Germany, Netherlands and Finland seek to limit use of European Stability Mechanism funds for bank bailouts

In what might prove to be the defining moment in the adoption of the Swedish model to address the ongoing EU bank solvency led financial crisis, Germany, the Netherlands and Finland announced that they would like to limit the use of funds from the European Stability Mechanism for bank bailouts.

By limiting the use of funds for bank bailouts, they are forcing policymakers in Greece, Spain, Portugal and Italy to use their modern banking systems as they are designed.

Specifically, they are forcing these policymakers to follow the example set by Iceland and requiring the banks to recognize today all of the losses on the excess debt in the financial system that the banks would otherwise recognize by going through the long process of default, bankruptcy and foreclosure.

Having recognized the losses, those banks that can generate earnings to rebuild their book capital levels will do so.  Those banks that cannot generate earnings will be resolved.

Naturally as part of the resolution process, depositors will be protected and bank debt holders will absorb losses to the extent they exceed the capital in the bank.

Spain’s government bonds fell, with 10-year yields rising the most in almost eight weeks, after top- rated European countries said national authorities should bear the cost of earlier losses in their banking industry. 

Italian and Irish securities also declined as Germany, the Netherlands and Finland said late yesterday the region’s bailout fund, the European Stability Mechanism, should assume only a limited burden in bank recapitalizations.... 

“There’s an ongoing drip feed of negative news,” said Richard McGuire, a fixed-income strategist at Rabobank International in London. The ESM announcement “appears to cast some doubt as to whether Spain will be able to disburden itself of the liabilities it will assume via its banking bailout.”...

Of course, under the Swedish Model, there will not be a banking bailout.

Bank recapitalization “should take place based on an approach that adheres to the basic order of first using private capital, then national public capital and only as a last resort the ESM,” Finance Ministers Wolfgang Schaeuble, Jan Kees de Jager and Jutta Urpilainen said in a statement distributed by the Finnish Finance Ministry. That may rule out the bailout fund from being used to deal with the 100 billion euros in aid Spain sought for its banks in June....

This statement implies that Germany, the Netherlands and Finland want Spain to bailout its banks.

Why?

Because when it comes to resolution of the banks under the Swedish Model, banks in Germany, the Netherlands and Finland are going to recognize losses.

However, this is not a problem that Greece, Portugal, Spain or Italy should worry about.  Those banks are responsible for not having more exposure than they can afford to lose.  If they exceeded this exposure level, then it is up to the governments of Germany, the Netherlands and Finland to step up and apply the Swedish Model to these banks.

The statement by the German, Dutch and Finnish Finance Ministers “will come as a disappointment to the Irish government, who have been hoping for a significant element of ‘relief’ to their overall debt sustainability,” said Owen Callan, an analyst at Danske Bank A/S (DANSKE) in Dublin.