19/6/16: Irish Regulators: Betrayed or Betrayers?..

As I have noted here few weeks ago, Irish Financial Regulator, Central Bank of Ireland and other relevant players had full access to information regarding all contraventions by the Irish banks prior to the Global Financial Crisis. I testified on this matter in a court case in Ireland earlier this year.

Now, belatedly, years after the events took place, Irish media is waking up to the fact that our regulatory authorities have actively participated in creating the conditions that led to the crisis and that have cost lives of people, losses of pensions, savings, homes, health, marriages and so on. And yet, as ever, these regulators and supervisors of the Irish financial system:

1. Remain outside the force of law and beyond the reach of civil lawsuits and damages awards; and
2. Continue to present themselves as competent and able enforcers of regulation capable of preventing and rectifying any future banking crises.

You can read about the latest Irish media 'discoveries' - known previously to all who bothered to look into the system functioning: http://www.breakingnews.ie/business/report-alleges-central-bank-knew-of-fraudulent-transactions-between-anglo-and-ilp-740684.html.

And should you think anything has changed, why here is the so-called 'independent' and 'reformed' Irish Regulator - the Central Bank of Ireland - being silenced by the state organization, the Department of Finance, that is supposed to have no say (except in a consulting role) on regulation of the Irish Financial Services: http://www.independent.ie/business/finance-ignored-central-banks-plea-to-regulate-vulture-funds-34812798.html. 

Please, note: the hedge funds, vulture funds, private equity firms and other shadow banking institutions today constitute a larger share of the financial services markets than traditional banks and lenders.  

Yep. Reforms, new values, vigilance, commitments... we all know they are real, meaningful and... ah, what the hell... it'll be Grand.

26/12/15: Depositors Insurance or Depositors Rip-off?

What's wrong with this picture?

In simple terms, nothing. The Central Bank has embarked on building up reserves to fund any future pay-outs on deposits guarantee.

In real terms, a lot.

Central Bank deposits guarantee will be funded from bank levies. However, in current market environment of low competition between the banks in the Irish market, these payments will be passed onto depositors and customers. Hence, depositors and customers will be funding the insurance fund.

Which sounds just fine, except when one considers a pesky little problem: under the laws, and contrary to all the claims as per reforms of the EU banking systems, depositors remain treated pari passu (on equal footing) with bondholders (see note here on EU's problems with doing away with pari passu clause even in a very limited setting: http://trueeconomics.blogspot.ie/2015/11/271115-more-tiers-lower-risks-but.html). Now, let's consider the following case: bank A goes into liquidation. Depositors are paid 100 cents on the euro using the new scheme and bondholders are paid 100 cents on the euro using the old pari passu clause.

Consider two balancesheets: one for depositor holding EUR100 in a deposit account in an average Irish bank over 5 years, and one for the bondholder lending the same average bank EUR100 for 5 years.

Note: updated version

Yes, the numbers are approximate, but you get the point: under insurance scheme the Central Bank is embarking on, the depositor and the bondholder assume same risks (via pari passu clause), but:

• Depositor is liable for tax, fees and insurance contributions, whilst facing low interest rates on their deposits; while
• Bondholder is liable for none of the above costs, whilst collecting higher returns on their bonds.

So, same risk, different (vastly different) returns. Still think that insurance fund we are about to pay for a fair deal?..

8/8/15: Transactions Costs v Quality of Banks' Collateral

In standard financial theory (and practice), presence of transactions costs has an impact on asset prices traded in the markets. A recent ECB Working Paper, titled "Collateral damage? micro-simulation of transaction cost shocks on the value of central bank collateral", by Rudolf Alvise Lennkh and Florian Walch (ECB Working Paper Series, No 1793 / May 2015: https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1793.en.pdf) "analyses how changes in transaction costs may affect the value of assets that banks use to collateralise borrowings in monetary policy operations."

The authors estimate the effect of a 10 basis point increase in transaction costs to be a decline of -0.30% in collateral value. Adjusting for the expected drop in the volume of trades for each asset (reduced liquidity), the decline in asset prices is shallower - at -0.07%. "We conclude that banks will on average suffer small collateral losses while selected institutions could face a considerably larger collateral decrease."

So far - benign?

The problem, of course, is in that second order effect. The authors look at 25% and 75% decreases in turnover of pledged collateral debt instruments (e.g. bonds pledged by the banks in repo operations). This second order effect reduces the loss of collateral value to -0.22% and -0.07%, for the two assumed turnover reductions scenarios, respectively. In other words, the lower the turnover rate of the pledged assets, the lesser is the impact of the transactions costs on collateral value.

