Wednesday, August 20, 2014

Repaying the IMF loans and ‘Financial Stability’

The February 2013 liquidation of the IBRC resulted in the Central Bank of Ireland holding around €25 billion of Irish government bonds with maturities of between 25 and 40 years (there is also €3 billion of a 2025 bond that was used to finance the 2012 Promissory Note payment)

The drop in yields since then means that the market value of these is now likely to be above €25 billion.  Since February 2013, for example, the 10-year yield on Irish government bonds has fallen from 3.8% to 1.9%.  It would be useful to have a current estimate of the market value of these bonds held by the Central Bank but one does not appear to be available.

At the time of the transaction the following was included in a overview presentation published by the Department of Finance (slide 10):

The Central Bank of Ireland will sell the bonds but only where such a sale is not disruptive to financial stability. They have however undertaken that minimum of bonds will be sold in accordance with the following schedule: to end 2014 (€0.5bn), 2015-2018 (€0.5bn p.a.), 2019-2023 (€1bn p.a.), 2024 and after (€2bn p.a.).

A couple of days later the Governor of the Central Bank appeared on RTE’s The Week in Politics and said (from around 05:00):

The Central Bank of Ireland has undertaken to sell these bonds as soon as possible subject to financial stability conditions.

The 2013 Annual Report of the Central Bank contained the following about the €25 billion of Floating Rate Notes (FRNs) acquired by the Bank(footnote (i) to the table in page 123):

The Bank intends to sell the combined portfolio of the FRNs and the fixed rate bond as soon as possible, provided conditions of financial stability permit. The Bank will sell a minimum of these securities in accordance with the following schedule: to end 2014 (€0.5 billion), 2015-2018 (€0.5 billion per annum), 2019-2023 (€1 billion per annum), and 2024 on (€2 billion per annum until all bonds are sold). As part of these minimum sales, the Bank sold €350 million of the 5.4% Irish 2025 Government Bond by end December 2013.

In recent weeks there has been increased attention given to the early repayment of Ireland’s loans from the IMF.  The possibility of this has been discussed here for a while.  Recently the Minister for Finance indicated that the annual interest savings from the early repayment of €15 billion of the IMF loans could be around €375 million.  It seems that attempts will be made with the various EU creditors (requiring getting the agreement of all other Member States) to allow the early repayment of two-thirds of Ireland’s IMF loans.

It appears Ireland is in a position to repay €15 billion of IMF loans, presumably by issuing replacement debt.  It is not clear that agreement will be reached to do this.  If we have the financial wherewithal to refinance the IMF loans who is to say that the Central Bank of Ireland would not be able to sell €25 billion of government bonds, or say two-thirds of them, without being “disruptive to financial stability”?

It is worth repeating that the 2013 Annual Report of the ECB included the following (page 110):

The liquidation of the Irish Bank Resolution Corporation (IBRC) raises serious monetary financing concerns. These concerns could be somewhat mitigated by the disposal strategy of the Central Bank of Ireland.

Indeed.  We might gain a couple of hundred million from reduced interest payments by the Exchequer on the IMF loans but maybe that only rises the possibility that we could lose a couple of hundred million from reduced payments into the Exchequer Account from the Central Bank surplus. 

There has been little to indicate do far that these two sub-plots of Ireland’s government debt are linked but with many moving parts it can be unwise to try and look at different things in isolation.

Friday, August 15, 2014

1.999

The implied 10-year yield on Irish government bonds has fallen below two percent.  And as can be seen in the table below the implied eight-year yield is less than one per cent.

Bond Yields 15-08-2014

The yield has been falling for the past while but the drop today is an acceleration of that.

Bond Yields 10yr 15-08-2014

It is hard to see how anyone would give money to the Irish government for eight years at a yield of less than one percent.  Things are improving but risks remain.  Of course, they are not really buying these on the basis that Ireland will repay the money; they are buying on the basis that Mario Draghi will step in to give them their money back.  Draghi has had undoubted success in bringing government bond yields down. Is there any chance he could have similar success in bringing economic growth rates up?

Tuesday, July 8, 2014

Some factors affecting the fiscal arithmetic

The debate around October’s budget has been heightened recently with the positive results in the half-year Exchequer Returns and the large upward update of nominal GDP by the CSO.  The impact of these was explored in this recent post.

