Euro area Finance Ministers reached an agreement on the reform of the European Stability Mechanism (ESM) in the early evening of Monday 30 November. The euro area permanent rescue fund will play an enhanced role in managing the macroeconomic crisis in the euro area and will be the lender of last resort for the Single Resolution Fund (SRF), the financial arm of the resolution arm of the banking union.
This agreement, which “reflects the progress made in reducing risks” of a financial nature, makes it possible to expand the instruments available to the ESM, welcomed the President of the Eurogroup, Paschal Donohoe. He confirmed that the Eurozone countries will sign the reformed intergovernmental treaty of the ESM “in January” in order to initiate national ratification procedures.
If this step is completed in 2021, the ESM will become the SRF Fund’s ‘backstop’ in early 2022, 2 years earlier than originally planned. To this end, a specific credit line will be set up to replace the existing provisions for direct bank recapitalisation by the ESM.
According to EU Economy Commissioner Paolo Gentiloni, such an agreement would have been much harder to reach if the banking sector was not more robust today than it was during the financial crisis of 2008. ESM Director Klaus Regling praised a reform that “will minimise the risk of financial contagion in the event of bank failure”. He compared the future role of the ESM as a ‘backstop’ for the SRF to the role of the US government vis-à-vis the FDIC bank deposit guarantee agency.
In fact, the latest negotiations did not focus on the reform of the treaty establishing the ESM as such, but on the level of financial risk reduction required to enable this breakthrough in risk sharing within the euro area. The expected rebound in non-performing loans (NPLs) due to the Covid-19 pandemic did not prevent political decisions from being taken. The Eurogroup’s lengthy declaration, negotiated hard over the last few days, lists all the technical elements taken into consideration.
Italy finally approved the reform of the ESM, because it considers that it has won all the points it had raised, which had been the main obstacle to the reform. On Monday evening, Italian Minister Roberto Gualtieri described the Eurogroup’s declaration as “balanced”, as it does not foresee any tightening of banking supervision rules or stress tests for small banks and envisages a reform – in parallel – of the rules on state aid to the banking sector and the macroeconomic crisis management framework, both of which are due to be completed in 2023.
Most importantly, Mr Gualtieri said, the Italian banking sector is no longer considered problematic from the point of view of the stock of NPLs, unlike Greece and Cyprus, which will need to make further progress despite regulatory advances in bankruptcy regulation.
In these circumstances, Italy was able to approve the reform of the ESM combined with an anticipation of its role as a safety net for the ESM. Mr Gualtieri also decoupled this reform from the controversy dividing the Italian government coalition over the pandemic-specific credit line that the euro area’s permanent rescue fund has put in place to the tune of €250 billion, but which no euro-area country has activated to date (see EUROPE 12488/1).
German Minister Olaf Scholz said the agreed reform, even if it appears technical at first glance, will have a strong political impact by strengthening the euro area and its banking sector against speculators. “At the same time, we are continuing to reduce the risks on bank balance sheets”, he added. Welcoming Mr Gualtieri’s “political courage”, the French Minister, Bruno Le Maire, described the agreement on the reform of the ESM as “strategic”, making the Eurozone “the world’s most protected monetary area in the face of financial crises”.
See the Eurogroup statement: https://bit.ly/36oa9QI
See the Commission’s report on financial risk reduction: https://bit.ly/33AGPoe
Banking Union. Mr Donohoe hoped that the Eurogroup agreement will create a momentum to move forward on other issues aimed at completing banking union in the euro area, citing the creation of a European Deposit Insurance Scheme (EDIS) and the issue of liquidity in the event of a bank resolution.
On Tuesday 1 December, the Ecofin Council also took stock of the work in progress on banking union, on the basis of a progress report from the German Presidency of the EU Council. Mr Scholz recalled the four dimensions: bank crisis management, enhanced market integration in the banking sector, regulatory treatment of sovereign exposures and the design and features of the EDIS system. He reported “good progress” on crisis management, welcoming the European Commission’s commitment to present legislative proposals “in due course”.
In particular, the report shows that Member States remain divided on the treatment of bank exposures to sovereign debt.
See the report of the German Presidency: https://bit.ly/3ocL8Ol
On Friday 11 December, the President of the Eurogroup will report on the work in progress at the euro area summit. (Original version in French by Mathieu Bion)