ELA, Promissory Notes and All That: The Fiscal Costs of Anglo Irish Bank pdf

UCD CENTRE FOR ECONOMIC RESEARCH

WORKING PAPER SERIES

2012


ELA, Promissory Notes and All That:
The Fiscal Costs of Anglo Irish Bank

Karl Whelan, University College Dublin

WP12/06

February 2012

UCD SCHOOL OF ECONOMICS
UNIVERSITY COLLEGE DUBLIN
BELFIELD DUBLIN 4

1

ELA,PromissoryNotesandAllThat:TheFiscal
CostsofAngloIrishBank

ProfessorKarlWhelan
UniversityCollegeDublin
February2012



Abstract:ThisisabriefingpapertheauthordistributedtotheIrishparliamentarycommittee
responsibleforfinanceandpublicexpenditure.ItdescribesthebalancesheetofIrishBank
ResolutionCorporation,theorganisationthatwasformedbycombiningAngloIrishBankandIrish
NationwideBuildingsSociety.Thenatureofthelong
‐runcosttotheIrishstateoftakingoverthe
liabilitiesoftheseinstitutionsisoutlinedandsuggestionsaremadeforreducingthesecosts.
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1. Introduction
Itiswellkno wnthattheIrishstatehastakenonhugedebtsbytakingoverliabilitiespreviouslyowed
by privately‐owned banks, with the majority of this cost related to Anglo Irish Bank and Irish
NationwideBuildingSociety,whichhavebeenmergedtoformtheIrishBankResolutionCorporation
(IBRC).

The total cost of taking on these liabilities has been about €35 billion or 22 per cent of Ireland’s

nominalgrossdomesticproduct in 2011.Withoutthiscost,Ireland’s debt‐GDPratioin 2011could
havebeen85percent,roughlyinlinetheEurozoneaverage,ratherthanthe107
percentthatwas
recorded. It is possible that without the cost of absorbing the IBRC’s liabilities, Ireland may have
maintainedaccesstosovereignbondmarketsandthusavoidedanEU‐IMFprogramme.
It is alsowellknown thata significantfraction ofthefunds provi ded bythestate to theIBRC have
gone to pay off unsecured bondholders and, perhaps for this reason, much of the domestic and
international commentary has focused on the idea that the Irish government should change its
policyinrelationtopaymentofunsecuredIBRCbondholders.
It is worth stressing, however, that the amount of
IBRC bondholders remaining is small when
comparedwiththetotalcostofbailingouttheseinstitutions.Instead,themajordebtburdendueto
the IBRC relates to promissory  notes that the Irish government  has provided, which in turn are
largely being used to pay off so‐called Exceptional L iquidity Assistance (ELA)
 loans that have been
providedbytheCentralBankofIreland.
ThispaperdiscussesthefiscalcostsoftheIBRCbailout.Theissuescoveredareasfollows:
 ThebalancesheetoftheIBRCandthecrucialroleplayedbyitsELAdebts.
 Theprocessofgrantingandrepayment
ofELAandtheroleoftheECBinthisprocess.
 Thefunctionofthepromissorynotesandtheireffectonofficialdebtanddeficits.
Unfortunately, there are a lot of complex details associated with various aspects of the IBRC’s
relationship with the Irish government, the Central Bank of Ireland
 and the Eurosystem of Central
Banks,sothisnotefocusesatlengthonanumberoftechnicalities.However,Iwouldflaginadvance
thatthekeypolicyimplicationisasimpleone.
There are a number of ways that the burden of the debt incurred in the IBRC bailout could
be
reduced,bothintermsofnear‐termfinancingdemandsandlonger‐termnetpresentvalue.Thekey
obstacletosucharestructuringisthatanyplanofthistypecanbeblockedbyatwo‐thirdsmajority

oftheECBGoverningCouncil.Despitetheimpressionthatthisisacomplex
issuerequiringtechnical
discussions, the key question is whether the members ofthe ECBGoverning Council arewilling to
lowertheburdenonthe Irish peopleduetheirgovernment’sdecisiontotake overtheliabilitiesof
AngloandIrishNationwideandensurethatitsdepositorsandseniorbondholderswererepaid.
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2. TheIBRC’sBalanceSheet
TounderstandthenatureofthefiscalburdenassociatedwiththeIBRC,thebeststartingpointisthe
institution’sbalancesheet.TheIBRCwasformedonJuly1
st
2011byamergerofAngloIrishBank
andIrishNationwideBuildingSocietybothofwhichwerebeingwounddownafterhorrificlosseson
propertyloans.Table1onthenextpageillustrateshowtheliabilitysideofAnglo’sbalancesheet
evolvedoverthepastfewyearsusinginformationfrom
thebank’sannualandmid‐yearreports.
2.1. AngloIrishBank
Attheendof2007,priortothefinancialcrisisthatrockedIrelandfromlate2008onwards,Anglo
had€58.4billionindepositsand€23.6infundingfromdebtsecurities.Thesubsequentyears,amid
financialcrisisandnationalisationofthebank,sawthevastmajorityofthesedepositspulledfrom
the
bankandasubstantialreductioninfundingfromdebtsecuritiesasinvestorsviewedthebankas
toobigarisk.Combinedfundingfromdepositsanddebtsecuritiesfellfrom€82billionattheendof
2007to€19billionattheendof2010.
Someofthefundstopay
offdepositorsandbond‐holderscamefromsellingsomeofthebank’s
assetsandfromloanrepayments,whichsawthetotalsizeofthebalancesheetfallfrom€92.6

billionattheendof2007to€68.6billionattheendof2010.Butmostofthefundscamefrom
borrowing
fromcentralbanks.Atfirst,mostofAnglo’scentralbankborrowingtooktheformof
participationinstandardEurosystemrefinancingoperations.However,theseoperationsrequire
counterpartiestopledgeparticulartypesofcollateralinreturnforborrowingmoneyandAnglo
begantorunoutofeligiblecollateralastheIrishbanking
crisisbeganinlate2008.
InMarch2009,theCentralBankofIrelandagreeda“MasterLoanRepurchaseAgreement”with
AngloIrishBank,lending€11.5billionagainstcollateralthatdidnotqualifyforstandardEurosystem
monetaryoperations.
1
Thiswasthefirstofaseriesofso‐called“ExceptionalLiquidityAssistance”
loansthatweremadetothebank.(Themechanicsandlegalitiesoftheseloanswillbediscussedin
thenextsection.)Asthebankingcrisisintensifiedthrough2010,ELAborrowingsrampedup
significantly.Bytheendof
2010,Angloowed€16.9billioninEurosystemborrowingsandhad€28.1
billioninELAdebtstotheCentralBankofIreland.
InFebruary2011,AnglowasinstructedtotransfermostofitsremainingdepositstoAlliedIrish
BanksalongwiththeBank’sholdingsofabout€12billioninseniorbondsissued
toitbytheNational
AssetManagementAgency(NAMA)inreturnformostofitsportfolioofcommercialpropertyloans.
BecausetheNAMAbondshadbeenusedascollateralforEurosystemborrowings,Anglohadtopay
offmostofitsECBloans,whichfurtherincreaseditsdependenceonELAfrom
theCentralBankof
Ireland.BytheendofJune2011,Angloowed€38.4billioninELAandhadEurosystemborrowingsof
only€2.4billion.


