Mag. Matthias Gruber
Risk sharing in the Euro area
and the European Union
Limitations, lessons learned and potential leaps forward
BMF Working Paper Series
The content of this publication does not reflect the official opinion of the Ministry of Finance of Austria.
Responsibility for the information and views expressed therein lies entirely with the author.
Risk sharing in the Euro area
and the European Union
Limitations, lessons learned and potential leaps forward
Abstract: Since the onset of the financial and European debt crisis, market based risk sharing has decreased and it
has become apparent that some form of ex-post risk sharing – so when something has already gone wrong – among
the members of the Euro area might be useful or even necessary. In this vein Euro area member states established a
sovereign lending framework to help each other in case of dire need. There is no consensus on further policy areas that
could be subject to risk sharing among Euro area and potentially other European Union member states for the time
being. However, the outlook is such that it is not unlikely to see further integration and risk sharing within the framework
of the Banking Union over the next years. Certain general elements for risk sharing between countries can be determined
for the mechanisms that are in place in Europe today for providing financial assistance to the benefit of sovereigns. This
paper aims at identifying, structuring and valuing these general elements, thus providing decision support for any future
discussion on ex-post risk sharing among Euro area countries.
All cut-off dates for data are end of 2015 if not stated otherwise.
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List of abbreviations
APP
Asset Purchase Programme by the ECB
BoP
Balance of Payments Facility
BRRD
Bank Recovery and Resolution Directive
CRA
Credit Rating Agency
DGS
Deposit Guarantee Scheme
DRI
ESM Instrument for the Direct Recapitalization of Banks
EAD
Exposure at Default
EBRD
European Bank for Reconstruction and Development
EC
Excess-commitment
ECB
European Central Bank
EDIS
European Deposit Insurance Scheme
EFSF
European Financial Stability Facility
EFSM
European Financial Stability Mechanism
ESBies
European Safe Bonds
ESCB
European System of Central Banks
ESM
European Stability Mechanism
EU
European Union
GDP
Gross Domestic Product
GLF
Greek Loan Facility
GNI
Gross National Income
IFC
International Finance Corporation
IFI
International Financial Institution
IMF
International Monetary Fund
LGD
Loss Given Default
OG
Over-guarantee
OMT
Outright Monetary Transactions
PD
Probability of Default
QE
Quantitative Easing
RWA
Risk Weighted Assets
SRB
Single Resolution Board
SRF
Single Resolution Fund
SRM
Single Resolution Mechanism
SSM
Single Supervisory Mechanism
US
United States (of America)
VAT
Value Added Tax
4
Introduction
In early 2010 the first Euro area financial assistance
programme was applied for and decided upon eventually
in May of the same year1. In the absence of procedures,
mechanisms and an institutional setup, the then 16 Euro
area member states agreed to pool bilateral loans to the
beneficiary member state to avoid a liquidity crisis. At the
same time the Heads of State or Government decided to
put two temporary mechanisms in place, creating a 500
billion Euro envelope for financial assistance to financially
vulnerable Euro area countries. In 2012 a permanent institution, the European Stability Mechanism (ESM), started its
operations, taking over the existing tasks from its temporary predecessors. Those financial assistance mechanisms
were operating on very different grounds, both legally and
in terms of liability.
Already prior to the ESMs inauguration, discussions started
on how to increase flexibility of the instruments available
to the ESM in order to be able to address market disruptions more precisely2. In parallel, discussions on the creation of a Banking Union for the Euro area Member States
and potentially others has led to the creation of a single
banking supervisory authority under the European Central
Bank (Single Supervisory Mechanism – SSM), a Single Resolution Mechanism (SRM) in the form of an acting board
with a resolution fund (SRB/SRF) attached that should
cover for potential resolution costs and lastly unified rules
on national deposit guarantee schemes (DGS) (a common
deposit insurance scheme has yet to be developed).
Today, the ESM, while still a young organisation, already
finds itself in a significantly different environment compared to when it was designed and inaugurated. And the
environment will continue to evolve.
The purpose of the article is threefold. Firstly, I want to
look at the three main instruments designed over the last
few years or currently under discussion, which all imply a
certain amount of risk sharing among Euro area countries:
Financial assistance to sovereigns via loans to Euro
area member states,
Credit line to the banking sector via Bridge Financing
to the Single Resolution Fund and
Investments in bank equity via the Direct Bank Recapitalization Instrument.
Secondly and foremost, I want to analyse the three main
financing mechanism types established since the onset
of the sovereign debt crisis and draw up some lessons
learned from:
pooled loans (“100% Cash”),
a joint guarantee framework (“100% guarantee or
commitment”) and
a mix of the two (“Cash/Commitment mix”).
Lastly, I want to draw general conclusions and define
specific considerations to be undertaken in the potential
context of a possible future risk sharing exercise.
The outline of this discussion paper is as follows: Chapter
1 describes the instruments available or under discussion
to provide financial assistance in brief and touches upon
the limitations of the current frameworks. Chapter 2
explains and elaborates on the underlying structure and
mechanics of the already existing risk sharing mechanisms
in the Euro area and the European Union. Chapter 3
describes a model aiming at quantifying the expected cost
of financial assistance granted under each of the main
mechanisms outlined in Chapter 2. Chapter 4 gives an
overview over the amounts provided by member states to
back the financial assistance measures undertaken since
2010. Chapter 5 will then go into potential options to
improve the ESM framework and to reconsider the financial
stability architecture in the Euro area and the Banking
Union. Chapter 6 will conclude the discussion.
http://www.consilium.europa.eu/uedocs/cmsUpload/100502-%20Eurogroup_statement.pdf
http://www.consilium.europa.eu/en/european-council/pdf/20110311-Conclusions-of-the-Heads-of-State-or-Government-of-the-euro-area-of-11-march-2011-EN_pdf/;
http://www.consilium.europa.eu/en/european-council/pdf/20110721-Statement-by-the-Heads-of-State-or-Government-of-the-euro-area-and-EU-institutions-EN_pdf/
and http://www.consilium.europa.eu/en/european-council/pdf/20120629-Euro-Area-Summit-Statement-EN_pdf/:
in addition to loans, EFSF/ESM should be able to intervene in the primary and secondary market for bonds, provide precautionary assistance through credit lines or
special earmarked loans for the recapitalization of financial institutions (so called “indirect” recap), as well as the direct recapitalization of banks.
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Chapter 1:
Instruments and limits for the provision of
public financial assistance
Why could risk sharing be useful or even necessary
between Member States?
The European Union is not a federal state like the United
States of America but more of a group of likeminded member states that agreed to cooperate and coordinate in certain policy areas. A number of important policies remained
national to a vast extent. Especially budgets are decided
upon nationally, where responsibilities for both revenues
and expenditure come together. The EU budget has a size
of some 1% of Gross National Income and is thus not of
macroeconomic significance.
However, the sovereign debt crisis since 2010 has shown that
fiscal turmoil in one member state can have significant spillover effects on other countries in the Union. Even though
it is not possible to identify a precise counterfactual, a joint
approach to risk taking appeared justifiable and indeed
direly needed during crisis times, given the narrow financial
interconnections of member states through cross boarder
financial institutions of all kinds and the internal market.
According to Article 3 of the ESM-Treaty, “[t]he purpose of
the ESM shall be to mobilise funding and provide stability support under strict conditionality, appropriate to the
financial assistance instrument chosen, to the benefit of
ESM Members which are experiencing, or are threatened
by, severe financing problems, if indispensable to safeguard the financial stability of the euro area as a whole and
of its Member States.” Similar objectives are stated in the
EFSF framework agreement and the other relevant legal
documentation underlying the different EU instruments for
financial assistance (see Chapter 2 for more detail).
It has been widely discussed whether or not programme
design and financing were appropriate for those countries
that have received financial assistance, amongst others
most recently by Bruegel3 and the IMF4. From a purely
financing and institutional side, the instrument tool-box
of ESM (and its predecessor EFSF) was able to deliver
what was needed at the time, which is liquidity support at
favourable cost for the beneficiary countries.
However, in 2012 the limits of financial assistance through
public loans were reached as one Euro area member states
had to arrange for a voluntary debt restructuring exercise
with private sector investors in order to bring nominal debt
down by almost one third and thus being in a position to
re-establish debt sustainability. As the financial sector of
this member state was one of the largest creditors at the
time, the debt restructuring exercise led to large capital
needs for the domestic banking sector, which had in turn
to be covered by the public sector again.
This drastic example as one out of many should demonstrate how deeply intertwined the relations between
individual member states’ public finances and the respective domestic banking sectors can be5 . Several steps and
initiatives were taken throughout the last years to loosen
this link, still it remains to be seen to what extent negative
feedback loops between the public and the banking sector
were reduced.
