Eurozone bailout fund allowed to directly recapitalise banks

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Eurozone finance ministers have agreed to allow the region’s permanent bailout fund to hand money directly to troubled banks but only if governments intervene first.

The €500bn European Stability Mechanism will be able to use a maximum of €60bn to “directly recapitalise” banks that fall into distress on the condition that their national government has first invested.

Previously, the ESM was only allowed to bail out governments but the latest move is designed to stop eurozone members suffering the same fate as Ireland, Spain and Cyprus, where difficulties emerged for governments after they were unable to cope with large bank bailouts on their own.

Jeroen Dijsselbloem, the chairman of eurozone finance ministers, says: “This instrument will help preserve the stability of the euro area and remove the risk of contagion of the financial sector to the sovereign, thus weakening the vicious circle between banks and sovereigns.”

However, the bank bailout feature has a number of conditions that could limit how attractive it is in reality.

Governments would first have to recapitalise a troubled bank to ensure it meets the minimum common equity Tier 1 ratio of 4.5 per cent, before the ESM is able to buy shares.

Should the bank already meet this ratio, governments would have to provide 20 per cent of the necessary capital injection while the ESM contributes the other 80 per cent. This requirement will fall to 10 per cent after the powers have been in place for two years.

In addition, there is an assumption in the four-page agreement on the new feature that a shareholders, bondholders and, potentially, large depositors might be required to contribute to a ‘bail-in’ before the ESM steps in to help a teetering bank.

“An appropriate level of bail-in will be applied before the bank is recapitalised by the [ESM], in line with EU state aid rules and applying principles of the forthcoming bank recovery and resolution directive,” Reuters reports Dijsselbloem as saying.

ESM head Klaus Regling says the powers could be ready to use in the latter half of 2014, following stress tests on the region’s lenders by the European Central Bank and European Banking Authority.