Friday, January 18, 2013

Patrick Honohan on ELA

The exchanges in this week’s Joint Oireachtas Committee on Finance at which Governor of the Central Bank, Prof. Patrick Honohan attended as a witness provided some useful insights into to Promissory Note/Exceptional Liquidity Assistance arrangement used to prop up Anglo Irish Bank and the Irish Nationwide Building Society.  

Most of the details of the arrangement were generally known but some confirmation of them was provided by Prof. Honohan.  These are from the transcript.

1. The money is owed to the ECB.

Patrick Honohan: “Two years ago on 30 March 2011, some €3 billion was handed back to the Central Bank. The Government paid some €3.1 billion in cash to the IBRC. The IBRC is already borrowing and I cannot remember how much it had borrowed at that stage. It would then repay the Central Bank of Ireland, which has drawn on facilities in the ECB. Our drawing on the ECB facilities, in other words the money we owe to the European Central Bank as a whole, will decline by that amount.”

1b. Patrick Honohan owes it to the ECB!

Patrick Honohan: “I am the chief executive officer of the Central Bank and I owe that money. I am personally responsible for making sure that debt is repaid.”

2. Default on the ELA would be “uncomfortable” in some undefined way.

Patrick Honohan: “A unilateral action of the type Deputy Humphreys is talking about would be taken very poorly indeed by the ECB, which – without over-egging the case – has provided a lot of finance to this country at a low interest rate. There are a number of ways the European Central Bank, if it chose, could find to make things uncomfortable in a graduated way. It is not in that space but I have to think what it might do. It could do things that would make us uncomfortable. I will not give a list because it might give people ideas.”

“Large sums of money are being lent by the ECB to various Irish institutions and very low interest rates are being applied. All of that could change if the ECB wanted, but I do not say it would. The reaction of the international markets would also be of concern. I am too much of an academic and I take up the question when I should probably have said it is unthinkable and that I could not possibly imagine such a case. If the Deputy wants to go through it blow by blow, the blows would be unpleasant.”

2b. But the ATMs will stay open!

Patrick Honohan: “I will not describe on television some dramatic situation and give a one-liner such as that ATMs would be closed. ATMs would not be closed, but it is not as if one can decide not to give the money and use it oneself. There are consequences. There is a network of international contracts and lenders who will take action against the Government and we have seen it.”

3. The interest rate charged on the ELA is 2.50% (ECB + 1.75 percentage points)

Patrick Honohan: “I am afraid of getting this wrong but as far as I recall, the IBRC currently pays 2.25%.” [Subsequently amended to 2.50%]

4. The interest rate payable by the Central Bank for the facility is 0.75% (ECB MRO rate)

Patrick Honohan: It is at 75 basis points.

Nobody in the session mentioned the interest rate being paid by the Exchequer to the 100% state-owned IBRC so maybe it has sunk in that it doesn’t really matter.  Of the interest rates in the PN/ELA arrangement the one that counts is the 0.75% paid by the Central Bank to the ECB.

There was also some useful information (or at least the non-rebuttal of some information) on the ECB’s holdings of Irish government bonds through the now-defunct Securities Market Programme (SMP) which is below the fold.

Deputy Kevin Humphreys:  “The ECB purchased significant amounts of distressed euro sovereign debt in the secondary bond market in 2010 and 2011 through the security market programme. I understand that approximately €200 billion worth of bonds are being held to maturity. It is estimated that between €15 billion and €20 billion of Irish bonds were bought, mostly at distressed prices well below par.

The Barclays Capital report of January 2012 stated that about €19 billion of Irish Government bonds were being held by the ECB. Is that the correct sum?

We heard a lot about how Franklin Templeton made huge returns by buying Irish bonds at low prices. It is difficult to estimate the profits the ECB will make on the capital proportion of these bonds bought through the SMP but it could be in the range of €3 billion to €5 billion. The problem is, and I asked about this in private session before and was given short shrift, we do not know what the ECB profits may be because the ECB will not tell us. The Governor sits on the board, however, so does he know and will he tell us?”

Patrick Honohan:  “I know how much Irish paper is held by the ECB in the security market programme. I could try to calculate the profits.”

Kevin Humphreys:  “Am I far off in my calculations?”

