16 January 2013

WSJ: Obstacles arise for eurozone bank plan

Technical complications and second thoughts from some governments threatened to undermine commitments from eurozone leaders to take pressure off indebted governments by allowing their bailout fund to capitalise banks in these countries directly.

Direct injections into weak banks would deplete the eurozone bailout fund's lending capacity much faster than would extending loans to governments, the fund's usual role. At the same time, some governments are seeking ways to limit the fund's risks. Rich countries, including Germany, are insisting that governments should remain responsible for at least some of the direct aid to their banks so that they cover any initial losses made by the investments.

That marks a departure from a commitment by eurozone leaders, who in June vowed to cut the "vicious circle" linking a government's finances to the health of its banks. Expensive bank rescues had already pushed Ireland into a full-blown bailout and risked doing the same to much larger Spain.

Some of the eurozone's richest members, including Germany, as well as the Netherlands and Finland, have gotten cold feet about taking on responsibility for their weaker neighbours’ banks—especially for so-called legacy assets, or potentially problematic loans stemming from before the ECB takes over bank supervision next year. "We don't like the idea that we changed the rules of the game in the middle of the game", Finnish Prime Minister Jyrki Katainen said, adding that he was "not that enthusiastic" about allowing direct recapitalisations for banks still struggling with legacy assets.

Disagreement remains over how to deal with capital needs that go beyond those minimum requirements. A group of countries mostly from Europe's south want the ESM to take over at that point. That is opposed by the richer northern states, which want the banks' home government to keep at least some responsibility. Finance ministry officials are now discussing whether the home government should retain a stake in additional recapitalisations. Such national stakes could absorb the first round of losses on capital investments and protect the ESM and other euro countries. Discussions on this are still in the early stages, with proposals for national governments to put up from 5 per cent to 30 per cent of the additional needs.

Klaus Regling of the ESM said that because direct investments in banks are riskier than the traditional loans to governments, they could deplete the ESM's €500 billion lending capacity faster. With little or no national loss absorption, a €60 billion direct bank recapitalisation by the fund would use up the same as €180 billion in loans to a government. However, if the government retains some responsibility, that could take that amount down to €90 billion. Another option presented by Mr Regling was to create a subsidiary for the ESM that would take responsibility for direct bank recapitalisations. But that would require additional financial commitments from eurozone states and was therefore opposed by many governments

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