ECONOMY

EU set to tell markets it will stand by weak banks

European Union finance ministers will pledge on Friday to stand by their banks if health checks next year reveal they need to bolster their capital, according to a draft statement obtained by Reuters.

The Eurogroup of ministers from the 17 countries that share the euro were due to discuss the backstop arrangement for banks on Thursday, but more serious talks will only take place when finance ministers of all 28 EU member states meet on Friday.

The talks on making a clean sweep of bank problems are part of wider negotiations on setting up a eurozone banking union to police lenders and support weaklings or close them down.

The banking union will be preceded by a so-called asset quality review of eurozone banks by the European Central Bank and then a stress test of all banks across the wider EU to see how assets such as loans would fare in an economic downturn.

“The council (of ministers) reiterates that all member states participating in the (ECB supervision) implement appropriate arrangements, including the establishment of national backstops ahead of the completion of (bank health tests),” said the draft statement.

The results of the health checks are expected around the time that the ECB becomes the supervisor for euro zone banks, which is the first step towards banking union.

If the tests show that a bank is short of capital, its shareholders and other investors will be asked to raise it.

But if there is insufficient investor interest and the bank’s health cannot be repaired by imposing losses on junior bondholders, governments have to be ready to provide the missing money themselves.

Very few countries have any special funds set aside for such a purpose now, so the ministers have to make sure that at least all the necessary legislation is in place for them to be able to inject capital.

“In the eventuality that the (tests) reveal a capital shortfall, the established pecking order – first private sources, then national and euro area/EU instruments – will apply,” the draft statement said.

The draft statement by ministers made clear that government help will only be possible if private funds are not available.

State help, in other words, will come at a heavy cost — imposing losses on shareholders and junior bondholders, changing a bank’s management and capping salaries and bonuses.

In time, possibly as soon as 2015, senior bondholders and even depositors with more than 100,000 euros in a bank, will be asked to contribute to help restructure a bank.

If a euro zone government cannot raise the capital itself, it could ask the euro zone bailout fund, the ESM, for a loan, as Spain did to recapitalize its banks in 2012.

If a government cannot borrow enough from the ESM because that would make its own public debt unsustainable and it would not be able to repay the loan, the ESM could recapitalize a bank directly, without government intermediation, from November 2014.

On Friday the ministers will also discuss how to set up an agency and fund to close or revamp banks in trouble – another pillar of the banking union.

But officials said they expected no major progress here as euro zone countries are divided over which European institution should have the power to shut a bank and who should pay for it. [Reuters]