EU banks to face penalties if bailed out

DISTRESSED EU banks which tap national governments or the region’s €440 billion rescue fund for capital will be subject to state-aid penalties, involving compulsory restructuring or, in the worst case, orderly wind-downs.

The EU stance has emerged after several weeks of intense debate between European officials and banks over whether the plan for forced recapitalisations should be exempted from normal state-aid rules.

European leaders are set to meet at the weekend to approve rescue measures for the continent’s financial system, centred on a plan to boost capital levels in the banks.

Regulators at the European Banking Authority have identified a capital gap of about €80 billion if banks’ holdings of troubled euro zone sovereign bonds are marked down to market valuations and groups are then forced to lift core tier one capital ratios – a key measure of strength – to 9 per cent.

In draft guidelines, seen by the Financial Times, for the operation of the enhanced European Financial Stability Facility (EFSF), EU governments say a “planned restructuring/resolution of financial institutions” is “the sine qua non condition” for assistance.

The proviso – consistent with EU state-aid rules applied throughout the crisis – is likely to discourage banks from seeking public assistance and spur them to shrink their balance sheets instead, raising the danger of a credit crunch, bankers say.

EU governments have in recent weeks put pressure on their banks to beef up their capital cushions and make the region’s financial system more resilient should Greece be forced to restructure its bonds.

The confidential guidelines also outline the other tools which the EFSF has been given to better deal with the debt crisis – buying sovereign bonds in primary and secondary markets, and giving states precautionary loans.

But the document says nothing about how to increase the firepower of the EFSF to fund such precautionary credit lines, which are meant to run for up to two years and cover 2 to 10 per cent of a state’s gross domestic product.

According to the document, circulated to German lawmakers ahead of the EU summit, banks should seek funding on the markets and from national governments before turning to the EFSF as “the last-resort” instrument.

Banks considered for EFSF-funded capital injections would have to be “systemically relevant or [pose] a threat to financial stability”, with the relevant government and the European Commission drawing up a “restructuring plan”.

“As a rule, every beneficiary will be subject to a restructuring plan commensurate with the extent of financial support received,” the guidelines say, adding that this was meant “to limit, to a maximum, the distortion of competition”.

The cost of a recapitalisation loan, which will pass from the EFSF to banks via national governments, will be “consistent” with the cost of current EFSF loans to Ireland and Portugal. – (Copyright The Financial Times Limited 2011)