An EU bank bailout facility?

Bloomberg reports on a potential proposal by the European Commission to alter the EU’s ‘Balance of Payments’ (BoP) facility to allow it to aid banks which may need to be recapitalised in the aftermath of next year’s ECB Asset Quality Review and the EU's bank stress tests.

As a reminder, the BoP facility was originally created to aid countries with currency crises that may impact the rest of the EU or the fundamental stability of the state. It has since been adjusted to apply to only non-euro members and seen its scope widened slightly with its budget increased to €50bn due to the financial crisis. It is guaranteed by the EU budget and therefore ultimately by the member states - with the UK underwriting around 14-15%.

What is the rationale behind this move?

• Next year’s stress tests are hopefully going to be the most stringent and comprehensive so far, yet there are fears that, without clear aid to help banks found to be in trouble, supervisors may shy away from revealing any deep problems.
• This is backed somewhat by the ECB’s insistence that the stress tests will not be able to be effective unless there are clear backstops for banks in place.
• The eurozone does have some form of backstop in the shape of the ESM which can provide aid to banks (via states) but also has a direct bank recap tool.

Can it be done?

• The most likely approach would be to use Article 352 (the flexibility clause) to adjust the regulation establishing the facility.
• However, the facility also has a treaty base, Article 143, which specifies lending to states. For this reason, it seems unlikely that a direct recapitalisation tool could be added but a credit line which is lent to states to solely aid banks could potentially be. This could come with less or more specific financial sector conditions than other loans (for example see ESM and Spanish bank bailout).
• This would require unanimous approval in the Council. So far, Germany and the UK have expressed scepticism based on the fear that a backstop would reduce the pressure on banks (and their governments) to reform and clean up ahead of the tests.

Could it be significant?

• Yes. If it were approved it would create a collective fund to salvage banks should a member state be unable to deal with the problem alone. If the UK were to approve the move it could open up the door for future pay-outs of funds to aid other countries' banks – decisions taken under qualified majority voting. 
• Furthermore, it also seems to be driven by events in the eurozone. Firstly, it seems an attempt to extend this centralised banking union model (to break the so-called sovereign-bank loop) to the entire EU - even though the other countries have already rejected this to a large extent. If they really wanted to join the banking union, which some might, there will be chances for them to engage directly.
• The creation of the fund would raise some serious questions. Will this backstop exist without strong influence over the amount of risk taken in or the relative size of banking sectors to governments across the EU? If so, surely that creates a moral hazard problem. If not, it would necessitate far greater powers over member states' financial sectors. 
• Lastly, it highlights the level of concern around the health of many of the EU's banks. This was furthered by the EBA's recent assessment that the largest EU banks are some €70bn short of where they need to be to meet the new Basel III rules.