincanberemittedatsomepointbythe

CentralBankofIrelandbacktotheExchequer.

Thismeans

that

the

ultimate

interest

cost

to

the

Irish

state

of

the

ELA

funding

that

is

supplied

to

the

IBRCisthemainECBrefinancingrate,whichiscurrentlyonepercent.

ELARepayments

WhatoccurswhenELAprincipalisrepaidbytheIBRC?Therearetwopotentialscenarios.Inthefirst,

theCentralBankofIrelandmaintainsitsbalancesheetsizeexactlyasbeforeandsimplyaddstoits

stockofassets;forexample,theycouldpurchasegoldorsecurities.Profitsfromtheseinvestments

couldeventuallybereturnedtotheIrishstate.

Inthe

second

scenario,

the

Central

Bank

does

not

acquire

any

new

assets

but

simply

reduces

the

size

ofitsbalancesheet,markingdownboththevalueofitsELAassetandthevalueofitsliabilities.This

isthescenariothatactuallyoccurs.

ThegraphbelowshowswhathashappenedoverthepastfewyearswiththeOtherAssets

categoryontheCentralBankbalancesheet,whichprimarilyconsistsofELA. Afterreachingapeak

of70billioninFebruary2011,thedeleveragingprogrammesoftheIrishbanks(sellingassetsand

takinginloanproceedsandthennotlendingthemoutagain)haveallowedthemtorepayELAso

thatbyDecember2011,OtherAssetshaddeclinedto44billion(seechartbelow). Itappears

nowthatalmostalloftheoutstandingELAisowedbytheIBRC.


17/28

Tables4

ofFebr

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Liabiliti

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18/28

17

Table4:CentralBankofIrelandBalanceSheet,February2011(BillionsofEuros)

Assets Liabilities

EurosystemLending 117 Banknotes 12

Securities,gold,otherclaims 21 Reserveaccounts 9

Otherassets(mainlyELA) 70 OtherLiabilities 185

CapitalandReserves 2

Total 208 Total 208

Table5:CentralBankofIrelandBalanceSheet,December2011(BillionsofEuros)

Assets Liabilities

EurosystemLending 107 Banknotes 13

Securities,gold,otherclaims 25 Reserveaccounts 6

Otherassets

(mainly

ELA)

44 Other

Liabilities

155

CapitalandReserves 2

Total 176 Total 176


19/28

18

4. PromissoryNotesTherehasbeenconsiderablepublicdiscussioninIrelandabouttheideaofrestructuringtheIBRCs

promissorynotes.However,IthinkitisimportantthatthepriorissuesrelatingtotheIBRCsbalance

sheet,thenatureofitsELAdebtsandtheroleplayedbytheECBGoverningCouncilareestablished

beforeonecanaddressthekeyissuesrelatingtoanypotentialrestructuringofthenotes.

4.1. PaymentStructureDuring2010,itbecameapparentthatAngloandIrishNationwidehadtwoseriousproblems.The

firstwasaliquidityproblem;bothinstitutionswerelosingdepositsandhadnoaccessto

internationalbondmarkets. Inaddition,therewasasolvencyproblem,asitbecameclearthatboth

institutionshadsufferedenormouslossesonpropertyrelatedloans.

TheliquidityproblemwaslargelysolvedbyissuingtheAngloandINBSlargerandlargeramountsof

ELA.The

solvency

problem

was

trickier.

If

the

state

was

going

to

see

that

depositors,

bondholders

andELAdebtswereallrepaid,wherewasitgoingtogetthemoneyfrom?AsconfidenceintheIrish

statefinanceswanedduring2010,itwasclearthattherewasnowaythatthegovernmentcould

obtaintheenormoussumrequiredtorestoretheIBRCorganisationstosolvency31billionor20

percentofGDPbyborrowingfromfinancialmarkets.

ThusthedecisionwastakentosupplytheIBRCinstitutionwithassetsworth31billionintheform

ofpromissorynotes.TheseareeffectivelyIOUsfromtheStatetotheIBRCthatpromisetopay

moneyaccordingtoanagreedschedule.

Table6reportsthefullscheduleoftotalpaymentsonthenotesthathavebeenissuedasdescribed

inan

answer

to

aparliamentary

question

in

September

2011

by

Minister

Noonan

.11

The

first

thing

tonoteaboutthescheduleisthatitdiffersfrom,forexample,afixedratemortgageinthatthe

annualpaymentschangeovertime:

Thepaymentsare3.1billionperyeareveryyearonMarch31throughto2023(thefirstpaymentwasmadewithoutmuchfanfareonMarch31,2011).

