BRUSSELS (MNI) – Governments would be expected to guarantee the
European Stability Mechanism against losses for direct equity stakes
taken in national banking sectors, a senior EU official said on Friday.

Eurozone leaders last week agreed, subject to certain conditions,
to allow the new rescue fund to take direct equity stakes in banks in a
bid to break what they described as the “vicious circle” of dependence
between weak banks and heavily-indebted sovereigns.

Clarifying that agreement, the senior EU official said that the
purpose of the agreement was to prevent an increase in the national debt
of countries requesting aid to recapitalize their banks, but that those
countries would be expected to guarantee the ESM against losses on
equity stakes taken.

“The ESM is able, if one ever were to decide on such a programme,
to take an equity share in a bank, but only against a full guarantee by
the sovereign concerned,” the official said. He explained that this
would eliminate the direct impact on the government’s debt-GDP ratio,
since the aid would no longer be in the form of debt. However, the ESM
investment still “remains the risk of the sovereign because you have
this country guarantee,” he said.

The guarantee would be classed as a “contingent liability,” the
official noted. Still, it seems that adding contingent liabilities to
government books that are already saddled with rising debt will hardly
be reassuring to bond markets.

Spain would be unlikely to benefit from a direct recapitalisation
by the ESM, at least at first, because the creation of a single Eurozone
banking supervisor, which Eurozone leaders made a pre-requisite of
direct capitalization, would not likely be in place before the aid is
provided. However, some EU leaders, speaking after last week’s summit,
suggested that even if aid to Spain were first provided as a loan to the
government, it might later be taken off the government’s book once the
condition for direct recapitalization had been met.

The European Commission is expected to present draft legislation on
a common supervisory system for Eurozone banks after the summer, but
negotiations and implementation would likely continue into 2013.

Some Spanish banks would need to be recapitalized this autumn and
others next Spring, the official predicted.

Eurozone finance ministers meeting in Brussels next Monday are
expected to reach a “political understanding” on details of the Spanish
aid programme, which would be structured initially as an EFSF loan to
Spain of “up to E100 billion,” the official said.

The actual amount provided would depend on an ongoing assessment of
individual bank’s capital needs.

Once the ESM is ready, which should be “over the course of the
summer,” the loan would be transferred to the ESM. Once that happened,
the temporary increase in Spain’s debt because of the loan would be
lifted, because liabilities to the ESM, a supranational financial entity
like the International Monetary Fund, do not add to national debt
figures.

EU officials had previously hoped that the ESM would enter into
force as scheduled on July 9, but Germany’s constitutional court will
not examine the legality of the treaty until 10 July. This means the ESM
cannot start on time because countries accounting for at least 90%
percent of the ESM’s capital need to ratify the treaty. The delay in
Germany, the biggest ESM contributor, is more than enough to hold up
final ratification.

The Eurozone aid programme for Spanish banks would likely take
place over two years, but the duration of the loans would be far longer,
the official said.

At their meeting Monday, Eurozone finance ministers will likely
decide who to appoint to the European Central Bank’s executive board.

The ministers will have also have a first discussion with Greece’s
new finance minister, Yannis Stournaras, who is expected to brief his
colleagues on how far off track Greece has veered from the targets it is
expected to achieve under its EU-IMF aid programme.

The senior EU official warned that “there will be no disbursement
until the Eurogroup has determined that the adjustment programme is back
on track.”

–Brussels Newsroom, +324-952-28374; pkoh@marketnews.com

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