Independence and Interest Rate Setting – The Irish Banks 1952-1970
Dr. Ella Kavanagh1
Department of Economics
University College Cork
Abstract
Between 1922 (when the Irish Free State was founded) and 1979, the Irish pound was
linked one for one and was freely convertible into sterling. Consequently the impetus
for changing Irish interest rates came from changes in the (Bank of England) Bank
Rate. The Irish Banks Standing Committee (IBSC) was formed in March 1920 “to fix
rates for Overdrafts, Loans and Discounts for all banks” (IBSC Minutes, March 16th,
1920). In the 1920s and 1930s, the Irish banks adopted a fixed schedule, which they
followed for each change in the Bank Rate. By the beginning of the 1950s the
schedule was abandoned as it was no longer deemed to be relevant and it was decided
by the IBSC that any change in Irish interest rates, following a change in the Bank
Rate, would no longer be automatic but would be a decided by the IBSC.
This paper analyses the reasons behind the changing relationship between Irish
interest rates and the (Bank of England) Bank Rate during the 1950s and 1960s. The
independence that the IBSC had previously enjoyed in setting their retail rates began
to be eroded as a number of other players, the Central Bank and the Irish Government,
started to influence the way that interest rates were set while other factors, besides
purely banking considerations, entered into the interest rate decisions. The contents
of the Minutes of the meetings of the Irish Bank Standing Committee for the 1950s
and 1960s are used to analyse the role of the three agents, the Irish Banks Standing
Committee (Irish banks), the Central Bank and the Irish Government in setting retail
interest rates.
The paper analyses the economic and political reasons for the Irish government’s
interference in setting interest rates. The mid 1950s was characterised by economic
stagnation. This was followed by the emergence of economic planning in 1958 to
combat problems of high unemployment and emigration. The paper examines the
emerging and evolving relationship between the Irish Central Bank and the banks.
While initially the Central Bank played a minor role as mediator between the banks
and the government, during the 1960s the commercial banks began to recognise its
potential role as a protector against government interference. The paper highlights the
“threats” that were invoked by different governments, at different times, to get the
banks to behave more in line with their wishes and why government was willing to
incur the cost of interference in banking activities, in order to achieve their objectives.
It also documents how the banks responded to these threats. It demonstrates how the
banks used their role as lenders to the government to try to retain their independence
in setting retail interest rates according to their own banking criteria.
1
Tel: +353 21 4902571. E-mail:e.kavanagh@ucc.ie. This paper is prepared for presentation at the
Economic History Society Anuual Conference, University of Nottinghan, March 28-30, 2008. I would
like to acknowledge the Bank of Ireland for allowing me access to the Irish Banks Standing Committee
(IBSC) Minutes in the Bank of Ireland Archives.
1. Introduction
Between 1922 (when the Irish Free State was founded) and 1979, the Irish pound was
linked one for one and was freely convertible into sterling. Consequently the impetus
for changing Irish interest rates came from changes in the (Bank of England) Bank
Rate. The Irish Banks Standing Committee (IBSC) was formed in March 1920 “to fix
rates for Overdrafts, Loans and Discounts for all banks” (IBSC Minutes of March 16
1920). In the 1920s and 1930s, the Irish banks adopted a fixed schedule, which they
followed for each change in the Bank Rate. By the beginning of the 1950s the
schedule was abandoned as it was no longer deemed to be relevant and it was decided
by the IBSC that any change in Irish interest rates, following a change in the Bank
Rate, would no longer be automatic but would be a decided by the IBSC.
This paper analyses the reasons behind the changing relationship between Irish
interest rates and the (Bank of England) Bank Rate during the 1950s and 1960s. The
autonomy that the IBSC had previously enjoyed in setting their retail rates began to be
eroded as two other parties, the Central Bank, which had been established in 1943,
and the Irish Government, started to influence the way that interest rates were set. We
examine the evolving and rather volatile relationship between the Central Bank and
the IBSC and document the impact that it had on interest rate decisions. We also
investigate the role of the Irish Government and the Department of Finance in
affecting interest rates at different times during these two decades. The contents of the
Minutes of the meetings of the IBSC for the 1950s and 1960s are used to analyse the
role of the three agents, the Irish Banks Standing Committee (Irish banks), the Central
Bank and the Irish Government in setting retail interest rates.
This paper is divided according to particular time periods. Section 2 deals with the
period from 1952-1954, the beginning of government involvement. Section 3
examines the period from 1955-1957 when the government effectively dictated
interest rates to the IBSC with negative consequences for the economy. Section 4 is
the period of the First Programme for Economic Expansion, 1958-1962 and an
increasing role for the Central Bank. Section 5 reviews the period 1963-1967, which
matches the early years of the Second Programme for Economic Expansion. Section 6
examines the latter years of the 1960s. Section 7 concludes.
2
2. 1952 - 1954
At the beginning of the 1950s, the IBSC abolished the schedule that had previously
been used to set interest rates, which allowed for change in the relationship that had
existed between the Bank Rate and Irish interest rates. They wanted greater flexibility
in the rate structure “so that one rate could be changed without all others” (IBSC
Minutes of 22 February 1952). More significantly, they made the decision that “no
changes in the Irish bank rate structure will in future operate automatically on a
change in the Bank of England rate” (IBSC Minutes of 18 February 1952). Loan rates
were set as a mark-up over deposit rates. The Irish banks (both in the North and in the
Republic) were in competition with the British banks and the Trustee Savings Banks
(TSBs) and the Post Office Savings Banks (POSBs) in Ireland for deposits. As we
will see this was a significant factor affecting interest rate decisions.
During this period, the independence that the banking sector had previously enjoyed
in setting interest rates was eroded. The Minister for Finance began to directly
intervene in interest rate setting, which meant that other factors, besides purely
banking considerations, became important in interest rate decisions. The Governor of
the Central Bank acted as a mediator between both parties and appears to have had
very little direct influence.
2.1 Direct Government Interference
On 11th March 1952, the Bank Rate was increased from 2½% to 4%2 while the
London Banks Deposit Rate was raised to 2%. The IBSC proposed, at the 13th March
meeting, that the deposit rate should be set at the same rate as the London Banks
Deposit Rate. The overdraft rate was set at 6½%, a margin of 4½%.
The Governor of the Central Bank had no active role in the setting of interest rates.
The Chairman of the IBSC informed him of their decision and he in turn informed the
Minister for Finance3. The Governor of the Central Bank, Mr. Brennan acted as a
conduit between the IBSC and the government. He informed the IBSC that the
Government had requested the banks not to change rates “until such time as several
2
3
Figs. 1 & 2 showing changes in interest rate margins are available on page 38.
Mr. Sean McEntee of Fianna Fáil.
3
Ministers had an opportunity of examining the matter in more detail and if necessary
to discuss the proposal with the representatives of the banks” (IBSC Minutes of 14
March 1952). The banks agreed to this although not indefinitely and set a deadline for
the publishing of the new schedule. The Governor also stated his willingness to
convey to the Minister for Finance any views the banks might wish to express.
Although the Chairman did meet the Minister, a meeting was still requested by the
government with the IBSC. Prior to this meeting, and presumably in deference to the
government request, the IBSC proposed an adjustment in deposit rates – a 1½%
deposit rate on deposits of less than £25,000 and 2% on deposits of £25,000 or more.
This would enable a maximum overdraft rate of 6%.
The importance that the government attached to this meeting can be gauged by the
personnel who attended - the Taoiseach, Mr. Eamonn De Valera, the Taniste and
Minister for Industry and Commerce, Mr. Sean Lemass, Mr. Sean McEntee (Minister
for Finance) and Mr. Frank Aiken (Minister for External Affairs) along with Mr. Mc
Elligott (Secretary to the Dept. of Finance) and M. Moynihan (Assistant Secretary to
the Dept. of Finance). There was no representative of the Central Bank.
Three reasons explain the high level involvement by the government and the absence
of the Central bank. Firstly, the Central Bank had published a highly critical report on
the Irish economy on 25th September 1951. In it the Governor, had expressed concern
about the underlying forces causing the increase in the balance of payments deficit
from £9.5m in 1949 to £30m in 1950. “The present economic situation is one of high
consumption, high investment and low savings” (Central Bank of Ireland, 1951:16).
The factors that he identified as responsible were: “the constantly increasing scale of
the expenditure of the State and local authorities and the continuing rise in general
levels of remuneration” (Central Bank of Ireland, 1951:10). While most of the
discussion was on the need for fiscal correction, “rigorous restriction of bank credit
for non-essential and less urgent purposes” was also considered to be imperative
(Central Bank of Ireland, 1951:16). Moynihan (1975) discusses in some detail, the
outcry that followed its publication. Secondly the government was opposed to the
report.
According to the Minister for Industry and Commerce (Seán Lemass),
although the analysis by the Central Bank of the financial and monetary situation is
done “with reasonable accuracy”, the “line which the Government tends to follow in
4
the solution of these problems is diametrically opposite to that which the Central
Bank suggests”4 “The Central Bank says that the solution is to cut down consumption.
The Government believes that the solution is to increase the level of
production……In our efforts we expect to obtain the co-operation of the Central Bank
and the commercial banks. If necessary we are prepared to take steps to ensure that
we will get that co-operation”5. Thirdly the Minister for Finance was planning to
introduce a contractionary budget6, in response to the deteriorating balance of
payments (Fanning, 1978:483).
