JOINT COMMITTEE ON ECONOMIC REGULATORY AFFAIRS díospóireacht -
Wednesday, 10 Nov 2010

Stability of Irish Economy: Discussion with Governor of Central Bank

Chairman

The Governor of the Central Bank is in attendance to discuss the stability of the Irish economy. On behalf of the committee I welcome from the Central Bank, Professor Patrick Honohan, Governor, Mr. Bernard Sheridan, assistant director general for consumer protection, and Ms Anne Marie McKiernan, head of organisational risk.

By virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of the evidence they give to the committee. If they are directed by the committee to cease giving evidence in regard to a particular matter and continue to do so, they are entitled thereafter only to qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and asked to respect the long-standing parliamentary practice to the effect that, where possible, they should not comment on, criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable.

Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the House or an official by name or in such a way as to make him or her identifiable.

There is to be a live webcast of this meeting. I ask Professor Honohan to proceed with his presentation.

Professor Patrick Honohan

I thank the Chairman for inviting me to discuss issues of economic stability with the committee. I thank him for mentioning my colleagues who are accompanying me today.

The topic could not be more relevant, as I need hardly remark, and although it is specifically financial stability that is the most explicit part of our remit at the Central Bank, we also have as one of our main explicit objectives as set out by the Oireachtas in the Central Bank Reform Act passed a few months ago, the provision of analysis and comment to support national economic policy development. It is in that wider spirit that I approach our discussion today.

Clearly, this is a time of considerable risk and balance sheet stress in Ireland. One way of thinking about this is that banks, households, firms and the Government have all been under pressure and what inevitably will be a lengthy period of balance sheet repair is in progress which will involve the consolidation of net spending.

I will begin my introductory remarks with the banks, whose behaviour has been central to the situation that has emerged both because of their own losses but also because of the fact that the property price and construction bubble, which they fuelled with credit, created vulnerabilities in the financial position of other sectors, including the Government.

The banks as a group went into the downturn more exposed than most other banking systems internationally and, correspondingly, have had to cope with worse loan losses than most. The regulatory response over the past few quarters in Ireland has aimed at making the banks less vulnerable to confidence shocks or adverse sentiment. The scale on which bank capital has been replenished is very large, though the favourable impact on investor confidence has not yet been as strong as might have been hoped for. Much of the reason for the slow return in confidence lies in the parallel weakness of the fiscal situation, a weakness which also has its roots in the credit-driven property bubble, which lulled the managers of the public finances into a false sense of security, so that we ended up with a tax and spending structure that was highly vulnerable to the downturn. With the Government finances so stretched, the additional burden of recapitalising the banks has reduced fiscal headroom and contributed to the concern of the financial markets. However, as I have been reminding foreign observers, the recapitalisation burden is often overstated as a contributor to the required fiscal adjustment. Indeed, the interest cost of servicing the notes injected to recapitalise the banks only accounts for about one tenth of the fiscal adjustment now in prospect over the next four years.

I will not rehearse here the details of the scale on which capital has been injected into the banks, of which members of the committee will already be fully aware, but it is important that relevant foreign investors have this information at their fingertips so that they can run their slide rules over the figures and see the extent to which buffers have been created, not only to absorb the loan losses that can be fully expected to occur in the next few years, but also to take account of any additional loan losses over and above what has been projected as likely. I sense a concern in the market that other problems might be hiding somewhere in the banks. This may be due to the fact that the later NAMA loan tranches involved more severe haircuts than the first. Of course, the NAMA loans have all been settled now in terms of their prompt transfer.

Attention has naturally focused on the residential mortgage book and the scale of the loan losses that must be allowed for. Although the actual accounting provisions taken by the banks on this portfolio are small, the Central Bank has insisted that allowance be made for much higher loan losses. The stress case loan loss ratio of a little more than 5% up to 2012, as used by the Central Bank for the Irish residential loan books to determine required capital levels, is well outside historic experience in Ireland. Despite recent trends in arrears and rescheduling, there is as yet no hard indication that the stress levels would be exceeded. In anticipation of next year's update of the prudential capital assessment review, the Central Bank is embarking on a more granular analysis of this part of the portfolio, with a particular focus on tracking its evolving performance and determining whether the expected loss amounts remain sufficient. Undoubtedly, there are many stressed households with burdensome mortgage debts, not least in the buy-to-let category. The policy challenges that this presents in terms of achieving workable and fair solutions are more complex than the mere issue of the likely loan losses that might be involved.

Presumably, overcapitalising the banks could help build confidence, but this is not something that the State can be lightly asked to do, given the pressures on its finances. Indeed, the market's perception of the stressed condition of the sovereign is surely weighing on the banks in terms of interest costs and ready access to funding, just as the banking problems have weighed on the sovereign. Liquidity issues for the banks relate to the working out of the portfolio imbalances that had accumulated by 2008, specifically the very large loan-to-deposit ratio, which entailed borrowing abroad on a large scale. Much of this exposure to roll-over and withdrawal risk has been transformed into a claim from the ECB. Over time, this block of legacy indebtedness will be run off, a process that could be assisted by the sale of securitised parts of the portfolio, as I have been discussing elsewhere.

I now turn to the need to stem the deterioration in the Government's balance sheet and return it to a contained convergent path. Much ink has been spilled on this matter in recent days and weeks, and I do not need to provide much background. For the record, I strongly endorse the Government's decision to set out a multi-year budgetary plan. The need to announce and implement a clear and fully specified plan to bring the public finances onto a credibly convergent path of debt dynamics is of the utmost importance in restoring domestic and international confidence and thereby unblocking growth dynamics and restoring access to international capital markets at reasonable cost. I also regard the parameters that have been announced - €6 billion in savings this year, €15 billion in savings over the four years, and a deficit target of 3% of GDP by 2014 - as being within the credible range and a good basis for rebuilding confidence.

That is on the Government side, but household and business balance sheets are also stressed. I have already referred to the over-indebtedness of some households, not least those affected by the increase in unemployment. The Central Bank has specific responsibilities to work through these issues to ensure that distressed households are dealt with properly by the banks. My colleague, Matthew Elderfield, who has participated in the expert group on mortgage arrears, spoke publicly on these matters recently. I do not need to add anything to what he has said, except perhaps to emphasise and reiterate that in using the word "manageable" in recent times, when referring to the costs of bank recapitalisation, I have of course been referring to the overall fiscal programme. It is an important message for me to transmit to investors, drawing their attention to the fact that these costs are clearly not unmanageable. I have not referred to the consequences for individual households of the downturn and the fiscal measures already taken or contemplated; it would be more than impertinent for me to do so.

Finally, there is the question of the business sector. Here, more work is also required to restructure the finances of many small firms whose underlying viable business is threatened by the overhang of property-related debts that they accumulated on the side, so to speak. This is a challenging job for the banks to tackle, and it needs to be done expeditiously in order to ensure that viable businesses are not overwhelmed but can instead resume their contribution to the economic recovery. I look forward to the questions and the discussion.

Deputy Seán Ardagh

One item of particular interest and concern at the moment is the bond rate and the spreads against the German rate. In the opinion of Professor Honohan, what effect have the recent remarks by Angela Merkel, to the effect that bondholders may in future have to take on some of the risk when they invest in sovereign bonds, had on the bond spread?

Professor Patrick Honohan

The bond yields on Irish Government securities have been increasing sharply in recent days and again today.

Deputy Seán Ardagh

What is the yield at the moment?

Professor Patrick Honohan

It had gone up by 100 basis points at the two-year rate, including over 50 basis points today. I was referring to the change on the day, which was very sharp indeed.

Deputy Kieran O’Donnell

The latest report is that the yield is 8.39%.

Professor Patrick Honohan

Yes. I could take out my BlackBerry, but I will not.

The German proposal is a bail-in of private creditors, if you like. It is a term that used to be used but has not been much used recently. The idea is not a new one, but it comes at a time that is inconvenient for a country whose bonds have been under scrutiny. If there were no other problems, this would not have affected our bond rates, but with all the adverse focus on our bonds, it has had an effect, although I would not like to quantify it exactly. That is the view in the market. My interpretation of the proposal is that it is for the future. There were many discussions, after the extensive international bailouts over the past couple of years, about restructuring financial affairs - for example, the capital of banks - in such a way that a wider group of investors would be placed in a position of absorbing losses, so that the burden does not immediately pass to governments.

The discussion has been going on in the context of the new self-financing requirements for banks under Basel III. This agreement entails the banks drawing more of their resources from truly risk-sharing investors who can be made to absorb risk without the bank being shut down. The German idea on sovereign debt is, in a sense, an extension of that. It involves the structuring of future borrowings by governments in such a way as to allow more readily for a bail-in of private investors, so that more loss-sharing would be involved. People appear to have jumped ahead to making a presumption that this is something that would definitely and unconditionally be applied to existing bondholders for existing countries facing a debt workout from their current situations. In fact, it is a proposal for the future, one that requires much more articulation and discussion. We are seeing a response in the market to the market's concerns about how market participants would be affected by this when it settles down, but we do not know how it will settle down. It is not a definite concrete proposal and it does not immediately apply. I would like to see how that works out over a period of time. Has it destabilised the markets? It certainly may have to some extent.

Deputy Seán Ardagh

With regard to the need for more sovereign debt in the future, probably in the second quarter of next year, what exercise does Professor Honohan intend to carry out? He travelled around the financial capitals not long ago and successfully put the case for Ireland, after which we were able to buy bonds at a reasonable rate. What efforts does he anticipate being put in place before the next bond auction to try to mitigate the level of the yields at that time? What does he expect the yields to be in June 2011?

Professor Patrick Honohan

First, I am not a bonds salesman for the Government. That is the job of another agency, and it does a good job of it too. The most important thing is that our story be understood outside, and that has been my goal and the goal of others in our communications. We do not always get heard in the way we hope, and sometimes we are not heard at all. A very experienced journalist said to me the other day:

I understand now that you made a big effort in March to determine how much the banks would need, at least, and to require them to put more capital in. I know about that exercise at the end of March now, but at the time I was concentrating on Greece so what happened in Ireland really passed me by.

