A smack from the IMF : June 26 2009

the IMF weighed in in June 2009. It was spun as approval. It wasnt. Here is my Irish Times reaction piece


OPINION:The IMF report most certainly does not give Government banking policy the thumbs up, writes BRIAN LUCEY.

THE STATE of the Irish banking system remains parlous. This is particularly evident in its capital base. Notwithstanding the financial engineering of recent months, which has released capital through debt restructuring, Irish banks remain undercapitalised to meet regulatory and likely future losses.

Estimates by Oliver O Shea ( Restarting flow of credit the most immediate challenge facing main banks , The Irish Times, May 23rd) suggest that even under very optimistic scenarios total capital available to the main Irish banks is no more than EUR 50 billion. It is also useful to recognise that regulatory minimum ratios for capital are now significantly less than the market desired ratios. In plain language, although banks may well pass legal tests of being adequately capitalised, they may not pass market tests.

The present state of the Government s dealings with banks might best be described as piecemeal a smidgen of guarantee here, a dollop of preference shares over there, a bit of urging to restructure here, a nudge towards bolstering common stock elsewhere, and an overarching commitment to preserve the banks in as majority a public ownership as possible. Meanwhile, banks profit bases remain under stress and are unlikely to provide the tens of billions required to rebuild the balance sheets.

The International Monetary Fund (IMF), in its article IV consultation report just published, places the banking crisis front and centre. Its analysis of the response of the Government is damning. It is important to recognise the report is ultimately a political document and would have been drafted and redrafted. Thus any comments critical of the actions of the State must be read as having passed through several formal and informal filters prior to final publication.

The IMF starts its analysis with an estimate of bank losses of some EUR 35 billion. It is a massive indictment of the quality and competence of Irish economic governance that they state, on page 15, The authorities did not formally produce any estimate for aggregate bank losses.

In plain language, the Department of Finance either did not present or did not have any idea of the scale of the likely losses. It quite literally beggars belief that nine months into the crisis this could be the case. If the department does not have estimates, then it is grossly delinquent. If it does have estimates, and did not present them to the IMF, then one wonders what is being hidden. In any case, a loss of EUR 35 billion would render the Irish banks undercapitalised from a regulatory standpoint and most probably would result in their being economically insolvent.

The IMF report then examines the National Asset Management Agency (Nama) and emphasises over several paragraphs the importance of the new agency cleaning up the bank balance sheets swiftly and completely. Yet, we see (on page 19), They [the Department of Finance] agreed that piecemeal efforts could keep banks dependent on official support and unable to resume normal functioning. The Japanese experience is particularly cautionary.

This should chill the blood of any reader: the Department of Finance, which has led partial effort after partial effort to solve the banking crisis, and which is committed to more partial efforts, accepts that if these do not work, the economy faces a lost decade. Indeed, in that paragraph, the Department of Finance is reported as saying also: The authorities took note of these considerations for their further deliberations on setting up Nama.

Nine months into the crisis, five months after Nama was announced, and the department is considering further deliberations on Nama? No rush lads . . .

The IMF concludes with an analysis which echoes in all important elements the opinion in this newspaper (April 17th) of 20 economists (of whom I was one) that nationalisation plus Nama may be the way forward. The report states, Staff noted that nationalisation could become necessary but should be seen as complementary to Nama. Where the size of its impaired assets renders a bank critically undercapitalised or insolvent, the only real option may be temporary nationalisation . . . Having taken control of the bank, the shareholders would be fully diluted in the interest of protecting the taxpayer and thus preserving the political legitimacy of the initiative. The bad assets would still be carved out, but the thorny issue of purchase price would be less important, and the period of price discovery longer, since the transactions are between two Government-owned entities. The management of the full range of bad assets would proceed under the Nama structure. Nationalisation could also be used to effect needed mergers in the absence of more far-reaching resolution techniques.

Recall when reading this that the IMF has stated the losses are such as to leave the banks in a position of undercapitalisation at best. This argument from them echoes the almost unanimous consensus of academic finance observers. However, undaunted, the department (who, remember, don t seem to know the magnitude of the problem they are trying to solve) disagreed. However, their arguments (on page 19 of the report) are straw men the need for nationalised banks to operate under the same regulatory regimes as non-nationalised ones, the need for a clear exit strategy, the need for lack of politicisation of lending that have been discussed and to which solutions have been suggested in many forums including this newspaper.

So we are left with a Minister committed to incrementalism in solving a crisis the magnitude of which his department professes ignorance of, an incrementalism the department agrees runs the risk of a lost decade, and a determined if unargued rejection of all advice (internal and external) relating to the efficacy of the sole solution proposed.

And we wonder why the country is in crisis?

Brian Lucey is associate professor in finance in the business studies department of Trinity College Dublin


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