The European Central Bank has expressed "serious concerns" that a new law in Ireland could force the central bank to take losses on the collateral it accepts in exchange for loans to commercial banks.
Ireland parliament approved on Wednesday legislation which will give the government extensive powers to restructure the banking sector, including the power to impose losses on subordinated bondholders and transfer deposits.
Continue Reading Below
Opposition politicians have warned that the law, which fulfils Ireland's pledge to overhaul its banking system as part of an 85 billion euros EU/IMF bailout package, will turn Finance Minister Brian Lenihan into a "one-man legislature."
Analysts said they expected Dublin officials would work out the issue with the ECB and that for now they did not expect it to lead to any major upheavals or threats in the capital being provided to Ireland and its banks.
The bill, however, has yet to be ratified by the Irish president, who will hold a meeting on Tuesday to decide whether or not to refer it the Supreme Court amid concerns about its constitutionality.
In a legal opinion published on its website, the ECB said legal flaws in Ireland's bank aid legislation could affect its rights over collateral and demanded the law be clarified.
"The ECB has serious concerns that the draft law is insufficiently legally certain on a number of critical issues for the Eurosystem," it said in the paper dated December 17 and published on the ECB site over the weekend.
The issues include "the scope of collateral rights of central banks given as security against ELA (emergency liquidity assistance)," as well the rights of the ECB and possibly other central banks in the euro zone.
Analysts said the ECB wanted to ensure it would not have to participate in losses to bondholders.
"They feel this legislation could be a threat to both the ECB's and the Irish central bank's collateral," Unicredit economist Marco Valli said. Deutsche Bank economist Gilles Moec said he thought the ECB's statement was about protecting its balance sheet.
"In a nutshell, the ECB wants seniority," Moec said.
The ECB said the draft law should not affect the central bank or the ECB's ability to "enforce their rights including, without limitation, the enforcement of security over any eligible collateral posted by any relevant institution."
The ECB has lent banks in Ireland 136 billion euros, a quarter of all its outstanding loans, and the country's own central bank has given them 45 billion euros in emergency liquidity assistance amid a loss of confidence in the sector.
Analysts said the parties would have to get together soon to solve the issue.
"The whole text is expressing a lot of irritation between the lines," Deutsche Bank's Moec said. "We are in for some further negotiation between the ECB and Ireland."
Ireland defended the sweeping powers granted to the finance minister in the new banking law and said the ECB would not suffer from the measures.
"There is no question of the central bank, ECB or any NCB as creditors to the guaranteed institutions being exposed financially by the exercise of the minister's powers under the bill," a finance ministry spokeswoman said in a statement.
This should help push talks forward, analysts said.
"Finance ministry remarks are actually quite constructive -- they are perfectly aware they have to coordinate with the ECB and the central bank," Unicredit's Valli said.
The 16-country region's central bank also said governments should coordinate their policies to avoid distortions in global banking markets and added countries cannot have their own rules concerning bank access to liquidity, and added the law should make clear it will not weaken the ECB's or the Irish central bank's independence.
Ireland opposition politicians had criticized that law was rushed through parliament without sufficient time to debate it.
The ECB said it expected Ireland to tweak its plans to take into account the central bank's concerns, and also rapped Ireland for a late request for the central bank's opinion.
Irish sovereign debt was downgraded by five notches by Moody's on Friday in a move likely to put extra pressure on the country's already battered commercial banks.
ECB President Jean-Claude Trichet said on Monday that Ireland must stick rigorously to its economic restructuring plan.
The ECB set up a temporary 10 billion pound ($15.6 billion) swap arrangement with the Bank of England on Friday, in a fresh bid to limit the problems facing the Irish banking system.