At the meeting the banks were requested to adjourn the increase in interest rates. In
their introduction, the banks focussed on the danger of losing deposits and the effect
that this would have on the supply of industrial loans. The Taoiseach stressed, “the
anxiety of the government at the effect the increased interest rates would have on the
economy” (IBSC Minutes of May, 1952). McElligott (Secretary to the Department of
Finance) contrasted the much smaller increases in English lending rates with Irish
rates7. The Tániste and Minister for Industry and Commerce, Mr. Lemass pointed to
the high profits of banks and argued that the banks should be reducing their cost base
(by reducing branches). “The banks appeared to incline to the opinion that they must
be protected no matter to what extent other sections of the community suffered”
(IBSC Minutes of March 18th, 1952). The Minister for External Affairs, Mr. Aiken
argued that the banks should be able to distinguish between loans for productive and
non-productive purposes, charging a different rate to each. The Chairman of the IBSC
said that the banks were “discouraging advances for unproductive purposes” and the
bill system was enabling cheaper rates to be charged for loans for productive
purposes. Despite a further appeal from the Taoiseach to the banks to adopt a wait
and see approach, the banks made it clear that the proposals, which they had already
amended, would be introduced on the 20th March. On the 20th March, they were
introduced89.
4
Dáil Debates, Vol. 127, 7th November 1951
Dáil Debates, Vol. 127, 7th November 1951
6
Introduced on 2nd April, 1952.
7
McElligott had stressed a similar point in his Minority Report of the 1926 Banking Commission.
8
On the 25th March, the Minister for Finance was questioned in the Dáil about the government’s role in
this decision and whether the government concurred with the decision made. His response was that
“After discussion with representatives of the banks the Government felt that, in view of the need for
precautionary measures against possible serious loss of deposits and the curtailment of credit that might
5
5
2.2 Disagreements
The Bank Rate was reduced twice during the remainder of this period - on the 17th
September 1953 to 3½% and on 13th May 1954, to 3%. In line with the movements in
the Bank Rate, the London Banks Deposit rate was reduced to 1¾% and then to 1¼%.
The IBSC discussed a ¼% reduction in deposit and lending rates in response to the
September change.
The new Governor of the Central Bank (Mr. JJ. McElligott formerly of the
Department of Finance) conveyed to the Banks a request by the Minister that no
decision should be announced before the Government had been given an opportunity
of considering it (Moynihan, 1975:415). On the 21st September the Minister discussed
the possible change in interest rates with the Governor. McElligott supported the
banks in his discussion with the Minister – He pointed out that the banks had not
increased their interest rates in line with the British Bank Rate in March 1952
(Moynihan, 1975:415). At their meeting on the 22nd September, the IBSC proposed
that the deposit rate on amounts of £25,000 or over would match the London Banks
Deposit Rate while the deposit rate on amounts less than £25,000 was reduced by ¼%
to 1¼%. The margins were maintained by reducing the overdraft rate (and some other
lending rates) by ¼% only to 5¾%. In the expectation of potential government
interference the IBSC wished to “make the proposal attractive to government”. So for
the loan categories E2, E3 and E4, (i.e. those applying to government related loans) it
was agreed that a ½% reduction should be applied (IBSC Minutes of September 22
1953).
On the 25th September, the Acting Minister for Finance, Mr. Aiken, met with the
banks. He wanted more flexibility and experimentation in the way that interest rates
were set. Specifically he wanted the banks to reduce the rate charged on loans for
productive purposes to 5% and to reduce their deposit rates by more than originally
follow, they could not press further for a modification of the banks’ decision (Dáil Debates, 25th March
1952).
9
To protect their deposits of amounts less than £25,000, the IBSC requested and obtained an
agreement from the British Banker’s Association that the latter would not pay more than the Irish rate
on any new deposits for amounts less than £25,000 transferred to them by residents in Ireland. This
arrangement continued to apply through the 1950s and into the 1960s.
6
specified to accommodate this. The banks outlined their own banking considerations
in response: the danger of losing deposits if Irish rates were below British rates 10 and
the need to improve reserves which had been greatly affected by the fall in the value
of securities. The profitability of banks, already mentioned by Lemass in 1952,
continued to be an issue with the banks pointing out that the reduction in rates would
not give the banks the bonus of increased profits (as it was, profits were negatively
affected by the reduction in call money rates). Despite the request by the Acting
Minister for Finance, the banks held to their original decision and the new rates were
introduced from the close of business on 30th September 1953. Again as before an
agreement was made with the British Bankers Association in relation to deposit rates.
In response to the fall in the Bank Rate in May, the IBSC set the deposit rate on larger
amounts ( £25,000) equal to the London Banks Deposit Rate at 1¼%, the deposit
rate on smaller amounts (<£25,000) at 1%11 and the overdraft rate at 5.5% (decline of
¼%). Although the Northern Banks wanted the change introduced immediately, the
information would have to be given to the Governor of the CB and the Department of
Finance, prior to making it public. As noted by Moynihan (1975:416), the
Government was not satisfied. At the time they were entering a general election (The
Independents had withdrew their support from the government in May). Mr.
McElligott, Governor of the Central Bank and Mr. T.K. Whitaker, Assistant Secretary
of the Department of Finance attended a meeting with the IBSC. The government’s
concern was that that the banks were increasing their profits at the expense of
reducing the margin. The banks argued that this was necessary given their higher
costs and the need to increase their reserves to cover losses. Also in times of falling
interest rates, the banks interest return on “loans on call or at short notice” fell
reducing their interest earnings.
At a later meeting the banks discussed the possibility of reducing some of the special
interest rates. The feeling of the meeting was that it might be more politic to make
some concessions under these headings. The IBSC also wanted to introduce the
In the banks’ opinion, they were very vulnerable as many of the larger depositors maintained bank
accounts in England.
11
In May, the deposit rate on amounts of <£25,000 according to the banks could not be reduced below
1% (75% of deposits were at this lower rate).
10
7
changes with the existing government’s approval and their fear was that the
government would not be inclined to do so unless some concessions were made.
Consequently all other interest rates were unchanged, with the exception of the
interest rates on categories E3 and E4 (government borrowing), which were reduced
by a further ¼%. The Department of Finance was informed of their decision and the
new interest rates were introduced on May 24th, 195412.
At the end of this period, the margin between the overdraft rate and the rate on small
deposits (<£25,000) was 4.5%, lower than the margin between the overdraft rate and
the rate on large amounts (amounts of £25,000 or over), which was at 4.75%.
3. 1955-1957
There is much greater direct interference by the government in the setting of interest
rates during this period. The new Inter-Party government13 used threats to get the
banks to maintain their interest rates unchanged despite increases in the Bank Rate.
Although the Central Bank shared the views of the banks, they played a relatively
minor role in both the 1955 and 1956 episodes and discussions largely took place
directly between the IBSC and the government.
Government intervention had a partial negative effect on the banks’ margins. The
margin between the overdraft rate and the deposit rate on large amounts ended 1957 at
3.25% although it had fallen to 3% in 1955. However the margin between the
overdraft rate and the rate on small deposits had expanded from 4½% to 4¾%, which
accounted for two thirds of deposits. The relationship between the Republic of
Ireland’s banks’ interest rates and the British Bank Rate was also modified. The banks
had constantly re-iterated the need to keep their deposit rates competitive with the UK
– the deposit rate on amounts of £25,000 was kept equal to the London Banks
Deposit Rate. This relationship disappears post 1956/57 with the Irish rate usually
½% to 1% below the London Banks’ deposit rate (unlike the Northern banks which
12
Interestingly Whitaker also attempted to introduce more transparency in interest rate decisionmaking. The IBSC was requested to provide the government with “a statement setting out in general
terms the case made by the banks for their inability to reduce lending rates to the extent suggested by
the Government”. The IBSC were unanimously opposed to having to formally report the reasons for
their interest rate decisions to the government (IBSC Minutes of 20 th May 1954).
13
The cabinet consisted of three parties, Fine Gael, Labour and Clann na Talmhan.
8
maintained the connection between the two rates). The banks in the South were
facilitated in doing this by their arrangements with both the London Clearing Banks
and the banks in the North. This greater freedom in setting interest rates altered the
relationship between the overdraft rate and the British Bank Rate. The difference in
the Overdraft rate and the British Bank Rate, which had been 2.5% in December
1954, fell to ¼% in September 1957.
3.1 Threats to the Banks Independence and their Response: 1955
On January 31st, the Bank Rate was increased to 3½% and on the 24th of February to
4½%. The banks decided to raise the deposit rate on large amounts to 1½% following
the increase in the London Banks Deposit rate to 1½% but to leave the deposit rate on
small amounts and the overdraft rate unchanged at 1%. No reasons are given in the
Minutes explaining these decisions. The increase in the Bank Rate to 4½% and the
London Banks Deposit rate to 2½%, on the 24th of February necessitated another
response by the banks.
The banks again wanted to match the interest rate on large deposits with the London
Banks Deposit Rate to prevent an outflow of funds. In the interests of “equity” but
also to enable the banks to compete internally with the Post Office Savings Bank and
the Trustee Savings Bank, (particularly for the Nt. Ireland banks), the lower deposit
interest rate was to be increased to 1½%. Consequently to maintain margins they
proposed to increase the Overdraft Rate to 6¼%. The banks view was that the supply
of credit was of greater significance than the cost and the supply would be negatively
affected by a fall in deposits.
