European leaders have given the green light for a sweeping public guarantee of bank funding in an attempt to head off the threat of another debilitating credit crunch. The measures are designed to ensure that banks continue lending to the real economy as officials attempt to solve the debt crisis.
Politicians at the emergency summit in Brussels said the banking sector would need access to ways of borrowing money for the long term to supplement the short-term funding currently on offer at the European Central Bank (ECB) and national central banks.
To do so, they said guarantees on bank liabilities "would be required to provide more direct support" to some lenders seeking to borrow money for longer durations.
And unlike three years ago, when various countries and national central banks implemented extraordinary liquidity measures to support the financial system, European leaders said "a simple repetition of the 2008 experience with full national discretion in setting up liquidity schemes may not provide a satisfactory solution under current market conditions".
"Therefore a truly co-ordinated approach at EU-level is needed regarding entry criteria, pricing and conditions," they said, calling on the European Commission and financial bodies such as the ECB and the European Banking Authority (EBA) to "urgently explore" ways of achieving this goal.
Analysts said co-ordinated action was needed owing to the lack of financial firepower available to troubled eurozone states such as Spain and Italy.
Although funding needs for 2011 have been "mostly addressed", the EBA said the market for longer-term funds was currently closed "due to increasing concerns over the sovereign situation and banks may find it difficult to address their funding needs in 2012".
"Confidence in the market needs to be restored," it explained. "This can only be done through a three-pronged approach: addressing the sovereign situation, through banks recapitalisation and term funding guarantees."
But analysts said that in contrast to the recapitalisation plans agreed at the summit, which require banks to hold a capital buffer of nine per cent after accounting for their sovereign debt exposures, details of how the continent-wide liquidity mechanism would work and who would provide the guarantee were thin on the ground.
For its part, the EBA said banks will have to pay "a fee commensurate to the amount guaranteed and to the risk profile of the beneficiaries". "The scheme will support banks in accessing term funding at reasonable conditions. Therefore banks will have the possibility to continue their lending activities," it said, pointing out that most national guarantee schemes put in place in 2008 had turned a profit for the Governments in question.
Ian Gordon, a banking analyst at Evolution Securities, said the bottom line was that "necessary support to enable banks to overcome market paralysis will be forthcoming".
"I would speculate that they are toying with a guarantee from some central entity," he explained, adding that while there was little clarity on the nature of this entity, "it could be a special vehicle" with recourse to funds from the European Financial Stability Fund (EFSF), the eurozone's bailout fund.
RBS analysts also raised the prospect of a link to the fund. "Term debt guarantees have historically proven to be a good way to re-open private-sector markets. However, in order to break the inter-connection between banks and their sovereign we believe that the guarantor would need to be eurozone-wide, ie the EFSF," they said.
Among the options could be a Credit Guarantee Scheme along the lines of the one introduced by the UK Government as part of its package to protect the financial system in late 2008. Mr Gordon said the statements from Europe suggested that a similar mechanism might be in the works in Brussels.