1
Seepage102ofAnglo’s2009annualreport.

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
Table1:AngloIrishBank’sLiabilities(BillionsofEuros)
 End‐2007 End‐2010 Mid‐2011
TotalLiabilities 92.6 68.6 50.7
OfWhich: 
Deposits 58.4 12.1 1.2
DebtSecurities 23.6 6.9  5.7
SubordinatedDebt 5.3 0.5 0.5
OtherLiabilities 5.3 3.6 2.6
EurosystemBorrowings 0.0 16.9 2.4
ELADebtstoCBI 0.0 28.1 38.4

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2.2. IrishNationwideBuildingSociety(INBS)
ThesmallerIrishNationwideexperiencedasimilarcollapsetoAnglo.AswithAnglo,anaggressive
approachtopropertylendingcombinedwithdubiouscorporategovernancepracticescombinedto
produceenormous lossesonpropertyloans,mostofwhichwerecrystallisedbythetransferofits
commercialpropertyloanstoNAMA.From2008onwards,
thebanksawacollapseinitsfunding
fromdepositsandbondmarketsandahugeincreaseinitsrelianceoncentralbankborrowing.Table
2onthenextpageshowsthatthebuildingsocietylosthalfofitsdepositfundingbetweentheendof
2007andtheendof
2010andalsopaidoffalmostallofitsoutstandingdebtsecurities.Bytheendof
2010,Eurosystemborrowingsaccountedformorethanhalfofitsliabilities.
INBSdidnotpublishahalf‐yearreportin2011,sothereisnopubliclyavailableinformationabout
howitsbalancesheetchangedin
itsfinalsixmonths.However,its2010annualreport,publishedin
May2011,reportedthatthebuildingsocietytransferred“substantiallyallofitscustomerdeposits”
toIrishLifeandPermanent,aswellasNAMAseniorbondsworth€2.9bnandotherbondsworth

€790m.ThetransferoftheseECB‐eligibleassets
meantthatIrishNationwidealsoneededtoapply
forELA,soitlikelythatthebankhadELAdebtsofapproximately€3.7billionwhenitwasmerged
withAngloonJuly1,2011toformtheIBRC.

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Table2:IrishNationwide’sLiabilities(BillionsofEuro)
 End‐2007 End‐2010
TotalLiabilities 14.6 12.2
OfWhich: 
Deposits 7.3 3.7
DebtSecurities 6.7 0.6
SubordinatedDebt 0.4 0.4
OtherLiabilities 0.1 0.2
EurosystemBorrowings 0.0 7.4
ELADebtstoCBI 0.0 0.0


2.3. TheIBRC’sBalanceSheet
TheIBRChasnotyetpublishedabalancesheetbutTable3belowprovidesmyestimateofhowtheir
balancesheetwouldhavelookedonitsdateofbirth,July1
st
2011.Thishasbeencalculatedby
combiningthemid‐2011balancesheetofAnglowiththeend‐2010balancesheetofINBSand
accountingfortheshiftofdepositsandbondsfromINBStoIrishLifeandPermanent.
Asofmid‐2011,depositswereonlyaverysmallpartof
theorganisation’sliabilities,whiledebt
securitiesoutstandingweredownto€6.3billion,abouttenpercentoftotalliabilities.Thevast
majorityoftheIBRC’sdebts—€48.2billionofatotalof€58.6billion—areowedtocentralbanksand

thevastmajorityofthese(€42.2billionbymyestimate)taketheformof
ELA.
Therehasbeenaconsiderablefocusinthemediaandpopulardiscussionsonpaymentsto
unguaranteedseniorIBRCbondholders.However,asofJune2011,only€2.9billionoftheIBRC’s
debtsecuritieswereunguaranteedandunsecuredseniorbonds.SinceJune2011,therehavebeena
seriesofpaymentson
thesebonds,includinga$1billionbondthatwaspaidoutinOctober2011
anda€1.25billionbondthatwaspaidoutinJanuary2012.Asaresultofthesepayments,
unguaranteedunsecuredseniorbondnowaccountforlessthan€1billionoftheIBRC’sdebts.So,at
thispoint,
ifthereistobeasignificantreductionintheburdenimposedbytheIBRContheIrish
public,itwillneedtocomefromsomewhereelsethandefaultingontheremainingunguaranteed
6

seniorbonds.Specifically,itwillrequireanewapproa chtodealingwiththeIBRC’sdebtstocentral
banks.
Theleft‐hand‐sideofTable3explainswheretheIBRCistogettheresourcestopayoffitsliabilities
asitwindsdown.Ithastwoprincipaltypesof
assets.First,thereareloanstocustomers.Second,
thereareaseriesofpromissorynotesfromtheIrishgovernmentthatwereprovidedtoAngloand
INBSduring2010.ThesepromissorynotesarecurrentlyvaluedontheIBRC’sbalancesheetat€28.1
and(aswillbediscussedlater)arecurrently scheduledto
provideaseriesofpaymentsoverthenext
20years.
Animportantaspectofthisbalancesheetisthatwithoutthepromissorynotes,theIBRCwouldhave
sufficientassetstopayoffallofitsdeposits,itsbondholders,itsEurosystemborrowingsandallofits
otherdebtsapartfromELA.
Only€14.1billionofthe€42.2billionELAdebtscouldbepaidoffifthe
bankdidnothavethepromissorynotes.Thus,akeypointtounderstandaboutthefuturecostof
IBRCtotheIrishpublicisthat,effectively,thepromissorynotesonlyexisttopayofftheELA

debtsto
theCentralBankofIreland.

Table3:EstimatedIBRCBalanceSheetatMid‐2011(BillionsofEuros)
Assets Liabilities
PromissoryNotes 28.1 Deposits 1.1
Loans 27.5 DebtSecurities 6.3
Other 3. 0 SubordinatedDebt 0.7
 OtherLiabilities 2.3
Eurosystemborrowings 6.0
ELADebtstoCentralBank 42.2
Total 58.6 Total 58.6




7

3. TheABCsofELA
ThissectiondiscussestheprocessbywhichExceptionalLiquidityAssistanceisissuedandmoveson
tothevariouslegalandaccountingissuerelatedtotheissuanceandrepaymentofELA.
3.1. MoneyCreationandCentralBankBalanceSheets
BeforedescribingthespecifictopicofELA,itisworthclarifyinghowtheprocessofmoneycreation
worksintheEurosystem.ItiscommontoseemediareportsstatingthattheEuropeanCentralBank
isprovidingfundstothebankingsystem.Techn ically,however,thisisn’ttrue.TheECBitselfdoesnot

lendmoneydirectlytobanks.Rather,theEurosystem’srefinancingoperationsinwhichitsupplies
liquiditytoEurosystembanksareconductedonadecentralisedbasisbythenationalcentralbanks
oftheEurosystem.
Wheredothenationalcentralbanks(NCBs)getthismoneyfrom?Theansweristhattheydon’tget

itfromanywhere.Theprocessworksasfollows.EverybankintheEurosystemkeepsaso‐called
“reserveaccount”withitscentralbankandth isaccountcanbeusedtowritechequestocreditorsor
torequestcashfromthenationalcentralbanktouseinATMmachines.Whenabank
obtainsaloan
aspartoftheEurosystemrefinancingoperations,itreceivesthefundsviaitsNCBcreditingits
reserveaccount.Thisistextbookmoneycreationinwhichmoneyisconjuredoutofthinair.
Eachofthenationalcentralbanksreportsonamonthlybasishowmuchmoneythey
havecreatedin
thisfashionwhentheyreleasetheirbalancesheet.Ahighlystylisedcentralbankbalancesheetis
producedbelow.
StylizedCentralBankBalanceSheet
Assets Liabilities
Assetsacquiredbymakingloansandbuying
securities
Moneycreatedbymakingloansandbuying
securities
Someotherassets CentralBankCapital

Ontheleft‐hand‐side,thebalancesheetdescribestheassetsthatthecentralbankhasacquiredvia
moneycreationinadditiontoasmallamountofadditional
assetsthatitmayhaveacquiredover
timeindependentofitsmoneycreationactivities(e.g.transfersfromthefiscalauthority).While
centralbankswillhaveholdingsofgoldandothersecurities,formostcentralbanksthelargest
categoryofassetsistheloansthatithasmadetobanks.
8

