IRELAND'S BANKING SECTOR - ENOUGH TO MAKE FIANNA

C O N F I D E N T I A L SECTION 01 OF 02 DUBLIN 000130 SIPDIS TREASURY FOR VIMAL ATUKORALA E.O. 12958: DECL: 03/19/2019 TAGS: PGOV PREL ECON EFIN EI SUBJECT: IRELAND'S BANKING SECTOR - ENOUGH TO MAKE FIANNA FAIL? REF: DUBLIN 0086 DUBLIN 00000130 001.2 OF 002 Classified By: Pol/Econ Section Chief Ted Pierce; Reasons 1.4(b/d) Summary -------------- ¶1. (C) The Irish banking industry continues to weather the fallout from the Anglo Irish Bank nationalization. While there are no new developments in the Anglo Irish criminal investigation, a fifth member of the "Golden Circle" has been revealed, as have additional inappropriate dealings by former Chairman Sean Fitzpatrick. The government has proposed a series of reforms to its banking regulatory structure and bank executive compensation, but has not yet finalized plans for dealing with problem loans at Allied Irish Bank (AIB) and Bank of Ireland (BOI). Economists fear that the property market is considerably worse than originally expected and that write-offs at all Irish banks will exceed the previous worst case scenario. This situation, coupled with an S&P downgrade of the Irish banking sector to group three, has led some to predict a need for additional government funding. Difficulties have spread to smaller banks and credit unions; EBS Building Society recorded a large loss and at least ten credit unions have been asked to cease lending activities. We expect this weakness in the banking sector to contribute to a further deterioration of the Irish economy. In light of the government's handling of the banking industry, opposition parties are expecting to gain ground in the European Parliament election and Irish local elections in June 2009 and have hinted at the possibility of an early general election. End Summary. Anglo Irish: The Saga Continues -------------- ¶2. (SBU) Police continue to investigate alleged fraudulent activities at Anglo Irish, but difficulties in agreeing on a legal framework for the analysis of electronic information has hampered the investigation. Fallout continues as Paddy McKillen, property developer and Fianna Fail contributor, was named as the fifth member of the "Golden Circle," a group of ten individuals who borrowed funds from the bank to buy shares in Anglo Irish and artificially inflated its share price (reftel). Finally, Anglo Irish disclosed that it paid Euro 31,500 (USD 43,000) per year to rent a London apartment from former chairman Sean Fitzpatrick's family. Fitzpatrick's family members were permitted to stay in the apartment during this time. Banking Sector: Problems Mounting -------------- ¶3. (SBU) The Irish government is moving ahead with a plan to isolate problem loans from all Irish banks in a separate toxic asset company. However, this would require sharp write-downs far beyond the worst-case scenario originally envisaged by the banks. For example, experts predict that the value of residential development land in Dublin could fall 70% from its peak. This has led some economists to predict that government funding may not be sufficient. Ireland's banks continue to respond to the crisis with leadership changes. Following a loss of Euro 38.2 Million (USD 43.7 million) in 2008, the EBS Building Society chairman and finance director tendered their resignations. Finally, regulators revealed that the Bank of Ireland loaned Euro 11.3 million (USD 15.4 million) to a business associated with one of its directors, but did not disclose the transaction. ¶4. (SBU) In late February, the financial Regulator's Registrar of Credit Unions, Brendan Logue, instructed at least ten credit unions to cease lending to businesses due to concerns about their financial stability. The regulator is now working with these credit unions on a program of remedial actions to stabilize their business. ¶5. (SBU) The market and ratings agencies have continued to lose confidence in the Irish banking system. On March 16, Standard & Poors downgraded the Irish banking system for the second time in four months. Ireland is now listed in "group three" due to the reputational fallout from the events at Anglo Irish and weakened investor confidence in the framework of bank regulation. Analysts have also been concerned by the reluctance of the Financial Regulator to intervene. This downgrade will impact all Irish banks' cost of capital and could eventually contribute to a need for additional government funding. DUBLIN 00000130 002.2 OF 002 Regulatory Bodies: Broad Reforms Coming -------------- ¶6. (SBU) In light of the developing banking crisis, Minister for Finance Brian Lenihan, announced on March 18 that he would be proposing new measures designed to crack down on "crony capitalism" in Ireland. Proposals include a reformed financial watchdog with powers to restrict excessive bank lending, a ban on senior executives holding directorships in more than one bank, and a ban on bank chief executives from becoming chairmen. Lenihan added that there is a problem in all small countries with "too many incestuous relationships." These changes are a direct reaction to the weaknesses exposed by Anglo Irish Bank, where multiple cross-directorships were in place. Lenihan hopes to establish a central bank commission following the regulatory model of Canada. ¶7. (SBU) Lenihan is pressing forward with plans to tie the bank guarantee to an executive salary cap of Euro 500,000 (USD 683,500). This follows reports that AIB chief executive Eugene Sheehy expected to earn Euro 690,000 (USD 943,000) and that Brian Goggin, outgoing CEO of BOI expects to earn about Euro 2 million (USD 2.7 million). A report by the Covered Institutions Remuneration Oversight Committee (CIROC) determined that base salaries of Irish bank executives exceeded those in Britain and those of similar sized companies in Ireland. ¶8. (C) Emboff recently spoke with Tony Woods, Head of Risk and Compliance for Citibank Europe. He previously worked as a regulator and indicated that much of Ireland's regulatory woes can be attributed to the fact that, during the boom years, the government simply could not compete with the financial packages the private sector was offering. He and many of his former colleagues were widely sought after during the early-mid 1990s and he noted that "anyone with talent" followed the money to the private sector. This had the effect of hollowing-out a cadre of government officials who would now be in senior regulatory roles. Early Elections? Probably Not But... -------------- ¶9. (C) The growing banking problem is adding fuel to the opposition parties' fire. While there are no calls for an early election at the moment, neither Fine Gael nor Labour appear to be ruling out the possibility. Emboff recently spoke with Mark Garrett, chief advisor to Labour Party leader Eamon Gilmore. Garrett believes that in the absence of a "smoking gun" tying a government Minister to the improprieties at Anglo Irish, the status quo will hold. He does not believe that the Green Party will give up its current power unless it is soundly defeated in the European Parliament elections. Should that happen, he predicted, the Greens would be forced to distance themselves from Fianna Fail. (Note: If the speeches by party leaders at the Green Party national convention (March 6-7, 2009) were any indication, this distancing may already be happening. From party leader John Gormley on down, the common theme was rooting out corruption and cronyism. End Note) Garrett stated "the next election could be in two weeks or two years-we're preparing for both." Fine Gael officials have told us much the same thing. Comment -------------- ¶10. (C) The Irish economy will get much worse before getting better and the banking sector woes, reflected in a dearth of credit, will contribute to this decline. In the meantime, we believe that the government -- absent evidence of corruption -- will survive the Anglo Irish scandal, but its already battered reputation continues to erode. In the next three months the government will have to sell a new emergency budget (April 7) designed to plug a Euro 4.5 billion (USD 6.15 billion) hole in the state's finances, monitor the effectiveness of the Euro 7 billion (USD 9.6 billion) banking recapitalization, and compete in the Irish local and European parliamentary elections in June. This doesn't leave a lot of room for reforming the financial regulatory structure -- a priority if Ireland expects to regain the confidence of the global financial community. FAUCHER