A new Inter-Party government had been formed in June 1954. The new Minister for
Finance, Mr. Sweetman, rather than waiting to be informed of the banks decision,
made his views known to the Chairman of the IBSC in advance of their meeting. The
Minister expressed concern about the psychological effect that an increase in interest
rates would have on the fledgling recovery in employment in Ireland. He also argued
that the interest rate policy in Britain was temporary. Despite the Minister’s initial
intervention, the banks voted to raise interest rates.
9
The response of the Minister was to inform the Chairman of the IBSC that “should the
bank’s intimated intentions, be adhered to, he would be tempted to ask the public to
give him special powers to prohibit them from making any increase in their lending
rates, or alternatively use the powers available to him which the banks on another
occasion had asked him to operate” (IBSC Minutes of March 2 1955). The cost to the
banks of rebuking the Minister was clear. It would have taken away the banks’
autonomy in setting interest rates with, what they saw, as negative consequences for
the public’s confidence in the banking system. It was not perceived as an idle threat
and the Chairman was convinced that the Minister “would not hesitate to act to
implement his statement, should the necessity for doing so arise” (IBSC Minutes of
March 2 1955). The banks adhered to the Minister’s request on lending rates but did
increase the deposit rate on large amounts to 2½% to match the London Banks
Deposit Rate14. In a letter to Redmond, Secretary of the Department of Finance, the
banks emphasised that the reason for not putting their own decision into operation
was the pressure from official sources and the view of the Minister that the situation
in Great Britain was temporary (IBSC Minutes of March 4 1955). As before the
arrangement with the British Bankers was invoked to protect small deposits. The
Northern banks and the banks in the Republic of Ireland formed an agreement with
the intention of minimising both deposit outflow to the North and the inflow of
lending business to the South, at the Northern banks expense15.
The benefit for the Minister and the government was clear – expansionary monetary
policy and success at getting the highly conservative banks to reverse their initial
proposal. According to Moynihan (1975:421) “the Government regarded the
achievement as an occasion for legitimate pride”. It was expected by the government
that there would have been public support for such a move.
14
The Northern Banks decided to operate their own interest rate schedule. The ordinary deposit rate
(<£25,000) was increased to 1½% while the rate on deposits of >£25,000 was increased to 2½%. The
Overdraft rate was increased to 6½%).
15
The following instructions were to be issued to branch offices in both the North and the South. “That
while by reason of the differential rates now to operate in the two areas it may be difficult to resist
requests to switch deposits to Nt. Ireland offices or overdrafts to Republic of Ireland offices, no banks I
to take advantage of such differential rates to the detriment of the other. In support of this agreement it
is to be understood that no higher rate on deposits accounts than that operating in the Republic of
Ireland offices is to be paid by Nt. Ireland offices on deposit accounts offered to them for transfer from
a Republic of Ireland office of another bank. It follows automatically from this agreement that no lower
rates of interest than that applicable under the Nt. Ireland schedule may be offered in respect of bills,
loans or overdrafts ought to be transferred to a Republic of Ireland office from a Northern Ireland
office of another bank”. (IBSC Minutes of March 2 1955).
10
The Central Bank Governor, Mr. McElligott was in agreement with the banks that
interest rates should be increased. According to Moynihan (1975:421,422), the
Governor of the Central Bank sympathised with the banks and representations, both
oral and written, were made to the Minister by the Governor in February and March
1955 and were renewed from time to time. In August 1955, the Minister agreed to an
increase of ½% to 4% on government guaranteed advances, after discussions with the
Governor (IBSC Minutes of August 15 1955). The Central Bank Annual Report 1955
also referred to the close connection that existed between Irish and British interest
rates. The focus of the Central Bank was on the implication of differences in deposit
rates on the banks’ ability to obtain deposits, thus affecting their capacity to provide
loans and advances (Central Bank of Ireland, 1955:31). “The Governor had already in
September conveyed to the Minister observations by the Central Bank to the effect
that the dis-improvement in the balance of payments was “serious enough to require
early corrective action”, that the appropriate kind of action was not restriction of
imports but restriction of spending power; that bank rates should be allowed to go up;
that greater publicity might be given to the need for increased saving and for restraint
in demands for higher monetary rewards” (Moynihan, 1975:425).
The IBSC’s discussions with the Minister for Finance took place on a bilateral basis –
the Central Bank appears to have had little involvement. In August the IBSC decided
that they should make representations to the Minister on their own behalf rather than
leaving it to the Central Bank16. However at the IBSC meeting in September the
question was being raised whether “it would be more politic for the banks to make
their representations through the medium of the Governor of the Central Bank, rather
than directly to the Minister” in the light of the figures in the Central Bank aggregate
monthly returns. The outcome was that the Central Bank would be consulted for their
views on their submission to the Minister but the actual meetings would take place
between the Minister and the IBSC.
Although in August 1955, it was felt by the banks that “the situation had not developed to such an
adverse extent as to render it possible for the banks, to produce submissions, which would counter the
points of view held by the Minister, as conveyed to the banks in the course of several interviews held at
government buildings”
16
11
By September the July banking returns became available identifying a worrying
situation for the banks. The banks decided to prepare a memorandum to the
government. In it, the banks focussed on the monetary and banking implications of
the failure to increase interest rates – the static position of deposits, the increase in
advances now representing 64% of direct liabilities to the public, the large deficit in
the balance of payments and the sharp decline in the net external assets of the banks
from £122.4m in August 1954 to £97.0m in August 195517. The real implications for
the economy were evident – The banks now found themselves in the position where
they had to refuse loan applications. At the same time the reduction in their net
external assets weakened the liquidity position and the financial stability of the
banking system. According to the banks “this was a danger to the Banking System, to
the currency and to the country as a whole” (IBSC Minutes of November 1 1955).
Before their meeting with the government, the banks discussed how the situation
could be resolved. At the IBSC meeting of 21st October 1955, they examined whether
they themselves should restrict advances except for essential and productive purposes.
The discussion highlighted the difficulties that the banks themselves faced if they
attempted to do this. Firstly any agreement by the banks to restrict credit would be
time-inconsistent and lack credibility. Banks could not sanction each other. Each bank
had the incentive to increase its customers by giving credit to a customer who had
been refused credit by another bank18. As all banks faced this incentive, this
agreement would not hold. Secondly banks faced the difficulty of identifying clearly
what advances to restrict. Thirdly a unilateral policy of restricting credit would be
condemned by the public and politicians when it became known, as had been the case
in 1951. In the bank’s view a general increase in interest rates was necessary to cut
back lending.
The Minister of Finance, in his meeting with the banks on 11th November 1955,
questioned why the banks could not reduce lending by restricting credit rather than
having to increase interest rates. “If the anxiety of the banks as set out in their memo
17
The implications of the maintenance of interest rates for the economy has been well documented by
Honohan and O’Gráda (1997).
18
Mr. Klingner (Royal Bank) “instanced two cases where they would have to give credit to two clients
for large accommodation which in the existing circumstances they would rather refuse but were
worried that they would lose customers to other banks” (IBSC Minutes October 1955)
12
was to increase interest rates in order to reduce advances why as some banks appeared
to have affected that result without a rise in interest rates, could not all banks have
done the same” (IBSC Minutes of November 11 1955). The banks argued that an
increase in interest rates was a much more potent weapon and hoped that “it would
have a pervasive effect on the country as a whole” (IBSC Minutes of November 11
1955). In their view, the country as a whole was living beyond its means. Borrowing
from the banks needed to be reduced - “even in the field of productive enterprises
the tendency was to borrow rather than realise investments or bring in fresh capital”
(IBSC Minutes of November 11 1955). This borrowing was being financed by the
sale of sterling assets. At the same time deposits needed to be increased, otherwise
lending would be restricted.
The banks had their own weapon in dealing with the government. In December 1955,
the banks announced to the government that they were refusing to meet the
government’s temporary requirements and that three banks (Hibernian Bank, the
Royal and the Provincial Bank) did not intend to renew the bills maturing on 31st
December 1955. According to the Chairman “the banks would be failing in their duty
to their depositors were they to allow any further deterioration in so far as it lay in
their power to take preventative action” (IBSC Minutes of December 19 1955). The
banks argued that it was not that the banks would not provide the money but could
not. The Central Bank Governor met with the Chairman of the IBSC and the Central
Bank Governor agreed reluctantly to rediscount the Exchequer Bills. As a result the
banks agreed to provide the temporary accommodation.
At the same meeting of 19th December 1955, it was noted that the Minister had
agreed, in the light of the November balance of payment figures, to allow interest
rates to increase. However the Minister continued to exert his authority over interest
rate setting. Firstly he submitted two proposals to the banks for their consideration:
Table 1: Ministers Proposals 1955
Deposit Rate (<£25,000)
Overdraft Rate
Proposal 1
¾%
Increase
1% Increase
Proposal 2
½%
Increase
¾%
Increase
13
Outcome
½% Increase
¾% Increase
The Minister’s preference was for Proposal 1, which had been agreed to by the
Governor of the Central Bank. The Bank’s preference was for Proposal 2, because
“they would experience a serious loss of earnings by reason of the greater proportion
of their deposits in the under £25,000 class” (IBSC Minutes of December 19 1955).
Secondly the Minister stated that he intended to announce the change in rates at the
Dublin Stock Exchange Dinner. This was an important feature of bank autonomy “An
intimation of alteration in the rate schedule was considered to be the prerogative of
the Banks and one over which the Minister had no-effective jurisdiction” (IBSC
Minutes of December 19 1955). The Minister, after discussions with the Central
Bank agreed to their proposal and interest rates were allowed to be raised
19
which
resulted in an expansion in bank margins.
