I thank the committee for inviting me to the meeting today. I have circulated a briefing paper on the topic we are covering. There are many technical issues related to this topic and the paper covers many of them in detail. I will be happy to take questions on any of those issues later. In my opening remarks I will focus on the key policy issues, which are not as complicated. I will briefly describe the balance sheet of the organisation known as the Irish Bank Resolution Corporation, IBRC, what exceptional liquidity assistance, ELA, is and the role played by the European Central Bank, ECB, and I will discuss some ideas relating to restructuring of the promissory notes.
With regard to the IBRC, it is well known that the State has taken on huge debts that were previously the obligations of the privately owned financial institutions Anglo Irish Bank and Irish Nationwide Building Society, and it is well known that many of the debts were money owed to unsecured, unguaranteed bondholders. For this reason, much of the commentary still focuses on the idea that the burden of rescuing the IBRC institutions can be reduced by changing policies towards unguaranteed bondholders. However, it is worth stressing that the amount of unguaranteed, unsecured IBRC bondholders, at this point, is quite small at approximately €1 billion. That is small compared with the total debts of that organisation, which are still very significant. I estimate that the vast majority of the money owed by the IBRC, approximately €42 billion as of a few months ago, takes the form of so-called exceptional liquidity assistance loans that have been provided to it by the Central Bank of Ireland. This is a special form of assistance provided to banks that need liquidity support when they do not have the type of collateral that is used to secure a regular loan from regular euro system operations.
The IBRC will pay back its debts using two types of assets. The first is the loans that are still left on its books, the second is its promissory notes. Without the promissory notes the IBRC would have sufficient assets to pay off the remaining depositors, all of the remaining bondholders, all the money it has borrowed in its normal euro system borrowings and some of its ELA. Effectively, in that sense, one could say that the purpose of the promissory notes at this point is to pay off the ELA debts to the Central Bank of Ireland.
With regard to those debts, public coverage of this issue has been a little confused about two areas. The first is the role of the ECB. I have provided a full description in the briefing paper of the mechanics of what happens to the various balance sheets when ELA is issued and repaid. It is not the case, as has been reported in various media outlets, that the Central Bank of Ireland borrowed the ELA money from the ECB. Like all euro system monetary operations, ELA is money that was created at the relevant country's national central bank, in this case the Central Bank of Ireland.
The role played by the euro system and the European authorities relates to the fact that central bank lending to institutions that are insolvent violates the monetary financing element of the European treaty. Also, the ECB governing council can stop the ELA programme if two thirds of its members vote that it interferes with the ECB's objectives. In practice that means the ELA programme and all matters relating to the solvency of the IBRC have been under constant review by the governing council. Effectively, the payment structure for the promissory notes - we will have more to talk about in that regard over time - represents an implicit long-term timetable for the ELA. If the money is being put into the IBRC via the promissory notes in this fashion, that sets a schedule for how the ELA will be repaid. That is the role of the European authorities.
The second area of confusion relates to what happens when the ELA is repaid. As the ELA repayment goes from one publicly-owned body, the IBRC, to another public body, the Central Bank of Ireland, some people have concluded that these transactions are completely circular and there is basically no cost to the State. The truth is less attractive. When the IBRC repays its ELA debts, the money that was originally created to give the bank the ELA loans is destroyed and taken out of circulation. It is as if the money is being burned. There is no hidden benefit to the repayment of ELA. That means €3.1 billion per year, or 2% of GDP, is a full net cost to the State. There are no hidden benefits. This is a heavy financing burden on the State for the coming years, and any way we can restructure this to lighten the load on the State would be very beneficial.
Most of the public discussion of the cost of the promissory notes has ignored the question of the bank's ELA liabilities. To the extent that people have focused on restructuring the notes they have focused on the high average interest rate the notes carry. One regularly sees commentary pointing out that the total amount of payments on the notes will add up to €48 billion by 2031, which is €17 billion more than the original principal of €31 billion. In fact, reducing this interest rate will have very little impact on the long run cost to the State of the IBRC. Once the IBRC has repaid its ELA debts to the Central Bank of Ireland, it can be wound down and the notes can be cancelled at that point. The interest rate on the ELA is much lower than the interest rate the bank is getting on the promissory notes. Effectively, it is accumulating money inside it. I give an example in the paper.
I reckon that by approximately 2022, on the current schedule, the IBRC can be wound up. The total amount of payments that would have gone to it would never have been €48 billion but €37 billion. In fact, most of the difference between that €37 billion and the €31 billion that was originally borrowed from the Central Bank of Ireland would remain as profits inside the Central Bank which could go back to the Exchequer.
While over the long run there is very little benefit in reducing the interest rate, there is a shorter-term issue, which is that EUROSTAT will count the interest on the notes, starting in 2014, at a much higher rate than it has been counting it over the past couple of years. That €1.8 billion will be counted on our deficit. When I refer to the long run I mean that at some point in the future when the Irish Bank Resolution Corporation, IBRC, is wound up much of the interest that was supposed to be paid later will be cancelled. All of this comes out in the wash, so to speak, but that does not change the fact that in 2014 there will be a charge of €1.8 billion against the deficit as measured by EUROSTAT and focused on by the troika. This is something that should be reworked.
It is not 100% clear why the notes carry such a high interest rate, and we could talk about that in more detail, but effectively it means that when the notes were issued they were given an accounting treatment. That means they were what was called "mark to market" and treated like Irish Government bonds that were being sold on the open market. In fact, these bonds are not being held on the open market. They are not being held in what banks would call their trading book. Effectively, they are being held to maturity.
I do not see any problem with the technical solvency of the IBRC in terms of reworking the notes with a lower interest rate and valuing them at their face value. That can be dealt with but that does not reduce the longer term cost. The most effective way to restructure the notes is to simply defer the payments on the notes for a number of years. For instance, the payments could be delayed until some quantitative benchmark is reached such as when the level of GDP returns to its pre-crisis peak level. At a minimum the payments could be suspended until the point where the IBRC has already used the assets it has, namely, the loans and the income it is getting in, to pay off all of its debts, which would include some payment of ELA. Even if we put no more money in it over the next few years it can pay back some ELA.
It is likely that members of the European Central Bank governing council have already discussed this issue - it is considered on a regular basis - and it is likely that many of them object to a plan to delay promissory note payments. It is most likely that some of them see it as a bad precedent in that other countries will then want to use ELA for their banks and not pay it back or pay it back very slowly. They may also see a slow repayment of the ELA money that was created as a weakening of their commitment to low inflation.
The truth is that there is no slippery slope in regard to ELA. All ELA operations must be approved by the members of the European Central Bank governing council. It is up to them. They approved this programme because they wanted to see the senior bondholders and depositors in the IBRC institutions paid back. As far as they were concerned that was beneficial for European financial stability. Any future ELA decisions they make are up to them. The way this money is paid back does not lead to any sort of slippery slope or moral hazard problems.
Regarding money growth, the rate of money growth in the euro area is extremely low. There is no inflationary genie about to get out of the bottle. That should not be at the top of anybody's list of European policy concerns.
Any step that can be taken to hasten Ireland's departure from the EU-IMF programme are in the interests of the eurozone member states and the Irish people. A reduction in the funding burden associated with the promissory notes represents the most simple way to enable Ireland's debt burden to be lowered and a return to borrowing from sovereign bonds.
Some hope has been given that there may be some progress on this issue in terms of various comments from politicians. My suspicion is that any progress we will see will be incremental, and that this is likely to be a long-term campaign. It is very important for Irish politicians to understand the issues, know what we want and to make the case to European politicians and the European public at large.