Starting as early as 2011 and 2012 it was questioned
whether the tool-box of ESM financial assistance instruments was sufficient to make it a highly efficient crises
resolution mechanism for the Euro area6. At the time no
compromise could be reached regarding ESMs role in
banking going beyond the instrument for so called “indirect
bank recapitalization” (via dedicated loans to a beneficiary
member state) before the ESM-Treaty was signed in early
2012. However, as a consequence of severe financial market turmoil in most of the Euro area member states, the
ESM members stretched for a deal as early as June7 2012
in order to break – or at least alleviate – the deadly embrace between failing banks and public finances. After long
lasting discussions, in parallel to the creation of a Banking
Union, Euro area finance ministers in their role as ESM Governors finally decided in December 2014, […] to establish
the ESM instrument for the direct recapitalisation of institutions […] as a financial assistance instrument […]”8.
http://bruegel.org/wp-content/uploads/imported/publications/20140219ATT79633EN_01.pdf
http://www.imf.org/external/np/pp/eng/2015/110915.pdf
5
The sovereign bank loop has also widely been discussed and analysed. See for instance:
https://www.imf.org/external/np/pp/eng/2014/122214.pdf
http://scholarship.law.georgetown.edu/facpub/1293
6
for instant http://www.ft.com/intl/cms/s/0/995a3f18-d001-11e1-bcaa-00144feabdc0.html#axzz3wMimF5BC
or http://www.lisboncouncil.net/publication/publication/70-making-european-stability-mechanism-work.html
7
http://www.consilium.europa.eu/en/european-council/pdf/20120629-Euro-Area-Summit-Statement-EN_pdf/
8
http://esm.europa.eu/pdf/20141208%20Establishment%20of%20the%20instrument%20for%20the%20direct%20recapitalisation%20of%20institutions.pdf
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The introduction of the direct recapitalisation instrument
(DRI) was a far reaching step. While the ESM in its initial
conception included some form of risk sharing, the burden
clearly remained with the member state benefitting from
financial assistance (even if it would take a hundred years
to repay the debt). With DRI responsibility and risk sharing
between euro area states as ESM members was shifted
to a whole new level, as all members were accepting to
carry a certain risk together, still very limited in size for the
time being, in order to safe an ailing bank established in
one of its members territory. Preconditions for this decision were severe market panic in June 2012 (sovereign
yields for some large Euro area member states stood at
7% and above) on the one hand and the establishment
of the Single Supervisory Mechanism as well as the Single
Resolution Board on the other hand. Most of the immediate market pressure on sovereign yields has emanated since
then, mainly as a result of the ECB interventions announced and undertaken since August 2012. Still the potential
fallout from banking problems on some countries is non
negligible.
risk sharing with lacking control over national policies and
the new bail-in regime not yet fully proven in practice are
not dissolved, the application of DRI remains unlikely for
the time being. But even if the scope of the instrument
in its current form is rather narrow, the door for deeper
common risk sharing was opened.
DRI is a unique instrument in the international financial
assistance architecture. Whereas the World Bank/International Finance Corporation (IFC), the European Bank for
Reconstruction and Development (EBRD) or other International Financial Institutions can invest in bank equity under
development considerations, neither the IMF nor one of
the other European assistance facilities (BoP, EFSM or
Macro-Financial Assistance to third countries) has a comparable instrument in its tool-box for crises financing. None
of the existing instruments is designed to acquire shares
in distressed banks lacking a sufficiently strong growth potential. In order to address member states’ concerns about
the risks of such a joint operation, the current ESM-DRI
setup includes a number of clauses that limit the scope of
its usability. Amongst others it can basically only be applied
for member states that are financially strongly strained,
thus, effectively limiting DRI to banks in a hostile macroeconomic environment with a potentially vulnerable outlook
and weak, impaired assets. Also it poses a non-negligible
burden on the implicitly benefitting member states, in
which the bank is located. Still, member states go much
further in terms of risk sharing and joint action than with
any other similar instrument. Amongst others, ESM would
be the steward for the ESM members to hold and manage
the equity stake in a saved bank9.
The question that remains to be answered is what an
efficient strategy could be for cases in which the existing
and envisaged practices, procedures and mechanisms for
risk sharing among the private and public sector on the
one hand and among countries on the other hand reach
their limits. The question could either arise once public
indebtedness of one European country reaches levels that
make it no longer sustainable with high degree of certainty, as the IMF puts it13, or if the sovereign bank feedback
dynamics are such that spill-over effects are large enough
to pull public finances in one or more countries in Europe
down.
Finally in December 201311 and again in December 201512
Eurogroup and ECOFIN Ministers agreed to put a system of bridge financing in place to backstop the newly
established Single Resolution Fund (SRF). This backstop
is designed as a system of national credit lines to the individual country compartments within the SRF for the time
being. However, a common backstop should be created
by 2024 at the latest that is intended to further loosen the
link between national public households and potential bank
failures. In the absence of a political decision on whether
an existing or new institution should take over the role of
the common backstop, the paper amongst others aims
at identifying an analytical footing for how the financing
mechanism to backstop the SRF should be shaped.
The 5-Presidency-Report has identified the improvement of
the DRI as one of its priorities10. However, as long as the
reservations of some member states regarding large scale
http://www.esm.europa.eu/pdf/20141208%20Guideline%20on%20Financial%20Assistance%20for%20the%20Direct%20Recapitalisation%20of%20Institutions.pdf
http://ec.europa.eu/priorities/economic-monetary-union/docs/5-presidents-report_en.pdf
11
http://www.consilium.europa.eu/en/council-eu/eurogroup/pdf/20131218-SRM-backstop-statement_pdf/
12
http://www.consilium.europa.eu/en/press/press-releases/2015/12/08-statement-by-28-ministers-on-banning-unionand-bridge-financing-arrangements-to-srf/
13
http://www.imf.org/external/np/pp/eng/2015/052715.pdf
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Chapter 2:
Risk sharing mechanisms in the Euro area
and the European Union
In the first few years of the European sovereign debt crisis
risk sharing took place in the form of loans to a sovereign provided jointly. The lowest common denominator
was thus collective sharing of credit risk originating from
one member of the club by means of extended maturity
transformation at below market prices. The underlying
political assumption behind this approach was that there is basically no sovereign credit risk originating from
European countries and that no nominal write-offs would
ever be necessary. By pricing credit risk according to this
assumption significantly different than the market at the
time, the net present value of public debt was substantially lowered. The same principle applies for the option of
credit lines that are offered below market prices and thus
limiting liquidity risk on the one hand and which provide
the fall-back option to transform debt at market terms into
long-term loans at concessional terms. Where problems of
a member state emanated mostly from the financial sector,
equity risk was transformed to credit risk from the point of
view of the countries providing financial assistance through
the instrument of dedicated so called loans for the “indirect” recapitalisation of loans outside of a fully fletched
macro-economic adjustment programme with wide ranging
policy conditionality. The principle of shifting the burden of
equity risk back to the financial market via bail-in of debt
or of partially carrying it jointly among all member states
was established at later stages of the ongoing crisis.
From a theoretical point of view it is difficult to apply
concepts of risk sharing and insurance in this context.
Risk sharing or financing in the context of this paper takes
place where there is no longer a market participant willing
to take over certain risks such that there is no market
price available and the need for public risk sharing arises.
As events triggering these kind of risk sharing measures
are rare, there is not much data and estimates have to be
built on believes and experts opinions to a large extent.
Also the environment in which the analysed risk sharing
and financing mechanisms take place is determined by a
limited pool of members, so there is little room for broader
risk sharing and mitigation options. There is a certain risk
transfer element, as those countries, in which large parts
of the risk originate, do not necessarily carry a corre-
sponding share of the immediate burden of risk sharing
(for further detail see Chapter 4). However, risk absorption
and joint financing provides a broader benefit – a common good – to all members of the pool, namely financial
stability.
In the absence of structures and institutions at the onset
of the Euro area sovereign debt crisis member states
arranged the first financial assistance programme in the
form of pooled bilateral loans (the so called Greek Loan
Facility – GLF). All member states had to fund their share
in the loan individually whenever a disbursement was due.
Those loans were elevating national public gross debt
levels for providers and the recipient accordingly. As a
second problem, some member states were facing higher
financing costs than what they received in return for the
bilateral loan at some point in time. Thus, as no creditor
state should incur any budgetary costs through granting
financial assistance, a complex compensation framework
had to be established to reimburse those member states.
The terms of those loans had to be amended from time to
time in order to improve the debt servicing capacity of the
beneficiary. In the end some member states might end up
being faced with funding costs higher than the revenue
from their share in the pooled loan.
Therefore the European Financial Stability Facility (EFSF)
was created, a company agreed upon by the countries of
the Euro area in May 2010. EFSF was then incorporated
in Luxembourg under Luxembourgish law in June 2010
backed by guarantees of its member states14. The joint approach should enable EFSF to raise funding in the market
with a high rating attached and thus lower funding costs.
Ministers of Finance were furthermore hoping that the
guarantees would not materialize on their public balance
sheets as compared to the pooled bilateral loans. Despite
that hope Eurostat decided to fully reroute EFSF loans
to beneficiary member states to the guarantor states,
thereby again elevating the individual national stocks of
gross public debt. In addition, due to shortcomings in the
EFSF structure the guarantee ceiling had to be augmented
substantially by introducing large amounts of over-guarantees15. This joint and several liability structure basically
http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/misc/114977.pdf
http://efsf.europa.eu/mediacentre/news/2011/2011-011-efsf-amendments-approved-by-all-member-states.htm
16
http://esm.europa.eu/press/releases/20121008_esm-is-inaugurated.htm
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made the then six AAA-guarantor states liable for the
entire outstanding debt of EFSF, should the lower rated
members not be willing or able to deliver on their guarantees.
Bearing said structural encumbrances in mind, Euro area
leaders decided to create a permanent fully-fledged new
International Financial Institution (IFI) with independent boards, hoping that such an approach would create
sufficient confidence in the market for sovereign bonds
that the sovereign debt crisis would come to an end. The
European Stability Mechanism (ESM) was established in
October 201216 as a Treaty based IFI, following decisions
of the Heads of State and Government of the Euro area
and the ECOFIN council in 2010 and 201117.
Since then, ESM members have paid in more than 80 billion Euros in paid-in capital and provided more than
620 billion Euros as callable capital to the institution (see
Graph 1 below). As laid out in Article 3 of the Treaty18, ESM
funds its financial assistance operations through means
raised in the market, whereas the paid-in capital serves as
security for investors and remains untouched for programme financing.
