John McHale on the Irish Banks

Today’s Irish Times carries an extensive essay by John McHale on the Irish banks: you can read it here.

39 replies on “John McHale on the Irish Banks”

Excellent article by John McHale but I think this is looking at the capital adequacy tests in an odd way.

“The stress tests done by the Central Bank combined with capital-raising efforts suggest that both AIB and Bank of Ireland – where the bulk of the outstanding bonds lie – are likely to pass basic capital adequacy tests.”

I don’t think it is correct to look at the banks post recapitalization by the state to determine if they would pass basic capital adequacy test.

AIB has already received €3bn in state capital and requires an additional €7bn+ in order to remain solvent. IMO the bank would be insolvent without government aid, therefore it is right to say that creditors should not receive 100% of their money back.

Yes. Keep the pressure up on the present – bail em all out an screw the serfs present and future – craven capitulating strategy.

Bank Bonds entail Risk: ergo, negotiate.


“The limitation of this approach is that banks would have to fall below some critical capital adequacy threshold before triggering the resolution tools. ”

Can you be more specific about this John? What is this threshold in your view? On what basis do we determine what the threshold should be? Are the Swiss not shooting for a very high ratio: 16% I read somewhere? The world is a risky place. One could surely justify setting the threshold sufficiently high that this would not be a constraint. After all, the state would be setting up the SRR and would one assumes get to define the critical parameters.

And this is altogether aside from the issues raised by DE, which are perhaps (?: I am not a lawyer) more ethical than legal, but which are obviously hugely important.

I would frame the issue not in terms of a binary choice: we are solvent or not. I would frame it in terms of probabilities: the world is going to remain a very risky place. A bad shock — a world double dip, for example, or serious European turbulence, or contagion from Greece or elsewhere — could yet sink us. So could a worse than expected domestic growth performance — remember, what matters is aggregate, not per capita, and nominal, not real. No sense in weighting down the ship of state as she sails through turbulent waters any more than necessary.

Good article and more importantly its keeping the pressure on. I for one would like to like to see an article on a SRR every Saturday until September. Or until I see a Supplement on it… ‘The SRR, what it means for you’.. BTW where are the opposition on this?

@ DE: “Excellent article by John McHale ??” Informative but … …!

Last (longish) sentence of para 3: ” … to bear fiscal pain.” Pain? By whom?, on whom? I get a tad vexed when I read this sort of stuff. It is real human beings that are going to bear the cost (poverty, loss of home and savings) as a consequence of the reckless behaviour of others -not banks, but those persons in the employ of said banks, those in positions of authority. Might we see a -50% reduction in senior salaries all round? No? Why not?

The prior part of that sentence says it all. You can have your ‘recovery’ – whatever that means in Spinspeak – provided you have … … Well, Prof Mc Hale we ain’t gonna get them thingamagigs – not anytime soon anyway, so ta-ra ‘recovery’.

Bye the bye. What does ‘growth’ consist of? Just curious. It is a term that I notice is used frequently, yet no one seems to actually understand what it means – the reality that is. At what point does physical ‘growth’ become impossible?

B Peter

Borrowing means that we have used up the growth of the future, by bringing it into our “now”.

When we no longer borrow, there is no growth. All the fol de rol “industries” fail. FIRE drops to maybe 20% of peak. We must then do without the growth and AND repay the debt! As always, this happens according to KNOWN ECONOMIC principles.

By being clever, those who engineered this have left it that all the savings, for pensions, homes and the like, are actually the debt! Fail to repay it and then people have no savings.

Except that occasionally, hot money of the obscenely rich and stupid, who have no more awareness than the man on the Ballyfermot omnibus, is the debt. They deserve to lose it. This is no legal dilemma. This is deciding who is best placed to bear the loss.

I agree that Ireland is not insolvent. Yet. More delay and it may end up that way. Does John McHale make it clear that he is on his knees for low interest rates? Even Eoin knows they are now very high, given deflation. How does the author deal with that? Exponential debt growth is the solution? To what problem?

That article clarifies Morgan Kelly’s article. As a pair, they frame the debate well. It is worth repeating that Morgan Kelly did not advocate default on the Guarantee (and nor has any other academic commentator as far as I am aware).

Personally, I think we may well have resolution in time for the expiry of the Guarantee. I also think we have a good chance of making it to that point without a bank run. If we achieve that then we will probably achieve a limited exit from the Guarantee.

As John McHale says, €7bn may not be what we were hoping for but it is well worth pursuing. Also, limited default by banks on their unguaranteed debts must surely help the sovereign’s credibility.