That reflects what happened. It is as if we rise above the parapet from time to time. People catch glimpses of small countries such as Ireland, and it is usually bad news that brings us above the parapet. If we have news that we are taking certain steps on the way to fixing things, it will not get above the parapet easily and will not make the headlines. People then have to catch up quickly when there appears to be bad news in Ireland. They look back and see that the losses are much bigger than they thought, because they did not look at what was going on unannounced in March.

Communicating what is happening is very important. We have adopted an approach - it is adopted by NAMA as well as the Central Bank and is the view of the NTMA - to lay out everything clearly. Some people have said it might not be good to lay out everything clearly and that we might get away with hiding stuff. I do not believe that is the case. Perhaps bigger, stronger countries with unquestioned credit-worthiness can get away with not over-emphasising or going into detail about their problems, but if a small country such as Ireland has a big problem and it does not lay it out clearly, trying to give chapter and verse and to be convincing in detail that we have understood the scale of the issues and how to deal with them, a question mark will hang over us. That is what we are trying to dispel with our transparency. To some extent, until we build a convincing track record on this, markets will say we are probably like some other countries that are not as forthcoming when they encounter problems. There is communication of what we are doing.

Of course, nationally we must do the job that will bring us back onto the stable path. That is where I return to the budgetary plan for 2011 and the four-year programme. This must be convincing and its scale must be convincing. It must convince outside investors that a programme of this scale will be implemented and that the first necessary steps of 2011 are being implemented, including the details of that plan. Once that is happening, one can sell a convincing story. Then one will get the yields down. What is a steady state yield for Ireland and how soon will we get there? It is a hard question. We will never get back to the yields we had before the crisis, such as in 2005 and 2006, when just being in the euro area was enough to convince investors that 20 or 30 basis points above Germany would do the trick. We will never get back there because the crisis has exposed the scale of the risks that can be involved. Investors will want to be compensated for that, but not at anything like the current scale. These are crisis levels of yield. These will not continue.

Deputy Seán Ardagh

I have a final question. I asked a previous Governor of the Central Bank why he and the Central Bank did not state that there was a bubble which was about to burst. He said he had, but that people did not listen to him. Professor Honohan said in his presentation that one of the explicit objectives of the Central Bank is the provision of analysis and comment to support national economic policy development. How does he know that the bankers, developers, Government, Department of Finance and all the other players will listen to him?

Professor Patrick Honohan

There are a number of answers to that. First, I can repeat what I am saying in public, so everybody can hear it. Obviously, I do not repeat every sentence I might say in private but I am not making any secret of our views on the current situation. That is important. With regard to other entities such as banks and regulated institutions, we have extensive powers to require them to take actions to mitigate risks if they have not taken those actions themselves. We have powers as well as communication. For the general public, we can only make as many speeches as the newspapers will print.

Deputy Kieran O’Donnell

I welcome the Professor Honohan and his colleagues. The cost of borrowing has reached 8.39%, which is unsustainable. What cost of borrowing does he believe is sustainable for the Irish economy in the future, taking into account that growth and inflation should effectively be higher than the cost of borrowing?

Second, the Government has stated that one of the reasons it had to go from €7 billion to €15 billion in cuts was due to the downturn in other European and world economies. In fact, the growth rates for the eurozone have been revised upwards. Will Professor Honohan comment on that? In that context, how have we gone to doubling the cuts that are required when many of the world's economies are doing better than was forecast this time last year?

Third, the guarantee was extended today to the end of June next year. Mr. Jean-Claude Trichet said in the past week that he wishes to wean countries off the guarantee. Is Ireland like the weak calf that will never be weaned? How long does Professor Honohan believe the guarantee will be required? How will the banks survive when it is withdrawn?

What level of debt to GDP becomes unmanageable, to use the term in the presentation? Professor Honohan uses the term "manageable" and reinvents it to be unmanageable. It is a bit like saying "It is not legal, but it is not illegal either." It is a kind of play on words. Perhaps Professor Honohan will respond on that.

Anglo Irish Bank is currently renegotiating with its subordinated debt holders. Does Professor Honohan believe the other covered institutions should engage in similar mutually agreeable renegotiations? On the question of mortgage holders, Professor Honohan stated that 5% has been provided for losses on the mortgage book. However, we have seen that up to one third of the mortgage book of one of the institutions is impaired and in arrears. How can we deal with the looming mortgage crisis?

In his address, Professor Honohan, when speaking about how we got to be where we are, mentioned a weakness which also had its roots in the credit driven property bubble which lulled the managers of the public finances into a false sense of security. When speaking about the managers of the public finances, does he mean the Government or the regulators? In my opinion, regulation was one of the key issues and the professor's report on banking referred to that factor and to tax driven projects. Will he elaborate on what he meant? While the banks were reckless, they were allowed to be reckless.

Professor Patrick Honohan

There are a lot of questions to deal with. On the cost of borrowing and what would be sustainable, the Government is not borrowing at these rates. These are rates being transacted between investors taking speculative positions for or against and so on and so forth. It is a sort of game between those people. However, it is not irrelevant in influencing perceptions of where the market, on average, thinks the risks lie. These rates would not be sustainable and we could not imagine them going forward.

Deputy Kieran O’Donnell

What rate would be -----

Professor Patrick Honohan

I am coming to that. The textbook model is that the rate of interest should, if one is to get into a stable situation where the debt does not grow without continued further fiscal contraction, be below the real growth rate plus the rate of inflation. The aim of the ECB is to keep inflation rates below, but close to, 2% in the medium term. People have suggested that the growth rate in the medium term for Ireland would be approximately 3% and they have been regarded as pessimists. That brings us right up to 5%, to put in the pocket. That is the textbook model.

Deputy Kieran O’Donnell

Can we come back to what the Government suggests in its information? It has stated that the growth rate for 2011 will be 1.75% and the inflation rate will be 0.75%. That only brings us to a rate of 2.5%.

Professor Patrick Honohan

The Deputy asked a question about the medium term, but is now asking about interest and the growth rate. I am talking about medium-term analyses. I am giving the Deputy the medium-term interpretation.

Deputy Kieran O’Donnell

What rate would the bond markets have to be willing to offer in January and February so that we could go back into the market and borrow?

Professor Patrick Honohan

One could borrow at above what one wanted to be paying in the long run. This long-term equilibrium condition has nothing to do with one's -----

Deputy Kieran O’Donnell

What rate is sustainable?

Professor Patrick Honohan

One could borrow one lot at a very high rate of interest. Some borrowing was carried out earlier in the year at rates that were higher than one would want to see.

Deputy Kieran O’Donnell

I appreciate what Professor Honohan is saying, but it is a bit abstract for me. We are in a position currently where the National Treasury Management Agency, NTMA, has stopped borrowing on the international markets because the cost of borrowing is too high. It is 8.39% today.

Professor Patrick Honohan

I believe that if the Deputy asked the agency why, it would have a different reason for this.

Deputy Kieran O’Donnell

With due respect, the agency was borrowing for forward funding. Everybody knows that if the rate of borrowing is above 6%, it is generally regarded as unsustainable. The point I am making concerns the rate that will apply in January or February when, as we understand, we will have to borrow again from the international markets. What rate will the bond markets have to offer then in order that the professor would advise we borrow or above what rate would it be unsustainable to borrow? If the rate is unsustainable, what rate does Professor Honohan expect will be offered by the rescue fund or anyone else?

Professor Patrick Honohan

The Deputy has asked a number of questions there and has introduced other possible sources of funding. The question of sustainability has to do with the long run, not with one auction, one year or two years. That is a different consideration compared with sustainability. Borrowing the requirements for one or two years at a higher rate than would be applied -----

Deputy Kieran O’Donnell

I am talking about the ten-year borrowing, which is normal.

Professor Patrick Honohan

Borrowing at a ten-year rate for a small portion of one's total borrowing needs could be done at rather high interest rates. These are tactical decisions taken by active market participants such as the NTMA. They decide when it is good for them to go into the market to present a realistic borrowing programme that attracts investment.

Deputy Kieran O’Donnell

Is Professor Honohan saying they may not go back into the market in January or February?

Professor Patrick Honohan

I am saying there is no simple figure. I am not going to say they should wait until the interest rate goes to 6% and then borrow. It is not like that.

Deputy Kieran O’Donnell

That is not the question. We understand that in January or February the NTMA must go back to the market. Looking at growth and inflation rates, what rate or level would Professor Honohan as Governor of the Central Bank advise the Government and the NTMA he considers sustainable for the Irish economy?

Professor Patrick Honohan

I will not set out any single rate as an absolute. It depends on the dynamic of sentiment in the market. This is a very technical area. However, I will readily agree that the existing interest rates are well above the rate at which one would go back into the market.

Deputy Kieran O’Donnell

With due respect, the professor is avoiding the question. It is a reasonable question.

Professor Patrick Honohan

I will try to answer the question. There will be a point at which it will make a lot of sense for the NTMA to go back into the markets. That point will be determined not simply by the rate of interest, but by issues such as the flow of sentiment in the market, the size of the cash balances and effectiveness in achieving the budgetary adjustment. It will be influenced by far more than a simple interest rate.

Deputy Kieran O’Donnell

Is it not fair to say that unlike other countries, Ireland must be able to borrow over the next two or three years or it will not survive as an economy? There comes a point when the rate of borrowing is unsustainable. Ordinary people watching what is happening see that the Government is not able to borrow in the international markets currently at rates that are sustainable and they are entitled to know at what rate it would be sustainable. We are producing various plans and the Government guarantee is being extended again today, with the objective of bringing down bond yields in the international markets for Government stock.

Professor Patrick Honohan

The Deputy's suggestion is that it would be useful for the funding of the Irish State or the NTMA to set out a rate of interest at which they will come back into the markets. This would probably not be an effective strategy in lowering the cost of our funding.

Chairman

Perhaps Professor Honohan will now deal with the other questions.

Professor Patrick Honohan

With regard to how long the guarantee will last, I measure the guarantee in quarters rather than years. We have had a significant set back since the sovereign debt crisis emerged and sentiment moved against Ireland. That has put back the preferred time to terminate the guarantee. I had no hesitation in endorsing the guarantee's extension until June next year. It is possible sentiment towards the banks and the fiscal measures to bring matters back under control will have improved to allow for the guarantee to finish in June 2011. It is also possible the guarantee may be needed for several more quarters.

