Léim ar aghaidh chuig an bpríomhábhar

Joint Committee on European Union Affairs díospóireacht -
Tuesday, 30 Apr 2013

Economic and Monetary Union: Discussion (Resumed) with Central Bank

We have a quorum. I advise members and witnesses that they must turn off their mobile phones as they interfere with the broadcasting equipment which means the subsequent feed cannot be used. It is not sufficient to turn them to silent mode.

The first item on the agenda today is economic and monetary union and I am delighted to welcome our three guests from the Central Bank of Ireland, Professor Patrick Honohan, Mr. Patrick Brady and Mr. Colm Larkin.

Today's meeting is the sixth in a series of meeting during the term of the Irish Presidency in which we are discussing Ireland and the European Union. Today's session will focus on the implications for Ireland of an evolving European Union in terms of the proposed completion of EMU and the necessary steps to bolster democratic accountability and legitimacy across the Union. Important steps have already been taken towards achieving a banking union during the first half of the six-month Irish Presidency. We have seen the emergence at EU level of varying degrees of ambition by the European Council, the four Presidents and the European Commission, all in regard to the completion of economic and monetary union.

Today, we will hear the views of the Governor of the Central Bank on the creation of a complete banking union. We would also like to explore the outline plans for more integrated economic policy and fiscal frameworks, the so-called fiscal union, and whether Professor Honohan thinks they are realistic and in Ireland's interest.

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 Houses or an official either by name or in such a way as to make him or her identifiable. 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 this committee. If they are directed by the committee to cease giving evidence in relation to a particular matter and they continue to so do, they are entitled thereafter only to a 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 they are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise nor make charges against any person or entity by name or in such a way as to make him, her or it identifiable.

I now invite Professor Honohan to make his opening remarks.

Professor Patrick Honohan

I thank the Chairman and members for the invitation to appear before the joint committee and contribute to its work on the future of economic and monetary union. It is important work for a number of reasons, namely, the scale of the challenge to restore stability and create sustainable growth and jobs, and also because of the role of the joint committee in ensuring democratic participation and accountability on EU issues.

The euro area in particular has been battered by the fallout from the great financial crisis that broke out in 2007. When the flood of financial globalisation receded it exposed interrelated banking, fiscal and competitiveness weaknesses in many euro area countries. Cross-border banking claims threatened to transmit weakness from stressed countries such as Greece, Portugal and ourselves to banks elsewhere in the monetary union. The high indebtedness of some countries no longer seemed as easily supportable as had previously appeared, and even the stronger countries experienced sizable banking losses.

As we come out of that, accelerated balance sheet repair, associated with aggregate macroeconomic demand weakness, has meant that recovery has been slow and tentative. This combination of pressures, primarily related to banking and wider financial sectors, as well as to macroeconomic and fiscal imbalances and divergences in competitiveness, has represented a significant challenge to the cohesion of the union. Both borrowing countries and lenders became apprehensive and protective of their interests. At certain moments in 2011-12 the combination of problems seemed to market participants to threaten the very sustainability of the institutional arrangements supporting the common currency.

While such fears have been allayed by the credibility of subsequent action, most notably the announcement of the outright monetary transactions, OMT, programme of the ECB, the wider need to rebuild trust and to strengthen the institutional architecture of the system is evident and confirmed in a general recognition that progress needs to be made on four dimensions, namely, banking, fiscal, economic, and political, as has been adumbrated in the report of the four Presidents of the European Council, the European Commission, the Eurogroup and the ECB last June.

I could range far and wide but it would be most appropriate for me to focus my remarks today chiefly on the banking pillar, a banking union. We need banking union to transform the financial system from a source of risk and instability to a source of growth and support to the real economy. We have made considerable progress in the euro area in recent months, especially under the Irish Presidency, in the construction of a banking union, but much remains to be done.

Announcement of action to build a banking union combined with the firm commitment of the ECB has contributed greatly over the past several months to the gradual but clear restoration of confidence in euro area financial markets. I should stress that while it is not appropriate for me to touch on monetary policy issues today ahead of the ECB governing council meeting which will be held on Thursday, as this is a closed period for those immediate monetary policy issues, it is evident that, with some exceptions, sovereign spreads have generally declined in the stressed economies, not least in Ireland, and this trend has held even through the Cyprus situation. The financial markets are counting on the completion of a banking union. We must avoid any easing of tensions in the markets leading to a slackening in the pace of reform.

Banking Union, which involves shifting supervision of banks to the European level, combined with a single resolution regime and a common system for deposit protection, will reassure citizens and markets that a common, high level of prudential regulation is being consistently applied. Together with greater fiscal and economic co-ordination, it will help build the necessary trust between member states which is a pre-condition for the introduction of common financial arrangements.

The Irish Presidency has given top priority to the banking union files. At the Central Bank we have been heavily involved and a large number of my colleagues in the bank have been assisting in the discussions and the technical negotiations that have been happening around the large body of legislative reform that is required for banking union. I should first mention that the Irish Presidency brokered final agreement on the capital requirements directive and regulation, CRDIV as it is called. It is very complex and comprehensive legislation that is intended to strengthen capital and liquidity provisioning of Europe's banks and to improve governance and remuneration practices. Because of this achievement it is expected to apply from January 2014. Agreement has been also reached, following the informal ECOFIN held in Dublin a few weeks ago, on the single supervisory mechanism for banks in the euro area. This will transfer bank supervisory tasks to the European level and will provide strong and consistent supervision. Preparations are well advanced within the ECB to take on this task; it is one that will be performed by the ECB, for which active preparations are already under way, and this could happen as early as July 2014, depending on the formal implementation date. It has been a remarkable success to obtain agreement on this proposal, for which credit is due to all concerned, within just seven months of its publication.

