EFSF and the European Banking System

Around the time of the EU/IMF deal for Ireland, Patrick Honohan advocated that it would be more effective if the financial risks associated with fixing the Irish banking system could be shared across the European system, rather than just making ‘plain vanilla’ official loans to the Irish government.

In her Jackson Hole remarks, Christine Lagarde agrees:

Second, banks need urgent recapitalization. They must be strong enough to withstand the risks of sovereigns and weak growth. This is key to cutting the chains of contagion. If it is not addressed, we could easily see the further spread of economic weakness to core countries, or even a debilitating liquidity crisis. The most efficient solution would be mandatory substantial recapitalization—seeking private resources first, but using public funds if necessary. One option would be to mobilize EFSF or other European-wide funding to recapitalize banks directly, which would avoid placing even greater burdens on vulnerable sovereigns.

Today’s FT lead article also makes the same point  – but where the EFSF would guarantee funding lines for banks, rather than inject capital.

47 replies on “EFSF and the European Banking System”

These are good proposals.

While we’re thinking outside the box …

In an Irish context, I would love to see EFSF provide a thirty year low interest loan to Anglo to pay off the ECB and the ELA debt? Then we restructure the promissory note to be a bullet bond that pays off in thirty years time.

That could reduce annual Anglo-related payments to about a billion (3ish percent times of 30 billion) instead of the €3.1 billion scheduled into the middle of the next decade. Such a deal would also get the ECB off the Anglo hook and eliminate the unsightly ELA that was intended to be a short-term measure.

Should you not recapitalize banks during the good times rather the the bad ?
When banks recapitalize they give out less loans ,further reducing the credit money supply , further destroying their existing loans and the economy etc etc.

Surely its best to divorce money from the loans and use it to rebuild the physical economy rather then a series of fictitious & fraudulent bank balance sheets.
I find it amazing that these people think the economy is the banks rather then a mere utility servicing the real economy.
They have got the entire money production / supply chain back to front….. they can’t be that stupid……….. they must have skin in the game of bank survival.

and whilst we are at it, how about making banking sub debt work better ?
1) An efficient trading and clearing platform/market venue that publishes prices etc
2) An EU wide standard resolution mechanism that allows for enforced cancellation/equity swap

An active , liquid and healthy sub debt market should be one of the first barriers against bank failure.

I mentioned here before that Daniel Gros and others called for an Europeanwide fund to support banks in early Oct 2008. European leaders such as Berlisconi were calling for it then. It is my opinion that such a fund providing loans as Karl described above would have kept Ireland from exiting the bond markets and having the IMF over. It meet most opposition from Ms. Merkel. So Mr. Honahan also made this point before the bailout and was obviously slapped down.
Dr. Gros wisely pointed out at the time that the countries whose banks were not in seriuos trouble were opposing this kind of a fund for primarily selfish reasons. He actually predicited that if German banks shares fell by 30% we would see a change in attitude from the Germans.
The German bank shares fell by, funnily enough, 30% this summer and we did see a change in attitude. The ESFS was quietly modified to allow recapitalisation of banks. I stand to be corrected, it seems states can get loans to recapitalise their banks with no 1. Harsh MOU conditions 2. Penalising interest rates. French bank shares have fallen by over 32%. Now the French and Ms. Lagarde are really pushing for a European wide rescue mechanism for the banks.
There should be more private funds involved in a rescue fund for banks not a completely tax payer funded ESFS. When Long term capital management failed in the 90’s it was bailed out mainly by private funds from other financial institutions. The Federal Desposit Insurance Corporation in the Sates collects a levy from banks.

Liquidity is based on the banks’ willingness to lend to each other – right?
So it’s a confidence issue – is it? So it’s easy for banks not to be able to access liquidity despite being adequately capitalized?
A liquidity crisis in a major European bank would be extremely easy to envisage.
So too would be a run on deposits at a European level. I’m possibly wrong because I’ve no formal training whatsoever but this could get messy.
Problem with the EFSF is that it needs to be much bigger to cover countries and banks. Can’t see the Germans going into it. Problem with state backed recapitalization is that you f.u. the states (and make their bonds more useless) thus setting up a nasty vicious cycle.
JCT has always used the Credit Lyonnais solution to this problem without grasping just how big this was

I would suggest that rather than the financial transaction as proposed a proper Euro wide resolution scheme such as the FDIC one you suggested which can resolve a banking collapse over a weekend and also have the power to direct recaps and issue cease and desist orders for risky behavior. It cannot be that difficult to agree such a move amongst the 17 Eurozone members and would not involve fiscal transfers from taxpayers that the Germans are opposed to.