All of the banks have bought back some of their hybrid capital instruments over the past two years. The particular transaction that Anglo Irish Bank was involved in got much more attention because of the focus on its restructuring and the clause that people who had not signed up to it would have to take it. Anglo's situation is rather different to that of the other banks, which are continuing to develop new business. It is important to distinguish that Anglo, as the Government has announced, will not be doing new business.

There has been much discussion about mortgage holders and defaults. I have had this matter on my mind for some time. It is a large block, but not as large as one might think, of the banks' books. Is the 5% write-off provision we introduced enough? So far, there has been no indication in the trends of arrears in and rescheduling of mortgage repayments that losses for the banks will materialise above the 5% mark. We are watching this carefully, however, and a more detailed granular analysis will be conducted on it. It will examine the types of households and so forth falling into arrears. It is not a question of doing this based on a lump of losses already there. Many of these mortgages have 20 years to run and their performance will evolve over time. We will have to track how they perform in response to the changing economic situation with unemployment and economic growth.

If we find the allowances are insufficient during the banks' capital adequacy review early next year, they will require more capital. If not, then there is no need to overcapitalise the banks. The Government is not in a good position to do that anyway.

I used the term "the managers of the public finances" to be somewhat all-inclusive because there are different agencies and people involved in this process. It also includes officials and Government authorities.

Regarding a sustainable level of debt to GDP, I detected some criticism of the word "unmanageable". I have never used that word before for good reason. In March if I had said this is not unmanageable, it would have attracted attention from the wire agencies which, in turn, would have thought this was more serious than originally thought. Now some in the bond markets are asking those sorts of questions. I find it easier to call it not unmanageable. Some people felt a little bit miffed that I would be saying, "Take the medicine". That is very far from my view on this.

The International Monetary Fund, IMF, recently published a paper trying to pinpoint the question concerning defaults which examined a range of countries, including Ireland. We came well under the figure that would cause the IMF concern.

Deputy Sean Sherlock

I welcome Professor Honohan and his colleagues to the committee. It is good we are having this frank and open discussion.

Professor Honohan referred to burdensome mortgage debt, the buy-to-let category and the policy challenges arising from this. Will he give a more unambiguous view as to how active policy interventions can assist those ordinary mortgage holders at risk of defaulting? While I understand the points about capital adequacy ratios and the 5% write-off provision, the language used in describing this problem should be less abstract and provide some comfort for those mortgage holders pinned to their collars.

David McWilliams and others have posited the notion of debt forgiveness for mortgage holders. Is that a tenable proposal? Has the Central Bank information on private banks' bad debt provisions for residential mortgages? Is there an oversight mechanism in place for the various stages of default from a mortgagee moving to interest-only payments to actual arrears?

A report in last week's edition of The Sunday Tribune stated the European Central Bank holds €18 billion in Irish sovereign bonds, 20% of the total debt. For how long more will it keep purchasing Irish debt? Are we wholly reliant on it now?

We are trying to get a picture of how austerity measures and achieving growth will help get us out of the economic morass in which we find ourselves. It goes back to the language used in these discussions which is often suitably vague. I will have to go back and read some of Professor Honohan's answers three times to interpret them and read between the lines. Clear and unambiguous statements on the economy are needed not just for the committee but also for the wider audience.

Professor Patrick Honohan

The Deputy's last remark reminds me of something. Can I tell a joke?

Deputy Seán Sherlock

Somebody needs to lighten the mood.

Deputy Kieran O’Donnell

It might bring the bond yields down.

Professor Patrick Honohan

That is very unlikely. The other day, I was talking to a group of central bankers. At that meeting somebody, whose native language was not English, meant to convey that central bankers should be absolutely clear in what they say. That is not the tradition, however, and there are sometimes very good reasons for it not being the tradition at certain moments, perhaps including the present moment. Misusing English, he said: "The least we can expect from a cental bank is that it be ambiguous." He meant to say "The last thing we can expect...".

Deputy Seán Sherlock

We hope Professor Honohan will not take him literally in dealing with these questions.

Deputy John O’Donoghue

I knew a Taoiseach who was always deaf in one ear.

Professor Patrick Honohan

To get back to serious issues, the Deputy is asking about the other side of this matter. We were looking at how it imposes losses on the banks and therefore on the taxpayer who owns a large block of the banks, but the Deputy is looking at the other side of it - the households that are in distress.

Deputy Seán Sherlock

The households, yes, and we need to drill down to that level.

Professor Patrick Honohan

This is a tough subject for the following reasons. Those who are indebted include people who can pay and others who cannot. It is difficult to distinguish between those who cannot pay and those who will not do so. If one does not distinguish between them it is massively unfair and therefore risks the sort of things to which some people have referred, such as a complete political rejection of our borrowing and lending regime. That is why people do not go down the route of a crude system of debt forgiveness.

Is there some way of distinguishing between them? The expert group has made an interim report and I understand that its final report is coming up soon. It has been thinking about this and has some proposals to make. It has already made a large number of interim proposals. Other countries, including the United States, have made considerable efforts to find solutions that help people to stay in their houses if they can afford to do so, even if that imposed some loss on the lender, especially if the alternative was a mess with people losing their houses and the lender losing money in the recovery. The design of those schemes has not been terribly successful so far, in the United States in particular, but the number of people participating in them has been improving.

Our approach in Ireland has been that the banks have always taken a very long view. They have said: "If we sit this out, we will get repaid". The borrowers or mortgage holders want to live in their house and will pay when they can, so the banks have adopted a very long view of rescheduling. Of course, statutory obligations are imposed by the Central Bank to reschedule in the first instance, but the banks were doing that already. That has been their practice.

I saw that Mr. Matthew Elderfield cited repossession numbers for Ireland compared with the UK environment, which to some extent has not been too keen to repossess compared with the United States. In Ireland, there were 11 repossessions per 100,000 in the second quarter of this year, compared with 82 per 100,000 in the UK for the same period. The numbers in the US are vastly different. Therefore, transferring ideas from the US to Ireland about how much loan losses there will be can be very misleading because of the different nature of that country's mortgage business.

What is the Central Bank doing about it? The expert group made 41 recommendations, although I do not know them all off by heart. I did not sit on the expert group, but the Central Bank has published a consultation paper. Perhaps Bernard Sheridan can speak about this in a moment. We have to do consultations before we take statutory measures. We have published the consultation paper to implement these changes through a statutory mortgage arrears code.

The broad picture is that people in difficulties are aggrieved by big property developer borrowers, some of whom seem to be in a comfortable position with their debts remaining unpaid. It is difficult to get to grips with that because big borrowers are in a position to insulate themselves in advance against risks of that type, and to distance themselves from the loans they have accrued. Our legal system allows that to happen. It is not easy to change that, so there is going to be an unfairness which I cannot see a way of resolving completely. Perhaps Mr. Sheridan can speak about some of the specific measures. They are the group's interim measures, not the final ones.

Mr. Bernard Sheridan

We have an existing code in place and the main rule there is the 12-month moratorium. We have been out inspecting the lenders to ensure they are adhering to that and we have found high levels of compliance. We are now going to strengthen that code primarily as a result of the recommendations of the mortgage arrears group. We are proposing to stop other measures, such as switching people off tracker mortgages just because they have got into arrears. That will be in the new code. We are also proposing that arrears charges will have to stop. Hopefully, we will have the new code in place by the end of November, to be in full force early next year. We have intervened and continue to intervene on behalf of consumers to ensure they are given the time to try to sort issues out. There are occasions, however, when the mortgage will be unsustainable. The new code will set out approaches for how those people must be dealt with.

Deputy Sean Sherlock

I appreciate that response. What about the purchase of €18 billion in Irish sovereign bonds?

Professor Patrick Honohan

In May, the ECB introduced a programme called the securities market purchase programme or SMP. This was introduced at the height of the Greek crisis because it was felt that the markets for all securities, but government securities particularly, had frozen. There was no two-way trading in them and they needed to be unblocked in order that the monetary system in Europe could continue to function normally and that the ECB's attempts to have reasonably low interest rates prevailing at the short run across Europe would work fully. It was basically an unblocking of the market. The amount of securities purchased in this programme is published weekly, but no breakdown by country or security is published. In dealing with a market operation, the last thing one wants to do is lay out to other market participants what one's strategy and tactics are. Although the total amounts are being published regularly, one would notice that in the early weeks there were substantial purchases and in more recent weeks the purchases have on average been a good deal lower. I am not in a position to tell the committee the total amount of Irish securities, if any, purchased out of this by the ECB.

Deputy John O’Donoghue

I welcome Professor Honohan and his colleagues. I thank them for being with us. Everybody will note with a degree of encouragement that he has been telling international observers that the recapitalisation burden is often overstated in the context of the overall fiscal situation, and that the banks only account for about one tenth of the fiscal adjustment which is in prospect over the next four years. That is absolutely true and cannot be stated often enough. The most disconcerting sentence in Professor Honohan's contribution is where he states that he senses a concern in the market that some other problems might be hiding somewhere. This obviously can have enormous and very serious repercussions across the entire economy. Can the Governor outline in greater detail where the problems might be hiding and the international perception of these problems? The Governor speaks about the mortgage loan book but if there are other issues hiding somewhere, it is of crucial importance that these are found and addressed in respect of restoring immediate confidence.

The Governor also stated that households feel aggrieved. This is true and there is a perception that the big fish are swimming on while small fish are drowning. That does not extend only to households but to those in medium-sized and small enterprises. They are stressed and deeply concerned about their futures. These businesses are the backbone of employment in the Irish economy. Restructuring is of fundamental importance to many small and medium-sized enterprises. While the Governor says this is challenging work, which I accept, he may agree this is urgently required. I would be grateful if he can outline to the committee the steps to be taken to address the restructuring of finances of small and medium-sized firms in order to ensure their viability.

Professor Patrick Honohan

I am pleased to have the opportunity to clarify the point about concerns that market participants might have that something else is hiding. What else could they be concerned about? This is also my question and I am asked about what else is to come from Irish banks. We made some statements of losses in March, followed by some more in September. Some people will ask when the next round will be. My answer is that blocks of information had to be assembled, piece by piece, in order to understand the inherited losses from the crash. These blocks include the first NAMA tranche, which forced the first recapitalisation and the accelerated announcements we would have preferred not to make until we were sure, the remaining NAMA tranche, the non-NAMA tranche and the Anglo portion. These unfolded over a period of time when it would have been ideal to have it all out in one go.

