End of cheap ECB money closes profitable era for Central Bank of Ireland

As Irish retail banks drool over the prospect of their bottom lines taking off after the European Central Bank (ECB) hiked its interest rates on Thursday for the first time in more than a decade, the reverse is the case for the Irish institution that has profited like no other from the fallout from the financial crisis.

The Central Bank of Ireland has generated more than €23 billion of super profits in the 13 years since 2008, driven by the response of central bankers in Dublin and Frankfurt to the near collapses of the domestic banking system and the euro, and a decade of anaemic inflation across the euro zone (before the recent spike in consumer prices prompted this week’s rates action).

It was a period in which the Central Bank’s balance sheet ballooned from €50 billion to more than €200 billion as those of the Republic’s retail banks contracted dramatically, as they sold problem loans and unwanted assets, and households and businesses paid down debt at pace after the credit bubble burst.

Some €18.4 billion – or 80 per cent – of the Central Bank’s profits have been transferred to the exchequer over the 13 years, cushioning the State’s finances as taxpayers were forced to commit €64 billion to rescue the banking system and successive governments sought to narrow budget deficits. Indeed, the €2 billion-plus handed over by the Central Bank in both 2018 and 2019 made all the difference in the only two years that we saw budget surpluses following the crash.

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The Central Bank’s income was driven during the height of the financial crash by interest from domestic lenders, as they relied on the lender of last resort for scores of billions of euro of funding following a silent run on deposits – by computer clicks, rather than good old fashioned queues on streets.

Then came the restructuring in 2013 of the almost €35 billion of bailouts of Anglo Irish Bank and Irish Nationwide Building Society, which, by then, had been merged and were going under the name Irish Bank Resolution Corporation (IBRC).

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Most of the aid committed to the now-defunct lenders was not hard cash but by way of promissory notes – remember those? – that IBRC pledged to the Central Bank as collateral to secure emergency loans.

When IBRC was put into liquidation in February 2013, the State handed over €25 billion of government bonds to the Central Bank to replace the emergency loans.

The Central Bank has been selling off these bonds ever since, at a much quicker pace than initially outlined to appease the ECB, which was concerned from the outset that the restructuring of the promissory notes was dangerously close to the central bank funding of a government, which is prohibited in the EU.

The Central Bank has so far sold €20.5 billion of the government bonds at premiums of as much as 65 per cent above their normal value.

The massive gains have been due to the ECB pushing down market interest rates – or yields – over the past decade, initially with soothing words that it would do “whatever it takes” to prevent the euro’s collapse, but followed up by multitrillion-euro bond-buying programmes. As government bond rates fell over the period – including a time in recent years when much of Ireland’s debt was yielding negative rates – this led to an inverse increase in the value of the bonds.

Of course, the buyer of the bonds from the Central Bank has been the National Treasury Management Agency, which has had to borrow in the long-term debt markets to fund the transactions. But for governments making tough political decisions on budget days, the Central Bank gains on the sales of the notes have been welcome.

While the interest income from the government bonds has declined as the Central Bank sold them down, it has been making tidy sums in recent times from taking in tens of billions of euros of surplus deposits from Irish banks and the Government.

AIB and Bank of Ireland, for example, now have about €50 billion more deposits than they need due to the contraction of their loan books over the past decade and growth in household savings, which has been turbocharged by the Covid-19 pandemic.

Much of the surplus liquidity has been stored in recent times with the Central Bank on behalf of the eurosystem, attracting an annual charge of 0.5 per cent under a negative rates policy that the ECB started to pursue in 2014.

Last year alone, the Central Bank received €316 million of interest from commercial banks and almost €140 million from the Government for safekeeping of their cash – though some of this has been partly offset by interest expenses on a special ECB credit facility to banks, which also carries negative rates and is designed to encourage lending.

The ECB’s move on Thursday to ditch negative rates has killed off a nice earner for the Central Bank.

Meanwhile, the Central Bank generated €244 million of interest income on bonds it acquired in the market under ECB bond-buying, or quantitative easing, programmes. The Central Bank held almost €62 billion of such securities at the end of last year.

The ECB has stopped net new bond purchases under both its long-standing QE programme and a pandemic-related stimulus plan in recent months. This part of euro zone central banks’ balance sheets – and income lines – will eventually be wound down.

While the ECB unveiled a new bond-buying tool this week that would buy bonds of European countries that saw their market borrowing costs soar through no fault of their own, the hope, of course, is that it would never have to be triggered in the case of Ireland. Even if it would, by default, open a fresh income line for the Central Bank.