Europe: EU Summit to find solution for Euro zone; Cyprus seeks bailout

Updated On: Jun 26, 2012

EU Summit

On June 28-29, European leaders will meet at a summit in Brussels to sketch out a roadmap towards economic union in the currency bloc and to show that the leaders are united and determined to do whatever it takes to restore confidence in the euro.

However, on Monday, the global share prices and the euro slid as investors showed little confidence in the European leaders’ abilities to come up with radical measures to back up weak countries. This is the 20th meeting since the euro zone debt crisis hit Greece in 2010.

A 10-15 page document has been prepared for the meeting, discussing specific steps towards a cross-border banking union, closer fiscal integration, and the possibility of a debt redemption fund.

Based on last Friday’s mini-summit in Rome with leaders of the Big Four: Germany, France, Italy, and Spain, the leaders appear to be far from reaching an agreement beyond a 130 billion euro package to revive growth.

European leaders have said their first task is to try to break the link between bad banks and indebted governments and work on banking integration in an effort to ward off the worsening situation in Spain.

The document calls for the gradual introduction of a banking union, starting with supervisory power for the European Central Bank (ECB) and developing a deposit guarantee scheme based on pooling national systems, with a levy-funded bank resolution fund.

The expectation is that the ECB will eventually be given sole responsibility for overseeing Europe’s biggest banks, while the European Banking Authority watchdog retains a broader oversight role along with coordinating the work of national regulators.

The document further suggests that the euro zone’s permanent European Stability Mechanism bailout fund could be used to recapitalize banks directly rather than having to lend to governments.
All of these proposals would be possible under existing EU treaties and could be implemented relatively rapidly.

German Chancellor Angela Merkel disagrees with the other leaders and has so far rejected any joint deposit guarantee or resolution fund, as well as proposals that euro zone governments should assume joint liability for each other's debts through common euro zone bonds.

Merkel and would like to first see more progress toward fiscal integration, which would require changing the European Union treaty and a much longer time frame to complete.

The German leader has shown no sign of relenting in her refusal to take on new liabilities for German taxpayers until other euro zone states agree to hand more sovereignty over national budgets and economic policies to EU institutions.

Critics say that by refusing any such collective solutions, Berlin risks unleashing speculative attacks on Spanish and Italian bonds, hastening possible future bailout requests.

If the summit disappoints again or if the proposals are not implemented quickly enough, market pressure on Spain and Italy will reach danger levels and the ECB will need to step in.
Measures may include an interest rate cut, further easing of collateral rules for Spanish banks so they can continue to access ECB funds or even a resumption of the bank's bond-buying program.

Crisis in Cyprus

Furthermore, Cyprus announced on Monday that it was seeking EU rescue funds for its banks and its budgets, hours after Spain submitted a formal request for up to 100 billion euros to bail out its banks.

Cyprus joins Greece, Ireland, Portugal, and Spain as the fifth euro-zone country requesting a bailout, meaning more than a quarter of the 17 euro zone members are in trouble. Italy, with its soaring funding costs, could be next.

Cyprus has just four days to raise at least 1.8 billion euros, or about 10 percent of its domestic output, to meet a deadline to recapitalize Cyprus Popular Bank, its second largest lender whose balance sheet was badly hurt by Greek debt.

In response, Fitch cut Cyprus’ sovereign credit rating further to the junk BB+ grade. Cyprus’ existing bonds already have yields in the double digits, and the country is already barred from raising new funds on capital markets.

Report: Pre-summit document presses EU banking union (June 25, 2012, Reuters)

Report: Frustrated EU summit hopes weigh on Spanish debt (June 25, 2012, Reuters)

Report: And then there were five: Cyprus seeks EU aid (June 25, 2012, Reuters)