. competition for deposits therefore remains strong and rates high. it ’ s not just that higher bank funding costs will now be passed on to new borrowers, adding headwinds to the economic recovery, though that is certainly a factor. indeed, the lower policy interest rates set by the ecb since the crisis began have only been partly transmitted to borrowers in ireland and in the other stressed euro area countries ( figure 6 ). ( as is seen by the results of a recursive regression exercise, the pass - through from policy rate to irish residential mortgage svr rates has halved since the start of the crisis – figure 7. ) some of this can be rationalised as reflecting a higher credit risk - premium being charged by the banks, but some is also due to the higher marginal cost of funds. worse still for the health of the banks, and their ability to contribute to the economic recovery, is the fact that they are still coping with the consequences of their marginal cost of funds having delinked so sizably from the ecb policy rate. these consequences arise because of the long - term mortgage contracts the banks made when they assumed that their marginal cost of funds would always remain close to the ( risk - free ) policy rate. suffice it to say that a large block of residential mortgages was granted at interest rates which track the ecb policy rate plus a very low spread. these tracker mortgages, many of which have an average remaining maturity of 15 – 20 years or more, yield less than the marginal cost of funds ( figure 8 which is drawn on the assumption, not strictly valid, that the average spread of the trackers over policy rate was unchanged over time ). in effect, by assuming that their cost of funds would not deviate much from the ecb policy rate, the banks exposed themselves to a very large “ basis risk ”. in principle, they could escape bis central bankers ’ speeches this trap if there were a willing purchaser ( public or private ) with access to funding at a cost that is not contaminated by the sovereign stress. until such a purchaser comes forward, the banks will have to continue to fund this portfolio at a loss, even on performing mortgages, whose effects will spill over onto their customers and their owners ( not least the state ). conclusion irish sovereign spreads may no longer be bloated by redenomination risk, but at 300 basis points at the long - end, they do seem to reflect a

immune from loss - sharing ) large banking outflows and spreads exceeding five per cent made recourse to official assistance inevitable. ( figure 3 shows the plot with some relevant news stories flagged ). perhaps the most significant take - away from the sequence of spikes and troughs is the fact that some of them clearly relate to news that is country - specific, some of them to euro area general news. the same is doubtless true for all of the stressed sovereigns. default risk vs. devaluation risk vs. redenomination risk it ’ s worth pausing to recall that raw sovereign spreads such as we are seeing today in the euro area are not remotely unprecedented in pre - euro history. on the contrary, they were the norm as is illustrated by figure 1. the difference is that these spreads reflected a combination of default risk and currency risk. during the last fiscal crisis of the 1980s irish sovereign spreads ballooned out also. but that was for local currency denominated debt. eurobond borrowing by the irish government remained at fairly tight spreads despite the high overall debt ratio ( higher than today ), and the fact that almost half of the national debt was denominated in foreign currency. the high spreads reflected devaluation expectations and currency risk generally. and there were devaluations, though less than was baked into the spreads – by between 250 and 300 basis points on average during the last ten years of that ill - fated regime, the narrow - band ems. it is not that default and devaluation are close substitutes ; not at all, and for several reasons. for one thing, default has potential reputational consequences for the issuer qualitatively different to those of devaluation. in addition, though, devaluation affects not only the international value of the government ’ s debt promises, but also that of all other contracts denominated in local currency ; as a result, depending on the speed of price - resetting ( pass - through ) it can affect competitiveness throughout the economy. these differences have not been sufficiently emphasised, i feel, in recent discussion. as an example, i could mention the irish devaluation of august 1986. the main goal of this important action was restoration of wage competitiveness, not a lowering of the real value of the local currency - denominated debt. ( indeed, i recall that some domestic policymakers were confused on this point and thought that the debt burden would actually increase as a