Government scrambles to play down Merkel comments

The Government was tonight scrambling to play down comments by German chancellor Angela Merkel which appeared to rule out back-dated recapitalisations of euro zone banks and dash Irish hopes of a deal on its legacy debt.

At a press conference following a two-day summit in Brussels, Dr Merkel said the European Stability Mechanism (ESM) fund would not be used to take over liability from member states such as Spain for past bank rescues.

"There will not be any retroactive direct recapitalisation," Dr Merkel said. "If recapitalisation is possible, it will only be possible for the future, so I think that when the banking supervisor is in place we won't have any more problems with the Spanish banks, at least I hope not."

Her comments appear to cast serious doubt on the Government’s chances of securing a deal on Ireland's €64 billion debt burden. Coalition had been campaigning for a mechanism whereby the ESM could make direct investments in AIB and Bank of Ireland.

Minister for Finance Michael Noonan said the Government would seek to clarify the comments with Berlin tonight or tomorrow morning having previously received different feedback from the German chancellery.

"We will be clarifying these matters and the next phase now is that the (European Union) finance ministers will work out the criteria and within the criteria will be whether it will be retrospective with respect for Ireland."

However, a Government spokeswoman sought play down the import of Dr Merkel's comments, saying they related only to the recapitalisation of Spanish banks.

“We understand that chancellor Merkel was asked a direct question about the recapitalisation of Spanish banks and she replied in that context,” said the spokeswoman.

Earlier, Taoiseach Enda Kenny insisted that EU leaders had given a clear reaffirmation of the June 29th agreement to reduce bank debt. “I made it clear that what we wanted to see was progress toward following through on the principle and the concept of what was agreed in June to a more solid foundation and making that become a reality and moving on implementing that,” he said.

However, Fianna Fáil’s finance spokesman Michael McGrath said Dr Merkel’s comments represented a “massive setback to achieving a deal on Irish bank debt” and called for an immediate response from the Government.

Independent MEP Marian Harkin said that “Angela Merkel, having embraced Enda Kenny at the EU summit, subsequently showed this to be a ‘Judas kiss’ when she ruled out back-dated recapitalisation of euro zone banks". Speaking from the European Parliament, Ms Harkin argued that this is “an extraordinary setback and a real kick in the teeth to our leaders who have been struggling earnestly to achieve a fair deal for Ireland”.

Sinn Féin’s finance spokesman Pearse Doherty also used the 'Judas kiss' metaphor.

Despite Dr Merkel's comments, euro zone officials said they were exploring the possibility of sharing the cost of dealing with "legacy" toxic bank assets between the ESM and host governments, a crucial step to break to so-called "doom loop" between sovereigns and banks.

In the early hours of this morning, European Union leaders agreed that a single supervisor will take responsibility for overseeing euro zone banks from next year. Details on the precise number of banks to be monitored and the powers the supervisor - the European Central Bank - have are yet to be decided.

The decision opens the way for the euro zone's rescue fund to inject capital directly into ailing banks during the course of 2013, but whether that will allow Spain or Ireland to transfer some of its banking liabilities off the government's books now remains in serious doubt.

Tánaiste Eamon Gilmore this morning described the supervisory agreement as a major development which would have been unthinkable a short time ago. He said it stemmed from the June statement which also made reference to easing the Irish debt burden. He said there was speculation that the proceedings at the summit would pull back from the June agreement, but that the reverse had happened.

Mr Gilmore said there were two elements at play for Ireland, the promissory notes for Anglo Irish Bank and the recapitalisation of the pillar banks, which he said the State would pursue once the banking supervisor was in place and the ESM could directly recapitalise banks.

The Government was not contemplating not getting a deal, he told RTÉ's Morning Ireland.

"There was an agreement, a good agreement, on timing and about the banks as whole," French president Francois Hollande told reporters as he arrived for the second day of the summit following 10 hours of talks into the early hours of today. "There was a willingness to progressively put in place the (oversight) mechanism."

European Council president Herman Van Rompuy said the 27 leaders agreed to adopt a legal framework by the end of this year giving the European Central Bank overall responsibility for banking supervision, with national regulators consulted.

"Once this is agreed, the single supervisory mechanism could probably be effectively operational in the course of 2013," he told a 4am news conference.

French and EU officials said this morning that all 6,000 banks in the single currency area would gradually come under ECB supervision by 2014, starting with banks receiving state aid, then large cross-border institutions, even though the EU leaders statement did not specify a number or a timeline.

One of the thorniest issues - what representation non-euro zone banks that decide to join the scheme will have at the ECB - was left to one side and will have to be resolved by the end of the year, along with a number of other legal obstacles.

Creating an effective banking union, for which this deal was a first step, is regarded by the International Monetary Fund and market economists as a key component in overcoming the euro zone's three-year-old debt crisis.

Mr Hollande said the leaders did not discuss possible financial assistance for Spain, another critical issue in resolving the three-year crisis, but he laid out a series of steps that could help turn a corner.

Additional reporting: Reuters