Attention is now focused on negotiations to agree a bank recovery and resolution directive. This would ensure that authorities throughout Europe would have the means to intervene decisively when problems occur and that the costs of dealing with failing banks fall in a clearly defined rank order on the owners and creditors. If we had only had some of that in the past, we would have been in a better position to handle the problems that hit us several years ago. Ministers will discuss this text on 14 May and there is a target to reach agreement by the end of the Irish Presidency.

Considerable progress has been also made on other items of legislation in the financial area and I will highlight those that are key to the banking union. Linked to this is the need to get agreement on a common scheme of deposit guarantee funds throughout Europe, and it is also an objective of the Presidency. However, the combination of a European supervisor of banks with responsibility for the resolution of bank failures remaining at the national level might not be a stable equilibrium. We have got agreement so far on a common supervisor and we have very nearly got agreement on a recovery and resolution directive but it is a directive for national resolution authorities. Having that imbalance between a European supervisor and a national resolving agency might not be a stable equilibrium in political economy terms, as individual member state governments might question and resent the imposition from the single supervisor of bank resolution requirements potentially including recapitalisation costs. Clearly, supervision and resolution should be placed at the same level. The need for this has been acknowledged at successive European Councils which affirmed that it is imperative to break the vicious circle between banks and sovereigns. Now that there is agreement on a single supervisory mechanism it is especially important to press ahead with establishing a single resolution mechanism authority and a single deposit guarantee scheme. I could continue at length about that, but I have laid out some of the elements and I would be pleased to hear members' questions.

I am sure members will raise questions on Professor Honohan's contribution and possibly on the contributions of our other guests. The first questioner is Deputy Dooley.

I welcome Professor Honohan and his team. I have a few questions for him. At the time of the Heads of Government and State agreement last June a statement was made on Ireland's legacy investment - or legacy debt in the first instance - in our pillar banks. What is Professor Honohan's understanding of that decision? Much of the talk since then has indicated that until a final agreement has been reached on banking union, Ireland will not be in a position to get an investment from the ESM in return for the investment that was made at that time. What is Professor Honohan's view on that?

On the bank recovery and resolution directive, obviously in the case of Cyprus depositors found themselves being bailed in. Professor Honohan said that a European supervisor of banks with responsibility for the resolution of bank failures remaining at the national level may not be a equilibrium in political and economic terms. How could the Irish State make direct guarantees, as it has done, that a bail-in situation for depositors would never be countenanced in Ireland if, as Professor Honohan has said, no agreement has been reached on banking resolution under the banking union programme that is under way? Could we still find ourselves at the end of this process agreeing to a set of measures on a banking resolution that would countenance depositors bailing-in in the event of a catastrophic failure of a financial institution in this State?

The next questioner is Phil Prendergast, MEP, and the following two speakers will be Senators Reilly and Leyden as they have to be in the Seanad for 2.30 p.m.

Ms Phil Prendergast, MEP

I thank the Chairman and welcome the delegates to the committee. Last month President Higgins visited the European Parliament and urged us to challenge the dominance of the mainstream neoclassical economics and our response to the crisis and many of its unproven hypotheses. They are unproven but we wish we could call them untested. Unfortunately they have been continuously and most thoroughly tested in this half decade of the austerity experiment. I do not share the beliefs and assumptions that underpin the austerity experiment and the case for it has been continuously undermined from within. Last year and again in early 2013 the IMF did concede to growth forecasts. Its underestimation of the forecasts which seemed to be flawed was certainly problematic in terms of outcomes. Has Professor Patrick Honohan any particular comments to make on that issue?

I thank the Chairman and welcome the delegates to the House. In regard to the mortgage directive, how will it benefit Irish consumers who have unsustainable mortgages? By allowing greater competition in the mortgage market is the EU repeating the mistakes of the past by encouraging reckless lending as the only way of gaining competitive edge? Following on from what has been said earlier in terms of the European Council meetings and the need to break the link between the banks and the sovereign, many of the ratings agencies have said that while mortgage arrears continue to rise there is a risk that bank losses will exceed the PCAR assumptions and hinder the recovery of the banking sector. The chief economist at Davy Stockbrokers said he expects the main Irish banks' mortgage losses to exceed the €9 billion envisaged in the 2011 stress tests.

Last week, as part of the discussion on EMU and strengthening our economic integration, Dr. Alan Ahearne and Professor John McHale appeared before the committee. Dr. Ahearne mentioned breaking the link between the banks and the sovereign. When I asked how we could go about doing this he mentioned the single banking resolution and said the stress test should happen sooner rather than later to show if the banks are under-capitalised as investors are worried about the uncertainly around the banks as opposed to the fiscal situation in Ireland. When I asked from where more capital would come, he mentioned that, perhaps, some European fund could be linked to the single resolution mechanism. In terms of bailing-in he said it was not clear if policymakers would choose such action in the absence of a general lender of last resort to the banking system. Perhaps I could have an opinion on the bailing-in, the lender of last resort, from where potential funding to capitalise banks would come, and the stress test.