There are other factors that will feed into the fiscals sums for 2015.  It is not clear what affect they will have but they may come to prominence over the coming months.  The first is recurring but small, the second is large but once-off and the third is large and recurring (for a while) but seems unlikely to happen.

1. Changes to the EU VAT Directive

From the first of January 2015 “VAT on telecommunications, broadcasting and electronic services supplied by a supplier established within the EU to non-taxable persons established within the EU will also be charged in the Member State where the customer belongs.”  See here.  It is not clear what impact this will have on VAT revenues but one would think it will be positive, though will probably be small. 

The most visible change will probably be in relation to subscriptions paid to BSkyB the VAT on which will now be payable in Ireland.

2. Return payment under the ELG from IBRC liquidation

When IBRC (formerly Anglo and INBS) was liquidated in February 2013 there was just over €1 billion of state-guaranteed liabilities remaining in the zombie bank.  These were covered under the Eligible Liabilities Guarantee that was introduced in early 2010.  When the liquidation was announced the guarantee was triggered and the guaranteed liabilities were immediately paid with €1 billion from the Exchequer.  After making the payment the ELG scheme took the place of the covered liabilities on the balance sheet of the IBRC but as an unsecured and unguaranteed creditor.  When the liquidation is concluded the proceeds of the sales (minus costs) will be divided between the remaining creditors at the time of the liquidation.  Creditors will be repaid based on their status but it does seem that there will be funds to make a payment to unsecured creditors.

It is not clear when this will be made or how much this will be.  If the proceeds are sufficient the amount returned could be close to the €1 billion paid out under the ELG. This is a once-0ff receipt relating to the public interventions in the banking sector.  Ireland has been in the Excessive Deficit Procedure since 2009 but the “once-off” payments to the banks were omitted to give the “underlying” deficit when examining whether Ireland had satisfied the limits set out under the EDP.

If there is a repayment from the IBRC under the ELG then it could be that the “underlying” deficit will be greater than the overall deficit.  Is it only payments to the banks that are excluded to get the “underlying” deficit?  If receipts from the banks are excluded maybe 2015 would be an opportune time to start measuring our performance to the EDP limits with the headline deficit?

3. Early repayment of IMF loans

The benefits of this were discussed here and here back at the start of the year.  The issue arose in a PQ to the Minister for Finance again last week.  He repeated the position that all the programme loans have to be repaid in equal proportion.  Repaying the IMF loans means repayments also need to be made to the EFSF, EFSM and bilateral loans.  But loan agreements can be renegotiated and the Minister outlined how much such a renegotiation would be worth:

It is the obligation to pay everybody if we pay one and makes it not worth pursuing. However, there may be ways around that and it is still worth pursuing that aspect. At present rates in the market and with the rate we are paying on the IMF loan, it is worth about €20 million for every €1 billion we financed. We have about €18 billion of that type of loan from the IMF.

€20 million times 18 equals €360 million – though it will be phased-in in a sense as the IMF loans are amortised (repaid in instalments) over the next few years.  But how long will the Ireland 10-year yield stay below 2.5 per cent?

So we have a small effect that definitely will happen (VAT), a large once-off effect that will happen but mightn’t be counted (ELG) and a large recurring effect that mightn’t happen at all (IMF).  In an imaginary world where they all fell right the 3 per cent of GDP deficit in 2015 should be easily achievable.

Inversions and spotlights etc.

The Irish Times has a piece on US corporate “inversions” which says that “Ireland’s tax regime comes under US spotlight again”.  In this instance an inversion is where a US company merges with a non-US company and the merged holding company has its place of incorporation outside the US.  Under current rules the owners of the foreign company have to comprise at least 20 per cent of the ownership of the merged holding company for such an inversion to take place.  Some of the technical details about inversions and Ireland can be found here.

In the US Congress, Rep. Sander Levin (D), who is on the Ways and Means Committee has highlighted findings from the Congressional Research Library that US companies have been involved in 76 such inversions since 1983. That is an average of less than 3 per year but the rate has increased in the past decade as shown in this related infographic

It is not clear from the documents how many of the inversions have involved mergers with Irish companies or the incorporation in Ireland of the merged holding company but it is probably around 10 per cent of the total.