Theright‐hand‐sideofthebalancesheetshow sthetotalamountofmoneythatthecentralbankhas
createdovertimeaswellastheresidualvaluebywhichthebank’sassetsexceedthemoney
created,whichisusuallytermedthecentralbank’scapital.Notethatifthe
assetsacquiredvia

moneycreationriseorfallovertimerelativetotheiroriginalvaluewhenacquired,thencentralbank
capitalneednotcorrespondtothevalueofassetsacquiredindependentofmoneycreation.
Theright‐hand‐sideofthebalancesheetisoftendescribedasillustratingthecentralbank’s
liabilities.
However,itisworthstressingthatacentralbank’sliabilitiesarequitedifferentfromthose
ofanyprivateentity.Acentralbankthatprintsafiatcurrencythatpeoplewishtousefor
transactionscannevergooutofbusiness.
Suppose,forexample,thatacentralbankprintsoffmoney
toacquiregoldandthepriceofgoldthen
plunges.Inthiscase,thevalueofthecentralbank’sassetsmaywellfallbelowtheamountofmoney
thatithascreated,sotheentryfor“CentralBankcapital”wouldbenegative.Onecouldinthiscase
labelthecentralbank
asbeing“insolvent”insometechnicalsense.However,thisisnotan
insolvencythatcorrespondstoanyprivatesectorversionofthisconcept.Aslongasthebankcan
createmoneythatpeoplewishtouse,itcanpayoffanydebtsthatfalldueandhonourallofits
obligations.
3.2. CollateralandRisk‐SharingforEurosystemOperations
Bythesecommentsaboutthelackofimportanceofcentralbankcapital,Iamnotintendingtoargue
thatcentralbanksshould beabletoprintmoneyforwhatevertasktheywishandnotworryabout
the consequences.The ability to create money is an extremely powerful tool and needs to
 be 
carefully monitored. In particular, within acommon currency area,it is particularly important that
each participating member state is not seen to be particularly responsible for fuelling inflation by
abusingitspowertocreatemoney.
Forexample,forcountriesfacedwiththeproblemoffailingbankssufferingadeposit
run,itmaybe
tempting to provide such banks with loans from the central bank so that private creditors and
depositorscanbepaidoffandthenallowforslow(orno)repaymentoftheseloans.However,such
a policy could be inflationary and would be open to accusations of corruption
 and abuse of the

moneycreationpower.
To prevent such abuses, the Eurosystem’s refinancing operations take the form of repurchase
agreements that are handled in a way that is designed to prevent losses on money creating
operationsofthetypejustdescribedabove.
The Eurosystem’s repurchase agreements involve banks temporarily
supplying financial assets to
their local NCB as collateral in return for loans, with the terms of these loans set by the ECB’s
GoverningCouncil (consistingof the seventeennationalcountrygovernorsand the sixmembersof
the ECB Executive Board) at its monthly monetary policy meeting. Haircuts are applied to
 the
collateralsothattheamountthatisloanedtotheborrowingbankislessthanthevalueofthe asset,
9

with the amount that can be loaned increasing with the quality of the collateral.
2
 Should a bank
defaultonitsloansfromanNCB,thecollateralframework isintendedtoseetheNCBstillleftwith
anassetthathasthesamevalueastheloan.
That said,no risk‐control framework cancompletely rule out the possibility of losses on monetary
operations.For
example,LehmanBrothershadborrowed€8.5billionfromEurosystemcentralbanks
when it entered bankruptcy and it was thought at first that there could be large losses on these
loans. (In fact, recent media reports suggest the gradual sale of the pledged collateral will come
close to recouping the full amount
 of money loaned.)
3
More seriously, the Eurosystem has now
loanedlargeamountstobanksthathaveusedEuropeansovereignbondswithlowcreditratingsas
collateralandhasalsoengagedinlargedirectpurchasesofthesebondsonthesecondarymarket.
TheofficiallegalstatutegoverningtheEurosystemisquitevagueaboutthe

implicationsforanNCB
of losses incurred in monetary operations. Article 32.4 simply states “The Governing Council may
decidethatnationalcentralbanksshallbeindemnifiedagainstcostsincurredinconnectionwiththe
issue of banknotes or in exceptional circumstances for specific losses arising from monetary policy
operationsundertakenfor
theESCB.”Inpractice,theGoverningCounciloftheECBusedthedefaults
by Lehmansand otherbanksin2008to clarifyinastatementin March2009that losses should be
sharedinfullbytheEurosystemNCBsinproportiontotheirECBcapitalkeyshares.
4

NotethatdespiteregularcommentarypointingtotherelativelysmallsizeoftheECB’scapitalbase
oflessthan€10billion,theactualamountavailabletotheEurosystemtoabsorblossesonmonetary 
operationsissignificantlylarger:AsofFebruary2012,theEurosystemhasacombined€81billionin
capital
andreservesandanadditional€394billionin“revaluationaccounts”thatcanalsobeusedto
absorblosses.
Still, this does raise the question of what would happen should one or more Eurosystem central
bankshavetheircapitaleliminatedbylossesonoperations.Perhapssurprisingly,asfarasIcantell,

the legal structures underpinning the Eurosystem don’t discuss this eventuality. Article 27.1of the
ECB Statute requires each NCB to have its accounts audited by independent external auditors
recommended by the Governing Council and approved by the Council but it does not state what
should happen if the Governing Council
is unhappy with the accounts.Still, it is generally
understood that NCBs would need to be “recapitalised” by fiscal transfers from their national
government.

3.3. ELA,MonetaryFinancin gProhibitionandtheECBGoverningCouncil
TheEurosystemallowsforabroadrangeofassetstobepledgedascollateralinitsrefinancing
operations.However,from2009onwards,eachoftheIrishbankscoveredbystateguarantees

exhaustedtheirstockofeligiblecollateralandwouldhavedefaultedonbondsorfailedtohonour

2
SeeEuropeanCentralBank(2011)foradetaileddiscussionoftheoperationalframeworkformonetarypolicy
intheEuroarea.
3
SeethisreportfromtheFinancialTimes,datedJanuary20,2012.
www.ft.com/cms/s/0/30d1a26e‐42b8‐11e1‐93ea‐00144feab49a.html.
4
Seepressreleaseherewww.ecb.int/press/pr/date/2009/html/pr090305_2.en.html.
10

depositwithdrawalswithoutadditionalhelp.ThathelptooktheformofsomethingtheCentralBank
ofIrelandterms“ExceptionalLiquidityAssistance”butwhichtherestoftheworldcalls“Emergency
LiquidityAssistance”—either wayit’sELA.Thisassistancetakestheformofloansthatareprovided
tobankswhopledge
collateralthatitisnotacceptableforEurosystemoperations.
TounderstandthelegalbasisforELA,onehastostartwiththeobservationthatallofthenational
centralbanksintheEuroareawerefoundedpriortothestartofEMUandthuseachhavepre‐
existinglegalpowersand
obligations.Somearegivenvariousregulatoryandsupervisorypowers
whilesomearenot.Moreimpo rtantly,itiscommonfornationalcentralbankstobegivenanexplicit
setofpowersrelatedtofinancialstability.
TheActcurrentlygoverningtheCentralBankofIrelandgivesitageneralpowertolend
against
securitytocreditinstitutionsandalsoprovidesitwithanexplicitfinancialsecurityobjective.Thus,
theoriginallegalbasisfortheBank’spowertoprovidebankswithELAtopreventabankfromfailing
andtriggeringfinancialstabilityproblemscomesfromIrishlaw.
Thisdoesnotmean,however,thatthe
BankhascompletefreedomtooperateitsELAprograms

