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Explainer: What did the EU leaders agree overnight in Brussels?

The leaders of the Eurozone countries have agreed to allow bailout funds be used by banks. What’s it all about?

The agreement reached by Eurozone leaders means the arrangement for Anglo Irish Bank's promissory notes could be torn up and replaced.
The agreement reached by Eurozone leaders means the arrangement for Anglo Irish Bank's promissory notes could be torn up and replaced.
Image: Niall Carson/PA Archive

THE IRISH GOVERNMENT has hailed what it describes as a “seismic shift” in European economic policy – after the leaders of the Eurozone countries agreed to a deal which hopes to separate banking debts from national ones.

Enda Kenny said that while the nuts and bolts of the deal had yet to be worked out, the deal would mean a vast improvement on the terms of Ireland’s banking debts – while Eamon Gilmore also insisted that any deal for other countries would be applied retroactively to Ireland.

But what’s it all about? What’s the problem with things as they are? What have the leaders actually agreed to? And are there any question marks?

Here we’ve tried to explain the basis of what the leaders have agreed.

A background

Firstly, a quick revisit of the background. Greece became the first Eurozone country to enter a bailout in 2010, with Ireland following in November of that year. Portugal has since followed, while Spain and Cyprus are on the way.

The causes of the difficulties in each country are not all the same, however. While Greece and Portugal were forced into bailouts largely because of difficulties in government funding, in Ireland and Spain’s case the problem relates to the banks.

In 2008 the Irish government had agreed to guarantee the entire liabilities of the banking sector, hoping to soothe the nerves of investors who felt the banks might not have the means to meet their liabilities as they fell due.

While by all accounts the government believed its guarantee would never be called in (Brian Lenihan memorably called it the “cheapest bailout in the world”), over time the government was called upon to bail out most of the country’s banks.

The end result is that Ireland had to put so much money into its banks that investors – on top of its difficulties balancing its own budget – then began to wonder whether the Irish government itself was creditworthy enough to merit being lent to.

Eventually they started charging Ireland so much money that it simply became unaffordable – sending Ireland into the arms of the EU and the IMF for its money.

What they agreed

Spain has recently found itself heading in a similar path – with its banks looking like they would need the government’s help to ensure they survived any significant round of mortgage defaults.

The size of Spain’s problems, however, meant Europe needed to take another look at its system – because while Ireland’s bailout came to €67.5 billion, with that money also funding the government as well as the banks, Spain suggested it might need a whopping €100 billion for its banks alone.

In Spain’s case, because the bailout was not directly funding the government itself, questions arose as to whether the bailout money would be given directly to the banks, or be sent through the government – adding the money to the national debt.

Ultimately – apparently at the insistence of Germany – it was decided that the money would go directly to the Spanish government, which in turn would then give the money to its banks.

This was received pretty badly though – with the cost of borrowing for the Spanish government shooting up, as investors suspected the same fate could befall Spain as had already happened to Ireland.

In a single sentence, this is what the Eurozone leaders have agreed to change: when Spain’s banks will be receiving bailout funds, the money will go directly from the new bailout fund – the European Stability Mechanism – being established in two weeks’ time.

In a significant move, the Eurozone heads of government specifically agreed to examine how this principle would be applied in Ireland’s case – splitting, as far as is practicable, the link between the government and the banks.

The mechanics of how this will be done will be considered by the Eurozone finance ministers when they next meet.

Pros and cons

Assuming the same principle applies to Ireland as will apply to Spain, and the banks will get their recapitalisation funds from the ESM, there are a few question marks that still remain.

Firstly, it should be noted that most of the money needed by the Irish banking sector has already been put in by the government – there isn’t (touch wood) any need for further cash, and the banks have already been recapitalised to the extent they need, with the end result being that the government owns a majority in every Irish bank except for Bank of Ireland, where its stake is around 15 per cent.

Though the government’s long-term plan is to sell the banks again, it hasn’t arranged any sort of mechanism where it would automatically be repaid the money it’s put in so far. In other words, once the money is put in, it’s gone – and can only be recovered if the bank is sold off altogether.

The question therefore arises about whether any mechanism allowing the ESM to recapitalise the banks could allow Ireland to back out of this. That is: would the likes of AIB be able to give its money back to the government, reducing the government’s ownership, if it was able to substitute this money with money it borrows from the ESM?

That’s a major question – because if the answer turns out to be Yes, Ireland will be able to recoup tens of billions that it’s used to recapitalise the banking sector.

A tangible effect

A more certain prospect is what the Taoiseach calls a ‘re-engineering’ of the deal on the promissory notes held by Anglo Irish Bank, or rather the Irish Bank Resolution Corporation as it’s now officially known.

In that case, the money hasn’t all been handed over yet – with the government making the infamous annual repayment of €3.06 billion at the end of every March instead, something it’ll probably be doing for the next 16 years or so.

If this could be financed by the ESM, the Irish government would no longer have to make these massive annual cash payments – but that’s not to say that it gets off entirely. Don’t forget: the Irish government still owns 100 per cent of Anglo.

If Anglo is able to borrow from the ESM to repay the Central Bank for the cash it got using its promissory notes, it’ll still ultimately be up to the government to make sure that money is repaid.

The advantage, however, is that replacing one loan with another presents the possibility to totally renegotiate the timetable for repaying this back – reducing the overall cash burden on the government, and freeing up money to be used in other ways.

Read: Taoiseach: Irish debt burden on the tax-payer to be ‘re-engineered’

More: Gilmore says new eurozone deal is a ‘game-changer’ for Ireland

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About the author:

Gavan Reilly

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