Ireland’s Credit Guarantee Scheme for COVID-19 SME Lending

The government has announced a loan guarantee scheme for bank lending to Irish SME’s to help them emerge from the economic shutdown associated with the pandemic. The proposed program provides a lending bank with a guarantee giving 80% pari passu (proportional sharing) loan loss protection for eligible loans to Irish SMEs impacted by the pandemic shutdown. There is also a portfolio cap on the guarantee so that each bank can only claim 80% loss coverage on 50% of its covered loan portfolio.  This effectively shrinks the “tail risk” coverage (if the bank’s SME loan portfolio performs disastrously) to 40%. The guarantee is offset by a 50 basis point fee payable to the government. The budgeted €2 billion loan guarantee program equates to 0.58% of 2019 GDP. Policymakers still have a few weeks to best calibrate the program for maximum effectiveness before a prospective Dáil majority coalition passes the enabling legislation. Given the calamitous economic impact of the pandemic shutdown there is no guaranteed best strategy.

It is useful to compare the proposed Irish program with some of the existing programs. Spain has already opened a €100 billion 70-80% pari passu guarantee program; the budgeted magnitude equates to 8.02% of 2019 Spanish GDP. The French €300 billion loan guarantee program equates to 12.4% of French 2019 GDP. It has 90% pari passu loan coverage for lending to firms with 2019 revenues of €1.5 billion or less; 70-80% pari passu for larger firms. Most generous in the EU is the program of Germany, which has announced a loan guarantee program of €500 billion + which corresponds to 14.6% of 2019 GDP. The “plus sign” here denotes that the German government has explicitly committed to increasing the loan guarantee budget to however much above €500 billion is needed. It is not clear whether such an increase is pre-approved by the EU Commission or alternatively whether an increase will require subsequent vetting. The EU amended state aid rules require “the aid is granted on the basis of a scheme with an estimated budget” so it is ambiguous whether the German government can formally make this unlimited commitment within these newly amended rules. The German program pari passu loss coverage ranges from 100% for the smallest firms down to 80% for the largest eligible (the program covers both SMEs and larger firms, but the very largest German corporations are dealt with separately). The German program also offers fast-track approval and dispersal of funds for smaller loan amounts.

The UK is no longer bound by EU strictures regarding state aid rules and monetary financing rules and this flexibility is reflected in its SME lending aid programs. For small loans the UK government offers 100% loss coverage; 80% for larger loans, with no fee for the guarantee. For small firms (less than £41 million 2019 revenues) the government will pay the first six months of loan interest in addition to providing the guarantee, so the implicit “insurance fee” for the guarantee is negative. The small-loan Bounce Back Loan program has had a fast and successful start, whereas the Coronavirus Business Interruption Loan Scheme (larger loan amounts) which requires more vetting and paperwork has had less quick take-up. The UK budgeted amount for its loan guarantee programs is not fixed beforehand. The UK plan originally had a portfolio cap (as in the proposed Irish plan) but they have dropped it.  The very successful joint programs of the US Fed / US Treasury involve 95% outright loan purchases (equivalent to 95% pari passu loss coverage) with no fee payable. One of the two US schemes (the Paycheck Protection Loan Plan, see my earlier blog entry) has a large subsidy component since the loan amount due is partly or entirely forgiven if the loan proceeds are spent on retaining staff that otherwise would have been made redundant. Unlike the US or UK, Ireland has the prospect of a eurozone sovereign debt crisis looming in the background, shrinking the available fiscal space for bold giveaway programs to save jobs. Ireland also must navigate through the state-aid restrictions of the EU Commission.

The economic rationale for these loan guarantees is fundamental and needs to be understood clearly. To encourage a quick macroeconomic recovery, countries need their banking sectors to engage in this lending which, in the absence of a loan guarantee, is not in their financial interest. Sector risks are substantial in this new SME lending since no one knows for sure which currently impacted sectors will remain closed or deeply troubled. For example, there will be likely be considerable SME lending demand from Irish hotels. Should banks be willing to lend to hotels in Ireland, to allow them to reopen? In the absence of a government-funded loan guarantee, the correct answer is no. Commercial banks earn their value by “being boring,” that is lending to low-risk activities, with unsystematic risks which diversify across individual businesses and sectors, resulting in a modest and predictable realised default rate. In exchange the banks earn a relatively small but dependable interest margin over funding costs. The very uncertain prospects for SME lending outcomes in the post-pandemic period, with large systematic sector risks, are too exciting to be a sensible activity for commercial banks in the absence of a government loan guarantee.

The SME loan guarantee programs of EU countries include a 20-100 basis point loan guarantee fee paid to the national government so that each program can be ruled to not violate the EU rules against individual member state aid to industry. It does not make sense if the guarantee fees payable for these programs are market-value based fees which fully compensate for the value of the risk capital. Charging a market-value-based fee for the guarantee defeats the purpose of the program: to give powerful incentives for otherwise-too-risky lending to SMEs in vulnerable sectors.

