Will the ESM solve the crisis?
Hopes of a banking licence for the ESM boost the market
Markets have bounced back following comments by the ECB’s Ewald Nowotny that there were arguments in favour of giving the ESM a banking licence. In this piece, we examine the odds of one day seeing an EU emergency fund with direct access to ECB liquidity.
EU authorities’ response to the crisis marked by lack of means
A lack of means has been a constant feature of the authorities’ response to the euro-area crisis. The reluctance by creditor countries to mutualise euro-area public debt (and the political difficulties in having parliaments adopt such transfers) has always put a cap on the amounts offered to assist debt-strained countries.
Such a solution is thwarted by a cornerstone of European construction
As there is no fiscal federalism in the euro area, it is tempting to use one of the only federal institutions that works, the ECB and its substantial financial firepower to finance aid to debt-strained countries. However, those who devised the EMU were well aware of this temptation. Consequently, the whole legal construction was drawn up to rule out this possibility. Article 123 of the Lisbon Treaty is very clear and far-reaching in this regard:
Overdraft facilities or any other type of credit facility with the ECB or with the central banks of the Member States (NCB) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or NCB of debt instruments.
This is a cornerstone of the monetary union, and it is very unlikely that creditor countries, including Germany, will agree to have it removed at any stage.
A very unlikely prospect for the time being
So, what was Ewald Nowotny, Governor of Austria’s central bank, talking about? He said that there were arguments in favour of giving the ESM a banking licence. But he also said that there were arguments as well against such a move. He added that he was unaware of specific discussions within the ECB. We are clearly witnessing a case where the market heard what it wanted to hear.
A split between the ESM’s two mandate
In our view, the only way to circumvent the ban imposed in Art. 123 would be to make a distinction between the two tasks that the ESM is currently supposed to carry out. As defined in the 28/29 June EU Summit, the ESM will have a twofold mandate:
- to finance the recapitalisation of the euro area banking system.
- to help debt-strained countries to finance themselves on the capital market.
The first task does not pose a problem. As banks are private entities, financing them with ECB liquidity does not violate Art. 123. Moreover, keeping a sound and functioning financial system is part of the ECB’s remit. So the problem lies in the second mandate: interventions in the primary and secondary sovereign bond market. As long as the ESM has this double mandate, it appears very unlikely that it will obtain a banking status. The solution would therefore be to split the ESM into two institutions:
- one dedicated to bank recapitalisation, which could legally obtain banking status and thus drain the ECB’s liquidity to finance its activity
- another institution, capitalised by member states, dedicated to helping sovereign-debt issuances and intervention on sovereign secondary markets
Other ways to mutualise debt appear more feasible
Ewald Novotny’s remarks have been interpreted as a magic wand being waved to solve the crisis. Unfortunately, the legal reality makes this possibility very unlikely. The only possibility that appears feasible in the current circumstances is an ESM split between two entities one with a banking licence dedicated to bank recapitalisation and another with a mandate to intervene on the sovereign bond market.
However, other ways to mutualise debt, such as a European Redemption Fund, seem more achievable than obtaining a banking licence for the ESM with its current status and mandate.