In the following I would like to shed some light on the
underlying mechanics of risk sharing mechanisms in use
so far by the Euro area member states. Other Mechanisms
backed by all EU member states will not be looked at in
detail, though I will refer to similarities. This risk sharing
assessment is merely from a Member States ‎perspective.
Investors and Credit Rating Agencies perspectives will only
be touched upon briefly and treated as given externalities.
From a very narrow risk perspective, the Greek Loan
Facility (GLF) type is the “cheapest” option for the
highest (AAA/AA) rated member states19, as one Euro of
financial assistance comes at a cost of one Euro. Also there
are no ex-ante payments into the risk sharing pool that
would imply opportunity costs for the insurance against
certain risks. As long as public gross debt is at a reasonably low level, which is likely for high rated countries,
and interest received covers own financing cost entirely.
However, given that the amendments to the GLF have led
to very low interest payments by the debtor country, this
result would only hold in the context of a sovereign loan
for very optimistic assumptions on own funding costs for
a longer period of time and it definitely does not hold with
certainty for those member states with weaker credit ratings assigned, elevated levels of public debt and high and
volatile financing costs.
The underlying Inter-creditor agreement between the
countries contributing to the GLF includes an option to
step out of the obligations under the agreement, once a
member becomes a programme country itself. If a member
steps out of the framework, its share in future contributions has to be taken over by the remaining members,
which will increase their share accordingly (i.e. share per
Euro provided, it does not increase the nominal obligations
to pay but lowers the overall amount to be disbursed)20.
In the EFSF framework all members are jointly and severally liable with over-guarantees of up to 165% (the guarantee maximum amount divided by the maximum lending
capacity). This structure shifted most of the immediate risk
to the highest rated members of the guarantee-envelope. Over-guarantees are added on top of each individual
share of the guarantee and thus add credit risk of up to
65% of the share of each respective high rated member
state on top of the credit risk for the financial assistance
granted to one beneficiary member state (six EFSF members would have had to be held liable to pay back 100%
of each Euro raised in the market). The risk assessment
for the EFSF structure is thus depending on the assumptions on probability of “primary” default for the beneficiary
debtor country as well as “secondary” default for the lower
rated co-guarantors and the actual Losses Given Default
attached. On the other hand, as there is no upfront cash
payment, funding backed by EFSF type guarantees is “free
lunch” in terms of funding costs, as long as no guarantee
is called. Unfortunately, Eurostat decided in January 2011
that the funds raised in the framework of the European
Financial Stability Facility must be recorded in the gross
government debt of the euro area Member States participating in a support operation, in proportion to their share
of the guarantee given21.
The underlying framework agreement between the countries contributing to EFSF also includes an option to step
out of the obligations under the agreement, once a member becomes a programme country itself. This option could
be waived if a country is benefitting from financial assistance other than a macroeconomic adjustment programme according to criteria outlined in the specific instrument
guidelines22. Hence, the contribution keys for the financing
mechanisms to be analysed will depend on the purpose of
the applied instrument (for further detail see Chapter 4).
The ESM structure is a combination of the two concepts
above, where the liability side (authorised capital stock) is
backed by an upfront paid-in cash share (paid-in capital)
https://www.consilium.europa.eu/uedocs/cmsUpload/Conclusions_Extraordinary_meeting_May2010-EN.pdf
http://www.esm.europa.eu/pdf/ESM%20Treaty/20150203%20-%20ESM%20Treaty%20-%20EN.pdf
19
For the purpose of this paper the notion “highest rated member states” includes those Euro area countries that were assigned with at least AA by Standard and
Poor’s, Fitch as well as DBRS and at least Aa2 by Moody’s as of 31.12.2015. The criterion is slightly stricter than the regular definition of investment grade bonds. The
reason is that those countries that formed the “backbone” of the EFSFs rating since 2010 should be covered.
20
if share of countries x and y are 5% and 10% respectively, country x would have to take over 5% of the 10% of the stepping out country y:
21
http://ec.europa.eu/eurostat/documents/2995521/5034386/2-27012011-AP-EN.PDF
22
http://efsf.europa.eu/attachments/efsf_guideline_on_recapitalisation_of_financial_institutions.pdf
17
18
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and a guaranteed share (callable capital or authorised
capital unpaid). In the ESM framework members are again
jointly and severally liable for the ESMs liabilities, though
with limits. The implicit over-guarantee (i.e. sum of callable capital divided by the lending capacity not covered by
paid-in capital) is lower for ESM than for EFSF. However,
where EFSF guarantors are liable for each bond issued
individually to the extent of the applicable over-guarantee,
ESM shareholders could be asked to redeem a maturing
liability in full in the theoretical case that capital would be
depleted and a sufficiently large number of members is
not honouring its obligations. This is of course merely a
hypothetical case and, given the maturity structure of both
institutions’ liabilities, not of major concern.
Graph 1
In addition, where guarantors have to cover up for interest and costs of EFSF in full on top of the guarantees on
capital, commitments to ESM are limited to the individual
nominal shares so including interest.
In January 2013 Eurostat decided that, contrary to the
EFSF, debt of a beneficiary country will be recorded as
due to the ESM. Operations undertaken by the ESM, such
as borrowing on financial markets and granting loans to
beneficiary countries, will be recorded in the books of the
ESM and will not be re-routed to the Euro Area Member
States23. Lastly, in the ESM framework, beneficiary member states do not have the option of stepping out of the
guarantee obligations as with the EFSF, which again limits
the individual shares of the contributing member states to
some extent.
Both EFSF and ESM hold liquidity to varying degrees,
amongst others to cater for upcoming payment obligations. In addition ESM runs a T-bill programme and holds a
certain amount of paid-in capital in highly liquid assets to
further foster liquidity and improve credit strength. Lastly,
both institutions have a prudent funding strategy with debt
maturities of currently up to 40 years. The immediate risk
of a call on guarantees and callable capital is thus stretched along the curve of outstanding debt.
The following Graph 1 shows the EFSFs and ESMs capital
structure and visualizes the significant credit enhancement to be provided in the form of over-guarantees or
excess-commitments in order to ensure the targeted lending capacity at the highest credit rating possible.
EFSF had a credit rating at the cut-off date of AA/Aa1/AA
from Standard & Poor’s, Moody’s and Fitch24. ESM had a
credit rating at the cut-off date of Aa1/AAA from Moody’s
and Fitch Ratings, but none by Standard & Poor’s amongst
others for conceptual reasons25.
23
24
25
Note again that the concept of over-guarantees has to be
distinguished for the two different institutions. While for
EFSF the applicable over-guarantee is capped at a certain
percentage per debt instrument issued, it is more of an
average observation per member state for ESM. So for one
Euro issued under EFSF, each member can be held liable
for its own share plus up to 65% of that individual share
plus interest. In contrast, each member under ESM holds
a certain share for which each member is entirely liable
regardless of the amounts at risk including interest. For
instance, if ESM were to issue debt of one euro and all
but one member default in the event of a capital call, the
remaining member would have to redeem said one euro
in full. In a second step, there are internal mechanisms to
settle unfulfilled payment obligations that were taken over
by other member states for both EFSF and ESM.
As the liability side of EFSF is entirely backed by guarantees, the EFSF’s rating is fully depending on the credit
worthiness of its guarantors. It is thus more directly linked
to downgrades of individual member states then it is the
case for the ESM.
Now putting all the elements of the three financing mechanisms under scrutiny (GLF type with “100% cash”, EFSF
type with “100% guarantees or commitments” and ESM
type with a “cash/commitment mix”; where guarantees
and commitments can imply some form of over-guarantee
or excess-commitment) together, the effectiveness of each
type can be quantified based on a number of assumptions
and specifications (for further details see Chapter 3):
http://ec.europa.eu/eurostat/documents/1015035/2041337/Eurostat-Decision-on-ESM.pdf/6e87bbe1-f081-43a4-8543-cc62f32eefc1
http://efsf.europa.eu/investor_relations/rating/index.htm [23.03.2016]
http://www.esm.europa.eu/investors/rating/index.htm [23.03.2016]
10
Table 1 provides an overview of the characteristics and properties of the three possible risk sharing
structures:
Mechanisms
100% Cash
100% Guarantee /
Commitment
Cash/Commitment
Mix
Properties
“GLF” type
“EFSF” type
“ESM” type
√
(ad-hoc)
-
√
(up-front)
Guarantee/Commitment
-
√
(up-front)
√
(up-front)
Credit enhancement: over-guarantees or excesscommitment
-
√
√
(at national level)
√
√
Cash
Additional liquidity required
Funding costs fully covered
Not necessarily
By definition
By definition
Individual contribution keys
Variable due to
stepping-out
option
(fixed nominally)
Variable due to steppingout option
(fixed nominally)
Fixed
(no stepping out)
√
√
-
Debt rerouted to public balance sheet
Probability of Primary Default and Loss given Primary
Default of beneficiary member state,
Probability of and Loss Given Secondary Default of
co-guarantors and share of defaulting co-guarantors,
the purpose of the financial assistance operation,
which is amongst others relevant for the contribution
keys of contributing member states (stepping out
option!),
the amount of over-guarantee or excess-commitment
applied,
whether a cash payment has to be made by creditor/
guarantor member state (i) ex-ante (before risk sharing exercise is actually needed), (ii) ad-hoc (once an
actual risk has to be shared or a disbursement has to
be funded) or (iii) ex-post (once a guarantee has to be
drawn or a commitment fulfilled),
whether debt is (statistically) rerouted by Eurostat and
own funding costs, maturities and interest/dividends
received by creditor/guarantor member states.
It should also be referred to explicitly at this point that this
analysis does not reflect at all on the various aspects of
the organisational and operational setting of the mechanisms described. ESM as an institution has undoubtedly
a number of advantages as compared with its ad-hoc
predecessors that were more or less created overnight and
are definitely not designed to stay there for a longer period
of time.
