Feb 28 - The announcement of the end of the Irish Bank Eligible Liabilities Guarantee (ELG) scheme is another step towards the recovery of the banking sector, Fitch Ratings says. We believe government support for the largest Irish banks will not change despite the withdrawal of the guarantee and so any negative impact on bank funding is likely to be limited.
We had expected the scheme to end during 2013. The banks have been preparing for this by reducing their use of it: Bank of Ireland’s (BoI) covered liabilities fell by a third in the first 11 months of 2012, while Allied Irish Banks’ (AIB) came down by 20% in the first 10 months. They withdrew their UK, Isle of Man and Northern Ireland subsidiaries from the scheme and increased non-ELG covered deposits for corporate and institutional investors during 2012.
Risk of deposit flight is unlikely to be heightened by the withdrawal of the ELG for new liabilities from midnight on 28 March. There was no adverse impact on deposits when overseas subsidiaries left the scheme. Most of the domestic deposits are covered under the Republic of Ireland deposit guarantee scheme and volumes have been stable since the bank recapitalisations in July 2011. Deposits at banks covered by the ELG increased 4.8% for the year to January, according to data from the Department of Finance.
Sentiment towards Irish banks is improving slowly as they progress with their restructuring and recovery. They have been able to tap external funding markets in recent months. In Q412 and Q113 both BOI and AIB issued covered bonds (EUR1.0bn each). BOI also raised EUR250m in subordinated bonds and completed the sale of its EUR1bn contingent capital stake previously held by the Irish sovereign. We expect the banks to raise further secured funding in 2013 because access to senior unsecured markets at economic prices is still challenging. However, their dependence on central bank funding is likely to remain high until confidence is fully restored.
Confidence could improve if the banks correct funding imbalances and return to profitability. The removal of the guarantee should help the Irish banks improve their earnings. Their net interest margins have already benefitted from lower ELG fees as covered liabilities reduced last year. Fees should decline more quickly after the ELG withdrawal as the guaranteed liabilities run down. But the banks still face many challenges in generating sustainable profits, such as having to bear additional losses on their loan portfolios.
There is a risk that rising mortgage arrears could hinder the recovery of the banking sector. We see the current situation as in line with the moderate stress test under the 2011 Prudential Capital Assessment Reviews (PCAR). However, as long as mortgage arrears continue to rise there is the risk that losses will exceed the PCAR assumptions. This risk is reflected in the low Viability Ratings of the banks (BoI has a VR of ‘b’, AIB is ‘b-').