Challenges remain to secure retroactive aid

Following the promissory notes deal and the agreement to lengthen the maturity of Ireland's bailout loans, the State's bid to get debt relief on its investment in AIB and Bank of Ireland has proved more elusive.

Resistance to the concept of retroactivity – as opposed to legacy assets that still remain on balance sheets once the single supervisor assumes supervisory control of banks – has been in the ether since Germany, the Netherlands and Finland starkly outlined their resistance to such a move in a letter last September.

Since then the resistance has intensified, as euro zone finance ministers have discussed at their monthly euro group meetings how the European Stability Mechanism’s (ESM) direct recapitalisation instrument will operate.

To a large extent, the Irish issue has become entangled in a wider debate about the suitability of the mechanism fund to directly recapitalise banks.

While the remit of the €500 billion ESM is to provide financial assistance to euro area states that find themselves in trouble, directly recapitalising banks is another matter.

From the ESM’s perspective, an investment in banks could be seen as more risky and have an adverse impact on the fund’s credit rating (the ESM issues debt securities to provide liquidity assistance to countries).

The decision to limit the amount of the fund that could be earmarked for direct bank recapitalisation to around €60 billion – just shy of the fund’s paid-in capital of €80 billion provided by member states – suggests limits to the scale of the ESM recap project, while any direct recapitalisation would also involve a contribution by the sovereign involved.

On Wednesday, the European Commission’s deputy director-general for economic and financial affairs defended the ESM direct recapitalisation project.

Speaking at the Brussels Economic Forum, he pointed out that banks that run into trouble in the future would still be able to go to the markets for funding, while many governments would be in a position to recapitalise banks if needed.

In addition, he said the ESM offered other solutions for countries whose banks are in trouble, as happened in the €40 billion Spanish bank recapitalisation.

The potential role of the ESM in direct bank recapitalisation has also become entwined in the broader debate on banking resolution and recovery.

Finance ministers today will discuss common rules on winding down banks through a “bail-in” rather than “bail-out” mechanism, amid disagreement between member states on the creditor hierarchy in the event of a wind-down and the level of flexibility that will be afforded to member states in implementing the rules.

The commitment last night to examine retroactivity on a case-by-case basis is undoubtedly a positive step, but further battles remain, in particular overcoming resistance from some member states.