Apaymentof2.1billionisduein2024. Paymentsof0.9billionayearareduefrom20252030. Afinalpaymentof0.1billionisduein2031.

Inrelation

to

the

interest

payments,

these

are

dealt

with

somewhat

like

afixed

rate

mortgage.

An

annualinterestchargeisappliedtotheoutstandingprincipalandthereductionintheprincipal

outstandingequalstheannualpaymentminusthecalculatedinterest.Anexceptionisthetreatment

ofinterestintheyears20112013,wherealowerrateofinterestwasapplied(noneatallin2012).

Thenoteswereissuedgraduallyoverthecourseof2010andweregiveninterestratesthatwere

similartotheratesthenprevailingonIrishgovernmentbonds.(Theseratesrosesharplyoverthe

11Availableherehttp://www.kildarestreet.com/wrans/?id=2011 0927.896.0&s=promissory+notes#g897.0.q


20/28

19

courseof2010.)Thedeferralofinterestover20112013thenmeantthatforthebondstostillpay

outtheinteresttotalsoriginallyagreed,theinterestrateappliedfortheremainderofthepayment

schedulewouldbeapproximately8percent.Thus,onceinterestonthenotesisappliedatthislevel

in2014,therewillbeaninterestchargeof1.8billion,whichwillgraduallydeclineinlateryears.

ItisclearthatthispaymentstructurewastacitlyagreedtobytheECBGoverningCouncil,whoare

thereforeaware

that

IBRC

will

not

be

able

to

pay

back

its

ELA

for

many

years.

Indeed,

the

promissorynotecouldbesaidtorepresentanimplicitlongtermtimetableforELArepayment.

Table6:PromissoryNotePaymentSchedule

TotalInterest Repayments Total Capital

Reduction

TotalAmount

Outstanding

31/3/2011 0.6 3.1 2.5 28.1

31/3/2012

3.1

3.1

25.0

31/3/2013 0.5 3.1 2.6 22.4

31/3/2014 1.8 3.1 1.2 21.2

31/3/2015 1.7 3.1 1.3 19.9

31/3/2016 1.7 3.1 1.4 18.5

31/3/2017 1.5 3.1 1.5 17.0

31/3/2018 1.4 3.1 1.6 15.4

31/3/2019 1.3 3.1 1.7 13.7

31/3/2020

1.2

3.1

1.9

11.8

31/3/2021 1.1 3.1 2.0 9.8

31/3/2022 0.9 3.1 2.2 7.6

31/3/2023 0.7 3.1 2.3 5.3

31/3/2024 0.6 2.1 1.5 3.8

31/3/2025 0.4 0.9 0.5 3.3

31/3/2026 0.4 0.9 0.5 2.8

31/3/2027 0.3 0.9 0.6 2.2

31/3/2028

0.3

0.9

0.6

1.6

31/3/2029 0.2 0.9 0.7 0.9

31/3/2030 0.1 0.9 0.8 0.1

31/3/2031 0.0 0.1 0.0 0.0

TOTALS 16.8 47.9 30.6


21/28

20

4.2. TheLongRunIrrelevanceoftheInterestRateontheNotesMuchofthemediacommentaryonthepromissorynoteshasfocusedontheirhighinterestrateand

suggestedthatareductioninthisrateshouldbethefocusofanyeffortstoreducetheburdenof

IBRCdebtonthetaxpayer.Inparticular,therehasbeenconsiderablefocusonthefactthatthefull

total

of

scheduled

payments

on

the

notes

is

48

billion

once

interest

payments

are

added

to

the

31

billionprincipal.

Itshouldbestressed,however,thatloweringoftheinterestrateonthenoteswilldolittletoreduce

thelongrunburdenoftheIBRCdebtontheIrishstate. Indeed,verylittleofthe17billion

differencebetweenthepaymentstotalof48billionandtheprincipalof31billionrepresentsanet

costtothestate.

Toseethispoint,itisworthworkingthroughthestructureofpaymentsthatwehaveoutlined:

PromissorynotepaymentsareultimatelybeingusedbytheIBRCtopayoffELAtotheCentralBankofIreland.IBRCthusneedsanadditional28billiontorepaytheprincipalonits

ELAdebts.

IBRCalsoneedstopayinterestonitsELA.However,theELAinterestrateisapproximately2.5percent,soanyadditionalinterestpaymentsabovethisratewillrepresentaprofitfor

IBRCwhichcanultimatelybereturnedtothestate.

