In the wake of the referendum result and speculation of the ESM directly injecting capital into Spanish banks, there is a lot of discussion about the possibility of Ireland “getting a better deal on its bank debt”. It would help if people were more explicit about what they had in mind. I would not be surprised that many in the public believe that it means there would be retrospective collective European absorption of already crystallised losses in the Irish banking system. Although I would love to be wrong, I believe that the odds of this happening are approaching zero. Failure to deliver such absorption would increase the sense of grievance on Ireland’s treatment in relation to the bank and bondholder/depositor rescues. Some might argue that a sense of grievance is useful in strengthening Ireland’s bargaining position. I doubt it; and any benefits are unlikely to outweigh the costs in reduced domestic support for Ireland’s necessary adjustment efforts.
It is worthwhile to consider what an extension of the ESM’s role could realistically mean for Ireland. I consider some possibilities below. I would be interested in people’s views.
First, if additional capital injections are needed, Ireland would have a strong case for these injections coming via the ESM. However, this would not be a direct transfer, but a capital injection in return for a fair stake in the bank. The advantage would be that it would reduce the uncertainty around the value of balance sheet of the State relative to State making such injections.
Second, it is possible that the ESM could take over some or all of the State’s existing ownership stakes in the banks. Again, I think it would be unrealistic to expect the ESM to pay more than fair value. The advantage would again be reduced uncertainty over the value of the State’s balance sheet. But it is again important to recognise that this would be of considerably less value than any absorption of already crystallised losses.
Third, the fact that Ireland’s bank-rescue efforts preceded any development of the ESM as a mechanism for recapitalising banks could help Ireland get more traction on the extending the repayment schedule for the promissory notes/ELA. (It does seem unfair to be disadvantaged for faster recognition of the reality of bank losses.)
In considering the likelihood of a deal on the promissory notes, it is worthwhile to recognise the reason for the ECB’s strong opposition. The provision of ELA to IBRC effectively amounts to temporary monetary financing of a government. The euro system has allowed the Irish central bank to print money to temporarily finance IBRC, but on the understanding that the funds will be repaid by the Irish State, and the money creation eventually reversed. A monetary union could not survive with individual countries printing money on a permanent basis, as it amounts to a transfer to the country printing the money from other countries in the system. We would and should be firmly opposed to other countries engaging in such a practice. The ECB is therefore extremely uncomfortable with even temporary money creation. Extending the ELA beyond the agreed schedule has, so far, been a bridge too far. The question is whether the advantages of facilitating Ireland’s return to market creditworthiness by reducing medium-term funding needs means that they are willing to hold their noses a bit tighter and allow a longer repayment schedule. I think there is a strong case to be made for such extended repayment schedule, but we should not be surprised that it has been so difficult.
Fourth, an alternative to extending the maturity is for ESM to make long-term loans to the State to allow it to redeem the promissory notes. The ECB would certainly be happy with this arrangement. However, the benefits in terms in terms of longer maturity would have to be weighed against the higher interest rate, recognising the ultimate interest cost to the State from the promissory notes/ELA arrangement is very low. We would have to see the details to assess whether this would be a good deal.