What else is there? I am saying there is nothing else that is not laid out. Everyone can see what is there. What they can see is residential mortgages and it is hard to be precise about this aspect because it extends over a period of time and depends not on what has been inherited but on the future path of the economy and employment. It is very hard to be precise about this. If we take the examples from the United States and apply the loan loss rates experienced in some areas of the United States, it gives a high loss rate. If we consider the historical experience in Ireland or Britain and extrapolate to current conditions, it is hard to get worrying figures. We will continue to work in that area and as soon as we get material, even if it is bad, we will publish it.

The small business sector is very important. Some small businesses will not survive given the economic conditions, irrespective of what can be done. A number of small businesses have a viable core activity on which they loaded too much debt, usually with property deals and acquisitions that were not part of the core business. That is the area in which banks have the opportunity to rescue a good business but they need to identify what is good and recoverable and separate the contracts. Will they do this? They went into this situation having depleted their loan appraisal skills, particularly in the non-property area, and they are working to build up these skills. They are distracted by the capital issues, liquidity issues and other big picture issues. We have been trying to fix this but the banks are distracted by it. They are making efforts and Mr. Trethowan, who appeared before the committee recently, provides a very good insight into the process to the extent that he sees people whose loan applications are being rejected. What he says is quite illuminating and is consistent with my appreciation of the situation, which is that banks need to continue to upgrade their ability to appraise loans and do workouts of small businesses.

Senator Paul Coghlan

I welcome the Governor and his two colleagues. Is there a conflict between the position expounded by the State, where the Government implores the banks to lend money to businesses and exercise restraint in the enforcement of security, while the Central Bank requires banks to conserve capital? How is that circle to be squared? Could the difficulties with AIB have been avoided by allowing it more time to raise the capital required to meet the requirements imposed by the Central Bank? Does the Governor accept the future banking needs of the country require two strong banks, with at least one international bank with a strong presence in the country? Does the Governor accept the State has a bad record of running banks and that civil servants are not equipped to make decisions on risk, investment or enterprise? Should the strategy not be for the State to get out of the banks as soon as possible? What timescale should apply? What is the view of the Governor on the prognosis outlined by Professor Morgan Kelly?

Professor Patrick Honohan

The first question suggests people may be pulling in different directions, that the Central Bank may be anxious that banks hold back and not lend to the economy while the Government wants them to lend. I do not accept that. The Central Bank has specific responsibility, through its regulatory function, to ensure the banks are safe and sound, to ensure they have enough capital and to ensure they are funding themselves in a prudent way so that money will not run out. The banks must be run well. In anything but the shortest of terms, that cannot be an obstacle to them doing good lending business because if one does not have sound banks with enough capital and access to funding, they will not have the wherewithal to take risks by making loans. We are in the position of rebuilding the capital and liquidity situation of banks so they can move forward. It is not the case that we are asking them to be careful with the lending they are doing because they will run out of resources but rather that we have insisted on and succeeded in getting enough capital for a risk buffer. The Central Bank is working hard to provide liquidity and replace liquidity lost to international wholesale funders. I do not accept the premise that we are pulling against the provision of credit. Credit must be sound and the important thing is to build the appraisal skills so banks know the difference between a good loan and a bad loan and are not frightened away from both types of loan because managers are afraid of being censured for bad lending.

Senator Paul Coghlan

Does Professor Honohan accept that there is a huge policy of retrenchment on the part of the two main banks at the moment as regards ordinary working capital for existing established businesses? Many businesses are being called in about the renewal of loans and other such matters. The requirement is being greatly reduced.

Professor Patrick Honohan

That is absolutely true, but it is true primarily on the basis that the banks are nervous about the risks they took in the past and are trying to reduce them. It is not that they do not have sufficient capital because that was considerably augmented. It is not that we require them to hold additional liquidity buffers because we do not.

Senator Paul Coghlan

As we are aware, in some specific instances this is greatly impeding trade.

Professor Patrick Honohan

I am well aware of those comments and criticisms that are coming from customers. I stress that it is not part of our policy to block it.

Deputy Damien English

It is not just comment; it is the case that small businesses are not getting money.

Professor Patrick Honohan

The question is whether AIB should have been given more time. I do not think so. The chances of AIB raising capital in the private market in current circumstances in any short timeframe are essentially nil. There was no practical way of ensuring that AIB has enough capital to go forward than to call a halt and say now is the time. Some people abroad asked why we did not work more quickly at recapitalising the banks. We said "No", that we had to give them a reasonable number of months in which to raise the capital. AIB did its best. It put its best foot forward. AIB realised cash from the non-core assets but that did not add up to enough in total and the additional losses on the subsequent NAMA tranches made it clear that it could not reach the limit.

We cannot allow banks to run ahead without capital. That will not give sound lending in the future. I agree that it is better if the State is not involved in running banks. The State has only got involved in the ownership of banks because of their need for capital, because of the loss of confidence worldwide in banking, and in particular the focus on Ireland. The State should take the earliest opportunity to dispose of its equity stakes in the banks. That would be good for the customers of the banks. It would be good also for the fiscal accounts. If a reputable buyer walked in the door between now and 5 p.m. I would be interested in encouraging those concerned to deal with him or her.

Senator Shane Ross

What hopes has the Governor of that?

Professor Patrick Honohan

I have hopes but not before 5 o'clock. I said this morning at a conference that a great deal of money is to be made from sound banking in Ireland in the years ahead. There will be fewer participants. That will mean the spreads that can be achieved by the investors will be higher at the expense of the customer but at least the customer will be able to access funds. Access matters more than price. That sort of situation will encourage entrants. We are not encouraging an uncompetitive system. We would like a competitive system but the reality is that the market is currently without many players.

The question was asked about whether it would be preferable to have two local banks or three big banks. Three is a good number. I would hate to see it go below three. We have more than three. We have other players in the market who might not be as active at the moment as they might be in the future. There is always the potential for organic growth or growth by acquisition of some of the other players even though that has not been the trend in recent months. I am thinking of the future.

Senator Paul Coghlan

What is Professor Honohan's view of the prognosis of Professor Morgan Kelly as outlined in The Irish Times?

Professor Patrick Honohan

I always pay a great deal of attention to what Professor Morgan Kelly has to say. His articles enrage some people but they entertain me. He has a great way with words. I take what he says seriously. Some of the things he says are factually correct. Others are not really. Now I will get a telephone call from him asking what points are not factually correct. Perhaps I should withdraw that remark and say that I do not agree with much of it. He depicts a number of scenarios about which one could imagine writing novels or seeing movies. It is not something one can project as a likely scenario. All of the facts that are clear and substantiated in the article can be projected ahead to a much more favourable and viable outcome. Nobody is denying that the situation is difficult, particularly the fiscal situation. I do not regard his forecasts as representing a likely outcome at all. He is definitely always worth reading.

Deputy Olivia Mitchell

I am afraid I am going to return to Professor Morgan Kelly. It should not be a surprise given his article in the newspaper. I am sure the entire nation gulped when they read it.

Deputy Seán Ardagh

Especially people in Dublin South.

Deputy Olivia Mitchell

Deputy Ardagh is not that far away from Dublin South himself. When Professor Honohan was setting the capital requirements for banks earlier this year it was against a different economic background. We thought it was bad but it was not nearly as bad as we now know it to be. He made an assessment of what would be the likely losses to banks of problems with mortgage repayments. He said he is keeping an eye on the situation. Given that we now know for instance that the budget adjustment is 100% more than we expected it to be, is it not time to carry out a serious reassessment of the impact of that? Surely, if one is to take that much money out of the economy in terms of spending power - over six years, if one goes back two years and forward four, it is a fiscal adjustment of approximately 18% - that will have a major impact on the ability of people to repay mortgages?

Deputy Sherlock inquired about debt forgiveness which I realise is not a runner. Nevertheless, there is a whole demographic that is hugely in debt. They are either in negative equity or they are unable to meet their mortgage repayments. Is there a case to be made for helping that demographic to deleverage as quickly as possible, given that it is the group in society that we need to spend and invest? People in their 30s are the big spenders. They are the risk takers. However, they are tied to this debt. Professor Honohan said the banks expect many of them to meet their repayments. I am sure they will, but if they are repaying money to the banks endlessly they will do nothing else and spend nothing else. I realise this is a question for a politician rather than a banker but ultimately it all comes back to the banks and how they will survive.

Professor Honohan mentioned earlier about many issues being beneath the radar. It struck me this morning when I was reading the newspaper that we have all been so consumed with worry about Government bonds and borrowing that we have not looked at bank borrowing. There is a very small article in today's newspaper about Irish banks being kept out of the market since last April and that their exposure to the European Central Bank is of the order of €120 billion. How does Professor Honohan feel about that? Is he worried about it? Is that what he is talking about when he said that the markets are worried that there may be some big hole that they do not know about? Is that a bomb waiting to explode? When one hears about the debt of Irish banks I hear debt of Irish Government and debt of Irish taxpayer because we are all one and the same now. I would like Professor Honohan to comment on that.

Professor Patrick Honohan

The first question is whether things have deteriorated to an extent that we would want to reassess. We had a base case which was pretty pessimistic. It was more pessimistic than the banks were projecting. There was much toing and froing and challenging of the banks' projections, but we insisted on a higher base case. Some people believed everything was okay in April, as the issues were not as acute then as they are now. We have no mechanical link between growth and performance, but we knew that five difficult years lay ahead.

Our stress case was way beyond the base case. The probability of moving towards the stress case from the base case has increased, but the amount of capital provided was ample for even the stress case. We are keeping the matter under review. As to whether we need to do something panicky about it, we could do it in an orderly way. We are definitely keeping an eye on the month-by-month figures. It might have been Deputy Sherlock who asked whether we were tracking individual arrears and so on. In that respect, we have ramped up our collection of data and more is ongoing. I cannot add much more information to my answer.

On the question of finding a way to help people who are in negative equity and distress, I will discuss the negative equity issue to some extent. The situation can be damaging for someone who wants and needs to move to get a job. This is the crunch issue around negative equity. Where an otherwise comfortable middle class person bought a house that is now worth less than his or her debt, the situation is different. For example, just as much as middle class people such as myself who saw the apparent market value of our homes rising for a number of years in different parts of the country were a little bit happy at the time, there is a sort of regret among some people.