Ireland is fundamentally solvent, says John McHale, and an essential ingredient of solvency is low interest rates; but the danger is that the markets will demand rates of interest higher than this and thus render the state insolvent.
This argument is circular unless there is an empirical and conceptual distinction between fundamental interest rates and those set by the market; but since the 1870s in neoclassical economics there is no such distinction between fundamental value and market price.

Thank you for all the comments. Just a couple of immediate reactions:

My language is too vague referring to “basic capital adequacy. However, I do believe that special resolution authority should be used with great care and in only in extreme circumstances. These powers give the government substantial power to alter property rights. When I refer to “basic capital adequacy,” I do not mean the regulator’s target capital adequacy, such as the 7 percent target for equity capital. I mean the capital adequacy that would actually trigger resolution. In the US, the FDIC only exercises its resolution authority when an insured bank becomes “critically undercapitalised.” If you will forgive an extract from Wikipedia (link at end; also link to actual FDIC regulations):

“To receive this benefit [insurance], member banks must follow certain liquidity and reserve requirements. Banks are classified in five groups according to their risk-based capital ratio:
• Well capitalized: 10% or higher
• Adequately capitalized: 8% or higher
• Undercapitalized: less than 8%
• Significantly undercapitalized: less than 6%
• Critically undercapitalized: less than 2%
When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent and can take over management of the bank.”

@Dreaded_Estate & Kevin

It is possible that I am too trusting of the stress tests done by the CB. I know Karl has doubts that the “tests” are conservative enough. But when Patrick Honohan oversees the tests and comes out with the assessment below I have been inclined to believe to believe that capital ratios would fall low enough to trigger a resolution regime if it were in place. I hope that others will weigh in on this important point.

“Over the previous few months, we at the Central Bank have been making a careful assessment of the likely bank loan-losses that are in prospect over the next few years. This is over and above the valuation work being carried out by NAMA, and which gives us a good fix on the likely recoverable value of the larger property loans. We have been working on the non-NAMA loans and figuring out their likely performance as they suffer from the impact of the overall economic downturn – part of it of course attributable to the global crisis, and not just to the bursting of our own bubble. This exercise involved working with the banks, but challenging their estimates of loan-loss based on our own more realistic – some may say pessimistic – credit analysis. (I am over-simplifying the exercise, as it also looked at other elements of the profit and loss account over the coming years). The conclusions of this exercise are worth emphasizing.

To my relief, and slight surprise, it turns out that most of the banks started the boom with such a comfortable cushion of shareholders’ funds that they would be able to repay their debts on the basis of their own resources. This includes the two big banks. It is because of this fact – that their shareholders’ funds will remain positive through the cycle – that one of them, Bank of Ireland, has already been able to tap the private market for an additional equity injection. Of course they do need additional capital to move forward, but, as has happened in the US and elsewhere, the Government’s capital injections of last year into these two institutions looks like being well-remunerated.”

Is the statement that shareholders funds of the banks will remain positive throughout the cycle disingenuous ? Firstly, how long is the cycle and, secondly, is this based on the assumption that the taxpayer will continue to shovel massive amounts of cash into the banks. As DE pointed out, measuring capital adequacy post recapitalization is a curious way of approaching this matter.
As things stand the banks can continue to avail of State guarantees to roll over bonds for the next five years. Without this facility they would be insolvent regardless of capital adequacy measurements. It would appear that the new guarantee scheme will keep the taxpayer on the hook for a long time past September.

@podubhlain and DE

I take your points about solvency depending on capital injections/guarantees. As a practical matter, however, once given, I don’t see how decisions about bankruptcy (or alternative resolution mechanisms) could be made as if these interventions had not taken place. Don’t governments need to protect their ability to make credibe promises?

Good article however I think losses are going to increase to 80% GNP (I think we are all agreed we should be talking about GNP and not GDP when Ireland and manageable are used in the next sentence) when you factor in NAMA and the developing personal debt crisis. When interest rates hit 5% + and you have to factor in the “short term” deficit of 10% plus this in not “manageable” in any sense of the word.

We also have a very short window of opportunity to negotiate with the bondholders and the current administration has made it very clear that they are going to give the bondholders as much government paper as they can print to meet all “liabilities” making future default inevitable. Witness EBS.

The government having discovered (or created!) the errant cousin whose huge gambling debts have caused a crisis have responded by printing IOUs and for the first time in a generation bringing the very solvency of the state into question.