From an Irish perspective inversions offer very little.  Simon Carswell’s report today says that:

The practice is known as inversions where an American company acquires or merges with a foreign company that allows it to relocate its legal address for tax purposes outside the US to avoid paying the high American corporate tax rate of 35 per cent.

The report refers to inversions by US companies in recent years involving Irish-based firms including pharmaceutical companies Elan, Mallinckrodt and Warner Chilcott to benefit from the lower Irish corporate tax rate of 12.5 per cent.

This might suggest that the merged companies will be paying tax on a greater amount of profits at the 12.5 per cent Corporation Tax to Ireland.  This is unlikely to be the case.  Although the original US company may move its place of incorporation and tax residence to Ireland in many cases there is little substantial change in the operations of the companies.

If the US companies continue to have significant operations in the US (and they will) they will continue to be liable for the US corporate income tax of 35 per cent on the profits earned by those operations.   Place of incorporation has a limited role in determining tax liabilities.  The key factors are the location of a company’s risks, assets and functions with transfer pricing rules used to allocate profit across the company’s risks, assets and functions.  A legal inversion changes none of these.

The fact that the inversion changes so little of the tax liability is shown in further research cited by Rep. Levin but this time from the staff of the Joint Committee on Taxation.  This shows that if a proposal from Rep. Levin to limit US companies ability to invert their place of incorporation abroad the revenue gains over ten years to the US Treasury would be $19.5 billion.  That averages less than $2 billion a year.

The gain is relatively small because the US continues to levy the 35 per cent tax on the operations of the company in the US.  What the US loses out on is the right to levy its 35 per cent tax on the global, i.e. non-US, profits of these companies.  And it is also the case that the extensive deferral provisions for these tax liabilities means that much of that is not collected. 

For comparison in Irish terms the tax revenues gains estimated by the JCT scaled for size in Ireland would be the equivalent of around €15 million in Corporation Tax a year which is 0.4 per cent of current receipts.  Of course, there is more to it than just the tax revenue as companies are seen as reneging on their US identities.

Unless the companies move some risks, functions or assets to Ireland as part of the inversion they are unlikely to pay any additional tax in Ireland (above what was paid on activities in Ireland, if any, before the merger).  Like the US, Ireland has a worldwide basis for the Corporation Tax.  However, the companies will pay corporate income tax in the source country where there risks, functions and assets are. 

Ireland will levy a 12.5 per cent tax on such trading profits but will grant a tax credit for corporate income tax in other countries.  If the amount of tax paid abroad results in an Irish foreign tax credit greater than 12.5 per cent of the taxable income then the amount of additional tax due in Ireland will be nil. 

This is almost always going to be case as virtually every country these companies operate in have a corporate income tax rate greater than Ireland’s 12.5 per cent.  This is particularly the case if the inversions involve US companies which keep most of their risks, assets and functions in the US and remain liable to the US 35 per cent corporate tax rate for profits sourced from the US. 

The gain for the companies is clear.  They will no longer be liable to pay the US 35 corporate income tax on their global, i.e. non-US, profits.  This is one of the highest corporate income tax rates in the world so means that US companies do face an additional tax liability on their non-US profits even when they get a credit for foreign corporate income tax paid in the source country.  Of course, US companies can use the extensive deferral provisions in the US tax code to delay the actual payment of this tax liability until the money is formally repatriated to the US and in some cases this deferral can be indefinite.

By inverting their residence to a a country such as Ireland companies can reduce the additional tax they have to pay on top of the tax paid in the source country.  For most of these companies the source country will remain the US and it is also likely that the US authorities will be more active in assessing the structures, and particularly the transfer pricing arrangements, of these companies to ensure that the appropriate amount of profit is attributed to the risks, assets and functions in the US and not deemed “offshore”.

Also in the piece, Simon Carswell references a note from a US law firm on the practice of inversions.  The note rightly highlights some costs of these inversions to Ireland.  There will be no additional tax revenue but Ireland’s contribution to the EU budget may increase if the companies cause an increase in Irish GNP.  There can be one-off effect (if the US company has retained earning on its balance sheet at the time of it residence relocation to Ireland) and an ongoing effect (if the company generates profits that are not distributed to shareholders but are added to retained earnings).  As the merged company is Irish resident this income is added to Irish GNP.