Now, as the study notes, when collateral is held longer (turnover lower), liquidity in the markets is impacted. The longer the banks hold collateral assets off the markets and in the central banks' repo vaults, the lesser is market liquidity for traded collateral-eligible paper. Thus, the higher is the associated liquidity risk. Banks dump risk premium into the markets.

Cautiously, the ECB paper goes on: "The results underline that transaction costs in financial markets can be one among many factors contributing to the scarcity or decline of liquid, high quality collateral. …an upward transaction cost shock that occurs simultaneously with a market or regulation-induced shortage in collateral assets, and in particular high-quality collateral assets, could hamper the access of financial institutions to central bank liquidity. The central bank could [make] additional collateral eligible for monetary policy operations. As most of high-grade collateral is already central bank eligible, such a move could entail a shift to collateral assets with more inherent risk that would have to be compensated with appropriate haircuts. This in turn could increase asset encumbrance on banks’ balance sheets."

But there is another channel not considered in the paper: reduced turnover of collateral implies reduced supply of assets into securitisation pools, as well as into the OTC markets. Both effects are hard to estimate, but are likely to induce even higher risk premium into the markets for risky assets, pushing the above estimates of costs wider.

As an interesting aside, the table below summarises, by the end of 1Q 2014, one quarter of all collateral pledged into Eurosystem central banks repo operations was of low quality variety Non-marketable assets (in other words, assets with no immediate markets). This represents an increase in the share of low quality assets from 24.75% in 1Q 2012 to 24.96% in 1Q 2014. Medium-to-low quality stuff accounted for another 20 percent of the total.

Now, for all the esoteric debates about the ECB supplying liquidity, not providing solvency supports, one wonders just how much of a haircut would all of this proverbial 'assetage' gather were it to be collateralised into the markets to raise the said liquidity… for you know: if a bank is solvent, its assets would cover its liabilities, inclusive of haircuts, which means they are repoable… in which case, of course, there is no liquidity shortage to cover, unless markets were misfiring. The latter simply can't be the case in 2014 when the financial markets were hardly oversold.

2/1/2015: Negative Deposit Rates: Swiss Method

The best explanation of the Swiss negative deposit rates intervention I've read so far is here: http://perspectives.pictet.com/2014/12/19/switzerland-the-snb-introduces-negative-interest-rates/ via Pictet Perspectives.

27/7/2014: "Kragle!"... Lord Business' Prescription for the Irish Economy

There is an interesting and mildly entertaining article in the Sindo (http://www.independent.ie/business/irish/patrick-honohan-stay-the-course-its-paying-off-30460638.html#sthash.fHeQGdJO.dpuf), penned by the Governor of the Central Bank, Professor Honohan.

Now, before I make few comments on the article, a disclosure: I like reforms and changes Professor Honohan brought to the Central Bank. And I think Professor Honohan has done an excellent job in the past to subtly highlight major bottlenecks in the Irish economic policies.

With that in mind, here are few quotes and some of my comments:

"Managing domestic demand, ensuring the banks are healthy, and offering advice to Government: these are the tasks of the Central Bank, and our measured approach to all three over the past few years has, I believe, borne fruit. Recovery remains slow and partial," said Professor Honohan.

So where are we on these tasks?

Per Professor Honohan, on the banks health: "...it is still not possible to describe them as being fully restored to health and delivering the services needed by the economy." In other words, ensuring the banks are healthy is still unfinished business. Central Bank either walks away from the test on this, or gets a poor grade - you choose.

On domestic demand: "…the total number at work and average living standards are both still well below the peak reached at the top of the bubble. And the elevated debt levels remain a lasting legacy." Now, wait, this also doesn't look like the Central Bank's finer moment, is it?

That was just Professor Honohan's own admissions. Now, here's a chart plotting evolution of domestic demand, 'managed' by the Central Bank:

You wouldn't be calling this 'managing' unless your management job is in demolition business...

Professor Honohan credits the ECB for providing 'some insulation' to mortgagees "who can currently just afford to pay" in the form of "exceptionally low interest rates". But there is a problem with this from the Central Bank's point of view. ECB rates did drop. Significantly. From 3.1% pre-crisis average to 0.15% today - a swing down of 2.95 percentage points. Yet, with all the trackers in, current retail interest rates for outstanding loans have declined (compared to pre-crisis average) by only 0.86 percentage points for mortgages with original maturity between 1 and 5 years, and by only 1.14 percentage points for mortgages with maturity over 5 years. Short term consumer loans rates and overdrafts rates have actually risen. Things are even worse if we are to measure the average rates to peak property lending around 2006, omitting 2007. So 'insulation' might have been provided by the ECB, but as far as Irish Central Bank actions go, these have ensured that the banks can extract more blood out of the economy, not that the banking system supports households in trouble.