Deputy Olivia Mitchell

I am not referring to Professor Honohan, but to 30-somethings. Their negative equity is an inhibitor on spending.

Professor Patrick Honohan

I know, but negative equity per se is of more concern to me in respect of people who are unable to service their debts.

Deputy Olivia Mitchell

Exactly.

Professor Patrick Honohan

For example, someone could be unable to service a large debt because of unemployment, illness or other problems. Alternatively, his or her small business could be doing badly. Devising a break mechanical scheme that is viable and allows people who cannot service their debts without extreme difficulty seems to be beyond the scope of human invention. Had the Government tonnes of resources, a lavish scheme might have been possible.

I am disappointed. Six months ago, I believed we could arrive at a solution by following the example set by other countries or by devising something ourselves. So far, neither has been the case. I do not want to dismiss the efforts of the expert group on arrears, but it is clearly not answering in a comprehensive way the problems the Deputy is raising specifically.

Deputy Mitchell also asked about borrowing by the banks from the European Central Bank, ECB, although I am not sure what her exact question was.

Deputy Olivia Mitchell

Is it a worry? Is it a bomb waiting to explode?

Deputy Seán Ardagh

I am sympathetic to what Deputy Mitchell has mentioned in respect of the extra loans. We are not referring to people who find repaying a loan difficult. Rather, we are referring to those who are the engine of the economy. Is there a way to separate the old economy loan from the new economy loan? For example, if a house is worth €300,000 but the loan was for €600,000, is there some way to identify a segment of the loan as being different for the purposes of applying interest or tax relief?

Professor Patrick Honohan

These are the sorts of scheme that people have been considering, including shared equity schemes and rental schemes. In the latter case, a bank leaves someone in occupation and that person rents for a while before resuming the servicing of the loan if his or her position improves. However, the consensus among those who have studied these options is that they are only for people who cannot otherwise pay. If they can pay and irrespective of whether they are the engines of the economy, how could their inclusion in the schemes be rationalised? It is a fiscal issue. If the fiscal authorities identify a group of people whose worries and burdens in this respect must be removed despite the fact that they can afford them, it would be outside the realm of banking skills.

One can distinguish, for example, where a small business as a legal entity is being dragged down by someone's excessive indebtedness. To some extent, the problem with many of the cases to which Deputy Mitchell referred lies in this area. It is not a question of personal obligation, but of the obligation of the business, which can be separated in a clear way. While I will not exclude the possibility that someone somewhere, perhaps even us, will devise a solution, it is not available so far. We are trying.

Deputy Mitchell asked about the ECB. The borrowings of Irish banks from the ECB in the system are exceptionally large, which reflects the legacy of needing to repay wholesale loans from abroad that should never have been made on the scale in question. They cannot be recreated, as one does not want to recreate them on that scale. This issue must be worked out over time, in part through the sale of blocks of a portfolio. In better market conditions, they could be securitised and sold to international investors and the proceeds used to repay. To some extent, there will be some recovery of funding in terms of the issuance of bonds by Irish banks on the international market. They stayed out of the market when the interest spread started to move up towards the end of April. It was price that mainly encouraged their withdrawal from the long-term funding market, but they expected the yields to revert. It is only at the longer rates that the yields have bounced up. Shorter term financing and financing from the ECB system were cheaper, although that financing would need to be constantly rolled. This is what the ECB is about, but it would like the banks to resume being self-reliant in due course. It is not as if their access will be curtailed.

Deputy Olivia Mitchell

Is the Governor confident their access will not be curtailed?

Professor Patrick Honohan

Absolutely.

Deputy Damien English

I wish to put four or five questions, although I might have more. I am unhappy with the Governor's comments on dealing with people's personal debts and mortgages. I am annoyed by the Government's delay on this issue. I do not accept that finding a solution is impossible. A range of solutions that can be matched to different people will be necessary.

Given banks' access to our details, from credit and Laser cards to everything we spend, it is possible to see who is in trouble. If I am wrong, the Governor can correct me. He is trying to avoid a moral hazard, in that helping some people will cause other people to throw in the towel as far as their mortgages are concerned, but we must accept that this problem will not go away. We are more than two years down the road and we still have no solutions. A 12-month moratorium is not a solution. The markets are concerned that we are not providing solutions and that we are hoping the problem will go away, but it will not go away. There are various concerns about how large the problem is, although the Governor is in a better position than most of us to know exactly how large it is. The Government committee must come forward with a range of solutions that can be adapted to the needs of different people because this situation will not go away. In general, it is about mortgages and homes that are going to pass through generations in families. There are options for dealing with this - parking debt might be one but there are others. Imagination must be applied. There will be a cost to Government in any event, either through the banks which we more or less own anyway, social welfare, or through the housing budget. If one losses one's house one must have another house which will be paid for by the State. Let us look at the spend on housing, therefore, and see whether we can solve it using imagination. In addition, there may be a way of packaging a product so that private investors could buy a share of people's houses. There have to be solutions; I do not accept there are none.

I understand the situation is complex but it is no longer good enough to say merely that it is complex. We are two years down the road and there should be ten options for dealing with it. The markets will expect to see them because they are concerned about the problem. In addition, there is a moral need to help people who are under serious pressure. We are doing a disservice to people by not finding solutions.

I have referred to mortgages but we must also consider the short-term debts of people. There are many people who have such debts of €30,000 or €40,000, perhaps even more, which are costing them a fortune. I hope the Governor, through his position, will be able to work with the banks on developing financial products to solve that problem. If a person has two credit cards, a bank overdraft, a credit union loan and so on, all at 10% in interest or more, it costs a great deal of money to service those debts. There is a duty on the State and the banks to come together and provide a product that will ease that pain. I do not mean debt forgiveness but a way of spreading the cost over a longer period. There are two reasons for doing this: first, people need it and, second, the economy needs it so that people will begin spending again. It is not good enough to say the situation is complex. I realise that Professor Honohan is not a politician or a Minister but we get the same answer from Ministers and it is no longer good enough. I am sorry. That was a separate matter from my questions but I am annoyed by the attitude taken to this problem because it is very serious and yet has been ignored for so long. It must be dealt with.

I have some specific questions. I understand Professor Honohan commented on the IMF today, to the effect that it might not be necessary to bring it in and that any measures it might take would not be very different. Was that what he said? If so, will he elaborate on those comments? Some people assume it would be great to bring in the IMF. I do not agree with them but they have the impression the IMF would solve some of our problems.

Regarding our national debt, my colleagues spent much time trying to identify a sustainable interest rate. Some of our existing debt was at low rates but this will have to be rolled over in years to come. From 2014 or 2015 onwards a lot of debt must be rolled over and reissued. There is a concern it will become unmanageable if the interest rates remain too high in four or five years time. The planned interest bill for 2014 is already €8.5 billion but that was when some of the yields were 6%. I know the Governor hopes that with four-year plans and so on we will reduce that yield but it is a concern. My concern is about what will happen after the four-year plan and the debt arrears that will have to be rolled over.

Professor Honohan stated the banks have not recovered the confidence of the markets and that the impact on investor confidence is not yet as strong as might be hoped. Does he see that improving in the near future and, if so, when? As my colleague, Deputy Mitchell, noted, since April the banks have not been able to get money in the normal market. When will that situation change?

Professor Honohan stated that the managers of the public finances, namely, the Government, were lulled into a false sense of security. I find that a very soft comment. Health expenditure went from €5.3 billion to €15.3 billion in eight years. Social welfare went from €6.8 billion to €17.7 billion in the same period. Education went from €3.7 billion to €8.4 billion. There were massive increases in spending that were not sustainable and about which the Government was warned numerous times, budget after budget, by many people. Those concerned were not lulled into anything. A decision was made to increase spending massively. Anybody with a financial background should not have let that happen but it happened. It was not a question of being lulled into it. One does not proceed in jumps or increases of 150%, 160%, 120%, 187%. Decisions were made to spend that money and it was not sustainable. There are people who made personal decisions to borrow money, buy houses, or whatever, based on their Government job, a low-tax economy, or whatever. They made decisions because they were led into them. They were lulled into it, all right, but that is different. Now those people will suffer greatly during the coming four or five years when we make the adjustments to the finances. It was private individuals who were lulled.

Professor Honohan mentioned that many small businesses are under pressure because of property debt tied to the business. Does he have a solution to untangle that or is he satisfied progress is being made in that regard? I agree with him this is an issue. Many small businesses that might have survived will go under if we do not deal with that issue. The head of the credit review committee who attended this committee agreed there might be a need for a national recovery bank, or that such an idea might be considered. Fine Gael's belief in that regard is to get credit available to small businesses. His logic was different. He believes there might be a lack of competition left in the banking market if there are only two or three main players. Professor Honohan referred to three banks being essential but in reality we may have only two players. Does he see a need for a State recovery bank for a period in order to deliver money to small businesses?

In regard to NAMA, I am glad the Governor said what he said, namely, that many of the big guys were able to insulate themselves and distance themselves from their debts. I believe that too and have persistently asked the Minister about it. We are told that all personal assets of those bound up in NAMA will be chased and taken but I do not believe that is legally possible. The Governor made the same point. Is there much debt that is so very much separated from the original person who took it out that we will never get it? Is it the case that some of the figures in NAMA will not add up because of that? Is the amount significant?

We changed the threshold of loans being transferred to NAMA from €5 million to €20 million and so the banks have kept them under €20 million. How healthy are the loans in that bracket? It might be of concern to the markets too, that there is an issue about which we are not sure. I questioned the regulator on this matter as well. I ask Professor Honohan to outline his concerns about those loans.

The chairman of Anglo Irish Bank commented recently that there might be a need to see other banks introduce the good bank-bad bank scenario whereby they too would have their own little management asset agency within the bank. I do not believe that to be the case. What does Professor Honohan think? Are AIB and Bank of Ireland considering such a scheme to deal with loans under €20 million?

There is a question I have asked all delegates to this committee. Do the banks have the skills to deal with the current set of problems? I am not convinced they have. If not, what can be done to give them those skills? Many people, especially small business people and others with debts, are feeling the brunt with unskilled staff constantly telephoning and chasing them without being in a position to deal properly with them. That is causing major problems. I believe I am right about that but I would like to hear Professor Honohan's opinion.

