Patrick Honohan: Major banking decisions in Ireland during the financial
crisis
Introductory statement by Mr Patrick Honohan, Governor of the Central Bank of Ireland, to the
Oireachtas (National Parliament) Banking Inquiry, Dublin, 25 June 2015.
* * *
"Nexus phase"
I have judged it best to concentrate in this statement mainly on crisis management aspects.
These were the chief focus of the first years of my term of office from late September 2009 to
the end of 2013. Besides, my previous appearances before the Inquiry, and the separate
documentation submitted by the Central Bank have already covered much of the remaining
ground.1
Crisis management aspects
1. Appropriateness of bank guarantee decision
Much of the discussion on the appropriateness of the bank guarantee decision has focused on
what information was available to the political decision makers on the night of September 29th,
2008, on what should have been understood by their advisers, given the information that was
available, and on the alternative short-term courses of action which were available and which
might have achieved smaller losses for Irish taxpayers, whether that was to involve a sharing
with other EU governments or a bail-in of some creditors.2
After all the ink that has been spilled over this issue, nothing has altered the conclusion of my
May 2010 report which suggested some time should have been bought through emergency
liquidity assistance (ELA) in order to allow for consultation with the ECB and other EU
Governments, and to obtain a clearer picture of the potential exposure involved in blanket
guarantee. Probably some extensive form of guarantee would still have to have been granted,
but it should not have included subordinated debt nor existing senior term debt. Given the
evident failure of their business models - as was clearly indicated in the documents prepare
by the investment bank consultants, Anglo and INBS should probably have been dealt with
separately from the others through immediate nationalization and not included in a general
guarantee. To what extent additional bail-in of creditors could have been fully effected over
and above what was subsequently achieved is hard to say. As there was later, there would
have been strong pressure from EU partners not to bail-in senior debt, and it is unclear whether
any quid-pro-quo could have been secured in return.
All in all, the focus on the night of the guarantee has been excessive. As explained below,
much of the losses and the costs for the Irish people had already been ineradicably incurred.
2. Decision to recapitalize banks and alternatives
In what follows I focus on the qualitative and policy aspects of this issue as it was dealt with
during 2010.3
Given the existence of a watertight guarantee enacted through the CIFS legislation of October
2008,4 in designing policy with regard to bank capitalization I was guided by a fixed principle,
informed by the Central Bank's statutory mandate, that any event of default by a bank (as
would trigger a large cash call on the State) was to be avoided in view of the financial instability
that this would cause. In practice, this implied that the Central Bank had to ensure that all of
the guaranteed banks would continue to maintain regulatory capital compliant with
international standards. This would help ensure that they had access to the ECB's standard
liquidity facilities, as well as, where necessary, ELA.5
The second principle applied by the Central Bank was that, for the purpose of defining eligibility
for access to Central Bank financing, regulatory capital adequacy would continue to be
measured in line with conventional accounting principles.6 Anglo was the first bank to
encounter problems in meeting regulatory capital minima; their management advised in
December 2009 that they were likely to breach regulatory minima at end-year following a
reassessment of provisioning needs. This information triggered a request to the Minister for
Finance for an injection of capital sufficient to maintain capital at the regulatory minimum. The
Minister undertook to do so and this led to the creation of a Promissory Note (PN) which was
injected into Anglo in March 2010. The amount of the PN was increased several times during
2010 when additional provisioning needs were identified.
While the injection of State capital was essential if the eligibility of Anglo for Central Bank
financing was to be retained, it was evident that this might complicate subsequent efforts to
impose burden-sharing on Anglo's creditors after the ending of the initial guarantee.
NAMA first tranche and the March 2010 capital adequacy review (PCAR)
When they became available in late March 2010, the initial NAMA valuations (based only on
the handful of exposures that had been fully valued in time) implied much higher losses than
had been generally expected by industry specialists.
The Central Bank had decided to take the announcement of the valuations of the first tranche
of NAMA loan purchases as the occasion to the necessary capital infusions for Allied (AIB),
Bank of Ireland and EBS - the going concern guaranteed banks selling loans into NAMA.7 The
requirements announced by the Bank at the end of March 2010 (in what was known as
PCAR2010) assumed that all of the NAMA purchases would involve haircuts as large as
thefirst tranche, and also took account of forward-looking loss estimates in a base case and a
stress scenario of the non-NAMA books. For example, a flat 5% loan-loss estimate - much
higher than that assumed by the banks' managements themselves - was applied to the
residential mortgage portfolios. These banks were also required to reach capital adequacy
standards above the existing international regulatory minima - thereby reflecting trends in
international regulatory thinking. The banks were given a 9-month period in which to raise the
additional capital needed. Bank of Ireland proceeded immediately to raise capital from the
4
In order to allow the banks to continue to fund themselves as deposits and bonds matured during the two-year
period of the initial guarantee, a further more limited guarantee (known as ELG) on new deposits and bonds
was provided by the Government from late 2009.
