Posted by Alan Kelly on January 10, 2011 at 02:50 PM

Ireland and EU
Ireland and EU

I have just published the letter from EU Commission Vice President, Joaquin Almunia, explaining how AIB passed banking stress tests last July but was eventually nationalised by year-end. (See text of letter below this blog.)

It is clear that the latest AIB bailout was effectively caused by NAMA and the failure of the government to predict these losses while also taking the bank’s position at face value.

Commissioner Almunia makes it clear in his letter that NAMA’s second discount on AIB loans immediately required an additional €3b cash. This could only come from the Irish taxpayer.

When the government first stress tested the bank, it underestimated the NAMA discount – even though NAMA is a state-body. Was there no co-ordination on this by the Finance Minister?

The Government’s failure to identify the problem early enough resulted in AIB passing the stress test, only for NAMA to come along and see the mess the loan book was in.

It is typical of the approach they have taken all along – not realising the scale of the losses or appreciating the recklessness of the banks.

They have misled our EU partners and the new Government will have to work to restore our reputation.

They have presided over what has become an incredible farce. What amounts to a saving for the taxpayer by NAMA becomes a loss to the taxpayer as the government pumps pension funds into banks that will never return,”

No matter what, the taxpayer foots the bill.

Its worse than robbing Peter to pay Paul, they are robbing you and me to pay Sean and the other bankers.

It is also clear that both the government and the regulator, nearly two years after the collapse of the banks, still adopted the bank’s policy that the property market will recover and that the banks loan book was in good nick.

The competition Commissioner refers to ‘weaker than expected credit risk management practices – which is diplomatic code for they didn’t know how bad the problem was but put a more optimistic twist on it.

This might be believable if it wasn’t for the fact that most independent analysts were predicting the market much more correctly then the government. It is any wonder we have lost international credibility?

The real shame is it is almost too late to follow another policy. We should have temporarily nationalised our banks immediately and only guaranteed future lending. However the day for that has passed. Our only chance now is to work with Europe to fix this.

What is desperately needed is for the taxpayer to be divorced from our state-run zombie banks.

I believe this can only be done by establishing a strong-enough political union across Europe that will impose some form of debt relief on our busted banks and its bond-holders.

Remember this is an EU-wide problem. The Irish taxpayer can no longer afford to pay for the bad loans made by Irish bankers but that was also lent irresponsibly by international bankers.

I believe there would be a lot of sympathy among member states for an EU policy of burning the bondholders. Democracies must become stronger than markets and collectively I believe Europe can forces the losses on the banking system itself rather than on the taxpayer.

What is happening is immoral. However there is no evidence that the Irish government has ever pursued a European solution to this problem. They have let us down badly in Brussels and it is the ordinary people of Ireland who again will suffer.“I welcome the view being articulated more and more in Brussels that bondholders in future should be burned in these situations. They made poor investments and should pay the price for this.

We should learn from this scenario. We should not have let member states provide their own stress tests as the analysis was nowhere near rigorous enough.

We will have to renegotiate the EU/IMF deal as it tries to solve the problem of debt  by loading more debt onto the economy and undermining our capacity to grow. The sooner we have a change of Government the better."


Text of Letter

Dear Mr. Kelly,

Thank you very much for your letter of 20 October 2010. In this letter, you first raise a number of questions on the quality of the stress testing exercise coordinated by the Committee of European Banking Supervisors (the CEBS stress tests) for Allied Irish Banks (AIB), the results of which were announced on July 23, 2010. You then further ask whether the Commission can now be certain, after the second AIB rescue recapitalisation announced on 30 September 2010, that no more Irish taxpayers’ money will be required.

To answer your second query, the Programme for Support for Ireland which was agreed on 28 November between the Irish government and the EC, the IMF and the ECB, will result in further recapitalisation of Irish banks including AIB in the short term, with the aim of strengthening the bank’s solvency over and above the regulatory requirements in place until now.

As for your first question on the quality of the CEBS stress tests, I would like to clarify the sequence of events which led to the announcement of the second rescue recapitalisation for AIB in September.  

As you may know, the Irish Financial Regulator had performed in the first quarter of 2010, a prudential capital assessment review (the PCAR exercise) for all banks benefiting from the Irish government guarantee schemes. The results of this review were announced on 30 March 2010 and indicated that AIB needed to raise additional capital in an amount of EUR 7.4 billion by the end of the year. What CEBS concluded was the “the results of the exercise demonstrate that AIB and Bank of Ireland meet the stress requirements and do not require additional capital beyond the requirement set in March 2010 set by the Central Bank and Financial Regulator following completion of the Prudential Capital Assessment Review. Back in March 2919, it was believed that AIB could meet the additional capital need set by the Financial Regulator without further state capital by a combination of (i) sale of assets (Polish US and UK subsidiaries) (ii) market capital raising exercise and (iii) conversion of a portion of the State existing €3.5 billion Preference Shares (which had been injected in 2009 for the first recapitalisation.

Since then a number of unforeseen developments lead to the recapitalisation having to be increased and financed entirely by the State.  First, the recapitalisation amount had to be increased by €3 billion as a result of the revision of the haircut used in the PCAR exercise for the transfer of NAMA assets. As a matter of fact, the valuation exercise performed for the second tranche of assets resulted in a higher discount then for the first tranche. The assumption used in the PCAR exercise for the transfer of all NAMA loans was, however, based on the haircut used for the transfer of the first tranche. This triggered the need to update the PCAR results and increase the recapitalisation amount by EUR 3 billion.  Secondly, the sale of the UK business proved more challenging and although the sale of the Polish and US businesses is proceeding as expected in terms of amount and timing, this is still not the case for AIB UK. Finally, the market perception of AIB and if Ireland as a sovereign issue deteriorated sharply, making any attempt by AIB to raise capital on the markets impossible. State funding of the recapitalisation became the only available option for AIB.

In your letter you ask whether projected NAMA discounts had been taken into account in the stress testing. The answer is yes but the magnitude of the haircut for further tranches had been underestimated. When the PCAR exercise was performed, no loaned had yet been transferred to NAMA and the Irish authorities were at the beginning of the valuation process for the first tranche of assets, which resulted in an already very significant haircut. The underestimation of expected losses for the further tranches was basically due to sharper than expected decline in real estate prices and weaker than expected credit risk management practices in banks (including weak collateralisation and slow collection process) The extent of these weaknesses was only progressively revealed during “on-site” credit assessment of the NAMA process.

I would like to underline that the Commission is not directly responsible for the analysis of the results of EU wide stress tests. The Commission is only given the opportunity to intervene in the discussions on the assumptions and the macro scenarios to use in the tests. For all the other aspects and assumptions used in the tests, the only responsible institutions are the national authorities and CEBS. In any case, designing a set of assumptions for fair and accurate stress testing is not a simple exercise and is even more difficult when domestic and global economic conditions are uncertain.

I hope that these clarifications are useful.

Jauquin Almunia

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