“Today’s FT lead article also makes the same point… ”

…and also as the FT points out today, Christine would like it all funded by taxpayers and we saw all the problems in Ireland with not involving private investors, etc. etc.

It will all end in tears.

These guys are never going to save these “assets” as they are / were unproductive consumption holes build using a sea of oil.

Even if the decide to cull / starve credit Herbivores the bank assets will continue to go down because credit consumers graze on this declining credit biomass.
Its like as if a bunch of semi – intelligent lions decide to use some herbicide to kill the grassland – they would have a bumper kill for perhaps a month but what do they do then ?

Surely you stop the decline of the money supply when you convert it all to goverment money – then raise it at a rational rate of lets say 2% to build projects that internally generate real organic wealth.
These guys must know this – this rule by banks is now a quite farcical vista ,what is their agenda ?
Its certainly not altrustic.

@ PR guy

The FT argues for debt for equity swaps.
Poor Ireland is like the first patient to be treated for radical brain surgery. The operation was a success but future patients will be subject to different operational procedures which don’t involve the full lobotomy.

Banks do not need recapitalisation or any other form of bailout. They need to be wound down. In this country for example, all five state owned banks should be closed up, their deposits moved into Bank of Ireland, and their creditors told to hump off. Real Capitalism.

The reality that no-one is willing to face is that such roll-ups are in fact necessary across the continent; indeed, even in France, and in Germany itself. Banks across the continent are insolvent and instead of being responsible adults and dealing with the situation, European leaders are burying their heads in the sand Ireland style and coming up with half-cocked bailout funds like the EFSF, and then when these are shown up as lame ducks, everyone runs around trying to change it into a guaranteed lender of last resort, despite the ECB having already failed miserably to perform this function.

Banks should be allowed to fail like any other business, and let the reckless creditors take the hit, even if those reckless creditors happened to be “Stupid Germans in Düsseldorf” and even if the failing banks happen to be Landesbanks. The proper and responsible action that Europe must take right now is to implement laws, procedures, and systems for dealing with these necessary liquidations while protecting depositors. Since we’re coming on on four years into this crisis, such measures are long overdue.

@ Dork,
Large ‘too big to fail’ financial institutions and wealth funds do have enormous lobbying power and influence over governments.
Simon Johnson recommends breaking them up into smaller entities.
Another solution is increased political integration in the EU or at G20 level giving governments larger ‘bargaining power’ when dealing with them.
Jeffery Sachs recommends that politicans not recieve any corporate donations and instead get elected by campaigning for example on free social media.
How do you recommend dilluting their influence?

Don’t hold your breath – the strategic agenda is to transfer the global reserve currency from the Dollar to Gold.
For this to happen all of this credit must flow beyond the exponential debt event horizon and into a new monetory universe that also happens for some funny reason to be debt based.

Don’t hold your breath – the strategic agenda is to transfer the global reserve currency from the Dollar to Gold.

Dork once again, there is no strategic agenda. You are assuming a level of competence in the governing classes that simply does not exist.

The only “strategic agenda” that exists is the dogmatic requirement that no bank in Europe be allowed to fail, no matter what the cost. Our leaders are quite prepared to sink the entire continent into recession and possibly end the Euro to keep the likes of Anglo Irish Bank, AIB, and IKB ticking over indefinitely.

Hence the debacle that is the EFSF–a gigantic slush fund of bank bailout money which no-one can even agree on how to spend. The only clear fact is that every cent will be pumped into the zombie banks–all we’re debating here is the colour of the hose.

