Brian Lenihan Jnr (Dublin West, Fianna Fail)

Last weekend, the Government announced that it is prepared to support, alongside existing shareholders and private investors, a recapitalisation programme of up to €10 billion for credit institutions in Ireland. I want to set out the reasons for this announcement. At the outset, I want to make clear that this is a measured response to the dynamics of international capital markets, where expectations with regard to capital levels have altered in recent weeks. This has taken place in the context of an international financial crisis, which led to numerous state interventions in national banking systems across the world.

International financial markets have yet to normalise and the international financial system remains in a very fragile position. It is generally accepted that the fallout from the financial market difficulties is proving to be more acute and prolonged than anyone calculated at the outset.

The difficulties that began in August 2007 deepened significantly through September of this year with a succession of threatened collapses and rescues of financial institutions across the developed world. A pervasive uncertainty about credit risk emerged such that the market for interbank lending became extremely challenging. Matters worsened considerably when the big US investment banks came under stress, and across Europe the failure of the 158-year-old Lehman Brothers was a tipping point for the recent unprecedented turn of events.

Following this, the wholesale markets began to avoid all but the most minimal risks and this led to a drying-up of short-term lending. Despite liquidity injections to lower borrowing costs, the fear of further bank failures continued to deter interbank lending and led corporations, funds and banks to hoard cash.

Against this background and on the advice of the Central Bank, the Government acted with purpose and determination to guarantee the liabilities of credit institutions so that they could access funding in interbank lending markets. The prompt and decisive action on the part of the Government to guarantee all the deposits and certain debts was taken to allow the banks the support they needed to maintain their normal liquidity position in interbank lending and debt markets. The unequivocal advice to the Government from the Governor of the Central Bank was that this move was essential to allow banks to continue their normal ordinary business of providing credit in this country — what I have described as the lifeblood of the economy.

Following the initial announcement on 30 September, the Government brought the necessary legislation before the Houses of the Oireachtas to approve, first, the Banks (Financial Support) Act 2008 and, subsequently, the scheme to implement the Act. The Government's guarantee has been very successful. Irish banks have continued to do their business and all of our people and businesses have been able to deposit with financial institutions in confidence.

As with every country in Europe, Ireland has moved to ensure the security and stability of its banking system. For banks everywhere, liquidity — that is, the cash that comes in the form of deposits and interbank moneys — provides the funds that they then lend on. The guarantee has ensured that the banks can obtain that liquidity.

Since the guarantee scheme was introduced, my Department, the Financial Regulator and the Central Bank have been in ongoing discussions with the institutions concerned surrounding their obligations under the scheme. In addition, I have personally met with the chairpersons and CEOs of the institutions on a number of occasions. During these discussions I have asked the banks to examine options to attract or raise private capital to underpin their long-term sustainability and support their lending to the economy. These discussions have been productive and informative. This process of consultation, involving as it did close contact with the relevant institutions, provided a context for the Government's announcement of 14 December of support for a recapitalisation programme for Irish banks.

As I have said, banks need deposits and wholesale borrowings in order to have money to lend to the economy. The guarantee has enabled them to maintain this liquidity in very adverse circumstances. Capital is what allows the banks to take on the risk associated with lending into the economy, because capital provides a buffer against losses if they occur; less capital means less ability to lend. Even where a bank has plenty of liquidity, if it does not have capital it cannot afford to lend, and it will not be able to persuade others to lend to it. So recapitalisation will help to boost the ability of banks to lend and will place them on a more secure footing to contribute to our economy over the longer term. Moreover, it should also protect their ability to borrow money for their operations in the future, since higher capital levels reassure interbank lenders about the overall security of the banks they are lending to.

Recently, international capital market expectations in regard to capital levels in the banking sector have altered. Although Irish banks are capitalised above minimum European regulatory requirements, high loan impairments, whether already acknowledged or anticipated in the next few years, mean that the markets now expect that banks should have a higher level of quality capital. This expectation was reinforced when the United Kingdom carried out the recapitalisation scheme targeting this higher level. Other European countries have followed suit.

Significant falls in the share prices of Irish banks in recent times point to the capital market's belief that the Irish banks are undercapitalised. The Government's plan to recapitalise is intended to stabilise the Irish financial system and secure its funding base. Moreover, the Government's plan will enable banks to increase lending into the economy. Currently, the incentive is for banks to hoard capital to meet market expectations on capital levels. Reducing this incentive by injecting capital will facilitate lending to the real economy. Since the announcement of the guarantee scheme, many other countries have introduced state guarantees and recapitalisation programmes.

In Ireland, we have been able to monitor the actions taken by others and develop our own recapitalisation programme. Through this recapitalisation programme, the Government, working with the banks, intends to address the capital levels of the Irish institutions which have been the focus of capital markets in recent weeks.

As the House will be aware, the programme that the Government has announced envisages recapitalisation for banks in Ireland of up to €10 billion. This programme will include appropriate terms and conditions, and capital will be provided through the National Pensions Reserve Fund or otherwise. Accordingly, legislation to amend the National Pensions Reserve Fund Act 2000 will be brought before the Houses early in the next session.