3.2 Continued Threats to the Banks’ Independence: 1956
A similar situation arose in 1956. The British Bank rate was again increased on the
16th February 1956 from 4½% to 5½% with the London Banks deposit rate rising to
3½%. The latter required a corresponding increase in the deposit rate for large
amounts to 3½% (and 2½% for amounts less than £25,000). The Banks favoured
increasing the overdraft rate to 7½%. In the early months of 1956, the banks had
continued to experience a fall in deposits, an increase in advances and a reduction in
external assets (IBSC Minutes of April 13 1956).
The Governor of the Central Bank took a more active role in the discussions between
the banks and the government. He informed the IBSC that the proposed rates would
be unacceptable to the government and proposed an alternative, more in line with “our
own internal economy”20 whereby deposit rates for small and large amounts would be
increased to 2¼% and 3½% respectively and the overdraft rate would be raised to 7%,
reducing the margin on deposits £25,000. The Governor also stated that if the banks
Most authors identify the November trade figures as the predominant factor for the Minister’s
decision to increase interest rates. However as we noted at that time the government was requesting
more temporary accommodation but the banks stated that owing to their need to conserve external
reserves, (banks were selling off their sterling assets to fund lending), they could not sanction the
additional £5m requested. This may have influenced the Government’s decision.
20
One would have expected that the Governor would have favoured a larger increase in lending rates
given their statements on the causes of the Balance of Payments crisis in 1955. However it would
appear that the concern with banks profitability was the principal concern, reflecting his earlier views
in the First Banking Commission Report and the increase in bank’s profitability during 1955.
19
14
could recognise and define certain types of productive advances to which a
preferential rate might be applied, it would help in getting the Minister’s approval.
This was reiterated at a meeting between the Banks and the Minister on 28th February
but was rejected by the banks that it would be too difficult.
Although the banks intended introducing a new revised schedule (in a letter dated
10th March), the banks agreed to defer their decision “until they had an opportunity of
studying the measures to be announced in the Dáil by the Minister for Finance as
corrections to the present unsatisfactory Balance of Payments position” (Meeting of
the IBSC with the Minister and the Taoiseach on the 14th March 1956 and again at the
meeting on the 14th April, 1956). Again the banks fear of a change in the laws
affecting the banking system seems to have been an important factor here. It was
raised by the Governor of the Central Bank in February and explicitly by the
Taoiseach in April. “An Taoiseach stated that any action on the part of the banks in
raising interest rates must result in a conflict with the government and a demand from
many quarters for the introduction of legislation controlling the bank’s powers to
increase interest rates without prior government approval. The government would find
it difficult to resist such a change” (IBSC Minutes of April 13, 1956). The Tániste
referred to the Treasury control of interest rates operating in Great Britain and the
difficulty of countering a proposal for the introduction of a similar control in this
country. The banks “had a public duty of working in unison with the government and
assisting in the implementation of the government’s general economic policy” (IBSC
Minutes of April 13 1956). In response to the banks request to increase the interest
rate on government guaranteed advances, the Minister again reiterated that “it must be
realised that any present suggestion to that end must result in such a storm of protest
as to invoke demands for an amendment of the existing banking machinery,
particularly taking into account the improvement in the banking figures over the last
five months” (IBSC Minutes of December 7 1956). “Any suggestion for a present
increase in lending rates must certainly not be in the best interests of the banks”
(IBSC Minutes of December 7 1956). Another factor that affected the response of the
banks to the Government’s decision was the proposed National Loan. The banks felt
that if they pressed for an interest rate increase, and the impending National Loan was
unsuccessful then they would be blamed (IBSC Minutes of August 10, 1956).
15
The banks recognised the interdependency between the government’s borrowings
from them and their interest rate decision, which they, the government, had imposed
on the banks. On 4th May, in a letter to the Minister for Finance, the banks highlighted
the difficulties that they faced in financing government borrowings given the decline
in external assets and in deposit accounts. At the IBSC meeting of 15th June a more
explicit connection is made. “A point might also be made to the government that their
refusal to increase rates in February 1955 and again in March of this year had been a
contributory factor in the Bank’s present inability to provide government finance to
the extent required”.
The Irish banks did not change their interest rates after the change in the Bank Rate.
For the first time, the interest rate on large deposits was lower than the London Banks
Deposit Rate by 1%. The British Bank rate was reduced to 5% on the 7th February
1957. This appears to have signalled the end of this discourse. It was agreed that there
was no need for any change in the present rate schedule operative in Ireland. The 15th
Dáil had ended in December 1956, followed by a new Fianna Fail government in
March 1957, led by De Valera.
3.3. Minor Disagreements
The Bank Rate and the London Banks Deposit Rate were increased to 7% and 5%
respectively on the 19th September 1957. The initial proposal of the banks was 2½%
for deposits of <£25,000, 4% for deposits>£25,000 and a 7½% ordinary overdraft
rate.
This interest rate decision was closely linked with the setting of the Exchequer Bill
rate. The banks were initially in favour of a 6¾% Exchequer Bill Rate. At their
meeting on the 24th September to discuss changes in interest rate, the view of the
Chairman was that it would be unwise to go to the Minister with suggested rates that
would increase banks’ income by £600,00021 as banks would have to negotiate on
either reducing the proposed lending rates or reducing the Exchequer Bill rate. The
view was that the “banks should keep themselves in a position to indicate to the
Minister a schedule of rates over which they could stand as representing a fair
21
Although it was also pointed out by some banks that they would not be able to break even with a
7½% lending rate.
16
approach to the problem having regard to all relevant factors” (IBSC Minutes of
September 24 1957). Therefore the majority favoured a 1% increase in the lending
rate to 7¼% while keeping the deposits rates as earlier stated.
At a meeting with the Acting Minister for Finance (Sean Mc Entee) on 26th
September 1957, the Minister argued for a lowering of the overdraft rate to 7%, while
“compensating themselves for any deficiency in income arising there by increases in
other directions” (IBSC Minutes of September 26 1957). The banks argued against
this. The discussion then moved to the Exchequer Bill rate – the Minister wished to
obtain a rate of 6% while the banks wanted 6¾% to compensate them for the lower
lending rates22. It was understood that there was a need to maintain the Exchequer Bill
rate as competitive as possible so as to prevent an outflow of funds to UK Treasury
Bills. The banks and the Acting Minister for Finance agreed a 6% Exchequer Bill rate
with the Minister accepting the banks proposal for increases of 1% and 1½% in the
deposit rate with an all round increase of 1% in lending rates.
Relations between the government and the banks were restored satisfactorily. At a
meeting of the IBSC with the Minister for Finance on 14th October 1957, the Minister
said that “he would like to express his own appreciation of the spirit of co-operation
shown by the banks in arriving at an equitable decision in so far as the country was
concerned. He felt that the banks had met the government in relation to the Exchequer
Bill rate reasonably “particularly having regard to the 6 5/8% Treasury Bill rate,
which had operated for some weeks” (IBSC Minutes of September 27 1957).
4. 1958-1962
During this period, the Central Bank Governor took a more active role, acting as a
mediator between the banks and the government/Department of Finance, with no
direct discussions between the Minister for Finance and the IBSC. This was not only a
part of the “natural evolution” of the Central Bank. But it was also a direct response to
the introduction of the First Programme for Economic Expansion, which clearly
indicated the government’s policy stance on interest rates and their view on the role
that the banks and the Central Bank should play in economic development. This
Although the Chairman had the power to agree to a 6½% rate should the “necessity so arise in the
light of any material variation in the new Treasury Bill Rate” (IBSC Minutes of September 26th, 1957).
22
17
dominated the interest rate decisions in the late 1950s and resulted in disagreements
between the policy makers and the IBSC.
At the same time, a pattern began to emerge in the response of interest rates in the
Republic of Ireland to changes in the Bank Rate. As this “formula” developed during
the 1960s, intervention by the Central Bank and the Government/Department of
Finance in interest rate decisions is reduced with the IBSC just informing the other
parties of their decisions. There is also a change of personnel at the Central Bank
with Mr. Moynihan (formerly of the Department of Finance) replacing Mr. McElligott
as Governor of the Central Bank in 1961. Margins too are maintained with an increase
recorded on the margin between the overdraft rate and the deposit rate for large
amounts to 3.75%.
Unlike the earlier episodes and the later period, there is no discussion about the
balance of payments and the net external assets of the banking system in the Minutes
reflecting the balance that was achieved at this time on the Balance of Payments
(Central Bank Annual Reports 1961, 1962).
4.1 Agreement: Development of a “Formula”.
The Bank Rate and the London Banks Deposit Rate were reduced on three occasions
in the first 6 months of 1958. On March 20th they were reduced by 1% to 6% and 4%
respectively and by a ½% on the 22nd of May and a further ½% on the 19th June to 5%
and 3% respectively. The response of the IBSC was to reduce the Overdraft Rate (and
other lending rates) and the Deposit Rate for amounts of less than £25,000 by a half of
the decrease in the Bank Rate. The exception to this was the interest rate on deposits
for amounts of £25,000 or over, which were reduced by ¾% in March and ½% in
May and June, thus widening the margin between the overdraft rate and this deposit
rate.
