It is believed the Minister for Finance Michael Noonan told the IMF that he will look to Contingent Convertible Capital (CoCo) Notes if the banks need additional capital buffers following the stress tests.
The issue came up during his trip to Washington last month. A spokesperson for the Department of Finance said it doesn’t comment on speculation.
The date for the next round of stress tests still has to be decided. Sources familiar with the situation say that a date will be fixed during the next troika review of the economy in July, with the tests most likely to be carried out before the exit of the bailout programme in November.
The nightmare scenario for the Government is that the banks fail the stress tests and need more capital. In the continued absence of political agreement among EU political leaders, the ESM would not be permitted to directly recapitalise the banks.
As it stands, it can only lend directly to the sovereign.
The Government would then be forced to either stump up the funds, via the ESM, or tap private investors.
It is highly unlikely that the capital would come from private sources.
If the Government had to take the additional funds needed on the national balance sheet, it would raise the fiscal deficit and ensure that the country missed the 2015 target agreed with the troika to get the budget deficit within 3% of GDP.
According to the Central Bank’s Macro-Financial Review, released on Wednesday, there is roughly €25.8bn of mortgages in arrears over 90 days and €10.8bn of SME loan arrears, whereas the banks have only €9.2bn in additional capital buffers.
However, according to a person familiar with the situation it is highly unlikely that Bank of Ireland, AIB and or Permanent TSB will need capital following the stress tests.
The source says that following the last round of stress tests in Mar 2011, the three banks were ordered to raise an extra €24bn in capital.
Provisions were then made for losses in worse-case economic scenarios. The economy has not exceeded this scenario. Moreover, the banks have additional capital buffers because losses were much less than expected following the deleveraging process.
Also, these stress tests will be conducted according to more normalised market conditions, rather than the crisis conditions that formed the backdrop of the 2011 tests, says the source.
Consequently, it is unlikely that the banks will fall below the regulatory capital requirements following the stress tests. However, the banks may need capital buffers. "In that case, investors may be willing to invest in CoCo notes. It is only when capital is needed to meet regulatory requirements that CoCo notes become unattractive," says the person familiar with the situation.
CoCo notes are a hybrid debt instrument that pay a coupon. However, if the bank falls below its core tier one capital ratio, then they convert into equity.