I shall leave it at that. There are other questions I would like to ask but I do not want to go on too long. I have one final point. The Government has spoken of plans to take a holiday of a couple of years on interest payments on the promissory notes. What does Professor Honohan think of that? Is it wise? It is only deferring the problem for a couple of years. The Governor might comment unless it is an area he does not wish to cover.

Professor Patrick Honohan

I am sorry the Deputy thinks I have a casual attitude in regard to personal-----

Deputy Damien English

It is the decision makers who have a casual attitude.

Professor Patrick Honohan

I take some responsibility in my organisation. This is a matter of concern to us as well as to other people and I do not want to appear in any way as if I am taking this matter lightly. I am hopeful that, piece by piece, we will get to a better place than has been possible so far. The matter has received attention and the expert group has been the forum for it. The group has made a certain amount of progress. I would have liked to have seen more but perhaps that will be achieved.

I was asked about the IMF this morning at the conference although I cannot precisely remember the nature of the question. Many people have been asking the same question in newspapers and so forth. I know a lot about the IMF because I used to work there 40 or so years ago. I have many friends who still work there and so forth. I have a fair idea of what the IMF does, what way its people think and so on. Over the years the IMF has been a key part of the international system, stepping in where countries have got into financial difficulties. Many times those countries got into trouble because of not having found a sensible policy route out of their financial difficulties. That is where the IMF has been both controversial and, in most cases though not all, very successful in turning policies around in a way that recovers confidence.

The point I was making this morning in that regard was that in this case, knowing where it is coming from, I assume the IMF would be inclined to sign up to the policies proposed by the Government, including the policies on banking, and in effect say, "You want our advice - well, you're doing it". The point I was making is that an IMF package would not look much different.

Deputy English is concerned about interest rates and what happens after four years. Debts are maturing all the time, and some years have bigger tranches of debt maturity than others. For sure, the rates of interest in the markets today cannot be sustained for a long period. The situation has to be turned around in a way that makes the market completely confident, so that Ireland can be lent money at the spreads that it was getting only seven or eight months ago. There is no reason to believe that cannot be achieved. If the fiscal situation can be turned around in the way that is being programmed, this should be quite viable so that those rates of interest - in April it was 120, 130 and 150 basis points above Germany - would allow a viable continuation of the programme.

Deputy Damien English

Is Professor Honohan saying we can get back to that?

Professor Patrick Honohan

We cannot get back to 2005-06 rates where we were paying practically nothing compared with Germany. However, I do not see why we cannot get back to the position at April.

The Deputy asked about a national recovery bank, and a proposal for that exists. I do not have a particular observation to make. I am not wildly enthusiastic about the Government running the banks, but the Government in Germany runs many banks. The Government here owns many of the banks. New entrants, effectively managed and adequately capitalised would improve competition and enhance the range of alternatives on offer to customers. It is a matter of policy for the Government to set up such a facility, although I should not rush to recommend it.

Deputy Damien English

There are pros and cons, I suppose.

Professor Patrick Honohan

Yes, there are pros and cons. We are in a situation of rebuilding the banks at the moment.

On NAMA, I cannot give the Deputy a specific answer on particular developers and who has the personal-----

Deputy Damien English

There is an amount. That is my concern.

Professor Patrick Honohan

I have no idea about that.

Deputy Damien English

There is an amount. That is all I need to know, because I have been chasing this for a long time.

Professor Patrick Honohan

I draw the attention of the Deputy to the report I did in May where several banks claimed to have taken personal guarantees from developers, but had not assured themselves about how much they were worth. I am sure there are cases where there are personal guarantees, but I suspect there are cases where there are not personal guarantees.

Deputy Damien English

That is grand. We shall find out, eventually.

Professor Patrick Honohan

On the €5 million to €20 million which represents the so-called seventh tranche that will no longer exist for practical purposes, a number of people thought they did not want to take the hair-cut on this. However, in the Central Bank, obviously we would not stand for that, so we have insisted that capital requirements now include a provision for the €5 million to €20 million, bank by bank. The hair-cut will depend on which bank it is, in arriving at the required capital figure. The hair-cut to be applied will be the average of all the NAMA haircuts for tranches (1) to (6), inclusive, and this will be applied to tranche (7). We know what (1) to (6), inclusive, is because that figure was announced. We have not said, in effect, "We won't make any provision for that". We have made what I believe to be a pretty hefty provision in that regard.

Deputy Damien English

I accept what Professor Honohan is saying about the provision, but how healthy are the loans?

Professor Patrick Honohan

One assumes that those loans, in terms of recoverability, are no worse than the average of (1) to (6). On whether other banks should make a split-----

Deputy Damien English

I am not sure about this. Are other banks thinking of this? I asked the Minister about it and then subsequently Mr. Alan Dukes made a statement to the effect that they should do it. Will Professor Honohan confirm whether there is any likelihood of this happening?

Professor Patrick Honohan

I am not supposed to talk about individual banks, but I do not believe that is a matter of confidentiality since I am sure it is in the Ulster Bank's report, but that bank has adopted a type of internal procedure. It has carved out a bunch of loans which it wants managed down, as they are interfering with normal operations. The bank has assigned a certain amount of internal capital to that, so it is a device that has been used. I am not sure that there is such a specific idea in train for the other banks, but they will be able to enlighten the Deputy on that, I believe. Have I covered the questions? What was that about interest rates? Oh yes, it is the promissory note.

Deputy Damien English

If Professor Honohan is not allowed to comment on interest rates, that is all right.

Professor Patrick Honohan

Yes, the promissory note is a very complicated instrument in different ways. It will still be paid. They have done it in different years and it is a type of fiscal thing.

Deputy Damien English

It is playing with figures. Professor Honohan is recommending that business loans be untangled from property loans. How does he foresee that happening, and in the event, how quickly?

Professor Patrick Honohan

The banks should do it on the basis of their relationships with customers on an ongoing basis. They should have the people there-----

Deputy Damien English

Is there any instruction Professor Honohan can give to-----

Professor Patrick Honohan

I do not give instructions, but it is something I have been encouraging them to do.

Deputy Damien English

Has that actually happened, and who moves this?

Professor Patrick Honohan

It is in the interests of banks to do this, as the prospects of a bank recovering a loan that is in difficulties because the whole property portfolio is dragging down the rest of the business are improved by separating the two and working them out separately. That is true also for residential mortgages on a case by case basis if the banks recognise what will happen and take the appropriate steps. What is difficult is to provide a publicly mandated scheme which does not cost the Exchequer an arm or a leg, is fair and initiates what may be achieved on a case-by-case basis.

Deputy Damien English

That is a fair point.

Mr. Bernard Sheridan

On an earlier point made by the Deputy about personal debt other than mortgages, I advise the committee that we have published a proposal to try and strengthen protections there. The whole principle underlying the proposal is to give the consumer time to sort out arrears, and for the lender to come up with a practical arrangement.

Deputy Damien English

Is there a duty on the Government or the Central Bank to produce some solution to this? We are obsessed with giving people more time, but the interest rate is increasing, so this is not really solving anything, with regard to personal debt or mortgages. I have not seen the banks coming forward with solutions. We have provided for the credit unions to be able to do it, with new legislation, but where is there evidence of some movement in the banks on short-term personal debts, which carry very high interest rates? I hope somebody will produce a product. I have some ideas on products, but I am not in charge of the banks. However, this has to be dealt with. A bit of space and time is grand and people can get six months of happiness. However, it comes back to haunt them because the interest has increased and the problem will not go away.

Mr. Bernard Sheridan

We are proposing to ban any charges on arrears, for example, to try and keep the costs down for consumers.

Deputy Damien English

We are not getting anywhere with it. Banning the charges is not banning or stopping the high interest rates which are going up all the time.

Deputy Joe Behan

I join with the Chairman and members in welcoming the Governor and his colleagues. He will be glad to hear I have only one issue to raise but it concerns the topic for discussion. Two hours later we are only getting to what is the major issue for many people, namely, the stability of the Irish economy and specifically the four-year plan. In his presentation the Governor said "I strongly endorse the Government's decision to set out a multi-year budgetary plan. ... I also regard the parameters as being within the credible range and a good basis for rebuilding confidence." That is not an amazingly strong endorsement. I ask him to expand a little on the reasons he is supporting this plan, in light of the recent ESRI quarterly commentary, one line of which reads; "An austerity package of €15 billion within four years could damage the potential of the economy to grow its way out of the recession". It further states: "It would have been preferable and would have been seen as being credible by international lenders to extend the time period to 2016".

In my book the ESRI is a reputable, independent institution. Its comments have been echoed by others in society, namely, the Irish Congress of Trades Unions and the community and voluntary pillar which represents the vast range of community organisations in Ireland. I think that reservation is a very stark warning.

To a large extent, the Governor of the Central Bank is independent of Government, independent of politics, and is in an important pivotal position in our country at this moment in its history. I ask him to honestly state why he feels that pushing the people to the edge of the cliff, to suffer another €6 billion worth of cuts to be announced in the next three weeks, will assist this country in getting out of the current economic morass? It is unfortunate that the main political parties who represent the vast majority of politicians in this institution, have bought into this four-year timeframe, that is, the 3% and the four years. Effectively, they have agreed that the people will be pressurised into this position. I do not think that is right but, more importantly, for the purposes of this discussion, I do not think it will work. I ask the Governor, as a reputable person in a very powerful position, to say why he thinks it will work.

Professor Patrick Honohan

This is a very important point. Though we may not like it, it is pretty visible to everybody now that we actually have to jump to what the lenders expect. We must convince the lenders that we can get to a situation where our debt is not spiralling away out of control. They are not in that position at present. We just have to look at the interest rates. They are saying they are not sure they are going to do it. In considering this issue and in giving advice on it, it was a question of identifying what kind of package will make this convincing. Deputy Behan does not think it will work. If it does not work then it will not convince the markets. I think it will work. I think there will be damaging effects but the damaging effect of attempting a much lighter reduction in the deficit, particularly for 2011, would definitely not work and would be more damaging. If there were not investors outside this could be managed over a longer time period. It is because we are so dependent on rolling over debt from the investors outside that we have to get this visibly under control and quickly.