There appears to have been little direct involvement from the authorities. The Central
Bank Governor did contact the Chairman of the IBSC prior to the May meeting to
suggest that interest rates might be reduced by the full ½%, but this was not acted on
by the IBSC. In general, the IBSC just simply informed the Governor of the Central
Bank and the Department of Finance (for the information of the Minister) of their
18
decisions. The changes in interest rates were introduced one week after the Bank Rate
change.
4.2 First Programme for Economic Expansion
The recognition that “something had to be done” about the low levels of production,
and high levels of unemployment and emigration, resulted in the First Programme for
Economic Expansion in 195823. The Government’s view on how the banks and the
Central Bank were expected to contribute towards achieving the aims of the
Programme is clearly articulated. The Government wished the facilities provided by
the banks, financial institutions and the Stock Exchange to be improved so as to
promote industrial and agricultural development. “It will be the concern of the
Government to make sure that capital for productive development is available as
cheaply as possible” (First Programme for Economic Expansion, 1958:9). They also
favoured the channelling of domestic funds towards “productive home uses” and “not
to the accumulation of further external reserves or investments” (First Programme for
Economic Expansion, 1958:9). The Government also viewed “with approval the trend
towards a more active exercise of the functions by the Central Bank24” (First
Programme for Economic Expansion, 1958:9).
The Government expected the Central Bank to give full consideration to the
objectives of the Government policy contained in the Programme and that “the Bank
will, so far as its resources and statutory obligations permit, continue to develop its
functions so as to facilitate economic expansion” (Moynihan, 1975:448). In their
Report of 1959, the Bank welcomed the Programme and reiterated its role as defined
by the Minister.
23
This was based on the book Economic Development by T.K. Whitaker (Secretary of the Department
of Finance). Given his importance as Secretary of the Department of Finance, it is important to give his
views on the role of the banks. “Their aim should be to make credit available on the most liberal terms
possible consistent with retaining the goodwill of depositors and preserving their own
solvency”(Whitaker, 1958).
24
The Central Bank signalled, in the 1957 Report, that their role as “a middle term” in Irish financial
activities would be expected to develop “by natural evolution” in the future. “Already the Bank is
playing a more significant role than formerly in discussions and consultations concerning the
responsibility of the banking system in financial and economic policy and in this way it is ready to take
a more active part to the extent to which the State authorities desire and encourage such development”
(Central Bank of Ireland, 1958:41).
19
4.3 Disagreements
The alignment of the views of the Central Bank and the Government are clearly
evident in the intervention by the Central Bank Governor, McElligott in the IBSC
deliberations on the Bank Rate decrease in August 1958. The Bank Rate and the
London Banks’ Deposit Rate were reduced to 4½% on the 14th August, 1958. The
IBSC wanted to leave their interest rates unchanged as they were under pressure for
deposits from both new competitors and old (The bank interest rate on amounts of
<£25,000 was similar to the Post Office Savings Bank (POSB) rate of 2.5%).
Reference was made by one of the members to the 58.8% increase in POSB deposits
over the period 1950-1957 in contrast to the 14.2% increase in bank deposits.
The Chairman of the IBSC expected that the banks would be asked to reconsider and
they were. The Governor of the Central Bank contacted the IBSC and requested a
meeting with them. In his role as mediator, McElligott both made the arguments of
the banks known to the Minister and conveyed to the banks, the “disappointment” of
the Minister that interest rates had not been reduced as “a decision by the banks to
further reduce interest rates must…have a beneficial effect on the expansionist
movement, which seemed to be underway not only from a financial point of view but
also a psychological point of view” (IBSC Minutes of August 26 1958).
The banks referred to current government (and Central Bank) policy on the need to
increase savings. They also pointed to the consequence of a loss of deposits for their
future ability to underwrite government issues.
McElligott reiterated the inconsistency between the IBSC stance and government
policy and his concern that leaving interest rates unchanged would have a deflationary
effect on the economy. “The banks could best serve the national interest by a
reduction in interest rates unless such a reduction would be a disservice to themselves
(IBSC Minutes of August 26 1958). On the competition for deposits, he argued that
the new rate of interest rate would still leave bank interest rates higher than in the
past. He also pointed out that the recent increases in post office deposits were largely
due to accrued interest and not new inflows.
20
The Central Bank had planned to reduce their Re-Discount Rate by ½%. “Should the
commercial banks make no change in interest rates it could well give the impression
that the Central Bank and the Commercial Banks were not at one in their assessment
of the country’s position, a factor that must be deplored, as their interest rates were
identical” (IBSC Minutes of August 26 1958). The banks while still maintaining that
they wished to keep interest rates unchanged, decided, at the meeting of the 29th
August, that it would be “politic” to reduce their rates (hence maintaining their
margins). Although the Minister had requested a ½% reduction, the banks favoured a
¼%. The IBSC informed McElligott that rates were changed “with reluctance and in
deference to the representations made by him”.
The Bank Rate and the London Banks Deposit Rate were again reduced in November
1958 to 4% and 2% respectively. McElligott made his views known to the IBSC in
advance of the meeting. A reduction in interest rates of ¼% would give a welcome
stimulus to industrial development. At the same time a further reduction in deposit
rates would not have an adverse effect on deposits25.
Although the banks favoured leaving interest rates unchanged, they were aware that
not reducing interest rates would lead to pressure from the Government to do so, “in
the light of the ambitious programme of economic development that was envisaged”
(IBSC Minutes of November 21 1958). They were also aware that they could not use
the potential for the loss in deposits resulting from the change, as “despite strong
competition from other savings the deposit resources of the banks had improved very
materially in recent months” (IBSC Minutes of November 21 1958). McElligott was
informed of their decision to reduce deposit and lending rates by ¼% (½ of the ½%
fall in the British rates).
4.4 Agreement - The “Formula”
The Bank Rate and the London Banks rate increased on two occasions in 1960. The
former was raised by 1% to 5% in January and by a further 1% to 6% in June. The
latter was increased to 3% in January and 4% in June. There appears to have been
25
The Central Bank was also planning to reduce the re-discount rate to 4¼%.
21
little discussion about the January decision – interest rates26 were increased by what
was now becoming a “formula”, ½ of the rise in the Bank Rate, thus keeping margins
intact. Again the Central Bank and the Secretary of the Department of Finance were
informed27.
There was some disagreement between the parties about whether interest rates should
be raised following the increase in the Bank Rate in June. Again the Governor of the
Central Bank acting in his role as mediator, called on the Chairman to stress the
pressure that might be forthcoming from government circles against any increase in
Republic of Ireland lending rates, given the emphasis in Government policy on
increasing exports. The banks response was that banking considerations (i.e. the
competition for deposits) necessitated an increase in rates although economic
conditions did not. The “formula” was applied to the lending rates and to the deposit
rate on amounts of <£25,000 but not to amounts of £25,000 or more. This rate was
increased by ¾%, thus narrowing the margin between the overdraft rate and this
deposit rate.
There were falls of ½% in the Bank Rate in October and November 1960. There is
little discussion in the Minutes of either of these decisions. The “formula” was applied
for the October decision and partially for the November decision. In the latter case,
the rate on deposits on amounts of £25,000 or over was reduced by the full ½% fall in
the Bank Rate thus increasing the margin. Interest rates were changed about 1 week
after the change in the British Bank Rate.
In July 1961, the Bank Rate was increased by 2% to 7%. The “formula” was applied
but again, as when interest rates had been previously increased, with the exception of
the deposit rate on amounts of £25,000 or more which was increased by 1½%. “The
Chairman said that the rate schedule would be acceptable by the Department of
Finance as it was now considered as normal” (IBSC Minutes of August 18 1961).
During late 1961 and 1962, the general trend in interest rates was downward. The
26
For this period of agreement there is discussion on the appropriate interest rate that should be
charged for interest rates on loans directly guaranteed by the Government and those loans under the
Trade Loans Guarantee Act.
27
There may have been some disagreement with the Department of Finance as the Minutes state that
“after a series of phone calls with the Department of Finance, the revised schedule was agreed” (IBSC
Minutes of January 25 1960).
22
Bank Rate declined by ¼% in October and November 1961, twice in March 1962 and
again in April 1962. The “formula” was applied on each occasion with the exception
of 2nd November 1961 and 27th March 1962, when the deposit rate on amounts of
£25,000 or over was reduced by the full ½% fall, restoring the margin.
5. 1963 – 1967
During this period conflict re-emerged between the Government and the IBSC. The
disagreement between both parties revolved around the banks’ unwillingness to
finance the government’s expenditure plans in the Second Programme for Economic
Expansion. The expansion in private and public sector credit had negative
implications for price inflation, the balance of payments and the net external assets of
the banking system. Both the Central Bank and the IBSC shared similar concerns,
which resulted in a much closer and cooperative relationship between the Central
Bank and the IBSC. It appears too, from the Minutes that, the concerns of the IBSC
about uncontrolled government borrowing and their realisation that they needed the
Central Bank to protect them, was, the motivating factor behind the Central Bank’s
decision to become more active in monetary policy. During this period the Central
Bank specified particular targets for the banks to achieve which, if adhered to, would
restrict the amount and type of credit that could be created.
At the beginning of 1963, the overdraft rate was 6%, the deposit rate was 1.25% on
amounts <£25,000 and 2.25% on amounts  £25,000. This meant that the margin
between the overdraft rate and the deposit rates were 4.75% and 3.75% respectively.
