Lenihan on the ECB and the Guarantee
This post was written by Karl Whelan
In my earlier post on the government’s criticisms of the IMF, I left out what was probably the most interesting argument because it raised a number of other issues.
Speaking on This Week on Sunday, the Minister for Finance criticised the IMF’s assessment of the cost of the liability guarantee on the grounds that the guarantee would not be called on. I’ve already noted that this is a somewhat spurious way to look at the cost of the guarantee. However, what was particularly odd about the Minister’s comments was his particular explanation of why the guarantee would not be called upon.
About four minutes in, the Minister said the following:
We don’t accept their estimate because, like many commentators from the US and American world, they do not take into account our Euro membership. Those kind of figures can be made available to us and are being made available to us through the European Central Bank system. It’s based on a presumption that the state guarantee will be called in and that the guarantee on deposits will have to be funded by the taxpayer. And the President of the European Central Bank, Mr Trichet, has made it clear that the European Central Bank will not permit any bank in the eurozone to fail. That has been spelt out very very clearly.
These comments appear to confuse the issues of bank solvency and liquidity. As described in a speech by M. Trichet on Monday, the ECB has extended its already-broad definition of eligible collateral for obtaining funds from the ECB, switched from rationed auctions to unrationed fixed rates for its refinancing operations, and provided more and longer-maturity financing than before (see here.)
As Trichet put it on Monday:
We have been determining the lending rate – at a very low level – and we stand ready to fill any shortage of liquidity that might occur at that interest rate for maturities of up to six months. This means that we currently act as a surrogate for the market in terms of both liquidity allocation and price-setting.
The ECB’s policies deal with problems banks may have in getting short-term liquidity, provided they have enough eligible collateral (which, for instance, Anglo did not have on September 29). This is in no way a commitment by the ECB to bail out insolvent banks.
If a bank has sustained substantial losses and thus becomes insolvent, the ECB will not move in to help. Instead, regulators need to move in to shut it down or ensure that some outside investor provides new equity capital. The ECB’s policies would not in any way prevent the Irish government from having to provide funds to re-capitalise insolvent banks so that the guarantee is not called on.
At this well-advanced stage of the banking crisis, I find the continuing confusion between liquidity and solvency to be disturbing.