ESM Power to Aid Banks Directly Wins Euro-Area Accord

The euro area’s firewall fund will be ready by November to provide direct aid to banks if needed, fulfilling a two-year-old promise by European Union leaders to break the cycle of crisis contagion between banks and sovereign borrowers.

The 18-nation currency zone today reached political accord on how to expand the European Stability Mechanism’s toolbox, said Dutch Finance Minister and Eurogroup chief Jeroen Dijsselbloem. That means the new powers will be ready when the European Central Bank takes on bank supervision later this year.

Countries may request direct aid for their banks if they can show that their banks are crucial to financial stability and that they can’t afford to provide help on their own, according to ESM rules. Private-sector creditors also will be required to take losses, and the ESM would take a temporary equity stake in any bank that receives assistance.

“The instrument may be activated in case a bank fails to attract sufficient capital from private sources and if the ESM member concerned is unable to recapitalize it, including through the instrument of indirect recapitalization of the ESM,” Dijsselbloem said in a statement.

EU leaders in June 2012 promised to liberate countries from the burden of backing their financial systems during a market meltdown, provided bank oversight was consolidated under the European Central Bank. The ECB is now poised to take on its new role before year-end after completing a health check of the euro area’s biggest lenders.

Spain Assistance

So far, the ESM has offered only indirect assistance to banks via loans to nations. “With these funds the government then recapitalizes the banks, which is how the ESM provided assistance to Spain,” the ESM said on its website. “However, such assistance adds to the beneficiary country’s public debt, which could have a negative impact on market sentiment.”

Direct recapitalization powers would reduce the impact on host nation finances. To use the new tool, nations will need to make a capital contribution alongside the ESM.

The capital investment will vary depending on what shape the bank is in. Countries must raise a bank’s capital if, after private-sector losses are imposed, the bank in need of aid can’t meet the legal minimum requirement of 4.5 percent common equity tier 1 capital. If a bank does meet that standard, national burden-sharing is required.

“This contribution will be equivalent to 20 percent of the total amount of public contribution in the first two years after bank recapitalization enters into force,” the ESM said. “Afterwards, the ESM member’s contribution will amount to 10 percent of the total public contribution.”

In 2015, nations that wish to tap the new ESM instrument will need to apply a “bail-in” equal to 8 percent of all liabilities and also tap any funds that are available through a new euro-area bank resolution fund. From 2016 onward, forthcoming EU bail-in rules will apply for creditor losses.

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