€400bn bailout - A welcome and decisive move

The United States Congress balked at a rescue package worth $700 billion (€485bn) on Monday, because of the implications of providing government support for bad private investments. The Irish Government, on the other hand, effectively drew up a guarantee for the banks of €400bn, or $570bn.

In comparison with the rejected American rescue package, the Irish rescue measure was breathtaking in its scope. It could amount to more than 10 times the national debt, which is estimated at €45bn, or more than twice the country’s Gross Domestic Product.

It was a brave, positive move, all the braver when one considers that it could also be deemed reckless, because the Government will be, in effect, writing a blank cheque to protect the Irish banking system. It could be compared to an individual mortgaging the family home, business and in a sense the family’s future, but the Government has acted on a national scale with the financial future of all of us in mind.

Of course, it does not expect it will be called upon to meet anything like the full guarantee. Our financial credibility as a nation is essentially on the line.

The Government has announced it will guarantee all Irish bank deposits for two years up to September 28, 2010. This covers Allied Irish Banks, Bank of Ireland, Anglo Irish Bank, Irish Life & Permanent, Irish Nationwide Building Society, and the Educational Building Society and “such subsidiaries as may be approved by the Government”, according to Finance Minister Brian Lenihan.

This was after banking shares fell by 26% on Monday, but before the US Congress rejected the American rescue package. As a result, an even worse day might have been expected yesterday, but instead the banks made a dramatic recovery as a result of the Government’s bold and decisive action.

The minister deserves commendation for demonstrating the willingness to act decisively. It is mercifully rare that governments need to take such decisive action and all the more welcome when they do so. The Government had already raised the protection limit for bank deposits from €20,000 to €100,000 in order to prevent a run on any of the banks, but 10 days later found it necessary to expand the guarantee to encompass all bank deposits.

This was therefore in essence a second attempt to address the problem, and it was necessary that it should be seen to be decisive in order to be effective. Once initial efforts prove inadequate, credibility is damaged and it becomes all the more difficult for subsequent measures to be effective. Hence it was imperative for the Government to act boldly yesterday.

Mr Lenihan emphasised that the move should not be seen as a “bailout” for the Irish banks, but as a facility subject to a charge or a levy set by the Central Bank. “The guarantee has been provided at a charge to the institutions concerned,” the minister stated. “It will be subject to specific terms and conditions so that the interests of the taxpayer are safeguarded and protected.”

“Let us be clear about this,” Mr Lenihan added, “the Government is not underwriting shareholders’ funds or hazardous investments in banks.” The Taoiseach emphasised that the charge to banks availing of the guarantee would reflect commercial reality.

The actual charge to banks regarding this welcome and uncharacteristically decisive bailout plan should be transparent, so there is no repetition of what happened in the 1980s when the Government was stampeded into rescuing Allied Irish Banks from its reckless involvement in the ICI debacle. There appeared to be no tangible benefit for the ordinary taxpayers, while AIB subsequently paid handsome dividends to its shareholders.

Within EU competition laws, it is necessary that the protection being provided is not seen to distort banking competition, which makes it all the more imperative that the banks assume the responsibility for their own mistakes. There must be no question of the Government bailing out bad or reckless investments at no cost to profligate investors.

The Government’s objective in taking decisive action yesterday was to maintain banking liquidity and reassure depositors their money was safe, thereby preventing a run on any of the Irish banks. There was a real danger nervous depositors might have looked for protection within the banking systems of rival member states.

It should be recognised that confidence in the country’s banking system is imperative, and that such confidence is priceless. It is significant that other countries are apparently considering following the Irish lead in this matter, and the dramatic way in which the Irish stock market rebounded was an obvious vote of confidence in the Government’s initiative.