Private sector involvement in bailout must be voluntary: ECB

13th October 2011, Comments 0 comments

The European Central Bank reiterated its opposition Thursday to a possible debt default by a eurozone member state and said banks should not be forced to foot part of the bill of any bailout.

"The ECB has strongly advised against all concepts that are not purely voluntary or that have elements of compulsion, and has called for the avoidance of any credit events and selective default or default," the central bank wrote in its regular monthly bulletin, published on Thursday.

The debate about private sector involvement in a bailout of Greece has increased in recent weeks with fresh calls for banks to shoulder a bigger proportion of the costs.

In a deal hammered out by European leaders in July, it was agreed that the private sector accept a 21-percent write-down on its holdings of Greek debt.

This was not viewed by the financial markets as a "credit event" because the banks were seen as agreeing to it voluntarily, albeit under heavy pressure.

Private sector involvement "can be expected to have direct negative effects on the banking sector across the euro area ... (and) could trigger a need for large-scale bank recapitalisation," the ECB warned.

Moreover, it could lead to "a sudden increase in risk aversion among financial market participants (and) the market access of other countries may be hampered ... even if the economic fundamentals of the other countries remain unchanged."

A vicious cycle could arise where bank recapitalisation increases the debt burden of states, who would see their sovereign debt ratings downgraded, which in turn would make the situation more difficult for banks, the ECB argued.

Finally, it "could also damage the reputation of the single currency internationally, possibly adding to volatility in foreign exchange markets."

© 2011 AFP

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