howeveritwishes.AnumberofdifferentlayersofEurosysteminvolvementareworthflagging.
First,in2005,thebankingsupervisoryauthorities,thecentralbanksandtheFinanceMinistriesof
theEuropeanUnion(EU)haveagreedonaMemorandumofUnderstandingon
co‐operationin
financialcrisissituations.ThisMoU,whichisnotapublicdocumentnorlegallybinding,consistsofa
setofprinciplesandproceduresforcross‐borderco‐operationandlikelyincludesagreementabout
theuseofELA.
Second,the2008ECBConvergenceReportofferstheopinionthat“National
legislationforeseeing
thefinancingbyNCBsofcreditinstitutionsotherthaninconnectionwithcentralbankingtasks(such
asmonetarypolicy,paymentsystemsortemporaryliquiditysupportoperations),inparticularto
supportinsolventcreditand/orotherfinancialinstitutions,isincompatiblewiththemonetary
financingprohibition.”
5
HowexactlytheECB’sdefinesof“temporaryoperations”isunclear.
Third,anarticleintheECB’sFebruary2007MonthlyBulletinstatesthat“theEurosystemalsohas
proceduresinplaceregardingtheprovisionofELAtoindividualcreditinstitutionsintheeuroarea,
whichareundertheresponsibilityofthenational
centralbanks(NCBs).Theseproceduresareaimed
atensuringanadequateflowofinformationwithintheEurosystemtothedecision‐makingbodiesof
theECB.Inthisway,theimpactofanELAinterventiononaggregateliquidityconditionsintheeuro
areacanbemanagedinamannerconsistentwith
themaintenanceoftheappropriatesingle
monetarypolicystance.”
6

Finally,andmostcrucially,Article14.4ofthe“ProtocolontheStatuteoftheEuropeanSystemof
CentralBanksandoftheEuropeanCentralBank”states“Nationalcentralbanksmayperform
functionsotherthanthosespecifiedinthisStatuteunlesstheGoverningCouncilfinds,byamajority
oftwothirds

ofthevotescast,thattheseinterferewiththeobjectivesandtasksoftheESCB.”
7


5
Seewww.ecb.int/pub/pdf/conrep/cr200805en.pdf
6
Seewww.ecb.int/pub/pdf/mobu/mb200702en.pdf
7
Seewww.ecb.int/ecb/legal/pdf/en_statute_2.pdf
11

Tosummarise,theECBmustbeconsultedwhenELAisissuedanditwillassesswhethertheissuance
ofELAinterfereswithitsmonetarypolicystance.TheECBalsoviewsloanstoinsolventcredit
institutionsandnon‐temporaryliquiditysupportprogrammesasillegal.AndtheGoverningCouncil
canvote
atanytimebyatwo‐thirdsmajoritytostopanyELAprogramme.
Forthesereasons,theECBhasbeenheavilyinvolvedinthedesignoftheELAprogrammefromthe
start.Forexample,itislikelythattheECBapprovalwasrequiredinrelationtothepayment
structureofthe
promissorynotesthatIBRCisusingascollateralforELAloansandwhichprovides
thefundswithwhichELAwillberepaid.Inaddition,theECBlikelysoughtvariousassurancesthat 
ELAwouldberepaidsuchasthe(apparentlylegallynon‐binding)“lettersofcomfort”sentfromthe
Ministerfor
FinancetotheGovernoroftheCentralBankoneachoccasionanewELAprogramme
wasinitiatedindicatingtheintentionthattheELAwouldberepaidandtheprovisionofso‐called
“facilitydeeds”whichtheCentralBankannualreportasprovidingagovernmentguaranteein
relationtorepaymentofELA.
8


Inpractice,itappearsthatELAcreditisprovidedtobanksforaveryshortperiodoftime(acoupleof
weeks)andtheECB’sGoverningCouncilregularlyconsiderswhethertostoptheprogramme.In
addition,theECB’sviewontheneedforsolvencyofinstitutionsinreceiptofELA
meansthatmost
likelytheymustapproveofanyrestructuringoftheassetsofsuchabank,suchasachangeinthe
termsoftheIBRC’spromissorynote.

3.4. Target2andIntra‐EurosystemAssetsandLiabilities
BeforedescribingthemechanicsofhowexactlyELAworksandhowitaffectsthebalancesheetof
theCentralBankofIreland,ithelpstodescribeoneaspectitsbalancesheetinabitmoredetail.

Intra‐EurosystemBalances
Onthenextpage,I’veproducedaslightlylessstylisedcentral
bankbalancesheetthantheone
describedbefore.Itislessstylisedinthatititemisesthedifferentsub‐componentsthatcorrespond
towherethemoneycre atedbyacentralbankendsup.
Thethreesub‐componentslistedhereare:Reserveaccounts,banknotesandIntra‐Eurosystem
liabilities.Thefirsttwo
ofthesecomponentsaresimpleenough;thelastone,unfortunately,isoften
misunderstood.
 Whenacentralbankcreatesmoneyviaaloantoafinancialinstitution,itcreditsthatbank’s
reserveaccount.Thisshowsupasincreasedliabilitiesonthecentralbank’sbalancesheet,
withtheloanshowingup
asacorrespondingentryontheassetside.

 Iftheborrowingfinancialinstitutionrequestsadeliveryofbanknotes,theirreserveaccount
isdeductedbytheamountdeliveredandthe“banknotes”entryonliabilitysideofthe

8
Copiesofmostofthelettersofcomfort,whichwereobtainedviaaFreedomofInformationrequestbyRTE,

areavailableatwww.rte.ie/news/2011/0718/centralbank‐business.htm.
12

centralbankbalancesheetiscredited.Thereisnochangetotheassetsideofthecentral
bankbalancesheet.


ASlightlyLessStylizedEurosystemCentralBankBalanceSheet
Assets Liabilities
Assetsacquiredbymakingloansandbuying
securities
“CentralBankCapital”
Someotherassets Moneycreatedbymakingloansandbuying
securities
 Ofwhich:
 ReserveAccounts
 BankNotes
 Intra‐EurosystemLiabilities

ThatbringsustoIntra‐Eurosystemliabilities.Thisitemisbestexplainedviaatransactioninwhich
a
depositor(callhimJean)withanIrishbank(callthem“Anglo”)requeststhat€100betransferred
fromtheiraccounttoadepositaccountwithaFrenchbank(callthem“SocGen”).Thisworksas
follows:
 Jean’sbankaccountisdeducted,reducingAnglo’sliabilitiesby€100.
 Atthesametime,
AngloinstructstheCentralBankofIrelandtodeduct€100fromitsreserve
accounttosendthefundstoSocGen.
 ThereductioninAnglo’sdepositaccountwiththeCentralBankofIrelandreducesthis
componentoftheBank’sliabilitiesby€100.However,theCentralBankofIreland

immediatelyincreases
anentrylabelled“Intra‐EurosystemLiabilities”.
 ViatheEurosystem’sreal‐timepaymentssystem,Target2,theBanquedeFrancethen
receiveseithera€100credittoits“Intra‐EurosystemAssets”ora€100reductioninits
“Intra‐EurosystemLiabilities”dependingonwhetheritisanIntra‐Eurosystemcreditoror
debtor.

