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News : EU Economy Last Updated: Nov 29, 2010 - 3:21:51 AM

Euro Debt Crisis: Similarities and differences in the woes of Ireland, Greece and Portugal
By Finfacts Team
Nov 26, 2010 - 6:09:37 AM

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Click here for interactive chart; Deutsche Bank Research has Irish bank assets at 829.1% of GDP. International data on Irish banks includes units of foreign banks based in Dublin's International financial Services Centre.

Irish GDP in June 2010 was €160bn and the balance sheet of the 6 domestically owned banks was €523bn according to the Department of Finance, giving a ratio of 327%.

Euro Debt Crisis: Deutsche Bank Research says the reasons for the current woes of some Eurozone sovereigns on the capital markets differ from country to country. In the case of Greece, it was mainly a persistently unsound fiscal policy that led to a loss of confidence among investors, while in Ireland this was primarily due to a credit bubble which had inflated the size of the financial sector. Portugal didn't even have a mini-lending bubble.

In Ireland, as we well know now, annual credit growth of 30% or more was bonkers and while there is currently a focus or hope that talks with the European Commission/European Central Bank/International Monetary Fund, will result in a 'haircut' or discount on bank bond debt, foreign deposits from institutional and corporates, also supported the boom edifice.

It was striking during the boom years that among the major three Irish banks, the builders' bank Anglo Irish Bank invariably offered the highest deposit rates. It was likely making a loss on some of these deposits but it was presumably considered a good strategy as reported profits were for a decade among the best in European banking. 

Anglo was able to brag in it 2006 Annual Report: 'Ten year compounded annual growth rate in profit before tax of 39%; 21 years of successive profit growth.'

SEE: Lenihan says failure of Anglo Irish Bank would "bring down" the country

Glas Securities said in a report earlier this year that Irish bank debt maturities in 2010 were €51bn, of which €25bn is debt issued under the 2008 State bank guarantee. Covered Bonds accounted for €26bn of outstanding bank bond debt of  €115bn.

The outflow of deposits this year combined with the need for the banks to raise new debt as Irish sovereign bond yield began to spike, raised the red flag.

The banks began increasing borrowing from the ECB, which rose to about €100bn in October and in addition the Irish Central Bank issued emergency funding of €34bn.

The Economist reports that David Owen, chief European financial economist of Jefferies International, an investment bank, says that the deposits of non-residents in Irish banks were nearly €203bn in September, a figure larger than the €166bn held by domestic residents and than Irish GDP.

The newspaper says some €179bn of deposits belong to customers from outside the Eurozone, including many from Britain who were attracted by the Irish government’s guarantee, offered back in 2008.

Last Friday, Allied Irish Banks reported an outflow of €13bn in 2010 with most of it dating from June; the three main Irish banks have lost €35bn in deposits in 2010 and an estimated €109bn in overseas deposits or debt securities in the two years to September  2010.

A continuing outflow of overseas deposits, say sparked by bond debt 'haircuts,' would be alarming even with an EU/IMF rescue.

Deutsche Bank Research economist, Jan Schildbach, says that in times of tight markets, in particular, attention should be paid not only to the common characteristics of the individual economies and banking sectors in focus but also to their differences. The new DB Research Interactive map European banking markets helps with this differentiation (see caption to image at the top of the page). It shows, among other things, the size and growth of the financial sector in each of the 27 EU countries over the past few years. It becomes apparent that the problems faced by Greece and Ireland (or Portugal, for that matter) differ in nature and cannot be traced back to the banking sector in every case.

The economist said lending to private companies in Greece, at a mean growth rate of 10.6% p.a., was expansive in the run-up to the crisis, yet not much more than in the Eurozone area as a whole (+8.2%). In Ireland, on the other hand, loan volumes increased by more than 26% on average every year between 2002 and 2007, not least because of the booming construction industry. Nominal corporate debt tripled in less than five years - - definitely a clear indicator of unsustainable, excessive credit growth. In Portugal, there was no sign of a lending bubble at all, with loans outstanding advancing by only a moderate 6% per year on average.

Schildbach says at second glance, lending to private households confirms the general impression: Irish household credit growth, which averaged 21% p.a. from 2002 to 2007, was clearly unsustainable and mostly used to finance continuously rising housing costs as more homes were built and real estate prices increased. By contrast, the Portuguese figure of 8.9% remained close to that for the Eurozone as a whole. Credit volumes in Greece tripled over the same period of time (+24% p.a.) - -  also an unhealthy development, though from a significantly lower starting level than in Ireland: household debt in Greece doubled from 27% to 56% of disposable income, while it galloped from 92% to 166% in Ireland. As a result, Irish borrowers were much more vulnerable than Greek debtors to a correction in the housing market and the consequences of the recession that followed the financial crisis.

The economist says two additional factors made the crisis especially painful for the Irish banks and ultimately Irish citizens. First, Ireland’s financial institutions were used to only low credit losses until 2007 - -  with the effect that both operating margins and reserves for irrecoverable claims were lower than in Greece. Second, the Irish banking sector had grown so strongly that its stabilisation was bound to represent a major challenge for an economy of Ireland’s size. With a doubling of its banking assets by 2007 from an already high level in 2002 (360% of GDP), Ireland dwarfed most other EU member states - -  and particularly Greece where the financial sector expanded quite moderately and also stayed considerably smaller than in almost all other EU-15 countries, relative to GDP.

”Confidence is key here and unless we can trust that the data looks achievable, it will be difficult for the markets to calm down,” Dariusz Kowalczyk, senior economist and strategist at Credit Agricole told CNBC on the Irish debt crisis:

Overall, it was mainly country-specific reasons that triggered the deterioration of the situation. In Ireland the oversized post-bubble financial sector got the sovereign into difficulties - - aggravated by insufficient banking regulation and supervision and driven by an interest-rate level that was too low for Ireland as well as by overly optimistic private borrowers. On the other hand, there was no bloated banking industry in Greece and even less so in Portugal. In these two countries it was primarily fiscal policies - - which were already unsound before the crisis - - that led to a massive loss of confidence on the capital markets in the current recessionary times.

Concerns over contagion in the Eurozone are warranted but the biggest challenge is likely on the political front, says Magnus Prim, chief strategist for Asia at SEB, as  he discusses the region's debt crisis with CNBC's Chloe Cho, Anna Edwards and Yousef Gamal El-Din:

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