There is a bigger problem for Professor Honohan here: if these borrowers 'can currently just afford to pay', what happens to their ability to pay when rates do rise? Or is Central Bank's 'managing banks and domestic demand health' not including looking into the near-term future?

Finally, on something from the Central Bank's own frontline: the mortgages arrears. "At the same time, far too many cases persist where no adequate cooperation between bank and borrower has been achieved. It is mainly for these cases that the banks have gone down the legal path towards repossession. ...I would urge borrowers who have not been cooperating to recognise that that is a hazardous course of action: bear in mind that banks can get court approval for repossession if borrowers are not cooperating."

Professor Honohan is correct - there are many cases in which borrowers in arrears fail to cooperate with the banks. But Professor Honohan neatly omits thousands of cases where certain banks - two of which are Irish Government-rescued and form the 'Pillars' of the 'new banking system' here - are not cooperating with the borrowers. Presumably, criticising the borrowers is Central Bank's job, but criticising the lenders is not…

To sum up, the Central Bank has done quite a bit of a good heavy-lifting job on all fronts. But this is hardly the right time to start talking up its achievements to-date. As Governor Honohan points out himself: "our measured approach to all [policies areas] over the past few years has, I believe, borne fruit." That fruit is: "Recovery remains slow and partial". Not exactly commemorative medals time, yet, eh?..

23/5/2014: An Icy Gust from the IBRC's Promo Notes Past...

So Irish Central Bank pre-sold EUR350 million worth of 'Anglo' bonds that were due to be sold under its minimum commitment to sell EUR500 million worth of bonds in 2014. Except it pre-sold them back in 2013... Here is the original Bloomberg report on the matter:  http://www.bloomberg.com/news/print/2014-05-01/irish-central-bank-said-to-mull-faster-2014-bank-aid-bond-sales.html

Why is this important?

Remember, the EUR25 billion worth of 'Anglo' Government bonds held by the Central Bank after the February 2013 'deal' or swap of Promissory Notes for bonds carries with it a commitment to sell minimum required volume of bonds annually to the market.

Here's Minister Noonan on this:

Also, remember, the bonds held on Central Bank balancesheet accrue interest payments from the Government that the Central Bank subsequently 'returns' as divided to the state (having taken its 'cost' margin out to pay for necessary things, like, new HQs building etc).

Once the bonds are sold, however, the interest is paid to their private sector holders.

It is likely that the yield on Government bonds sold was somewhere around 3%, which means that Irish taxpayers just spent EUR10.5 million in interest payments that were, put mildly, unnecessary. We were not required to sell these bonds in 2013 and could have waited until 2014 to do so.

Let's put this into proper perspective: EUR35 million was pledged by the Government this month to help resolve homelessness crisis. Laughably small amount, but still - a necessary gesture from the cash-strapped state. This could have been EUR45 million (or more) should the Central Bank not engage in bonds activism.

So why did Professor Honohan go to the markets to sell the bonds back in 2013? The reason is simple: ECB was never too happy with the 'deal' that pushed Ireland dangerously close to using Central Bank to fund the state (IBRC). Accelerating sales of bonds pro forma accelerates Central Bank exit from such an arrangement.

Alas, happy or not, ECB hardly can do anything about unwinding the 'deal' in practice without doing some serious damage to the euro system. That said, we might see Frankfurt ramping up pressure on CBI to accelerate future sales, once the banks stress tests are fully out of the way - in, say, 2015. That will once again bring to our attention the simple fact that the mess that was IBRC did not go away.

Keep in mind that the Government own estimates of the impact of the promo notes deal on government deficits over the short term was the total 'savings' of EUR2,025 million in 2014-2015. Doubling the rate of disposals from current will see this reduced by EUR30 million in two years.

More problems are ahead relating to the interest rates. The bonds are floating rate notes, with yield tied to  6 months euribor http://www.ntma.ie/news/ntma-issues-eight-new-floating-rate-treasury-bonds-in-exchange-for-promissory-notes/ reset every six months.

The problem is that whilst euribor was running at 0.372% back in February 2013, nowadays it is at 0.410% - a difference of 0.038%, which, over EUR25 billion quantum implies annual interest costs increases of some EUR95 million. Most of this is going to be rebated back to the Government via the Central Bank, but with any acceleration in the sales of bonds, this is also going to get eroded.

