Ireland to set up Europe’s first ‘bad bank’

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The Irish government has announced plans to establish a ‘bad bank’ in a bid to quarantine toxic assets and restore confidence in its ailing financial system. The move comes as part of a tough emergency budget, and makes Ireland the first EU member state to adopt such a strategy to deal with the credit crisis.

Finance Minister Brian Lenihan said the move would give Irish banks a “clean bill of health” and get credit flowing to individuals and businesses in the real economy. 

Loans given by banks to fund investments in property and land will be transferred to a new government agency and vigorously pursued, according to the minister. 

Lenihan insisted that all borrowers will be required to meet their full legal obligations for repayment. 

“These assets pose the main systemic risk to the banking sector in Ireland, and the most significant obstacle to the recovery and restoration of lending by the banking system,” he said. 

The Irish government estimates the maximum value of the loans to be transferred to the bad bank to be in the region of €80 billion to €90 billion, but that the state will pay less than this to reflect the fall in property prices. 

The new National Asset Management Agency will purchase the assets by issuing government bonds to the banks. Lenihan acknowledged that this will result in an increase in gross national debt, which would be offset by the value of the assets taken in and income collected over time. 

Dr Aidan O’Boyle, chairman of the Small Firms Association, welcomed the move, which he said “will mean a return to ‘business as usual’ lending by the banks to small firms who desperately need support, in particular on working capital”. 

Critics of the plan suggest the full extent of the toxic assets is unclear and could be even greater than current government estimates. 

Several EU leaders have already shied away from establishing bad banks, with French President Nicolas Sarkozy openly opposing such a move on the grounds that it “means nationalisation of losses” (EURACTIV 03/01/09).

It has also been suggested that the nationalisation of Ireland’s two main banks – the Bank of Ireland and Allied Irish Bank – could become necessary later this year should their capital position weaken further. Ireland has already nationalised the smaller, business-oriented Anglo Irish Bank. 

In addition to the plan to clean up the banks’ balance sheets, Minister Lenihan revealed that former Deputy Governor of the Bank of England, Sir Andrew Large, will advise on the process to select a new financial regulator as part of a major shake-up of the Irish banking system. 

The budget was viewed by commentators as necessarily harsh, with tax increases across the board and spending cuts in several areas as part of sweeping measures designed to restore order to Ireland’s public finances. 

However, opposition politicians were critical that tax hikes rather than public spending cuts were used as the primary tool for balancing the books. There was also concern that the government warned of further tough measures in the annual budget later this year. 

Ratings agency Moody’s downgraded ratings on 12 Irish banks today (April 8), despite the government’s plan to soak up bad loans. Moody’s said ongoing losses resulting from tumbling property prices could weaken the capital positions of banks in Ireland for the next two years. 

Irish banking shares jumped yesterday as rumours emerged of the plan for a bad bank and other tough measures to shore up Ireland’s finances. However, shares in larger Irish banks were down this morning. 

The collapse of Ireland's housing boom and the global credit crisis have taken a heavy toll on Irish banks. 

The government has nationalised Anglo Irish Bank – which had lent billions to property developers – and has also injected €7 billion into the two largest banks, Bank of Ireland and Allied Irish Bank. 

Plummeting property and land values have seriously damaged bank's balance sheets, with developers at risk of defaulting and newly-unemployed homeowners struggling to meet mortgage repayments. 

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