TheCentralBank,inturn,currentlypaysaninterestrateofonepercentonitsreserveandIntraEurosystemliabilities,soitisalsomakingaprofitofanestimated150basispointson

itsELAloanswhichcanalsobereturnedtothestate.

Puttingthesepointstogether,itturnsoutthatonlyasmallfractionoftheinterestpaymentsonthe

promissorynotesrepresentanetcosttothestate.

Anotherway

to

see

this

point

is

to

consider

how

long

it

will

take

the

promissory

note

payments

to

clear28.1billioninELAdebt(effectively,ImassumingthattheIBRCsotherassetswillbeusedto

payoffallotherliabilitiesandtheadditionalELAestimatedaboveat14.1billionatmid2011).

Table7providesascheduleforhowtheIBRCcanusetheannualpaymentsonitspromissorynotes

toreducetheamountofELAoutstanding.IhaveassumedthattheELAinterestrate,whichis

ultimatelylinkedtotheECBsmainpolicyrate,willnotremainaslowas2.5%foreverandhaveset

outascheduleinwhichitwillmoveuptowards4.5%andthenstaythere.

Accordingtothesecalculations,thecurrentschedulewouldmeanthatIBRCwillbeabletopayoffits

ELAdebts(withpresumablyallotherdebtslonggone)in2022.Atthatpoint,thegovernmentcould

windup

the

IBRC

and

simply

cancel

the

remaining

payments.

Note

here

that

the

total

amount

of

promissorynotepaymentsinthisexamplewouldbe37billion. Theadditional11billionin

paymentsscheduledafter2022justwouldnthappen.

Thus,theintensefocusonthetotalrepaymentsfigureof48billionismisplacedandany

restructuringofthepromissorynotesthatissoldashavingthebenefitofreducingthe48billion

figuretosomethinglowerwillactuallybedoingverylittletoreducethelongtermburdenofthe

IBRC.


22/28

21

Table7:ANotionalScheduleforRepaying28.1BillioninELAUsingPromissoryNotePayments

ELAInterestRate Repayments InterestPayments TotalAmount

Outstanding

31/3/2011 0.025 3.1 0.78 28.1

31/3/2012

0.025

3.1

0.70

25.7

31/3/2013 0.025 3.1 0.64 23.3

31/3/2014 0.030 3.1 0.70 20.7

31/3/2015 0.035 3.1 0.73 18.3

31/3/2016 0.045 3.1 0.82 15.8

31/3/2017 0.045 3.1 0.71 13.4

31/3/2018 0.045 3.1 0.60 10.9

31/3/2019 0.045 3.1 0.49 8.3

31/3/2020

0.045

3.1

0.37

5.6

31/3/2021 0.045 3.1 0.25 2.7

31/3/2022 0.045 2.8 0.12 0.0

4.3. TheShorterTermRelevanceoftheInterestRateontheNotesWhiletheamountofinterestpaidonthepromissorynoteshaslittlelongrunimpact,theseinterest

paymentsaresettohave anunfortunateimpactontheIrishbudgetaryprocessoverthenextfew

years. ThisimpactrelatestoEurostatsaccountingtreatmentofthepromissorynotes.

Eurostatsaccrualsbasedaccountingforbudgetdeficitscountedthefull31billionprincipalofthe

promissorynotesonIrelandsgeneralgovernmentbudgetdeficitin2010.Theinterestpaymentson

thepromissorynotesarethencountedonthegeneralgovernmentdeficit(GGD)intheyearsthat

theyoccur.However,Eurostatsrulesallowfordebtinstrumentstohaveinterestholidaysinwhich

nointerestischargedandthepromissorynotesweredesignedwithsuchaholidayperiodover

20112013.12

Whenthisperiodisscheduledtoend,theinterestpaymentsonthenotewillgofromhavingno

impactontheGGDthisyeartoa500millionimpactin2013anda1.8billionimpactin2014.Even

thoughthecashflowimpactofthenoteswillnotchangeduringtheseyears,thegovernmentwill

needto

find

an

additional

1.8

billion

in

spending

cuts

and

tax

increases

over

the

next

two

years

ifit

istosticktoitsofficialtargetsforthismeasureofthedeficit.

