Lenihan on the ECB and the Guarantee

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.

14 replies on “Lenihan on the ECB and the Guarantee”

Ever thought of spin doctoring – many sense a growing bunker mentality setting in. Anyone any idea yet of how the new DGS will be funded?

Lenihan has been making statements like that for a while which suggests that it is a line being allowed by the ECB, perhaps viewed as a form of cheap talk. But part of the confusion seems to be that the ECB does accept very broad collateral in liquidity operations, including subordinated bank debt.

The ECB line is an interesting one. Lenihan seems to be correct that the ECB is providing plenty of liquidity to the market. Due to the Irish guarantee of sub-ordinated debt, as Frank points out above, the amount of liquidity available to the banks should be sufficient.

But, as Karl Whelan points out in his post, liquidity is not the problem, solvency is.

The banks are able to recycle their debts because of the liquidity provided, but if a time comes where the have to actually pay down their debts then the government will see whether the guarantee will be called upon or not.

Gee, guys, if you keep pointing out that de emperor, he got no clothes on, dey is going to have to raise de confusion again, see!

It is called a con trick ‘cos you need confidence……

Remember, it is only other people’s money…..

Look at the Eurointelligence headline for this – “The Irish expect to be bailed out.” Now that’s more disturbing than some bluster or incoherence from the Minister!

But is it that he is deliberately misrepresenting this, he made a mistake when caught on the hop or he doesn’t understand?

And given that most Irish people have a pretty reasonable understanding now of the difference, after many months of bank crisis, is he behind the curve? Surely such a [mistake?] should not have been made by anyone with even a passing interest in what is happening to our banks?

Not sure, Karl, if you picked up the posts by Ahura Mazda and John Looby in the thread you initiated on Sarah Carey’s piece on nationalisation, but they plausibly develop observations in some of the posts above. The major Eurozone players and the ECB don’t want the IMF near a Eurozone member – although they are happy for the IMF to pick up the tab in Hungary and Poland. What is at stake for them is not the solvency of Irish banks, but the solvency of the Irish state as a Eurozone member. They seem happy to finance Irish banks’ purchases of Government bonds as a means of achieving this. The banks will be kept on life support as a conduit for this transfer and in the hope that they will eventually limp towards some measure of solvency. Despite the relative seriousness of Ireland’s fiscal and economic situation, given Ireland’s low absolute impact on the Eurozone (using a variety of economic, financial or demographic measures), it is possible that the ECB will be happy to continue this support until, in Micawberish fashion, “something turns up”.

Minister Lenihan’s insouciance may be well-founded, even if he, unsurprisingly, is being economical in revealing why.

To “the banks will be kept on life support”, I should have added “and at arm’s length – ergo NO nationalisation”.


I’d speculate that liquidity facilities can postpone losses in certain circumstances. Consider the Schrödinger’s cat of loan products, interest roll-up loans. By assuming the loan is not dead, you capitalize the interest and take advantage of the liquidity facility. Although this increases the eventual loss severity, it delays insolvency. And if you can delay indefinitely, then in a very twisted way, Mr Lenihan is correct.

It’s difficult to get any information of the quantity of interest roll-up loans and the amount of accrued interest. The pages published from the PWC report seem to confirm their existence, but that’s about all. As far as I’m concerned, these loans are the smoking turds of the Irish banking system. I suspect (but can’t prove) that accrued interest on roll-ups was run through as Interest Income earned on annual reports. In effect, declaring profit on non-performing loans. As an example Anglo’s 2008 Consolidated Income Statement shows ” Interest and similar income” = €6,324m. Is this amount actual interest payments received or does it include accrued on roll-ups? And if so, how much?

Another aspect of these loans is what valuation the banks are using for their LTVs. This is particularly relevant with NAMA lurking. In order to maintain nice looking LTVs, whilst throughout the duration of the loan the L is getting bigger, it must be tempting to use a large V. One which doesn’t necessarily equate to purchase price.


You’re inferring a good deal more than I suggested in my post. Then again, this is the internet so feel free 😉


I have no wish to implicate you further than you are comfortable with, but you got the ball rolling with your comment on Government bonds being repo’d from the ECB via the banks. That encouraged John Looby’s subsequent expansion of this idea and the penny (or Euro cent) finally dropped for me. I was aware of this channel, but took it at face value as a liquidity booster. The idea is devastating in its simplicity. The Government borrows money indirectly from the ECB via Irish banks; the ECB keeps rolling over the short-term advances to the banks; the Government can use some of the funds borrowed indirectly from the ECB to finance equity injections in the banks as required.

Lenihan seems to be fundamentally misunderstand the nature of the guarantee we have given. He believes the guarantee will only be used if the banks go default but in reality we have guaranteed any gap that arises between the assets and liabilities regardless of what happens to the banks.

Comments are closed.