Patrick Honohan: last resort

The run on the Irish banks in recent weeks has been of a scale that has set new records for national financial systems in western Europe. In September, a chunk of senior and subordinated debt was repaid to private lenders. Starting in early summer, big companies in Ireland and Britain had withdrawn their cash from the guaranteed Irish banks – because by then it was clear the state guarantee, put in place two years earlier to insure the huge liabilities of the banks with weakening government finances, had already snapped. Ordinary customers too have withdrawn cash in recent weeks. When you hear taxi drivers discussing the finer points of opening Swiss bank accounts, you know that the good old-fashioned run on the banks continues to run its course.

Official figures confirm the scale of the flight of cash. As deposits flow out the front door, the European Central Bank and, significantly, the Irish Central Bank through its own so-called "exceptional liquidity assistance" have pumped tens of billions of euro in at the other end on a weekly basis to keep the banks from closing. By late last month, from a small base, the Irish Central Bank's 'exceptional' facility to the banks had grown to a truly astonishing €44.6bn.

But the question of who will end up repaying the exceptional loans should concern us. Could it possibly be that some of them end up being dumped on taxpayers? Expert Lorcan Roche Kelly has done most to untangle the financial statements of the Irish Central Bank and ECB. From his base in Sixmilebridge, Co Clare, the trained engineer and occasional share trader unpicked the mystery of how an insolvent bank like Anglo Irish was keeping its doors open. What he learned has helped him focus his sleuthing skills on the Irish Central Bank's ongoing funding of the banks.

"The story starts in March. What happened was that Anglo reported its 2009 annual report, and I couldn't understand how it was funding itself. From my knowledge of the markets, I knew that players were reluctant to fund banks, especially to provide subordinated debt to state guaranteed banks. I came across something called a Master Loan Repurchase Agreement [MLRA], which surprised me because Anglo was not using ECB funding."

Roche Kelly called a friend who used to work at the Irish Central Bank, who told him that the MLRAs had not been used since the days of the punt and even then only in exceptional occasions when a bank was in danger of running out of money. "I emailed the Central Bank which very helpfully emailed back and said it can provide Exceptional Liquidity Assistance (ELA). The Central Bank as lender of last resort can satisfy itself to accept certain assets."

By the summer, the latest interim report from Anglo showed that the master loans had metamorphosed into something called a Special Master Repurchase Agreement. This again raised a key question – why was Anglo not tapping cash from the ECB by pledging or repo-ing its assets for cash? It was instead turning to the Irish Central Bank. "If Anglo could not repo assets with the ECB and the Irish Central Bank was providing 'exceptional' lending, I thought there must be something smelly with the assets Anglo was offering in the first place," Roche Kelly concluded.

The next significant date was last September. The banks had managed to bunch a huge €55bn in repayments to senior and subordinated bond holders into a few weeks ahead of the ending of the original state guarantee.

"The Irish Central Bank's financial statement showed a jump of €55bn at the end of September. That was the next big piece of the jigsaw," Roche Kelly said. "The significance of the €55bn was that the banks had bonds in the market and the market was not prepared to refinance those bonds. So, all the €55bn due for repayment in September was repo-ed at the ECB and the Central Bank. After that, it became a matter of watching the 'other assets' column in the monthly Irish Central Bank statement where the exceptional liquidity assistance appears."

In his blog, corner­, Roche Kelly has documented the escalation of the funding for Anglo and other unnamed banks this autumn, as the run on the banks continued apace.

In September, the Central Bank reported its own 'exceptional' cash to the banks had increased from €7bn to €21bn. In October, the Central Bank loaned another €13.5bn. By the end of November, it loaned another €10bn to bring its exceptional funding to €44.6bn. That sum will have grown in recent weeks.

Sleuthing through the figures, Roche Kelly spelled out the significance of the funding: "Of the €44.6bn, some €31bn is in promissory notes and €2bn is in other assets. That leaves €11.5bn in bank assets with the Irish Central Bank we don't know much about. But we know it is not of good enough value to be repo-ed at the ECB, which is the place to go for banks to get cash."

He noted: "The ECB is not saying 'no' to too much. But what it is saying 'no' to, the Irish Central Bank is saying 'yes' to. The Irish Central Bank is doing this with the blessing of the ECB even though it is not part of normal monetary procedures."

The promissory notes and the other mystery assets the banks have pledged to tap the Irish Central Bank for its 'exceptional' facility, are being turned into cash. Bluntly, says Roche Kelly, the Irish Central Bank, by creating cash from the promissory notes – IOUs drawn on taxpayers – is engaged in a form of quantitative easing.

Roche Kelly's next goal is to unpick another puzzle: at what point do the ECB, the EU and IMF decide it would be better to close banks here rather than have our state finances pushed even deeper into a private banking mess?

Dame Street brief - Central bank's party line

The Irish Central Bank is sticking to its party line: "Similar to other central banks, the Central Bank of Ireland can supply exceptional liquidity assistance to institutions when that is judged necessary. This facility is not part of regular monetary policy operations. The bank does not, however, comment on these operations. The Central Bank does, however, publish details of its liquidity operations. Any loans by the bank are contained within our balance sheet which is updated on a monthly basis as part of our monthly statistics."