12SeethisDepartmentofFinanceinformationnotereleasedinNovember2010:

www.finance.gov.ie/documents/publications/reports/2010/noteprommissory2010.pdf


23/28

22

5. PotentialPolicyOptionsThissectiondiscussesthereasonsinfavourofrestructuringthepromissorynotes,outliningmy

preferredoptionsforrestructuringaswellasthepotentialargumentsthatarelikelytolevelled

againstthisapproachbymembersoftheECBGoverningCouncil.Ialsoprovidesomeargumentsfor

changingtheIBRCsaccountingtreatmentofthenotes.

5.1. WhyRestructurethePromissoryNotes?Beforeconsideringpolicyoptionsforchangingthestructureofthepromissorynotes,itisworth

emphasisingwhysucharestructuringisdesirable.

TheEuropeanCommissionslatestreportonIrelandprojectsthattheIrishdebtGDPratiowillpeak

at119percentattheendof2013,justasthestateissettorunoutofitsEUIMFfunding. Thisdebt

ratioiswellbeyondlevelsthathavetraditionallybeenconsidereddangerous,evenpriortothe

recentexample

of

private

sector

sovereign

debt

restructuring

within

the

Eurozone

set

by

Greece.

As

currentlystructured,thereislittledoubtthattheIBRCspromissorynoteswillrepresentasignificant

negativefactorinrelationtofinancialmarketsassessmentofthesustainabilityofIrelandsdebt

burdenatthattime.

Ihaveprojectedabovethat,basedonthecurrentscheduleandthenatureofIBRCsELAdebts,

Irelandissettomakeitstwelfthandlastpromissorynotepaymentin2022. Effectively,the

promissorynotesactliketwelvedifferentzerocouponbondswithmaturitiesrangingfromoneto

twelveyears. Thus,theeffectiveaveragematurityofwhatisleftofthisdebt,whichaccountsfor

twentypercentofGDP,isaboutfiveyears.

Combinedwith

an

average

maturity

as

of

March

2012

on

Irelands

existing

private

debt

of

about

80

billionofaboutsixandahalfyears,thismeansthatIrelandwillhaveverysignificantfunding

requirementsoverthenextfewyears,evenbeforeoneconsiderstheincrementalborrowing

associatedwithbudgetdeficits.13

ItisthefirmhopeofIrelandsEurozonepartnersthatIreland,whichiswidelypraisedforits

willingnesstoimplementausteritymeasures,beabletoaccesssovereigndebtmarketsby2013.Any

stepsthatcanbetakentohastenIrelandsdeparturefromtheEUIMFprogrammeareinthe

interestsofboththeEurozonememberstatesandtheIrishpeople. Areductioninthefunding

burdenassociatedwiththepromissorynotesrepresentsarelativelysimplewaytotakesuchastep.

13Calculationsbasedoninformationinwww.ntma.ie/GovernmentBonds/Daily_Bonds_Outstanding.pdf


24/28

23

5.2. WhattheIrishGovernmentShouldLookFor:PaymentDeferralAnysuccessfulnegotiatingstrategyrequiresacleargoal.Inthecaseofthepromissorynotes,the

Irishgovernmentshouldbeproposingtorestructurethenotessothereisno3.1paymenttoIBRC

onMarch31,2012orforanumberofyearsafterthat. Thiswouldreducethestatesfunding

requirements

over

the

next

few

years

and,

by

reducing

the

net

present

value

burden

of

this

debt,

helptoconvinceinvestorsthatIrelands120percentdebtGDPratioisnotasonerousasitlooks.

Forhowmanyyearsshouldthepromissorynotepaymentsbedeferred?Clearly,fromanIrish

perspective,theidealanswerwouldbetodeferthepaymentsaslongaspossiblebut,giventhe

needforagreementfromtheECBGoverningCouncil,thisisunlikelytobeobtained.Aslightlyless

strongapproachwouldbetolinkthebeginningofpromissorynotepaymentstoquantitative

benchmarksinrelationtotheperformanceoftheeconomy:Forexample,thatpaymentswould

beginwhennominalGDPhasrecovereditsprecrisispeakandunemploymenthasfallenbelowten

percent.AnevenweakerapproachwouldbetosuspendrepaymentsuntilIBRChasusedupallits

nonpromissoryassets.Asnotedabove,theIBRCwouldbeabletorepayapproximately14billion

overtime

in

ELA

even

ifit

was

never

received

any

promissory

note

payments.