The fundamental solvency condition boils down to asking if no default / no risk premium (i.e. no expectation of default) is an equilbirum. Of course, this could be an equilibrium and default / high risk premium (i.e. high expectation of default) is an equilibrium as well. The high interest rate is what eventually forces the default. The bottom line is that fundamental solvency is not enough. One the policy challenges is then to prevent markets co-ordinating on the bad — i.e. default — equilibrium. In the current volatile markets, it is not hard to imagine a shift to a bad equilibrium coming about. That is why policy measures such as the international stabilisation fund at the country level and the ability to guarantee bank debt at the national level are so important.

While I can see that my piece today is likely to be read as being more sanguine about the getting into funding difficulties than Morgan’s, I hope it comes through that I am very concerned about a bad equilibrium taking hold. That is why I put so much emphasis the importance of protecting the credibiliy of state promises.

@ jules

‘The government having discovered (or created!) the errant cousin whose huge gambling debts have caused a crisis have responded by printing IOUs and for the first time in a generation bringing the very solvency of the state into question’

Exactly. Nothing could more clearly illustrate the fact that our history is so very different from our European neighbours. They are centre and we are periphery. The local Powers that Be have chosen to protect the assets of their various clans clan by sacrificing our state. Sleepwalking.

Leaving aside the issue of the banks only being well capitalised (in shareholder funds sense) because the state is bunging in more cash, I have a concern that the stress test is not stressful enough. Given we can expect in an average property crash losses to peak about 12% of bank assets, where there is a banking crisis too, a bit higher than that, we seem to be stressing our above average crisis to only average levels?

So at 440 bn in assets, 12% would be about 50 bn in losses. The banks need to be left capitalised at the end of all this, so we can’t actually count existing equity (it will have to be made up). As the banks had almost no loss reserves coming into the crisis, all losses will require recapitalisation in the absence of resolution. No?

Lake Woebegone, eat your heart out!

John McHale’s op-ed piece is an excellent contribution to this debate, but is it all not somewhat too little and too late? Ireland went into orbit with the blanket guarantee and it seems that the competent EU institutions have being doing their best to get it back closer to terra firma. But there is precious little evidence that the DoF has moved on very much from its initial shock and denial at the debacle it had overseen. Perhaps it is due to a lack of capacity as Zhou has frequently suggested. But it may also be due to the extent to which the real decisions are being being made in Brussels and Frankfurt. However, perhaps more important is the fact that we have a Government that is clinging by its finger nails to the last remaining shreds of constitutional legitimacy and the longer it delays in moving the by-election writs the more its grip is failing. The Government lacks the moral authority and popular mandate to take the steps, particularly in relation to bank resolution, that are required. This is “flying by the seat of the pants” governance to retain a factional grip on power that is to the detriment of the public interest.

However, all this is rapidly becoming a petty little side-show and the finite resources that may be deployed at the EU level to help get the silly Paddies out of the mire now have a much more serious call on their attention. The entire EU project is at risk.

The hard-headed scepticism of bond investors is being pitched against the nebulous EU ideals of competiiton, co-operation and solidarity. These might have some substance if the EU elite had made an effort to bring thier voters with them, but, for the last 20 years, the project has been pursued by the Council and Commission in a way that by-passed national parliaments. The European Parliament has proved an inadequate substitute.

The chickens are now coming home to roost and it would be a brave person who would pronounce confidently on the outcome.

I agree a good article but a couple of contradictions, I think. He says it was a mistake to extend the guarantee to all bonds. The guarantee was to all comitments over the next 2 years. Very little would have been gained by leaving long bonds out as to default on the coupons on these (that’s all we were guaranteeing) would have meant liquidation anyway.

Surely this bank resolution thing requires legislation and cannot be retrospective. Senior bondholders got +20bp for their “risks”. If there was any prospect that they could be discriminated against v depositors they would have needed 400bp at least. They were providers of funds not capital.

@ Pat

From your link

‘Mr Daly (NAMA) said that due diligence by his staff had discovered remarkable flaws in the legal agreements that developers had signed to secure their loans. He said that “much of this lending was carried out in haste and inadequately secured and documented”, making it difficult to pursue developers for the personal guarantees that many had offered to secure their loans’

Goodness me. Must have been the champagne.

@Brian Woods
I could be wrong, and John can correct me if I am, but I think the point is that extending the guarantee to existing bonds was never needed. By all means guarantee the issue of new bonds.
But what did the guarantee of existing bonds achieve? They could never have been a run of any sort. It was over kill

“Surely this bank resolution thing requires legislation and cannot be retrospective. Senior bondholders got +20bp for their “risks”. If there was any prospect that they could be discriminated against v depositors they would have needed 400bp at least. They were providers of funds not capital.”

