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Banking union to boost EU sovereign creditworthiness

31 May, 2014

The creditworthiness of European Union (EU) sovereigns may, over the longer term, benefit from the Bank Recovery and Resolution Directive (BRRD)/Single Resolution Mechanism (SRM) package, and, more broadly, the steps taken by the EU towards a banking union, according to Moody Investors Service.
The measures aim to reduce the risk that bank-related contingent liabilities will crystallise on EU government balance sheets in a future banking-sector stress scenario, the rating agency said in a new report. However, in the short term, the new framework will have no direct impact on EU sovereign ratings.
Moody's said that the BRRD creates a clear toolkit for sharing resolution costs with bank creditors and constrains the ability of national governments to provide support to their domestic banks in a crisis.
Moreover, the creation of a Single Resolution Fund (SRF) -- in addition to the availability of the European Stability Mechanism (ESM) as a last backstop -- will, over time, further reduce the risk of a crystallisation of liabilities on government balance sheets.
However, while the reforms represent positive steps, Moody's does not expect rating implications for any EU sovereign in the short term. This is because most of the official-sector bank restructuring and recapitalisation measures in the EU countries have already been completed, and, in that context, bank-related liabilities have to a large extent already crystallised as explicit liabilities on governments' balance sheets.
Over the longer term, Moody's said that it remains to be seen how effective the new framework will be. The BRRD contains several "escape clauses" linked to concerns over financial stability and contagion. At the current juncture, it is difficult to predict how national governments may use this flexibility when faced with a future banking crisis. Moody's considers that these clauses may enable national authorities to continue to support troubled banks without burden-sharing; even once the resolution process has been triggered.