Whataretheobstaclestothegoalofpaymentdeferral?Anyonewhohastakenapassinginterestin

thisissuewillknowbynowthattheIrishgovernmentishavingtechnicaldiscussionswiththe

troikaaboutthisissue. ThetruthisthattheECBGoverningCouncilistheonlybodythatreally

mattersforthisquestion.Ifaplantorestructurethepromissorynoteswasacceptedbythe

GoverningCouncil,thenitisveryunlikelythattheeithertheCommissionortheIMFwouldobject.

WhatobjectionsmightGoverningCouncilmembershavetorestructuringthepromissorynotes?In

reality,membersoftheCouncilhavebyandlargeavoidedcommentingonthisissue(partlybecause

theyare

rarely

asked.)

But

it

is

likely

that

objections

take

the

following

form:

TheMoralHazard/SlipperySlopeArgument:IfpromissorynoterestructuringleadstoaslowerpaceofrepaymentofELA,thenothercountriesmayalsoseektouseELAtobailout

theirbankingsystemsandtheconsequencesmaybeinflationary,violatingtheECBsprimary

policyobjectiveofpricestability.

TheLegalisticArgument:ItislikelythatvariouslawyersandcentralbankersattheECBandnationalcentralbanksbelievethattheexistingELAprogrammefortheIBRCcomescloseto

violatingtheirunderstandingofthemonetaryfinancingprohibitionarticleintheTreaty. For

theseindividuals,

any

change

to

the

current

arrangement

should

not

be

considered

because

itmayrunintolegaldifficulties.

TheWhatsYourProblem?Argument:ManyEuropeanpoliticiansandcentralbankersarefondofpraisingIrelandsEUIMFprogrammeasagreatsuccess.Fortheseindividuals,they

wouldprefertowaittoseefirmevidencethattheprogrammehasgoneofftrackbefore

acceptingtheneedtochangeanyofitskeyaspects.


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24

Eachoftheseargumentsareworthrespondingto:

ELAprogrammesneedtheacquiescenceandcooperationoftheGoverningCouncil.TheECBwasstronglysupportiveofprovidingfundstopayoffbondholdersanddepositorsatfailing

IrishfinancialinstitutionsonthegroundsthatthesedecisionspromotedEuroareafinancial

stability.However,

the

Irish

ELA

programme

does

not

represent

aslippery

slope

to

frivolous

ELAprogrammesacrosstheEurozonebecausetheGoverningCouncilcansimplychooseto

saynotofuturerequeststhatitdoesnotsupport.

SlowrepaymentofELAdoesnotcauseinflation.TheELAmoneyhasalreadybeenprintedanddidlittletostokeEurozoneinflation.Choosingtorepaythemoneymoreslowlywillonly

contributetoEuroareainflationarypressuresifthemonetaryaggregatesareexpanding

morerapidlythantheECBiscomfortablewith.Atpresent,growthinEuroareaM3isvery

slow.Ifinflationbecomesaconcern,theGoverningCouncilcouldmakedeferredrepayment

ofELAconditionaloncontinuedslowgrowthintheEuroareamoneysupply.

Thelegalisticargumentsagainstrestructuringthenotesarerelativelyweak.IBRCisasolventinstitutionthatisbeingprovidedwithsufficientfundstorepayallofitsdebtsovertime.A

deferralofELAdoesnotchangethatsituationandsoitdoesnotbringusclosertomonetary

financingofaninsolventinstitution.AndanyprogrammetopaybacktheELAeventually

technicallycountsasatemporaryprogramme.

InrelationtotheWhatsYourProblem?approach,itcouldbearguedthatnowisthetimetolooktobuildonwhateverpositivemomentumisthereinrelationtothesuccessofthe

Irishprogramme.WiththeEuroareaeconomyapparentlyenteringrecessionandIrish

exportsweakening,IrelandislikelytoneedanimproveddealfromtheEUiftheprogramme

isto

truly

succeed.

5.3. AccountingTreatmentofPromissoryNotesAseparateissuefromthekeygoalofachievingasignificantdeferralofpromissorynotepaymentsis

theaccountingtreatmentofthepromissorynotes.

Therehasneverbeenanofficialexplanationofwhythepromissorynotesneededtocarryasimilar

yieldaswasprevailingonIrishgovernmentbondsin2010.ANovember2010DepartmentofFinance

notereportedthatForcapitaladequacypurposesthePromissoryNotesmustbevaluedatparinthe

institutionsaccounts.

Accordingly,

interest

must

accrue

on

any

amount

due

until

it

is

paid.

The

interestratechargedisbasedonthelongtermGovernmentbondyieldappropriatetowhenthe

amountswillbepaid.

