Constancio Urges ‘Flexibility’ on Use of European Bailout Fund

Constancio Urges ‘Flexibility’ on Use of European Bailout Fund

Dec 09, 2010 7:01 pm ET

Dec. 10 (Bloomberg) -- European Central Bank Vice President Vitor Constancio signaled European governments should be ready to increase the size and flexibility of their bailout fund as the ECB urges leaders to do more to fight the fiscal crisis.

Asked whether the fund could be used to buy government bonds, Constancio said in an interview that “more flexibility in the euro-zone resources would be helpful.” Constancio, who spoke to Bloomberg Television late yesterday, declined to speculate whether the rest of the ECB Governing Council would support such a move.

ECB officials are putting pressure on governments to step up their response to the market turmoil that last month forced Ireland to seek a bailout. While the ECB has bought government bonds to help stabilize markets, the policy has been criticized by Germany’s Axel Weber who says it threatens the ECB’s independence. Weber said last month that governments could increase the size of their rescue fund and Constancio said that such a move may be “helpful.”

Constancio, the ECB’s top official after President Jean- Claude Trichet, made the remarks after presenting the semi- annual Financial Stability Report. The central bank said a “small” number of banks depend too much on its emergency liquidity funds and the “overall economic and financial system is still fraught with risks.”

Officials are debating their next step after Ireland’s rescue failed to stamp out fears of contagion spreading through euro region bond markets. Attention is turning to the bailout pool set up in May after the Greek crisis threatened to destroy the euro. European Union governments have pledged 440 billion euros ($582 billion) to a European Financial Stability Fund.

ECB Pressure

While using the EFSF could take some pressure off the ECB, the move could be fraught with legal issues and the funds would need to be raised before they could be spent, says Carsten Brzeski at ING Groep NV.

Constancio’s comments “show clearly that the ECB doesn’t want to be the sole savior of the euro region,” said Brzeski, senior economist at ING Groep in Brussels. Still, “at the moment, the EFSF couldn’t do it because it doesn’t have any money. Even if governments decide to put in cash it will be tricky legally because of the no-bailout principle.”

The Maastricht Treaty says governments can’t directly take on the debt of other nations.

Investor concern about excessive deficits in some euro-area countries this year triggered a bond-market rout that forced Ireland and Greece to seek international bailouts to refinance their debt. That’s hampering some banks’ access to funding on financial markets, forcing them to rely increasingly on the ECB.

Too Reliant?

“A small number of institutions” are “excessively reliant on central bank liquidity” and account for “a substantial share of the overall refinancing volumes,” the ECB said yesterday in its report. “The main source of concern stems from the interplay between sovereign debt problems and vulnerabilities in segments of the euro-area banking sector.”

The central bank didn’t provide new estimates on the losses facing banks in coming years and didn’t identify the institutions that it views as being too dependent on its funds.

The ECB also urged government to take “swift and decisive steps” to defuse the risks created by a “limited” number of financial institutions.

“Action is needed by the responsible authorities in the form of restructuring, de-risking and, where necessary, downsizing of the balance sheets of such firms,” the ECB said.

Euro-region governments’ funding needs “will remain significant and there is a risk of increasing competition for funding,” the ECB said in its report. “Any additional requests to provide support to ailing banks may further exacerbate the risk of adverse feedback between the financial sector and public finances.”

--With assistance from Jann Bettinga in Frankfurt. Editors: John Fraher, James Hertling

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