Just to mention them, other forms of risk sharing that are
applied in the European Union and play a role in crises
financing in one way or the other are the European Union
budget and the balance sheet of the European System of
Central Banks (ESCB).
The European Union budget is endowed with so called own
resources, which are partly collected from national sources, mostly VAT revenues, and sources considered common
revenues, mostly customs. Every Member States contributes to the common budget according to a contribution
key, derived from a number of key indicators (mainly Gross
Nation Income – GNI) without any kind of over-guarantee
attached. The total (actual) payments ceilings in the financial framework are always lower than the own resources
ceiling. The margin between own resources ceiling and
the ceiling for payment appropriations allows the financial
framework to be used, to cover unforeseen expenses26.
Amongst others, this margin is used to back bonds issued
in the context of the Balance of Payments assistance (BoP
for non-euro area EU-member states27) and the European
Financial Stability Mechanism (EFSM for euro area member
states28). In economic terms, each member state is sever-
http://ec.europa.eu/budget/explained/budg_system/fin_fwk0713/fin_fwk0713_en.cfm
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32002R0332&from=EN as amended
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32008R1360&from=EN and
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32009R0431&from=EN
28
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32010R0407&from=EN as amended
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32015R1360&from=EN
26
27
11
ally liable, similar to a guarantee without over-guarantee.
The European Union, however, has a sizeable budget and
thus sufficient liquidity available. A Euro area budget could
theoretically mimic these features, though it is not likely to
be realized anytime soon for political reasons.
Note that the relative contributions to the EU budget of
each member vary slightly over time due to changes in the
underlying indicators, whereas figures for Gross National
Income play an important role. It appears that the rating of the EU budget is not adversely affected by these
changes. The European Union had a credit rating of AAA/
Aaa (outlook stable) from Fitch and Moody’s as well as an
AA+ (outlook negative) rating from Standard & Poor’s29 at
the cut-off date30.
EFSM, EFSF and ESM have in common that they are
backed by some form of guarantee (guarantees, callable
capital and the margin). Regardless of the actual construction of a commitment the legal nature of a commitment
needs to be sufficiently assuring to investors, for which
questions on the governing law need to be addressed.
For the European Central Bank (ECB), profits and losses
that cannot be offset against provisions are shared among
the participating national central banks according to the
capital subscription key31.
Other forms of pooled funding are for instance the EIB
that has a somewhat similar capital structure as the
ESM (paid-in plus callable capital from all 28 EU member
states)32 and the SRF, for which Banking Union member
states collect contributions based on the SRM-Regulation33
and the Intergovernmental Agreement34 and provide credit
lines to assure a certain amount of liquidity in the national
compartments.
Another key factor for a crises financing mechanism is that
funds need to be readily available, once a decision to disburse is made. Liquidity is therefore of utmost importance,
which is one more reason why all mechanisms described
above aimed at achieving the highest possible grade from
Credit Rating Agencies (CRAs).
Creditor seniority and equal treatment are issues to be
considered for sovereign loans. GLF and EFSF loans are
pari passu, while ESM financial assistance in general
benefits from the institution’s preferred creditor status.
29
30
31
32
33
34
35
36
37
38
For banking related activities the question of seniority is
different. Bridge financing to the SRF is repaid through
ex-post levies collected from the entire banking sector and
is thus no liability in their balance sheets. On the other end
of the spectrum, equity potentially acquired under a direct
recapitalisation exercise is by definition the first share to
absorb losses in case of insolvency or resolution.
One last aspect that should be mentioned is the involvement of national parliaments in crises financing that evolved during the Euro area sovereign debt crises throughout
a number of Euro area member states. The involvement
is most evidently visible for ESM as compared to the other
mechanisms as ESM constitutes by far the largest exposure
for members as well as the only permanent obligation compared to the temporary mechanisms GLF and EFSF.
Few EU member states have national procedures in place
for the EU’s BoP Facility and the EFSM to date. However,
it could be possible that if either the capacity or the role
in banking related crises financing of one or both of these
two EU mechanisms would be extended, national parliaments in more and more member states might want to
have a say in the decision making process.
Concluding this chapter, it should be mentioned that the
three mechanisms analysed in detail as well as the other
mechanisms mentioned do not represent the entire universe of options. A number of alternative concepts have been
discussed in the last few years for different ways to share
risks among member states that will not be analysed in
this paper. Just to name a few, for instance a “blue bond”
proposal was created by Bruegel35, a concept for a “Schuldentilgungfonds” (bond redemption funds) by the German
Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung36, European Safe Bonds (ESBies)
by the euro-nomics group37 and a special report was drawn
up by the EU Expert Group on Debt Redemption Fund and
Eurobills38.
As a thought experiment, a completely different approach for Euro area countries could have been to provide
guarantees or collateral directly to programme countries to
back individual national debt issuances‎, instead of funding financial assistance loans via a joint mechanism. This
instrument is used for instance by the Japanese and the
US government to support access to funding for countries
under fiscal stress (for example in 2014 to the benefit of
Ukraine and Tunisia or most prominently during the late
http://ec.europa.eu/economy_finance/eu_borrower/index_en.htm as of 23.03.2016
The Analysis does not yet take into considerations the potential fallout from the decision of the UK to end its membership in the EU.
https://www.ecb.europa.eu/ecb/orga/capital/html/index.en.html
http://www.eib.org/attachments/general/statute/eib_statute_2013_07_01_en.pdf
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R0806&from=EN
http://register.consilium.europa.eu/doc/srv?l=EN&f=ST%208457%202014%20INIT
http://bruegel.org/wp-content/uploads/imported/publications/1005-PB-Blue_Bonds.pdf
http://www.sachverstaendigenrat-wirtschaft.de/fileadmin/dateiablage/download/publikationen/arbeitspapier_01_2012.pdf
https://euronomics.princeton.edu/esb/
http://ec.europa.eu/economy_finance/articles/governance/2014-03-31-redemption_fund_and_eurobills_en.htm
12
1980ies and throughout the 1990ies when large quantities
of Bonds commonly known as “Brady Bonds” were backed
by the US Treasury to the benefit of several developing
and emerging market countries 39).
Regardless‎ of any operational or organisational pros and
cons of those alternative approaches, the assessment of
exposure for the guaranteeing member states to interest
and credit or equity risk would have been the same as for
the three mechanism types GLF, EFSF and ESM. Thus, the
same considerations regarding the provision of liquidity,
loss absorption capacity and potentially credit-enhancement would apply for alternative approaches.
https://www.jbic.go.jp/en/information/press/press-2014/1008-30692 https://www.usaid.gov/news-information/press-releases/july-24-2014-government-tunisia-issues-500-million-bond-us-guarantee
https://www.usaid.gov/news-information/press-releases/may-16-2014-government-ukraine-issues-us-1-billion-bond-us-guarantee
http://www.people.hbs.edu/besty/projfinportal/ssb%20brady%20primer.pdf
39
13
Chapter 3:
Expected value of financial assistance granted
In order to rank the different financing mechanisms discussed in this paper, a valuation tool was established that
models and generalises the individual features of the structures analysed into a framework with restricted complexity.
The model is deliberately simple and does only consider a
limited number of factors to evaluate the expected value
of one Euro of financial assistance granted by the three
main mechanisms (pooled loans, pooled guarantees and
cash-commitment-mix) applied since 2010. The other
financing options, such as the EU budget as discussed only
very briefly in Chapters 1 and 2, are not considered in this
evaluation exercise.
where:
The expected value E(a), where a defines all necessary
underlying parameters, is determined as follows:
E(a)= PD*EAD*LGD
For simplicity reasons EAD is defined as one unit per
member state participating in the scheme. In this model
E(a) is compiled by several terms, whereas PD is treated
as exogenous and EAD and LGD are impacted by several
factors:
PPD
EAD LGD PaLSD
Probability of Primary Default of beneficiary member state
Exposure at Default
Loss Given Default
Probability of and Loss Given Secondary Default of co-guarantors (PSD * LGSD)
π (OG)
Share of co-guarantors to be taken over by other member states as a function of maxi
mum Over-guarantee/Excess-commitment.
The parameter indicates by how much the individual contribution to financial assistance
is increased by the share of defaulting co-guarantors and ranges between 0% and
Number of years for which financial as
sistance is granted
maturity
(1) – (2) – (3) – (4) = (5)
(1) Expected revenues from financial assistance granted
+ (1-PPD)*(1+r)maturity
+ PPD*[(1+r)years to D-1]+(1-LGPD)*(1+r)(maturity-years to D)
+ (1-PPD)*(1+d)maturity +PPD*(1+d)years to D
(2) Capital and funding costs
- (1+i)maturity
(3) Expected cost of beneficiary defaulting
- PPD*LGPD*(1+i)(maturity-years to D)-1
(4) Expected additional cost of co-guarantors defaulting
- PPD*LGPD*PaLSD* (1-1π) *(1+i)(maturity-years to D)
(5) = Expected value of one Euro financial assistance
granted for creditor/guarantor MS
years to D Number of years after granting financial as
sistance at which a beneficiary defaults
i
Own funding cost
r
Interest received (not necessarily the same as i)
d
Dividends received on paid-in capital (not necessarily the same as i or r)
While the EFSF guarantee limit does not include interest, it is covered by ESMs authorised capital. The maximum share of co-guarantors defaulting relevant for the
maximum lending volume of 500 billion Euros is thus smaller or equal to ~32% depending on ESMs own funding costs.
40
14
In this context, sovereign loans are associated with
and
(1 ) the first line is straightforward and shows the calculation of the expected amount to be amortized once financial
assistance granted is redeemed plus optional dividend
payments on paid-in capital.
