Market panic abates as EU pledges to help banks, eurozone

Jul 12, 2011, 15:53 GMT

Brussels - European Union finance ministers pledged Tuesday to shore up cash-strapped banks and member states, as market concerns seemed to abate over the upcoming release of bank stress tests and fears of the euro debt crisis spreading to Italy and Spain.

EU leaders are to attend a special eurozone summit on Friday, to add their weight to the efforts to turn the tide on the debt crisis, diplomats confirmed.

The euro recovered to 1.39 dollars on Tuesday afternoon, from an earlier low of 1.38 dollars, after dropping below the 1.40 mark for the first time in four months. The Milan and Madrid stock exchanges recouped some of the heavy losses incurred on Monday.

EU Economy Commissioner Olli Rehn warned during the Brussels talks that the eurozone debt crisis 'poses a serious contagion threat to the European economic recovery.'

He later said Europe was suffering from 'a severely intertwined combination of the sovereign debt crisis and banking sector fragilities. We cannot solve one without the other.'

Overnight, eurozone finance ministers signalled that they would expand the powers of their bailout fund in a bid to prevent the single currency's debt crisis from spreading to Italy and Spain.

Options include lending Greece money to help it buy back some of its debt at reduced prices, thus lowering its debt burden.

Another suggestion is for the eurozone bailout fund to buy up Greek debt from banks, reducing the pressure from private creditors.

However, uncertainty remained over the role of the private sector.

German Finance Minister Wolfgang Schaeuble insisted that private lenders should share part of the cost of a second Greek bailout - expected to be similar in size to the 110-billion-euro (154-billion-dollar) package from last year.

But the European Central Bank has resisted those calls.

On Tuesday, Schaeuble tempered his demands, calling for a 'sufficient' contribution and dropping earlier requests for a 'substantial' one.

Schaeuble also rejected 'rumours' that more money should be poured into the euro bailout fund, as well as suggestions that Italy was in danger of becoming the next victim of the financial crisis.

On Tuesday, risk indicators on Italian and Spanish government debts reached record levels. But market panic seemed to abate by the early afternoon, with 'spreads' compared to benchmark German government bonds falling for both countries.

'I would not ask my grandmother to pull her savings from Italian government bonds, at least not yet. I cannot say the same for some other countries such as Greece,' quipped Sony Kapoor, head of the Re-Define think tank.

Italian Finance Minister Giulio Tremonti left Tuesday's meeting early for Rome, in order to muster opposition support for the quick approval of a 40-billion-euro (55-billion-dollar) austerity package.

Luxembourg Finance Minister Luc Frieden insisted that, as long as EU nations 'stand together, no country will be at risk.'

Tuesday's talks also focused on how the EU will react to the release Friday of a new round of banking stress tests, meant to assess 91 European lenders' resistance to financial crises.

Diplomats in Brussels expect several institutions to fail the tests, set to be tougher than those last year which did not spot problems in Ireland's banks.

'It is quite clear that the new bank stress tests will be more rigorous than those done last year. What is not quite clear yet is whether this will be enough to restore faith in the EU banking system,' Kapoor observed.

This time, the EU wants to simultaneously publicize the 'backstop measures' it plans to implement for failing banks, in a bid to avoid further financial market volatility.

In a joint statement, finance ministers said that 'necessary remedial actions following results of the test will be taken.' This included 'the provision of government support in case of need.'