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ECB mulls cash injections to smooth bank rescues

Proposal would allow the central bank to fund the viable parts of a lender spun out of failing financial institution

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The new policy tool being considered by the ECB will tackle a gap in rules for dealing with troubled lenders.

Brussels

THE European Central Bank is considering a new policy tool that would allow it to inject cash into banks that are being rescued from the threat of insolvency, tackling a gap in rules for dealing with troubled lenders.

The proposal would allow the ECB to fund the viable parts of a lender - the so-called good bank - spun out of a failing financial institution, according to a confidential document obtained by Bloomberg News and based on a March 21 presentation to the ECB's governing council.

The suggested framework for Eurosystem Resolution Liquidity (ERL) lays out conditions including a far-reaching public guarantee to safeguard against central bank losses.

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The measure is potentially controversial because the ECB is banned by law from financing actions that should be undertaken by public authorities, such as bank resolution. Executive board member Yves Mersch warned in January that "resolution planning should not assume that central bank liquidity will fill the gaps". The proposal suggests that ERL should be seen as a monetary-policy tool, ensuring the banking system can transmit official interest rates to the real economy. An ECB spokesman declined to comment on the document.

A new liquidity source has been debated since the Single Resolution Board, the euro area's bank-failure agency, handled its first big case last June by forcing the sale of Spain's Banco Popular Espanol SA to Banco Santander SA. SRB head Elke Koenig has said Santander provided more liquidity than her institution could have done, highlighting the need to find a solution for when the good bank can't immediately find a buyer and has limited or no access to normal sources of liquidity.

"There are a number of scenarios in the context of a resolution in which currently no (additional) liquidity can be provided by Eurosystem central banks," according to the document. "A permanent framework to provide liquidity in resolution would send a strong signal related to banking union and improve overall confidence in the functioning of the euro-area resolution framework." BLOOMBERG