Merkel bows to Italy, Spain on bonds and bank supervision

Van Rompuy June 2012.jpg

Banks in eurozone countries that are complying with European Union budget discipline rules will be able to access the bloc's bailout funds directly, under an agreement announced early today (29 June). In addition, a new banking supervisory body will be created under the auspices of the European Central Bank.

Under the deal, struck after late-night talks between the 17 leaders of the eurozone, Italy, Spain and other troubled countries will also be able to tap the bloc's temporary EFSF and permanent ESM rescue funds to support their government bonds on financial markets.

Rome and Madrid will be allowed to use the rescue funds to buy their government bonds and lend money directly to recapitalise banks without adding to their public deficit – a major concession by German Chancellor Angela Merkel.

"We affirm that it is imperative to break the vicious circle between banks and sovereigns," said a euro area summit statement published on Friday (29 June).

"The process was tough, the outcome was good," Italian Prime Minister Mario Monti told reporters, adding that Italy did not intend "at this time" to apply for the emergency support.

Countries that requested bond support from the rescue fund would have to sign a memorandum of understanding setting out their existing policy commitments and agreeing a timetable. But they would not face the intrusive oversight of a "troika" of international lenders to which Greece, Ireland and Portugal have been subjected, Monti said.

Bank loans with strings attached

However, loans to troubled banks will come with strings attached. And the rescue funds for the banking sector will only be offered to countries that are in line with the budget deficit ceilings decided at the European level.

"We are opening the possibility to countries that are well behaving to make use of financial stability instruments in order to reassure markets and to get again some stability around some of the sovereign bonds of our member states," said European Council President Herman Van Rompuy at a 4:30 a.m. news conference.

Spain and Italy had withheld their agreement to a growth package at a European Union summit to demand emergency action to bring down their spiralling borrowing costs.

Speaking earlier, French President François Hollande confirmed that Italy and Spain had withheld approval of the growth pact until eurozone leaders agree short-term measures to stabilise markets, but said he expected a deal today as the summit continues.

"Everyone must make an effort so that markets are convinced that the measures are effective, and they must be," Hollande told a news conference. "We all need Italy and Spain to have lower interest rates today and for Spain's banks to be recapitalised because that will bring relief for the eurozone."

'Major game changer' for Ireland

The decision to allow rescue funds to lend directly to recapitalise banks is a "major game changer" for Ireland and will ease its path back to financial markets, the country's deputy prime minister said.

"When the details are worked out between July and the end of the year, it will have a real impact on our debt level and will greatly improve our ability to get back into the market and not to need a second bailout," Eamonn Gilmore told national broadcaster RTE.

Banking supervision

In a related decision, European leaders also agreed to create a single supervisory body for eurozone banks.

Van Rompuy said the aim was to create a supervisory mechanism involving the Frankfurt-based European Central Bank by the end of this year, and to break the "vicious circle" between banks and sovereign governments.

ALDE group leader, Guy Verhofstadt, greeted the decisions taken by the European Council, especially the ability for member states in need to access the EFSF/ESM.

"The measures adopted buy time but now they must be put to good use unlike at the beginning of the year when ECB long-term refinancing operations temporarily calmed the markets but the EU failed to exploit that hiatus to put in place the necessary structural changes," he said.

"However, what is urgently needed is not so much the fleshing out of these building blocks but specific legislative proposals from the Commission as soon as possible on all of the four elements - economic, banking, fiscal and political union."

The Greens/EFA group cautioned that measures again fall short of delivering a lasting and comprehensive solution to the crisis and lack proper democratic oversight, while deeming proposals aimed at stimulating economic growth as unconvincing.

"Allowing the EU's bail-out funds to lend directly to banks is an important step to breaking the debilitating chord between bank and sovereign debt, but it needs to be implemented diligently. The failure to do so long ago has had disastrous consequences for the Eurozone. Much stronger EU-level banking supervision is an essential accompanying measure and the move towards a single supervision of banking institutions by the ECB is welcomed but it must be accompanied by democratic accountability. However, instead of agreeing on the necessary comprehensive banking union, this is a piecemeal approach," said Greens/EFA co-presidents Daniel Cohn-Bendit and Rebecca Harms.

Voicing the concerns of the 4.000 local and regional co-operative banks in Europe deeply involved in the financing of the real economy, the European Associations of Co-operative Banks (EACB) said that the banking union raises concerns among many co-operative banks across Europe as it fears the new supervisory mechanism may remove diversity in the banking market by creating on-size-fits- all solutions.

EACD chair, Christian Talgorn said that any new supervisory mechanism shall respect the subsidiarity principle concerning the supervision of local and regional bank. “This is an ambitious and extremely important project. Co-operative banks will contribute significantly to the discussion to ensure that their role will be properly taken into account”, he added.

The idea of a eurozone banking union with a bail-out potential has been making headway in recent days, as Spain's banking crisis has deepened.

The Commission had already proposed a single deposit guarantee scheme years ago but it had been unanimously rejected by member states. This time around though, a number of countries were pressing for such a scheme.

European Commission president José Manuel Barroso maintained that a "banking union with more integrated financial supervision and deposit guarantees" was the necessary step to complete the monetary union with an economic union. Europeans must do "whatever is necessary to ensure the stability of our currency," he added.

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