A half-good bad bank scheme

Ireland’s bad bank scheme has always looked a mixed bag – good in parts but less so in others. Tuesday’s announcement of the terms under which the National Asset Management Agency will buy an initial tranche of impaired assets with a book value of €16bn does little to dispel this sense.

This is just the first chunk of what will ultimately be a bad loan book with a nominal value of €81bn. To take on such a debt mountain was always going to be a huge risk. The sum, after all, represents a frightening 47 per cent of Ireland’s 2009 GDP. Such a risk is only worth taking if the cost to taxpayers has been minimised and the assistance provided genuinely draws a line under the bank’s losses. Unfortunately, in this case, neither of these conditions has clearly been met. The government might have done more.

This is a shame because the scheme has admirably crunchy elements. It legally obliges banks to dispose of troubled assets – getting round the chicken and egg problem that any voluntary clean-up scheme faces: namely, of getting banks to crystallise, rather than run, their losses. It also avoids the self-selection problem, where banks only sell the rubbish for which the state is overpaying.

Moreover, the government has used this power to impose some stark haircuts on the banks. The discount on the first tranche, at 47 per cent, is much steeper than was anticipated when Nama was established last year. Those on future tranches may be lower but the overall discount is not expected to be less than 37 per cent.

Unfortunately, the resulting losses will not be shared beyond the equity holders. Until September, the debt holders will continue to be guaranteed. This means the state will have to underwrite any equity injections needed to recapitalise the banks.

A second flaw is that Nama does not truly draw a line under the losses. Although Ireland’s finance minister, Brian Lenihan, promised a “once and for all” solution, the deal leaves open the possibility of a subsequent levy on the banks if Nama itself makes a loss. The whole point of a bad bank is to provide certainty about bank balance sheets. There is little point to one that does not absorb all the risk and reassure private investors that the institution is clean.

It is a shame that a largely admirable scheme has been marred in this way. But it may reflect the fact that Ireland has swallowed as much bank risk as it can bear.