Eurozone countries facing Irish-style bank collapses will still have to shoulder a large portion of future bailouts if they want to receive any aid from the eurozone’s €500bn rescue fund, according to a proposal seen by the Financial Times.

The plan, circulated late last year among eurozone finance ministry officials, would force struggling countries to either invest in failing banks alongside the rescue fund, the European Stability Mechanism, or guarantee the ESM against any losses.

By forcing burden-sharing on struggling countries, the plan raises questions about EU leaders’ vow to “break the vicious circle” between failed banks and their host governments.

In Ireland, Cyprus and Spain, billions of euros in national funds needed for bank bailouts exploded sovereign debt levels, forcing Dublin and Nicosia into full-blown government bailouts and pushing Madrid to the precipice of a similar rescue.

Many in Ireland and Spain had hoped that proposals for so-called direct recapitalisations in failing banks by the ESM, agreed in June, would be a game changer that would shift the cost of bank bailouts from their sovereign books on to the ESM, which is funded by all 17 members of the single currency.

A full shift would end one of the most poisonous dynamics of the eurozone crisis and protect sovereign governments from being brought low by bank rescues that, in the case of Ireland, amounted to 40 per cent of GDP.

Instead, the two-page proposal drafted by the European Commission would force countries that could afford it to inject their own national funds into failing banks to make them viable before the ESM would shell out any of its own cash.

In the case of a country that would face insolvency after a bank bailout, the national government would still have to “indemnify the ESM for any loss”, or guarantee the ESM would get all its money back.

“Member states’ complacency has been evident in the politics of ESM direct bank recapitalisations for some time,” said Mujtaba Rahman, a Europe analyst at the Eurasia Group risk consultancy. “We are far from the clean break between banks and sovereigns leaders signed up to in June.”

Senior eurozone officials declined to comment on the draft, other than to say EU leaders had given them until June to come up with a final decision and that the draft was likely to be changed in the interim.

“Discussions are ongoing, and we have a mandate from the European Council to finalise discussions for June,” said one senior official involved in the discussions.

The issue is acute for Ireland, whose €67.5bn bailout funding runs out in November. Irish officials have become increasingly vociferous that they would struggle to convince the bond market to fully fund the government this year without some relief on the €64bn it has spent to rescue Irish banks.

A spokesperson for the Irish government said Dublin would not comment on leaked documents.

Under the plan seen by the FT, Ireland could potentially get some relief from the ESM, although it is likely to be only a small portion of the €28bn it used to bail out its two surviving big banks.

Eurozone leaders have already ruled out using the ESM to help Dublin with banks that were wound down, including Anglo Irish Bank. Separate negotiations on Anglo Irish’s debt are ongoing with the European Central Bank.

Peter Spiegel in Brussels, FT online here

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