Debt relief for Ireland no closer in SRM deal

Taoiseach Enda Kenny welcomed the agreement on the Single Resolution Mechanism which was reached in the early hours of Thursday morning in Brussels, but how far will it impact on Ireland's bid for further debt relief?

The agreement between the European Parliament and member states concerns the next phase of banking union, the so-called Single Resolution Mechanism and its accompanying resolution fund, which will be charged with managing the wind-down and resolution of troubled banks in the future.

The SRM is a key strand of the EU’s plan for an integrated banking supervisory and regulatory system as it tries to safeguard the European financial system from future financial crises.

Following last year’s agreement on the SSM (Single Supervisory Mechanism) which paved the way for the ECB to start supervising euro zone banks, the SRM was the next major policy objective, with a centralised resolution system seen as essential for a shared supervisory system. The original third strand that was envisaged – a deposit guarantee scheme – is still outstanding.

Yesterday's agreement trashed out after months of negotiations is undoubtedly good news for Ireland in terms of the State's exposure in future bailouts. Under the plan, the fund will move from a collection of national compartments to a fully shared or mutualised fund within eight years rather than 10 – the pace of mutualisation will also be front-loaded, with 70 per cent of the fund mutualised within three years.

In other words banks paying into the fund will see 40 per cent of their money going into the mutualised fund in the first year, and 60 per cent into their national compartments, and so on. In effect, this means smaller countries such as Ireland, with smaller national funds, will have access to more mutualised funds earlier, and the link between sovereign and banking debt will be broken earlier.

In terms of Ireland’s bid for further debt relief through direct bank recapitalisation from the European Stability Mechanism (ESM) , yesterday’s agreement on the second pillar of banking union has no impact.

The ESM’s bail-out fund is a euro zone rescue fund designed to provide financial assistance to member states.

Unlike the SRM which is funded exclusively by the banking sector, the ESM fund is funded by member states, and as such is the only shared, mutualised fund consisting of taxpayers’ money that exists to financially help countries in the euro zone. The €60 billion direct bank recapitalisation instrument, from which Ireland hopes to secure retroactive assistance, is only one element of the fund.

The ESM will continue to exist alongside the exclusively bank-focused SRM, which is expected to be up and running in 2016. However, with the introduction of new state aid rules on “bail-in”, which entered into force last year and will be replaced by even more stringent creditor bail-in rules under the Banking Recovery and Resolution Directive (BRRD), it is envisaged that the ESM would only be used as a very last resort. Under the BRRD, creditors including junior and senior bondholders and large depositors would be tapped, before the ESM fund would be considered.

The framework for the direct bank recapitalisation instrument agreed last year states that ESM direct bank recap will only be available once the Single Supervisory Mechanism is up and running at the end of this year, a fact that was underlined by the Taoiseach again yesterday in Brussels. From that point, the political discussion about whether the ESM fund can be used retroactively is free to begin.

To date, senior euro zone figures have signalled that there is little support for the concept. Even the agreement last June to look at retroactive direct recapitalisation on a "case by case" basis surprised many in Brussels, who believe there is little political will for the process. ESM fund chief Klaus Regling said earlier this year that there is no political consensus within the euro group to grant retroactive direct recapitalisation to Ireland, a view echoed by European Commission president Jose Manuel Barroso at December's summit, though the outgoing EC president moved to clarify his remarks at a ceremony in UCC earlier this month when he said the "spirit" as well as letter of the agreement of June 2012 should be fully respected by euro area member states, pledging that the European Commission will "continue to stand by Ireland" now that it has exited the programme.

The other question is whether ESM direct bank recapitalisation is in fact the right option for Ireland. As the value of the Government’s stake in the two pillar banks increases, there is less incentive to surrender its shareholdings in the banks for ESM funding.

Ireland may in fact be keeping the option of retroactive direct bank recapitalisation on the table in order to secure different concessions, for example some kind of arrangement for tracker mortgages.

Ireland’s argument that, despite new incoming “bail-in” rules, it was forced to bail out its bondholders at the height of the banking crisis still elicts significant empathy among euro zone figures, despite resistance to retroactive measures. Further, the government is subtly pointing out that Ireland’s debt to GDP ratio is still one of the highest in the euro zone, a third of which is due to the bank debt the government assumed during the bailout.

Meanwhile, yesterday’s agreement on the SRM will be welcomed by the ECB in particular, which has urged EU leaders to ensure a proper resolution system is in place as it begins to assume supervisory authority for banks.

But with the ECB’s asset quality reviews and stress tests due to be completed by November, concern persists as to whether sufficient backstops are in place to meet capital holes that may be revealed. The SRM and BRRD rules it will implement will not be up and running until 2016. Even at that point, questions have been raised about the scope of the €55 billion fund to deal with major bank crises, though the credit line and borrowing capacity that has now been written into the legislation setting out the SRM will significantly bolster the firewall if needed.

Between now and 2016, banks that face capital holes will be subject to the state aid rules which came in last August, which envisage a hierarchy of creditors to be bailed in (though not senior bondholders as included in the BRRD). EU figures also stress that banks will be encouraged to tap the markets in the first instance (now a much more feasible option than the height of the euro zone crisis)

Nonetheless, the imminent stress tests do still suggest that national governments may have to move in and bolster their banks if needed, when the results of the stress tests are revealed, despite all the talk of separating banking and sovereign debt.