5
Having run out of eligible assets for normal ECB liquidity operations, Anglo requested ELA in February 2009
shortly after its nationalization. The amount of ELA it drew fluctuated up to about €15 billion between then and
late September 2010.
6
Of course there was the known potential of a large haircut on the purchase of property-related loans by NAMA,
but the prospective losses might not fully affect accounting measures of capital until the losses were incurred.
This approach sufficiently balanced the need to ensure adequate capital for prudential purposes with the need
to avoid needless and damaging acceleration of the crystallization of the costs of the Government guarantee. It
also took account of the existence of the Government guarantee as a form of quasi-capital support.
7
A capital adequacy assessment of Anglo and INBS was deferred. PTSB too was not included in that special
capital adequacy exercise as it was not affected by NAMA purchases.
market; Allied (AIB) started to dispose of some of its noncore assets in order to reduce the
additional cash capital needed.
Although PCAR2010 increased projected capital requirements, there was, given the prevailing
uncertainty surrounding these badly-impaired portfolios, still a large margin of error which
might eventually consume the apparent surplus above international minima. Early hopes in the
Central Bank that comfortable over-capitalization could be safely engineered were soon
replaced by a concern that there was insufficient information to back what risked being a
destabilizingly large need of State capital (when taken into account with the steady
deterioration of the remaining fiscal prospects). The situation was complicated by the extended
interval over which partial information about the NAMA haircuts would unfold. How could bank
solvency be assured throughout this period of uncertainty? The "choreography" of this interval
necessarily involved a risky choice between two options.
The first option was to require banks to build an unquestionably ample capital buffer; the
problem with this option was the very large potential margin of error in estimates of the NAMA
haircuts. To announce a sum that the Government would have to inject so that the banks would
have sufficient capital to cover all eventualities would have triggered an immediate loss of
market confidence in the Government's finances (putting paid, for example, to the chance of
the Government being able to avoid an IMF programme).
An alternative, less exigent option was therefore chosen. This required additional capital
sufficient to cover NAMA haircuts on the assumption that the first tranche was representative,
but without a further buffer in case later tranches were worse than the first. These haircuts
were much more severe than that generally mandated for the European CEBS stress test later
that summer, but they proved insufficient when information about the second and third NAMA
tranches became available in August and September. Additional capital requirements had to
be announced in September 2010 for Allied (AIB) and also for Anglo, because of Anglo
management's estimate of additional costs imposed by the split and wind- down plan that the
Government had already announced earlier in the same month.
The September 2010 bank funding cliff
Faced with the steep cliff of bank liability maturities in September, I gave some consideration
to possible alternative courses of action which might be recommended to Government.8 The
only safe way forward seemed to continue to rely on ELA while also pursuing all possible steps
to rebuild confidence...and recognizing that recourse to an IMF Programme would be the
fallback position.
It is important to note that the increase in ELA during September 2010 and through to the end
of the year did not create a new contingent liability for the State, but merely shifted that liability
from one set of creditors to another. Mar a deir an seanfhocal, "Cibé cé ólfhas 's é Domhnall a
íocfhas".
3. Programme of assistance
International assistance mooted
By September 2010 most informed international observers began to factor in a likely need for
Ireland to enter a programme of official financial assistance. The prospective rapid increase in
ELA (due to the funding cliff at the end of the initial guarantee period) and the growing evidence
that the Government's multi-year fiscal plan would not stabilize the debt dynamics were the
main influences here. The drip-feed of news about bank recapitalization needs did not help.
Realizing that ELA that was now likely to increase considerably over the following couple of
months, ECB officials increasingly looked to official borrowing by the Government as a way of
getting the ELA repaid promptly. Given the additional interest burden that borrowing from the
IMF or EFSF would impose, the Government was not interested in following this line of
approach to dealing with the ELA.
However, the growing yield spreads on Irish Government debt made recourse to official
borrowing essential to fund the rest of the Government deficit, which was also veering wider
than had been projected in the Government's 2009 plan - a plan whose spending and taxation
policies had been adhered to, but which had seen a wider than projected deficit largely
because of the weaker than projected external demand position. The fact that there were cash
balances sufficient to cover the deficit for several months did not alter this perspective.
