Euro-zone bailout fund to keep banks safe

The finance ministers of the Euro-zone agreed to let a bailout fund pump cash directly into struggling banks. That would happen only if countrys governments share the risk by making capital investments in such banks.

This strategy of direct recapitalizing banks through the 500 billion euro bailout fund is seen as a crucial achievement to help prevent future crisis similar to those in Cyprus, Spain and Ireland.

“This instrument will help preserve the stability of the euro area and help remove the risk of contagion from the financial sector,” said Jeroen Dijsselbloem, chair of the group of eurozone finance ministers who brokered the agreement in Luxembourg, cited by Financial Times.

Because of the requirement that each country should first put its own stake into the struggling bank, there is a chance the Euro-zone Stability mechanism not to work for governments which are already experiencing those problems as they wouldnt have the assets to help the banks.

Until now, the Euro-zone’s bailout fund could only lend to governments, which could then use the cash to bail the banks. But that system caused a “vicious loop” where otherwise healthy government balance sheets were brought low by bank collapses.

The system would work for banks which are in need of a recapitalization due to below-minimum capital requirement. Raising above common equity ratio of 4.5% would first trigger a request for countries to put in their own cash to bring the bank up to that limit before the ESM could help.

The total investing power that can be used for bank recapitalization stands at 60 billion euros. However, the ESM’s board has the ability to raise that limit.