Ireland may have gone out on a limb when it announced its state-funded bank guarantee scheme last autumn, but it wasn’t long before the country’s EU neighbours followed suit.
Although initially controversial, the Irish government’s state bank guarantee scheme has succeeded in bringing some much-needed stability to the country’s financial sector.
When Ireland’s minister for finance Brian Lenihan announced on 30 September last year that the government was taking bold and unprecedented measures to shore up the domestic economy by way of a state bank guarantee, other European jurisdictions were quick to protest. Yet only a matter of weeks later, most had put in place similar or more sweeping intervention measures for their own banking systems.
The Credit Institutions (Financial Support) Act 2008 was introduced as emergency legislation to address the serious threat to the stability of the Irish credit institutions and the financial stability of the state. Pursuant to the act, the Credit Institutions (Financial Support) Scheme 2008 provided for a two-year state guarantee of all covered institutions, including deposits and senior unsecured debt of certain covered institutions.
“The government gave itself a great deal of flexibility in relation to the provision of support, declaring that for a two-year period it would offer an unlimited guarantee covering all retail, commercial and inter-bank deposits, bonds and debts of designated institutions,” explains McCann Fitzgerald partner John Cronin.
Law firm Arthur Cox advised the Irish government on the legislation. “It was a pre-emptive move by the government which, having seen what happened a few months earlier with Northern Rock in the UK as a result of delayed action, wanted to avoid any potential for queues of customers lining up on the high streets of Ireland,” says partner Cormac Kissane.
As the first country to respond to the credit crisis, Ireland’s measures immediately prompted the accusation that it was acting unilaterally by introducing the sweeping two-year guarantee. The scheme was greeted with widespread political criticism that Ireland was merely saving itself while simultaneously plunging banks in other countries into crisis. The UK in particular was vocal about the possibility of a flight of capital from other markets to Ireland.
“There was an initial concern that the Irish guarantee would attract customers to banks here, to the detriment of the UK economy,” says Kissane. “But under the terms of the scheme, covered institutions are prohibited from abusing the guarantee and therefore cannot use the guarantee in marketing, advertising or any communications to customers or potential customers, so the initial concerns that there would be a flood of English deposits from English to Irish banks proved to be unfounded.”
Nevertheless, growing international fears over – not to mention press coverage of – a new wave of economic nationalisation provoked European Central Bank president Jean-Claude Trichet to comment that European policymakers should not tear up the rule book when launching emergency rescue packages, while French president Nicolas Sarkozy argued that the Irish had created a spiral in which money would have gone from country to country depending on which offered the most, and German chancellor Angela Merkel admonished Ireland for not consulting with its fellow EU governments before taking the decision.
“In the early stages there was a huge amount of interest internationally, particularly from law firms in the UK,” says Joe Beashel, a partner in the asset management and investment funds group of Matheson Ormsby Prentice, which advised Anglo Irish Bank and Postbank on the scheme. Another partner adds: “The reality is that Ireland did what it needed to do and other countries have since come forward and done exactly the same thing.”
Indeed, things were moving very quickly across Europe over that period of time and in the weeks following the Irish announcement a whole variety of extraordinary measures have been taken by member states to protect their troubled financial institutions. During this period of rapid change, European state aid rules have been pushed to their limits, with the European Competition Commission continually updating its policy as each new country introduced measures.
“Each jurisdiction has addressed its own particular issues with the commission,” says Arthur Cox managing partner Pádraig Ó Ríordáin, who leads the team advising the state. “And of course, as the commission gets comfortable with an approach, that then informs the thinking in the next country.”
“Ireland was simply the first country to take positive steps over the sustained turmoil and loss of confidence in the banking industry,” says Cronin at McCann FitzGerald. “The Irish government had to step in more quickly than most because, with the smaller number of banks here, we needed immediate comfort to protect the valuable financial sector. Ireland couldn’t afford to wait for a pan-European response.”
