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EC: EU bailout fund could rescue banks

by Renee Cordes in Brussels | Published May 30, 2012 at 12:09 PM

The European Commission on Wednesday called for a eurowide approach to recapitalizing troubled banks, suggesting that the funds come out of the bloc's permanent bailout fund instead of national budgets. But the proposal faces strong political headwinds.

"To sever the links between banks and the sovereigns, direct recapitalization by the [European Stability Mechanism] might be envisaged," the European Union's executive branch said in policy recommendations released in Brussels, part of its annual review of national reform programs of the 17-nation euro zone.

The Commission also supported the idea of a "banking union" in which all countries would share responsibility for bank supervision and crisis management.

The Commission is particularly concerned about signs of declining cross-border activities and banks "retrenching" behind national borders as they divest foreign assets. "To counter this trend of financial disintegration, more coordination at European level is needed," the Commission said in a 27-page report.

But even if the Commission follows with a concrete legislative proposal for more liberal use of European bailout money, the idea is unlikely to get very far.

"The proposal for the ESM to lend directly to banks does have some practical and economic merit, but it is fraught with political difficulties," said Raoul Ruparel, head of economic research at Open Europe, a London-based think tank. "Not only would it step on the toes of the European Central Bank, it would also funnel foreign taxpayer cash to stressed banks without a sovereign guarantee. Naturally, the likes of Germany and Finland are therefore strongly opposed to this plan."

He added that the key factor will be the ability of the ESM to "enforce conditions on banks and, importantly, for those banks with unsustainable business models or unworkable balance sheets to be allowed to fail, albeit in as managed a way as possible."

Wednesday's news comes amid growing expectations that Spain will be forced to request an international bailout for its troubled lenders, following the surprise resignation of Bank of Spain Gov. Miguel Angel Fernandez Ordonez late Tuesday.

Bankia SA, Spain's fourth-largest lender, was created in late 2010 from the merger of seven regional savings banks. It surprised markets May 25 with a request for a bigger than expected aid package of €19 billion ($23.8 billion) to cover its capital shortfall.

Adding to uncertainty about Bankia's future, the Financial Times reported late Tuesday that the Frankfurt-based ECB had rejected Spain's latest request.

The €19 billion would come on top of about €4.5 billion already pledged to the bank by Spain's government when it announced May 9 that it would exchange debt in return for a 45% equity stake in the Madrid-based lender.

Over the weekend, the Spanish government reportedly floated the idea of raising the extra €19 billion by injecting sovereign bonds into its parent company, Banco Financiero y de Ahorros SA, which could then be swapped for cash using the ECB's three-month refinancing window, thus avoiding the need to raise the money on bond markets.

On Wednesday, the ECB said it had not been notified of a new recapitalization plan.

"Contrary to media reports published today, the ECB has not been consulted and has not expressed a position on plans by the Spanish authorities to recapitalize a major Spanish bank," it said in a statement. "However, the ECB stands ready to give advice on the development of such plans."

Franca Rosa Congiu, a spokeswoman for the European Banking Authority, said that while the London-based agency is in constant contact with national authorities on banks, "it's not up to the EBA to comment on country-specific issues."

While Spain has argued that the Bankia case is unique, Ruparel said that its problems go well beyond the one lender. "It may be the worst case, but similar exposure to souring real estate and construction loans plague the banking sector as a whole and a combined larger response to this issue will be needed," he said. "In this case it is unlikely that Spain will be able to shoulder this burden alone, and some external European funding will be needed."

Separately on Wednesday, the Commission approved restructuring aid granted by Spain to Caja de Ahorros del Mediterraneo, or CAM, a failed savings bank being taken over by Banco Sabadell SA.

Sabadell agreed to buy CAM for a symbolic €1. As part of the sale, the Spanish Deposit Guarantee Fund and the country's Fund For Orderly Bank Restructuring, or FROB, granted support to the banking business being taken over by Sabadell.

The support measures include a 10-year guarantee on losses stemming from a €24.6 billion loan portfolio, and a €2.4 billion capital injection, on top of the €2.8 billion recapitalization already received by Alicante-based CAM from FROB.

"The Commission's investigation concluded that the complete exit of Banco CAM from the market as an independent entity, the sale of its banking business in an open and competitive tender and the deep restructuring foreseen for the business with Banco Sabadell, will ensure the viability of the sold business," it said in a statement.

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