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It should put this into motion as soon as possible, taking into account the lessons from 2008 crisis and applying EU state aid rules. A eurozone recapitalisation fund would much better limit distortions to the functioning of the single market, compared to the current arrangement of ad hoc guarantees and support mechanisms.
But the details of a European TARP matter hugely. How far should coverage stretch? What should be done if banks refuse to accept capital injections? And what conditions should be imposed for state purchases of bad assets?
A European TARP should be strictly obligatory for all eurozone banks whose core-capital ratio is below 4 per cent on a non-risk-weighted basis and taking into account reasonable haircuts on sovereign exposures. The core-capital ratio of the eurozone's banking system as a whole increased to 6.5 per cent from 5.9 per cent between the end of 2007 and the end of 2010, but large banks have significantly lower levels of capital. The balance sheet of Europe's 14 largest banks, with balance sheets of about or over €1 trillion, grew to 4.1 per cent from 2.8 per cent between 2008 and 2009, and 4.3 per cent in 2010.
The IMF estimates the amount needed to recapitalise Europe's banks to be between €100 and €200 billion. These funds should be subject to clear conditions on lending, including structural reforms. The EU's state aid authority, in cooperation with national authorities, would be in charge of monitoring the implementation of these rules. Noncompliance would ultimately lead to full state control of the bank, and possibly to a winding up.
In addition to a European TARP, a eurozone-wide deposit-guarantee scheme should also be created. All eurozone banks would be obliged to participate in a pre-funded scheme and to pay a premium based on their retail deposit base. Such a fund could, over time, be merged with a European TARP to become a market-funded, EU-wide bank resolution scheme. Discussions in the European Council and the European Parliament on amendments to the EU's deposit-guarantee schemes Directive have so far taken away any openings for an EU-wide fund; Member States are not very keen on an EU-wide resolution mechanism anyway.
The EFSF is an opportunity to stop the unravelling of the single market and to create European mechanisms for European problems. Addressing the banking sector's funding problems first would limit the spillover of the sovereign crisis to the real economy.