Germany casts doubt on Irish deal

Germany has once again cast doubt on Irish hopes of securing bank debt relief via the European bailout funds.

European Central Bank governing council member Jens Weidmann today appeared to rule out retrospective European assistance on so-called legacy bank debt, a key aim of the Irish Government.

Mr Weidmann said the proposed banking union could not solve the euro-area debt crisis.

"Done correctly, a banking union can be an important building block, even a pillar of a stable monetary union," Mr Weidmann, who heads Germany's Bundesbank, said in a speech in Frankfurt today.

"But is it also the key to finding a solution to the crisis? No, it's not, and we shouldn't overburden it with this expectation."

European leaders in June agreed to hand the ECB powers to oversee all 6,000 euro-area banks as part of a so-called banking union that would unlock joint recapitalisation funds for the region's ailing lenders.

The question of who takes responsibility for “legacy” banking debts has divided Germany and France.

Mr Weidmann said the banking union should not take responsibility for legacy risks and debts.

"The current problems in the banking system are above all a result of past mistakes on the national level," he said.

"Balance-sheet risks that occurred under national responsibility must also be overcome by the respective member state."

To spread these risks via a banking union would amount to fiscal transfers and

contradict the purpose and justification for the banking union, Mr Weidmann said, adding such a course could reduce the incentive for countries to reform their banking systems.

The banking system needs to be better protected from the effects of the debt crisis, he said, proposing that the banking union be flanked by other regulatory measures.

"Two are particularly important to me," Mr Weidmann said.

"First, there should be a limit on lending to sovereigns for each bank. Second, banks should have capital buffers that take into account the risk of their sovereign debt or lending to the state."

Banks can currently hold sovereign debt without setting aside capital for it because it is still treated as risk- free.

German chancellor Angela Merkel caused consternation in Irish Government circles last month when she said historic debt would not be covered by the European Stability Mechanism rescue fund.

However, she later issued a joint communiqué with Taoiseach Enda Kenny affirming that the “unique circumstances” of Ireland’s economic crisis required a special approach.