I thank the Chairman for allowing us in before the Order of Business and our colleagues for agreeing. I welcome Professor Patrick Honohan and his team from the Central Bank of Ireland. Today is an important day as the Central Bank returns profits of €1.4 billion to the State. That is a successful outcome.

The Central Bank is discussing the deposit guarantee fund at present. Like Deputy Dooley I was taken aback that Professor Honohan in his position at the Central Bank, as a member of the European Central Bank, and, indeed, the Government would encourage, contemplate or support the Cypriot Government in taking a 10% cut or more from depositors. That is something the Central Bank and the late Brian Lenihan protected here in the very critical period. Were it not for that there would have been a flight of capital from this country and there would have been an enormous collapse of the banking system. I compliment the Central Bank and the late Brian Lenihan on a very wise decision. From a historical point of view as far as Cyprus is concerned, it has caused concern throughout the whole European Union. That is the reason the deposit guarantee fund and a guarantee for deposits is vital. There should be no doubt in the future that any of the 17 members of the European monetary union would be affected.

The funding provided to the pillar banks and its release to small enterprises is a cause of grave concern. What level of monitoring is being conducted by the Central Bank on AIB and Bank of Ireland? I have experience of them doing extremely good work in releasing funds to small new start-up businesses. However, some other companies are very concerned about the issue. What level of monitoring is being conducted by the Central Bank in this regard?

I ask Professor Honohan to address those issues.

Professor Patrick Honohan

Those were interesting questions, some of which overlapped. Let us start with the whole question of breaking the link between the sovereign and the banks. When we were discussing and negotiating with the troika in November-December 2010 that was precisely the problem, namely, the international markets felt they did not know how bad the Irish banking situation would get. That is what it thought three years ago. It did not know the scale of the losses. The Irish authorities were trying to pin it down but nobody could be sure. That was the tail risk. We thought we might be at a certain level. That was the picture.

We constantly said to the troika that this was the problem and asked if we could find a mechanism whereby the tail risk would be absorbed by some larger entity that had the capacity to absorb it. We were prepared to pay for that but these were risks which were difficult for us to absorb. The answer was "No, forget about it." The troika said they were simple people and would only give loans. There was no mechanism whereby it could take a direct capital stake in the banks or provide some insurance mechanism. We did argue and take it up at all levels but all we got was "Forget about it, this is not part of the portfolio."

That was the reason we were pleased to hear last summer that the Heads of State landed on the recognition that European funds could be used in that way, not just to lend a block of money to, for example, Spain to allow the Spanish Government to inject capital into its banks but to provide the money directly into Spanish banks as an investment. They get their money back, perhaps, at a higher return but it reduced the indebtedness and the leverage in Spain. The Spanish Government did not decide to follow that route. It did not ask for that. It borrowed money directly as the Spanish Government and used it to recapitalise its banks. It did not go our route because its problem was that, relative to the size of the economy, it was smaller. It could say it did not need to do that and, in any event, there was still an uphill struggle to negotiate that. It was an agreement in principle with the Heads of State that this could be envisaged.

If one wanted the money fast, presumably one would have had to go down the old route. That has not really been activated yet. I admit that in public statements from different parts of Europe there has been push back from other important policymakers who say there is no need to do this in practice. I regret that. It has meant that the Irish Government has, as we are all aware, put a very large sum of money into banks. Some of that is lost forever but some of it is there just to keep the capital of the banks.

When I last looked at it, there was over €20 billion of accounting capital in the banks. The Government had to put that in. I would like to have seen more progress on that. I do not want to argue the other person's side. I tend to look at the other person's position. When one is negotiating, one should know where the other person is coming from. It is clear that strong countries are nervous that they will somehow end up doing something that looks like or can be presented as an investment, but is actually lost money. That is still a work in progress.

Senator Reilly asked about the 2011 PCAR. She wanted to know whether the losses are going to be greater than expected in that review. This is something we are studying now. We are preparing and doing a great deal of background work for our next PCAR, which is scheduled to take place in the latter part of the year. That is still the timetable. We are talking about the timetable. We are considering whether we should do it a little later. It will probably take place at the end of the year. That is what we are going on now. We have not landed on a number. We are trying to do a great deal of detailed background work which would give us a bit more precision than we had the last time. It is very hard to be precise on this.

There are some things that we know have worked out better than was expected in the spring of 2011. For example, banks that decided to sell off assets in order to shrink their size have been able to sell those assets for prices that are better than those envisaged in the stress case. That is a plus. On the other hand, there are minuses. Mortgage arrears have grown more rapidly than we expected or provided for. They are just arrears - they are not losses. We all know about the whole programme of getting the banks and their customers back on track. It involves getting those who can afford to pay back onto their original schedules and designing some kind of sustainable solution for those who cannot afford to pay back. The price of houses was another dimension in the PCAR calculations. Immediately after the PCAR, house prices continued to fall faster than was provided for. At a certain point, they were falling a little faster than was provided for in the stress case. They stopped falling and are now above the stress case. That is a plus.

There are many moving parts in this regard. We have not landed on a number. It is really not going to be a number. I need to point out to people that bank capital needs in Ireland and elsewhere are increasing all the time. This will lead me to another part of the question asked by Senator Leyden. They are increasing because Europe and the world international regulators have decided that banks should hold more capital. In other words, they should be funded more by risk-taking equity investors and less by depositors. There is a target that says the banks will have to have more capital by 2019. One can tell that the Irish banks will need more capital by 2019. That does not necessarily mean we have to start putting money aside for that now. We are hoping, planning and making every effort to get the banks into a situation where there is sufficient confidence on the part of investors that they will want to go and buy equity stakes in Irish banks again.