State aid rules
The Competition Commission issued a communication in mid-October to clarify the measures it currently considers to be compatible with state aid rules and put in place a fast-track procedure for the approval of measures, aiming to do so where possible within 24 hours. To qualify for the fast-track procedure a country must demonstrate that the intended scheme is targeted and proportionate to the objective of stabilising financial markets.
The Irish scheme was originally limited to the six largest domestic banks: Allied Irish Bank (AIB), Bank of Ireland, Anglo Irish Bank, Irish Life & Permanent, Irish Nationwide Building Society and Educational Building Society. But the exclusion of non-Irish banks, including Ulster Bank, Bank of Scotland and National Irish Bank, led to criticisms over distorted competition, and following discussions with the competition commissioner, the guarantee scheme was made available to foreign-owned banks of ‘systematic relevance’ to the Irish economy, irrespective of their origin.
However, none of the non-Irish banks, apart from Postbank, ultimately took part in the scheme. These banking subsidiaries are covered by similar state guarantees in their parent jurisdictions, but may also have been reticent to opt in due to the conditions and cost of taking part.
As part of the terms for banks becoming ‘covered institutions’, the guarantee scheme has imposed restrictions on asset and liability growth and provides for detailed reporting requirements. “The government has the right to appoint two directors to oversee activity quite closely,” explains Beashel, “and some of the banks have been keen to maintain their own flexibility.”
Striking the balance
Within six weeks of joining the scheme, each bank must submit a plan to restructure executive remuneration packages, as the scheme means bonuses will be linked to reductions in guarantee charges and excessive risk-taking, as well as encouraging the long-term sustainability of the institution. Golden parachute payments, for example, are prohibited.
Banks signing up to the scheme are also expected to pay an aggregate sum of around e500m (£447.19m) to the government annually.
“The minister has complete discretion to set the charging model,” continues Beashel, “but the amount of the charge payable each quarter will be calculated by each covered institution and verified by both the minister and the institution’s auditors.”
The Irish scheme is unusual in that it has a set two-year term and also because it guarantees all unsecured liabilities
– whereas the UK, for example, has guaranteed particular debt issues for a longer period, yet this only extends to particular specified bond issues on a transaction-by-transaction basis.
“At the time the guarantee was devised everything was happening very quickly and it was difficult to predict where the market was going and how long intervention would be needed for,” explains Arthur Cox’s Ó Ríordáin.
“The pressing concern was the immediate state of the banks and that the timeframe was adequate to deal with short-term liquidity issues. Longer term, we hope that the two-year span of the Irish guarantee will strike the right balance between supporting the banks and incentivising them as commercial entities to get back on a sound independent footing.”
While the state guarantee ensured that Irish banks had enough cash on hand to continue their day-to-day business, and brought immediate stability to the financial system, the market has since moved on, and further intervention, this time in the form of a recapitalisation, is needed. “As has happened across Europe, the initial support of government in the form of a guarantee has been followed through with capital support,” explains Cronin.
On 21 December the government announced a e5.5bn (£4.92bn) recapitalisation plan. It will take e1.5bn (£1.34bn) in preference shares in Anglo Irish Bank and e2bn (£1.79bn) in preference shares of AIB and Bank of Ireland. The Department of Finance said the state may use money from the National Pensions Reserve Fund for the scheme. Existing shareholders and private investors will also contribute.
One lasting legacy of the bank guarantee scheme is a permanent modification of Irish competition law, altered under the new act. The legislation speeds up the merger approval process in the banking sector and returns power to the minister for finance, so if consolidation becomes necessary the government will be in a position to facilitate it.
The Irish legal community is split over whether the competition changes were a step too far, with some lawyers expressing concern that the finance minister should not be able to override the jurisdiction of the Irish Competition Authority, while others are more pragmatic over the need to use any means possible to protect Ireland’s valuable financial sector.
“It would be very short-term thinking for the government not to put in place the tools it needs to help to solve this problem,“ says Ó Ríordáin. “The legislation reacted to the commercial reality. If putting banking institutions together supports the long-term stability of the financial system, then the law should approach the competition analysis with this policy imperative in mind.”