New government has little room to manouevre on banks' issue

The timetable for the new government will not be fixed by the new government. It is already decided by the EU and the IMF and the State has signed up to that. So there is no leeway there and the timetable is very demanding, writes Vincent Browne.

For starters, it is required that "the government will rigorously implement the budget for 2011 and the fiscal consolidation measures announced afterwards". Fine Gael and Labour can moan all they like about the budget and what changes they would prefer. Maybe a little fiddling at the margins but whatever is done must be "consistent with the requirements of the excessive defence procedure". And there will be a review of progress on the implementation of the budget and of the fiscal consolidation measures at the end of this month.

And to emphasise this, the agreement states: "The Department of Finance will continue to ensure tight supervision of expenditure commitments by line departments and effective tax collection, to make certain that the primary deficit target in cash and the general government nominal budget deficit (is being implemented)".

There is a problem straight away with our masters about the banks' recapitalisation. There was an absolutely explicit commitment in the agreement with the EU and IMF that €10 billion from the Pension Reserve Fund would be spent on recapitalising the banks by the end of February. Brian Lenihan refused to go along with this and deferred this to the new government. Fine Gael in its manifesto has said this money would not be transferred until the banks' stress test was completed by the end of March, implying that if the stress test showed a much worse situation than we know already, then the €10 billion might not be invested. This is not an option. The agreement clearly stages: "The Irish authorities will ensure that AIB, BOI (Bank of Ireland) and EBS are initially recapitalised...And will fund early deleveraging by making available €10 billion in the system; the recapitalisation will take the form of equity shares" and this has to be completed by the end of March.

Our masters have also said that the stress tests must be completed by the end of March along with what is called "the diagnostic evaluation of banks' assets".

Also by the end of March the Central Bank must have completed the assessment of the banks' restructuring plans. Nama is required to take €16 billion of land and development loans in AIB and Bank of Ireland that were previously excluded from Nama, as they were below the €20m threshold. By the end of March there will have to be agreement with the IMF, ECB and EU Commission on a strategy for securing the viability of the Irish banks, to ensure they will operate without the further need for state support, which really means ECB support.

Almost certainly the stress test undertaken on the banks by the end of March will reveal the need for yet more money for them and we will be required to come up with that more money, probably through additional borrowing from the EU and IMF. The Fine Gael manifesto commitment to avoid that through renegotiation of the entire deal has close to zero chance of success in the immediate and medium term future, by which time the additional funding will have been provided.

There is a menu of further requirements by the end of March, more by the end of April, then the end of June and on and on, year after year. This is nightmare stuff.

On Wednesday the Central Bank published a table of the scale of the bonds issued by the Irish banks, as of 8 February 2011. There are almost €21 billion of senior bonds, covered by the state guarantee. There are a further €35.5 billion of senior bonds not covered by the guarantee and there are almost €7 billion of subordinated bonds. We will get a discount on the €7 billion subordinated bonds, in agreement with the IMF and EU. But there is no discount to be had on the remaining €56.5 billion, not even on the €32.5 billion which is not covered by the guarantee, which many have found both perplexing and infuriating.

The reasons appear to be these: that under Irish company law it is not permissible to give priority to some senior bondholders over others for they all rank equally in a liquidation and also rank equally with depositors; and, anyway, the ECB and EU Commission will not allow a default on senior debt because doing so would destabilise the banking system across the EU.

Perhaps there is a good explanation for the deficiency in the legislation concerning the bank guarantee (there might have been a constitutional impediment to discriminating between various senior bondholders) but whatever it was, it seems incredible that nobody noticed or at acknowledged that the bank guarantee extended far beyond what was originally contemplated or implied. And of course nobody enquired of the EU Commission or the ECB whether they would countenance prioritising guaranteed senior bondholders over others – the terms of the bank guarantee were not cleared in advance with the EU, which in itself is astonishing!

All in all, we are in a terrible pickle and the new government will discover the scale of the pickle in jig time.