ela promissory notes and all that: fiscal costs of anglo irish bank
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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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ELA,PromissoryNotesandAllThat:TheFiscalCostsofAngloIrishBank
ProfessorKarlWhelanUniversityCollegeDublin
February 2012
Abstract: ThisisabriefingpapertheauthordistributedtotheIrishparliamentarycommittee
responsibleforfinanceandpublicexpenditure.ItdescribesthebalancesheetofIrishBank
ResolutionCorporation,theorganisationthatwasformedbycombiningAngloIrishBankandIrish
NationwideBuildingsSociety. ThenatureofthelongruncosttotheIrishstateoftakingoverthe
liabilitiesoftheseinstitutionsisoutlinedandsuggestionsaremadeforreducingthesecosts.
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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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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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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
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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.
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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
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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.
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Tables4
ofFebr
ofsecur
reserve
Liabiliti
Indeed,
ofELAe
Thatth
moneyt
somep
andthe
states,s
thestat
circulati
thesere
10Seew
and5show
ary2011an
ities,golda
accounts. T
s,thecateg
inthesame
ndupreduc
ELAgoest
hatit
has
cr
blicdiscuss
passingoft
omehavec
.Therealit
on.Effectiv
payments.
w.kildarestr
howthese
dDecembe
dotherclai
hus,thedec
orythatincl
parliamenta
ingIntraEu
wardsredu
eatedisi
ionofthisis
ismoneyo
ncludedth
isthatthe
ly,itisasif
eet.com/wra
evelopmen
2011respe
msandvery
lineof26b
udesIntraE
ryanswern
osystemlia
ingtheCen
portantbec
ue.Becaus
theCentra
tthesetran
henIBRCr
itisbeingb
s/?id=2012
16
tsalteredth
ctively. The
littlechang
illioninELA
urosystemli
otedabove,
ilities.10
tralBanksli
auseit
corr
thepayme
lBankareb
sactionsare
epayitsELA
rned:There
131.767.0&
eCentralBa
rewasasm
inbankno
hastranslat
abilities:Thi
MichaelNo
abilitiesef
ctsamisco
ntofmoney
othtransact
completely
debts,that
isnohidde
s=mathews#
nksbalanc
lluptickint
esorthea
edintoade
scategoryf
onanhassai
fectivelyre
ceptiontha
bytheIrish
ionsinvolvi
circularand
moneyissi
benefitto
774.0.q
sheet,des
heBanksh
ountheldi
clineinOth
llby30bil
dthatrepa
ucingthea
thas
appea
Exchequert
garmsofth
havenone
plytakeno
heIrishstat
ribingit
ldings
r
lion.
ments
ountof
edin
oIBRC
eIrish
costto
utof
efrom
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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
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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
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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
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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.
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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
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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
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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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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
-
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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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References
EuropeanCentralBank(2008).ConvergenceReport.May2008.
EuropeanCentralBank(2011).TheImplementationofMonetaryPolicyintheEuroArea,February
2011.
Sinn,HansWernerandTimoWollmershuser(2011).TargetLoans,CurrentAccountBalances and
CapitalFlows: TheECBsRescueFacility.CESIFOWorkingPaperNumber3500.
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