(2) the second line entails the calculation of capital and
funding costs for those options, where member states
have a liability in their books throughout the lifetime of
financial assistance granted even if no cash payment has
been made, that have to be born in any case. For the EFSF
type the value is one, because member states only have
their share rerouted to national public debt but there is no
immediate cost or benefit attached to the guarantee. For
ESM as there is not additional liability rerouted to national
public debt beyond the capital share has to be paid in in
advance.
(3) the third line deducts additional costs that only occur
for those options, in which no upfront cash payment has
been made, once a beneficiary defaults with a certain Probability of Default. This is not relevant for GLF, where all
costs and interest received is accounted for in the first two
lines. However, once a member state defaults on EFSF or
ESM and a guarantee is drawn or callable capital is called,
member states will incur costs for financing their share in
the financial assistance lost.
(4) the fourth line shows how the additional cost for
those options is deducted, where over-guarantees or
excess-commitment apply if co-guarantors in EFSF or ESM
default on their guarantee or callable capital subsequently to a beneficiary member state defaulting. The formula
makes it clear that this cost element will be rather limited
from an entirely probability based point of view.
The basic rational between the different calibrations of the
model are again simple:
Maturities are longer for financial assistance in the
form of sovereign loans (currently between 30 to 45
years) than for banking related operations (between
two to three years for loans to SRB/SRF and five to
seven years for equity investments).
Default is the moment in the lifetime of the investment, where actual losses on the nominal amount
have to be realised. Years to Default defines the
number of years for which the investment performs
as planned. Default in this model is a single event, at
which a one-off loss has to be written off. There is no
consecutive restructuring or loss incurrence, both for
loans and equity.
41
42
a low to medium risk of outright default and very
long maturities, as there will almost always be a debt
restructuring until the respective beneficiary is in a
position to service its debt. However, if a potential
default would only occur after several years, the time
span to default was set at 10 years in the model which
is the current grace period enshrined in the terms and
conditions for GLF, EFSF and ESM loans.
Banking related operations could occur either in the
form of loans to the SRM or in the form of equity
investments through DRI, which are associated with
either low or high risk and short to medium term
maturities respectively. A loan to SRM would be shortlived with a maturity of up to three years41 as currently
defined for the temporary backstop. The assumption
is that a hypothetical default would most likely occur
during or after the second year. There is no predefined
maximum time horizon for equity investments, so a
proxy of 7 years is used, which is derived from state
aid rules42. A potential default or more accurately loss
absorption in this context would most likely occur
towards the end of this period.
Own funding costs of contributing member states can
range between very low cost if shorter term funding is
considered and higher cost if an average nominal interest rate paid on the entire outstanding stock of public
debt is considered. Funding costs do not necessarily
have to be covered by interest received, dividends,
profits or fees. This could especially be the case for
GLF type financing where member states with lower
credit ratings and/or higher debt stocks outstanding
could be confronted with revenue flows that do not
cover their own funding costs.
The purpose of the model is to assess which financing
mechanism should be used for which kinds of applications.
I will therefore use the three cases described in detail in
Chapter 2 to determine the risk and cost associated with
each option. The various assumptions used are purely
hypothetical and not based on econometric analysis. In
the absence of historical data, the scenarios for Probabilities and Loss Given Default are not empirically tested.
The parameters chosen aim at forming a reasonable scenario
and describing the underlying mechanics of the three different
financial assistance financing arrangements.
http://data.consilium.europa.eu/doc/document/ST-14346-2015-INIT/en/pdf
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52013XC0730(01)&from=EN
15
The approach differs from a standard credit rating agency
assessment that looks at the Probability of Default over
a specific time horizon. In this model all investments are
compared over the entire distribution of Probability of Default in order to identify areas in which different financing
mechanisms could perform differently. However, relevant
individual values for PD can of course be chosen for each
type of investment to enable a credit rating based evaluation and to produce comparable one-off pictures.
For the tables and graphs shown in the Annex, different
figures for own funding costs and maturities were applied,
whereas maturities are associated with different kinds of
operations and thus risk and loss distribution (see next
page), everything else being equal.
A standard set of Probabilities of Primary and Secondary
Default, maturities and funding costs as well as potential
revenues will be used for the scenarios. The parameters
LGD, and years to D are not assumed flat over the entire
lifetime of an operation and are subject to risk weighting
along specific probability distributions. The following graphs show how the risk relevant parameters evolve over the
relevant ranges.
From a singular perspective, the Loss Given Primary Default is varying with the purpose chosen, while Probability
of Secondary Default (including Loss Given Secondary
Default) and share of defaulting co-guarantors is steady as
it is attached to the same sovereign risk in all three cases.
The displayed distributions for Losses given Primary
Default as well as for the point in time of occurrence of a
default are the basis for the results of the cost assessment
for the individual financing mechanism types discussed on
the following pages (note that percentages are used for
the parameter Years to Default as the actual maturity of
the investment differs significantly for the three types considered: Sovereign loan, SRF loan and Equity investment).
16
Graph 2
only with longer durations such as sovereign loans. On the
other hand, ESMs operations are not recorded on national
public debt and there is no stepping out option under the
ESM-Treaty, which in turn constitutes a significant advantage for higher rated member states that have to provide
a smaller share in such a setting. Also ESM is assigned
with the higher rating that is more robust than the one
for GLF (measured as hypothetical average rating of Euro
Area countries) or for EFSF. The latter case makes the ESM
the cheapest option for beneficiary debtor countries as it
stands today.
Default has a very distinct meaning for all the three types
of investment. For an extremely long term sovereign loan,
default of a country rated at the brink of investment grade,
is not entirely out of the world, even though still not very
likely. If ever to occur, losses are assumed to lie in a range
between 10 to 30% of capital for most of the cases. A
loan to the Single Resolution Fund would be short-lived,
between 2 to 3 years, and backed by the entire banking
sector of the Banking Union. An actual default appears
quite unlikely, though if ever to occur losses are assumed
to be higher than for a sovereign loan. Lastly, default for
an equity investment has the meaning of realising a loss.
Given the distressed environment and state of the bank
itself, such an event is more likely than not.
Different parameters play a role in the assessment depending on the three cases of application. Overall the assessment is robust regarding the underlying mechanics of the
modelled mechanisms and thus in terms of deducted rankings. It is therefore possible to draw general conclusions
from the analysis (see Graph 3 and graphs in the Annex).
The expected values are sensitive regarding the assumption on own funding costs and duration of an operation. The
more expensive capital costs for ex-ante paid-in capital
or cash the more attractive is a guarantee structure.
The main disadvantage of ESM that comes into play in
the model is the fact that paid-in capital has to be provided, which is never to be reimbursed to the contributing
member states. The presence of dividends received on
paid-in capital would naturally alter the results. Also if this
component would be considered sunk costs and thus less
relevant for the analysis, the effect would be significantly lowered to funding costs of the paid-in share, which
affects the difference in expected values for risks shared
The ESM type appears to be less attractive as own funding costs for the national shares in paid-in capital of ESM
have to be financed regardless of the actual Probability
and Losses given Primary and Secondary Default. In the
absence of any dividends received, own funding costs
result in being the main cost driver for the ESM type
option. If dividends are received on ESM paid-in capital
and the paid-in capital share is not considered to be a cost
component, ESM turns out to be the most cost effective
mechanism to finance stability support. It also needs to
be mentioned again that ESM is the only mechanism that
does not foresee a stepping out option for beneficiaries of
sovereign loans.
For medium term operations, as associated in this context with operations with potentially higher Losses Given
Default, the GLF type expected costs develop in parallel
to the EFSF types’ expected cost, as long as own funding
costs are covered in full. Only for longer term operations
and very high Probabilities and Losses Given Default, GLF
type costs converge towards ESM types’ full cost. Own
funding costs play a significant role in this development. If
own funding costs are higher than revenues received in return, the GLF type financing structure is inferior to an EFSF
or ESM type structure. It should be noted in this respect
that it is not unlikely for lower rated contributing member
states that own funding costs cannot be entirely covered
for the GLF type financing structure.
Over-guarantees and excess-commitments play a limited
role in the analysis and do only matter for very high ratios
of Loss Given Default and a share of co-guarantors defaulting.
Also dividends on paid-in capital do not alter the overall
picture significantly.
17
Graph 3: Baseline Scenario (see also Annex)
Summing up, the three financing mechanism types converge only either for very high Probabilities of Primary and
Secondary Default as well as high Losses given Primary
and Secondary default or for low to medium risk of primary default, assuming low own funding costs in the risk
based cost assessment. That means that where very high
probabilities of primary default and large losses of the investment are assumed – as it could be the case for certain
banking related operations – the difference between EFSF
type and ESM type structure could become less significant for the member states contributing to the financing
mechanism.
18
Chapter 4:
Who contributes and how much?
The following chapter will provide an overview over the
origins of risks as well as the contributions by member
states to share these risks ex-post, i.e. once something
has gone wrong. Potential risks in this respect emanate
mostly either from public gross debt, or from bank balance
sheets as outlined in Chapter 2 (for banking related activities, both total and risk weighted assets (RWA) are used
as an indicator).
greatly for programme countries due to the stepping out
option on the one hand and the new members of the Euro
area on the other hand.
Graph 5a
When Euro area member states are pooled according to
their individual credit ratings as of the end of the year
2015, two major blocks can be formed. Graph 4 shows
that potential risks emanate to a larger extent from those
countries that are rated below high grade (AAA or AA) as
compared to their cumulated shares of Gross Domestic
Product.