Offsettingthis€100improvementinitsbalancesheet,theBanquedeFrancecredits
SocGen’sreserveaccount,thusincreasingSocGen’sassets.
 SocGenthencreditsJean’sdepositaccountwiththatbank.
NotethatfromJean’spointofview,allthathashappenedisthathis€100hasgonefromhisIrish
bankaccounttohisFrenchbankaccount.However,thewaypaymentssystemsactuallyoperate,
therehavebeensixdifferentoffsettingtransactionsthathaveoccurredalongtheway.Most
13

importantlyforthepurposesofthispaper,theassetsideoftheCentralBankofIreland’sbalance
sheethasnotchangedbuttheliabilitysideshows€100lessinreserveaccountsand€100morein
Intra‐Eurosystemliabilities.AsimilarchangewouldhaveoccurredifAnglohadwrittena
chequeto
payoffabondholderwithadepositaccountoutsideIreland.
TheseIntra‐Eurosystembalancesaverag etozero.ThosecountrieswithIntra‐Eurosystemliabilities
payinterestontheseliabilitiesattherateoftheEurosystem’smainrefinancingrate(currently1per
cent).ThisinterestisaccumulatedattheECBand
redistributedtothosecountrieswithIntra‐
Eurosystemcredits.

AnAside:The“Target2Debate”
Ashasnowbeenwelldocumented(e.g.pages34and35oftheBundesbank’sMarch2011Monthly
report)themovementsofdepositsassociatedwiththebankingandsovereigncrisesofrecent years
havegeneratedverylargeIntra‐

EurosystemliabilitiesincountriessuchasIrelandandaparticularly
largeIntra‐EurosystemcreditfortheBundesbank.
Itisbeyondthescopeofthispapertodiscussthevarioustechnicalissuesthathaveariseninrelation
totheIntra‐Eurosystemflowsthathavebeengeneratedbythecapitalflightfromthe
peripheryto
thecore.However,Iwouldnotethatanumberofeconomistshavereceivedsubstantialmed ia
attentionformisleadingclaimsrelatingtotheBundesbank’sIntra‐Eurosystemcredits.
Inanumberofcontributions(ofwhichSinnandWollmershäuser,2011,isthemostcomprehensive)
Hans‐WernerSinnoftheIfoInstitute
hascharacterisedtheBundesbank’sIntra‐Eurosystemcredits
as“TargetLoans”.Thischaracterisationisunhelpfulinrelationtobothwordsemployed.
 Asdescribedabove,thepurposeoftheTargetsystemistoseethatJeancantransferhis
€100fromhisIrishaccounttohisFrenchaccount.Sinnhasproposeda
numberofwaysto
restricttheoperationoftheTargetsystem.Byrestrictingthefreemovementofcapitalwith
theEurozone,theseproposalsareeffectivelyacalltoendthecommoncurrency.
 Thesecreditshavenoneofthecharacteristicsofloans.Theyarenotinstigatedbythe
Bundesbanksupplying
itsownfundstotheCentralBankofIreland.Rather,theyrepresenta
transferoffundsoutofIrelandtowardsGermany.
Morerecently,anumberofmediacommentatorshavefocusedontheideathatGermanyissubject
toanenormouscreditriskinrelationtoapossible“default”onitsIntra
‐Eurosystemcreditsinthe
eventofaEurobreak‐upandconsequentlargefiscalco stsofaBundesbankinsolvency.Thesefears
areunfoundedfortworeasons.First,thevariousEurosystemcentralbanksretainsufficientassetsto
allowforafullandfinalsettlementoftheIntra‐Eurosystembalancesifsuch
wererequired.Second,
asnotedabove,concernsaboutinsolvencyofcentralbanksareunfoundedprovideditprintsafiat
currencythatpeoplewishtohold.OnecanbesurethatintheeventofacompleteEurobreakup,
theBundesbankwillfindplentyofdemandforitscurrency.



14

3.5. IssuanceandRepaymentofELA
HereIwanttodescribethemechanicsofhowELAissuanceworksaswellaswhathappens
afterwardsinrelationtointerestandprincipalrepaymentsonELA.

Issuance
ThereasonIhavedescribedIntra‐Eurosystemtransactionsinsuchdetailisthattherehasbeensome
confusioninmediaandpolitical
circlesinrelationtothenatureoftheELAissuance.Anumberof
mediastorieshavereportedthat“theELAmoneywasborrowedfromtheECB”.Thisisnotthecase.
TheECBdoesnotissuemoneyatallasthistaskisdelegatedintheEurosystemtonationalcentral
banks.

Amoresubtleversionofthe“ELAwasborrowedfromthe ECB”claimwasprovidedinananswertoa
parliamentaryquestionbytheIrishMinisterforFinance,MichaelNoonan,onJanuary31,2012.
9
Mr.
Noonanstatedthat“ELAisitselffundedbytheCBIthroughIntra‐Eurosystemliabilities”.
Theword“funded”canhaveanelasticmeaning.However,thisanswersuggestsaninterpretationin
whichtheappearanceofanELAassetontheCentralBankofIreland’sbalancesheetisaccompanied
byan
increaseinIntra‐Eurosystemliabilities.Itismyunderstandingthatthisisnotthecase.Atthe
momentof“conception”,sotospeak,oftheELA,thecorrespondingincreaseinliabilitiesisacredit
tothereserveaccountofthebankreceivingtheELAloans.Onlyifthatbankthenuses
itsELAfunds
totransfermoneytobankaccountsoutsideIrelanddoestheCentralBankofIreland’sbalancesheet
starttoshowanincreaseinIntra‐Eurosystemliabilities.

BecausetheIBRCappearstohaveusedthevastmajorityofitsELAloanstopayoffforeign
bondholdersandpeoplemoving
theirdepositsoutsideofIreland,thereislittledoubtthatthe
issuanceofELAhasledtoasignificantincreaseintheCentralBank’sIntra‐Eurosystemliabilities.
However,itisnotaccuratetodescribetheELAashavingbeeneither“borrowedfromtheECB”orto
describeanincreasein“Intra
‐EurosystemLiabilities”asthesourceofthefunds.
IshouldemphasisethatinpointingoutthatELAfundswerenotborrowedfromtheECBortherest
oftheEurosystem,itremainsthecasethattheECBGoverningCouncilcaninsistonanendtothe
ELAprogrammeatany
pointandisalsolikelytorequireconsultationinrelationtoanyproposals
thatwouldinvolvechangestothenatureoftheIBRC’sassets.

InterestPaymentsonELA
TurningfromELAissuance,toitsrepayment,afirstquestionrelatestotheinterestratesthatthe
CentralBankofIrelandchargeson
itsELAloans.TheBankhasnevercommentedpubliclyonthis
interestrate.GiventhatELAisnormallyissuedattimesoffinancialcrisisanditsmereexistencemay
beaverysensitivematter,itislikelythattheyarefollowingEurosystemguidelinestoadoptthe
FightClubapproachto
communicationsonELA(“ThefirstruleofELAis:YoudonottalkaboutELA”).

9
Seewww.kildarestreet.com/wrans/?id=2012‐01‐31.767.0&s=mathews#g774.0.q
15

Despitethisofficialapproach,AngloIrishBank’srecentreportshavenotedthattheinterestrateon
itsELAloansislinkedtotheECBmarginallendingfacility,whichiscurrently1.75percent.In
addition,theCentralBankofIrelandreported€510millioninELAinterestin2010in
itsannual

report,whiletheentryfor“Otherassets”averaged€21.3billionin2010.Dividingtheinterestbythe
averagevalueofotherassetssuggestsaninterestrateof2.4percent.Giventhatthemarginal
lendingfacilityratewas1.75percentthroughout2010,myguessisthattheformulaused
to
determinetheELAinterestrateissomethinglike“marginallendingfacilityplus75basispoints.”
GiventhattheCentralBankiscurrentlypayingoutinterestof1percentonbothmoneyheldin
reserveaccountsandonIntra‐Eurosystemliabilities,thisraisesthequestionofwhathappenstothe
profitsincurredviatheestimated75basispointspreadchargedonELA.
ProfitsrelatingtoEurosystemmonetarypolicyoperationsaresharedamongthevariousnational
centralbanks.However,asfarasIcantell,thisisnotthecaseforprofitsassociatedwithELA
operations.Ifthisiscase,thenthe
75basispointmargincanberemittedatsomepointbythe
CentralBankofIrelandbacktotheExchequer.
ThismeansthattheultimateinterestcosttotheIrishstateoftheELAfundingthatissuppliedtothe
IBRCisthemainECBrefinancingrate,whichiscurrently
onepercent.

