Ireland’s banking crisis bears the clear imprint of global influences, yet it was in crucial ways home-made: Ireland’s Banking Crisis Assignment, UCD, Ireland

Ireland’s banking crisis bears the clear imprint of global influences, yet it was in crucial ways “home-made.” This report aims to clarify how different factors – external and domestic, macroeconomic and structural – interacted to cause the crisis. On this basis, it seeks to draw policy lessons, and it also fulfills the mandate of identifying follow-up areas for the planned Commission of Investigation. It is thus a diagnostic rather than a forensic study, and it aims to complement a parallel report by Governor Honohan.

In the run-up to Ireland’s crisis, global financial markets featured an extended period of high liquidity and low-risk premia. Monetary conditions in the euro area were also easy relative to the levels of growth and inflation in Ireland. Financial integration in the euro area was deepening, and banks in Ireland had unprecedented access to cross-border funding.

As in many smaller EU economies, moreover, the entry of foreign banks intensified competition in lending. Against this backdrop, it is not surprising that Ireland experienced a strong and extended domestic financial boom, accompanied by an influx of foreign savings.

This boom needs to be seen also in the context of Ireland’s strong and extended expansion during the previous decade when the economy caught up with and surpassed average EU living standards. This fostered expectations of a continued rise in living standards and in asset values. Another factor, with even deeper roots, was the strong and pervasive preference in Irish society for the property as an asset, and the fact that Ireland had never experienced a property crash.

This was a setting in which official policies and banking practices faced key challenges. There was scope to mitigate the risks of a boom/bust cycle through prudent fiscal and supervisory policies, as well as strong bank governance – thus raising the chances of a “soft landing” for the property
market and for society at large. In the event, official policies and banking practices in some cases added fuel to the fire. Fiscal policy, bank governance, and financial supervision left the economy vulnerable to a deep crisis, with costly and extended social fallout.

While global and domestic factors thus interacted in mutually reinforcing ways, it is feasible to disentangle the main “homemade” elements in the debacle.

Fiscal policy heightened the vulnerability of the economy. At the macroeconomic level, it should have done more to dampen the powerful monetary and liquidity impulses that were stimulating the economy. Budgets that were strongly counter-cyclical could have helped to moderate the boom, and would also have created fiscal space to cushion the recession when it came. But budgetary policy veered more toward spending money while revenues came in.

In addition, the pattern of tax cuts left revenues increasingly fragile, since they were dependent on taxes driven by the property sector and by high consumer spending. Ireland was also unusual in having tax deductibility for mortgages, and significant and distortive subsidies for commercial real estate development, yet no property tax.