The Government's detailed statement of 14 December sets out the main principles that would guide its approach to the recapitalisation of the banking system in Ireland. Important issues, such as the mechanisms through which the State could invest, the options available to the State for investment in the banking system and the maximum size of the fund, were all dealt with in the statement. It made explicit that the detailed guidance set out in the European Commission communication on recapitalisation on key issues, such as pricing, would be a central element of the Government's approach.

The nature of the State's investment may be by way of preference or ordinary shares and the State may, where appropriate, participate on an underwriting basis. I will now engage further with the banks themselves — indeed, I have engaged with them already since the announcement — with a view to specific proposals being brought forward by them in early January. Any capital investment will then need to be approved by shareholders and the Financial Regulator as appropriate.

I have met in recent weeks with a number of banks and investment businesses regarding their proposals for investment in Irish banks. Any serious propositions were referred to the institutions themselves.

Some existing shareholders have expressed an interest in subscribing for new capital. The Government has indicated that it intends to support the recapitalisation of banks alongside private investors and that, in principle, existing shareholders will be expected to have the right to subscribe for new capital on the same terms as the Government. Any role for private investors will reduce the need for State investment.

State investment will not be forthcoming without conditions. A key principle in the operation of such a fund will be to secure the interests of the taxpayers through an appropriate return on and appropriate terms for the investment. The relevant financial institutions have been asked to submit detailed proposals on how they might avail of the recapitalisation programme announced by the Government.

The Government guarantee scheme sets out strict terms and conditions for covered institutions in terms of commercial conduct, control and oversight on remuneration and bonuses, requirements to establish appropriate funding structures, compliance with the regulator's targets on assets and liabilities if necessary and drawing up the restructuring of management plans. Any capital support will build on the measures contained in the guarantee scheme, including those to secure an adequate return and to safeguard the interest of taxpayers. In addition, the Government may require compliance with such further transparency and commercial conduct requirements as it sees fit.

In the period after the guarantee, the State commissioned an extensive report, conducted by PricewaterhouseCoopers, into the asset quality of the covered institutions. On receipt of that report in November, I immediately arranged meetings with the relevant credit institutions to raise issues in the report and matters that also arose in the context of the business plans submitted to me by the covered institutions. That dialogue process has been ongoing and intensive. Deputies will appreciate that, as I am in a negotiating position with the banking sector on these issues, I am not in a position to give further detail to the House. However, I am most anxious to ensure that the negotiations are brought to a conclusion as swiftly as possible.

Concerning the availability of capital for small and medium-sized enterprises, SMEs, the Government is committed to ensuring that funds are available to sound businesses to support their commercial activity. I have asked the institutions covered by the bank guarantee scheme to consider the contribution that they should make to the economy through appropriate credit initiatives for SMEs and otherwise. On foot of this request, several institutions have announced comprehensive SME support packages.

I have also met Mr. Plutarchos Sakellaris, vice-president of the European Investment Bank which announced that it was providing additional funding through its lending facility for SMEs in the European Union. Mr. Sakellaris confirmed that the bank has been in discussion with a number of Irish financial institutions about participating in this facility and that the investment bank hopes that agreements to provide such loan facilities can be finalised as soon as possible. I have urged Irish banks to utilise the facility to the maximum extent possible with a view to making the additional funding available to SMEs as soon as possible. I note that a number of banks have announced their intention to do so.

I wish to refer to the action taken at a European level and to outline how our proposals accord with European Commission guidance and action taken in other member states. Any investment of capital by the State in any bank will be undertaken in line with best practice in the EU and elsewhere and consistent with EU state-aid rules, in particular the recent Commission communication on recapitalisation. These guidelines address how member states can recapitalise banks in the current financial crisis to facilitate adequate levels of lending to the rest of the economy and to stabilise markets without unduly distorting competition.

Ireland has been participating in this work at EU level in the past year to enhance financial stability arrangements and the ability of authorities to respond to serious disturbances in financial markets. The programme of actions involves reviewing, along with the EU's international partners, how to improve the transparency of complex financial instruments, valuation standards, the prudential framework, risk management and supervision and market functioning, including the role of rating agencies. Ireland will continue to help to progress this agenda so that the EU, working closely with its international partners, can bring about a far-reaching reform of the international financial system, underpinned by principles of transparency and integrity.

Deputies would profit from examining an interesting interview conducted in today's Financial Times with the deputy governor of the Bank of England. He pointed out that monetary policy must be directed towards getting credit flowing to every component of the economic chain. He made the point that an obsession with capital ratios would not necessarily be the most successful way to do so and expressed doubts about whether the degree of capitalisation decided upon by the United Kingdom's Government some weeks ago is adequate to ensure that type of credit flow in the real economy.

I mention this because I have noticed in public commentary some impatience that capitalisation has not proceeded at a faster pace. We should be careful about how we get involved. For this reason, I have insisted that the onus was on the banks in the first instance to capitalise themselves, as they are private institutions. In an earlier debate, Deputy Rabbitte may have mentioned the possible use of the National Pensions Reserve Fund. I agree that it can be applied where there is a prospect of an upswing for the taxpayers in an investment in a particular financial institution, which was made clear in the Government's statement last weekend.

We have done a great deal of work since the guarantee was given. The detailed examination of the asset quality within the banking sector and the submission of the detailed business plans have enabled my officials and I to have a far more informed view of the state of the Irish banking sector. Together with the structured dialogue, this was the context that led to the Government's announcement last Sunday, which will be implemented in a short timeframe.

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