The ‘takeaway’ in the note is that US firms seeking to invert to Ireland should do more than the basic minimum required which does not require the relocation of any significant risks, assets or functions.  The law firm concludes that:

Although not a requirement, corporations should consider tangible investments beyond the requisite minimum of board meetings, including the establishment of accounting and treasury, legal, intellectual property and business development functions; the appointment of an Irish advisory board or resident Irish directors; and the establishment of regional trading or intellectual property hubs.

If some of these came to Ireland as part of an inversion then there might be gains here.  Absent them we are likely to continue to see articles on Ireland’s Corporate Tax regime.  And the attention may not be in the right place.  Sander Levin was not shining a spotlight on Ireland’s tax regime; he was shining it on the US regime which in the first instance makes these inversions attractive (due to its relatively high rate) and in the second instance allows them (with a low legal barrier to inversions).

There is nothing Ireland can do about these inversions.  We rightfully have freedom of establishment and, within certain limited restrictions, allow people to set up companies here.  There is nothing underhand that makes Ireland attractive for these inversions.  There is the low rate, stable regime, legal system, EU membership, network of tax treaties and all that. 

Changing these could reduce the attractiveness for inversions from which Ireland gains nothing bar unwanted, and maybe even unwarranted, attention but these are the key attributes Ireland uses to attract traditional foreign direct investment which brings a much more tangible benefit – employment.  As the policy of attracting FDI is likely to remain it looks like inversions will be a negative side effect of an attractive regime unless the US can overcome the paralysis in Congress and actually do something about it.  That would be a positive for Ireland but it seems unlikely. 

Thursday, July 3, 2014

Revised National Accounts and Fiscal Targets

The CSO have published the 2013 National Income and Expenditure Accounts along with this explanatory note highlighting the impact of some of the methodological changes.

Real GDP growth in 2013 was 0.2 per cent which is a revision of the previous estimate of –0.3 per cent. Nominal GDP has gone from a first estimate of €164 billion to a revised and updated estimate of €175 billion which is a very significant increase for the fiscal targets.

Here are the main fiscal aggregates as presented in April’s Stability Programme Update.

SPU Main Aggregates

If we leave everything unchanged except the 2013 NGDP (i.e. use the same nominal growth rates and same fiscal projections) we get the following:

SPU Main Aggregates - Revised

The changes are pretty clear.  The end-2013 debt ratio has changed from 123.7 per cent of GDP to 116.1 per cent of GDP even though the debt and the economy which has to service it is exactly the same – it is just measured differently.

The projections used in the SPU now result in a 2015 deficit of 2.8 per cent of GDP (and an ‘underlying’ deficit of 2.7 per cent of GDP which is the one that has been used up to now as the metric for the EDP targets).

The revisions and updates published today by the CSO mean that a larger deficit of around 0.2 per cent of GDP (c.€350 million) is allowable while still targeting the ceiling set for the deficit in the EDP – if that is what one wishes to do.

A second helping factor (and one that actually reflects economic performance rather than statistical revisions) is the revenue buoyancy that is evident in the Exchequer Returns for the first six months of 2014.  The budget day projection for general government revenue in 2014 was €60.9 billion.  This was unchanged in April’s SPU.

SEPA issues aside it seems that tax revenue is ahead of the DoF’s projections by around €500 million.  PRSI contributions are about €100 million ahead of the projection while the surplus from the Central Bank is around €200 million larger than expected.

There are some offsetting factors on the expenditure side – main health overrruns and a larger than expected contribution to the EU Budget.  Voted Capital Expenditure is “behind profile” but that could due to timing issues.

For recurring or standard items the fiscal position is probably around €500 million (c.0.3 per cent of GDP) better than was expected when the Budget and SPU projections were made.  This means the 2014 deficit outturn could be around 4.2 per cent of GDP if these improvements from H1 are just held and maybe even close to 4 per cent if the improvements continue to accumulate.

