Oct. 20 (Bloomberg) -- European Central Bank President Mario Draghi said banks should be able to access public aid without wiping out junior bondholders if regulators decide a lender needs more capital and isn’t on the brink of failure.
Draghi urged the European Union to make clear when it will allow exceptions to state-aid rules that require private-sector creditors to take losses before government backstops can step in. He said public capital needs to be available -- without wiping out subordinated debt holders -- if a bank’s holdings are above regulatory minimums and also below what supervisors deem necessary in a particular case.
“An improperly strict interpretation of the state-aid rules may well destroy the very confidence in the euro-area banks which we all intend to restore,” Draghi said in a July 30 letter to EU Competition Commissioner Joaquin Almunia, which was obtained by Bloomberg News. The ECB president called for the possibility of “precautionary recapitalizations” that would dilute shareholders without forcing losses on junior bondholders, and give banks temporary access to public money.
The ECB will be conducting comprehensive assessments of bank balance sheets as it prepares to become the euro area’s bank supervisor next year. The Frankfurt-based central bank has said its reviews need to be tougher than previous rounds of European stress tests in order to reassure investors that euro-region banks aren’t on the brink of another crisis.
New EU state-aid rules that took effect in August require shareholders and junior debt holders to share in the burden of absorbing bank losses before public assistance steps in. The rules are linked to all of the EU’s other efforts to define how it will handle struggling banks, including several proposed EU laws and rules on when lenders could have direct access to the euro area’s 500-billion-euro ($684 billion ) firewall fund.
German Finance Minister Wolfgang Schaeuble has resisted efforts to put EU-wide backstops in place, instead calling for banks to rely on private investors and national resources. During Oct. 14-15 talks in Luxembourg, a rift emerged among finance ministers between proponents of enhanced backstops and those who believe existing options will suffice.
Draghi’s letter emphasized his view that public resources will be necessary to shore up the euro-area banking system. At an Oct. 2 press conference, he said it “astonishes” him that investors have doubts about whether enough backstops will be in place. In the July 30 letter, he stressed the importance of putting mechanisms in place.
“It is essential that member states commit credible public backstops to ensure that resources are available in case private sources of capital are insufficient in the face of capital shortfalls,” Draghi said in the letter. “The absence of a public commitment would undermine the credibility of the exercise from the outset.”
Draghi urged the EU to clarify formally how and when it will allow banks to tap state aid without wiping out junior bondholders. The European Commission has been in talks with the ECB, the European Banking Authority and national regulators, Antoine Colombani, a spokesman for Almunia, said today in an e-mailed statement.
“The revised guidelines also foresee exceptions, which would be applicable for financial-stability reasons and on a case-by-case basis,” Colombani said. He said the rules don’t require senior bondholder losses and seek to limit use of taxpayer funds by asking a bank, its capital holders and junior creditors to “contribute to a maximum extent.”
Since June 2012, when EU leaders handed euro-area oversight to the ECB as a way to break the bank-sovereign links that had exacerbated the debt crisis, EU officials have sought to portray public assistance as a last resort. Creditor countries like Germany and the Netherlands have sought to make it harder for banks to gain access to public money, particular from cross-border backstops.
“The Netherlands and Germany are on the same line. Only under exceptional situations and under strict conditions,” should countries be able to ask the European Stability Mechanism for direct bank aid, Dutch Finance Minister Jeroen Dijsselbloem told lawmakers in The Hague last week. He said the ECB’s balance-sheet reviews and stress tests would probably take most of 2014 to be completed.
Luxembourg Finance Minister Luc Frieden said on Oct. 15 that the EU needs a resolution mechanism that is “as broad as possible” so the EU doesn’t harm its banking sector.
“We have to watch out not to create two kinds of securities, two kinds of banks,” Frieden told reporters in Luxembourg. He called for more discussion of how to step in when a bank requires restructuring.
“The question is about what happens when a bank resolution is needed, whether national or European, and we’re pleading for a more European solution,” Frieden said.
Draghi’s July letter warned that the EU’s efforts to strengthen its banks could have the opposite effect without clearer access to public funds. Banks deemed healthy enough to survive should try to raise capital from financial markets, and they also should have avenues to tap public funds if they can’t raise private capital quickly, he said.
Requiring junior bondholders to take losses, “as seems to be implied by the revised state aid guidelines, could negatively impact the subordinated debt market, which would in the future be wary of a ‘non-resolution’ probability of conversion,” Draghi said.
An ECB spokesman confirmed Draghi’s letter, saying the central-bank president sought to address how the EU would handle cases where bank reviews found that a lender is solvent and also in need of additional capital.
Martin Kotthaus, Schaeuble’s spokesman, declined to comment yesterday. A spokesperson for Dijsselbloem did not have an immediate comment yesterday.
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