Wednesday, November 30, 2011

The EFSF: Unfinished business

by Bálint Horváth and Harry Huizinga


November 30, 2011

The European Financial Stability Facility was set up eighteen months ago as a response to the then Greek sovereign debt crisis. This column looks at the effect of the fund on the financial system in particular bank shareholders, the holders of bank bonds, and the holders of sovereign debts.

On 9 May 2010, Eurozone countries announced the creation of the European Financial Stability Facility (EFSF) to contain the Eurozone sovereign debt crisis. But is it working?

The EFSF was set up to make loans to Eurozone governments experiencing refinancing problems, with its own debt guaranteed by individual Eurozone countries. As originally conceived, these credit guarantees were limited to €440 billion but in July this year Eurozone politicians agreed to increase the guarantee ceiling to €780 billion, providing the EFSF with an effective lending capacity of €440 billion.

In October, Eurozone leaders decided to leverage up the remaining, uncommitted lending capacity of €250 billion to more than €1 trillion to be able to backstop the debt of a major Eurozone country such as Italy. However, leveraging the EFSF has proven difficult, as investors have shown limited interest to provide the necessary funding.


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