Last year or the year before last, Bank of Ireland sold equity stakes to US investors at what one might consider to be a pretty cheap price. We want to get to a situation where all of the banks can sell equity stakes - there is sufficient confidence around them because their mortgage situation is under control. To the extent that that works, all of the capital they need will be provided by the private sector. That is the ideal situation. When we announce the results of the PCAR, they will be in terms of a projection of likely further losses because we know there will be further losses, in terms of the period of time over which the additional capital that we know will be required will have to be provided and in terms of how much will be required. We are also working on how that can be achieved.

Does Professor Honohan have an assessment of when the capital assessment review will be completed?

Professor Patrick Honohan

Our current plan it to have it ready by September or October. We are actually talking about that right now while the troika is here. We are considering whether to stick to that, adjust it a little or align it with what is being done elsewhere. One of the things that has been in our minds all along in the European context is whether we need to align our capital assessment exercise with that of the European Banking Authority. It is kind of messy to do them at different times. One ends up using different assumptions and slightly different presentations. There can be confusion. Another factor, in addition to the European Banking Authority, has arisen since we announced our intention to do a PCAR. The single supervisory mechanism will also do a stress test in two phases - an asset quality review and the stress test itself. I can go into the details if the committee wants them. It will be a two-phase thing. It should be completed before the single supervisory mechanism is actually operational. Therefore, it should be completed by the summer of 2014. The European Banking Authority will line up with that in terms of timing and methodology. For good order, it would be great to align them all together. However, that would leave it a bit long. People are interested in the Irish banks. The market is interested. The lenders are interested. Maybe we cannot really leave it that long. We are going to land on that pretty soon. At the moment, plan A is to stick to September or October.

I think that covers the first group of questions, which related to bank capital. I was also asked a number of questions about Cyprus. It is a bit delicate to talk about what has happened in respect of another country. I do not want to go into chapter and verse. Nobody is very pleased with the whole way the Cyprus situation has been worked out. Some elements of it are good and move in the right direction. Some elements were very bad. Some elements were just medium bad. On the whole, I do not think it was the best day's work. I was also asked what it means for us. I do not think it means an awful lot for us, to be perfectly honest. There are many different contextual issues for us. We have done the job, basically, for our banks. One might ask "what about the PCAR?". Basically, grosso modo, we have done the job. As Senator Leyden said, it protected everybody. It protected everybody except the taxpayer. It protected bank depositors and creditors here and in Europe. We have had many discussions about whether it could have been done more cheaply. It probably could have, on the night. They were protected. It is not on, politically, to be thinking in terms of a Cyprus solution. First of all, there is no Cyprus problem. It is not on, politically or domestically. It is not needed. It is not desirable. I see no read-across.

We are talking about agreeing a banking resolution system for the future. We hope the system will be in place for quite some time.

Professor Patrick Honohan


Obviously, it is a question of whether we will agree to a unified methodology of banking resolution, which would ensure decisions like those referred to by Senator Leyden are controlled on a national basis. Alternatively, will we have to adhere to a toolbox of measures that may be agreed as a universal standard?

Professor Patrick Honohan

The whole design of where we are going involves putting in a much larger buffer of capital. I would actually go a lot higher than the level proposed in Basel III and CRD IV, which are lifting the capital buffers much higher than they were. Between 3% and 5% of the liabilities of our main banks were in the form of equity. As soon as that was wiped out, they were in trouble. There would be a whole layer of different types of instruments - not just equity - that would be easier to bail into.

When buying one of these instruments, it will be possible to know that one will get a bit more, that this bank can be trusted. The cushion will be so high and also the quality of the regulation and supervision. That is the mechanism. In theory then after that, there will be creditors who would have to suffer losses before the taxpayer does. However, nobody envisages it will get to the point of the small depositor or even the medium depositor. I do not think this resolution directive should be a matter for investors to worry about. In fact they get better clarity and, more important, they get better management of the banks because the old system with so little equity meant that banks which had started to get into trouble had an incentive to behave in a more reckless manner. Now with so much equity at stake, they will be managed more prudently and cautiously - more like a public utility than some kind of high risk speculative activity.

Ms Phil Prendergast, MEP, asked about the position taken by President Higgins on the dominance of neoclassical economists. I was amused at his recent remark about untested theories. Since then, we have had a very high profile case in which some scholars discovered that they made mistakes and they had somewhat overstated their conclusions in this area. In fact, the conclusions are still in the same direction but not as dramatic nor as convincing as they seemed to be. One thing I like is that there is not so much labelling of neoclassical economists. If somebody talks about neoclassical economists, it means they are anti-neoclassical economists. Nobody who is a neoclassical economist will label themselves as such. President Higgins also talks about radical individualism which is a wider context. I would emphasise that side of his vision of where we should be and where we are not.

