Bank resolutions and recapitalisations by the ESM may end up politically swayed

Klaus Regling, Managing Director of the European Stability Mechanism (third from right), speaks at the Committee on Economic and Monetary Affairs (ECON) of the European Parliament. Sharon Bowles (third from left), in the chair of ECON Committee. (European Parliament Audiovisual Services, 24/09/2013).

Klaus Regling, the Managing Director of the European Stability Mechanism (ESM), speaking yesterday at the European Parliament, when pressed by legislators, accepted that the wealthy ESM under conditions could function as a backstop and finance jointly with other sources, euro area bank resolutions and recapitalisations. Regling did concede that he was “open to considering other possible legal interpretations which could justify this role for the ESM”. The dreadfull meaning of that remark will be analyse below, together with a timely observation by some MEPs.

In any case the questions of how and who will foot the bill of bank resolutions and recapitalisations, is presently blocking the progress towards the creation of the most important European institution after the euro, namely the Banking Union. Seemingly, this Gordian knot will not be cut until Germany forms a coalition government. If Angela Merkel’s partners will be the socialists of SPD, a lot will change in structuring the Banking Union.

ESM’s money for all?

MEPs’ questions to Regling focused almost exclusively on whether the ESM could act as a “backstop” for the EU Single Resolution Fund, which is planned to be set up next year, and start directly recapitalise struggling banks or pay for their resolution. Legislators are very well aware that the issue of funding bank resolutions and recapitalisations has to be agreed by the end of this year.

It was only last Monday that the President of the European Central Bank, Mario Draghi, told the MEPs that early next year the ECB, in its capacity of supervisor of the banking sector, will conduct, with the help of private auditors, bank balance sheet health checks. For those checks to be credible he stressed, there must be in place a bank resolution and recapitalisation scheme.

Coming back to Regling, after some questions he didn’t only accept that the ESM could act under conditions as a backstop in euro area bank resolutions. He went as far as to say “some form of backstop would indeed be needed for the Single Resolution Fund” then he added, “it would be needed permanently and not just until the fund reached its target levels of money”. However, he also said that the “ESM’s current legal setup would not allow it to take on this role. The ESM however could pass money on directly to banks, if there was a unanimous decision of the Eurogroup”.

In this way the Managing Director of ESM left open a lot of options for the Mechanism to support bank resolutions and recapitalisations, thus unlocking the procedure for the enactment of the Banking Union. In plain English though he left to be clearly understood, that the ESM can do whatever the Eurogroup wants, when in unanimity. He also clarified that even the legal status of the ESM can change, and permit the direct recapitalisation and bank resolution funding under some form of qualified majority, again if the Eurogroup wants.

Or for some?

Some MEPs however argued pointedly that in reality there is no legal impairment whatsoever, preventing the ESM from acting as a backstop for the Single Resolution Fund. Given that, they concluded that there is much truth in the widespread understanding, that once the single supervisory system of ECB approved, the ESM could interact directly with banks themselves, thereby severing their links with governments. This possibility will prove very productive, but risks will remain until the umbilical cord between banks and governments is cut off.

As for the direct control of governments over the ESM it could have devastating consequences for some. It may lead to a situation, where the politically strong member states could direct the Eurogroup and the ESM in serving certain interests, to the detriment of others. Every time they can change affiliations and groupings in order to effectively control the Eurogroup and the ESM.

If such an arrangement is possible the entire edifice of the Banking Union will be made subordinate to the politically strong euro area countries. Over indebted countries and their banks would thus be always dependent on Germany. Vae Victis…