ELARepayments
WhatoccurswhenELAprincipalisrepaidbytheIBRC?Therearetwopotentialscenarios.Inthefirst,
theCentralBankofIrelandmaintainsitsbalancesheetsizeexactlyasbeforeandsimplyaddstoits
stockofassets;forexample,theycouldpurchasegold
orsecurities.Profitsfromtheseinvestments
couldeventuallybereturnedtotheIrishstate.
Inthesecondscenario,theCentralBankdoesnotacquireanynewassetsbutsimplyreducesthesize
ofitsbalancesheet,markingdownboththevalueofitsELAassetandthevalueofitsliabilities.
This
isthescenariothatactuallyoccurs.
Thegraphbelowshowswhathashappenedoverthepastfewyearswiththe“OtherAssets”
categoryontheCentralBankbalancesheet,whichprimarilyconsistsofELA.Afterreachingapeak
of€70billioninFebruary2011,thedeleveragingprogrammesofthe

Irishbanks(sellingassetsand
takinginloanproceedsandthennotlendingthemoutagain)haveallowedthemtorepayELAso
thatbyDecember2011,“OtherAssets”haddeclinedto€44billion(seechartbelow).Itappears
nowthatalmostalloftheoutstandingELAisowedbythe
IBRC.




Tables
4
ofFebr
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m
thasappea

r
Exchequert
n
garmsoft
h
havenone
t
m
plytakeno
t
heIrishsta
t

c
ribingit
o
ldings
n

e
r
lion.
y
ments
m
ountof
r
edin
oIBRC
h

eIrish
t
costto
utof
t
efrom
17

Table4:CentralBankofIrelandBalanceSheet,February2011(BillionsofEuros)
Assets “Liabilities”
EurosystemLending117 Banknotes 12
Securities,gold,otherclaims 21 Reserveaccounts 9
Otherassets(mainlyELA) 70 OtherLiabilities185
CapitalandReserves 2
Total208 Total208





Table5:CentralBankofIrelandBalanceSheet,December2011(BillionsofEuros)
Assets “Liabilities”
EurosystemLending107 Banknotes 13
Securities,gold,otherclaims 25 Reserveaccounts 6
Otherassets(mainlyELA) 44 OtherLiabilities 155
CapitalandReserves 2
Total176 Total176











18

4. PromissoryNotes
TherehasbeenconsiderablepublicdiscussioninIrelandabouttheideaofrestructuringtheIBRC’s
promissorynotes.However,IthinkitisimportantthatthepriorissuesrelatingtotheIBRC’sbalance
sheet,thenatureofitsELAdebtsandtheroleplayedbytheECBGoverningCouncilareestablished
before
onecanaddressthekeyissuesrelatingtoanypotentialrestructuringofthenotes.

4.1. PaymentStructure
During2010,itbecameapparentthatAngloandIrishNationwidehadtwoseriousproblems.The
firstwasaliquidityproblem;bothinstitutionswerelosingdepositsandhadnoaccessto
internationalbondmarkets.Inaddition,therewasasolvencyproblem,asitbecameclearthatboth
institutionshadsufferedenormouslosses
onproperty‐relatedloans.
TheliquidityproblemwaslargelysolvedbyissuingtheAngloandINBSlargerandlargeramountsof
ELA.Thesolvencyproblemwastrickier.Ifthestatewasgoingtoseethatdepositors,bondholders
andELAdebtswereallrepaid,wherewasitgoingtogetthe
moneyfrom?AsconfidenceintheIrish
statefinanceswanedduring2010,itwasclearthattherewasnowaythatthegovernmentcould
obtaintheenormoussumrequiredtorestoretheIBRCorganisationstosolvency—€31billionor20
percentofGDP—byborrowingfromfinancialmarkets.
Thusthedecisionwastaken

tosupplytheIBRCinstitutionwithassetsworth€31billionintheform
ofpromissorynotes.TheseareeffectivelyIOUsfromtheStatetotheIBRCthatpromisetopay
moneyaccordingtoanagreedschedule.
Table6reportsthefullscheduleoftotalpaymentsonthenotesthathave
beenissuedasdescribed
inananswertoaparliamentaryquestioninSeptember2011byMinisterNoonan.
11
Thefirstthing
tonoteaboutthescheduleisthatitdiffersfrom,forexample,afixed‐ratemortgageinthatthe
annualpaymentschangeovertime:
 Thepaymentsare€3.1billionperyeareveryyearonMarch31throughto2023(thefirst
paymentwasmadewithoutmuch
fanfareonMarch31,2011).
 Apaymentof€2.1billionisduein2024.
 Paymentsof€0.9billionayearareduefrom2025‐2030.
 Afinalpaymentof€0.1billionisduein2031.

Inrelationtotheinterestpayments,thesearedealtwithsomewhatlike
afixed‐ratemortgage.An
annualinterestchargeisappliedtotheoutstandingprincipalandthereductionintheprincipal
outstandingequalstheannualpaymentminusthecalculatedinterest.Anexceptionisthetreatment
ofinterestintheyears2011‐2013,wherealowerrateofinterestwasapplied(noneat
allin2012).
Thenoteswereissuedgraduallyoverthecourseof2010andweregiveninterestratesthatwere
similartotheratesthenprevailingonIrishgovernmentbonds.(Theseratesrosesharplyoverthe

11
Availablehere />19

courseof2010.)Thedeferralofinterestover2011‐2013thenmeantthatforthebondstostillpay

outtheinteresttotalsoriginallyagreed,theinterestrateappliedfortheremainderofthepayment
schedulewouldbeapproximately8percent.Thus,onceinterestonthenotesisapplied
atthislevel
in2014,therewillbeaninterestchargeof€1.8billion,whichwillgraduallydeclineinlateryears.
ItisclearthatthispaymentstructurewastacitlyagreedtobytheECBGoverningCouncil,whoare
thereforeawarethatIBRCwillnotbeabletopaybackits
ELAformanyyears.Indeed,the
promissorynotecouldbesaidtorepresentanimplicitlong‐termtimetableforELArepayment.