Eoin keeps repeating this line of defense as well and I think it is complete rubbish.

Firstly, the notion that ANY investment should be risk free is completely bogus. Capital isn’t risk free and neither is funding!

Secondly, one of the major causes of the current crisis was the mis-pricing of risk. Risk was under priced everywhere including Irish bank senior bonds.
Before the crisis Greek bonds was 25bps over German bonds. Would you consider these risk free now?

I think saying that senior bondholders only demanded 20bps over therefore they assumed the bonds were risk free therefore they should be bailed out is a circular argument.
The fact is that investors in corporate credit all over the world under priced the risk. Should they all be bailed out because they assumed that they were taking on far less risk than they thought?
How much was demanded for B rated bonds, how much was demanded for junk bonds? How much is demanded now?

The investors got it wrong in demanding only 20bps but I can’t see how their fundamental mistakes should be paid for by the state.

@DE I am going to address your points in two posts.

Absolutely nothing was to be gained by leaving some bonds out of the guarantee. People forget the guarantee was only for TWO years. To argue that we should have left out some bonds is to argue that by now we could have defaulted on these but that would mean liquidation, exactly what we are trying to avoid. the two years are almost up and we need to make a call again. Maybe someday liquidation of the banks will be the least worse scenario. If Kelly’s armageddon looks like unfolding we will have plenty of time to swallow the poison pill of natonal default – far too early for that yet.

I am asking can a bank resolution scheme be credibly applied retrospectively? Is there any precedent? For sure, if we can torch bondholders and avoid liquidation, go for it. I am citing as circumstantial evidence that it is not so simple the fact that if it were the risk would have been priced much greater than 20bp. But that’s only circumstantial evidence. Can anyone answer the straight question: can we credibly (by international precedent) retrospectively change the rules of the game so that bondholders do not after all have the depositors as hostages as they thought was the case when they provided the funds?

@Brian Woods II
Bondholders have legal right to receive the same as depositors in the even of a wind up. They do not have and never had a legal right to hold depositors hostage IMO.

A bank resolution regime simply allows greater controls the liquidation process and allows the bank to continue to operate as normal during that process under control of the state or regulator.
I see nothing that changes the legal claim the senior bondholders have over the assets of the bank.

I am sorry but the liquidation of the banks is not the same as national default. It is the default of a private company. And it we wait until Kelly’s prediction is becoming likely then it will be far too late. Better to cut the banks lose now IMO.


To allow the banks liquidate under existing rules would be seen, as you say, as a private company default and not an act of national default, I agree.

But not even Kelly is asking for that. What seems to be being suggested is that the government should change the rules of the game retrospectively so that bondholders are placed in a much weaker position than under existing legislation and so that they will be forced un their knees into negotiating a debt equity swap. That to me is a national default or national breach of faith. The suggestion that we could just shrug our shoulders and say that’s a private company matter when we had changed the law to facilitate a certan outcome is disingenuous in the extreme.

@Brian Woods
IMO bondholders are legally entitled to get equal proceeds from the value of the banks assets that is it. And a banking resolution doesn’t change their legal entitlement.

They aren’t entitled to have a defacto veto over reform of bankruptcy laws within the state.


Okay, that sounds logical. Problem is the official line is that AIB/BOI are solvent, merely short of a capital cushion, so no immediate scope to torch bondholders or force them into a debt equity swap.

I suppose the bondholders couldn’t complain if any extra state capital in some way ranked above them at any future liquidation. It would be a funny instrument, equity as a going concern but ahead of bondholders on a winding up.

I think what DE is saying is that “after liquidation” , not “at liquidation” the government can treat depositors or anybody else as they please. They must conform to the rules at liquidation. At least that is the impression I get from discussions here and on other threads.

@ AMcG
I don’t think that is what DE is saying. Under that arrangement the deposit guarantee falls to the taxpayer. What DE and Kelly et al are suggesting, I think, is to change the bankruptcy rules for banks so that depositors rank ahead of bondholders in a liquidation. In that way the deposit guarantee would be borne by the bondholders and not the taxpayer in a liquidation.

Faced with such a dramatic shift in the ground rules the bondholders would accept a debt for equity swap. The point being that the threat of liquidation then becomes very real and not the kamakazi bluff which it is under current rules, thus severely weakening the bondholders’ negotiating position.

@Brian Woods
Aidan is correct Brian, I am not suggesting that we change the rules so that depositors rank ahead of bondholders. I can’t speak for Kelly but I don’t think that is what he is suggesting either.

