EU’s Greek Bailout Toolbox Holds Three ESM Options for Banks

Greek Anti Austerity Rally
Protestors march through the streets during an anti-austerity rally in Athens on Friday. Photographer: Yorgos Karahalis/Bloomberg

Greece’s road toward a third bailout package will have to go through the country’s banks.

Both Prime Minister Alexis Tsipras and Greece’s creditors face tough decisions about how to shore up the country’s financial system and reopen its lenders, which have been shut for two weeks amid record deposit withdrawals and doubts over the country’s place in the euro area.

Tsipras seeks a bailout of at least 53.5 billion euros ($60 billion) to rebuild the Greek economy, and bank aid is one of the areas where those funds are most needed. To win support and keep Greece firmly in the currency bloc, he has submitted a packet of spending cuts, pension savings and tax increases for study by creditor institutions and finance ministers.

The Greek application includes a “request for stability support” within the euro area’s treaties, “given the risk to the financial stability of Greece.”

Greece has three main options available to prop up its banks through the euro-area’s firewall fund, the European Stability Mechanism. The first of these would be an ESM support program for the government with funds earmarked for banks.

This arrangement would be similar to Greece’s second bailout from the European Financial Stability Facility, the ESM’s predecessor organization. The 143.6 billion-euro package included 48.2 billion euros for bank recapitalization, delivered to the Greek government for the Hellenic Financial Stability Fund to recapitalize and resolve banks.

Spanish Option

A second option could reprise Spain’s assistance program in 2012, whereby the government in Madrid borrowed 41.3 billion euros from the ESM specifically to shore up banks weakened when a real estate bubble burst during the financial crisis.

The ESM transferred the funds to the Fondo de Restructuración Ordenada Bancaria, or FROB, the bank recapitalization fund of the Spanish government. This was a loan to the Spanish sovereign, and the government is responsible for its repayment.

The last option, which would keep any loans off the state’s books, is a direct recapitalization of individual banks by the ESM. This would ordinarily take the form of the acquisition of common shares that satisfy the rules on common equity Tier 1 capital under European Union law.

Such an approach comes with a long list of preconditions that could make it less attractive to the Greek authorities.

Direct Request

The government in Athens can request that the ESM directly aid a stricken Greek bank without having applied for a broader program. The tool is intended to address “acute difficulties” with a country’s financial sector “that cannot be remedied without significantly endangering its fiscal sustainability due to a severe risk of contagion from the financial sector to the sovereign.”

The measure is to be used for recapitalizing financial institutions, not for shutting them down. A restructuring plan for the bank must first be approved that ensures its viability after the capital injection. Before funds can flow, shareholders and creditors must offer loss-absorbing buffers equivalent to 8 percent of the bank’s total liabilities including own funds.

And after all that, Greece may still have to kick in hefty sums of its own.

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