Thursday, 09 October 2008, 10:21

C O N F I D E N T I A L SECTION 01 OF 02 DUBLIN 000556

SIPDIS

EO 12958 DECL: 10/09/2018

TAGS EFIN, ECON, PREL, PGOV, EI

SUBJECT: THE BANK GUARANTEE: AN IRISH SOLUTION TO AN IRISH

PROBLEM

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Classified By: Pol/Econ Chief Theodore S. Pierce. Reasons 1.4 (b/d).

1. (C) Summary: On September 29, the Irish government announced plans to back deposits in all Irish-domiciled banks. Foreign banks with significant Irish operations were initially left out of the scheme but some look now to be included. Irish government officials maintain that impaired assets at Irish banks are still relatively insignificant and are mostly confined to commercial property loans. They say that regulatory oversight of the financial sector will be tightened and that the drying up of credit to Irish banks forced the decision to guarantee all deposits. The crush on Irish banks could not have come at a worse time -- immediately preceding next week's presentation of what is widely expected as the most austere government budget in years. End Summary.

A Crisis Unfolds

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2. (U) Following a late-night September 29 meeting with leading bankers -- Central Bank Governor John Hurley and Chief Executive of the Financial Regulator Pat Neary -- Prime Minister Brian Cowen took the decision to guarantee the deposits, loans, and obligations of the six Irish-owned Banks for two years. The next day Finance Minister Brian Lenihan and Hurley briefed their key European counterparts. During a marathon session (almost 22 hours, a record) on October 1, the Irish parliament passed legislation that would make the guarantee operational. On October 2, President Mary McAleese signed the Credit Institutions (Financial Support) Bill 2008 into law. On October 6, Lenihan faced questions about the scheme from other EU Finance Minister at an ECOFIN meeting in Brussels and the Central Bank and the Regulatory Authority met to finalize the terms of the plan. On October 8, the Irish Cabinet met to discuss the plan but delayed announcing anything until the EU gives its formal approval, which is widely expected to happen early next week.

A Perfect Storm

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3. (C) Econoff and visiting EUR/WE Desk Officer met with Central Bank and Financial Services Authority officials Gordon Barham, Maria Woods, and Billy Clarke on October 6 to talk about the government's bank guarantee plan. Clarke said that the regulator had been carefully watching the banking sector as the months-long credit contraction unfolded. Explaining the seemingly sudden pressure on Irish banks last week, he said a "perfect storm" of external events related to the credit crisis had dried up the traditional sources of financing for Irish financial institutions. Barham maintained that the level of impaired assets in the system stood at between 0.5 and 0.8 percent and these are mostly confined to loans to commercial property developers. When pressed, Barham said the media had exaggerated the level of problem assets and those that existed could be managed.

4. (C) Clarke hesitated to make predictions but said that it is "likely" the regulatory system would move from one that relied heavily on bank management working within broad guidelines laid down by the regulator to a "rules-based" one. An example he gave was that the regulator may be given the authority to limit the percentage of the banks' loan books that are extended to any one sector (i.e. commercial or residential property). Barham and Clarke said that the banks would not be allowed to securitize and sell impaired assets under this scheme. Rather, the banks, the regulator, and other government agencies would have to figure out how to "unwind the problem assets without exposing the Irish taxpayer to undue risk."

5. (C) Econoff spoke with Kevin Cardiff, Second Secretary General at the Department of Finance, who has been deeply involved in putting together the guarantee package. Cardiff echoed the regulator and pointed out that auditors contracted by his Department to look at the books of at least two of the institutions under pressure came away with "a favorable impression of the loan books." While he admitted that the amount of "speculative loans, or those that are not currently productive, is not insignificant," he stressed that all involved in putting together the package were confident that the government would not be forced to bail out the banks.

6. (C) Cardiff said that credit to the Irish banks "virtually dried up" on September 29 and that the government had to step in to salvage the Irish financial sector. The genesis of this was classic "herd mentality" based mostly on rumor and innuendo about Irish banks rather than any hard facts. However, fighting the herd became impossible, he added. He added that non-Irish institutions with significant Irish

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operationsXXXXXXXXXXXX would likely be included in the scheme. XXXXXXXXXXXX

7. (C) Although the move did not win any friends across Europe, Cardiff said that there is a gradual realization in Brussels that each country should be allowed to tailor its response to local conditions. He characterized the Irish government's discussion with EU officials as "positive" and indicated that the Irish solution would soon gain approval. In an aside, he pointed out that Irish Finance Minister Brian Lenihan and his British counterpart, Alistair Darling, had engaged in a very constructive exchange of views. Cardiff continued that the prevailing mood in Europe is that "large-scale failures just make things worse" and that he expected more Irish-like solutions. He warned, though, that the battle had just begun.

Comment

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8. (C) Against the background of a steep slump in the property market and anecdotal evidence we have picked up, it may be that government officials are being a bit optimistic in their assessment of the level of impaired assets. It begs the question: if the level of impaired assets is not a problem, why the sudden pressure on Irish banks? Perhaps the perfect storm answer is the right one. Whatever the answer, the Irish government has its work cut out for it as it works with the private sector to stop the bleeding and then rebuild the Irish financial sector. With the government maintaining that the Irish banking sector nearly collapsed during the past two weeks and the announcement of what is expected to be a very draconian 2009 government budget next week, Irish economic policymakers are facing their most significant challenge in decades. FOLEY