Ireland bailout to reduce burden for central bank

By Marc Jones

FRANKFURT (BestGrowthStock) – With Ireland’s plan to take an international bailout, the European Central Bank has won a round in its fight to resolve the euro zone debt crisis while limiting damage to its balance sheet and credibility.

For much of this year, the central bank has been forced by circumstances and political pressure into adopting radical and expensive steps to keep heavily indebted countries afloat.

Ireland’s decision this week to seek emergency loans from the European Union and the International Monetary Fund gives the ECB a chance to reduce its exposure to the crisis and transfer part of the burden to those institutions.

“De facto they (the ECB) are supporting the Irish, Portuguese, Greek and to a lesser extent the Spanish banks,” said an economist at a top European bank, declining to be named because of the sensitivity of the issue.

“They would like to move away from this situation. They clearly see the bailout as a way toward that.”

BURDEN

Since the euro zone crisis erupted this year, much of the burden of containing countries’ debt problems has fallen on the ECB. As banks in those countries lost access to market funding, the ECB began lending them huge sums in money market operations.

In May, as Greece obtained a 110 billion euro international rescue, the ECB was pressured into buying government bonds of weak countries from the secondary market to cap their yields — a highly controversial step at odds with its reputation for conservative monetary management. To help support Greek banks, the ECB also relaxed its rules for the quality of the collateral it accepts in its money market operations.

And last month, ECB officials tried but failed to dissuade Germany’s government from discussing the creation of a system for sovereign debt restructuring in the euro zone. The idea panicked investors, raising market pressure on weak states.

But the Irish bailout appears to move the crisis in the right direction for the ECB. Sources familiar with the bailout talks said the central bank was heavily involved in persuading Ireland to accept international aid, offering its technical expertise to smooth the process.

In fact, in the weeks before Ireland’s decision, the ECB appeared to contribute to the conditions which made that decision inevitable. It sharply cut back the amount of government bonds that it was buying, signaling that Dublin would have to seek other assistance.

Under the bailout, which is expected to be finalized around the end of this month, Ireland may receive about 85 billion euros from the EU and the IMF over several years, with much of the money going to recapitalize its banks.

The emphasis on recapitalizing the banks is a major difference between the Irish bailout and the Greek rescue, which involved the creation of a fund to support Greek banks in case of emergency but did not focus on a comprehensive clean-up of the banking sector.

If Ireland’s banks are cleaned up, they may be accepted back into interbank money markets, which would reduce their need for ECB funding.

“Once there was a sufficient recapitalization, in theory it shouldn’t take more than a few weeks” for Irish banks to regain access to interbank markets, said a money market trader at a European bank.

“Someone would just have to put a business case together that we want to do business with these guys. It would have to follow a certain procedure but that should be it.”

BONDS

Greece’s experience suggests it could take many months for Irish banks to become able to survive without ECB funding. Greek banks are still borrowing as much from the ECB as they were before Greece was bailed out, so analysts say the ECB may have to be keep offering unlimited cash for longer than it hopes.

“It is going to take a long time to recapitalize the Irish banks and during that time the need for ECB liquidity will still be high,” said Societe Generale economist James Nixon.

“It’s not obvious how they will get out of this any time soon. What happened with the Greek banks will now happen with the Irish banks…the contagion effects will spread and we will see a rise in demand for liquidity in Portugal and Spain.”

But even if the ECB remains on the hook to support Irish banks, the bailout means it will not face as much pressure to support the Irish government.

Under the protection of an EU/IMF safety net, Ireland would not need to borrow from the markets to fund itself. This implies the ECB could further cut back its purchases of Irish bonds, limiting the Irish risk carried on the ECB’s balance sheet.

Even better from the ECB’s point of view, the Irish bailout has created a precedent for handling future national crises in the euro zone.

If Portugal’s debt troubles worsen, for example, the central bank can argue that rather than requiring the ECB to step up its buying of Portuguese bonds or take other radical steps, the EU and the IMF should be brought in.

Luxembourg central bank head Yves Mersch, an ECB policymaker, alluded to this on Wednesday, saying the need for ECB bond purchases was not as acute as it was at the time of the Greek bailout since the EU had now established its European Financial Stability Facility to handle crises.

“We have seen the setting up of the European financial stability fund…We are in a whole different environment now than when the SMP (bond buying program) was set up, and we have to take into account this change,” Mersch said.

“This does not mean the SMP will have to be scrapped altogether, only that it is not at present in the same functioning mode as it has been six months ago.”

ECB President Jean-Claude Trichet and other policymakers at the central bank have made it clear that they are keen for the ECB to end its emergency support measures for the euro zone as soon as it can safely do so.

Trichet has even insisted that if the threat of inflation demands it, the ECB is prepared to start hiking interest rates while continuing to provide emergency lending support to banks.

Policymakers know this would be a difficult maneuver, both technically and politically, if two or three countries in the euro zone were still desperately weak at the time.

Nevertheless, the Irish bailout brings the ECB a step closer to a time when it will be able to relinquish its role as a savior of the euro zone and return to a more limited, traditional role as guardian of price stability.

(Additional reporting by Sakari Suoninen; Editing by Andrew Torchia)

Ireland bailout to reduce burden for central bank