Graph 4
relevant for national public debt according to Maastricht
criteria as accounted for by Eurostat
*)
ESM paid-in capital is relevant for gross public debt under
the assumption that it is debt financed
Graph 5b
Sources: European Central Bank, European Commission,
European Central Bank via Macrobond, own calculations
As a next step I will look at the amounts provided in
cash and via guarantees or commitments by the individual member states to back the financing mechanisms
GLF, EFSM, EFSF and ESM. The following graphs compile
information for the exposure of Euro area countries in the
context of mechanisms applied to provide crises financing
to other Euro area countries. EFSM, which is not under
scrutiny in detail, is looked at in this chapter as a special
form of a financing mechanism backed entirely by guarantees purely for illustrative reasons. The figures differ
Sources: European Commission, ESM, EFSF, national statistics offices, own calculations
EFSM is backed by the EU-budget, thus by all 28 EU
member states
*)
Note that the figures for ESM include the entire authorised
capital (thus also the unused amounts)
19
Countries that entered the Euro area after GLF and EFSF
were agreed did not retroactively become members of those two financing arrangements, as both were only considered to be short-lived at the point of time of their creation.
Only the EU budget and the ESM-Treaty foresee an option
for countries to become new members of the mechanism.
This option applies retroactively, i.e. new members are
fully liable for exposure incurred before their membership.
When again pooling the member states according to their
individual credit ratings as of the end of the year 2015,
two major blocks can be formed.
Graph 6
following analysis will reflect on the numerous specifics
of the financing mechanisms to the extent possible, while
still remaining as broad as possible, based on experience
made during the years 2010 to 2015.
The different burden sharing agreements for GLF, EFSM,
EFSF and ESM play a role for the question whether or
not some form of credit enhancement is required for the
financing arrangements, depending on the size and structure of the guarantee or commitment framework.
If the contributions are pooled according to the underlying
credit ratings and in addition compared to the targeted
lending capacity, it can be seen in the following graph that
the largest part of the first hit in a theoretical worst case,
black-swan kind of scenario, in which most of the member
states are unable to honour their commitments, will be
taken by the highest rated member states.
Graph 7
Sources: European Commission, ESM, EFSF, own calculations
*)
EFSM contribution keys are 5 year averages for the period 2011-2015 for all 28 EU member states
The potential impact of the United Kingdom leaving the
European Union is not reflected
Whereas those member states that were assigned with the
highest credit ratings represent 62.3 % of Euro area GDP
(cut-off date 31.12.2015 as compared to 61.5 % at the
end of 2012), their share in the Solidarity measures ranges
between 57.7 % for ESM and 62.3 % for EFSF (the Total
measured as overall weighted average is 58.8 %). Note
that the contribution keys for GLF and EFSF would have
initially been closer or almost similar to the ESM figures
but were retroactively elevated through the subsequent
stepping-out of co-creditors or co-guarantors respectively
(i.e. programme countries). In this context it needs to be
recalled that for certain types of financial assistance it is
not foreseen for beneficiaries to step out of guarantee
framework (stepping-out ex-ante is by no means related
to a subsequent potential Secondary Default of a co-guarantor!). From a general point of view, it is hard to tell how
large the shares to be taken over would be in a hypothetical future actual application of the mechanisms. The
20
Sources: European Commission, EFSF, ESM, own calculations
*) EFSM is backed by the EU budget and thus by all 28 EU
member states
ESM Paid-in capital is shared according to the ratios shown
above in Graph 7. From this perspective some 9.4 % out
of the 16 % displayed come from AAA/AA rated member
states and the remaining roughly 6.6 % from lower rated
member states. Thus the total share of AAA/AA countries
is around 81.4 % of total hypothetical immediate maximum loss absorption for ESM.
However, following the risk based approach outlined in
Chapter 3 it will become clearer that this immediate maximum risk will not materialize for higher rated member states with high probability (see Table 2). Given the prudent
liquidity and funding strategy of EFSF and ESM, the risk of
large concentrated calls on guarantees or callable capital is
substantially lowered.
Table 2:
AAA/AA countries’ share in the mechanisms considered under different perspectives
Mechanism
Cash
nom.
Share*)
immediate
first hit
share**)
risk weightedshare***)
Sovereign loans
rating based
simulation based rating based
simulation based
shares
GLF
risk weightedshare****)
Banking related
100%
60.4%
61.4%
61.4%
61.4%
61.4%
61.4%
0%
63.2%
63.2%
63.2%
63.2%
63.2%
63.2%
EFSF
0%
57.9%
100.0%
62.3%
62.5%
57.9%
58.1%
ESM
16%
57.7%
81.2%
57.7%
57.8%
57.7%
57.8%
EFSM
initial contribution key for AAA/AA countries in the pool without stepping out and potential default of coguarantors
**)
maximum share to be covered by AAA/AA countries
***)
contribution keys for AAA/AA countries after stepping out of programme countries (historical values where
applicable) and default of some co-guarantors based on based on Standard and Poor’s standardised Probabilities
of Default and own simulations (assumptions are built upon Standard and Poor’s rating table: assumed
probabilitie for default is 14.6% for a sovereign loan)
****)
assuming no stepping out
*)
If a crises financing or risk sharing mechanism is ought to
be assigned with a sufficiently high rating there will have
to be some sort of credit enhancement, either in the form
of paid-in cash or by way of providing over-guarantees or
excess-commitment. Especially AAA/AA countries thus face
a trade-off between (potentially uncovered) own funding
costs on the one hand or (potentially higher) risk exposure
due to higher regular contribution keys or higher over-guarantees or excess-commitment on the other hand. Establishing a fair contribution key is definitely not a clear cut and
straightforward task, as it is depending on a number of
assumptions and believes as well as relying on the purpose
of the risk sharing measure in question. The revealed preference of Euro area and European Union member states
appears to anchor the individual contributions mostly to
the economic strength of each member and not to the
origin of risk.
21
Chapter 5:
Proposals to improve the existing risk
sharing framework in Europe
In this chapter I will elaborate on potential options to
improve the existing ex-post risk sharing framework in
Europe against the background of the before mentioned
lessons learned and the analysis of different funding and
risk sharing structures as outlined in Chapters 2, 3 and 4.
Readers should be aware that none of the following policy
options have been assessed regarding their legal and
political feasibility in full detail. The author considers these
proposals as potential elements for any form of future joint
funding and risk sharing structure apart from any central
form of Euro area or European budget, deposit insurance
or alike. It should also be noted that the discussion does
not reflect in detail upon issues such as incentive compatibility and the design of policy conditionality but focuses
mostly on financing and risk sharing options.
i) Streamline the financial assistance architecture
ESM has taken over the tasks of the various temporary
financial assistance financing arrangements GLF, EFSF and
EFSM. However, due to the repeated alteration of terms
and conditions and thereby extension of maturities, the
temporariness of these mechanisms is as long as 45 years
as of today.
Thus, in the Medium to long run ESM as the main institution of the Euro area should take over EFSFs assets and
liabilities to effectively become the sole provider of stability
support. ESM could also do so for the same reasons with
the bilateral loans of the Greek Loan Facility.
This merger, however difficult to implement, would serve
several purposes. Firstly, it would integrate Euro area
financial assistance under one roof. Secondly, it would free
public balance sheets of creditor and guarantor countries from debt incurred and rerouted to finance stability
support. Thirdly, the concentration of financial assistance
within the ESM would sprawl the burden to all current Euro
area member states as a number of them are not party
to the GLF and the EFSF. Furthermore, it would take away
budgetary costs as the financing costs for the GLF for
some member states might be higher than what is received in interest payments someday. Lastly, it would finally
establish ESM as the single debt issuing body for the pur43
http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ecofin/129381.pdf
22
pose of financing stability support. The increased stock of
ESM debt securities could lead to more liquidity for those
bonds and thus potentially slightly lower funding costs.
The ESM as a crisis financing mechanism solely designed
to support a limited number of members will by definition
not become active very often but only during rare times
of financial crises. In the presence of rather deep financial
turmoil ESMs available resources might not be sufficient.
For example, as a consequence of the deepening sovereign debt crisis the Eurogroup decided, amongst others,
to extend the joint EFSF/ESM-lending capacity from 500
to 700 billion Euros43. If ESM would take over existing
financial assistance programmes and loans under GLF and/
or EFSF, it could be argued that its capacity would need to
be increased in order to have the necessary “fire power”.
One of the options to temporarily increase the lending
capacity of ESM would be to add a guarantee like structure
to the ESM. This “inflation mode” could allow the ESM to
borrow additional means in the market backed by additional commitments of ESM member states under certain
circumstances and potentially only for a limited amount of
time (this proposal should be read against the background
the analysis in Chapter 3).
This mechanism could be structured by way of mirroring EFSF type guarantees for the ESMs callable capital
(authorised but not called) on top of the existing capital
stock. The trigger for activating the inflation mode could
be for instance that the Forward Commitment Capacity
(FCC) falls below a certain threshold (say 20 to 30% of the
overall capacity) or the FCC would no longer be sufficient
to cover certain financing needs (for instance a potential
Secondary Market Purchase Programme target level or the
current size of the SRF if ESM were to provide a credit line
to the SRM).
Further improvements to the ESMs capital structure to take
into account the dynamics outlined in Chapter 3 on the
risk implications of the different mechanisms to share risks
or fund financial assistance measures could be warranted. Taking cash flow management’s, rating agencies’ and
member states’ perspectives into consideration, it could
make sense to apply different ratios of cash to guarantees/
commitments for the specific purpose in question:
Exposure through sovereign loans to member states
Exposure to the banking sector, either through investment in bank equity or potentially a future direct credit
line to SRB
In addition to the existing ways to call on capital under
Article 9 of the ESM-Treaty, shareholding member states
could consider introducing contingent capital calls as well
as a temporary capital increase:
A contingent capital call is a decision to call on authorised unpaid capital if certain conditions are met. It
would improve the quality of a capital call under Article
9 (2) by adding legal certainty, basically making it a
guarantee in economic terms.