All in, we are already running below EUR2 billion 2014-2015 'savings' assessed on the Promo Notes deal, and counting...

17/5/2014: Central Bank Annual Report 2013: Not Much to Report, Much to Promote

This is an unedited version of my Sunday Times article from May 4, 2014.


This week, the Irish Central Bank published its annual report for 2013.

In the opening statement, Governor Patrick Honohan said: "The Bank’s key priorities included the ongoing repair of the banking system and achieving progress in the delivery of sustainable solutions for distressed borrowers. Significant progress was achieved on these fronts, though many tasks still remain to be completed."

This was not a great moment to stake such a claim.

In recent days, the state-controlled Ptsb, announced a substantial hike in variable rate charges on mortgages. Bank of Ireland, faced criticism for using a 'blunt force approach' with distressed borrowers.

Central Bank data, highlighted in the annual report, shows that in 2013 lending to non-financial corporations in Ireland posted its steepest year on year decline since the start of the crisis, down 6 percent. Credit to households fell at the second fastest annual rate, down 4.1 percent on 2012. Mortgages arrears, including the IBRC mortgages sold to the external investment funds, as percentage of all house loans outstanding, were virtually unchanged year on year at the end of 2013.

Reading through the Central Bank own financial accounts also reveals some significant insights into the inner workings of our financial system and its watchdog.

In the last three years, Irish Exchequer reliance on income from the Dame Street has gone up exponentially. In 2009-2013, the Central Bank paid EUR4.73 billion in total dividends to the State. Of this, 50 percent came from its operations in 2012-2013. This makes the CBI the largest net contributor to the State coffers of all public and semi-state organisations.

The bulk of the Central Bank earnings come from interest on assets it holds. Last year marked the second year of declines in this income. Back in 2010, the Central Bank collected EUR3.67 billion worth of interest. As the scope of the emergency lending to Irish banks fell, the interest income also declined, reaching EUR2.6 billion in 2012 and EUR2.02 billion in 2013.

Central Bank’s highest-paying assets today cover Irish Government Floating Rate Notes, NAMA bonds, and a Irish 2025 bond. All in, the money paid by the Government and NAMA to the Central Bank is being recycled back to the Exchequer at a hefty cost margin.

In a sign of continued improvement in the Irish banks funding situation, marginal refinancing operations and long-term refinancing operations (MROs and LTROs), representing lending to credit institutions from the Eurosystem fell to EUR39.1 billion in 2013, down from EUR70.9 billion in 2012. At their peak in 2010, these lines of credit amounted to EUR132 billion.

Central Bank’s staff-related expenses rose from EUR106.3mln in 2012 to over EUR121.4mln in 2013. These increases were down primarily to salaries, allowances and pensions, as staff numbers employed stayed relatively unchanged between 2011 and 2013. Per employee staff expenses are now up 15 percent on 2012 levels.

Other operating expenses were up from EUR57.5 million to EUR70.3 million. The largest hikes incurred were in Professional fees, which rose by a quarter to EUR27.1 million. Only in 2011, at the height of banks’ recapitalisation, did the Central Bank manage to spend more on external consultants. So far, the banking crisis has been a bonanza for the Central Bank advisers who were paid EUR98.3 million in fees since 2009.

In return for the rise in expenses, the Bank marginally expanded some of its enforcement and supervisory functions. There was a rise in prudential supervision activity, but a decline in authorisations and revocations of regulated entities. The number of investigations also fell, from 216 in 2012 to 184 in 2013. However, the Central Bank oversaw 1,004 regulatory actions taken in 2013, up on 2012, but down on 2011.

Overall, the Annual Report paints a picture of the Central Bank continuing to engage in active enforcement and supervision, amidst overall declining need for banking sector supports.

26/3/2014: 13 months on, the Promo Notes deal stinger is still in...

Back in September 2013 I wrote in Sunday Times that ECB might want to consider accelerated disposal of the Government bonds held by the Central Bank post-restructuring of the IBRC Promissory Notes: http://trueeconomics.blogspot.ie/2013/10/8102013-german-voters-go-for-status-quo.html

And now, guess what... http://www.irishtimes.com/business/economy/pressure-to-offload-long-term-bonds-in-promissory-note-deal-over-ecb-unease-1.1737924#.UzJ8fqxmKCE.twitter

Per Irish Times article linked above:

"Ireland is facing pressure to offload the long-term government bonds it issued as part of last year’s promissory note deal and at a faster pace than the timetable originally outlined, amid continuing concerns from the European Central Bank about the deal.