Patrick Honohan (2020) overviews these loan-guarantee programs internationally and expresses his concern that these loans may impose too much debt on troubled firms and generate prolonged financial distress. Such a concern is particularly pertinent for Ireland, with its extremely slow and cumbersome non-performing loan (NPL) resolution framework. Honohan also worries that many of these government-guaranteed loans may effectively transform into subsidies via non-payment; this is particularly relevant in the case of Ireland given its political-business culture regarding NPLs. Honohan suggests adding an equity-conversion feature to the loan guarantees, but this might be a bit too complicated in the Irish case.

In terms of the Irish proposal, the 80% guarantee coverage is on the low side relative to comparable nations. 90% coverage would be better; imposing a 20% risk exposure on the banks might slow take-up substantially. Getting a fast and high take-up rate requires that the program is administratively easy to access and well-incentivised for both the SMEs and banks in terms of risk-reward acceptability. The €2 billion budgeted amount seems very low. The guarantee fee (which is counterproductive) should be pushed as low as the EU commission will allow. It would be good if the smaller loans at least could have some sweetener attached, linked to payroll or job retention.

Clifford Chance (2020). Coronavirus – Guarantee Scheme in Spain. [online] Available at: [Accessed 7 May 2020]

Department of Business, Enterprise and Innovation (2020). Credit Guarantee Scheme for COVID-19 FAQs. [online] Available at: [Accessed 7 May 2020]

European Central Bank (2020). ECB announces new pandemic emergency longer-term refinancing operations. [online] Available at: [Accessed 7 May 2020]

European Commission (2020). Temporary Framework for State aid measures to support the economy in the current COVID-19 outbreak. [online] Available at: [Accessed 7 May 2020]

European Commission (2020). State aid: Commission approves German measures to support economy in Coronavirus outbreak. [online] Available at: [Accessed 7 May 2020]

Financial Times (2020). State-backed SME lending picks up pace too late for many. [online] Available at: [Accessed 7 May 2020]

Financial Times (2020). UK set to launch loans scheme for small businesses. [online] Available at: [Accessed 7 May 2020]

Financial Times (2020). How will the UK’s ‘bounce back’ loans work? [online] Available at: [Accessed 7 May 2020]

Financial Times (2020). Loan guarantees: what funding will be available to UK businesses? [online] Available at: [Accessed 7 May 2020]

Financial Times (2020). More than 100,000 apply for ‘bounce back’ loans. [online] Available at: [Accessed 7 May 2020]

Patrick Honohan (2020). Pandemic loans to firms: Postponing the evil day? [online] Peterson Institute for International Economics. Available at: [Accessed 7 May 2020]

Ireland Strategic Investment Fund (2020). Pandemic stabilization and recovery fund. [online] Available at: [Accessed 9 May 2020]

Bruno Robino (2020). Capped Portfolio Guarantee. European Investment Bank. [online] Available at: [Accessed 11 May 2020] 

Shearman and Sterling (2020). Updated – Covid-19 France: State Guarantee Scheme for New Money Loans. [online] Available at: [Accessed 7 May 2020]

The Telegraph (2020). Germany’s 100pc guarantees highlights shortcomings of UK loan scheme. [online] Available at: [Accessed 7 May 2020]

Capital Sources for Pandemic Emergency Funding of Irish SMEs: Can Ireland Mimic the US Approach?

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,; “With $2.3 Trillion Injection, Fedʼs Plan Far Exceeds Its 2008 Rescue” New York Times, April 9, 2020, (behind paywall) and “Fed Rolls Out $2.3 Trillion to Backstop Main Street, Local Governments,” New York Times, April 9, 2020, By Reuters, (behind paywall).

[2] See “SBCI Covid -19 Scheme,” Strategic Banking Corporation of Ireland, April 20th, 2020.

A gap in current policies for Irish financial stability

In a recent speech, the Deputy Governor of the Central Bank of Ireland, Sharon Donnery, floated the prospect that the CBI might impose Counter Cyclical Capital Buffers (CCyB) on Irish banks, in order to guard against an unstable credit build-up in the currently strong economic environment. She also used the speech to discuss current conditions in the Irish financial system and review the macroprudential regulation policies of the CBI.

In many ways, Irish macroprudential regulation has been exemplary, but there is a glaring defect. Stanga et alia (2017 and 2018) compare 26 countries regarding mortgage arrears, financial stability and macroprudential policies, and Ireland’s profile is remarkably poor. As Stanga et al. note, controlling mortgage arrears is a key objective of macroprudential policies, and Ireland has very poor performance by this metric.