Temporary capital could allow the ESM to call on
authorised unpaid capital where needed to back certain risks and return it to shareholding member states
– once an operation has successfully been terminated
– without limiting the overall capital ceiling.
Both options would improve the capital structure of the
ESM, either if the institution were to temporarily extend
its balance sheet or to invest in riskier assets such as bank
equity under DRI.
In designing such a mechanism it would be of utmost
importance to clarify how the structure would work, as the
backing of ESMs debt issuance should not be altered in
terms of quality and as ESM should not create a dual market for its bonds issued. Besides the legal implications, the
question has to be discussed with Credit Rating Agencies
how this would be reflected in the ESMs credit assessment. A potential way forward could be to strengthen the
Forward Commitment Capacity framework in combination
with the rules applicable to capital calls and make it more
binding in order to clarify that ESMs bonds issued would
at all times be backed by sufficient paid-in and callable
capital.
ii) Improve risk sharing and risk mitigation among
private and official sector
Risk sharing can be seen from two distinct perspectives in
the context of this paper. One is on public risk sharing, so
how member states share a certain burden amongst each
other, whereas the other is on how to share risk between
private investors and the public sector.
Regarding the first perspective, Chapter 4 provides an
overview over the amounts at stake within the risk sharing
mechanisms in place to tackle the Euro area sovereign
debt crisis. The model presented in Chapter 3 analyses the
44
underlying dynamics. One means to go beyond the current
understanding of sharing risks by using fixed contribution keys would be to introduce asymmetric (temporary)
capital calls, as a special case of temporary capital suggested under proposal i). Such an asymmetric call would
ask a certain country to temporarily pay in more capital
than its share would initially ask for. The clear benefit as
compared with credit enhancement via over-guarantees
or excess-commitment is that the overall exposure would
be lower and that it would place risk mitigation measures
at its origin. This mechanism could for instance serve
the purpose to stabilize the ESMs overall credit rating if
one countries’ credit worthiness is deteriorating. Such a
measure would be temporary, until the credit rating of
that country has improved again. Otherwise, it could help
to set the right incentives for a country benefitting from a
certain risk sharing measure. The member state in question would need to keep some skin in the game, if risks
were shared via the ESM but control over the origin of
the risk is at least partially national and not entirely within
the joint reach of Euro area countries. Such a mechanism
would work in a similar spirit as the agreement on burden
sharing under Article 9 of the ESM Guideline on Financial
Assistance for the Direct Recapitalisation of Institutions.
Regarding the perspective of risk sharing among the
private and public sector, as discussed in Chapter 1, it
should in general be the primary goal to limit exposure
of public means to private risks to the extent possible.
Amongst others, recital 13 of the ESM-Treaty foresees the
option of private sector involvement in the context of full
macroeconomic adjustment programmes in line with IMFs
experience. Current discussions within the IMF go into
the direction of required debt restructuring prior to IMF
assistance44.
In the same spirit as the IMF, ESM should assess how debt
could be made sustainable both through concessional
lending at unconventional terms as well as through compulsory (in the medium to long run automatic) maturity
extensions for debt held by private investors in the run-up
of an ESM programme. This would aim at avoiding heavy
refinancing needs during an ESM programme, reduce
overall interest payments of a country due to concessional
lending terms and reduce the net present value of debt.
For financial stability reasons the focus however should
lie with limited adjustments to the terms and conditions
of debt, as the latest Euro area debt restructuring has
amongst others effectively driven the banking sector of
two Euro area countries into insolvency. Automatic re-profiling elements should thus only be enshrined into newly
issued debt, for instance, based on general provisions as
outlined in Article 12 (3) of the ESM-Treaty foreseeing the
introduction of Collective-Action-Clauses into Euro area
For further information, see: http://www.imf.org/external/np/spr/2015/conc/index.htm and http://www.imf.org/external/np/pp/eng/2015/040915.pdf
23
sovereign debt. A potential sweetener for such a scheme
could be to trigger such clauses only for countries under
an ESM macro-economic adjustment programme and only
if needed to achieve certain debt sustainability targets,
whereas net present value losses for holders of debt of a
potential beneficiary country should remain limited. The
latter could work by adjusting interest rates accordingly,
by linking maturity extensions to higher coupon payments.
Such a framework, however, has to ensure that provisions
do not lead to self-fulfilling prophecies, amplify market
panic and undesirable herding behaviour. Where debt is
supposedly not sustainable with high certainty and a large
share of means from an adjustment programme goes into
refinancing of existing obligations, vast maturity extensions via very long lived ESM loans might turn out to be
unavoidable after all. It appears to be most suitable to
find some form of mixed burden sharing for those cases
where private investors could chose to amend terms and
conditions in line with ESM loans or accept nominal write
offs for their claims. In parallel, ESM would shoulder the
remaining burden through lengthy maturities, low interest rates and potentially further debt burden alleviating
measures.
In the long run the equation should be simple. Excessive
risk taking and debt accumulation by private investors
should be solved in general via bail-in and restructuring.
Where excessive private sector risk accumulation leads to
systemic stress that can no longer be managed through
such measures, risk sharing among member states should
avoid fiscal distress of individual countries. Risk sharing
measures should furthermore be limited to stretch credit
risks by maturity transformation. Losses from private sector risks should not be covered by public finances. Where
losses from financial sector related activities cannot be
avoided, member states should be reimbursed by collecting ex-post contributions from the banking sector.
However, in practice this will also mean that as long as
banks’ risk exposure remains to a large or at least some
extent geared to national factors, further risk mitigating
measures that go into the direction outlined by the European Commission in the context of their proposal for a
European Deposit Insurance Scheme would be required45.
iii) Streamline the financial stability architecture
As mentioned in the introduction, the 5-Presidents-Report
suggested improving the instrument guidelines of DRI,
“especially given the restrictive eligibility criteria, currently
attached to it”. The central term in this respect is understood to be “precautionary recapitalisation” as allowed for
under Article 32(4)(d)(iii) of the BRRD, which does not
45
46
47
http://europa.eu/rapid/press-release_IP-15-6152_en.htm
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0059&from=DE
https://www.fdic.gov/deposit/insurance/assuringconfidence.pdf
24
trigger the “failing or likely to fail” of an institution provided the conditions specified in that Article are met46. This
option together with the aforementioned eligibility criteria
was excluded by definition, thereby limiting the use of DRI
to very rare and extreme cases.
The assertion of the five Presidents, however, does not
take into consideration the motives leading to the definition of eligibility criteria in the first place. The clear aim
of most member states during the negotiations leading to
DRI was to limit the potential losses for ESM to an absolute minimum in order to avoid calls on ESM capital. This
means that the eligibility criteria could only be loosened if
the threat of losses could be minimised further or potential
losses could be offset by new sources. It could therefore
be envisaged to attach some form of insurance element
and have for instance the SRM offset ESM for losses from
DRI by collecting ex-post contributions from the banking
sector.
Lastly, risk sharing in this respect would include actual
management of a bank with all its legal and professional
responsibilities. It would require skilled professionals and
private sector know-how. ESMs core competence lies with
funding and lending activities whereas the SRM is specialised in monitoring, restructuring and resolving banks. DRI
was established with ESM in between the initiation and
the implementation of the Banking Union and is a bit of an
alien from an institutional point of view. Either a clear cut
division of labour between the two institutions or a merger
of two could thus be called for.
If the route were to be chosen to further separate tasks
between ESM and SRM, ESM would still the efficient choice
as the common backstop for the SRM. This would combine
the fiscal strength and liquidity of the ESM with the purpose of the SRM to ensure financial stability through swift
and adequate bank resolution. Experience from the US
shows that the need for drawing on such a credit line from
the resolution authority occurs very rarely and is merely
necessary for having sufficient liquidity when means in
the resolution fund are absorbed from illiquid assets taken
from failing banks balance sheets47.
The alternative option would be to fully merge ESM and
SRM. From a macro perspective both institutions serve the
same broad purpose, namely safeguarding financial stability in the Euro area and/or within the Banking Union (if
ever different). While SRMs resolution actions might occur
more frequent, though potentially clustered around the
business cycle and potentially also geographical areas, the
number of ESM activities will most likely be rather limited
and concentrated towards crises times. In order to ensure
an efficient use of human resources and financing capacities, both institutions could be merged into one
Single European Financial Stability Mechanism. This
would entail a vast number of considerations, necessary
steps to be taken and side-effects and would require a
fundamental overhaul of the ESM-Treaty and the SRM-Regulation as well as a comprehensive implementation plan
for the envisaged merger.
There are actual examples in some EU member states for
such a step. For example in Sweden or Germany the DMO
has been appointed to take over all or certain resolution
functions48. On a side note, the Swedish DMO is also in
charge of the deposit insurance system. However, the discussion on a European Deposit Insurance Scheme (EDIS)
has by far not yet reached the stage of the institutional
setting.
see https://www.riksgalden.se/en/press/press-releases/2015/Debt-Office-gets-expanded-bank-crisis-management-powers/ or
http://www.bundesfinanzministerium.de/Content/DE/Pressemitteilungen/Finanzpolitik/2015/12/2015-12-14-PM-FMSA.html (german) [14.04.2016]
48
25
Chapter 6:
Conclusions
The Euro area sovereign debt crisis has shown that joint
action and risk sharing in certain policy areas can be called
for. How this could be done depends on the actual risk
to be shared or operation to be financed and the policy
preferences regarding risk sharing and potential loss
absorption. While title and scope of this discussion appear
rather narrow, the underlying analysis, considerations and
proposals could be applied to any Euro area or Banking
Union financing or risk sharing mechanism.