The move to the EU-IMF Programme
By the time that spreads on 10-year bonds exceeded 500 basis points on November 4, with
accelerating depositor outflows also reflecting a loss of confidence, it was clear to me that
application for a programme could no longer safely be deferred. The Minister agreed to
exploratory discussions with Troika officials in Brussels.
Delayed until November 14 (apparently because of the need for the Troika to agree a strategy
among themselves), these discussions, attended by about twenty Irish officials, confirmed that
there was a basis for full negotiations on a programme which, with the approval of the Minister,
began in Dublin on November 18. These meetings took place in an increasingly tense situation
of national and international media speculation, market tensions (which had brought the yield
on Irish Government 10-year bonds above 8 per cent)9 and considerable international official
alarm at the highest levels.
In an attempt to restore depositor and public confidence, I was anxious to make a credible
public statement especially as depositor outflows were accelerating.10 Indeed, the previous day
had seen an outflow of €900 million of retail deposits - by far the largest daily figure before or
since. The start of negotiations provided a basis for convincing reassurance, which was clearly
needed, and I gave a radio interview to that effect on the morning of November 18.
Meanwhile ECB officials made public and private overtures to the Irish Authorities to encourage
application for a programme. Given the views of Irish officials, already preparing the ground
for a programme, these overtures were behind the curve and as such can be considered at
best as having been largely gratuitous. This includes the letter of the ECB President to the
Minister for Finance on November 19.
The Programme structure
The Programme finally agreed with the Troika largely reflected the 4-year budgetary plan
published by the Government at the outset of the negotiations. Indeed, the target date for
reaching the threshold deficit level of 3 per cent of GDP was pushed back in the negotiations
to 2015. But would the implied degree of "fiscal austerity" be sufficient to bring the public
finances back on to a sustainable path? Here the remaining question-mark over the banking
system was key.11 (11)
The Programme included the requirement for a new and much more comprehensive stress
test of the banks, capitalization of the banks up to an even higher standard than before, and a
programme of rapid deleveraging of the banks.
Provision was made in the Programme's financial envelope for up to €35 billion in cash to be
borrowed by the Government and injected into the banks if it proved necessary following the
stress test. The Central Bank shared the view of other Irish officials that, if €35 billion were
really needed for that purpose, debt sustainability of the Irish government would be likely
unattainable.12
Indeed, the Central Bank found the financial terms of the Programme unsatisfactory especially
in regard to the high interest rates and the lack of an insurance mechanism against tail risks in
the banks.13 Nevertheless, having set out these concerns, I advised the Government in writing
that it should proceed on the basis of the Programme, given that the alternative of struggling
forward without access to market finance would have been more economically damaging. If
the Programme proved unable to deliver a sustainable debt path (as seemed possible, even
likely14) then it could be renegotiated. The spending and tax adjustments that would have been
needed if Programme funding was not available would be much more severe. Mar a deir an
seanfhocal "Ní hé lá na gaoithe lá na scolb."
Better financing conditions help make the Programme a success
Fortunately, there were subsequent considerable improvements in the terms of financing, not
least through the reduction in EU interest rates (from an initial level of about 5.8 per cent per
annum) and lengthening of the loan maturities, and subsequently through the financial
arrangements around the liquidation of IBRC.
These improvements, combined with close adherence to the budgetary targets in the following
three years, allowed the Government to take the decision to exit the Programme on schedule
at the end of 2013.
Despite the risks and the pressures involved at the outset, recourse to the EU-IMF loan proved
to be a successful policy move for Ireland, limiting the need for fiscal austerity (because funding
was made available in amounts and at costs far below what the market would have offered),
and underpinning a relatively rapid return to confidence. Successive Governments' adherence
to the Programme, in difficult political circumstances, helped restore Ireland's international
reputation for disciplined macroeconomic management, a reputation essential for sustained
recovery of employment and incomes.15
4. Promissory Notes
The origin of the PNs (for Anglo Irish Bank, INBS and EBS) has been explained in section 2
above. The PNs were created and provided to these banks in order to ensure that they
complied with regulatory capital requirements. As liquidity drained from the system in the last
months of 2010, these PNs became part of the collateral pledged by Anglo to the Central Bank
of Ireland in return for the growing amounts of ELA that were being provided.