“I stand to be corrected, it seems states can get loans to recapitalise their banks with no 1. Harsh MOU conditions 2. Penalising interest rates. ”

You may have missed another condition – they first have to agree to commit their own capital contribution, callable at will by the ESM directors. In Ireland’s case for example that is €11 billion. The total (initial) fund envisaged in the ESM Treaty signed on 11 July is €700 billion. That can change.


Another IMF good priest trying to square the circle.
You could wipe out all the banks but give one bank the power to create money and they would be back in the game.
Gold is their final refuge when all else fails – this will sterilize their loan losses and clear their transactions so that they can remain in the credit business.
Non debt based goverment fiat is never going to happen given the strange power dynamics in the west , only Gold will protect the average soul but also is the banks lifeline.
Such is life.
Take what you can get because you ain’t seen nothing yet.


If EFSF is used to recap banks then it means that new equity is injected and this new equity will in some cases give influence and in other cases it will give total control to the one borrowing from EFSF. Who would get this influence/control? EFSF?

Therefore I do not see it possible that the EFSF can recap the banks directly, I do see the possibility of soverigns borrowing from the EFSF and making equity investments in banks. Given the low interest rate from EFSF, the ROI on the equity doesn’t need to be very high for the investment to break even for the soverign.

If current equity investor want to protect their control of the banks then it seems they’ll have to inject more of their own money. The value of shares can go down to zero, it appears many investors seem unaware of this basic fact.

@ All

As I pointed out on the thread dealing with Schaeuble’s reporting remarks on the cause of the crisis (Kevin O’Rourke thread), there was a pretty detailed report on this idea in the weekend Sunday Times. Unfortunatelly, the FT also reports today that little progress is being made in relation to the proposal, despite its evident merits. It would, one supposes, not be caught by the famous no-bail out clause which refers unequivocally to “public” bodies, whether this includes state-owned banks, however, being the 60,000 dollar question. (It seems that it is the state owned banks in Germany that are stalling on participation in the PSI for the second Greek deal, which is rather ironic, to say the least, given the fact that PSI was a sine qua non for the German government).

The head of the employers federation in France, Laurence Parisot, sees, if not a plot, an “orchestration” originating in the good old USA.

I cannot even pretend to understand the technicalities but it seems that there is something of the inevitable about this new/old line of thinking for the reasons given by Chris above.


The continental banks were badly wounded by the American default in 71 – the Euro was all about taking down the dollar – it was designed that way.

What other central bank ever revalued its Gold holdings every quarter ?
That does not happen by accident.
We just happen to be the casualties in this limited financial war.
However I am not sure where Lagarde loyalties lie given her connections and now her position in the IMF.
Anyhow I believe Europe is draining America of its Gold not unlike what it did in the 60s – why do you think the BIS wants you to go into austerity ? / whats austerity ? , it means you default on your credit loans , but the excess energy does not disappear – it goes somewhere…………….
This entire sham does not make any sense with Gold

While there is clearly a distinction between providing equity financing and long term term debt financing by the ESFC in situations where the solvency of the bank is at issue providing long term financing may simply result in that bank’s private creditors escaping without doing anything to fix the solvency issue.

If the bank will not be allowed to fail – then admit that and at least make sure it is well capitalized. Otherwise the problem may become more difficult because the bank will lose private funding that could be difficult to recover. If the funding difficulties of the bank are caused by solvency concerns the provision of official long term financing seems to just allow private creditors an orderly exit – it doesn’t necessarily stop them leaving.

Therefore, once you accept the bank won’t be allowed to fail, then it may follow that equity injections are a better way of dealing with funding problems – essentially because any losses that could be suffered on the equity injections (i.e the extra risk) is in large part actually be borne by the official lenders in any event because they won’t let it fail.

So teh costs of equity injections are the same or similar to lending – but the benefits in terms of retaining private funding and improving stability (and maybe even returns on the equity) are better.

I would say that equity injections are better in a world where banks wont be let fail


While i could see difficulties with the fund owning banks could you explain why you think they are insurmountable?

@ ObsessiveMathsFreak

Your so correct. The problems in Europe as in Ireland was failure to recognise the vast scale of bank insolvency due to gross incompetence at their trade. Governments need to allow banks to fail. They were bulling about banks that were “too big to fail” meanwhile, the state fails because of all the private debt it took on board.

