MILAN Banks that are still viable but need state aid to boost their capital base should be allowed to receive help without inflicting losses on their junior bondholders, European Central Bank President Mario Draghi told the European Commission.
In a July 30 letter addressed to EU Competition Commissioner Joaquin Almunia, Draghi said imposing losses on junior creditors in the context of such "precautionary recapitalizations" could hurt subordinated bank bonds.
"By structurally impairing the subordinated debt market, it could lead to a flight of investors out of the European banking market, which would further hamper banks' funding going forward," Draghi said in the letter seen by Reuters.
New EU rules on state aid to struggling banks came into force in August 1 after a major overhaul agreed the previous month with the aim of shifting the burden of restructuring a lender from taxpayers onto shareholders and holders of junior debt.
However, "the revised guidelines also foresee exceptions, which would be applicable for financial stability reasons and on a case-by-case basis", a Commission spokesman said in an emailed note on Saturday.
The spokesman said the Commission had worked closely with the ECB after receiving Draghi's letter and following the entry into force of the new rules "to identify in advance any potential challenges and solutions in implementing the burden sharing rules".
The new EU rules address public outrage at the use of state funds to prop up ailing banks during the financial crisis.
Draghi said in the letter mandatory burden-sharing with shareholders and junior bondholders was warranted when a bank was on the brink of collapse or its capital had fallen below the minimum regulatory threshold.
There could be cases, however, when a bank had a viable business model and its capital was above the minimum threshold, but its supervisor still required it to raise additional funds.
In such cases, if the bank could not raise the capital needed in the market quickly enough, the ECB said state aid should be possible without junior bondholder getting hit first.
The letter also said incentives should be in place to ensure that banks did their best to raise private capitals before resorting to state aid.
The ECB is due to take on oversight of euro zone's lenders from national regulators late next year as part of the bloc's plan to adopt a unified system of bank supervision and support, known as banking union.
The ECB will assess lenders' balance-sheets and run stress tests on them before that.
The ECB said on Saturday that the letter Draghi sent to Almunia on July 30 concerned the application of state aid rules to banks that were deemed viable under the balance-sheet assessment but had capital boosting needs when stress-tested.
Italian newspaper la Repubblica reported on Saturday that Draghi wrote to the EU Commission last month asking that junior creditors be spared any losses in a bank rescue at least until the banking union is fully operational.
(Additional reporting by Robert-Jan Bartunek in Brussels and Eva Taylor in Frankfurt; Editing by Alison Williams)