BRUSSELS (Reuters) - The euro zone's ESM bailout fund is likely to set a cap on the amount of money it can use for direct bank recapitalization at between 50 and 70 billion euros, a euro zone document showed on Wednesday.
Euro zone leaders decided in June 2012 that the European Stability Mechanism (ESM), which has a lending capacity of 500 billion euros, should be able to directly recapitalize banks if a government is unable to raise sufficient funds on its own because market borrowing could endanger the sustainability of its public debt.
The instrument was meant to break the vicious circle of highly indebted sovereigns borrowing even more to recapitalize banks that need more money because their sovereign bond holdings have lost value due to the excessive government borrowing.
The exact rules on how such recapitalizations could take place, under what conditions and which banks might be eligible are to be decided by euro zone finance ministers later this month, at a meeting in Luxembourg following six months of discussions. They appear close to agreement on some issues.
"With a view to preserve the ESM's high creditworthiness and its lending capacity for other instruments, the Board of Governors (of the ESM) resolves ... to limit the amount of financial assistance available for the ESM instrument for the direct recapitalization of institutions to EUR," the document obtained by Reuters said. The square brackets mean the numbers might be changed.
Euro zone policy-makers want to set a limit on the amount of money the ESM may use for direct bank recapitalization because this form of help eats into the ESM's resources more quickly and requires higher risk provisions than normal lending to governments.
A second document said direct recapitalization could not be decided under the ESM's emergency voting procedure, which requires only 85 percent of the votes, rather than the usual unanimity.
To directly recapitalize an institution, the ESM board of governors will set up a subsidiary, the document said, that would channel the aid and take care of all the current business related to it.
"The ESM shall, for the purpose of implementing financial assistance in the form of direct recapitalization of institutions and to facilitate private participation, establish a subsidiary as an entity of public international law ('Subsidiary'), fully owned by the ESM as the only shareholder," the document said.
The subsidiary may set up sub-entities "for the purpose of implementing financial assistance in the form of direct recapitalization of institutions", it said.
Euro zone finance minsters agreed in April that if the ESM were to directly take a stake in a financial institution to recapitalize it, the government of the country where the institution is based would have to shoulder 10 percent of the cost of the recapitalization so that it would be in the government's interest to keep the bank healthy.
Direct recapitalization will only be possible once the European Central Bank takes over the supervision of euro zone banks from mid-2014.
It is unclear whether banks that ran into trouble before that time could be considered eligible for ESM recapitalization.
Reporting by Jan Strupczewski; editing by Andrew Roche