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Friday, June 21, 2013

Eurozone compromise on using ESM to directly recapitalise banks - a stopgap at best?

Eurozone finance ministers finally reached a compromise yesterday which will allow the ESM, the eurozone
bailout fund, to directly recapitalise ailing banks.

This is likely to be an important element of any ‘solution’ to the eurozone crisis, especially since it will probably be incorporated into the plans for a eurozone banking union and single bank resolution fund.

Below we summarise and analyse (in bold italics) the key points of the agreement:
€60bn limit: ESM funds available for direct bank recaps will be limited to €60bn out of the total €500bn, since this method of funding eats up the capital of the ESM more quickly. Given the size of the eurozone banking sector – around €34 trillion or 360% of eurozone GDP – this seems far from sufficient.

Burden sharing: National governments will have to contribute 20% of the funds for the first two years and 10% thereafter. Furthermore, ESM funds can only be injected once the bank has reached a core tier one capital buffer of 4.5% - any recapitalisation to achieve this minimum level will also fall on national governments. This is a logical compromise, but it means that the link between sovereigns and banks is not completely broken. It is only "diluted" (as EU Economic and Monetary Affairs Commissioner Olli Rehn put it). Combined with the above funding limit, this places some tight constraints on the level of capital injection possible.

Strict conditions: The funds can only be used for banks which are deemed 'saveable' and have no other alternative. These banks must also be systemically important (in the relevant member state at least). It must also be impossible for the member state to bailout the bank on its own without harming its fiscal sustainability. There must also be independent stress tests performed ahead of any ESM contribution. Any contribution will come with strict conditions both on the bank and possibly on the member state.
Bail-ins: The agreement states that “sufficient contributions from existing shareholders and creditors of the beneficiary institution”will need to be explored. This suggests that the final agreement on the Bank Recovery and Resolution Directive will play an important role in determining how and when this fund is tapped. The emphasis on bail-ins is of course positive but until related plans are settled uncertainty will remain.
Final liability: A subsidiary of the ESM will be set up to directly purchase equity in ailing banks. This allows final liability for the rescue programme to rest with the ESM rather than states.

Retroactive use (legacy assets): The funds can be used to retroactively takeover the burden of previous bank bailouts, although this will be decided on a case-by-case basis. German Finance Minister Wolfgang Schäuble described this as "a concession to our Irish friends". This gives hope to Ireland that the cost of its bank bailout can be shifted. However, given the above limits and the conditions, this still seems a distant prospect.
At first look then, it is positive that an agreement has been reached but this looks to be a stopgap at best. It is clearly tightly constrained by the limits on lending but also by the conditions – in particular the need for a strict independent stress test which could eat up precious time in a crisis. The hurdles to retroactive use are also significant – there is far from sufficient funds to cover for the Irish, Spanish and Greek bank bail-outs (up to €125bn in total), while opening a country's economy to further oversight is far from desirable.

To be fair, given how tied in this is with the single bank resolution mechanism, banking union and the Bank Recovery and Resolution Directive, it may be too early to fully assess how effective it might be. It's also worth noting that the plan will likely need approval from some national parliaments, notably the Bundestag (H/T Bruegel).

The most conerning point is probably that if this is a precursor to the eurozone's single resolution mechanism, it is likely to fall short of fully breaking the dangerous sovereign banking loop in the eurozone.

5 comments:

ayman khlifat said...

Very great , thank you

Chris said...

PONZI-squared

Rik said...

They never make 2014. Well may be year end if they are very lucky.

Present ESM is before the GCC, ruling say October. Approval current ESM can first realistically happen after that.
Subsequently the ESM treaty/ German inplementation law has to be changed. It simply requires a change of the German law. Which undoubtedly will give rise to another GCC case.
Subsequently ESM has to decide to do the thing (which if all the prior steps are taken looks a formality.

Finns are imho also doubtful. But probably can be formally overruled. Which is politically however not the wisest move.

Jesper said...

At least this agreement concerned something that might best be handled on a transnational basis - contrasted with the handling of olive-oil...
Rule of thumb should be: If something is important enough to be dealt with at minister level then it MIGHT possibly be something to be agreed on a transnational level.

The agreement appear to meet some criteria for success:
-it is an agreement and not having an agreement would cause a loss of face for some important people.
-on the other hand the agreement is at the moment so vague it is almost meaningless. And that is important for other important people.

I'd say that it is another example of imprudent deal-making: -Assumptions have been made, countries are still so different and ivorytower-living decisionmakers are not aware of major differences which will change the outcome resulting from any agreement
-Details are not yet specified and the devil is in the detail. ECJ will be the body responsible for interpreting the details and most likely that will mean that further competences risk being transferred (covertly?) from nations to EU-bodies.

Rik said...

@Jesper
Some remarks:
1. The ECB is hardly a guarantee that no bankingcrisis can develop in the future. It missed the current one completely for starters. And it is really helpful in creating the next one by allowing PIIGS banks to go massively into PIIGS bonds. It is simply trying to mix politics (saving PIIGS and the Euro), with proper CBing and not very well.

2. One of the problems is that this way a lot of people's own responsability is taken away. Savers are not forced to say goodbye to rubbish banks. Spain as an example has not only an issue in relation with the North of the EZ. It also has one internally half at least of the banking sector is undiluted rubbish. And that turn over in numbers it is probably even much higher. Most of its Cajas should get one between the eyes if having a healthy banking sector in the future is a priority. Horribly managed 19th century like institutions.
Anyway the EU and Spain even more seem very reluctant to do something about it. It looks like Spain is waiting for somebody else to pick up the bill. Systems that allow that are usually not very successful.
And the pressure the ECB cut put on them now, is simply not used as well.
I truely believe that proper accountancy rules would do a lot more benefit. Now the rules are purely legalised (what you can get away with) if you can have a proper 'old fashioned' BS and P&L it is much easier to solve risk problems, rescue things, recapitalise banks, liquidate bad banks and above all manage things.