If the objective is to draft a budget targeting a 3 per cent deficit the fiscal effort required to so might be little more than the introduction of water charges.

PS Is there any indication somewhere of the budgetary impact in Ireland of the changes to the EU 6th VAT Directive that are due to come in force in January 2015?  That is the change that means the VAT payable on, for example, television subscriptions will be collected in the country of the customer rather than the country of the supplier.  

Friday, June 27, 2014

Retail Sales are going nowhere (but up on last year)

The May update of the CSO’s Retail Sales Index doesn’t show a whole lot of movement.  The May readings (though provisional) of both the value and volume for the series of the index excluding motor trades are almost exactly the same as those recorded six months ago in December 2013.  There has been some fluctuation in the interim but there has been no overall positive or negative movement in the past six months.

RSI Ex Motors to May 14

It can be seen that both series are ahead of where they were in the first half of 2013.  Thus the annual changes paint a slightly healthier picture.  The recent annual increases are the fastest since early 2008 and are only matched by those that were seen around the time of the temporary fillip that resulted from the ‘digital switchover’ of the broadcast television signal in October 2012.

Annual Change in RSI to May 14

However, unless there are increases over the coming months to match those seen towards the end of 2013 the annual changes will reduce to zero.  Still, on the goods side at least, we are likely to see an annual increase in Consumption Expenditure for H1 2014 compared to H1 2013.

The monthly changes again highlight that it is difficult to read anything into changes over a short timeframe given the volatility in the series.

Monthly Change in RSI to May 14

Overall, retail sales are ahead of where they were this time last year but the growth of the final few months of 2013 has not continued into 2014.

Friday, June 13, 2014

The EU has made a negative state aid judgement against Ireland’s Corporation Tax regime

The announcement this week is not the first time the calculation of the tax base for Ireland’s Corporation Tax has appeared on the radar of the EU’s state aid rules.  There was a previous formal investigation launched by the  EU in 2001 and it concluded in 2003 with a negative state aid ruling against Ireland.  Unlike now though the Ireland was not under the glare of international scrutiny and condemnation.

The case related to an exemption from Irish Corporation Tax for foreign income of Irish resident companies and branches if that income was used for investment and job creation in Ireland.  It was introduced in 1988 when the top rate of Corporation Tax was 40 per cent so there would have companies who would have benefitted if the tax rate in the source country of their foreign income was less than the Irish rate.  Of course, Ireland’s dual system of Corporation Tax fell foul of EU rules and the top was rate reduced significantly until the single rate of 12.5 per cent was introduced in 2003.

When the rate fell to 12.5 per cent the exemption of foreign income under investigation was almost obsolete as the tax rate in the source country for Irish companies’ foreign income was almost certainly to be greater than 12.5 per cent.

Anyway, the EU did undertake an informal information gathering exercise and subsequently proceeded with a formal investigation and concluded that the exemption was state aid.  The companies who benefitted from the state aid were not asked to make redress payments and by the time the final decision was reached the exemption was obsolete and only one part of it remained (and that had been closed off to new entrants in 2001).

Some details of the case can be accessed from here.  The quickest summary is in the press release rather than the judgements.

Friday, June 6, 2014

Back in the A Class

Standard and Poors have upgraded Irish government bonds from BBB to A- with positive outlook.  Their statement justifying the upgrade is below the fold.

10-year yield drops to 2.48%

Two point four eight.  Really?

Bond Yields 10yr 06-06-14

It seems so.

Wednesday, May 14, 2014

European Spring: Right villain, wrong reason

Philippe Legrain’s recent book, European Spring, has generated a good deal of reaction in Ireland.  Although it is a very broad-ranging book, and a recommended read, the focus in Ireland has been very narrow and mainly has been on the following passage:

For example, had Irish banks defaulted on all their debt at the end of September 2010, German banks would have lost €42.5 billion, British ones, €27.5 billion and French ones €12.3 billion.131

