EU Soothes German Aid Qualms to Agree on ECB Bank-Test Backstops

European Union ministers overcame German unease on direct aid to lenders and agreed on rules for how public funds can be made available for banks shown to have insufficient capital in upcoming balance-sheet checks.

EU finance ministers meeting in Brussels yesterday smoothed the wording of a statement on how they’ll deal with shortfalls after the European Central Bank’s asset-quality review and stress tests. The final wording gives reassurances that Germany’s parliament would have the right to veto any direct aid from the region’s common bailout fund.

Member states should “implement appropriate arrangements, including the establishment of national backstops ahead of the completion of this exercise,” according to the statement published by the Council of the European Union. Direct lending by the ESM bailout fund may only be used “when adopted according to euro-area and national procedures,” leaving room for the Bundestag to object.

German Chancellor Angela Merkel’s Christian Union bloc and the Social Democrats, in negotiations to form Germany’s next government, were deadlocked this week on whether to allow direct recapitalizations for weakened banks. The statement’s language reflects Germany’s reluctance to commit to rules before it forms a new government, and its view that direct recapitalization of banks via the ESM won’t start for at least another year and will then still require approval by German lawmakers.

Not Agreed

“The formation of the new government isn’t completed and insofar as a government can’t make commitments that go beyond existing law, that’s why I made this caveat in the statement,” German Finance Minister Wolfgang Schaeuble told reporters after the meeting. “Direct bank recapitalization played a role during the election campaign. One has to deal with this reasonably - this isn’t agreed and that’s why I made it clear that it isn’t agreed.”

Schaeuble said that Germany will still adhere to a euro-area commitment made in June 2012 providing for an eventual facility to allow direct bank recapitalizations.

The ECB began a three-stage probe this month into the balance sheets of lenders across the 17-nation euro area, as a precursor to its assumption of financial-supervision duties in November next year. The Frankfurt-based central bank has insisted that governments put backstops in place so that the test is credible.

Spanish Model

Direct bank aid, which can in most cases only happen after the single supervision mechanism starts, is at the end of a cascade of options for dealing with underfunded yet viable lenders. That process starts with banks trying to tap markets for more private capital before they can access public funds in their own country.

According to the document, the ESM fund could then be tapped in a manner similar to Spain’s 2012 bank bailout, which saw the government assuming the debt taken on to rescue its own lenders. If that’s not an option, direct capital injections could then ensue.

“We need these instruments after the SSM has come into existence,” said Thomas Wieser, the official in charge of preparing meetings of euro-area finance ministers. “Because the question of recapitalization only then arises.”

The tools “would be as bad as euro bonds,” SPD lawmaker and coalition negotiator Johannes Kahrs said in a Nov. 12 telephone interview, signaling that if no agreement is found, Germany is unlikely to be able to approve direct recapitalizations should it ever be needed.

Merkel, SPD leader Sigmar Gabriel and Horst Seehofer, who heads Merkel’s Bavarian Christian Social Union sister party, started coalition talks on Oct. 23 with the goal of sealing Merkel’s third-term coalition by Christmas.

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