As Christy says, we require an FDIC solution, shut them down, merge them, whatever it takes, America is laughing at Europe’s failure in this regard. Ms. Lagarde is just going around in circles. “Sovereigns be ware of banks, banks beware of sovereigns” meaningless jargon when what is required is a mechanism to cleanse the system of failed overleveraged and insolvent banks.

It seems country-specific central bankers are the barriers to greater transparency and accountability of the European Banking sector. They don’t want to expose their banks (real-time) balance sheets and that’s why the entire stress test done by EBA was a political travesty.

Commissioner Bannier (Fr) can’t get a handle on european banking sector because CBs are objecting to real-time transparency – competitors will be able to see what the hell is going on and short some of them.

LBs in (West) Germany are a case in point. There is a serious case under way by Commission to find ways and means of winding down some of the LBs.

It’s conceivable that the weakest link in the EZ money market – Lagarde now calls it *liquidity* constraint – is the EZ banking sector. That’s one reason why their balance sheets have to be exposed and rectified, otherwise market specualtion will not end, me thinks.


I’m not sure that there are insurmountable obstacles to the EFSF controlling banks, if there is a will then there is a way. I’d say that the issue is that it would be unwise to concentrate so much control in so few hands. Unelected officials controlling balance sheets containing trillions of euro without transparency sounds 🙁

The US FDIC approach doesn’t work on TBTF banks or in other words, it doesn’t work. I don’t think it would work here either.

“moral hazard” is a phrase that is used so often these days that I think people switch off a bit.

It was wheeled out – then ignored around LTCM.

And again when the Greenspan put” was all the rage, driving risk cheaper and cheaper. It was ignored.

Rinse. Repeat…..

Every time, it is viewed as expedient to ignore it. Look what that has achieved!

The banking lobby appears to have totally captured the regulatory and political process.

Why will anybody try to apply market discipline to the allocation of capital again? The asset manager’s job will be to discern what cover bankers will be able to extract from politicians and then work out what that will do in terms of setting asset prices. They have knackered capitalism.

@The Dork


Not much gold in Dublin – do you have it in Cork?


‘IMmoral hazard’ more like – the term ‘moral hazard’ has lost all credibility around here since Sept ’08. In the parallel universe occupied by rational man, efficient market hypothesis, and beauteous equilibria it retains its power in the lifeworlds of the Borg …. (and a large number of ontologically challenged academics)

Well the price is no different to what it was 2 weeks ago really so the real HardCore Gold Ticks who are buried deep into the skin of the matrix are not letting go just yet.

Also central banks have official reserves which in Ireland is 6 tons or so and then they have unofficial reserves – which is all private gold recorded in their juristiction.
From a holistic monetory standpoint it does not matter whether they pay you back the new higher price so that you can buy their debt but they may decide to be bad bastards and raise the capital gains tax when/ if the stuff is nationalised again – although under the current freegold regime nationalisation is passe.

My bet is that Europe has a S£$load of private gold not registered on the official books built up over the last decade or so of higher euro / dollar value and higher interest rates and in the event of the US treasuary seizing the stuff under Manhattan island plan B will come into action.
But whatever happens they own your ass unless you are a very big fish.

30 year money. @ 3 -4 pct would be a great idea to re fi the pro note. However if it were to do that it would be below the Market rate for the fund for 30 year money and thus a fiscal transfer. If they were to that, they should go the whole hog and haircut the pro note.

Trichet’s response to Ms. Lagarde a few hours ago, “There is no liquidity or collateral shortage for the European banking system.”

Well, there you have it, what more is there to be said? It’s a conspiracy theory against the ECB and European banks, and it is one of smoke and mirrors, take away the smoke and the mirrors to reveal healthy, well capitalised banks.

Trichet has just said since there’s no liquidity crisis in European banking, we shouldn’t be worrying about solvency: http://www.telegraph.co.uk/finance/financialcrisis/8729822/EU-rules-out-fresh-capitalisation-for-Europes-banks.html

Yet short selling bank shares is banned in Belgium, Spain, Italy, France, Greece…

I’m beginning to think a whole new academic discipline is needed: Economic Psychiatry…it should aim to treat all of those hopelessly out of tune with economic reality.

