The effective closure of the Irish economy due to the pandemic generates very difficult problems in economic analysis; Irish policymakers are struggling to respond quickly. The situation is unprecedented, and it is hazardous to speculate about best policy responses. Nonetheless, with that caveat clearly stated, I want to make some informal remarks about the best ways to get adequate lending to Irish SMEs to help them resume normal business, and the role of the Irish banking sector.
The main point that I want to make is that the best approach to SME support might be through bank-mediated lending in tandem with capital replenishment via loan purchases by the government or central bank. The US Fed has already demonstrated that this works, with a very large loan purchase program already showing positive impact [1]. If loan purchases are not feasible, perhaps some other method of providing contingent capital to the banking sector (to encourage lending) could be used.
It is useful to strip the problem back to some basics: there are three possible sources of funding in this context: government expenditure, private bank capital, and monetary financing through the central bank, and two funding types: cash subsidies or loans. There are of course numerous potential mixtures and combinations of these three capital sources and two funding types.
In the USA, the $349 billion Paycheck Protection Loan Plan (PPLP) is being run by the Small Business Administration in collaboration with the commercial banking system (the $349 billion authorization was quickly exhausted; the amount will likely be topped up this week with an additional $250 billion). Ireland quickly implemented a somewhat parallel scheme, the Covid-19 Pandemic Temporary Wage Subsidy Scheme (TWSS). The PPLP and TWSS have similar objectives, but the TWSS is a direct wage payment/subsidy whereas the American PPLP is packaged as bank-mediated lending with a subsidy attached if the SMEs workers are successfully retained.
The direct-subsidy approach of the TWSS provides a fast start but is limited by its expensiveness per euro of impact. TWSS unlike PPLP also fails to take advantage of the well-developed lending and credit monitoring capabilities of the private banking sector. The Strategic Banking Corporation of Ireland Covid-19 Working Capital Loan Scheme uses the private banking sector but is limited in scope [2].
In the case of SME support based on private bank lending rather than subsidies, it is fair to ask why not rely entirely on private bank capital? Again, it is important to strip back to some fundamental issues. One, the capital at risk from emergency SME lending is potentially large in magnitude and very risky. Two, there is a big public interest in this emergency lending taking place quickly and aggressively to get the economy back up and running normally. The risks are large and the potential (public interest) rewards are also large. The restructuring of the Irish economy post-pandemic could be modest, or it could be massive, and the downturn could be brief or prolonged. Generous SME lending is macroeconomically vital, but risky.
In the USA, the central bank (Fed) quickly implemented a $2.3 trillion debt asset purchase plan backed by its monetary resources. The $2.3 trillion authorized amount equates to 10.7% of 2019 GNP. The Fed is putting a huge amount of risk capital into unusually risky debt assets relative to the classes of assets it has previously had in its portfolio. If this program is successful in helping to restart the US economy, the Fed will get its money back and will have served the national interest. If this risky lending goes sour, which could happen, the risk capital is backstopped by $454 billion (19.7% of the capital amount) that the US Treasury has handed over to the Fed as credit insurance for the program. It is a type of contingent monetary financing which makes good sense under the circumstances.
The Fed purchase program will be split between purchases of private sector debt (78% of the total) and state and municipal debt (22%). As one component of the program, the Fed has stepped in to help facilitate the PPLP; it has launched a $350 billion program to buy up PPLP loans from banks, leaving a residual 5% ownership position in the banks. In tandem with the $350 billion purchase authorization for PPLP-linked loans, the Fed has initiated a $600 billion loan purchasing facility called Main Street Lending Program to purchase non-PPLP bank loans of small and medium-sized US firms. Additionally, the Fed has begun corporate bond purchases of up to $850 billion; note that the US corporate bond market rather than bank lending often serves as a lending vehicle for larger US firms (less true in Europe).
In a rough parallel to the Fed program, the ECB has launched the Pandemic Emergency Purchase Program (PEPP) with authorized funding of €750 billion, which equates to 6.3% of 2019 euro-area GDP. The credit criteria differ from previous ECB asset purchases in that Greek non-investment-grade sovereign debt is included, but there are no major changes to the credit criteria for eligible private debt assets.
One difference between the Fed’s debt asset purchase plan and the ECB’s is that the Fed’s approach is mostly about purchasing private debt assets whereas the ECB’s is mostly about purchasing government debt assets. The ECB’s focus (very understandably) is on preventing a sovereign debt crisis in Italy, Greece and/or Spain; purchasing credit-risky private bank assets is not on the agenda.
Unlike US banks, Irish banks cannot rely on any direct capital support for emergency SME lending from their central bank. Could private bank capital in Ireland prove adequate to fund all pandemic emergency SME lending? Just prior to the pandemic Irish banks had healthy capital ratios and very ample liquidity ratios. Nonetheless, it might be better if these unusual debt assets could be moved off the banking sector balance sheet, as is being done in the US by the Fed’s purchase program. This segregates this unusual lending stream from the other lending activities of the Irish banks and allows them to continue normal lending channels for mortgages, automotive finance, new business finance, and SME expansion. Commingling the normal lending portfolios with this unusual emergency lending is potentially damaging to normal bank lending. Also, if private bank risk capital is used for this SME lending, it does not capture all the public interest rewards from this lending in helping to stabilize the economy. There is a “tragedy of the commons” market failure since the economic gains from a successful lending effort by the banks is shared widely across the economy, but the potential losses associated with the program are paid from private bank capital. This could incentivize banks to under-lend relative to what is needed. Something like the US approach seems appropriate in the circumstances.
