Tuesday

6th Dec 2022

Analysis

When banks need a backstop

In Brussels this week talks have returned to the familiar theme of banks, bailouts and backstops.

On Monday (23 September) European Central Bank boss Mario Draghi told MEPs on the influential Economic affairs committee that a new resolution fund to cover the costs of eurozone bank failures would need access to its own credit line.

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  • The eurozone needs a backstop but the ESM won't provide it, says Klaus Regling

A day later, Klaus Regling, director of the European Stability Mechanism (ESM), the eurozone bailout fund, was equally frank with MEPs on the same committee. The eurozone's banking network needs a backstop. But he was equally clear that the ESM could not provide this credit facility under the ESM treaty ratified by governments in 2012 on the grounds that, legally, it is not an EU institution.

"In the long run I see that the ESM will be integrated into the EU treaty, but this will take a decade," he said on Tuesday (24 September), adding that "we will also need separate EU institutions for bank resolution and supervision."

This came as a disappointment to MEPs, some of whom argued that there is nothing preventing the €500 billion ESM from acting as a backstop for a eurozone resolution fund. They also reminded Regling of the agreement struck by eurozone finance ministers, that once the single supervisory system starts in mid-2014 the ESM could offer direct recapitalization to banks.

The question of how resolution funds would be able to raise money seems set to become the hot topic in the latest round of banking union legislation.

Last month, Joerg Asmussen, a member of the ECB's executive board contradicted Regling, claiming that the ESM could temporarily underwrite the resolution fund in the early stages while it was still building up its capital.

"The ESM could lend money to the fund that could be reimbursed to the ESM so there is no permanent transfer," Asmussen said.

For her part, Portuguese MEP Elisa Ferreira, who is responsible for drafting the assembly's position on the legislation, is also expected to include provisions for a credit facility, with the support of several of the main political groups, in her draft report later this week.

The logic is straightforward enough.

The plan drafted by financial services commissioner, Michel Barnier, would establish a resolution fund worth €55 billion, with the money accrued from the banking sector over a ten year period. That is all well and good, but poses two questions.

Firstly, what happens if a bank needs to be resolved before then, and what happens if the cost of resolution is larger than the fund itself? The latter is a serious point. For example, the UK taxpayer-funded bailouts for Royal Bank of Scotland and Lloyd's were worth ₤65.5 billion (€76 billion). In order to prevent the resolution fund from being a 'paper tiger', lawmakers and markets need to know that it will be able to cover all costs.

That said, the debate in Brussels may have evolved but the German government is resistant to agreeing on any kind of common eurozone fund, let alone a fund with a potentially unlimited credit line. Liberal deputy Wolf Klinz told Regling that a eurozone resolution fund would inevitably involve a transfer of liability from one member state to another.

Berlin fears that the commission proposal would create yet another bailout fund and is well aware that, as the bloc's largest country, it would be required to pay in the most.

In fact, we are looking at a mechanism that amounts to a statement of intent similar to the ECB's Outright Monetary Transactions (OMT) programme.

Although the Bundesbank has taken the Frankfurt-based bank to the German constitutional court in Karlsruhe over the programme, which allows the ECB to buy up unlimited numbers of government bonds, Draghi's promise last summer that the ECB would "do whatever it takes" to prop up the eurozone has not been tested.

In the 13 months since its launch the ECB has not spent a single cent on OMT. Draghi's four word promise was enough to calm the financial markets.

The ESM boss also pointed out that the resolution regime in the United States has a sizeable credit line with the US treasury but has never used it.

The eurozone debt crisis has been as much about symbolism as hard cash. A resolution credit facility would be a purely temporary funding instrument, with inbuilt guarantees that all monies would be paid back by financial institutions.

No European politician ever wants to be in a position where unlimited supplies of money have to be poured in to prop up the banking sector but, as Regling put it, "sometimes it is good to have instruments that are visibly available" if you want to keep markets calm.

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