The ECB is reviewing the controversial promissory note deal as it prepares to publish its annual report for 2013.

… A crucial aspect of the promissory note deal agreed last year after months of negotiations was the length of time the Central Bank would hold the long-term bonds that replaced the promissory notes."

I have consistently argued that promo notes restructuring represented the perfect target for debt relief for the state. One example is here: http://trueeconomics.blogspot.ie/2012/03/2132012-anglos-promo-notes-perfect.html. And I highlighted our 'deal's' sensitivity to earlier disposal of bonds here: http://trueeconomics.blogspot.ie/2013/03/2332013-sunday-times-10032013.html (see bottom of the article for box-out).

30/11/2013: Is the Central Bank Heading Into a Crisis?

Throughout the crisis, I have been highly critical of the Central Bank's role in the creation of conditions that drove us toward the crisis. And of the weaknesses in the CB's attempts to address the mortgages crisis, as well as the lack of direct and open assessment of the crisis.

At the same time, the CB also deserves praise. With Prof. Honohan in the driving seat, the organisation implemented major changes in operations, strategy, regulatory and reporting areas. It is well on its way toward breaking free from the past.

The CB beefed up reporting and compliance, opened up databases, cleaned up data disclosure, beefed up research. It is also a much more open organisation when it comes to communications with the analysts and the media. In dealing with the banks, the CB took a more pro-active role than is normally required. This reflected the nature and the extent of the crisis in our banking sector, as well as growing realisation within the CB that extend-and-pretend approach to the crisis is not going to help resolve the issues.

These processes of change are still ongoing and are far from being completed. The last thing we need now is a crisis in the Central Bank. With many competent people who took CB through significant and positive changes in recent years leaving, it is imperative that Prof. Honohan is given a chance to rebuild the team and press on with changes. The questions to be asked of the CB should not be limited to 'What is going on?', but must extend to include 'What is next?' We cannot allow the CB to slide back into the swamp of complacency it was prior to the crisis.

21/10/2013: IMHO Submission on Minimum Competency Requirements 2013

Irish Mortgage Holders Organisation submission to the Central Bank on consultation paper on Authorisation Requirements and Standards for Debt Management Firms and the Amendment of the Minimum Competency Code is now available on the Central Bank page here: http://www.centralbank.ie/regulation/poldocs/consultation-papers/Documents/CP70/IMHO%20submission.pdf

10/10/2013: Prof Honohan is correct on 'strategic defaults'... but...

It is good to see Prof Honohan making a substantive and strong statement on the issue of 'strategic' mortgages arrears, contrasting the current 'debate' with some reasoned commentary:
http://www.independent.ie/business/irish/patrick-honohan-some-mortgage-holders-not-paying-up-29649978.html

Prof. Honohan is correct - there are borrowers who are attempting to game the system. This is rational and expected. And often it is abusive. Prof. Honohan is also correct in pointing out that Ireland's environment for insolvency and bankruptcy resolution is different from the US, making comparisons to the US data and evidence incomplete at best.

However, Prof. Honohan is not correct in solely placing the blame for the insolvencies crisis on the shoulders of borrowers. Irish State and banks are to share in responsibility for this crisis as well by:

1. Banks - due to failing to properly price risks in issuing loans. Banks are paid to price these risks (this is what they collect the lending margins for) and they have not done their work in properly selling loans to some/many households.
2. State - due to failure to properly supervise loans risk pricing in (1) above and due to failure to protect borrowers from occasionally excessively aggressive loans origination practices of the banks.
3. Banks - due to failure to secure sustainable funding for loans origination, leading to excessive reliance on short-term borrowings and thus increased exposure to funding risks. These risks, once materialised, have been in part loaded onto the shoulders of borrowers with adjustable rate mortgages, in some cases potentially precipitating and in other exacerbating the extent of the crisis.
4. State - due to failure to properly regulate and supervise banks risk taking activities in funding markets.

None of the points 1-4 are liability of the borrowers. All of the points 1-4 are contributors to the crisis to some extent. 

There is co-shared responsibility by the State and the Banks and this responsibility must translate into liability to aid homeowners in distress. Such assistance can and should take form of cost-efficient and effective solutions. Unfortunately, current discussion does not even begin tackling this issue and Prof Honohan's comment today is not helping the process either

Note: my recent Sunday Times column on strategic defaults issue is here:

http://trueeconomics.blogspot.ie/2013/09/592013-sunday-times-september-1.html

My full position on strategic defaults and related matters of foreclosures is here:

http://trueeconomics.blogspot.ie/2013/08/182013-strategic-defaults.html