Cause and Effect in European Politics and Law

EU Starts a Major Bank Recapitalisation

Ralitsa Kovacheva, October 27, 2011

The EU leaders have agreed on a common bank recapitalisation plan, aimed at providing medium-term funding to banks and "to enhance the quality and quantity of capital of banks."

"There is broad agreement on requiring a significantly higher capital ratio of 9% of the highest quality capital and after accounting for market valuation of sovereign debt exposures, both as of 30 September 2011, to create a temporary buffer, which is justified by the exceptional circumstances," a statement of the 27 reads.

Polish Finance Minister Jacek Rostowski explained that Member States have explicitly insisted on the wording 'temporary buffer in exceptional circumstances’ to reassure financial markets that this was a single, temporary exercise that would not be repeated in the future. The requirement will apply to all systemically important banks that have participated in European stress tests, Mr Rostowski told reporters. The deadline to meet the new requirement is 30 June 2012.

First, banks need to raise the necessary funding by themselves from private sources. Until the 9% capital ratio is met, "banks should be subject to constraints regarding the distribution of dividends and bonus payments." If necessary, the national government will give financial support to banks. Where this is not possible, "recapitalisation should be funded via a loan from the EFSF in the case of Eurozone countries."

The decision must be approved by the eurozone leaders as part of a broader package, together with the decisions for private sector involvement in the deal to reduce the Greek debt and increase the eurozone rescue fund EFSF. Jacek Rostowski said that the total amount of funds needed for the recapitalisation of banks would depend on the agreement with the private sector what losses it would bear in the Greek debt write-off.

The decision for a coordinated European plan to recapitalise banks came after two bank stress tests (2010 and 2011) and numerous criticisms that the risk to the banking system, arising from the debt crisis, was greatly underestimated. Even the IMF Managing director Christine Lagarde bluntly called on Europe to urgently recapitalise its banks, given their large exposure to sovereign debt. Europe resisted to recognise this need, until it became clear that there must be a massive Greek debt write-off and the 'Sword of Damocles' of markets' mistrust hung over the core of the euro area, in the face of Italy and France.

The Franco-Belgian bank Dexia has recently been bailed out for the second time in three years, which is interpreted by the markets as merely the first tile from the potential domino of bank failures. So the European Banking Authority had to urgently diagnose the needs of the banking system, which led to last night's (October 26) decision for a common and coordinated recapitalisation of systemically important financial institutions.

Polish Prime Minister Donald Tusk explained that the bank recapitalisation agreement was a precondition, so the other decision to be taken more easily. He denied to predict how final and detailed these would be but said that leaders were close to a political decision, although there were important details that might take longer.