Irish bank problems push state closer to edge

Ireland moved closer to default and restructuring of its sovereign debt yesterday as a further €24bn (£21bn) burden was piled on to the cost of supporting her busted banking system.

The Irish Central Bank said that the major Irish banks would need that much in extra capital to cope with what it described as "adverse and unlikely" economic circumstances as a result of more stringent "stress tests" than were administered last year. Even so, international investors regarded this exercise as far from the end of the matter.

In the past few months, Ireland has received an €87bn bailout from the EU and IMF; seen a general election and change of government; and is now seeking a "renegotiation" of that rescue plan, as the stress of servicing its loans is starting to look unsustainable.

Reflecting broad and longstanding scepticism about Ireland's ability to emerge unscathed from its unprecedented crisis, however, the price of Irish government bonds remained steady. The euro, too, was unperturbed, ahead of an anticipated rate rise by the European Central Bank next week.

The pressure on Portugal, though, has resumed: Portuguese bond yields marched relentlessly higher, sending spreads over German Bunds to euro lifetime highs after Lisbon's caretaker government reported that the country had missed its 2010 budget deficit goal, adding to the impression of a near-certain bailout and eventual default. Portuguese sovereign 10-year bond yields have climbed above 8.5 per cent and 5-year yields are at 9.3 per cent.

Though unconfirmed, only substantial liquidity support from the European Central Bank is keeping the financial systems and, indirectly, the governments of peripheral states such as Ireland, Portugal and Greece alive, their banks often acting as conduits to supply funds for nations effectively locked out of private capital markets.

Separately, the now-nationalised Anglo-Irish Bank, a financial institution that has come to symbolise everything that went wrong with Ireland's financial system, announced a loss of €17bn, reflecting the heavy discounts on the transfer of its bad property loans to the Dublin government's National Asset Management Agency or Nama, the so-called national "bad bank".

The latest recapitalisation of the largest Irish banks – all now nationalised or in the process of becoming state-owned – takes the total direct cost to the state of the rescues to €70bn (£61bn). Further costs, amounting to loans of many hundreds of billions of euros, have been borne by Ireland's eurozone partners, the IMF and the ECB. The British Government directly lent some £3bn in the rescue last year. Trading in the remaining privately owned shares in Ireland's largest banks, Allied-Irish and Bank of Ireland, were suspended; Irish Life & Permanent, which owns the country's largest mortgage lender, Permanent TSB, was temporarily removed from trading after its share price collapsed.

The troubles of Ireland's banks – and their losses – were in effect adopted by the Irish people on 30 September 2008 when the then Finance Minister, Brian Lenihan, gave an open-ended guarantee to all creditors of the Irish banking system, not merely small depositors, as the global financial system melted down after the collapse of Lehman Brothers. Since then, the banks' losses have grown inexorably, and the Irish economy seems close to being engulfed by a "death spiral". The cost of servicing the national debt and the banks' debts has led to ever more stringent austerity packages, which have simply depressed the Irish economy further and created even greater bank write-offs and losses, adding to the vicious deflationary cycle.

The interest rate on Ireland's national debt – more than 5 per cent on the EU/IMF rescue package – is also far in excess of Ireland's likely growth rate. With debt at well over 100 per cent of GDP, plus banking liabilities, its economy may soon again be unable to cope with the stress of honouring her obligations.