Effectively,theapproachtakenin2010wastovaluethepromissorynotesaccordingtoamarkto

marketapproachsimilartohowbanksvaluebondsthatarekeptintheirtradingbooks. However,

mostEuropeanbanksallocatethemajorityoftheirsovereignbondstotheirsocalledbanking

bookswhichisintendedforassetsthatareheldtomaturity. AstheEuropeanBankingAuthority


26/28

25

explainedinanotediscussinglastyearsEUbankingstresstestsTherealityisthatshocksto

sovereignbondsonlyimpacttheregulatorycapitalpositionviathetradingbook.14

Thepromissorynotesarenotintendedtobetradedontheopenmarketandareintendedtobeheld

tomaturity.Thusabankingbookaccountingtreatmentisappropriate.Inaddition,theriskprofile

ofthepromissorynotescanbedistinguishedfromthoseofregularsovereignbondsduetothe

additionalletters

of

comfort

and

facility

deeds

that

have

been

provided.

Evenifthegreatergoalofdeferringpromissorynotepaymentscannotbeachieved,thegovernment

shouldatleastseekagreementwiththeECBGoverningCounciltoissuenewnoteswithaninterest

rateequaltotherateontheIBRCsELAloansandtovaluethesenotesatparonaholdtomaturity

basis.SuchanapproachwouldprovideIBRCwithsufficientfundstorepayitsELAdebtsasoutlined

inTable7inthispaperwiththeinterestcountingagainstthegeneralgovernmentdeficitbeingthe

muchloweramountsreportedthere. Forinstance,theinterestchargeontheGGDunderthis

accountingmethodin2014wouldbeabout700millioninsteadof1.8billlion.

6. ConclusionTothosewhohaveexperiencedtheIrishbankingandfiscalcrisisatfirsthand,themoraland

practicalargumentsforeasingtheburdenontheIrishtaxpayeroftheIBRCsdebtmayseem

obvious.MuchofthisdebtwasincurredbytheIrishstatesothatunsecuredandunguaranteed

seniorbondholdersinthenotoriousAngloIrishBankandIrishNationwideBuildingSocietywouldbe

paidback.ThiswasapolicythattheEuropeanCentralBankrepeatedlyurgedtheIrishgovernment

toadoptintheinterestsofEuropeanfinancialstabilitybutwhichleadIrelandtothevergeof

nationalbankruptcy. Today,Irelandisagaintoutedastheposterchildforausterityandreformand

aneasingoftheburdenofthisdubiouslyassumeddebtwouldgreatlyimprovethechancesofa

successfuloutcome

from

this

process.

Inreality,theunderstandingofIrelandseconomicwoesfromEuropeanpolicyauthoritiestendsto

belesssympatheticandmoralisingargumentstendtohavelittleimpact. TheECBGoverningCouncil

isextremelyfocusedonitspricestabilitygoalandmanyofitsmembersviewrepaymentofthe

IBRCsELAdebtsasquicklyaspossibleasessentialtoavoidsettinginflationaryprecedentsinthe

conductofmonetarypolicy.

Intheory,IrelandneedsonlytogetablockingonethirdminorityontheECBGoverningCouncilto

alterthetermsofitsELAprogramme,whichwouldallowforarestructuringoftheIBRCspromissory

notes.Inpractice,theGoverningCouncildoesnotoperateinthisway,preferring unanimousor

nearunanimous

decisions.

While

hopes

have

been

raised

that

an

agreement

many

soon

be

reached

toreducetheburdenofthepromissorynotes,Iexpectanyprogresstobeslowandincremental.

AngloandIrishNationwidearelikelytocontinuetoposeaburdenontheIrishstateforalongtime

tocome. Makingprogressonreducingthisburdenislikelytorequireasustainedcampaignfrom

IrishpoliticianstoexplaintherelevantissuestotheirEuropeancounterpartsandthewider

Europeanpublicandtoputthecaseforrestructuringasclearlyaspossible.

14Seewww.eba.europa.eu/EU widestresstesting/2011/Questions andAnswers.aspx


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26

References

EuropeanCentralBank(2008).ConvergenceReport.May2008.

EuropeanCentralBank(2011).TheImplementationofMonetaryPolicyintheEuroArea,February

2011.

Sinn,HansWernerandTimoWollmershuser(2011).TargetLoans,CurrentAccountBalances and

CapitalFlows: TheECBsRescueFacility.CESIFOWorkingPaperNumber3500.


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ela promissory notes and all that: fiscal costs of anglo irish bank

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