A deal on reducing the cost of Ireland's banking debt is under construction. (Get it?) Michael Probst/AP

Explainer: What's reportedly being discussed in talks on Ireland's bank debt?

RTÉ says Ireland’s banks could be given bonds by the EFSF, which could then be used to go to the ECB and get funds.

IT WAS REPORTED last night that ongoing talks between Ireland and its European paymasters, on the cost of Ireland’s banking debt, had moved to the possibility of the banks being given direct access to European bailout funds.

RTÉ’s report suggested that the European Financial Security Facility, the bailout fund which is currently giving cash to Ireland, could issue a bond to the banks which could then be used as collateral for the banks to access the everyday cash they need.

So – in short, if this was to happen, what difference might it make?

The current setup

When the credit crunch kicked in in 2008, and banks found it much more difficult to get cash from each other, the Irish government stepped in with a scheme that we all now know as the promissory notes.

These notes are essentially a form of government guarantee – a piece of paper which carries a government’s guarantee, saying ‘We will pay you a certain amount, at a certain interest rate, at defined points in the future’.

These notes were then used by the banks – primarily Anglo Irish Bank, but also Irish Nationwide – to get ‘Emergency Liquidity Assistance’ funds from the Central Bank of Ireland, which were used to cover their day-to-day activities and general running costs.

The Central Bank, as central banks do, simply created this money: fabricating the money out of thin air, on the eventual understanding that once the cash is repaid, it simply disappears again, dissolving into an electronic web of 1s and 0s.

The problem is, of course, that the State’s obligations are now being called in. (Naturally, the bank guarantee of 2008 also led to this.)

The total volume of the promissory notes given to Anglo and Irish Nationwide is around €30.6 billion, and these are now being repaid in annual instalments of €3.06 billion.

Their interest rate, incidentally, is around about the same interest rate the government would have paid to borrow cash itself at the time. It’s understood to be around 8.1 per cent.

While this is important in one sense – as it means the government’s overall bill for the promissory notes is higher, and therefore takes more cash out of the Budget – it is less important in another, as the interest is eventually being paid to IBRC, which is owned by the State itself.

It’s also worth noting that the banks are paying interest on the money they got from the Central Bank in exchange for these notes. This has never been confirmed, but it was reported last year that it’s somewhere between 2 and 3 per cent.

What’s being reported

RTÉ’s report suggests that the proposed arrangements would see the banks weaned off the promissory notes, and instead be given bonds – a form of IOU – from the European Financial Stability Facility.

That’s the EU’s current bailout fund, set up originally as a temporary vehicle, and the fund which is contributing just under a third of Ireland’s €67.5 billion bailout.

The EFSF raises its own money through a combination of contributions from Eurozone member states, and by issuing its own bonds. The idea is that the promissory notes can be slowly phased out, with the EFSF bonds introduced instead.

These bonds, issued by a reputable agency which has a AAA credit rating with two of the three ratings agencies (Standard & Poor’s downgraded it two months ago), would carry a far lower interest.

The overall idea is that instead of using an Irish government note to get cash from the Irish central bank, the banks would be given an EFSF bond which could be used as collateral to get cash from the European Central Bank.

Upsides and downsides

This would be welcome for the government, as the banks (which are now almost all state-owned) can get cash from the ECB more cheaply than they can get it from the Central Bank of Ireland.

Furthermore, the idea of replacing the note with the bond would basically mean there wouldn’t need to be discussion about ‘restructuring’ the promissory note and its repayment schedule – it could simply be replaced by another system on more favourable terms.

It would also be seen as a good thing by the ECB, because Frankfurt is obsessed with trying to prevent inflation, and the solution would allow the Central Bank of Ireland to be gradually repaid and to remove its newly-made cash from circulation.

The difficulty? Well, let’s go back to where the EFSF gets its money from – the other eurozone countries. All of them, bar Greece, pay the fund: we would need the approval of pretty much every eurozone member, therefore, if the proposal was to be pursued.

There’s also the possibility that the world’s investors could see Irish banks as a risky prospect – and charge a higher interest rate for the bond than we might expect.

Read: Government in discussions with EFSF on debt deal (RTÉ) >

More: Confirmed: Noonan announces deal on promissory notes

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