When Ireland was forced to seek a loan from EU and the IMF in November 2010132, the Irish government sought to backtrack on its foolish promise, made in the heat of the post-Lehman panic in October 2008, to guarantee all Irish banks’ debts.  Had it succeeded, the doom loop would have been greatly weakened.  Instead eurozone policymakers, notably ECB President Trichet, outrageously blackmailed the Irish government into making good on its guarantee, by threatening to cut off liquidity to the Irish banking system – in effect, threatening to force it out of the euro.  Thus, having exhausted the borrowing capacity of the Irish government, the creditors of Irish banks could now call on loans from other eurozone governments, along with Britain’s, Sweden’s and the IMF.  This was a flagrant abuse of power by an unelected central banker whose primary duty ought to have been to the citizens of countries that use the euro – not least Irish ones.  Bleeding dry Irish taxpayers to repay foreign debts incurred by Irish banks to finance the country’s property bubble was not only shocking unjust.  It was a devilish mechanism not for the safeguarding financial stability in the eurozone – which would be the ECB’s defence for its actions – but rather for amplifying instability.  It entrenched governments’ backstopping of bank debts, sparking fears about countries that had experienced an Irish-style bank-financed property bubble, notably Spain.  And it threatened to drag even countries with a reasonably sound banking system, such as Italy, into the doom loop if the situation deteriorated.

The sentiments expressed in the second paragraph here are not in serious dispute.  It was the case that the Irish government, through then Minister for Finance Brian Lenihan, did ”raise the issue” of  a “dishonouring of senior debt”.

It was then the case that haircuts to senior bank bondholders were ruled out and the ECB had a key role in this though the detail behind the decision are unclear.  In the clip above Brian Lenihan indicates that the ECB’s refusal to contemplate haircuts to senior bondholders (presumably only in Anglo and Irish Nationwide) was “unanimous”.

In an interview with The Irish Times in January of this year Jens Weidmann said of the time:

Jens Weidmann:  The Governing Council then was weighing bail-in versus financial stability risks, and its majority concluded that the latter were more relevant under the concrete circumstances. In that debate the Bundesbank has always considered it important to make investors bear the risks of their investment decisions and already then favoured contributions of investors in the event of solvency problems, especially for banks that are to be wound down. Our common goal is to be able in the future to wind down banks without endangering financial stability.

But a view opposing such haircuts was previously put forward by Jörg Asmussen in a speech delivered in Dublin in April 2012:

Jörg Asmussen: I know that the decisions concerning the repayment of bondholders in the former Anglo Irish Bank have been a source of controversy. Decisions taken by the Irish authorities such as these are not taken lightly. And the consequences of subsequent actions are weighed carefully. It is true that the ECB viewed it as the least damaging course to fully honour the outstanding senior debts of Anglo. However unpopular that may now seem, this assessment was made at a time of extraordinary stresses in financial markets and great uncertainty. Protecting the hard-won gains and credibility from the early successes in 2011 was also a key consideration, to ensure no negative effects spilled-over to other Irish banks or to banks in other European Countries.

It should be noted that Weidmann did not work for the Bundesbank or Asmussen for the ECB at the time these decisions were made in November 2010 so these are views that were subsequently relayed to them.  It is also worth noting that Legrain became an advisor to Barroso in February 2011 so he too was not involved when these discussions took place.

Regardless, it is now clear that the prospect of enforcing losses on senior bondholders in Anglo and Irish Nationwide was ruled out, in large part, at the insistence of the ECB.  But it is hard to see how this decision was made to save German, French or UK banks.  The decision was made to save the skin/face of the ECB.

In November 2010, the amount of senior bonds remaining in Anglo and Irish Nationwide was around €6 billion.  This is a very significant sum in Irish terms but relatively minor in the overall scheme of the European banking system.   A 66 per cent haircut on these would have been €4 billion of losses which would be little more than a ripple in the pool of European bank losses (even assuming such banks held all of them). 

The impact of the undertaking the action on capital and interbank money markets might have been a consideration but those markets broke down anyway.  Little was gained from refusing Lenihan’s request to impose losses on the €6 billion of Anglo/INBS senior bonds.

By November 2010, private banks had relatively little to lose from the bust Irish banks as a result of the repayments made during and, most significantly at the end, of the two-year guarantee introduced in September 2008.  But one institution did stand to lose heavily if the Irish banks collapsed (or if Ireland withdrew from the euro).  That was the institution that provided the money for these repayments to be made – the European Central Bank.

