The Irish government is poised to take a majority stake in Bank of Ireland, which will leave the Republic without a single significant lender independent of state control.
The increased government stake is under discussion as part of an €85 billion rescue package from the European Union and International Monetary Fund, which aims to restore confidence in Ireland’s troubled economy and its ailing banking industry.
Fears of contagion from Ireland’s banking problems swept through Europe on Tuesday, sending the euro to its lowest level against the dollar in two months and hitting shares. A poor Spanish debt auction, which forced the country to pay extremely high premiums, prompted some investors to ask if the eurozone crisis could spread to Madrid and threaten the single European currency.
Spain’s cost of borrowing jumped to a record over Germany—Madrid now has to pay a higher interest rate for three months of borrowing than Germany pays for five-year debt.
The details of the Irish rescue package are still being finalized but will include a large capital injection into Ireland’s banks to lift their core tier one capital ratios—a measure financial strength—up to 12 per cent.
While the Irish government is keen to avoid a full nationalization of Bank of Ireland, the amount of capital that will be pumped into the bank will leave Dublin with a large stake, according to Irish government officials. The government currently holds 36 percent of the bank.
The move will be a blow to Bank of Ireland, which, until recently, looked to be the only lender likely to emerge from the financial crisis without succumbing to majority state control.
The government’s stake in Allied Irish Banks was already expected to increase to 95 percent later this year following a €6.6 billion share offer that is underwritten by the state and could now go even higher.
In addition to providing the banks with immediate capital—which is intended to boost their ability to withstand future losses—the Irish government will be able to use the €85 billion of rescue funds to provide further top-ups to the banks should their capital levels fall below 10.5 percent in future. This is aimed at easing concerns that the banks are likely to be hit by further losses on bad loans as their mortgage books start to deteriorate.
The government is also planning to introduce formal targets for the banks to shrink their balance sheets over the next five to 10 years. Bank of Ireland and Allied Irish Banks are likely to be forced to wind down or sell off large portfolios of assets deemed non-core, which will be split from their core assets. The government is also understood to be willing to provide some level of insurance on future losses of certain assets to encourage buyers.
Irish bank shares fell more than 20 percent, with Bank of Ireland and AIB suffering some of the biggest losses.
Alan Wilde, head of fixed income and currency at Baring Asset Management, said: “Contagion is a big problem for the eurozone. The danger is that worries about Ireland will continue rather than ease, and the crisis will spread to Portugal and then to Spain. If Spain needs to be bailed out, then that raises worries about the eurozone as a whole.”
The Dublin government will present a four-year austerity plan on Wednesday that aims to slash the deficit without plunging the economy into a slump.
The plan is likely to involve €6 billion in spending cuts and revenue-raising measures next year and another €9 billion between 2012 and 2014. It is designed to pave the way for a €80 billion-€90 billion rescue package from Ireland’s European Union partners and the International Monetary Fund.
The European Commission urged Irish lawmakers to approve the proposed 2011 budget in a timely manner, and not to be delayed by political jockeying.
“Stability is important,” Olli Rehn, the commissioner for economic and monetary affairs, told reporters at the European Parliament in Strasbourg.
To add to the unease, Portugal’s state deficit widened in the first 10 months of 2010, according to government figures, suggesting that austerity measures designed to ease financial market concerns have so far had little impact on public spending.
The figures, showing a 2.8 percent increase in state spending compared with the same period last year, threaten to undermine Portugal’s effort to reassure investors that it will not need to follow Ireland in seeking an international financial rescue.