Banking resolution simply allows a bank to be liquidated in an orderly manner. Ideally the bank would continue to operate 100% normally while assets would be sold in an orderly manner. Bondholders and depositors would get exactly the same proceeds from the sale of those assets.

The key point is that depositors would have a guarantee from the state for 100% of their money, bondholders would have nothing from the state.

This isn’t changing the rules the bondholders signed up to it is just giving extra protection to depositors and as I have always said the state is free to guarantee anyone or no one after liquidation.


That is abundantly clear and sorry for the misinterpretation of your position.

But…I see this as an awful option for the taxpayer. It immediately precipitates the deposit guarantee, which so far has cost nothing and with a following wind never will cost anything.

Sorry about 2 posts, hit return before I meant to.

The guarantee has not been zero cost Brian. Everything € we put into Anglo & INBS is an indirect result of having to prevent those banks from becoming insolvent and triggering the guarantee.

The banks have a multiplier of less than one ie for every billion pumped in, the lending and wages etc, are less than 1 billion ……. Is that so?
How much longer will that be the case?

To fix the deficit, we need taxes. Taxes are not always deflationary, discuss! By spending them, the masters of out universe will be combatting the deflationary effect of their cuts? Those who choose to pay taxes, would only have saved the money, sabotaging the consumer economy we all love.
This way the people that the voters most trust get to decide who gets their paws on it first! Reflationary or what?

Once we fix the deficit, we can then pay into the banks cos they were so good to us before, helping everyone to buy expensive housing.

@ PD: Hi, Pat. “… the Ballyfermot Omnibus.” That would be steam or horse drawn?

Your mention of Econ 101 Principles rings a sour note. Not a single commentator has ever raised the issue of the totally daft economical (sic) ideas enclosed within the minds of these contributors. You cannot expect continuous exponential growth in a finite system – yet this is what they appear to believe in. If I’m wrong, please correct.

Growth: This is the Chief God – Easter Island type, you inderstand. Its like a creature emerging from a foggy, methane-ridden swamp. Until this is faced up to, no solutions can be found that will have any chance of dealing with the massive debt that the FIRE has given birth to – or should that be hatched from egg?

Most of the commentaries in this thread are interesting, in so far as they clarify some finance and banking issues about debt, solvency, bonds etc. But not a single commentator seems to have any grasp of the calamitous situation that is slowly emerging. They, (inc. myself) shall be forced to purchase our necessaries on a dimished income! Worse, energy costs and any oil-based manufactured good will slowly increment in price. (Its actually occurring but the effect is being masked by economic downturn). So the Great God of Growth will sink back into its swamp. What’s the replacement Rapanui then?

Would some of ye, please, try to explain to me what ye believe will ‘grow’ to such an extent that we will be able to emerge from this mess. Thanks.

Brian P

These powers give the government substantial power to alter property rights.

Especially, it would seem, if they include the power to alter the standing of different groups of already-existing creditors. If the plan is to soak all the subordinated bonds in (say) AIB, and only the subordinated bonds, and it so happens that all AIB’s subordinated bonds have a long maturity, then maybe it’s possible to execute the plan without re-ordering the creditors (and without burning any creditors holding short-term debt). In any other case where the SRR shelters all short-term debt – especially, but not only, any case where some unsubordinated bonds are impaired but some subordinated bonds are not – this would seem (IANAL) to be an expropriation.

From a moral point of view, this would actually in some ways be more odious than subjecting government bondholders to a haircut or repudiating the bank guarantee in June in order to liquidate AIB. From the point of view of enlightened self-interest, the reordering would be to the immediate benefit of Irish government bondholders and (especially) the holders of short-term Irish bank debt, and it would signal to them the Government’s intention to keep them happy at present; however the reordering would also signal to them the Government’s willingness to break the rules when upholding those rules is no longer to its benefit. So a scheme involving an SRR that re-orders the creditors (as distinct from an SRR which does not) seems to defeat Prof. McHale’s intended objective of maintaining the reputation of the sovereign.

One way around this problem would be to have a straightforward insolvency or a special resolution process that doesn’t reorder the creditors, but for the Government to give the short-term bondholders compensation for their losses, in a like manner to deposit insurance. But that has several problems of its own.

From a moral point of view, this would actually in some ways be more odious than subjecting government bondholders to a haircut or repudiating the bank guarantee in June in order to liquidate AIB.

And of course Morgan Kelly proposed neither course of action, but instead one – allowing the bank guarantee to lapse in September – that involves no government default at all.

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