When the guarantee ended the reliance of the ‘covered’ Irish banks on central bank liquidity shot up.  By November the six banks were accessing €88 billion of liquidity from the ECB and also around €42 billion of ELA from the Central Bank of Ireland.

Central Bank Funding

The ECB did not bounce Ireland into a bailout to rescue German banks; it did so to ensure it would not be burned itself.   Central bank funding of the ‘covered’ banks was €130 billion in November 2010 and it peaked at around €150 billion in February 2011.  These are massive figures in all contexts. 

The ECB wanted to tie Ireland into a programme to ensure this was repaid.  And they were successful.  ECB funding to the remaining covered banks is now down to €23.5 billion while the use of ELA all but ended with the liquidation of the IBRC last February.  Reliance on central bank funding by the covered banks has been reduced by 80 per cent.

The first paragraph above extracted from Legrain’s book has some large numbers for potential losses to German, French and UK banks if the Irish banks defaulted in November 2010.  These numbers are meaningless in the context of the Irish banking collapse.  Footnote 131 tells us where they come from:

131 Bank of International Settlements Quarterly Review, March 2011.  Foreign exposures to Greece, Ireland, Portugal and Spain, by bank nationality, end-Q3 2010, converted from US dollars to euros at exchange rate on 30 September 2010 of €1 = $1.3615.

The BIS report referenced can be accessed here with the accompanying statistical annex here.  The figures used by Legrain are from Table 1 on page 15 of the report with panel below showing the figures for claims on Ireland with the German, French and UK bank claims on banks in Ireland circled.

BIS Q3 2010 Ireland

For some reason these figures for Q3 2010 are not the online BIS database. The total liabilities of French, German and UK banks to Ireland are available for Q3 2010 but in  it is not until Q4 2014 that a breakdown by sector (bank, non-bank private and public) is available from the database.

The table below shows the claims for German-, French- and UK- headquartered banks on Ireland (banks, public sector, non-bank private sector and total) for all quarters in 2010 and 2011 and the sectoral breakdown where available from the database. Click to enlarge.

BIS Claims on Ireland Data

The first quarter for which the sectoral breakdown is provided in the BIS database is Q4 2010 and the data shows that at that time the amounts owed by banks in Ireland to German-, French- and UK-headquartered banks were $28.5 billion, $8.1 billion and $18.3 billion respectively.  These are somewhat distant from the $57.8 billion, $16.8 billion and $37.4 billion figures for the previous quarter shown in the Q3 2010 BIS report.  This is not surprising and the reason for the rapid decline is the bank run that happened in Ireland in late 2010.

The figures are precisely true for what they represent: claims of foreign banks on banks in Ireland.  The figures are precisely useless for what they are most frequently used to represent: losses avoided by foreign banks from the rescue of the six ‘covered’ banks in Ireland.

One reason is that saying “German banks would have lost €42.5 billion, British ones, €27.5 billion and French ones €12.3 billion” requires there to have been a 100 per cent default which is patently unrealistic.  However, the main reason for the inappropriateness of the figures in trying measure potential bank losses that were avoided by the bank bailout is that there was far more than six banks operating in Ireland in late 2010. 

The Irish government rescued AIB, Anglo, BOI, EBS, INBS and PTSB.  The €64 billion comes from their rescue.  Included in the above BIS figures are also Ulster Bank, Bank of Scotland (Ireland), Danske, KBS, Rabobank and other foreign-owned retail banks operating in Ireland.

Most importantly though the above figures include the liabilities of banks operating in the IFSC which have close to nothing to do with the domestic Irish economy (apart from providing employment and paying some taxes) and equally nothing to do with the collapse and bailout of the Irish banking system.

A look at the post on the Irish bank run shows that an almost equal amount of deposits were leaving ‘Other Banks’ (i.e. IFSC banks) and all the ‘Domestic Banks’.  In fact, in the last six months of 2010 deposits in banks operating in Ireland fell by €200 billion; the reduction for the covered banks (a sub-group of the ‘Domestic Banks’) was €75 billion.  Most of the deposit flight from Irish banks was in those banks not bailed out by the Irish government. 