I was reading Focus, the German magazine , last night and they showed a graph of the seat split in the German parliament. Angela has a thin enough majority given 12 of her party voted against the last bailout . It looks like an open goal for the opposition if they go any further. Germany has already shot itself in the foot over nuclear and could well do the same over the Euro, all for local political reasons.

@ All

FYI (Google translate does a good job).


The skirmishing is evidently taking place on several fronts.


The obvious compromise would be, as the Sunday Times reported, “to see cash from the €440 billion eurozone rescue fund used to temporarily insure bonds sold by banks”. And for Continental banks – notably French and German – to fess up to the reality of their situation.

I think it’s possible that the next stage of the crisis is coming into view – the collapse of a major French/European bank and a trigger across the continent.
But now I’ll go back to the really important stuff – Richard tol has come up with another way to show how good he is compared to everyone else…silly me for getting distracted


Thanks for the link. I’ve been looking for a good source of Greek news (or even some good Greek news). Looking at one of the other articles (public sector pay being slashed – and backdated to the start of the year slashing at that!), I still wonder why Ireland wasn’t forced to do some of the things being asked of Greece when the Troika rode into town. No wonder they are rioting.

Greece is toast unfortunately.


“I think it’s possible that the next stage of the crisis is coming into view ”

Still plenty of rumours around about a major French bank having trouble getting credit (but getting it from the US?).

Then there’s Italy’s ‘austerity’ measures already starting to unravel as Bunga Bunga rows back on the promise to introduce additional taxes on higher earners. I’m sure that’s going to go down like a lead balloon in some quarters (ask for help, make promises, receive help, go back on promises – not a good strategy).


Though I suspect the most likely thing will be the second bailout for Greece falling apart. It will certainly hit the fan then.

@ All

The kite flown by the head of the EBA, and reported upon by FT Deutschland, has, according to Reuters, been shot down in flames by the “national authorities”, notably of Germany. Countries will continue to be aided to help their banks if this is beyond their capacity. But not banks directly or indirectly; the Irish solution, in other words.


The FT has an excellent summary of the situation being faced by the EA over the next few weeks. As usual, the markets will be the decisive voice.


Did anyone else notice the Donal O’Mahony style riff in the Irish Times today ?


Export competitiveness has already improved sharply, and labour markets are open and flexible. The entrepreneurial spirit has not yet been extinguished, and there is a strategy for mastering the fiscal mess and recapitalising banks. Sweden faced a comparable crisis in 1992 and emerged stronger.

Loving those flexible labour markets. All are flexible but some are much more flexible than others.
And how big was Sweden’s bad bank compared to NAMA ?

Wilbur is forecasting a subpression. Is this a new one for economists?
He is also saying nice things about Ireland on Bloomberg.

You guys working overtime?

CNBC reporting ECB back buying Italian bonds after disappointing auction. I thought the auction was supposed to be a success. Gold back at 1830$. seems risk off again.

@ Grumpy
It adds support to what Eoin was saying in a previous thread. There is some positive sentiment towards Ireland.
Also I think some not so negative sentiment towards Italy. That makes sense.
It seems that the markets really are focusing on Greece. It looks like the Troika aren’t happy and that will spell trouble. Without a doubt Greece will be first out – but who’s gonna be next…..

@ All

Article in today’s IT – taken from the FT – suggests that the EBA kite still has some flying time in it.


The German financial authority, Bafin, it its usual iconclastic manner, states that the matter under discussion goes beyond the powers of the EBA as presently constituted, the basis on which it comes to such a conclusion, and its authority to express it, not being explained.

The agreement of 21 July, however, is clear. It refers to an agreement to “finance recapitalisation of financial institutions through loan to governments including in non programme countries”.

Intriguing situation! The German cabinet has now agreed veto powers for the Bundestag in respect of changes to an agreement in the form of a “framework agreement” under Luxembourg private law which have not yet, it seems, been finalised.

Comments are closed.