[1] See “Federal Reserve takes additional actions to provide up to $2.3 trillion in loans to support the economy” Press Release, Board of Governors of the Federal Reserve System, April 9th, 2020, https://www.federalreserve.gov/newsevents/pressreleases/monetary20200409a.htm; “With $2.3 Trillion Injection, Fedʼs Plan Far Exceeds Its 2008 Rescue” New York Times, April 9, 2020, https://nyti.ms/3caFiH1 (behind paywall) and “Fed Rolls Out $2.3 Trillion to Backstop Main Street, Local Governments,” New York Times, April 9, 2020, By Reuters, https://nyti.ms/3c5qPwk (behind paywall).
[2] See “SBCI Covid -19 Scheme,” Strategic Banking Corporation of Ireland, April 20th, 2020. https://sbci.gov.ie/schemes/covid-19-loan-application
2 replies on “Capital Sources for Pandemic Emergency Funding of Irish SMEs: Can Ireland Mimic the US Approach?”
This post is very welcome. I was beginning to think that Irish economists who were not directly involved in the policy-making process, with the honourable and notable exceptions of John McHale and former Governor Honohan, had taken a vow of silence during this pandemic.
I can understand the reluctance to comment on policy in the absence of access to the data and information available to the governing politicians and policy-makers, but there is always a risk that they are too close to the trees (which may be springing up at an alarming rate) to see the wood that’s being populated. External assessments and comments from a base of knowledge and experience should always be welcome – and are actually essential. We still haven’t recovered from, or applied effective remedies to, the baleful impact of official groupthink and of the pandering to the interests of the powerful, wealthy and influential, in the lead-up to, and during the early stages of recovery from, the economy’s most recent near-death experience.
We are woefully unprepared going in this crisis with a severe disjunction between the optical illusion of macroeconomic functionality and severe and fundamental microeconomic dysfunction. It was the baleful effects of this dysfunction and the resulting popular disgust and anger that largely determined the distribution of votes in the last election. And the pandemic is exacerbating, and will exacerbate, the damaging impacts of this dysfunction.
I also suspect that part of the reluctance of economists to weigh in is due to the pace at which previously held, damaging dogma is being overturned and comfortable, convenient and self-serving orthodoxies are being shredded. This post highlights some of the radical policy actions that are being taken and considers how best they may be co-ordinated and applied.
In addition, there is a much increased understanding among the public about how money is actually created, by governments (in collaboration with their central banks) and by banks, when they, respectively, spend and advance credit, and about how it is extracted (and effectively destroyed), respectively, via taxation and the repayment of credit advanced. And any money created by governments in excess of what is extracted via taxation is extracted via public borrowing that creates private wealth. The genie is out of the bottle – and it ain’t gonna go back in. This must be truly frightening for the current crop of governing politicians, policy-makers and central bankers – and for the powerful, wealthy and influential to whom they pander. And this must be much more frightening than the impacts of this pandemic which eventually will pass.
The outcome will be a massive re-orientation of public policy with governments focused on promoting prosperity and productivity, with the fruits distributed equitably, and with a relentless and effective application of all the regulatory and policy instruments available to governments to prevent destabilising imbalances and to maintain economic stability across and within all sectors of the economy – and with the rest of the world. The nasty and ugly mutation of capitalism (misnamed as neoliberalism) that has dominated over the last 40 years will no longer hold sway. The only liberalism involved was the freedom of all sectors (and particularly the powerful and wealthy within these sectors), with the specific exception of governments (who were to be totally constrained), to behave as they please generating destabilising economic imbalances and capturing economic rents at the expense of the majority of citizens who have been deliberately deprived of any effective political, economic or organisational power. That time has truly passed.
I have no wish to be seen to monopolise the comment space here, but it’s impossible to comment on any specific policy initiative in response to this crisis without providing some context – which I have attempted to do in my previous comment.
Almost all governments, both individually and collectively, were woefully unprepared for the onset of this pandemic. Once the transmission exceeded the ability of the “test, track and isolate” strategy that has previously worked for SARS, MERS and Ebola, the only option was an almost total lock-down to suppress the pace of transmission. Some countries have been able to ramp-up the capacity to “test, track and isolate” and to combine this with less severe lock-downs (or with very limited constraints on general activity) – South Korea is the leading example, but most governments, having been slow out of the blocks, really had no option but to impose lock-downs.
And because government had left themselves so exposed and so unprepared, it is their primary responsibility to address the economic and social consequences of the lock-downs they have been forced to impose. So governments should spend, and spend without limit, to ramp up the capacity to suppress this virus and to compensate for the economic impacts. In the short-term this will lead to the bailing-out of businesses that were swimming naked before the tide went out, but there will be time for a reckoning. So in this instance, there is little point expecting the rapacious banks to serve the immediate public interest. Governments simply have to be the lenders of last resort for any credit advances they make to business – in the same way as central banks have committed to be lenders of last resort to governments.
This leaves the much more difficult issue of exiting lock-downs. “For everything there is a season…a time to be born and a time to die”. A large number of deaths each year occurs close to the point when, for each person involved, it is time to die. All other deaths are early deaths. And Covid-19 has dramatically increased the number of early deaths. The cost and efficacy of medical interventions is generally assessed against a measure of the Quality of Life Years (QALYS) expected. In this instance, in addition to the direct medical costs incurred in dealing with those seriously affected, we have to add the social and economic costs of the lock-down and see how this stacks up in relation to the projected number of QALYS.
It is a brutal calculation, and I certainly don’t envy those who will have to make it. But it will have to be made and we will have to be clear-eyed about it.