New Projections of Interest Rates on EU Loans

The topic of the interest rate on Ireland’s EU loans has attracted a lot of attention. Unfortunately, however, hard information on the loans and comparisons with the loans being offered to Portugal is not always easy to come by. The purpose of this post is to provide the information that is publicly available on this issue and to present new calculations of the likely interest rates on Ireland’s loans.

The most common media reference point for the cost of Ireland’s loans is this information note released by the NTMA in November. That document projected the cost of Ireland’s loans from the European Financial Stability Mechanism (EFSM) at 5.7 percent and the cost of Ireland’s loans from the European Financial Stability Facility (EFSF) at 6.05 percent.

With €22.5 billion being provided to Ireland by the EFSM, €17.7 billion by the EFSF and €4.8 billion coming from bilateral loans, the NTMA note assumed the interest rate on the bilateral loans would be the same as the EFSF rate. Thus, the estimated average cost of the EU loans was 5.875 percent. (I am leaving aside in this note the question of the cost of funding from the IMF, which is determined according to standard, if somewhat complex, IMF procedures.)

In a briefing note for the Oireachtas Committee on European Affairs, I noted that market interest rates had risen since the November briefing and the pricing of the first EFSM bond had not gone as well as anticipated. Based on those considerations, I suggested that the cost of EFSM funding was likely to be 6.09 percent while the cost of EFSF loans would be 6.44 percent.

The period since that briefing note was written has seen a number of EFSF and EFSM bonds issued to Ireland and Portugal, so now seems like a good time to attempt to get a more accurate picture.

Here’s a link to a spreadsheet that describes each of the bonds issued by EFSF and EFSM as well as the conditions on which they were disbursed to Ireland and Portugal. I have made estimates of what the interest rates will be on funds that are not yet drawn down by assessing their likely average maturity (to match the planned 7.5 year average maturity for Ireland and Portugal), calculating current market interest rates for those maturities (based on the mid-swaps benchmark used by the EFSF and EFSM) and then adding in the estimated margins.

A quick summary:

1. The average interest rate on EFSM loans for Ireland is projected to be 6.13 percent.

2. For Portugal, the EFSM loans project to have an average interest rate of 5.34 percent. The lower rate than for Ireland is because the EFSM’s profit margin on Portuguese loans is 77 basis points lower than for Ireland.

3. The average cost of EFSF loans for Ireland is projected to be 6.29 percent. This is lower than I had estimated in January because I had used the assumption underlying the NTMA’s November document that the margin over funding cost that would determine the effective borrowing cost for Ireland would be 317 basis points. Based on the one EFSF bond issue for Ireland so far, I now estimate that this average margin will be 305 basis points.

4. The average cost of EFSF loans for Portugal is projected to be 5.76 percent.

5. Based on the assumption that Ireland’s bilateral loans (not yet drawn down) will carry the same average interest rate as the EFSF, the average interest rate on Ireland’s EU loans will be 6.21 percent, 33.5 basis points higher than estimated last November. The average interest rate on Portugal’s EU loans is projected to be 5.55 percent, 66 basis points lower than the projected rate for Ireland. 

6. The current terms on Greece’s EU-IMF loans have been widely reported to be 4.2 percent for a 7.5 year average maturity after Greece was granted a 100 basis point reduction at the March 11 meeting of the Heads of Government of the Euro Area member states.

For those interested, here’s a rough description of how the calculations were done.

Corporate Tax Saga, May 11 Edition

The saga over Ireland’s request for a reduction in the interest rate on its EU loans continues, with the French continuing to link this issue with Ireland’s corporate tax, a role they swap every so often with the Germans (media stories from today here and here). As Christine Lagarde’s recent comments show, having made such a big deal of the issue, the French are now motivated to achieve the crucial goal that “Everybody will have to save face.”

It is worth noting, however, that the French signed this document “Conclusions of the Heads of State of Government in the Euro Area” on March 11. It stated:

Pricing of the EFSF should be lowered to better take into account debt sustainability of the recipient countries, while remaining above the funding costs of the facility, with an adequate mark up for risk, and in line with the IMF pricing principles.

Note the absence of any mention of corporation tax or renegotiation of deals.

Despite the constant repetition of the line that Ireland is somehow looking to change the status quo, it seems to me that there is a strong case for the opposite position. Having agreed to change the pricing of EFSF loans on March 11, the EU’s principle political leaders have reneged on this agreement for the moment, most likely because the political kudos that come with appearing tough on Ireland outweigh those associated with honouring agreements made at Heads of State level.

Those who believe that Ireland’s situation will end well because European institutions have our best interests at heart may wish to consider how things have played out over the past few weeks.

A Flexible EFSF

In his latest speech, Lorenzo Bini-Smaghi provides some insights into how European financial stability can be improved.  Some key passages:

One objection to a more integrated banking system in Europe is the role of national budgets in crisis resolution. As long as budgets remain national – so goes the argument – crisis resolution has to remain national, and so does supervision. The crisis has shown that bank resolution and restructuring are more complicated for cross-border institutions, given that any fiscal costs have to be distributed across several host sovereigns. As Charles Goodhart has said, “…cross-border banks are international in life, but national in death”. [4]

As I see it, enhanced financial integration in the euro area does not necessarily imply a need for greater fiscal union – if that is understood as a pooling of tax revenues, harmonisation of tax rates or issuance of a common bond. Instead, we must develop the capacity at the area-wide level to address specific financial tensions that threaten to spill over to the area as a whole, minimising disruptions to market integration and supporting the transmission of monetary policy.

