The Eurogroup took an important step towards breaking the vicious link between sovereigns and banks on Thursday, when it agreed on ESM direct bank recapitalisation.
We see ESM direct bank recapitalisation as an extra backstop that will help to reduce tail risk. It also shows a willingness towards burden sharing within the euro area.
The details of the recapitalisation instrument are better than hoped for. The instrument can be used retroactively on a 'case by case' basis and legacy assets are not excluded.
For Ireland, the option of retroactive direct bank recapitalisation is particularly interesting as Irish sovereign debt jumped as a result of bank recapitalisations. Using the direct recapitalisation retroactively for Ireland could significantly reduce the sovereign debt, but it is not clear whether Ireland will apply.
The instrument is limited to EUR60bn and will be ready for use in Q2 14. However, the amount can be increased if needed.
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