COMMENT: No template, but ESM is last port of call | Reuters

By Divyang Shah

Tue Mar 26, 2013 10:30am EDT

LONDON, March 26 (IFR) - Strictly speaking, eurozone policy makers are correct in saying that Cyprus is not a template for bank restructuring. Which class of investor will take the hit cannot be determined in advance, as it depends on who can contribute the most to reducing the total bailout cost for the eurozone taxpayer. But there is an underlying thesis building that when the next eurozone bank restructuring comes around, the ESM will once again be the last port of call.

It is worth taking a look at what Dijsselbloem said beyond the headline-grabbing "template" quote. "We should aim at a situation where we will never need to even consider direct recapitalisation," he explained, highlighting the motivation not to use the ESM for that purpose. This is not new, as in early March Reuters reported the ESM head as saying that deep reservations from some European states could ultimately stop the ESM from being used for bank recapitalisation.

Germany had already said that it wanted to limit ESM funds used to recapitalise banks to EUR80bn. Regling offered us a possible explanation, saying that "if money from the ESM goes into saving banks, then it reduces the ESM's capacity to make loans to needy states." Clearly, the concern is that helping one sovereign with its bank recapitalisation would open the floodgates and reopen the debate over whether the ESM has sufficient firepower. This in turn will raise concerns over an eventual dilution of German creditworthiness, as well as over the weak link of France in the ESM self insurance chain.

So even if there is no template, now we know the rationale. The game plan, according to Dijsselbloem, is that if a bank is in trouble then "we'll talk to the shareholders and the bondholders, we'll ask them to contribute in recapitalising the bank, and if necessary the uninsured deposit holders." For Spain's Bankia, that meant bailing in hybrid debt and preference shareholders, and for Cyprus the target was uninsured depositors and bondholders too.

While bank stocks have fallen and the cost of insuring financials has gone up, the real impact of Dijsselbloem's comments won't be felt until another bank restructuring comes onto the radar screens. This is the new way the eurozone is looking to disconnect financial sector from sovereign risk. Bank stocks, senior debt and bank CDS will now have to discount a higher probability of being bailed in. (Reporting By Divyang Shah, editing by Julian Baker)