Risk can be shared by member states by putting cash
on the table (as done with the pooled loans in the GLF),
providing commitments and guarantees (as for EFSM or
EFSF), or combining the two elements at a certain ratio (as
with ESM). Ex-ante paid-in cash reserves have by definition
the best quality and highest rating attainable as compared
to a guarantee. The quality and value of a national guarantee or commitment depend strongly on the fiscal strength
of the individual member states providing them, as reflected by credit ratings. In order to improve the quality and
value of pooled guarantees or commitments, higher rated
members of the group have to guarantee more than their
share either via an upfront above average contribution key
or via over-guarantees or similar forms of excess-commitment that kick in, only once lower rated member states
cannot honour their obligations. In the latter case, each
member covers its share of Primary Probability of Default
of the beneficiary member state, as well as Secondary
Probability of another member of the scheme defaulting.
Cash and capital are costly for member states and should
be used wisely. The larger the cost, i.e. the difference
between interests or dividends received and own funding
cost, the more attractive are guarantees or other forms
of legally binding commitments for the member states
providing them. This holds even if high over-guarantees
are applied and sufficiently high Secondary Probability of
Default and Loss Given Default are assumed. The larger
the share of guarantees or commitments relative to the
cash share is, the larger the contribution key of member
states assigned with the highest credit rating could have to
be to ensure a sufficiently high rating and thereby liquidity
at low cost. This will amongst others depend on the actual
purpose of the risk sharing exercise. Another issue in this
respect is the legal nature of a commitment that needs to
be sufficiently assuring to investors.
49
Where the risk of outright Primary Default and the need
for nominal debt write-offs is low and the lifetime of an
investment is short, the use of guarantees with over-guarantees or similar commitment structures comes with
lower budgetary costs. However, using the actual EFSF
structure is not the preferred option, especially because
of debt rerouting to guarantors and high over guarantees
applicable. Nonetheless, the EFSF type guarantee structure
could be mirrored within the ESM callable capital framework (assuming that it would not be re-routed to national
public debt within ESM). Where the risk of Primary Default
and the need for nominal debt write-offs is higher, as with
certain banking related operations, the cash share should
be higher in the cash-commitment-mix backed funding
mechanisms, in order to limit the need for credit enhancement and ensure sufficiently high credit worthiness. Depending on the circumstances this could be “cheaper” for
higher rated member states, amongst others, because the
share that has to be over-guaranteed is smaller (assuming
that the risk of Secondary Default of other co-guarantors is
likely to be higher in a Situation of Bank distress). A higher
cash share can also lead to a rating uplift above what a
mechanism backed solely by guarantees or commitments
could acquire. The ESM structure is assigned with a higher
and more stable credit rating than the EFSF structure,
which is less vulnerable to downgrades of individual
shareholding member states.
Liquidity is also a key issue that should not be ignored.
Experience from the European Union budget suggests that
a budget institution with high liquidity might not require
higher guarantees in the form of over-guarantees after all.
However, the share of higher rated member states is higher for the EU budget as for the Euro area mechanisms49.
In the light of the underlying analysis and conclusions, the
following concrete options could be considered:
If the ESM s mandate remains unchanged, it should be
considered to concentrate all existing financial assistance programmes at the ESM, thereby freeing public balance sheets from rerouted or incurred debt and
to benefit from enhanced liquidity of ESM debt instruments. The ESMs authorised capital base should then
be altered to have more flexible economic capital and
potentially higher callable capital if needed. It should
It remains to be seen what the impact of the United Kingdom leaving the EU on its credit worthiness will be.
26
become possible to increase ESMs capacity beyond the
currently agreed limit in times of extended need, which
would call for some form of “inflation mode”. Otherwise the crises management tools (“firewall”) could
always be subject to market concerns and ECB could
have to step in. This pressure should at least partly
be alleviated over time through the implementation of
additional burden sharing mechanisms into sovereign
debt instruments.
Furthermore, even if the ESMs mandate remained
unchanged, further consideration should be given to
the issue of overall financial stability in the context of
sovereign debt sustainability. Debt write offs at the
expense of private investors are popular in the political debate, however, uncertainty about private sector
involvement in the course of one of the macro-economic adjustment programmes has had effects on the
country itself as well as side effects on other countries
perceived as periphery. If this route were chosen,
burden sharing between official and private creditors
should be rules based and follow foreseeable patterns
to avoid unorderly restructuring of debt.
If the ESM mandate is enhanced towards banking related activities, it should become possible to increase the
cash share on a temporary or permanent basis. The
amount of economic capital to be provisioned should
be determined depending on the purpose of a measure
(loans to SRF or equity investment) to ensure sufficient
loss absorption capacity, a sufficiently high credit rating
and thereby investors’ confidence.
In general, a crisis financing mechanism should have
funds readily available in times of need. This applies
to any institution, regardless of who will be there to fill
the gap for the SRF or EDIS. Leaving the ESM unchanged and establishing new institutions in parallel that
have more or less the same task – namely mobilising
funding to safeguard financial stability – appears inefficient and an undesirable policy choice. Merging certain
or all functions of ESM, SRM and potentially EDIS
should thus be considered.
A reinsurance system backed by contributions from the
financial sector could be established in the framework
of existing ESM structures, amongst others to at least
partially cover for potential losses from direct equity
investments or other banking related activities.
The aforementioned proposals could help to manage risks
emanating both from the financial sector as well as from
the market for sovereign debt more efficient. Public risk
sharing measures should only come into play as a last
resort. As long as business activities of financial institutions
have a home-bias, cross boarder risk absorption capacity
of the private sector remains limited. In order to improve market based risk absorption, further risk reduction
measures should be put in place prior or in parallel to the
implementation of the proposals set out in this paper.
27
Annex:
Scenario analysis based on Expected value
model described in Chapter 3
Baseline Scenario: higher average own funding costs, partially covered plus dividends received – incl. ESM
paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
3,00%
3,00%
3,00%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
2,50%
0,00%
1,50%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,71
-0,03
-0,31
100% Guarantee EFSF type
-0,11
-0,01
-0,28
Cash/Committment mix ESM type
-0,62
-0,23
-0,42
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
28
29
Scenario 1: low own funding costs, fully covered – incl. ESM paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
0,30%
0,30%
0,30%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
0,30%
0,00%
0,00%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,7
-0,01
-0,24
100% Guarantee EFSF type
-0,7
-0,01
-0,24
Cash/Committment mix ESM type
-0,36
-0,22
-0,37
30
31
Scenario 2: low own funding costs, partially covered – incl. ESM paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
0,50%
0,50%
0,50%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
0,30%
0,00%
0,00%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,19
-0,02
-0,25
100% Guarantee EFSF type
-0,07
-0,01
-0,25
Cash/Committment mix ESM type
-0,38
-0,22
-0,37
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
32
33
Scenario 3: low own funding costs, partially covered – excl. ESM paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
0,50%
0,50%
0,50%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
0,30%
0,00%
0,00%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,19
-0,02
-0,25
100% Guarantee EFSF type
-0,07
-0,01
-0,25
Cash/Committment mix ESM type
-0,11
-0,01
-0,25
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
34
35
Scenario 4: higher average own funding costs, fully covered – incl. ESM paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
3,00%
3,00%
3,00%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
3,00%
0,00%
0,00%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,17
-0,01
-0,28
100% Guarantee EFSF type
-0,11
-0,01
-0,28
Cash/Committment mix ESM type
-0,77
-0,24
-0,44
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
36
37
Scenario 5: higher average own funding costs, partially covered – incl. ESM paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
3,00%
3,00%
3,00%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
2,50%
0,00%
0,00%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,71
-0,03
-0,31
100% Guarantee EFSF type
-0,11
-0,01
-0,28
Cash/Committment mix ESM type
-0,77
-0,24
-0,44
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
38
39
Scenario 6: higher average own funding costs, partially covered – excl. ESM paid-in capital
General assumptions
Sovereign
loan
SRF loan
Equity investment
14,6%
2,0%
55,1%
Loss Given Default of beneficiary MS/institution
risk weighted
average
risk weighted
average
risk weighted
average
Expected Loss
risk weighted
average
risk weighted
average
risk weighted
average
Probability of Default of co-guarantors * Loss Given
co-guarantors Default
risk weighted
average
risk weighted
average
risk weighted
average
Share of defaulting co-guarantors
risk weighted
average
risk weighted
average
risk weighted
average
3,00%
3,00%
3,00%
30
3
7
Years to default
risk weighted
average
risk weighted
average
risk weighted
average
Specific assumptions
100% Cash
GLF type
100% Guarantee EFSF type
Cash/Committment mix ESM
type
Upfront payment by creditor/guarantor MS
1,00
0,00
0,16
Debt rerouting
0,00
1,00
0,00
Repayment
1,00
1,00
0,00
Over-guarantee percentage
0,00%
65,00%
47,62%
Interest/dividends/fees received by creditor/guarantor MS
2,50%
0,00%
0,00%
All Member States
Sovereign
loan
SRF loan
Equity investment
100% Cash GLF type
-0,71
-0,03
-0,31
100% Guarantee EFSF type
-0,11
-0,01
-0,28
Cash/Committment mix ESM type
-0,50
-0,03
-0,31
Probability of Default of beneficiary MS/institution
Own funding costs
Maturities
40
41
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Herausgeber, Eigentümer und Verleger:
Bundesministerium für Finanzen, Johannesgasse 5, 1010 Wien
Für den Inhalt verantwortlich: Sektion III „Wirtschaftspolitik und Finanzmärkte“
Layout: Druckerei des Bundesministeriums für Finanzen
Oktober 2016
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