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Bailing Out the Banks: New Rescue Plan Agreed by EU

Eurozone's Bailout Fund Bailing Out the Banks

Guidelines have been agreed on how to use the eurozone's bailout fund to help by bailing out the failing banks. The move by European finance ministers is intended to bring financial stability to the eurozone.

Under the agreement, the European Stability Mechanism will be able to inject up to 60 billion euros into bailing out the banks that are struggling, rather than allow them to go under. The total rescue fund is worth 500 billion euros.

Allowing the ESM to shore up struggling banks is a move away from past policy. Previously, the ESM had only been allowed to bail out national governments rather than European banks. 

This new banking rescue plan to stabilise the eurozone agreed just four months after the Chancellor, George Osborne, announced the UK banking reform bill going to parliament.

Eurozone Banks Face Bigger Losses Than Their Governments Can Cope with

In some of the countries which have suffered financial collapse, it was the banks that needed help. For example, the governments of the Republic of Ireland, Cyprus and Spain received bailouts but they in turn had to use the money to rescue their own banks. That could have unsettled the markets, with fears that the banks in the eurozone might suffer losses bigger than their governments could cope with. The problem is made worse by the fact that many of the governments are dependent on their own banks to lend them funds.

National Governments Across the Eurozone Relied on for Bailing Out the Banks

The rescue package is designed to break a 'chicken and egg' situation, where the governments depend on their own banks for funds and the banks depend on their national governments to bail them out. It's intended to spread the risk of a bail-out across the whole eurozone, rather than allowing individual countries to fend for themselves.

Limits Set on Bailing Out the Banks 

However, the eurozone governments with stronger economies have raised concerns about their level of risk. Led by Germany, they have sought to limit to the amount of funds the ESM can supply. This means that the national governments of those banks which have been bailed out will still take the biggest risk.

Big Depositors May be Expected to Contribute

The terms of the new directive includes a so-called 'bail-in', where the banks' shareholders, lenders and even big depositors may be expected to make a contribution before any ESM funds are released.

Fears of a New Financial Crisis

Previously, only institutions which had agreed to contractually accept this risk were liable, but the new rules have prompted fears that any large depositors will simply put their money elsewhere
and set off a new financial crisis. The new agreement will come into effect in 2014 as long as it is ratified by a new Bank and Recovery Directive which is agreed by all of the EU finance ministers.

Written by David Archer of Circle Square  -  Investment Banking division

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