There are many uncertainties. This is why I used the word "plausible" or "convincing", or a similar type word, because we must assess the range of uncertainties about growth rates in the future. One might say, if it has only caught up, could we not do less? It is possible that if growth is much more disappointing than is projected by the Government, then they will not reach the 3% in 2014. It is plausible that we could reach the 3% in 2014 within the range of possibilities. Much more important than that, the steps taken now are the steps that will convince or otherwise the markets in the immediate future. The frontloading taken now is what is crucial and the policies that will be adopted. The investors want to see that the politicians across the board are understanding of the needs and have the ability to design policies that will stick. This is a very worrying situation where we are all concerned about the impact of the different measures which we have not seen. We do not know what the particular measures are on different elements of the economy. However, in total, it is possible to put together a package of €6 billion that keeps the economy in a growth mode and allows this convergence to be plausibly attained by 2014.

If I had to sit down and draw up a package, which is not my job, this is more or less the package in terms of overall numbers that I would come up with. That is why I think it should be adhered to. I know the Labour Party has said we should try another number but these numbers which are proposed by the Government will make sense and can convince the markets. It is not something that is done lightly. Deputy English does not like my use of the word "lulled". However, standing back, it is important to recognise that just as this problem arose because of excesses in spending, both in wage rates and in the scale of spending, and the tax bands were narrowed too much, the steps towards restoring that situation appear very harsh. The steps are harsh and they cause problems for people who have become exposed and over-indebted on the way to it. If we could magic our way back to where we were in the late 1990s in terms of those structures and patterns of spending, I do not mean the exact wage rates, we were perfectly happy then. Those structures will not do the trick now because the debt is higher and that extra amount of debt has to be serviced. However, if we can get to where we will be in 2014 that state is not an uncomfortable one. It is the wrenching adjustments imposed on people as they get from here to there and the loss of jobs that are the damage that is happening on the way. There is no doubt it is very costly and painful.

Deputy Joe Behan

I cannot understand how Professor Honohan can say that when we are taking another €6 billion from the economy, including €4.5 billion in direct cuts, which will mean cuts in people's incomes, whether on social welfare, in the public service or wherever. Many people on social welfare spend every penny they get and are unable to put any of it away for a rainy day in a savings account. They are paying out money every day and keeping the economy going. How can he say that taking that amount of money from those people and this economy will lead to growth? I think it will go in the opposite direction.

Mr. Patrick Honohan

It is not that it will promote growth but the alternative is a more damaging inability to fund. That is the point. This is consistent with a growth path. It will not drive a negative period of years of growth but it is good only relative to the alternative. That is not a very encouraging thing to say.

Senator Jim Walsh

I thank the Governor for his submission and I thank you, Chairman, for allowing me, as a non-member of the committee, put four questions to Professor Honohan. The first concerns Professor Honohan's comment on the 5% projected loss on the residential mortgage book. That appears to be low, and I am happy to hear Professor Honohan say there is no hard evidence it will be exceeded. I am not an economist but I have seen the overall book for mortgages reported as being €180 billion. Are we saying the loss is in the order of €9 billion? Am I reading that correctly from what Professor Honohan said? People have talked about debt forgiveness. Could Professor Honohan tell us the percentage of mortgages that are currently fully performing? What percentage is interest only and what percentage is impaired?

On the question raised on the other side of the table, it is often the case that people on mortgages are the drivers of the economy because they are middle class people who are spending money and the fact that they are affected is having its own adverse consequences on the economy and the potential for economic growth. Would it be prudent to introduce something like full marginal tax relief for those who are distressed and apply it to a ratio of, say, full mortgage repayments as a designated percentage of their income? Once they go above a certain level they would qualify for that to assist them.

Professor Honohan also mentioned charges with regard to impaired loans. What is the position of the Central Bank with regard to impaired loans attracting penalty interest rates? Given the current position, particularly that of the banks, the regulatory authorities and the State apparatus, including people in these Houses, and I take my share of the responsibility for the mess we are in, what is Professor Honohan's policy on allowing banks apply penalty interest rates to people who have got into difficulties? Obviously, those loans will sink their ship anyway but what is Professor Honohan's view?

My second question relates to the need to assist small firms. Professor Honohan mentioned the need to restructure finances in many small firms that accumulated property debt. Many of them who are experiencing difficulties but whose businesses are viable have been good in the past and are giving good employment. How will that be achieved without distorting competition? I agree the problem should be tackled. How extensive is that in small businesses?

As part of that, given the banking situation, one of the great difficulties in getting credit flowing, apart from the solvency and liquidity area, is the confidence of individual bankers, which has been shattered. Everybody's confidence, including that of investors and consumers, has been badly hit by this mess in which we find ourselves. I spoke recently to a man called Roberto Newell, a noted economist who was co-author of Dangerous Markets and his view was that confidence was unlikely to improve unless the personnel in the banks are changed because what happened has been so shattering to their belief in what they were doing up to now. He said that for them to go forward and operate normally from a banking perspective is very difficult. How do we deal with that? One of the suggestions he made - I do not claim credit for it - was that there may need to be a focused guarantee on future lending in very specific areas where the State would give some guarantee on a shared basis with the banks. All the risk cannot be removed from the bank but we may need to give a 50% or 60% guarantee, for example, to ensure the banks have a vested interest in it. We must come up with some innovative suggestions in that area.

This might be a criticism of the representatives and in general of the manner in which we have been managing this crisis but I believe we are not as expeditious in our response as is needed, and I will outline the reason for that in a moment. A lot has been going on with regard to the huge loans of developers and so on but I do not understand why two years into this very serious crisis we do not have a handle on what is likely to happen on that front. The mortgage book is a potentially huge area of risk. I would have thought we would have a strong feel for it and what needs to be done. Action in regard to the small firms is essential also.

The second question relates to future economic growth rates. Are we more influenced in our growth rate by what happens in the United States than what happens in Europe? I ask that because Germany and perhaps some of the other economies in the EU that have not taken the same hit may well be ahead of the US in that regard. Both the man about whom I spoke earlier and Art Laffer, who spoke to Deputy Ardagh and me in March, were negative about future economic growth. Roberto Newell maintains it will be flat. Art Laffer reckoned the United States will go into a fairly significant recession next year because of the coincidence of the stimulus packages running out and tax increases. It may take some steps with regard to the tax increases which are to take place. Which is the greater influence?

Third, a real issue for this economy is competitiveness. Unless we correct our competitiveness our economic growth will remain retarded. Fiscal rectitude and balancing our budget, apart from satisfying the markets, is essential to economic growth. Can we achieve competitiveness without salaries in the public sector being reduced? I do not wish to single out people because it is right across the board but our Supreme Court judges, for example, get €100,000 a year more than their counterparts in the US. Our university professors are almost 50%-----

Senator Shane Ross

Chairman, this is meant to be a question session. Many of us are waiting to speak. We do not need a lecture on that area from someone like Senator Walsh.

Senator Jim Walsh

Those disparities are unsustainable.

Fourth, are we too optimistic in our projections? We have had to correct them downwards a number of times. The fact that that impacts on the confidence of consumers and investors means that we are elongating the difficulties. Should we be more realistic to pessimistic in the approach we take to ensure that in future the message will be one of positivity in order to restore that confidence? I apologise for taking so long.

Professor Patrick Honohan

The Senator asked many questions about the residential mortgage book, quantification and so on. I do not have the numbers for the Irish residential mortgage book in front of me but from memory it is nearer the €100 billion mark.

Mr. Bernard Sheridan

It is around €117 billion.

Professor Patrick Honohan

One can make the calculation. That is a stress case calculation but if one makes a calculation and puts a number on it somebody will put it in a headline. I am looking at spreads in the market and they will think this looks like a new loss, and it is not a new loss. It is something we have already provided for and we have ensured that the banks have enough capital to meet that. It is history.

Why do we not know exactly how many of those people will repay over the next 25 years of their mortgage? We do not know that because we are in the midst of an unprecedented recession in the economy and face difficult conditions ahead. Despite what I would say, the growth we are projecting for the future is not strong growth. Over a period of time good things as well as bad things can happen. It is inherently not easy to forecast these things. I do not make any apologies for that, and it is not for want of thinking about it or looking at it. We will do more work on it and, as it evolves, we will have more and more information.

On the question of what percentage of mortgages are in arrears and impaired, we have some numbers for those arrears. I understand the Taoiseach made some announcement on numbers which coincided with draft material I saw. Those numbers will probably be officially published in due course.

On the proposal for marginal tax relief, this is one of the schemes people mention. There is also mention of budgetary costs, benefits for the people who are paying, especially at higher rates of tax. I would not pick holes in it. None of these schemes is proving completely satisfactory.

I will ask Mr. Bernard Sheridan to answer the specific question on the impaired loans and the question of penalty interest rates. What are our rules on that now?

Mr. Bernard Sheridan

The surcharge or the penalty interest rate is included as part of the charging and therefore it would be covered by the ban on charges. Obviously, we do not regulate interest rates on the loans per se, but if it is a penalty interest that is imposed on top of the interest charged, that is covered by the proposal to stop the charges.

Professor Patrick Honohan

There was a question and comments about small firms, which is an important dimension. It takes quite a while to restore the self-confidence of bankers. However, banks are moving people and putting fresh blood or, in some cases, old blood back into the lending function to try to overcome that to some extent but clearly this is a psychological factor which is affecting the willingness of banks to make loans at this stage. The scheme Mr. Trethowan runs is designed to provide an offset to that.

We talked in this committee previously about the question of partial credit guarantee schemes by Government, the pros and cons of that and how there had been some schemes that have not worked well. For example, a British scheme has proved to be disappointing. The Korean scheme was very expensive without a great deal to show for it. We mentioned in the past the Chilean scheme, which is considered the best in the class. I am aware there have been discussions in some Departments about such a scheme. Generally, the story is mixed. It is a matter for a government whether it wants to participate in the risk of making new loans but it is certainly something that has been on the agenda.

Regarding future economic growth prospects and the role of competitiveness, the competitiveness aspect is very important. Remuneration levels in the economy in general are too high. The figures show that. There are other dimensions to competitiveness but wage and remuneration competitiveness deteriorated steadily from the time we joined the euro until 2007. It has improved since then but not enough. If further remuneration adjustments are made they should start at the top, including my own, to which I have made some adjustments, but it could afford to go lower.