Table6:PromissoryNotePaymentSchedule
 TotalInteres
t
 Repayments TotalCapital
Reduction
TotalAmount
Outstanding
31/3/2011 0.6 3.1 2.5 28.1
31/3/2012 ‐ 3.1 3.1 25.0
31/3/2013 0.5 3.1 2.6 22.4
31/3/2014 1.8 3.1 1.2 21.2
31/3/2015 1.7 3.1 1.3 19.9
31/3/2016 1.7 3.1 1.4 18.5
31/3/2017 1.5 3.1 1.5 17.0
31/3/2018 1.4 3.1 1.6 15.4
31/3/2019 1.3 3.1 1.7 13.7
31/3/2020 1.2 3.1 1.9 11.8
31/3/2021 1.1
3.1 2.0 9.8
31/3/2022 0.9 3.1 2.2 7.6
31/3/2023 0.7 3.1 2.3 5.3

31/3/2024 0.6 2.1 1.5 3.8
31/3/2025 0.4 0.9 0.5 3.3
31/3/2026 0.4 0.9 0.5 2.8
31/3/2027 0.3 0.9 0.6 2.2
31/3/2028 0.3 0.9 0.6 1.6
31/3/2029 0.2 0.9 0.7 0.9
31/3/2030 0.1 0.9 0.8 0.1
31/3/2031 0.0 0.1 0.0 0.0
 
TOTALS 16.8
 47.9 30.6
20

4.2. TheLong‐RunIrrelevanceoftheInterestRateontheNotes
Muchofthemediacommentaryonthepromissorynoteshasfocusedontheirhighinterestrateand
suggestedthat areductioninthisrateshouldbethefocusofanyeffortstoreducetheburdenof
IBRCdebtonthetaxpayer.Inparticular,therehasbeenconsiderablefocusonthefact
thatthefull
totalofscheduledpaymentsonthenotesis€48billiononceinterestpaymentsareaddedtothe€31
billionprincipal.
Itshouldbestressed,however,thatlowering oftheinterestrateonthenoteswilldolittletoreduce
thelong‐runburdenoftheIBRCdebt
ontheIrishstate.Indeed,verylittleofthe€17billion
differencebetweenthepaymentstotalof€48billionandtheprincipalof€31billionrepresentsanet
costtothestate.
Toseethispoint,itisworthworkingthroughthestructureofpaymentsthatwehaveoutlined:
 Promissory
notepaymentsareultimatelybeingusedbytheIBRCtopayoffELAtothe
CentralBankofIreland.IBRCthusneedsanadditional€28billiontorepaytheprincipalonits
ELAdebts.

 IBRCalsoneedstopayinterestonitsELA.However,theELAinterestrateis
approximately
2.5percent,soanyadditionalinterestpaymentsabovethisratewillrepresentaprofitfor
IBRCwhichcanultimatelybereturnedtothestate.
 TheCentralBank,inturn,currentlypaysaninterestrateofonepercentonitsreserveand
Intra‐Eurosystemliabilities,soitisalsomaking
aprofitofanestimated150basispointson
itsELAloanswhichcanalsobereturnedtothestate.
Puttingthesepointstogether,itturnsoutthatonlyasmallfractionoftheinterestpaymentsonthe
promissorynotesrepresentanetcosttothestate.
Anotherwayto
seethispointistoconsiderhowlongitwilltakethepromissorynotepaymentsto
clear€28.1billioninELAdebt(effectively,I’massumingthattheIBRC’sotherassetswillbeusedto
payoffallotherliabilitiesandtheadditionalELAestimated aboveat€14.1billionatmid‐2011).

Table7providesascheduleforhowtheIBRCcanusetheannualpaymentsonitspromissorynotes
toreducetheamountofELAoutstanding.IhaveassumedthattheELAinterestrate,whichis
ultimatelylinkedtotheECB’smainpolicyrate,willnotremainaslowas2.5%
foreverandhaveset
outascheduleinwhichitwillmoveuptowards4.5%andthenstaythere.
Accordingtothesecalculations,thecurrentschedulewouldmeanthatIBRCwillbeabletopayoffits
ELAdebts(withpresumablyallotherdebtslonggone)in2022.Atthatpoint,
thegovernmentcould
winduptheIBRCandsimplycanceltheremainingpayments.Noteherethatthetotalamountof
promissorynotepaymentsinthisexamplewouldbe€37billion.Theadditional€11billionin
paymentsscheduledafter2022justwouldn’thappen.
Thus,theintensefocusonthetotalrepayments
figureof€48billionismisplacedandany
restructuringofthepromissorynotesthatissoldashavingthebenefitofreducingthe€48billion
figuretosomethinglowerwillactuallybedoingverylittletoreducethelong‐termburdenofthe

IBRC.
21

Table7:ANotionalScheduleforRepaying€28.1BillioninELAUsingPromissoryNotePayments
 ELAInterestRate Repayments InterestPayments TotalAmount
Outstanding
31/3/2011 0.025 3.1 0.78 28.1
31/3/2012 0.025 3.1 0.70 25.7
31/3/2013 0.025 3.1 0.64 23.3
31/3/2014 0.030 3.1 0.70 20.7
31/3/2015 0.035 3.1 0.73 18.3
31/3/2016 0.045 3.1 0.82 15.8
31/3/2017 0.045 3.1 0.71 13.4
31/3/2018 0.045 3.1 0.60 10.9
31/3/2019 0.045 3.1 0.498.3
31/3/2020 0.045 3.1 0.375.6
31/3/2021 0.045
 3.1 0.25 2.7
31/3/2022 0.045 2.8 0.12 0.0

4.3. TheShorter‐TermRelevanceoftheInterestRateontheNotes
Whiletheamountofinterestpaidonthepromissorynoteshaslittlelong‐runimpact,theseinterest
paymentsaresettohaveanunfortunateimpactontheIrishbudgetaryprocessoverthenextfew
years.ThisimpactrelatestoEurostat’saccountingtreatmentofthepromissorynotes.
Eurostat’saccruals‐basedaccountingfor
budgetdeficitscountedthefull€31billionprincipalofthe
promissorynotesonIreland’sgeneralgovernmentbudgetdeficitin2010.Theinterestpaymentson
thepromissoryno tesarethencountedonthegeneralgovernmentdeficit(GGD)intheyearsthat
theyoccur.However,Eurostat’srulesallowfordebtinstrumentsto
have“interestholidays”inwhich

nointerestischargedandthepromissorynotesweredesignedwithsuchaholidayperiodover
2011‐2013.
12

Whenthisperiodisscheduledtoend,theinterestpaymentsonthenotewillgofromhavingno
impactontheGGDthisyeartoa€500millionimpactin2013anda€1.8billionimpactin2014.Even
thoughthecashflowimpactofthenoteswillnotchange
duringtheseyears,thegovernmentwill
needtofindanadditional€1.8billioninspendingcutsandtaxincreasesoverthenexttwoyearsifit
istosticktoitsofficialtargetsforthismeasureofthedeficit.



12
SeethisDepartmentofFinanceinformationnotereleasedinNovember2010:
www.finance.gov.ie/documents/publications/reports/2010/noteprommissory2010.pdf
22

5. PotentialPolicyOptions
Thissectiondiscussesthereasonsinfavourofrestructuringthepromissorynotes,outliningmy
preferredoptionsforrestructuringaswellasthepotentialargumentsthatarelikelytolevelled
againstthisapproachbymembersoftheECBGoverningCouncil.Ialsoprovidesomeargumentsfor
changingtheIBRC’saccountingtreatmentof
thenotes.

5.1. WhyRestructurethePromissoryNotes?
Beforeconsideringpolicyoptionsforchangingthestructureofthepromissorynotes,itisworth
emphasisingwhysucharestructuringisdesirable.
TheEuropeanCommission’slatestreportonIrelandprojectsthattheIrishdebt‐GDPratiowillpeak
at119percentattheendof2013,justasthestate

issettorunoutofitsEU‐IMFfunding.Thisdebt
ratioiswellbeyondlevelsthathavetraditionallybeenconsidereddangerous,evenpriortothe
recentexampleofprivatesectorsovereigndebtrestructuringwithintheEurozonesetbyGreece.As
currentlystructured,thereislittledoubtthatthe
IBRC’spromissorynoteswillrepresentasignificant
negativefactorinrelationtofinancialmarket’sassessmentofthesustainabilityofIreland’sdebt
burdenatthattime.
Ihaveprojectedabovethat,basedonthecurrentscheduleandthenatureofIBRC’sELAdebts,
Irelandissettomakeitstwelfthandlast
promissorynotepaymentin2022.Effectively,the
promissorynotesactliketwelvedifferentzero‐couponbondswithmaturitiesrangingfromoneto
twelveyears.Thus,theeffectiveaveragematurityofwhatisleftofthisdebt,whichaccountsfor
twentypercentofGDP,isaboutfiveyears.
Combinedwithan
averagematurityasofMarch2012onIreland’sexistingprivatedebtofabout€80
billionofaboutsixandahalfyears,thismeansthatIrelandwillhaveverysignificantfunding
requirementsoverthenextfewyears,evenbeforeoneconsiderstheincrementalborrowing
associatedwithbudgetdeficits.
13

ItisthefirmhopeofIreland’sEurozonepartnersthatIreland,whichiswidelypraisedforits
willingnesstoimplementausteritymeasures,beabletoaccesssovereigndebtmarketsby2013.Any
stepsthatcanbetakentohastenIreland’sdeparturefromtheEU‐IMFprogrammeareinthe
interests
ofboththeEurozonememberstatesandtheIrishpeople.Areductioninthefunding
burdenassociatedwiththepromissorynotesrepresentsarelativelysimplewaytotakesuchastep.






