Ireland: Stress tests reveal additional capital needs
April 1, 2011
On 31 March, the Central Bank disclosed the results of its stress test on the country's four main banks: Allied Irish Banks (AIB), Bank of Ireland (BOI), EBS Building Society (EBS) and Irish Life & Permanent (ILP). The results showed that the four institutions need an additional EUR 24 billion in bailout funds from the government. The Central Bank claimed that the extra funds are necessary as the dire state of the domestic real estate market continues to erode the balance sheets of the banks that are already struggling to meet more restrictive standards for cash reserves. The EUR 24 billion comes on top of EUR 46 billion that the government has already poured into the financial services industry and EUR 30 billion in risky property loans from banks that an agency absorbed over the last year. In total, the Irish bank rescue package amounts to EUR 100 billion, equivalent to about two-thirds of the Irish economy or about EUR 22,400 per capita. The majority of the new funds will come from the National Pension Reserve Fund. However, the government also announced that it will ?seek direct contributions to solving the capital issues of the banking system by looking for a further significant contributions from subordinated debt holders, by the sale of assets to generate capital and where possible by seeking private sector investors?. Even though the financing of the additional capital requirements is secured, ratings agency Standard & Poor's downgraded Ireland's sovereign credit rating by one notch from A- to BBB+ on 1 April. The agency cited future risks to bond holders as the main reason behind its decision. Simultaneously, S&P moved the outlook from negative to stable, claiming that the assumptions underlying the stress tests seem sufficiently robust and that sharp economic contraction has reached an end. Fitch Ratings was less upbeat and warned that it might cut its BBB+ rating on the back of weaker economic growth and rising bailout costs. The rating agencies' decisions carry less weight though, as on 31 March, the European Central Bank (ECB) had ?decided to suspend the application of the minimum credit rating threshold in the collateral eligibility requirements?. Against this backdrop, the market's reaction was, in general, neutral with the 10-year Irish bonds trading at 10.07% on 1 April and the spread to the German bonds amounting to 6.70%. The stress test results were accompanied by a government announcement regarding the future structure of the banking system. According to the plan put forward by the new finance minister Michael Noonan on 31 March, the Irish banking sector will be reorganised into two main or ?pillar? banks: Bank of Ireland and the merged AIB-EBS. These entities are expected to cut risk by reducing its financial leverage over the next two and a half years.