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A Eurozone Restructuring Agency (ERA)
The authors propose that by mid-2014, at the end of the process of the asset quality review (AQR) and stress tests, weak banks be referred to a temporary eurozone Restructuring Agency for restructuring and resolution purposes.
In the first phase of its existence, the resolution agency would have to separate weak banks into viable and unviable financial institutions, based on the results of AQR and stress tests.
Unviable banks would be liquidated while viable weak banks would be restructured, preferably in the form of a separation of good and bad banks. This phase should also involve a partial or full bail-in of junior (and maybe senior) creditors of unviable banks. Liquidating unviable banks should thus involve minimal public funding, with losses borne mostly by non-insured creditors and equity holders.
In the second phase, the ERA would gain responsibility with regard to both the good and the bad banks that emerged from phase one.
Once the bail-in of bank creditors is completed, the ERA would inject capital in the good banks, but in return receive equity claims in them (as currently envisioned in the case of direct ESM bank recapitalisation, see ECOFIN, 2013b). One arm of the ERA would thus partially or fully own and manage the good banks, and sell them at the best achievable price after the restructuring is finalised. The second arm of the ERA would be responsible for liquidating the assets of the bad banks, and these assets would also be partially or fully owned by the agency.
The ERA would be jointly owned by the 17 eurozone members, in the same proportion as their shares in the European Stability Mechanism (ESM). All liabilities, but also assets and equity stakes in the good banks, would thus indirectly be owned by European taxpayers. As a result, any returns from the asset liquidations or bank sales would be disbursed to the ERA shareholders and, thus back to the eurozone governments.
Financing and control
In essence, the ERA scheme amounts to an exchange of bailout money (from creditor countries) against management control over weak and failing banks and their assets (in debtor countries). It is obvious that a lot of capital will be needed for the scheme to work.
The initial funding for the ERA could come from the ESM, in a way that preserves the ESM’s AAA creditor status. This could require paying in additional ESM capital or additional loan guarantees by eurozone governments, including from creditor countries like Germany. Early on, the ERA should also seek market funding for additional equity stakes in individual banks. In addition, the ERA itself could be given the ability to issue bonds on the market.
With its capital the ERA would provide loans and/or capital to AMCs and bad banks across eurozone countries, including to those entities that have already been created (e.g. FROB in Spain or NAMA in Ireland). The ERA would also replace the current ESM scheme of recapitalising banks by lending to the sovereigns or via direct recapitalisation.
At the end of the process, the ERA will thus become a mother entity with decision and delegation power over national resolution schemes. This means that a country like Spain would have to give up sovereignty in deciding how its unviable banks will be restructured and how its assets will be liquidated.
Convincing the north and the south
How can creditor and debtor countries be convinced to agree to such a scheme? We propose the following ideas [abridged]:
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The advantages of the proposal
While the authors' proposal is not a panacea for the resolution of the eurozone crisis (and will face high legal and political barriers), it has some critical advantages over the current approach, which has overly relied on regulatory forbearance as well as implicit bailouts and liquidity support by the ECB:
It would create a “clean plate” for a forward-looking eurozone Banking Union and allow a quicker resolution of current bank distress across the eurozone. A centralised bank resolution agency on legacy losses would be a necessary complement to the three pillars of eurozone bank regulation, supervision, and deposit insurance.
It would add transparency on the losses incurred so far, and create more certainty about the resources needed to resolve the crisis. This is crucial to re-establish confidence in the soundness of European banks. Importantly, it would also force creditor and debtor countries within the eurozone to compromise on a scheme to clean up bank balance sheets and on the distribution of losses, instead of further delaying this process.
Any cash injection (bailouts) would imply a partial or full transfer of bank ownership and a more direct control over the bank wind-down and assets. Taxpayers would thus jointly participate not only in the down-side risk but also in the up-side risk. This contrasts with previous practice, which merely gives out loans to governments to recapitalise their banks, but does not involve a transfer of equity on the eurozone level.
A centralised institution would create clear rules of the game and replace the current patchwork of national solutions. The freedom from political intervention and strong legal powers could speed up the liquidation of bad assets and maximise returns in the interest of European taxpayers.