A lot has been learned about the strengths and weaknesses of different views of economics. I would not agree that there is something called the austerity experiment where this is something we could choose - either the austerity experiment or some other experiment - and that we have backed this losing horse. I do not think that is correct. It is a concept of balance. We know that governments all around have become very heavily indebted and that this has costs for the borrowing they want to make. It creates uncertainty and it defers investment decisions. In itself it produces these negative consequences which may not be as evident as the potential benefits of spending a little bit more on this high profile expenditure need or a decision to lower this politically sensitive tax rate. That is a very direct and obvious apparent benefit but the consequence is the pressure on the indebtedness. It is a question of balance. As a result of what happened and because of the indebtedness - a lot of which came from the banking system and the imbalances in public expenditure after the revenue just vanished - it means that the correction has tilted over to a need to cut back. There can be argy-bargy about by how much - perhaps the last billion or perhaps €500 million more spending.

In the case of Ireland, we have discussed this in the Central Bank. It may be different for big countries which have more ability to make judgment calls. We are much more constrained here. What was agreed with the troika was not beyond what we would have been recommending in terms of the need to get the house in order. In fact, it might have been better to do it a little bit faster so that we would have it all done by now. I am not saying we should go further; I am just saying that we should get it over with. We would all probably be happier now if we thought we did not have to do any more but that is a matter of judgment. It does not matter now because we are doing it according to the schedule and we are on track.

We need to think of the public out there. They would have been suffering even more.

Professor Patrick Honohan

That is a very important point. The question is whether one trades suffering now for suffering later. It is not just a question of coming down on the lowest paid but rather it is a question of when. Is it better early rather than later? Can we get away with any less? The answer is we cannot. It is not just because of the troika. If it had not been the troika, it would have been the markets. In fact, it was the markets; the markets told us it was a case of no more, that we could not borrow any more. We said we needed to borrow because the Government has expenditure needs. Basically, the troika said that the market would not allow us to borrow, that it would loan us a bit more but we would need to get expenditure under control. The troika members are our friends in this respect, even though I have fights with them over details.

Ms Phil Prendergast

If I may make a comment-----

Very briefly because other speakers are indicating.

Ms Phil Prendergast

I understand. One of the problems is the strict conditionality imposed by the ECB. We do not have equally forceful measures to force investment or lending by the private banking sector to small and medium enterprises. It seems the seesaw is skewed very much to one side and there is an imbalance or a disproportionate response for particular lending to SMEs.

Professor Patrick Honohan

That relates to the question asked by Senator Kathryn Reilly on how the Central Bank is monitoring mortgage lending and lending by the banks generally. We are very concerned with ensuring that while we repair the banks or while they are being repaired, that they can still provide the credit and services that are needed. One may complain about the ECB as much as one likes. For better or for worse, it has lent our banks enormous sums of money so that no bank comes to me and says, "We would lend more if only you could find us a bit more liquidity". No bank says that because that is not their problem. They do not lend probably because at all sorts of levels in a bank, decision-makers have become more risk-averse. They have seen what has happened to their bank and their colleagues for making loans that went sour. It is sort of easier to say "No" than to say "Yes".

Everyone complains about not getting money from banks both in good times and in bad times. On the question as to what extent the Irish banks are out of line now or if there is a danger that we are trying to push them into something more reckless as suggested by Senator Reilly, in so far as we can judge the Irish banks are still less prepared to make loans to small enterprises than banks in other parts of Europe. The survey evidence still shows Ireland as being not as bad as Greece but over towards that end of the extreme. However, we are not hearing so many anecdotal complaints. Members of the committee are politicians-----

We might pick up on that point in the next batch of questions.

I thank Professor Honohan for his attendance. I have three questions following on from Professor Honohan's contribution. He made the point that supervision and resolution need to be placed at the same level and that if this does not happen, there will be a question of lack of equilibrium from a political economy point of view.

My question is whether supervision and resolution at non-national level raise issues of equilibrium and democratic accountability. A central pillar of how financial regulators have done their work to date has been the fact that they are politically independent. They are not elected but appointed and are independent of the Government. If there was a rerun of what happened from 2007 to 2010 and the decisions to deal with bank costs and bondholders were all made outside the country by people who were not elected by the Irish people or accountable to them, it would raise major questions about accountability, a central theme of what we are doing. It does not just concern monetary union but also political union. If major decisions on bank regulation and resolution are being made by authorities independent of national governments, as opposed to being independent within their jurisdiction, how do we square the circle and the expectations of people living in the countries affected? It appears that a large part lies in the answers in which reference was made to equity buffers and the role of other mechanisms. It appears we are heading towards other tensions that we should discuss. I am interested in the contribution of the delegates on that point.

Whither the deposit guarantee scheme post what happened in Cyprus? Questions will be raised about how we bolster the credibility of a new scheme, given what happened there. Ms Phil Prendergast, MEP, put the question on the austerity experiment in Ireland. In the case of a country that does not have its own currency and has massive borrowing requirements, if no one will lend, what is the choice except to close the gap, which is what we are trying to do? I am interested in the perspective of the delegates on whether there are other options that were not apparent when these decisions were made.

The topic is economic and monetary union, but I will play it by ear.

I apologise for interjecting, but I asked Professor John McHale and Dr. Alan Ahearne last week whether economists lived in a different world from politicians. We do, but we are co-dependent. From an economic point of view, I can see the argument that we should have inflicted more pain more quickly, but I ask the delegates to look at it from a political point of view. We can overdose the patient to such a degree that there is a negative response such as social upheaval.

I am more relaxed after two and a half years in government. Neighbours were talking to each other and asking whether they should open bank accounts in England or Northern Ireland in the sterling area. Others were talking about getting out of the eurozone and investing in dollars. Others opted for silver and gold, but we have overcome that sense of insecurity. The price of gold means it is not as sound an investment as it was supposed to be.