13
Calculationsbasedoninformationinwww.ntma.ie/GovernmentBonds/Daily_Bonds_Outstanding. pdf
23

5.2. WhattheIrishGovernmentShouldLookFor:PaymentDeferral
Anysuccessfulnegoti atin gstrategyrequiresacleargoal.Inthecaseofthepromissorynotes,the
Irishgovernmentshouldbeproposingtorestructurethenotessothereisno€3.1paymenttoIBRC
onMarch31,2012orforanumberofyearsafterthat.Thiswouldreducethestate’sfunding

requirementsoverthenextfewyearsand,byreducingthenetpresentvalueburdenofthisdebt,
helptoconvinceinvestorsthatIreland’s120percentdebt‐GDPratioisnotasonerousasitlooks.
Forhowmanyyearsshouldthepromissorynotepaymentsbedeferred?Clearly,froman
Irish
perspective,theidealanswerwouldbetodeferthepaymentsaslongaspossiblebut,giventhe
needforagreementfromtheECBGoverningCouncil,thisisunlikelytobeobtained.Aslightlyless
strongapproachwouldbetolinkthebeginningofpromissorynotepaymentstoquantitative
benchmarksin
relationtotheperformanceoftheeconomy:Forexample,thatpaymentswould
beginwhennominalGDPhasrecovereditspre‐crisispeakandunemploymenthasfallenbelowten
percent.AnevenweakerapproachwouldbetosuspendrepaymentsuntilIBRChasusedupallits
non‐promissoryassets.Asnoted
above,theIBRCwouldbeabletorepayapproximately€14billion
overtimeinELAevenifitwasneverreceivedanypromissorynotepayments.
Whataretheobstaclestothegoalofpaymentdeferral?Anyonewhohastakenapassinginterestin
thisissuewillknowbynowthatthe
Irishgovernmentis“havingtechnicaldiscussionswiththe
troika”aboutthisissue.ThetruthisthattheECBGoverningCouncilistheonlybodythatreally
mattersforthisquestion.Ifaplantorestructurethepromissorynoteswasacceptedbythe
GoverningCouncil,thenitisveryunlikelythat

theeithertheCommissionortheIMFwouldobject.
WhatobjectionsmightGoverningCouncilmembershavetorestructuringthepromissorynotes?In
reality,membersoftheCouncilhavebyandlargeavoidedcommentingonthisissue(partlybecause
theyarerarelyasked.)Butitislikelythatobjectionstakethefollowing
form:
 TheMoralHazard/SlipperySlopeArgument:Ifpromissorynoterestructuringleadstoa
slowerpaceofrepaymentofELA,thenothercountriesmayalsoseektouseELAtobailout
theirbankingsystemsandtheconsequencesmaybeinflationary,violatingtheECB’sprimary
policyobjectiveofpricestability.


 TheLegalisticArgument:ItislikelythatvariouslawyersandcentralbankersattheECBand
nationalcentralbanksbelievethattheexistingELAprogrammefortheIBRCcomescloseto
violatingtheirunderstandingofthemonetaryfinancingprohibitionarticleintheTreaty.For
theseindividuals,anychange
tothecurrentarrangementshouldnotbeconsideredbecause
itmayrunintolegaldifficulties.

 The“What’sYourProblem?”Argument:ManyEuropeanpoliticiansandcentralbankersare
fondofpraisingIreland’sEU‐IMFprogrammeasagreatsuccess.Fortheseindividuals,they
wouldprefertowaittoseefirm
evidencethattheprogrammehasgoneofftrackbefore
acceptingtheneedto changeanyofitskeyaspects.

24

Eachoftheseargumentsareworthrespondingto:
 ELAprogr ammes needtheacquiescenceandco‐operationoftheGoverningCouncil.TheECB
wasstronglysupportiveofprovidingfundstopayoffbondholdersanddepositorsatfailing
IrishfinancialinstitutionsonthegroundsthatthesedecisionspromotedEuro‐area

financial
stability.Howe ver,theIrishELAprogrammedoesnotrepresentaslipperyslopetofrivolous
ELAprogr ammes acrosstheEurozonebecausetheGoverningCouncilcansimplychooseto
saynotofuturerequeststhatitdoesnotsupport.

 SlowrepaymentofELAdoesnotcauseinflation.TheELAmoney
hasalreadybeenprinted
anddidlittletostokeEurozoneinflation.Choosingtorepaythemoneymoreslowlywillonly
contributetoEuro‐areainflationarypressuresifthemonetaryaggregatesareexpanding
morerapidlythantheECBiscomfortablewith.Atpresent,growthinEuroareaM3isvery
slow.If
inflationbecomesaconcern,theGoverningCouncilcouldmakedeferredrepayment
ofELAconditionaloncontinuedslowgrowthintheEuroareamoneysupply.

 Thelegalisticargumentsagainstrestructuringthenotesarerelativelyweak.IBRCisasolvent
institutionthatisbeingprovidedwithsufficientfundstorepayall
ofitsdebtsovertime.A
deferralofELAdoesnotchangethatsituationandsoitdoesnotbringusclosertomonetary
financingofaninsolventinstitution.AndanyprogrammetopaybacktheELAeventually
technicallycountsasatemporaryprogramme.

 Inrelationtothe“What’s
YourProblem?”approach,itcouldbearguedthatnowisthetime
tolooktobuildonwhateverpositivemomentumisthereinrelationtothesuccessofthe
Irishprogramme.WiththeEuroareaeconomyapparentlyenteringrecession andIrish
exportsweakening,Irelandislikelytoneedanimproved
dealfromtheEUiftheprogramme
istotrulysucceed.



5.3. AccountingTreatmentofPromissoryNotes
Aseparateissuefromthekeygoalofachievingasignificantdeferralofpromissorynotepaymentsis
theaccountingtreatmentofthepromissorynotes.
Therehasneverbeenanofficialexplanationofwhythepromissorynotesneededtocarryasimilar
yieldaswasprevailingonIrishgovernmentbondsin2010.
ANovember2010DepartmentofFinance
notereportedthat“ForcapitaladequacypurposesthePromissoryNotesmustbevaluedatparinthe
institutions’accounts.Accordingly,interestmustaccrueonanyamountdueuntilitispaid.The
interestratechargedisbasedonthelongtermGovernmentbond
yieldappropriatetowhenthe
amountswillbepaid.”
Effectively,theapproachtakenin2010wastovaluethepromissorynotesaccordingtoa“mark‐to‐
market”approachsimilartohowbanksvaluebondsthatarekeptintheir“tradingbooks”.However,
mostEuropeanbanksallocatethemajorityoftheir
sovereignbondstotheirso‐called“banking
books”whichisintendedforassetsthatareheldtomaturity.AstheEuropeanBankingAuthority