Monday, July 9, 2012

To guarantee or not to guarantee

It is not surprising that there has been some confusion in the aftermath of the recent euro summit statement.  One such issue is whether direct bank recapitalisations from the ESM will require a sovereign guarantee from the country involved.  If true, this, of course, means that the ESM involvement would not “break the vicious circle between banks and sovereigns”.

On Friday, Reuters carried this report which said:

Direct ESM bank aid needs sovereign guarantee-official

BRUSSELS, July 6 (Reuters) - Any risks attached to financial assistance given directly to banks by the euro zone's ESM permanent rescue fund would remain the responsibility of the country requesting it, a senior euro zone official said on Friday.

The official, speaking on condition of anonymity because of the sensitivity of the discussions, said that if the European Stability Mechanism were to take an equity stake in a bank it would only be "against full guarantee by the sovereign concerned".

"There is some degree of mystification going on here ... in the broader public who think that under current rules the ESM could all of a sudden end up owning Bankia with the full risk of Bankia on the balance sheet of the ESM," he said, referring to the Spanish lender. "This is very much not the case.

"Does it still remain the risk of the sovereign or does it become the risk of the ESM? It remains the risk of the sovereign because you have the counter guarantee of the sovereign."

He later signalled, however, that this may change once a new supervisory structure for banks were put in place.

"In the very distant future ... if we have a single euro zone supervisor supervising all banks ... if there were to be direct bank recapitalisation would this still require a counter guarantee of the sovereign, my understanding is that it would not," he said.

The official said that the benefit of lending directly to banks would be that it would not add to the country's national debt. "It cuts out the effect of that loan on the debt to GDP (Gross Domestic Product) ratio for the sovereign," he said.

Today, Reuters carried this report:

Euro zone can help banks directly once supervisor set up

Direct recapitalization of euro zone banks will not require sovereign guarantees as soon as the bloc has established a new banking supervisory body, the European Commission said on Monday.

A senior euro zone official said on Friday that sovereign guarantees could only be dropped "in the very distant future.

"I would like to clarify that there will be no need for sovereign guarantees for banks being directly recapitalized by the ESM," said Commission spokesman Simon O'Connor, referring to the bloc's permanent rescue fund.

"The ESM will be able to decide by a regular decision once the single supervisory mechanism is in place to adopt an instrument that would allow for the direct recapitalization of banks."

A bank supervisor could be operational sometime next year.

It should be pretty clear that both reports say exactly the same thing.  The difference is that the first puts the emphasis on the period before a eurozone bank supervisory structure is put in place and the second puts the emphasis on the time after such a supervisory structure is put in place.  There is nothing that is contradictory between the reports.

However, in the period prior to the set up banking supervisor there is actually no need for guarantees as the loans will first be maybe to the Member State’s government and then passed onto that country’s banks.  This is what is initially going to happen with the Spanish bank bailout.  The general principle of the June 29 euro summit statement is that once the banking supervisor is in place this funding will be revisited and the loans to the banks may be transferred to the ESM with no reference to a guarantee from the Spanish government.

All this was covered in detail in today’s midday briefing from the European Commission.  Almost all of the 20 minutes (beginning at around 2:15) in this recording of the press briefing deals with the bank recapitalisation/sovereign guarantee issue (which actually is a bit of a non-issue).


UPDATE:  Having been asked what is the issue if the sovereign guarantee is a non-issue this exchange from a 1am press briefing after the eurogroup meeting provides some insight.  The following exchange took place from 29:45 in this video.

Matina Stevis, Wall Street Journal

“Can you please tell us in no uncertain terms, are you in a position to say today, that the ESM will not request any guarantee in any form from sovereigns when it injects capital and receives equity in rescued banks? Will it request some guarantees or full guarantees for this equity share that it will take on its balance sheet or will the risk be shared with the sovereign somehow?”

Klaus Regling, CEO of the EFSF and incoming MD of the ESM Board

“Well the first point, as you know, the ESM is not operational so we are planning now everything for the bank recapitalisation in the case of Spain via the EFSF and that was discussed today.”

Ollie Rehn, VP of the Commission in charge of Economic and Monetary Affairs

“On the ESM and direct bank recapitalisation. I think the word and concept “direct” is a very clear concept. This direct bank recapitalisation, not indirect through the sovereign, but there is a very clear and necessary condition. It is that there has to be an effective and well-functioning single supervisory mechanism of banks that are part of this arrangement of direct bank recapitalisation.”

Thomas Wieser, President of the Eurogroup Working Group

“Just to complete what was said by the two previous speakers. And then there will be no sovereign guarantee required.”

The key is now a “well-functioning single supervisory mechanism of banks” but it is unlikely the crisis will wait 12 to 18 months (or maybe even longer) for this to come into being.

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