The recent crisis – and, in particular, developments in Ireland – have demonstrated that, despite the imperfect integration of the European financial system, very strong cross-border contagion takes place within the financial sector. The instruments available at present to block this contagion are not efficient and have side-effects. In practice, much of the burden to contain contagion has fallen on central banks. This is neither desirable nor appropriate.

In my view, the European authorities need to develop a capacity to conduct a surgical strike’ on problematic financial institutions or market segments in the event of a financial crisis. Through such actions, the area-wide externalities created by specific problems can be contained. In practice, this means ensuring that programmes such as the European Financial Stability Facility (EFSF) or the European Financial Stabilisation Mechanism (EFSM) – and their envisaged permanent successors – are given sufficient financial resources and the required flexibility by the Member States to act as necessary to support financial stability. To do so, these bodies may also need to be able to support the recapitalisation of an ailing banking system, if its weakness threatens the stability of the area as a whole. All this of course comes with strict conditionality in the context of an overall EU/IMF programme.

This has been the case in both the Greek and Irish programmes, in which funds are dedicated to the recapitalisation of the weak banks. A more systematic approach should be pursued, making it easier for countries to implement such a scheme.


The recent crisis has demonstrated that the European financial system was insufficiently robust. Further measures to deepen integration and bolster stability are required. Looking forward, we have to identify any remaining weaknesses and seek to address them.

Until now, it has generally been argued that the main responsibility for financial supervision has to remain at national level. The consequences of failures in supervision ultimately fall on the taxpayers of the country where the bank resides. To align incentives and ensure appropriate accountability, nationally defined tax bases imply nationally defined supervisory institutions.

However, the crisis has demonstrated that the implications of supervisory failures extend well beyond national boundaries. First, cross-border contagion has been magnified by externalities and spillovers arising from greater area-wide financial integration. Second, experience has shown that, within a more integrated market, greater specialisation may imply that financial systems in one country outgrow the capacity of national taxpayers to support them.

The implications of this experience are profound. As I have argued, they point to the need for a much greater euro area and EU perspective in the supervisory and regulatory framework. While progress has been made in this domain, much remains to be done.

Oireachtas Appearance on EU-IMF Interest Rates

I appeared today before the Oireachtas Committee on European Affairs to discuss the interest rates on the EU-IMF loans. I provided the committee with a briefing paper (available here) and a short presentation (available here). I will edit this post later to include the transcript of my opening statement and the questions and answer session when these materials are posted on the Oireachtas website.

There’s a lot of material in the briefing note and I’m not going to repeat it here. One point I would briefly point to, however, is that the note discusses how recent movements in market interest rates and the pricing of EFSM’s initial bond issue on January 5th (EU Commission press release here) meant that, by my estimates, the cost of funding from the EFSF and EFSM would be 40 basis points higher than had been estimated in the December note released by the NTMA.

These materials were prepared prior to today’s €5 billion bond auction the EFSF. Press stories have been very positive about how this bond auction went (e.g. here and here). However, the material I prepared discussed the pricing of the EFSM bond yield relative to swap rates. The January 5th bond was priced at mid-swaps +12 basis points while this bond mid-swaps +6 basis points, so the interest rate on today’s bond would not change my judgment on this issue by much.

Update: As promised here‘s the transcript of my appearance

Paying Attention to European Crisis Resolution Developments

Even as we are distracted by political upheavals at home, the debate on how best to reorient the euro zone’s bailout mechanisms continues.   The proposal gaining most traction, with at least a degree of German support, is to allow countries in difficulty to use EFSF funds to buyback their own debt on the secondary market.   The initial focus is on Greece, but any new mechanism should be available in time to Ireland.   (Wolfgang Munchau provides a critical analysis here.)

The attraction of buybacks is that they allow a country to reduce the face value of outstanding debt without a formal default.   A disadvantage is that they can be gamed by bondholders: it makes sense for bondholders to hold out for a higher price if a buyback is really expected to improve creditworthiness.   One partial solution that I mentioned previously is for countries to buy back the debt accumulated by the ECB through its Securities Markets Programme (see here).  

Writing on Friday before the latest developments, Arthur Beesley reminds us of the stakes:

[T]he debate merits serious attention across the political spectrum in Dublin. Political activity for the next . . . weeks will centre on the election, but neither the Government nor the Opposition can afford to lie low on this front.

The debate on Greek debt takes place amid an intensive negotiation of key reforms to the European Financial Stability Facility (EFSF) rescue fund, including lower interest rates. Any inattention here would hamper Ireland’s argument for a rate cut, which is already difficult. But the Irish dimension does not end there, far from it.

.  .  .

[S]etting the election date brings clarity as to when a new government is likely to take office. From the perspective of European talks, the timing is tricky enough. Polling day is March 11th. EU leaders are working to make final decisions on EFSF reforms and a new permanent bailout fund at a summit only 13 days later.

There will be time – just about – to install a new taoiseach. By then, however, the really tough talking may well be done.