Both before and after entry into the EU-IMF Programme, the question of finding a long-term
solution for the huge stock of ELA was increasingly pressing. ECB rules specify that ELA
should be short-term; but there was no obvious source of an early repayment. A cash call on
the Government by the Central Bank would have clearly been highly destabilizing. Besides,
the Government's contingent liability here had been assumed (as a result of the guarantee of
September 2008) in the interest of financial stability and in part on the recommendation of the
Central Bank. It would be strange indeed for the Central Bank to then turn, in a financially
destabilising manner, on the State, which had only stepped into the situation in order to stem
a financial stability problem traceable to imprudent bank lending.
Squaring this circle was very challenging, especially considering the Treaty prohibition of
monetary lending to the Government (TFEU Article 123). Only if the ELA could be extinguished
and replaced by some long-term financing facility could stability be protected. A variety of
financial engineering approaches was suggested, but in the end, only one seemed both
compliant with law and acceptable to all involved. It required a liquidation of IBRC under special
17
legislation.16,
After the liquidation, the Central Bank was in possession of a PN in the amount of €25 billion
(as well as about €3.5bn of Government bonds and almost €14bn of NAMA bonds, most of the
latter obtained in return for the Central Bank's claim on the remaining assets of IBRC). These
large acquisitions meant that the Central Bank's net financial asset holdings were well above
the normal agreed ceilings.
The PN, being not freely transferable or marketable, was not an ideal instrument for the Central
Bank to hold, especially considering that it would need to be disposed of. Accordingly the
Central Bank had arranged, as part of the liquidation plan, to exchange the PN for marketable
bonds. The Government agreed to this on the basis that the bonds to be exchanged would be
very long-term and carry floating rate interest. Thus all parties were satisfied with the
exchange: an end to ELA, acceptable assets on the Central Bank's books and a satisfactory
improvement in the terms and conditions of Irish Government debt.
The ECB continues to monitor the disposal of the bond portfolio with a view to ensuring
compliance with Article 123. These disposals are being made as quickly as possible subject
to financial stability considerations, and have been running well ahead of the minimum
schedule announced in February 2013.
5. Cost of crisis
The question: "What was the cost of the crisis?" is far from unambiguous. Cost of what
aspects? Cost to whom? Compared to what? Direct costs only or also including the indirect
costs related to the wider adjustment of the economy and of the cost of borrowing? Including
all gross outlays, or net of subsequent recoveries? While my earlier appearances before the
Inquiry have touched on some of these questions, it is worth adding some further discussion.
• Net cost of Government assumption of banking liabilities. With so many non-
performing and other questionable bank loans still awaiting cure or collection, with a
block of NAMA assets still awaiting sale, and with a large part of the ownership of the
banking system still in the hands of the Government, it is too soon even to have a
definitive estimate of even some of the most straightforward versions of the question,
namely those related to the fiscal costs of making the creditors of the banks whole. In
January I provided the Inquiry with an estimate of about €40 bn or a little less for this
dimension of the costs.18 To arrive at that figure one can take the gross fiscal outlay,
of about €64 bn, subtract the guarantee fees paid by the banks, and the cash
recoveries through sale of capital instruments, and the NTMA's estimate of the value
of the remaining Government investments in the banks. An adjustment - in practice
small - should also be made for the time value of money, in order to bring each outlay
and receipt to a common date. This figure will change from time to time as the
investments are revalued or realized. Any profit of NAMA, or from the IBRC liquidation
will also serve to lower the estimate.19 It is noteworthy that the net figure is about the
same as the aggregate haircut on the NAMA purchases of property- related loans:
had there been no losses on those, the net fiscal cost of the assumption of banking
liabilities would have been small. In other words, the main banks had enough
precrisis capital (€28 bn between the top two) to absorb the actual and prospective losses
on residential mortgages.
• Loan losses of the banks. This is another potential cost figure. Banks normally incur
only very small loan losses. In this crisis the losses of Irish banks and foreign banks
operating in Ireland greatly exceeded the figure noted under (a) insofar as they burned
through all of their equity capital (thereby imposing sizable losses on private
shareholders) and much of their subordinated debt. As I have already mentioned in
public several times, the overall figure here is well in excess of €100bn. (To be sure,
the banks had made unsustainable profits in the boom years).
• Overall economic cost to Ireland of the banking boom and bust. Of course (a) and (b)
are only partial views of the overall costs. The boom brought some transitory
prosperity even to those not directly involved in construction or property; the bust
threw many out of work and imposed losses on many Irish people other than those
that came through the losses on bank loans. And of course a sizable part of the
economic downturn 2008-12 was not home-grown but attributable to the global
financial crisis. In order to get an overall cost to Ireland of the Ireland-specific banking
boom and bust we would need to model how the economy might have performed in
the presence of prudent pre-crisis banking practice. A precise quantification of this is
impossible, but it is clear that the net cost is well in excess of €100 billion and still
growing (cf. Honohan, 2015b).