In contrast to credit policy above, there was little open disagreement between the
three parties regarding the appropriate interest rate to set subsequent to a change in the
British Bank Rate. The only difference that emerged between the IBSC and the
Central Bank was in relation to the first Bank Rate change in January 1963. For the
remainder
of
the
period
the
Central
Bank,
the
IBSC
and
the
Government’s/Department of Finance’s objectives were aligned.
5.1 Initial Disagreement
On the 3rd January the British Bank Rate and the London Banks Deposit Rate were
reduced from 4.5% to 4% and from 2.5% to 2% respectively. The Governor of the
23
Central Bank conveyed to the IBSC his view that “the formula as previously followed
should apply” to changes in Irish interest rates (IBSC Minutes of January 7 1963).
Although he recognised that it was now becoming costly for the banks, he supported
the “formula” because “it secured harmonious relations between the interested
parties” (IBSC Minutes of January 7 1963).
The Banks put their own business and profits ahead of these political considerations.
They favoured a reduction of ¼% in the overdraft and deposit rates only (unlike the
“formula” which would have implied a ¼% reduction overall) to cover their
additional wage costs. Although the Central Bank Governor was unhappy with the
decision, he did not have the power to reconvene the IBSC to reconsider the result.
The banks desire to maintain their autonomy in setting interest rates is apparent.
When questioned by the Governor whether this meant that the “formula” was now
abandoned, he was told that, “no such formula existed to operate automatically on
each interest rate change” (IBSC Minutes of January 7 1963) implying that the banks
still reserved the right to change interest rates as they saw fit.
5.2 Government Policy - The Second Programme for Economic
Expansion
The Second Programme for Economic Expansion was published in August 1963 and
all relevant parties were asked for comments. Unlike the previous programme, it set
down a specific target of a 50% increase in real GNP between 1960 and 1970. The
IBSC responded on 5th March 1964. They stressed the importance of bank stability for
economic development and the need for banks to be able to pursue independent
policies in order to maintain confidence in the banking system. These policies
included being able to: (i) make profits to remain solvent; (ii) have sufficient liquid
resources to meet customer demands and; (iii) being able to obtain sterling on demand
at par for their customers.
The Second Programme “expected that the private sector, stimulated and guided by
public policy and supplemented where necessary by State initiatives, will be the
principal source of new productive projects” (Second Programme for Economic
Expansion, 1963:17). The banks highlighted the factors, under government control,
24
that would negatively affect the availability of bank resources to this sector: (i)
excessive government borrowing (which would reduce the availability of resources
for the private sector)28; (ii) balance of payments deficits (which if not matched by
capital inflows, would reduce the net external assets of the banking system); (iii) the
requirement of the banks to make disclosures about their customer’s affairs for
income tax purposes (which would reduce the attractiveness of banks as recipients for
deposits) and (iv) increased competition with other state-owned savings institutions,
the Post Office Savings Banks and the Trustee Savings Banks (which again would
reduce deposit inflows into the banks).
5.3 Credit Policy and Government Financing
In response to a letter (dated 23rd July, 1964) from the Secretary of the Department of
Finance to the IBSC requesting £8m from the banks to help finance the capital
budget, the IBSC formed a Working Group to examine the capacity of the banks to
fund the private and public sectors during the Second Programme for Economic
Expansion. To do this, projections and information were needed on each of the
following: (i) the growth of resources; (ii) the demands of the private sector; (iii) the
demands of the public sector; (iv) the amount of external reserves and marketable
securities in banking terms needed to meet contingencies and; (v) the willingness and
the capacity of the Central Bank to support the banks in short-term and long-term
investments (IBSC Minutes of July 23 1964).
The Central Bank and the IBSC shared similar concerns about the small size of the
balance of payments deficits projected under the Second Programme (The expectation
was that the deficit in external payments in 1970 would be only £16m). Consequently
“the Central Bank had stressed that it would be desirable and indeed necessary to have
the closest liaison between the Central Bank and the Commercial Banks” (IBSC
Minutes of September 25 1964). By February 1965, the external assets ratio29 of the
The banks’ view on the inefficiency of government borrowing is highlighted. “The economy should
grow in strength and if employment can be ensured at fair and rising wages our people will be put in a
position to do a great many things for themselves better and probably cheaper than can be done by
contributions to state funds for similar purposes” (Report of the Banks on the Second Programme of
Economic Expansion to the Government, 5th March 1964).
29
This is the ratio of net external assets plus balances at the Central Bank to current and deposit
liabilities. This ratio would decline due to an increase in domestic credit (when credit was used to pay
for imports in excess of exports or when there was an exchange for currency at the Central Bank). On
28
25
banks had fallen to 24.5% (as a result of balance of payments deficits that were no
longer completely matched by capital inflows) and the Central Bank were projecting
that this ratio would fall to 15% before 1970, which the Central Bank considered to be
intolerable (IBSC Minutes of February 26 1965).
After a further request on 15th February 1965 from the Department of Finance for
£30.5m30, and the expectation by the banks of, an additional requirement of £20m by
the government to fund the capital budget in 1965-1966, the banks decided that
“action needed to be taken to curb government spending and that the Central Bank
was the appropriate body to take this action” (IBSC Minutes of February 26, 1965)31.
The Working Group felt that there needed to be discussions between the Governor of
the Central Bank and the banks. Following on from this the Central Bank would
indicate to the banks “a prudent level on which to base future credit policy” (IBSC
Minutes of February 26 1965). “The Central Bank would need to express its views on
government financing and, more importantly, its willingness to support the banks”
(IBSC Minutes of February 26 1965).
The banks acknowledged their need of the support of the Central Bank at the IBSC
meeting of the 8th March 1965. Mr. Morrison representing the Bank of Ireland on the
IBSC, stated that the banks were under pressure from both the private sector to extend
credit and the government for increased funding and therefore “the commercial banks
required the assistance of the Central Bank to contain the mounting pressure on them
from both sectors of the community” (IBSC Minutes of March 8 1965). In response to
the short-term funding demands of the government, the Governor of the Central Bank
proposed that: (i) the banks would agree to convert the outstanding £15.5m Exchequer
bills into 1-year bills and (ii) that the banks would agree to a limit of 50% on the rediscounting facility for the new issues.
the other-hand the expansion in domestic credit would increase liabilities to the public on current and
deposit accounts.
30
The banks were asked to convert the outstanding £15.5m Exchequer Bills into 2 year Exchequer
Notes and to provide additional accommodation of £15m.
31
The banks were also under pressure for resources, as “the government was doing everything possible
to absorb all available funds in the country” and “the government too were permitting foreign banks to
establish themselves in the country and so increase competition for the diminished resources available”
(IBSC Minutes of February 26 1965).
26
The banks response shows their willingness to support the Central Bank. They agreed
to (ii), despite consistently demanding full convertibility, because by doing so “it
would considerably strengthen the Central Bank’s position and their own in resisting
pressure from the Government32. By not allowing full re-discounting facilities “the
Central Bank was limiting their support for the commercial banks in meeting the
present government requirements and in this way a brake was being applied to the
growth of domestic credit in the private sector”. Also by agreeing with the Central
Bank proposal it would help “the banks to secure the full support of the Central Bank
in meeting the problems which would confront them in the immediate future” (IBSC
Minutes of March 8 1965).
The Central Bank provided their initial credit advice to the banks on the 13th May,
1965. Firstly the expansion in credit in the nine months to December 1965, should
not expand, in relation to the resources in the state, as rapidly as during the year ended
31st March 1965. Secondly the average ratio of the Associated Bank’s net external
assets plus deposit with the Central Bank as a ratio of current and deposit accounts
(known as the Central Bank Ratio) should not be lower than 22%. Thirdly the
Associated Banks should give priority to loan applications for productive purposes
and especially those relating to the exports of goods and services (Central Bank of
Ireland, 1966: 12).
There was a further request for government funding at the end of June, 1965. The
Government required a renewal of the existing £29m Exchequer Bills and the
provision of a further £12m in Exchequer Bills. At that time the banks were over-lent
(the Central Bank ratio was 20.8%). To provide this funding the banks needed to (i)
increase their resources or (ii) call in existing loans to the private sector with its
negative consequences or (iii) or be able to re-discount these bills fully at the Central
Bank with its negative consequences for inflation. It is clear from the Minutes of the
meeting of June 22 1965, that the Central Bank and the Banks were in agreement that
the government needed to curtail their expenditure. The Department of Finance also
accepted the situation, which is consistent with government speeches (See the Budget
32
The IBSC agreed to provide financing by way of 3-month bills, that the limitation on rediscounting
should be confined to £7.5m of the £15m new bills and that an assurance would be given that full
rediscounting was available for the public issue of bills.
27
speech on 11th May 1965 and the speech delivered by the Taoiseach to the Dáil on the
15th July, 1965). However the Governor of the Central Bank expressed some
reservations about the government’s intended response given the greater importance
they attached to “the target figure of 4.2% annual growth in GNP” than the “yearly
deficit of £16m in external assets” (IBSC Minutes of June 22 1965). Throughout the
summer of 1965, there were numerous communications between the IBSC, the
Central Bank and the Department of Finance regarding the need for further borrowing
by the government from the banks, the need to curtail certain categories of borrowings
by the private sector, and the need for full re-discountability of Exchequer Bills by the
Central Bank.
At the meeting on the 3rd August 1965, the decision was made to reduce the Central
Bank Ratio (which now netted out Exchequer Bills) to 20%, which would permit an
increase in advances. However it was still felt that given the government’s
requirements, banks would be unable to attain this ratio, unless they cut back their
loans to the private sector. At this point the Secretary of the Department of Finance
(Mr. T.K. Whitaker) suggested that the Central Bank should be prepared to finance
some portion of the government borrowing.