Ireland’s intractable mortgage arrears problem stems in large part from its defective legal system regarding loan security, with extremely limited lenders’ rights to collateral repossession. This defect in turn limits the reliability of Ireland’s quite restrictive macroprudential policies. As Stanga et al. state in their international overview:

“Better institutions – which improve judicial efficiency and make it easier for banks to enforce their rights – reduce the level of mortgage defaults. We consider several proxies for institutional arrangements and compile an index of institutional quality (IQ). We find a significant and negative relationship between IQ and mortgage arrears, both before and after the onset of the financial crisis – the higher the average quality of institutions, the lower the average mortgage default ratio (Figure 3). Moreover, the effects of macroprudential policies and institutional quality on mortgage defaults are mutually reinforcing. As illustrated in Figure 4, the effect of the MPI [Macro Prudential Index] on defaults becomes stronger in countries with better institutions. This result suggests that the effect of tougher macroprudential policies (that reduce household leverage and ultimately deter defaults) is amplified in an institutional environment conducive to an efficient judicial system with better protection for lenders’ rights and better enforcement capabilities.”

In addition to making banks more cautious, the limited-repossession system in Ireland makes the CBI more stringent in its macroprudential squeeze on credit flows. The prospect of a future spike in mortgage defaults is a key concern for the CBI, along with the high average loss-give-default in such a scenario. Because of this, the CBI is correct to stamp down hard on any signs of substantial credit flow into the domestic housing market.

When it comes to tackling the underlying defect in the Irish system (the too-limited repossession rights of lenders) the CBI has taken the line that this is somebody else’s problem. The CBI harangues the government endlessly on tax and spend policies (which are also not strictly the CBI’s problems) but when it comes to addressing the big defect in the Irish system regarding repossession, the CBI is as quiet as a mouse.

Who is paying for this unusual Irish system of extremely-limited repossession rights? Nondelinquent mortgage borrowers pay for the limited-repossession system since their mortgage interest rate includes the expected cost of default, capturing both a high probability of default and a high loss given default. Households looking for mortgages suffer in two ways: one, the Irish limited-repossession system makes mortgages more difficult to obtain; two, the system has a knock-on effect on housing construction: property development is a high-risk business and with no guarantee of mortgage-ready buyers, developers are extra-cautious.

The net effect of the Irish limited-repossession system on housing prices is indeterminate since there are opposite effects on the demand and supply sides. Cash buyers might benefit or lose on a net basis: they lose from the decrease in house construction (hence higher prices) but benefit from reduced bidding competition against mortgage-based buyers. Existing mortgage holders (other than defaulters) lose, and prospective mortgage holders lose twice over.

At the conclusion of her speech Donnery states:

“While there are uncertainties placing a precise value on the short-term benefits and costs, in the longer-term, increasing the margins of safety in an uncertain world is of benefit to all.”

Consider a young Irish household wishing to buy a family home using mortgage finance. In exchange for a mortgage loan, they might be willing to take a chance that they lose the house in some future scenarios if things turned out badly and they could not pay the loan back. They want a house now and are willing to take a chance on the future. Such a mortgage contract is not legally available to them in Ireland nowadays, since repossession can only be enforced in ridiculously limited circumstances and, due to this legal reality, banks are not allowed to issue mortgage loans unless they are virtually default-risk-free. The young household will have to rent or live with parents, for many years into their future.

The Irish financial system, where there is virtually no chance of receiving a default-risky mortgage and even less chance that such a loan could end with repossession, is not of benefit to all. For many people in many circumstances, risk is good.

Sharon Donnery (Deputy Governor, Central Bank of Ireland) speech on macroprudential policy

The Department of Economics, Finance & Accounting at Maynooth University welcomes Sharon Donnery, Deputy Governor of the Central Bank of Ireland, who will deliver a talk on “Building resilience in the face of uncertainty – what role for policy?”, followed by a panel discussion, chaired by Bridget McNally (Maynooth University) with panelists Robert Kelly (Central Bank, Head of Macro-Finance Division), Dermot O’Leary (Chief Economist at Goodbody Stockbrokers), and Gregory Connor (Maynooth University), on Thursday 31st May 2018,  at 11am – 12:15 pm, Renehan Hall, Maynooth University. R.S.V.P. For further information tel: 01-7083728 / 7083681

Four Cheers for Conor Skehan

On Wednesday, Conor Skehan, outgoing head of the Government’s Housing Agency, was grilled by the Oireachtas Housing Committee for the mortal sin of noticing things and speaking honestly about them. Mr. Skehan claimed that some individuals in Ireland were gaming the public housing system, in order to become eligible for public housing ahead of others. Members of the Committee, devout in their observance of the Holy Laws of political correctness,  castigated Mr. Skehan for his public remarks and the evidence he presented to justify them. They noted that it is not possible that a housing-eligible person could game the system – as PC dogma clearly states, lower income individuals are gifted with Immaculate Conception (born without sin) and can do no wrong. So the evidence that Mr. Skehan presented had to be false, and his presentation of it before the committee was proof of his fall from a PC state of grace.

On the plus side, there was at least one honest person in the Oireachtas on Wednesday.