• Cost of the guarantee decision relative to the best alternative available on the night.
Finally we come to the least important and yet most over-analyzed question in this
area, namely what was the net economic cost to Ireland imposed by the guarantee
decision, relative to the best alternative available on the night. What if an alternative
path had been tried, following prior consultation with EU partners during an interval
covered by ELA, involving a more limited guarantee, excluding some or all existing
senior bonds and subordinated debt, and in conjunction with an attempt to get
agreement that Anglo and INBS bondholders would be bailed-out only on the basis of
cost-sharing with EU partners? How much (in net national economic terms) might
have thereby been saved. This is not a question susceptible of any precise
quantification: could a cost-sharing deal have been successfully negotiated? And if
not, what then? All in all, a possible net economic saving in the area of €2-€10bn
could be imagined, but surely no more than that.20 If so, by September 2008, well over
90 per cent of the net economic cost to Ireland of the boom and bust had become
unavoidable.
The other areas of the Inquiry's focus
As mentioned, this Statement does not dwell on the other areas highlighted to me by the
Inquiry, namely regulatory, supervisory and Government, and banking aspects.
The very extensive changes in regulatory and supervisory staffing, methodology and culture
2009-2013 brought into the Central Bank have been documented in papers submitted by the
Central Bank to the Inquiry. I believe that the smooth transition of the prudential aspects of
Ireland's supervision of banks to the ECB's Single Supervisory Mechanism in November 2014
testifies to the credibility of the transformation that was achieved in those years.
On the rehabilitation and restructuring of banking in Ireland - aside from the recapitalization
aspects - in the period 2009-13, I have spoken repeatedly to Oireachtas committees about
the disappointingly slow progress in dealing with non-performing loans, especially mortgage
arrears. The banks have now got reasonably effective systems in place to deal with collection
and restructuring on the scale needed, but they did not introduce adequate systems until
chivvied by the Central Bank from late 2011. The mortgage arrears targets introduced in early
2013 simplified a quantitative assessment of progress being made by the banks. An increasing
number of loan restructurings, designed to be fully sustainable, have been agreed. Compliance
with the restructured payments schedule is high, though deeper restructuring would arguably
increase assurance that the borrowers would not fall again into arrears and would reduce debt
overhang in the economy at large. However, despite all of the efforts, including the initiation of
court repossession proceedings, there is still insufficient engagement between borrower and
lender in a large number of cases. The resulting lengthy delays leave the borrowers in a limbo
of over-indebtedness and hamper both the borrowers' and the banks' ability to put the crisis
behind them.
References
Honohan, Patrick. 2012. "Recapitalisation of Failed Banks: Some Lessons from the Irish
Experience". Lecture given to the 44th Annual Money, Macro and Finance Conference, Trinity
College, Dublin, 7 September 2012.
Honohan, Patrick. 2014a. "Ireland's EU-IMF Programme: Delivering what it said on the tin".
Address to the European Commission DG-ECFIN Conference (in collaboration with Trinity
College Dublin) Future Directions for the Irish Economy. 10 January 2014.
Honohan, Patrick. 2014b. "Brian Lenihan and the Nation's Finances" in Brian Murphy, Mary
O'Rourke and Noel Whelan, eds., Brian Lenihan: His Times and Trials (Dublin: Irish Academic
Press), pp. 64-82.
Honohan, Patrick. 2015a. "Some Lessons Learnt from the EU-IMF Programme", Speech at
the IMF-CEPR-Central Bank of Ireland Conference Ireland-Lessons from Its Recovery from
the Bank-Sovereign Loop, Dublin Castle, 19 January 2015.
Honohan, Patrick. 2015b. "Where did all the money channelled into property-backed lending
go? Irish Times, 31 January 2015.
Honohan, Patrick. 2015c. "Reconciling Diverse Interests in an International Stabilisation
Programme: Some Thoughts about the EU-IMF Programme for Ireland." Speech at Institute
for New Economic Thinking (INET) Annual Conference, Paris, 9 April 2015.
Schadler, Susan. 2013. "Unsustainable debt and the political economy of lending: Constraining
the IMF's role in Sovereign Debt Crises." CIGI Papers 19, Center for International Governance
Innovation, Washington DC.