5.4 Agreement on Interest Rate Changes
During 1964, the Bank Rate was changed on two occasions. On February 27th it was
increased to 5% and on November 23rd it was further increased to 7%. The London
Banks’ Deposit Rate rose to 3% and 5% respectively. On both occasions the Governor
of the Central Bank had prior discussions with the Department of Finance. In the first
instance the recommendation was an increase of ½% in the overdraft and deposit rates
with a ¼% increase in the other rates. This left the margin unchanged. The banks
concurred as they were proposing “to increase current account fees” and “bank figures
showed that no case could be made to the public or to the government to justify large
revenues from an increase in interest rates” (IBSC Minutes of March 2 1964). In the
second instance the proposal was for an all round increase of 1%. Due to the 2% point
increase in the London Banks’ Deposit Rate, the banks decided to increase their
interest rate on amounts of £25,000 or more by 1½%. This effectively reduced the
margin between this deposit rate and the overdraft rate.
28
There was one interest rate change in 1965. On June 3rd the Bank Rate was reduced to
6%. The initial reaction of the IBSC, at their meeting on June 4th was to leave interest
rates unchanged. In their discussion they refer to the need for consistency between
their own interest rate decision and Government and Central Bank policy at the time.
In the Budget statement of the Minister for Finance, on the 11th May 1965, he stated
that “the budget of 1965 should be so constructed so as to result in a balance on
current account33” and “that in the credit field it must be accepted that the commercial
banks cannot afford to expand credit as liberally as in recent years and that, in any
case, it is undesirable that they should lend so much as to cause the balance of
payments deficit to exceed the 1964 figure; at the same time they should ensure that
credit is available for productive purposes, especially those connected with the
expansion of goods and services” (Budget Statement 1965: 9). As we noted earlier the
Central Bank had provided advice to the banks on restricting credit. Maintaining
higher interest rates was also consistent with the banks’ need to increase resources.
Although the Central Bank and the Department of Finance supported the IBSC’s
initial decision, the Minutes still record a discussion amongst the members about
whether interest rates should be reduced, pointing to their continued desire for
autonomy. One issue raised was whether the Central Banks and the Department’s of
Finance agreement would mean that the bank’s freedom of action in the future would
be curtailed. All parties were concerned about the public’s reaction to the decision not
to reduce interest rates. Consequently in the Press Release, reviewed by all parties, the
emphasis is placed on the need to maintain high interest rate to enable the banks to
increase resources to match the demand for loans.
The next increase in the Bank Rate took place in July 14th, 1966. At the time there
was a bank strike in Ireland and the decision was not to change interest rates until the
bank strike was over. However at a meeting of the IBSC on the 22nd July the IBSC
stated that they wished to increase interest rates to increase deposits and reduce
lending. The Central Bank Governor responded that, “if such a decision was reached
the Department of Finance might wish to probe its effect on profitability” (IBSC
33
The Balance of Payments deficit was projected to be £30m in 1965. This was the same as in 1964.
However whereas the deficit in 1964 was balanced by net capital inflows, resulting in an increase in
external monetary reserves by £5.2m in 1964 (Central Bank Annual Report 1964/1965:7), the deficit in
the first quarter of 1965 resulted in a fall of £13.5m in external monetary reserves.
29
Minutes of July 22 1966). By the 5th of August 1966, the position of the Department
of Finance had changed. The IBSC were contemplating an increase of 1% in the
deposit rates and of 0.75% in lending rates (which would have reduced the margin).
Both the Central Bank and the Department of Finance approved of the change and
recommended a change as soon as possible. In fact the Secretary of the Department of
Finance mentioned to the IBSC the possibility of the government increasing the
interest rates of their domestic competitor, the Post Office Savings Banks.
The IBSC wanted the Central Bank to support their decision to increase interest rates.
However at the same time they wanted to maintain their independence. This was
violated by the Governor’s Press Release on the 29th July on credit policy, which
signalled a relaxation in credit supply (and which the banks stated was affected by
political considerations) and that the banks would be increasing rates on deposits and
loans, which pre-empted the banks’ own announcement.
6. 1967-1970
At this stage, the Central Bank’s role in influencing interest rates is much stronger.
They provided guidance to the IBSC on appropriate changes in interest rates and
discussions take place between these two parties only. The view of the Central Bank
was that although it was not a price fixing authority, it was entitled to offer comments
on the rate changes it considered appropriate (IBSC Minutes of March 28 1967).
Direct interference from the Minister for Finance/Department of Finance also appears
to be less and in some cases the Minister appears not to have been consulted in
advance of the interest rate change. However despite little direct contact, concern by
the banks about interference from the Department of Finance in banking affairs, is
sufficient to influence their decisions and importantly getting them to co-operate with
the Central Bank. By 1970, the view of the then Governor, Dr. Whitaker, was that
any change in interest rates was a matter for a decision by the Associated Banks in
consultation with the Central Bank (IBSC Minutes of April 17 1970).
One issue that features many times is the size of the interest rate margin. What is
interesting over this period is that despite the concerns of the Central Bank about its
large size, the interest rate margin between the overdraft rate and the deposit rate on
30
smaller amounts rises, over this period, from 4.5% to 5% while the interest rate
margin between the overdraft rate and the deposit rate on larger amounts rises from
3% to 3.5%.
6.1 Disagreements
There are two trends in interest rates in 1967. During the first 6 months, the Bank
Rate fell by ½%, on three occasions in January, March and May from 7% to 5.5%.
The second half of 1967 is dominated by the three interest rate increases associated
with the sterling devaluation, on the 19th October to 6%, on the 9th of November to
6.5% and on the 18th November to 8%.
There is continued guidance from the Central Bank on interest rates during 1967.
Prior to the meeting on the 10th February, the governor had requested that, “any
decision reached should not be implemented until they had been further discussed
with him”. After the Bank Rate change on the 21st March, he had requested that no
change be made until he had consulted with the board of the Central Bank.
A number of factors affected banks’ decisions. Firstly, interest rates paid by their
competitors. The banks were concerned about paying a deposit rate of 3% on small
amounts (<£25,000) due to competition from the Post Office, which was paying 3.5%
at that time.
Secondly the banks were expecting increased demand from the
government for accommodation, which necessitated keeping their resources up and
the demand for advances down.
Thirdly the banks were concerned about their
profitability. Consequently, the IBSC34 were in favour of keeping interest rates
unchanged in January 1967. Although the governor of the Central Bank referred to a
possible public outcry if the overdraft rates were not reduced, he recognised that given
the possibility of a further reduction in March, the Central Bank “took the view that
on balance there should be no change now” (IBSC Minutes of February 10 1967).
There was some internal disagreement between the member banks – one bank favoured an
immediate reduction in interest rates (due to the fall in earnings as a result of the more than expected
decline in call-money rates), the other banks placed greater emphasis on the need to remain competitive
for funds.
34
31
There is much greater disagreement between the Central Bank and the IBSC in
March. The Governor felt that interest rates should now be reduced by the full ½% (“a
¼% decline would be faced with public derision”). He particularly focussed on the
current wide spread between the lending and the borrowing rate (4.5% and 3%
respectively), and his personal view, that this should be narrowed. In the exchange
between the Chairman and the Governor, the Chairman said, that “if the Central Bank
sought to impose its views on the commercial banks it would result in a serious
deterioration of their relations at a time when it was most important that everything
possible should be done to improve them” (IBSC Minutes of March 21 1967). The
IBSC calculated a £800,000 fall in earnings as a result of the decline in money market
rates. They proposed a reduction of 3/8% in the overdraft rate and a ½% and ¾%
reduction in the deposit rate for amounts of <£25,000 and £25,000 respectively. The
size of the reduction was determined by the desire not to reduce deposit rates on the
lower amount below 3% (given the POSB rate of 3.5%).
The Central Bank board responded (Letter dated 22nd March, 1967) that in its view it
was appropriate to reduce the rate of interest on deposits <£25,000 by ½% and on
amounts of more than £25,000, by a higher amount. The banks could reduce their
overdraft rate by ½% particularly if no reduction is made on the rates charged in other
categories. The Bank also felt that an aim of policy should be the reduction in the
margin between the rate of deposits under £25,000 and the overdraft rate. In their
response (Letter dated 30th March, 1967) the banks replied that this margin had been
reduced, that there had already been a loss of 1% on earnings from liquid assets, and
that deposit rates were necessary as lending was extremely high. One comment is
insightful on the IBSC’s view on the Central Bank at that time “Central Bank thinking
at times follows a line which showed that they were somewhat remote from the
practical problems of commercial banking” (IBSC Minutes of March 28 1967).
The Minister for Finance does not appear to have been consulted on these interest rate
decisions. In a letter to the Standing Committee, dated 31st March, the Minister
expressed his disapproval at their decision – the low reduction in the overdraft rate
and no change in the special overdraft rates. “The banks without specific consultation
with the Department decided to change the relationship between the lending rates on
32
ordinary and special accounts, which emerged as a result of discussions some years
ago”. (This was the “formula”). The Minister expected a further reduction in interest
rates and he urged, “that the banks should take an early opportunity to revise the
matter”.
