The deal: what it means

For Greece, the banks and the bailout fund

FOR GREECE

THE DEAL will cut the value of Greek debt in private hands to some €100 billion from about €210 billion. This will ease some of the fiscal pressure on the country, but Greece will also have to accept a much deeper level of external intrusion in its internal affairs.

The summit communique says the “mechanisms for monitoring of implementation of the Greek programme must be strengthened, as requested by the Greek government”. This raises the prospect of a much more “directive” approach by the EU-IMF towards the development of fiscal policy in Greece and its execution.

The government of prime minister George Papandreou is already under siege. Although euro zone leaders were very careful in their use of language, it is clear that Greece faces a further loss of sovereignty as its international sponsors seek tighter control over its wayward finances.

As part of the initiative, Greece is also set to receive a further €100 billion in bailout aid from the euro zone countries and the International Monetary Fund.

HOW THE DEAL WORKS:

The first Greek debt write-down, settled in July, embraced a loss of 21 per cent on the net present value of the country’s bonds. That arrangement was scrapped as the country’s recession worsened.

The new deal will be applied in a different way. It will cut some 50 per cent from the face value of Greek bonds in private hands, reducing the weight of Greece’s public debt to €100 billion from €210 billion.

In the July deal, Greece’s public debt would still stand at 160 per cent of gross domestic product by 2020. In the new plan, that is set to drop to 120 per cent in the same period.

To avoid a damaging “credit event”, euro zone leaders insist that participation by banks should be on a voluntary basis only.

The leaders used both moral and financial pressure when they gave an ultimatum to the Institute of International Finance, which represents the world’s biggest banks.

Participating institutions will receive a “credit enhancement”, in which the euro zone will provide them with the equivalent of a triple-A guarantee over 30 per cent of the Greek debt they still hold after the haircut is applied.

WHAT WE STILL DON’T KNOW:

The write-down will be executed by way of a complex bond exchange programme, which euro zone leaders hope to complete next.

The maturity of the new Greek bonds and the interest rate they will pay remains subject to negotiation. This will be crucial to the effectiveness of the debt-restructuring plan.

FOR THE BANKS

WHAT HAS BEEN AGREED

: Europe’s banks will need to raise €106 billion in fresh capital to allow them absorb the losses on their holdings of Greek debt, which are being written down by 50 per cent as part of the package of measures agreed yesterday morning.

The banks will seek to raise the money in the markets and, failing that, their own governments are expected to provide support.

Banks will have to stop paying dividends and bonuses before they can ask for government help.

The European Financial Stability Facility, which is also being revamped as part of the wider plan, will provide money to recapitalise banks as a last resort.

Banks have until next June to hit the new target of 9 per cent Tier I capital. This is roughly equivalent to having €9 in cash for every €100 euro they have lent out to customers.

MORE BANK BAILOUTS

: Banks will try and raise the bulk of the money themselves by selling assets and hoarding capital. The actual amount of new money that may have to be raised from shareholders or national governments could be as low as €20 billion.

The bigger European banks will almost certainly be all right. Lenders, including Royal Bank of Scotland Group and Deutsche Bank, have already written down their holdings of Greek debt to market value, while French banks said the 50 per cent discount would be included in their third-quarter results.

If regulators – at both a national and European level – are unconvinced that a bank will be able to make the higher capital level under its own steam, they are likely to take action as soon as the difficulties become clear, say European officials.

DETAILS REMAIN UNCLEAR:

Even as markets cheered news of the deal, analysts cautioned that crucial details remained unclear – including what assets banks could count as capital, how the weakest institutions would raise funds and what additional steps would be taken to support banks’ access to funding to stave off a financing crunch.

CONSEQUENCES FOR IRELAND

: Any co-ordinated effort to help banks access funding markets could be very helpful to Ireland as the Irish banks are very dependent on the European Central Bank for funding.

Longer term, if another member state is forced to tap the European Financial Stability Facility to recapitalise its banks, that could open the door to the possibility of Ireland refinancing some of the €76 billion of borrowed funds that have been injected into the Irish banks.

FOR BAILOUT FUND

EURO ZONE leaders want to strengthen the European Financial Stability Facility without extending the sovereign guarantees which underpin it. In the deal, they will leverage the unused €250 billion in the fund by a factor of four or five. The aim is to yield about €1 trillion for interventions but the final sum may be higher.

HOW IT WORKS:

Two new mechanisms will be introduced and the EFSF will have the freedom to use them simultaneously. In the first, the EFSF would provide first-loss insurance to vulnerable euro zone countries when they issue new bonds. It would be open to private investors to buy such risk insurance when they buy bonds in the primary debt markets.

In the second, the EFSF would create a special purpose investment vehicle which would deploy resources from the fund itself and seek funding from private and sovereign wealth fund investors.

The vehicle would make investments in sovereign bond markets, and would be first in line for any losses. Because the debt crisis in essence flows from a lack of investor confidence, the expectation is that the vehicle may have to offer sweeteners in the mode of the “credit enhancement” plan under the Greek haircut initiative to get support from private sources.

WHAT WE STILL DON’T KNOW:

It falls to euro zone finance ministers to hammer out the detailed operational features of the leveraging initiative so the final plan remains to be seen.

The amount of any additional support that the IMF provides also remains in question. So too does the level of support that might be available from cash-rich emerging countries like China and Brazil.