In the banking sector, the delegates last week and this week touched on the investment in the Bank of Ireland by American investors. Others are buying property all over the country and expecting to make a killing. They are delighted to be investing here. There is, therefore, some hope we are moving in the right direction.

I thank the delegates for their presentation, which was illuminating. We smiled collectively at the notion of the State picking up the tab for the bank. As a nation, we are subject to criteria imposed by the troika. Then we look at Cyprus and ask whether it is experimenting with the currency and on the stability issue. It is applying different methodology to the banking crisis in different countries. We would have wished that our day had come later in order that there would have been a separation of the sovereign from the banks.

Unfortunately, last week the division bells rang and I could not hear his answer, but Dr. Alan Ahearne mentioned that it was the Government's position to get out of the programme in November or at the end of the year. Professor John McHale mentioned our indebtedness, at 123% of GDP, which was very high. Dr. Alan Ahearne said we should be careful as we might be jumping too soon. Will the delegates give us an opinion on whether it will be appropriate to move at the end of the year? Are we ready to move, given the GDP ratio of 123%?

I join colleagues in welcoming the delegates. This is the second or third time Professor Honohan and I have met, having met in a different context a couple of years ago at events in the constituency I represent.

Do the delegates believe we will achieve banking union? It appears we are on course to do so. To what degree will it contribute to an opportunity to create a further stimulus for job creation? There is some €6 billion in the multi-annual financial framework for the purpose of job creation. Can more money be allocated or will €6 billion suffice? Will banking union create a regulatory framework, whereby it will be easier and prudent to invest in job creation measures? Nothing supersedes the need to create jobs across Europe, as the statistics from Spain and other countries demonstrate. When can we move and to what degree will banking union enable us to do this?

How confident are the delegates that we will receive help in dealing with the issue of legacy debt in the banking sector? Will we break it? If we do, I presume it will have major implications for our recovery. I am interested in their prognosis and knowing how optimistic they are, despite the negative soundings in some parts of Europe.

Professor Honohan has referred to the banks as being risk averse. Depositors are equally risk averse in terms of investing in local initiatives or employment creation. Am I correct in saying there is €100 billion in savings in the country? Will the delegates comment on how we can change people's lack of willingness to take risks? If there was an overall context, it would make them more confident and would help.

If we progress economic and monetary union with banking union to ensure the fitness of the economy and so on, we will have to face up to the issue of a debt write-off in a number of cases. I appreciate this is a difficult issue. However, from practical experience gained in listening to and meeting people, I assume a debt write-off will be necessary as part of the resolution of a considerable number of individual cases as the year progresses. This would apply to debts of up to €20,000. Will Professor Honohan comment on the need for a debt write-off in individual cases? Will he also comment on how workable the American model of printing more money would be in a European context? These points are put to us as we go about our daily work and it will be interesting to hear his response to them.

I have a few questions of my own for Professor Honohan. We have seen major developments in economic and fiscal policy during the past few years. We had the introduction of the six-pack legislation at European level. We also had a referendum on the fiscal compact treaty. The two-pack legislation is coming down the line, but we still do not have the capacity to access any kind of shock absorption fund to help countries in financial difficulty. Does Professor Honohan have a view on whether such a fund would be useful and, if so, does he have thoughts on how it could be paid for?

My second question relates to something Professor Honohan said and I may have cut him off a little early. I ask him to address this question first, as it would allow him to finish the point he was making. He referred to people involved in the bank lending sector as being risk averse and to the fact that might be one of the reasons the amount in loans being approved was lower than it should be. When we were at school, if a teacher failed too many students, there would be a mark-up. Surely there is a role in this instance for the authorities and the Central Bank to examine how the marking system is working and if it is clear too many businesses are failing to receive credit compared to the position in other European banks, perhaps we need to do something about it. From speaking to business people in my county of Meath, including a businessman from Ashbourne who is trying to obtain funding for a business expansion scheme, they find it very difficult to gain access to credit, which they find strange bearing in mind all of the money that has been put into the banks and having heard all politicians talk about how much the money there is available for banks to lend. They do not see this as the reality on the ground. Professor Honohan might address this question first as he had half addressed it before I interrupted him.

Professor Patrick Honohan

A wide range of questions have been asked. I will start with the Chairman's question because we were dealing with that point. It is not an easy one with which to deal. He gave the analogy of a teacher and a headmaster or headmistress who would say a teacher was being too hard on the students and ask the teacher to lift their scores and to score them on a curve. Our role is not exactly like that because in the Central Bank we do not claim to be super duper bankers. We are trying to ensure the banks are run properly, that they are not moving towards a situation where they will cause losses for everybody and that they deal fairly with their customers. We have all of the consumer protection mechanisms in place. However, if a bank does not have the capacity to make good lending decisions, it will fall back in its profit performance and lose out on other customers, which would not be good for it either. We do not pretend to check everything they do, but we do monitor how they go about their business. Their big business in SME financing is to work with the customers who are exposed through over-indebtedness. Members may ask what about new people, but the customers who are over-indebted are also the potential phoenixes and many of them have a variety of businesses. One or two or perhaps a core business could move forward but it is being dragged down by a property development on the side and the borrower as a whole is not creditworthy. What the bank has to do and wants to do in such a case - it takes many resources and a long time to do it - is to get a picture of the borrower's situation as a whole and decide that it cannot pay that amount. It could have a good business in terms of the rest of it and sort it out in that way.