The discussions by the IBSC about their response to the decline in the Bank Rate in
May, provides a clear statement on the now differing roles of both the Central Bank
and the Department of Finance on interest rate decisions. “The Governor of the
Central Bank took the view that it was the function of his Board to advise on the
changes considered desirable, but he recognised that the Department of Finance were
entitled to make representations concerning these rates which affected them” (IBSC
Minutes of May 12 1967). The banks concern about the government is clearly evident
in the discussions. Their concern stemmed from the investigation currently being
conducted by the National Board for Prices and Incomes in the UK, on bank charges
and their fear that if the Board was critical of the UK banks, that a similar inquiry
might be established in Ireland35. The belief voiced was that “co-operation with the
Central Bank was the best defence against the Department of Finance” (IBSC Minutes
of May 12 1967)36. Interestingly the Central Bank also shared this view - they saw
their position as being “middle-term” between the government and the Bank and they
“would not like to see the authorities drawn too closely into the banks affairs” (IBSC
Minutes of May 26 1967). The Governor advised the banks that if they adopted a
“stand-offish attitude, did not co-operate with the Central Bank on disclosures (of
profits) and did not accept the advice of the Bank, politicians might press for this
inquiry”. He re-iterated clearly his desire not to get involved in banks “prices and
profits” and “that if the bank wanted to remain independent the banks should be
careful not to provide opportunities for interference by outside influences” (IBSC
Minutes of May 26 1967). The banks agreed the rate decreases; a ½% fall in deposit
rates (bringing it below 3%) and a 3/8% fall in the overdraft rate. Interestingly this
increased the margin on deposits of less than £25,000 to 4.75% but reduced it to 3.5%
on amounts of £25,000.
35
The Report was published on 15th May, 1967.
It would be embarrassing for the Central Bank if the banks continued to refuse advice as had
happened the last time (IBSC Minutes of May 12 1967).
36
33
The second half of 1967 was dominated by the increases in interest rates associated
with the sterling devaluation of 18th November 1967. Neither of the increases in the
Bank Rate on the 19th October or the 9th November was followed by an increase in
Irish rates. The advice of the Central Bank was that interest rates should be left
unchanged given current Irish economic conditions. The Central Bank suggested the
increase in the Bank Rate on the 18th November should be followed by an increase of
1¾% in all deposits and a 1¼% on overdrafts and advances. This was not in line with
either the original views of the Chairman of the IBSC (he favoured a 2% increase in
deposits and a 1½% increase in advance rates “to prevent a distortion in net external
assets, through transfers or deposits, while at the same time avoiding a deflationary
effect in the economy”) or the Department of Finance which wanted lending rates to
increase by ¾% and deposits by 1%. The banks adopted the Central Bank’s view.
The reasons that they gave were: the need to safeguard deposits, to avoid a significant
difference in overdraft rates between Ireland and London which would mean that
British subsidiaries in Ireland would increase their borrowings here, to distinguish
between conditions in Ireland and the UK37 plus the resultant reduction in margins
would eliminate any discussion on bank profits38.
6.2 Disagreement - Government Financing
There were two declines of ½% each in the Bank Rate on the 21st March and the 19th
September. The banks decided to leave their interest rates unchanged after the first
reduction (as there was uncertainty about the future path of interest rates). The
discussions subsequently on interest rates were overshadowed by the government’s
capital budget statement “there is no shortage of credit for productive private
investment and it is reasonable in these circumstances to call on the banks to provide
the estimated residual finance required” (IBSC Minutes of April 11 1968).
The emphasis on government borrowing concerned the banks for a number of reasons
and effectively stalled the change in Irish interest rates until after the second Bank
Rate change in 1968. The banks argued that this should not have been published
“The Irish economy was at present strong and the banks’ must encourage rather than inhibit business
confidence” (IBSC Minutes of November 20 1967).
38
The banks wanted to “avoid at this stage any suggestion of improvements in profits especially in
view of the forthcoming investigation by Cooper Bros.” (IBSC Minutes of November 20 1967).
37
34
without prior consultation. They stressed the negative implications that this would
have for the Irish economy in terms of the quantity of funding and they questioned
how they could support the financing of the programme, through the acceptance of
Exchequer Bills (with their lack of marketability), and still at the same time satisfy
liquidity requirements.
The Governor of the Central Bank concurred with the banks concerns. He was
concerned about “the level of public expenditure, the ability of the economy to accept
injections of the order proposed and the ability of the banks to finance the private
sector” (IBSC Minutes of April 11 1968). The frustration of the Secretary of the
Department of Finance, Mr. T.K. Whitaker with the inability of the government to
obtain funds is apparent and the IBSC’s concern that “the Department might adopt the
alternative of competing with the banks for funds” (IBSC Minutes of April 11 1968).
The banks reduced their overdraft rates (to make it acceptable to the government) and
deposit rates to the same level as in August 1966 when the Bank Rate had last been
7%. The deposit rate on amounts of <£25,000 and >£25,000 were reduced by ¾% and
½% respectively, while rates on advances were reduced by ½% which allowed them
to increase the margin between the lower deposit rate and the overdraft rate. The
Department of Finance had also made it clear that it would have increased interest
rates on Post Office Savings if the Associated Banks had left their rates at the
previous high level.
6.3 New Governor
The new Governor (former Secretary of the Department of Finance, Dr. Whitaker)
was in place for the next Bank Rate increase to 8% on the 27th February 1969. The
increase in inflation and balance of payments deficits dictated the Central Bank’s
views on interest rate increases. In their view “primary attention should be given in
this context to the production of liquid monetary resources and the restraint in
lending” (IBSC Minutes of March 10 1969). The Central Bank suggested the actual
size of the interest rate increase that should be introduced (1¼% increase on deposits
of amounts <£25,000 and a 1% increase on the overdraft rate and the deposit rate on
35
larger amounts. These increases were greater than those favoured by the Department
of Finance (1% increase in deposit rates and ¾% increase on overdraft rates).
The banks concurred more with the Central Bank, favouring an increase of 1% all
round in lending rates to deter borrowers and encourage depositors. These changes
enabled them to maintain their margins. In contrast as pointed out in a letter sent by
the Governor to the IBSC, after the change, the Central Bank did not object to the
banks’ decision, the reduction of margins “is however a consideration which might
appropriately be taken into account on the occasion of a future review of interest
rates” (Letter dated 12th March 1969).
7. Conclusions
This paper has reviewed the emerging and evolving relationship between the Irish
Central Bank and the IBSC. In the 1950s the Central Bank played an insignificant
role. However as it evolved it became a much more active participant in interest rate
discussions. Its relationship with the IBSC fluctuated during the decades. Initially it
was just simply informed of interest rate changes. However by the 1960s the banks
began to recognise the benefits of cooperating with the Central Bank because of its
potential role as a protector against government interference.
During these two decades the government interfered, on a number of occasions, in the
interest rate decision-making of the IBSC. They used a variety of threats to get the
banks to behave more in line with their policies (removal of autonomy, enquiries into
bank profitability, bank charges, increasing interest rates of competitors). In many
cases this resulted in a modification of the original interest rate decisions of the banks.
At particular times, the banks responded by using their unique role as lenders to the
government to try to retain their independence in setting retail interest rates.
36
References
Banking Commission (1926), Final Report of the Banking Commission, Dublin: The
Stationary Office.
Central Bank Annual Reports, Various Issues.
Commission of Inquiry into Banking, Currency and Credit (1938). Reports, Dublin:
The Stationary Office.
Fanning R. (1978) The Irish Department of Finance 1922-1958, Institute of Public
Administration, Dublin.
Lee J.J. (1989) Ireland 1912-1985, Cambridge University Press.
Moynihan M. (1975), Currency and Central Banking in Ireland 1922-1960, Gill and
MacMillan.
O’Grada C. and P. Honohan (1998), The Irish Macroeconomic Crisis of 1955-56 –
How much was due to Monetary Policy, Irish Economic History XXV, 52-80.
O’Mahony D. (1964), The Irish Economy, Cork University Press.
37
Fig. 1: Irish Overdraft Rate, Irish Banks Deposit Rates
& British Bank Rate 1952 - 1960
5
4.5
4
Gap Between
OR & Deposit
Rate<£25,000
3.5
%
3
2.5
Gap Between
OR & Deposit
Rate > £25,000
2
1.5
1
Gap Between
OR & British
Bank Rate
0.5
July
Nov
Mar-59
July
Nov-58
Mar-58
July
Nov
Mar-57
July
Nov
Nov
Mar-56
Jul-55
Mar-55
July
Nov
Mar-54
July
Nov-53
Mar-53
July
Nov
Mar-52
0
Year
Fig. 2 Irish Overdraft Rate, Irish Banks Deposit Rate
& British Bank Rate 1960-1970
7
6
Gap between
Or & Deposit
Rate <£25,000
5
4
3
%
Gap Between
OR & Deposit
Rate > £25,000
2
1
Ja
n-
60
Ju
l-6
Ja 0
n61
Ju
l-6
Ja 1
n6
Ju 2
n6
D 2
ec
-6
Ju 2
n6
D 3
ec
-6
Ju 3
n6
D 4
ec
-6
Ju 4
n6
D 5
ec
-6
Ju 5
n6
D 6
ec
-6
Ju 6
n6
N 7
ov
-6
M 7
ay
-6
N 8
ov
-6
M 8
ay
-6
N 9
ov
M 69
ay
-7
N 0
ov
M 70
ay
-7
1
0
-1
-2
Year
38
Gap between
OR & British
Bank Rate