Patrick Honohan: “I would steer the Deputy away if I thought he was. I think that more information about the SMP holdings will be provided. The SMP has terminated as a programme and the reasons of market sensitivity that caused it not to be disclosed would fade away. At present, however, I am not at liberty to give out those numbers.”


  1. I was under the impression for the longest time that we owed the money to the CBI (who were given permission to create it by the ECB).

    Is it crazy that I thought this? I know there was no neat CBI/DoF press release on the issue but wasn't that the prevailing logic from various academics and columnists for the longest time?

  2. Your impression was as outlined in Karl Whelan's highly-regarded article (plus revised article) on the workings of the promissory note.

  3. @G Ocos

    Yep, certainly the most high profile reason for my impression.

    What that means for the so-called 'letter of comfort' I am not sure.

    1. @ Rob,

      I have flipped on this myself. In March 2011 I said:

      "Using the ELA is essentially further borrowing from the ECB but it is channelled through the domestic central bank (who also bear the risk of non-repayment)."

      but then flipped to the view that it was the Central Bank of Ireland that created and subsequently "burned" the money. Here is the full exchange between Sean Fleming and Patrick Honohan on creating and 'un-creating' money. I'd say both parties were somewhat exacerbated at the conclusion.

    2. Deputy Sean Fleming: I am not asking the Governor to discuss anything about the negotiations on the promissory note, but will he explain the original intention of such a note? What happens physically or electronically to the repayment that is due to the Central Bank on 31 March each year? What happens to the €3 bn repayment and the cash equivalent that is handed back to the Central Bank at the close of business on 31 March?
      Professor Patrick Honohan: Two years ago on 30 March 2011, some €3 bn was handed back to the Central Bank. The Government paid some €3.1 bn in cash to the IBRC. The IBRC is already borrowing and I cannot remember how much it had borrowed at that stage. It would then repay the Central Bank of Ireland, which has drawn on facilities in the ECB. Our drawing on the ECB facilities, in other words the money we owe to the ECB as a whole, will decline by that amount.
      Fleming:The IBRC will transfer in the normal course of events some €3 bn into the Central Bank.
      Honohan: To repay the debt.
      Fleming: At the end of March or 1 April, does Professor Honohan have the additional €3 bn sitting in his balance sheet or does he hand it over immediately to the ECB? On which balance sheet does that €3 bn appear?
      Honohan: It is an automatic reduction in our indebtedness results through the processes.
      Fleming: Does the Central Bank get the €3 bn?
      Honohan: No, we do not have to send the cheque to them. It works automatically.
      Fleming:; On 1 April does the ECB have approximately €3 bn more on its balance sheet?
      Honohan: It has been repaid the currency it created to make a special loan.
      Fleming: Will it un-create the currency, so to speak?
      Honohan: It will un-create the currency.
      Fleming: This is what I was driving at for the past three minutes. Will Professor Honohan explain in English the meaning of the phrase, to un-create €3 bn? Will Professor Honohan explain what happens to this €3 bn which will be un-created on 31 March? Does that mean burning it, shredding it or electronically wiping it out?
      Honohan: I know the Deputy is referring to the expression of shredding money, and the learned professor who described it very graphically in that way would not convince the assembled officials from the Central Banks of Europe that this is a correct way to describe the repayment.
      Fleming: Will that €3 bn exist on 1 April 2013?
      Fleming: The €3 bn goes ultimately from the IBRC to the Central Bank to the ECB?
      Honohan: All of these transactions are balance sheet transactions, the IBRC---
      Fleming: Is it not real money at all?
      Honohan: Real money is a balance sheet transaction.
      Fleming: I understand the money is un-created. What does that mean? I understand that to create currency means to make new currency, what does it mean to un-create it?
      Honohan: It has nothing to do with bank notes. The Deputy asked what is money that has been created or un-created.
      Fleming: Yes, what is un-created money?
      Honohan: Money is an entry in accounts. Those accounts can be created by the ECB, which is the monetary authority of Europe. It created it on the basis of making loans on secure collateral. It allows exceptionally the Central Bank of Ireland to make enormous exceptional loans against securities that the ECB would not normally accept. We have had to go out on a limb to meet that. Therefore when that can be repaid, the currency does not exist.
      Chairman: The Deputy's time is finished.
      Fleming: On a point of order, I asked a question and I got five minutes of waffle.