Europe needs to double the size of its bailout fund to 1 trillion euros (US$1.3 trillion) if it is to shore up its banking system and stop the spread of its spiraling debt crisis, according to a paper published on Thursday by the Organisation for Economic Co-operation and Development (OECD).
The paper, written by Adrian Blundell-Wignall — the special adviser to the OECD secretary-general — laid out a list of steps Europe has to take “if a fracturing of the euro is to be avoided.”
It includes making sure banks have enough money to weather the storm and forcing them to reduce their holdings of risky assets; making the banking system more secure by separating retail banking (the practice of lending to customers) from investment banking (a riskier business that involves making bets on investments); forcing Greece’s private bondholders to take at least a 50 percent loss on the debt; and increasing the size of the bailout fund, which will have 500 billion euros when it comes into effect later this year.
The list is not new — many analysts have suggested similar remedies — but it comes from a respected source and added to the pressure on European governments to act. European countries are already trying to shore up their banking system, and though they have long been reluctant to expand their bailout fund, that looks to be changing.
Their current fund, known as the European Financial Stability Facility (EFSF), has a lending capacity of 440 billion euros, but it is scheduled to be replaced by a new fund, the European Stability Mechanism (ESM) — with a lending capacity of 500 billion euros — this year.
The paper suggested that those funds could run concurrently, saying that Europe needs a far larger “firewall” to contain the crisis. That idea has been floated among leaders themselves, and they will make a decision next month.
Blundell-Wignall said that the bailout fund should be involved in lending to struggling governments, helping banks to increase their rainy day funds and perhaps eventually buying bonds from the European Central Bank (ECB), which has been gobbling up sovereign debt in an effort to keep governments’ borrowing costs down.
“The size of resources EFSF/ESM may need for all potential roles, particularly bank recapitalization, should not be underestimated,” Blundell-Wignall wrote. “This is not independent of what the ECB does, but it could be around 1 trillion euros.”
The paper recognized that the fund has struggled to raise money and said that private investors would likely be unwilling to make up a shortfall, if governments decide they do need to increase its resources.
It suggested that the EFSF could be given a banking license, so it could tap the unlimited resources of the central bank.
The ECB has been lending to banks at very favorable rates at a time when many are struggling to fund their daily operations because fear of a bank collapse has made them reluctant to lend to one another.
That suspicion stems from the fact that Europe’s banks hold a substantial amount of their governments’ debt, and it is now clear that at least Greece won’t repay those loans in full. Athens is in negotiations with its creditors on the size of the losses they will take.
The paper also suggested that the ECB could lend money to the IMF, which would then presumably pour it back into Europe. European leaders have already suggested giving money to the IMF, though a limited amount so far.