July 31 (Bloomberg) -- The European Union wants to know how far its national governments are willing to go to ensure that the euro area’s new bank resolution authority has the funds it needs in an emergency.
As part of its drive to prevent future financial crises, the EU created the Single Resolution Mechanism for the euro area backed by a 55 billion-euro ($74 billion) fund to cover the costs of saving or shuttering banks. During the eight years when the fund is filling, or if even the full amount proves insufficient, it may need extra bridge-financing cash fast to get the job done.
The European Commission identifies three main options in a document circulated this week to EU governments and obtained by Bloomberg News. States could provide guarantees allowing the resolution fund favorable access to financial markets. Barring such common guarantees, which have little political support, countries could pledge the money needed on their own or through a pooled arrangement, according to the document.
At stake is the EU’s drive to break the link between sovereign struggles and bank-sector woes, a major source of contagion during the euro-area financial crisis. When the resolution authority was created, nations agreed to provide bridge financing for the fund. Now the commission wants to clarify how that will work.
“A progressive pooling of credit lines would have the advantage that the sovereign-bank nexus would gradually weaken,” and the resolution fund would enjoy “more certain and swift” access to emergency financing, the document states. Without such pooling, the targeted link between countries and their banks would remain.
‘Credible and Strong’
The banking sector would be responsible for paying back any debt issued by the resolution fund via the fees lenders will pay in over time.
“We would need something credible and strong for the immediate future,” Portuguese Finance Minister Maria Luis Albuquerque said at a meeting with her EU counterparts in March. “The stronger and the more credible it is, the less likely it becomes that we may actually need it.”
The bridge-financing debate is separate from talks on a possible public backstop that could be put in place after the resolution fund is filled.
The commission document asks countries whether they’d be willing to provide direct bridge financing, whether they’d support a system of guarantees for market borrowing and how they’d respond if a country couldn’t meet its commitments.
The board of the SRM, which assumes its duties in January 2016, could tap financial markets for as much as 20 billion euros during its start-up phase, according to a commission estimate of its stand-alone borrowing capacity.
Furthermore, it’s impossible to know how much money might be needed during a crisis, according to the document. This means EU nations face additional pressure to find a strategy acceptable to voters and to financial markets.
“Irrespective of the option considered, it does not appear possible at this stage to make a reliable estimate of the amounts potentially needed for bridge financing,” the document states. As a result, any financing ceiling “must necessarily be the outcome of political rather than technical considerations.”
Countries face a trade-off between creating a reliable system and retaining the discretion to review all decisions before any funds are released, according to the document. If a member state doesn’t deliver on its promised commitments, it could make it difficult for the fund to resolve a bank without hurting financial stability.
When designing the financing mechanisms, the EU will need to consider how it will handle non-euro nations that sign their banks up for European Central Bank supervision, which begins in the euro area in November, and for the SRM. Bulgaria said it has approached the ECB, and Denmark is considering its options.
If the EU decides to use existing facilities to provide bridge financing, non-euro nations face significant drawbacks, according to the document.
Nations inside the euro zone could tap the 500 billion-euro European Stability Mechanism, which in addition to its sovereign bailout tool kit has the power to provide direct aid to banks or to offer targeted aid to a national government, as it did for Spain’s financial sector.
The EU’s balance-of-payments facility, which has offered rescues to non-euro nations, does not have such targeted powers, and the U.K. and Germany have blocked a bid to extend that fund’s rescue options. Broader issues of capacity might also come into play.
“Existing sovereign backstops have limited resources which -- if used for banking resolution -- would not be available for more general financial needs in crisis situations,” the document states.
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