The banking guarantee, which has cost the taxpayer €46bn so far, was originally intended to allow the Central Bank to provide emergency funding to the collapsing financial sector without it being noticed by the ECB or the markets, according to documents recently released by the Department of Finance.

Legal and strategic advice contained in a confidential ‘scoping paper’ from January 2008 states repeatedly that a “comprehensive guarantee would be necessary” for the Central Bank to step in with emergency liquidity assistance (ELA) to help Ireland’s ailing banks.

“If there is any concern that a financial institution seeking ELA is insolvent, the [Central Bank] would not be in a position to provide liquidity support without the question of some guarantee arising from the Exchequer,” the paper said.

The documents also show the department was committed to a policy of “constructive ambiguity” early in the financial crisis to keep capital markets and the Irish public in the dark about its strategy.

“It is in the interests of the public that the situation is solved before it enters the public domain in order to prevent contagion,” one briefing note stated.

Officials considered being transparent about the government’s preparations to “help support public confidence” in the banks, but feared openness could jeopardise financial stability.

According to the documents, officials were searching for a way to give the Minister for Finance and the Central Bank latitude to intervene in the market together to help failing banks without violating either Irish or European law or signalling to the markets and public that Irish banks were failing.

“If an insolvent bank sought ELA, the [Central Bank] would be legally prohibited from extending it. However, if the bank was systemically important and the government agreed to extend a guarantee to its liabilities, then this would turn it from an insolvent bank into an illiquid but solvent one… so that the [Central Bank] could inject liquidity to prevent contagion.”

The papers indicate that Central Bank officials wanted recourse to the public purse before providing help, as the European Central Bank could have prohibited emergency funding if it was “deemed to interfere with monetary policy”.

Central Bank statistics from 2008 showed total ELA increased fourfold to more than €12bn in the year leading up to the guarantee. The latest figures show the Central Bank has lent €51bn in ELA money to Irish banks.

The January 2008 scoping paper also noted the “preferred outcome” for an insolvent bank was “failure and subsequent orderly wind-down” to prevent the costs of the insolvency transferring to the state.

That followed principles adopted by European finance ministers in October 2007 and referenced in the Department of Finance documents, which said creditors and uninsured depositors “should expect to face losses” in a bank failure.

The Ecofin Council agreement also said EU member states should share the fiscal burden when a failed bank had significant cross-border activities.

This is an article from the Sunday Tribune on 30th January, 2011.

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