Debts & Loans

The European Central Bank on Friday laid out the advice it gave politicians on pricing troubled bank assets and supporting crippled money markets as the credit crisis deepened in October and November.

In statements dated after a financial crisis summit in Paris on Oct. 12 and from late November, the ECB laid out a list of guidelines and urged officials not to guarantee interbank deposits on money markets which it is still trying to coax back towards greater independence after months of liquidity injections.

"With regard to the scope of the bank debt guarantee scheme, government guarantees on interbank deposits should not be provided," it said.

However, it did open the door for guarantees on the most frozen types of lending. "Government guarantees on short-term bank debt with maturity of 3 to 12 months could be provided, so as to help revitalise the short-term bank debt market," it said.

"That is fair enough. If there is one thing that would get interbank markets going again it would be guaranteeing interbank lending," said Investec economist Philip Shaw.

European governments sealed a 200 billion euro ($279.2 billion) pact to revive the bloc's battered economy last week and individual countries have also promised billions to bail out banks by buying up shares and troubled assets.

When bailing out the banks, the ECB said euro zone governments should get "an average rate of return" of 9.3 percent on the shares they buy and a rate of return of 6 percent on subordinated debt.

It also urged them to assess bailouts on a case-buy-case basis and also said governments needed to take a consistent approach to avoid giving any banks unfair advantages.

It said recapitalisations should be done on a case-by-case basis and only if the measures were likely to be effective. They said such deals should not put off would-be investors nor put taxpayer money in jeopardy.

EMERGENCY EXIT

The central bank added that governments needed to have a clear exit plan for removing their support and that deals should encourage banks to pay the money back as soon as possible.

"Terms should be set on the redemption or conversion of the instruments ... so as to retain the temporary nature of the state's involvement and discourage financial institutions from maintaining such involvement for an extensive period of time," it said.

On the provision of credit guarantees the ECB set out similar guidelines to the UK, calling for guarantees of bank debt of more than 1-year to be linked to banks' credit default swaps spreads and include a 50 basis point add-on fee.



"What the ECB is saying that member states should not take a carte blanche approach and guarantee bank debt and there should be a significant commercial element towards the price of the guarantee," said Shaw.

"The main message is that credit guarantees are a good thing but they must make commercial sense."