Europe needs to do a new round of stress tests on banks after Ireland's flawed vetting of lenders in 2010 raised doubts about a parallel Europe-wide health check, a European Central Bank executive board member was quoted as saying.
Unfortunately the fact that the Irish stress test turned out not to be credible affected the credibility of all the other stress tests, Lorenzo Bini Smaghi said in an interview in Saturday's The Irish Times newspaper.
This is why we need a new round of stress tests with more peer review and control on what national authorities are doing.
EU leaders agreed on a new review of the region's banks late last year as part of efforts to win back confidence of financial markets. The tests will begin in February.
Ireland's financial regulator stress-tested its two largest lenders -- Bank of Ireland and Allied Irish Banks -- early last year to prepare them for loan transfers to a state-run bad bank.
At the time, the Irish authorities said those domestic tests were tougher than a parallel Europe-wide review being carried out by the Committee of European Banking Supervisors, which Bank of Ireland and Allied Irish Banks also passed.
Judging from our side, the Irish supervisor underestimated the risks on the Irish banks' balance sheets, and the stress tests turned out not to be rigorous enough, said Bini Smaghi.
Mounting loan losses last year and funding difficulties eventually forced the Irish government to seek an 85 billion euro ($114.3 billion) EU/IMF bailout to help shore up its banking sector and cover its own borrowing needs.
Ireland's main opposition parties, which are likely to form a new coalition government in the next few months, have said they would like to make some senior bondholders in Irish banks share the burden of the losses.
But Bini Smaghi reiterated the ECB's opposition to such a move given its possible impact on Ireland's credibility.
If you want to put that into question, you put into question everything and the markets will also question the trust in the Irish state.
If the Irish state says, 'Support us, trust us, we will repay you,' and after a while you say, 'Sorry, we won't repay you,' then there's no way to regain the confidence not only of the markets but also of the rest of the people of Europe who have supported Ireland.
Bini Smaghi also said a new government would have to honor the promises made to the EU and the IMF under the deal, which involves an unprecedented round of fiscal austerity measures and an overhaul of the banking sector.
It would be dramatic for Ireland -- just by changing government you renege on the promises that Ireland as a sovereign has made, he was quoted as saying.
I don't think anybody outside Ireland should tell Ireland what to do, but you should not complain if now you have to increase taxes as a result of the choice of economic model the Irish people made.
(Reporting by Carmel Crimmins, editing by Jane Baird)