Commission urges direct bank aid


The European Commission advocated direct aid from a euro zone rescue fund to recapitalise distressed banks in a move that could eventually help Spain, the latest front in Europe's debt wars, overcome a worsening banking crisis.

Spanish government borrowing costs earlier lurched higher and the Madrid stock market hit a nine-year low today as investors rattled by fears about its financial sector fled to the relative haven of German bonds.

In a major economic policy document, the commission said the vicious circle of weak banks and heavily indebted states lending to each other must be broken.

While the commission is responsible for proposing laws, it is the member states, most notably Germany and France, that decide whether or not to implement those proposals.

Commission president Jose Manuel Barroso told a news conference that tighter euro zone integration could include a banking union, a joint bank deposit guarantee scheme and euro area financial supervision, saying the mood had changed since member states only months ago unanimously rejected a joint deposit guarantee fund.

"In the same vein, to sever the link between banks and the sovereigns, direct recapitalisation by the ESM (European Stability Mechanism) might be envisaged," the report said.

EU paymaster Germany has so far firmly opposed any collective European banking resolution and guarantee system and any use of bailout funds without a country having to submit to a politically humiliating EU-IMF austerity programme.

Spain's banking woes - the result of a burst property bubble aggravated by recession - have combined with growing uncertainty about Greece's survival in the euro zone to reignite Europe's sovereign debt crisis.

That drove the euro to a two-year low below $1.2450 today, while European shares also fell after Italy had to pay heavily to sell bonds.

Madrid said its bank rescue fund would issue bonds to inject funds into nationalised lender Bankia, but that looks expensive with 10-year borrowing costs at 6.67 per cent near their euro era peak and close to levels at which Ireland and Greece sought international bail-outs.

The Economy Ministry played down a Financial Times report that the European Central Bank had rejected an initial plan to rescue Bankia, Spain's fourth biggest bank, by stuffing it with government bonds that could be used as collateral to borrow from the ECB.

"Spain did not formulate any proposal to the ECB on funding the Bankia plan, so it was difficult for it to have an opinion," a ministry spokeswoman told Reuters. "The Economy Ministry maintains as a first option to go to the markets to recapitalise the entity."

The Frankfurter Allgemeine Zeitung, an influential voice in the conservative German financial establishment, said that by considering such "tricks", Spain was provoking the market distrust it sought to avoid at all costs.

Investors unnerved by Spain's deepening financial crunch pushed Italy's funding costs sharply higher at a bond sale, with 10-year yields topping 6 percent for the first time this year.In a sign of heightened anxiety in Washington, top US treasury official Lael Brainard was despatched to hold talks in Greece, Germany, Spain and France "to discuss their plans for achieving economic stability and growth in Europe", the treasury department said.

Mr Barroso said Europe's G8 partners, at a summit in the United States 10 days ago, had asked the euro zone to go further in financial and economic integration.A sudden economic deterioration in Europe would pose a serious threat to the US economy and hence to president Barack Obama's re-election prospects in November.