Total Deposits by Banks

The deposit flight can be seen in the reduction in foreign bank claims on the Irish banking sector in the above table from $148 billion and the end of Q2 2010 to $83 billion at the end of Q4 2010.  It is clear it is more than just foreign banks who withdrew deposits from banks operating in Ireland – again with most of that from the non-covered banks.

Whatever the BIS data can tell us, and it is useful in some contexts, it can tell us very little about the exposure of foreign banks to the six bailed-out banks in Ireland.  As shown in the table most of the foreign-bank exposure to Ireland is to the non-bank private sector which is likely to be collective investment funds based in the IFSC.

Do we have any insight on the foreign funding used by the six ‘covered’ banks?  Yes, from this research note from the Central Bank of Ireland which looked at the foreign-funding of “Irish-headquartered banks”.  By and large these were the six covered banks (AIB, ANGLO, BOI, EBS, INBS and PTSB) but did also include some banks active in the covered bank market (Pfandbrief banks) who had their headquarters in Ireland from 2002 to 2011.

The funding of Irish-headquartered banks is usefully summarised in this chart.

Foreign Funding of Irish Banks

The conclusion is pretty straightforward:

Throughout the 2000s the UK remained the predominant source of foreign funding for the Irish banking system, representing 77 per cent of foreign funding by mid-2008.  After the UK, creditors in the US and offshore centres accounted for the most substantial shares of foreign funding at 13 and 5 per cent, respectively by mid-2008

Germany was the source of approximately 11 billion or 25 per cent of total foreign funding at end-2002.  Thereafter, absolute German funding fell quite quickly to below 5 billion, or 5 per cent, by end-2006 and to below 1 billion or 1 per cent by end-2007. Pfandbrief banks headquartered in Ireland accounted for nearly eighty per cent of this funding.

The relative unimportance of other euro area countries as a source of the Irish banking system’s foreign funding is surprising.

And the chart is done on a residence basis.  If Irish banks got funding from affiliates abroad it would be included in the above chart.  Most of the covered banks had operations, of varying sizes, in the UK.  So if AIB-UK provided funding to AIB in Ireland it is counted as UK-sourced funding in the above chart. 

It can be seen in the chart below that almost all of the increase in the foreign funding of Irish banks was from banks (the red line) with most of this from non-affiliates (the blue line) than from affiliates (the purple line).

Sectoral Profile of Foreign Funding

It can be seen that at the end of bank guarantee funding from non-affiliated foreign banks collapsed from around €55 billion to around €5 billion.  This was offset by an equally sharp but temporary increase in funding from foreign-affiliated banks.  By the time of the bailout (the middle of the dashed lines) the amount of funding owed by Irish-headquartered banks to foreign banks was very very small.

Of course, the above data doesn’t allow us to pierce through and see where the affiliated foreign banks were getting the funding they were providing to their Irish parents. 

All this really shows is that in November 2010 German, French and UK banks were not in hock to the failed Irish banks.  The Irish banks did get funding by the UK interbank market but that ended with the guarantee a couple of months previously.  At no time did the Irish banks access significant funding from German or French banks.

The ECB did not force Ireland into a bailout and require the repayment of senior bond in Anglo and INBS to save German and French banks; it was done to save the ECB itself which was owed €150 billion by the Irish banks and was trying, and failing, to keep the European banking system fluid.  The ECB was ensuring that it got its €150 billion euro back and was trying to save face because as a central bank it can’t go bust.

Philippe Legrain is right to point out that ECB forced Ireland into costly actions such as the repayment of €6 billion of senior unsecured (and by that time unguaranteed) bonds in Anglo and INBS.  He is wrong to say it was to save German and French banks.  By November 2010, foreign funding from non-banks (c. €25 billion) was much larger than from foreign non-affiliate banks (c. €5 billion) and foreign affiliate bank funding was largest of all.  It is likely that most of the €6 billion repaid on those bonds went to non-banks.

Why did the ECB bounce Ireland into a bailout?  It wasn’t to rescue German and French banks.  It was probably to ensure that Ireland did not have the time to make provisions to put an alternative currency in place.  We don’t know if the government had a Plan B in place in November 2010, and even if there it it is likely to have been something that had close to zero chance of actually happening, but the ECB wasn’t going to give them the opportunity to think about it.