Deputy Joe O'Reilly spoke about write-downs and write-offs, but more broadly what is required is a restructuring of relationships. Borrowers may be able to pay off the debt over a longer period of time, but it needs to be structured in such a way that the viable elements can move forward. We are so long into the crisis that one would think the banks would have done this by now. They are getting on top of it and some banks are better than others. However, some are very behind to this issue, while some are motoring ahead, but it is complex. That is the area about which probably many of the complaints may have been heard. People said they were not getting money from the banks. The reason was they were deeply under water and their situations were complicated to work out. We have been monitoring and pressing the banks to improve the position and get their hands around this aspect. Very often it involves indebtedness to different banks or lenders, which is also true of the household sector. There is unsecured and secured lending. As members will know, in such cases we have been facilitating dialogue between the secured and unsecured parties to get them to agree to deal with the matter in a way that they will not be blocked and to avoid them saying they will not do anything until the other party does something first. We have been getting them together. We are working on the matter, but it is not a question of saying to the banks they have to ratchet up their approvals ratio. If we do this, they will say the Central Bank told them to lend and then when things go bad, they will say the bank told them to do it and that it should bail them out. They have to make the credit decisions. That is not a great answer, but it is the best I can do.

I note Senator Terry Leyden has left. The establishment of the Credit Review Office was an innovation introduced by the late Brian Lenihan. It was innovative. Some inspirations from operations in other countries fed into it, but it was a home grown idea. It is a small office, but Mr. Trethowan has done a great job to sensitise the banks that the nation will be dissatisfied if they keep on turning down viable credit customers. When an applicant refers what he or she considers to be a proposal that was turned down by the banks to the Credit Review Office, Mr. Trethowan will examine it and say it was not such a good proposal and that the applicant should go away or, in many cases, he will say it is a good proposal and that he will contact the banks and often they will say they will have another look at it. It involves a surprisingly small number of cases. SME lending forms a small part of the business of the banks, as they were into property and other things. I do not know if I can say much more on the issue.

Deputy Joe O'Reilly asked about European funds being used to augment measures. The European Investment Bank is assisting. There were blockages up until now because suddenly the ratings of Ireland and other countries were lower and started to block some of the programmes of the European Investment Bank because these programmes required a co-guarantee from the national government. Some of these blockages have been removed and that lending is going ahead. That is a wider initiative. I do not expect banking union per se to lead to turning on a flow of resources in that way.

I will come back to Deputy Paschal Donohoe's question about democratic accountability and removing all of these items - bank supervision and resolution - from national control. That is one way of thinking about it. Another way is that we all use the products from Microsoft Corporation, Apple and so on, but we do not expect to have national control over software, although there is some. We buy in these services and, to some extent, should get away from the re-nationalisation of banking which has tended to come with the crisis and use banking services as if they were a Europe-wide service. In the 1980s the first banking directives envisaged a pan-European banking system, such that if one received a licence in France or Ireland, one could bank anywhere in Europe. The designers of that system imagined that eventually there would be a lot of cross-border banking activity, even at the retail level, and that we would move to a state where we would buy our computers from Dell, Microsoft, Apple and so forth and our banking services from whoever else was strong in the marketplace and that it would not be a national but a European system. I do not see any problem with this. However, we did not reach this for market structure reasons. It was not the way banking went. If it had been all foreign banks which had lent to us for the purchase of residential property and so on, we would be laughing. We had a number of foreign banks lending, including Ulster Bank, Bank of Scotland Ireland and so on. What happened to them? The Government did not bail them out. They were bailed out by their shareholders and the British Government had to put its hand in its pocket also.

I refer to getting to a situation where banking union is not just centrally controlled in terms of supervision and resolution. I am not against a degree of local banking. International banking concerns have been no less anonymous than the large banks we now have. Of course, one has community banking also, but for the big ticket items, if it is seen as mechanical rather than something tied in with national political pressures, banking works best.

The difference between Microsoft and a bank, in particular a large one, is the issue of systemic importance to an economy. I think somebody said banks lived globally but died locally. Let us say we reach this point again, that by that stage the ESM is able to directly recapitalise banks and that the people running it make the decision that before it can directly capitalise banks, the Irish taxpayer has to make a contribution to it, all of these decisions would be made by people not part of any national body or not accountable to the Government, let alone the Oireachtas. Does that then not throw up another question of accountability that is as big as anything we have dealt with to date?

Before Professor Honohan answers that question, I call Senator James Heffernan who will be followed by Deputy Joe O'Reilly.

I thank Professor Honohan for his presentation and presence. I heard on the news today that he had given back a fair chunk of his salary, for which I thank him. It is a very important gesture of goodwill and solidarity with families and working people who are finding it difficult and at the coalface of the austerity experiment.

A couple of weeks ago we heard the former chief of the IMF, Ashoka Mody, say with great clarity and the benefit of hindsight that perhaps we had done and expected too much. There is an argument that we should have laid it all out on the line, made the more difficult cuts and difficult decisions early on and got them out of the way, instead of stringing it out. Where does that leave us in tackling the legacy debt? Does it strengthen the Government's hand that we have people like Ashoka Mody on our side in acknowledging that perhaps we expected too much too soon?

