ECB throws Ireland lifeline; debt trap remains

The European Central Bank's (ECB) plan to give medium-term funding to Irish banks alleviates Ireland's most pressing crisis but it does not solve the fundamental problem of Dublin's debt trap. Prime Minister Enda Kenny can breath a sigh of relief at Frankfurt's decision, disclosed to Reuters by a euro zone central banking source, but he still needs Europe to cut the cost and extend the term of a controversial EU-IMF bailout if investors are to be persuaded Ireland isn't a default risk.
"It's a positive for the sovereign and it's a positive for the banks but there is still major work," said Oliver Gilvarry, head of research at Dolmen Securities. "The state still has to deal with the other problems as well. The interest rate and the term of the EU-IMF package will have to be extended."
Stress tests on Ireland's banks are expected to show they will need around 25 billion euros ($35 billion) in additional capital, putting further strain on a sovereign whose debt levels have quadrupled to nearly 100 percent of GDP since its financial crisis erupted. The ECB's new facility, expected to be unveiled next week to dovetail with the stress tests, will reassure investors that Ireland's banks will not have to sell loan books in a depressed market to cut their liquidity requirements. Davy Stockbrokers have estimated that such a fire sale of up to 70 billion euros of assets could trigger 20 billion euros in additional capital requirements.
The ECB's plan will be a euro zone wide facility but it is "tailor made" for Irish banks which are dependent on central bank funding to survive after the European Union and International Monetary Fund rescue failed to restore confidence in a sector brought to its knees by property loans.
Frozen out of debt markets, suffering deposit outflows, rating downgrades and tougher collateral requirements, banks in Ireland had ECB loans outstanding of 117 billion euros, accounting for over 25 percent of all ECB borrowings, last month. On top of the ECB loans, some of which go to foreign banks based in Ireland, Ireland's domestic lenders had outstanding loans of 70 billion euros from its own central bank.
The ECB's "tailor made" plan is a coup for Kenny. In return, he may have to relinquish his threat to impose losses on some senior bondholders in Irish banks given Frankfurt's opposition to such a move because of the contagion risk. Ireland is hoping the latest round of bank stress tests, conducted under the noses of the IMF, the ECB and independent experts and with a high minimum capital threshold, will convince investors that there are no more nasty surprises.
Ireland's banks, most of them under government control, have already swallowed 46 billion euros in state capital despite passing Irish and European stress tests last year. There is a sense among some academic economists, however, that the tests cannot reveal a capital hole bigger than the 35 billion euros earmarked for Ireland's banks under the joint 85 billion euros EU-IMF bailout.