EU Says Countries Must Shoulder Responsibility for Ailing Banks

Euro-area states should only be able to seek direct help for their banking systems from the currency zone’s firewall fund if their national solvency is at risk, the European Commission said in a draft report.

Otherwise, the European Stability Mechanism should lend funds to the affected nation, which would then be responsible for channelling the money to overhaul its lenders as was the case for Spain, according to the document obtained by Bloomberg News. Direct ESM aid is part of the European Union’s strategy to shore up its banking system through common supervision and standards for dealing with failing banks.

A nation with weak banks “will qualify for a direct recapitalization only if its public finances are very seriously at risk,” said the undated report intended to accompany commission plans for centralized bank resolution in the euro area, scheduled for release in coming weeks.

As the EU struggles with how to restore economic growth and overcome its sovereign debt crisis, Germany and France last week said work on a banking union to bolster crisis prevention needs to proceed in a coordinated way, suggesting that guidelines for ESM direct aid won’t be ready mid-2013 as planned.

Direct Aid

EU leaders agreed last year that the ESM should be empowered to bypass national authorities and give aid directly to banks in a crisis. The step, like the broader banking union plan, was targeted at breaking financial links between banks and sovereigns.

The EU should confront troubles in its financial system that led to five euro members seeking rescues, according to the undated document. “The question of who pays and assumes losses when a bank is resolved is critical,” it said. “Losses cannot be legislated away.”

The 500 billion-euro ($661 billion) ESM is expected to make as much as 60 billion euros available for bank aid, according to the draft. Taking into account other ESM lending, this would leave 210 billion euros available for new programs, and that amount would rise to 270 billion euros by the end of this year when Spain’s bank-aid program ends.

The prospect of direct aid from the ESM will complement proposals for a Single Resolution Mechanism that will include roles for the commission, bank supervisors and national authorities. This mechanism needs its own fund, which will start out guaranteed by nations and over time be replaced by industry fees, which also would repay the fund for any losses, the report said.

Common Fund

The common fund “should have a guarantee and/or credit line from a public backstop,” the report said. “This could match the target size of the fund the first year and be progressively reduced so as to cover only the difference between the target size of the fund and its actual size.”

The EU should move ahead with all components of the banking union plan as fast as it can, the report said. To avoid delays “concluding these steps should however not be conditional on one another,” the report said.

The draft also said nations will be responsible for any public funds required before 2015, when EU regulators are expected to gain powers to force losses on some creditors under new “bail-in” rules.

EU resolution rules will apply to countries within the euro area, along with any other nations that sign for joint supervision by the European Central Bank. To make the bank backstop system work, nations could amend the ESM treaty or sign bilateral arrangements with participating non-euro nations, according to the document.

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