I endorse strongly Senator James Heffernan's remarks about Professor Honohan's gesture. I welcome Professor Honohan's exhortation to banks to continue with restructuring. I know he is being proactive in arranging this and that there are targets in that respect. A colleague of mine puts it to me regularly at our party meetings that we should adopt the Japanese model, expand the length of mortgages from 30 to 40 years and let mortgages be inter-generational and that that is how we should deal with a number of the mortgages in distress. I would be interested in hearing Professor Honohan's response to this as a solution to an Irish difficulty. If our clinic work is any indicator, there are large numbers and perhaps that might be the solution.

Professor Patrick Honohan

I am snowed under in trying to sort out which questions-----

I know Professor Honohan is under time constraints. Will he answer as many questions as he can in the next ten minutes? If, on reflection, he would like to add anything, he could contact the committee and we could take a submission in writing.

Professor Patrick Honohan

I thank the Chairman.

I would like to pick up on some of the issues Deputy Eric Byrne raised. One of the questions he asked was about exiting from the programme. One year ago a couple of seemingly well informed people from abroad came to me and said we would not get out of this programme at the end of 2013 and that it was a joke. I said to wait and see. Now the mood is completely different. Why does mood matter? It matters because it is about the NTMA and Mr. John Corrigan and his colleagues selling Irish Government bonds to people who know they will be repaid. That is what has been happening because the Government has chosen a programme - one might not like it - to which it is sticking. That is what is giving credibility. At this point, it seems that exit on schedule is perfectly feasible; therefore, let us hope no great disturbances hit us from outer space. That is plan A. Of course, we can see how things go. There are more gradual ways of doing it, but for now that is the plan and it looks feasible.

The point Deputy Eric Byrne made about Cyprus is not coming to me.

What about the ratio of 123% of GDP? Does Professor Honohan have an opinion on whether we can exit the programme with a debt ratio that high?

Professor Patrick Honohan

I do not hold a strong view one way or the other. There is no doubt that 123% is a high debt ratio but some countries have higher figures. We got it down remarkably quickly before in the 1980s, if the Deputy can remember what happened then. It reached a peak in 1987 or early 1988 and within 20 years we were down to a figure of 27% or thereabouts. It will not be as easy the second time, but we can get away from 123%. By the way, this figure includes a large cash balance which has built up and we are in a comfortable position to move forward and fund ourselves on the basis of our own credibility.

With regard to the question of whether the Europeans help us, we are always talking about them helping us, but that is a little like the béal bocht. One must be sparing and careful in dealing with this matter. When we entered into the programme, things were not as we would have liked. I have already talked about insurance against tail risk, but we did not like the interest rate because to us it seemed very high. We knew that it was what was available but that it could be negotiated downwards. A lot has been negotiated and the term has been pushed out - Deputy Joe O'Reilly talked about intergenerational mortgages - both for the explicit loans and the promissory notes. This represents a very considerable easing. The lowering of the interest rate means that our worries about interest rate levels on the European loans have gone away and we are in a much better position than we were. Should we be looking for more? I am sure that it is the Government's business to look for as much as it can in as shrewd a way as possible. Disciplined behaviour is the key in order that the other parties do not think that these are people who will never stop asking them.

One of the issues raised was whether should there be a fund or a way to mutualise debt in Europe. This is forward looking rather than backward looking. It is much harder to negotiate about bygones. Part of the vision of the European Union, the fiscal dimension, is that there be a greater degree of common decision-making and, therefore, common responsibility and perhaps common mutualisation of indebtedness in the long run. That is where this is bringing us, but at what speed I do not know. It requires not just a greater move towards fiscal union but also the democratic legitimacy that goes with it, as otherwise it will not happen. Borrowers and lenders must be satisfied about its democratic legitimacy. This is one of the things, as I attend a European affairs committee, that concerns me most - that and what I used to experience in meetings 20 or 30 years ago. The crisis has eroded trust in the European Union. Those of us involved in European affairs, like members of the committee, feel this. Therefore, we need to rebuild it, particularly along the fault line of borrowing and lending. It can be done. It is a challenging political process and presents a challenge to institutional design in order that not only do people trust each other as good people with whom to deal, but also that they deal within a system of rules and understandings that works fairly for both sides. That is a big challenge. The decision-making structures in Europe must also be improved because so many decisions have had to be taken in a rush late at night.

One of the questions was related to a deposit guarantee scheme. Let us take a look at the situation in Cyprus. A lot of damage was done by the first decision to be taken. The attitude was whatever about a deposit guarantee scheme, money could be taken from deposits. On consideration, nobody thought it was a good idea. People looked around and asked from where had the idea come. I think it came from an inadequate process and the decision-making process was under pressure in unsuitable circumstances. It will take time to restore confidence. I do not know whether it has had that much of an impact, but people are talking about the matter. I have often spoken to people about the components of banking union, supervision, resolution and deposit guarantee. They chose to leave the deposit guarantee and did not view the matter as being urgent. Now, because of what happened in Cyprus, there is no way the issue of a deposit guarantee can be taken off the table. Of course, when it is at European level, people stop worrying about it.

On behalf of the joint committee, I thank Professor Honohan and his colleagues for attending and answering our questions. We have had a stimulating debate which has increased our knowledge of the subject.

The joint committee went into private session at 3.25 p.m. and adjourned at 3.40 p.m. until 2 p.m. on Tuesday, 7 May 2013.