Senator Jim Walsh

Would Professor Honohan put a percentage on it?

Professor Patrick Honohan

On the overall-----

Senator Jim Walsh

Yes.

Professor Patrick Honohan

No.

Senator Shane Ross

I thank the Governor for attending. It is welcome to see him before the committee so often and being so open about what is going on, and it is unusual.

I would like to ask Professor Honohan a question about the new commission that was set up comprising four individuals, Mike Soden and Des Geraghty and I have forgotten the names of the other two. Willie Slattery may be one of them. How was that set up and what input did Professor Honohan have into it? It is a delicate question because it has political implications but if this is to be the new board or the new authority of the Central Bank, it is very important that we know how it is done, whether Professor Honohan has an input, how it is communicated to the people, how it is communicated to him, and the sort of procedure gone through when this new board is set up. In the old days the board of the Central Bank was set up by political appointment, which was not particularly satisfactory. This is obviously new but it seems, because of some of the appointments, and I do not think Professor Honohan will comment on the individuals, that some of the appointments are somewhat bizarre. I would like to know the procedures, the criteria, the qualifications that were used to put these people in place.

I would have thought it might be useful for us to ask them to come before this committee to tell us their view of their role in the Central Bank and their relationship with Professor Honohan as well, which is important, in terms of how corporate governance operates at that level in the Central Bank and whether these people are qualified to sit in this position of extraordinary delicacy. That is the first question.

I would like to ask Professor Honohan's view on a second question. What we have seen is a very interesting coincidence of views on front-loading the outline figure of €6 billion, with which Professor Honohan and the Government agrees and with which the European Commission also appears to agree in the form of Commissioner Rehn. Does Professor Honohan get the impression that Europe is calling the shots now in terms of the economy, economic stability and the parameters within which we will have to abide? In other words, is the budget Europe-led and, if it is, is that a bad thing? If Europe has so much influence, and obviously Commissioner Rehn came here to exert that influence, and he was not shy about letting us he was exerting that influence, and if the budget is to be backed by Europe, Professor Honohan and supposedly other independent bodies, does that mean that our economic independence is being lost, particularly on the issues of taxation, although I do not want to be specific about it? Is that a good thing?

Third, I do not believe Professor Honohan has touched on this point, and I do not want to get into too much detail, but would it be his view that the Croke Park agreement is essential to the future health of the Irish economy? I ask that question because it seems that what has happened in recent weeks is that the assumptions behind the budget figures, which we have not seen yet, will take into account some savings which it is anticipated will be made by the Croke Park agreement. If the Croke Park agreement is delayed, which it undoubtedly is, and Kieran Mulvey said on RTE earlier today that if it there were not improvements in six months he would be worried; I would have thought we should be worried sooner. It does not look as if the agreement will be adhered to on either side. In that case it looks as if the Government will look for more savings and there will be delay in terms of the performance and modernisation, which will make savings also, does that mean that the budget figures will go astray and that the international markets will read the budget figures as being astray and therefore the Croke Park agreement will become an essential ingredient in the immediate health of the economy, which is very important? In other words, is it a confidence builder and will the removal of the Croke Park agreement or lack of confidence in it mean that the budget will lose the confidence of the international bond markets, in which case we are in serious trouble?

I am anxious to be tactful and diplomatic about this but is there any evidence that money deposits are coming into or going out of the country in recent weeks? What is happening on that score? Are there significant inflows or outflows? Finally, several of my colleagues have mentioned this and it is slightly tangential to the immediate crisis as it relates to the banks in the future, but if so little competition is foreseen among the banks due to the strength of Bank of Ireland and AIB and nobody else, what specific measures does the Central Bank have to ensure we do not return to the bad old days of what some would have seen as a cartel? It could be one of the more less fortunate results of this. It might bring the immediate health of the banks back into positive territory very quickly but it would lead to the crucifixion of the consumer. What can the Central Bank do to ensure that as a result of this crisis the two major banks are not allowed to assume the positions they held in the past?

Professor Patrick Honohan

With regard to the members of the new Central Bank Commission, I do not have a formal role in this process. It is entirely a matter for the Minister for Finance. However, he did ask me for my advice and I offered a number of suggestions. I had a number of criteria in mind. The law states the criteria but I thought it would be good to have people with legal, economic, banking and financial market experience. Gender balance is important. A reflection of the range of political views and attitudes in society is also valuable. Those types of considerations - I am just jotting them down because I had not prepared them properly and probably left something out - influenced the suggestions I made to the Minister.

Senator Shane Ross

Were Professor Honohan's suggestions all accepted, rejected or was there a mixture? Can he give us an indication of what type of influence he had?

Professor Patrick Honohan

The Senator will then want me to give the names, and the names that were not accepted.

Senator Shane Ross

I know Professor Honohan will not do that.

Professor Patrick Honohan

Of course, I gave a lot of names, so they were not all accepted.

Senator Shane Ross

Was it more than four?

Professor Patrick Honohan

I gave more than four.

Deputy Seán Ardagh

Was Senator Ross one of them?

Professor Patrick Honohan

He is always first on every list.

Not all of the names had come from me but I was delighted and surprised in that respect. I am very happy with the names. They reflect the type of aims I had. However, it is a matter for the Minister. As to the process, I think I was advised: "We are thinking of this, this, this and this. Does that sound all right?" and I said: "Yes, go for it."

The next question was about Commissioner Rehn and his exertion of influence. I do not believe Commissioner Rehn was here to exert influence. Perhaps he was exerting influence to some extent in his discussions with different political parties but I do not think he was exerting influence on the Government. Obviously, the Minister travels to the euro group frequently and has constant dialogue with the Commissioner and so forth. I believe Commissioner Rehn's role here was slightly different. To come here and offer the views of the Commission at this time was very useful for people to get an independent, outside view. Of course, it is not outside because we are part of Europe in so many different ways, including membership of the European Central Bank.

He called to me and we discussed how the views on the budgetary profile were evolving. We see eye to eye. To an extent, it is a type of shared technocratic view. One can imagine alternative views coming into play but there is a large majority of converging technocratic opinion on something like this framework and when one digs into it, it is hard to find that an alternative framework makes sense as being the optimal way forward. That is the way to think about it. There are conversations. I am in Frankfurt twice a month. They are not talking about Ireland but there is a type of shared view on what can be done to restore the balances. I do not think of it in the type of terms portrayed by the Senator.

With regard to the Croke Park agreement, as I mentioned in my response to Senator Walsh, there is an issue over the level of remuneration in the economy. From one point of view the agreement does not move in that direction but from another point of view in terms of the efficiency of the performance of the public services, it seems to go forward. Senator Ross suggested that one could dig down into the budget and see some vulnerability in it. I do not know as I have not seen the plan or the budgetary projections. I suspect that the efficiencies will evolve over time and the first year is the crucial year to get right. I do not foresee an unravelling in the way he describes if there are some delays, but I could be wrong. However, that is jumping ahead. We do not know what is in the budget for these types of efficiency improvements.

With regard to the banks, we know there are net outflows from the banks, particularly in September. That is part and parcel of the increased reliance on the ECB. We know that was expected because there were many investors and foreign depositors in banks who had maturities in September and who had entered into the banking system at a time when it and the Government was more highly rated. The spreads were not as high. It is not a great surprise that when the bonds of such investors matured they would have reinvested them in banking systems which would have the characteristics of the Irish banking system when they had invested in it. There are no surprises there.

Senator Shane Ross

Was there anything in October?

Professor Patrick Honohan

The figures will be published. I would be getting ahead of myself if I gave any figures for October but there is nothing like September, when there was the big lump.

With regard to competition in the future with two banks, the cartel existed when there were far more than two banks. It does not just take two to form a cartel. We have legislation now, in both the European and domestic context, which gives additional powers - it is not specifically central banking legislation, although there are some provisions in that regard - to work against what will necessarily be a less competitive situation. One cannot micromanage this type of thing but there are legal tools. It will not be something that will be let drift where there are tools to combat it.

Deputy Kieran O’Donnell

There has been much discussion but growth appears to be the key variable.

Professor Patrick Honohan

Absolutely.

Deputy Kieran O’Donnell

What policies would Professor Honohan like to see implemented to stimulate growth and employment in Ireland? It is the key factor. Everything else for the future is determined by growth. Professor Honohan has obviously looked at this. We have not really discussed it today. He might give us his observations on the straightforward measures not being implemented that could be introduced to stimulate growth.

Professor Patrick Honohan

This is the constant preoccupation anywhere I go, not only on Ireland but internationally. People ask how we get growth going again. Senator Walsh spoke about this, and how the Americans are very concerned about it, except in the Far East where they are roaring ahead. However, in the Far East they are growing to converge with European living standards.

On getting growth relaunched, people ask me if the Irish model which gave us growth is broken and I reply by saying it is not. I tell them it got edged to one side by the property bubble. I mention what we were doing effectively in Ireland - exports, but also good productivity growth relying on competitive production of goods, and using the skills and networks of the multinational corporations but spinning off to our own. We did not destroy that model, of which we all know and which I need not describe here. That is still working.

We see the good performance of the export industry. It does not provide one with as many immediate jobs in the export sector but it spins off to the rest of the sectors, and it is the engine of growth. I do not know how many years it has to run. Maybe at some stage it will run out of steam, but it has not run out of steam yet. We must just refocus on it.

One of the actions we must take to ensure that we do not lose our position in that regard is to address the cost competitiveness and the risk that every time a new multinational company, or an Irish company, thinks of expansion, it asks itself what the alternatives are. Such companies ask themselves about Malaysia. Malaysia may be not as effective in a number of dimensions, but in the cost dimension it will be more effective. We really need to keep that in line, and that has drifted out of line. That is part of the policy measures. I would like to see the whole budgetary strategy over the next number of years have that built into it so that we roll back the excesses that occurred so that we can avoid shooting ourselves in the foot by just charging too much. That is all I can offer on that front at present.

Chairman

I thank the Governor for what was a lengthy meeting.

The joint committee adjourned at 5.05 p.m. until 3.30 p.m. on Tuesday, 16 November 2010.