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Euro finance ministers on Thursday agreed on broad guidelines on how to use the bloc's permanent bailout fund to rescue banks from failure, delivering on a long-promised goal to stabilize the bloc's financial system.
Enabling the 500 billion euro ($670 billion) rescue fund to shore up struggling banks directly is a pillar of the 17-nation eurozone's so-called banking union, which seeks to hand European institutions the job of supervision and rescue rather than leaving weaker member states to fend for themselves.
"We have made an important step on the way to the banking union by agreeing on the main points for a future regime for direct bank recapitalization," said German Finance Minister Wolfgang Schaeuble.
"We need the banking union to improve the trust of the financial markets in the stability of the European banking system," Schaeuble said.
It will still take some time for the European Stability Mechanism to kick in and Irish Finance Minister Michael Noonan estimated it at "12 months or so."
Several ministers also cautioned that despite a political agreement on the broad strokes, many operational details have yet to be hammered out, and it might take even longer.
The groundwork for the banking union was made by EU leaders a year ago at the height of the eurozone's three-year-old debt crisis. However, some countries, led by financial heavyweight Germany, have since sought to slow down the project and limit its scope. They fear that they might have to spend their taxpayers' money to rescue ailing banks in countries which didn't oversee the sector properly in the first place.
The initial idea of the banking union was to ensure that ailing banks don't wreck a nation's finances to the point that it might be forced to seek a bailout itself, as in the case of Ireland or Cyprus.
"This instrument will help preserve the stability of the euro area and help removing the risk of contagion from the financial sector" to the states, said Jeroen Dijsselbloem, who chairs the Eurogroup, the meeting of finance ministers from the 17 European Union countries that use the euro.
However, the ESM's firepower to recapitalize banks will be limited to 60 billion euros ($79.3 billion) to maintain the fund's top-notch credit rating, which it needs to raise money on the international bond markets. Also, funding from the ESM would only be made available once the bank's creditors had been tapped fully and the lender's government can no longer afford to prop it up.
Lending to banks that have lost market access is considered to be significantly riskier than lending to governments — for which it was initially set up as backstop — and so would hurt the ESM's credit rating.
The operational criteria for direct bank recapitalizations won't be finalized before an agreement on two other pillars of the banking union will be reached. One of them, a set of rules on how to unwind banks, including a clear pecking order of who will be hit in case of bank failures, will be discussed by a meeting of the EU's 27 finance ministers Friday. The second precondition is an agreement on a Europe-wide joint deposit guarantee — a discussion that has barely started.
Another sticking point was to what extent — or if at all — the ESM would also intervene to help ailing banks whose problems stem from before the planned ECB takeover over as supervisor. Nations like Ireland and Spain have dumped dozens of billions into shoring up their banks.
Ireland said the possibility of such retroactivity was secured on a case by case basis.
Germany's Schaeuble cautioned there was "little leeway" for direct recapitalizations, hinting that European rescue nets might lead to EU countries being tempted to load their problems on the region's authorities instead of dealing with them themselves.
The ministers also took stock of the progress made by Greece, which was granted some 240 billion euros in bailout loans by its European peers and the International Monetary Fund to avoid bankruptcy.
But the country, which is in the sixth year of a drastic recession, is in the middle of a political crisis that could see its government collapse. That would almost certainly lead the country to miss some of its agreed targets, which could force the creditors to withhold paying out the next tranche of bailout cash.
"I love Greece but I'm very much looking forward to a Eurogroup press conference where Greece is not going to be discussed and a summer where we don't have any Greek crisis," said the EU's top economic official, Olli Rehn.
"I want to appeal to the sense of responsibility of political leaders in Greece," he added.
Rehn stressed Greece has to push ahead with "the technical work on the fiscal policies and the structural reforms."
He dismissed media reports about shortfalls of several billion euros in Greece's bailout program, saying that if Athens meets the agreed milestones the next tranche can be paid out this summer. "Once this happens, there will be no financing problem," Rehn insisted.
The Eurogroup of finance ministers also signed off on Latvia's bid to become the currency union's 18th member nation starting next year — a decision that will then have to be rubber-stamped by a summit of EU leaders next week.
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