Funds still a major risk


On October 1, 2008 readers of the London Times would have opened their newspapers to see the following headline:

“Savings flow to Irish accounts as Republic offers solid guarantee – Britons take advantage of ‘safest banks in Europe’

It seems almost a lifetime ago since the introduction of the then Minister for Finance Brian Lenihan’s infamous blanket bank deposit guarantee on September 30, 2008. Hard now to countenance but at the time the move was greeted by many as something of a masterstroke, instantaneously arresting the accelerating haemorrhaging of funds out of the banking sector by putting the weight of the sovereign behind the banking system. Never mind that the guarantee of over €400 billion was more than two times GDP: the correct optics were exhibited and the necessary short term objectives achieved.

Not everyone was happy: in particular our closest neighbours who quickly saw the implications for their own banks’ funding. Again, The Times:
Savers on both sides of the Irish Sea started to empty accounts of UK banks and put the proceeds into Irish-owned banks in the wake of a controversial plan by the Republic of Ireland yesterday to guarantee all deposits.
Dublin was accused of making matters worse for non-Irish banks, with corporate treasurers and large savers pulling money out and putting it into the safer haven of Irish banks.
“If this is legal, then I’m a banana,” one disappointed senior British banker said, arguing that the Irish guarantee amounted to unfair state aid.
The same article went on to say that Irish banks said that British customers were “clamouring” to open sterling accounts. AIB said that its website had been “swamped by inquiries”.
Also unhappy as were our continental neighbours, notably one Nicolas Sarkozy. Ireland stood accused of taking inappropriate, unilateral action in the face of an EU-wide threat.
One of the remarkable features of the bank guarantee was how resolute and impervious our leaders – notably Lenihan and Taoiseach Brian Cowan – were in the face of criticism. This was the last (busted) flush of the Celtic Tiger. The idea that the guarantee was at any stage capable of being honoured by the Irish State is now laughable. What is not so funny is the awfulness of its legacy.

One valuable lesson of the guarantee is the critical element of confidence where banking systems are concerned. With the guarantee, the Irish government managed overnight to inject that confidence into a wounded Irish banking sector (albeit by means of a confidence trick). It was some time before the hollow nature of the guarantee was exposed.

Now the pathetic state of the Irish banking system has long been apparent and the confidence has drained away as relentlessly as their customer deposits.

And they are still falling away – just not as quickly as they once were.
According to the latest Central Bank figures, the annual rate of decline in Irish resident private-sector deposits slowed to 9.1 per cent at end-April 2011, following a decline of 10.0 per cent over the twelve months ending March. Deposits from households were 5.6 per cent lower in April on an annual basis.

The chart tells the sad story. Since the date of the bank guarantee there has been very few occasions where deposit growth has been in positive territory.

The causes of Irish capital flight are several. First, there is the overwhelming issue of confidence in the banking system: the simple fear that one day the banks will not open their doors. Second, Irish people are paying down debt in record amounts: this means less funds available for savings. Last, thanks to rising unemployment and salary deflation, there are more and more people living in whole or in part off their savings.

While we have yet the scale of capital flight experienced in countries such as Argentina and other Latin American countries over the past few decades, there exists the potential for even more ruinous runs on precious euro-denominated Irish savings.

First, there is the risk of expropriation of savings – a notion that was given some credibility following the decision of the government to introduce a pension levy last month to pay for its jobs initiative.
This was most forcibly expressed by the commentator Eddie Hobbs: “The only difference between a retirement fund and a deposit account in a bank is a set of tax rules, if they get away with this, if the Government get locked out of bond markets the Government are going to start appropriating money in deposit accounts… that is what is at stake here.”

Eddie Hobbs may be articulating an extreme view as it is difficult in almost any circumstances to imagine how any material expropriation of savings could do anything other than exacerbate an already fairly desperate state of affairs.

Whatever the case, Minister for Finance Michael Noonan was sufficiently aware of the potential for disaster to issue a pledge in the Dáil that bank deposits and investment funds would be left alone. It is up to the individual to decide what value attaches to such a pledge.

The big unknown is what would happen were the idea of a Euro exit to gather pace. The implications here for savers are of course enormous.

Currency controls disappeared years ago but it is still difficult for Irish savers to deposit funds offshore unless they have substantial assets. The exception is perhaps the UK – and in particular Northern Ireland branches of UK banks – where there is strong anecdotal evidence of funds migration – and so we would go full circle with our UK friends.

With Greece reeling and threats all over the Eurozone, this is no longer a fanciful proposition. It is still early days but if and when savers get any solid indication that they might wake up one morning and find their euro assets denominated in a reconstituted Irish punt, then the scramble to get out will be unseemly, to put it mildly.

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