ANALYSIS:The precariousness of the banks' position has led to the ECB's plan for a severe restructuring, writes SIMON CARSWELL

A SLOW run on deposits across the Irish banking system over the past two years has forced the European Central Bank (ECB) to call time on the Government’s bank rescue plan and bring the European Union and the International Monetary Fund to our shores.

The scale of the haemorrhaging of bank deposits has been severe since the Government bank guarantee in September 2008.

However, it is hard to understand why the ECB did not recognise well in advance that the banks were looking into a deep abyss in September when €25 billion of bonds fell due and the debt markets were closed to the Irish banks due to the European debt crisis.

There was no significant alternative source of funding other than the Frankfurt-based bank and our own Central Bank to repay those bonds, and the banks required those central bank parachutes as they were pushed over the edge of that high funding cliff.

The figures in this graphic show that the Irish domestic banks, which include Irish retail banking subsidiaries of foreign banks such as Ulster Bank and Bank of Scotland (Ireland), shed €109 billion in overseas deposits or debt securities in the two years to September.

This includes overseas deposits of €64 billion and debt securities held by overseas bondholders of €45 billion, according to the Central Bank’s banking statistics.

The lost funding was replaced by the central banks, at home and in Frankfurt – €130 billion was borrowed from the ECB by the end of last month and a further €34 billion from the Central Bank.

Given that Irish banks are estimated to have borrowed a further €24 billion during October, funding pressure on the banks continued through last month.

ECB borrowing by Irish banks rose €11 billion during the month, according to the statistics, while the Central Bank listed “other assets” rising by €13 billion in the monthly statistics on the banking sector. This is thought to refer to emergency lending assistance, loans which the Central Bank can provide against collateral not accepted by the ECB.

The figure for the rest of the world is so high as it largely represents UK deposits and funding.

Minister for Finance Brian Lenihan has said the banks were safe as the outflow of deposits from the lenders had been “gradual”.

“There wasn’t a sudden flight of deposits in Irish banks. There’s been a very gradual reduction of deposits over time,” Lenihan said this week. “The ECB provides full cash support to the Irish banks so there’s no danger of any actual instability in the system.”

Central Bank statistics support Lenihan’s view of the gradual loss of deposits from the system.

To give an idea of just how reliant the Irish banks are on outside funding, you only have to look at the gap between their deposits and loans – this stood at €175 billion at the end of September.

The vast majority of this has been filled over recent months by central bank funding as the debt markets have been shut off to the Irish banks amid fears about Ireland’s mounting financial crisis.

The increasing precariousness of the banks led to the ECB’s intervention and plan for a “severe” restructuring of the Irish system.

The lenders were only ever going to increase their reliance on central banks in the absence of market funding. The National Asset Management Agency is paying the five participating banks about €31 billion worth of Government-backed bonds which they have used – and would continue to use – to draw down ECB funding.

In a bizarre move, State-controlled Irish Nationwide Building Society issued €4 billion of Government-backed bonds to a property subsidiary and then used them as collateral to draw cash from the ECB to tide the lender over the September 29th refinancing date.

The three biggest Irish banks have lost a combined €35 billion in deposits this year, most of which has flowed out since June 30th.

To put this in context, the Irish banks are estimated to have lost €30 billion in funding in the run-up to the financial crisis of September 2008, prompting the Government to guarantee the banks.

Alan Dukes, the chairman of Anglo Irish Bank, said yesterday that the bank had lost €12 billion this year. The bank has lost a further €10 billion since the end of June in funding on debt securities.

According to Bloomberg, the bank’s securities have fallen from €17 billion at the end of June to €7 billion last month. The difference includes some €7.9 billion of debt repaid to bondholders whose debts came due in September at the end of the blanket guarantee.

AIB has lost €13 billion in deposits this year – €12 billion since June. This amounts to a whopping 17 per cent of deposits.

Bank of Ireland lost €10 billion in a six-week period over the end of August and the start of September. Downgrades in credit ratings – both for the bank and the State – were largely to blame.

AIB’s reliance on central bank funding has tripled since June, while Anglo has borrowed heavily under the Central Bank’s emergency lending assistance facility.

Anglo’s borrowing from central bank funding stood at €26.3 billion at the end of June. Given that the bank has shed about €7 billion in deposits and repaid some €10 billion in bonds since its half-year, Anglo’s reliance on central bank funding is likely to have soared well north of €43 billion – a figure amounting to almost half the size of its original balance sheet.

Anglo has suffered a slow death since the bank was in the eye of the September 2008 financial storm. Deposits fell to €27 billion at the end of last year from €51 billion in September 2008 (although the latter figure includes the controversial €7.4 billion deposits from Irish Life Permanent).

Funding continued to fall this year as customer deposits dropped to €23 billion at the end of June.

They are estimated to stand at about €16 billion, based on the figure given by Dukes yesterday.

The Government’s plan to split Anglo into a funding bank and an asset recovery bank would have required substantial funding, given the deposits being lost at the bank.

Undoubtedly this would have come from the ECB if the bank couldn’t hold on to its deposits, the reason for the funding bank being established in the first place.

But at a time when the ECB is seeking to reduce – not increase – its discounted lending to viable but troubled banks, the Irish lenders had to be taken off the drip of funding and a way found to allow them to stand on their own.

The EU and IMF are now devising a severe plan to fix the problem once and for all, and reverse what would otherwise be a slow, terminal decline for the State’s lenders.