Germany Takes Hard Line on Spanish Banks

Germany is set to clash not only with Spain and Ireland, but also with Italy and France

By GABRIELE STEINHAUSER

German Chancellor Angela Merkel took a hard line on Spain Friday, saying that Madrid will have to keep on its own balance sheet the tens of billions of dollars it is about to inject into its banks and won't be able to transfer them to the euro-zone bailout fund.

That position, laid out after a two-day summit of European Union leaders in Brussels, would mean that Spanish borrowing from the euro zone to bolster the capital of shaky banks—estimated to be as much as €60 billion ($78.72 billion)—will swell the country's already-heavy debt load.

Germany's stance appeared to dash hopes, fostered by the leaders at a summit in June, that the government's capital injections into the banks could later be transferred to the bailout fund once an effective euro-wide bank supervisor is in place, something that is now slated for 2013. The position could hurt the Spanish government's ability to fund itself on the market, just as interest rates on its bonds have dropped to multi-month lows.

"There will be no retroactive direct bank recapitalization [for Spanish banks]," Ms. Merkel told reporters. "As and when direct recapitalization is possible, it will apply only in the future."

In the early hours of Friday morning, EU leaders agreed that the European Central Bank could begin supervising banks in the euro zone sometime in 2013. The establishment of a powerful policeman for banks in the currency union had previously been made the main precondition for allowing the bailout fund, the European Stability Mechanism, to directly prop up failing lenders.

In addition to Spain, Ireland has also been hoping to transfer at least part of the €63 billion it injected into its banks onto the ESM's balance sheet.

Officials familiar with the discussions at the summit cautioned that the issue of the ESM taking over existing government holdings in banks wasn't discussed at the Brussels gathering. Experts from national finance ministries, responsible for figuring out how direct bank recapitalizations could work in practice, are in fact still in the very early stages of their talks.

Ms. Merkel's decision to set out her position in her postsummit news conference is significant, however, and signals that Germany is taking a tough stance in the negotiations.

In those talks, Germany is set to clash not only with Spain and Ireland, but also with Italy and France, which have urged that the link between bank debt and government debt be broken in order to resolve the euro zone's three-year old debt crisis.

Italian Prime Minister Mario Monti said Friday that he believes the ESM may already be allowed to directly recapitalize some banks even before the ECB has actually started policing all 6,000 banks in the euro zone.

"In my opinion, it's not needed for the bank-supervisor mechanism to be fully in place for all the banks to start vigilance, and so also direct recapitalization, on some of them," Mr. Monti told a news conference. He added that Spanish banks could start being recapitalized directly as soon as next year.