Ryan McGrath, Analyst at Dolmen Securities produced an upbeat note following the European Summit on 29th June.  While the summit communiqué lacks detail, it is the change in German sentiment towards direct bank recapitalisations that has impressed markets.

The summit agreed that once the single European banking regulator is set up, the European Stability Mechanism (following ratification), can be used to recapitalise individual banks subject to conditionality without recourse to the individual State’s balance sheet. This is a large step towards solving the European debt crisis, because it breaks the “vicious circle between banks and sovereigns”.

Once Spain has negotiated its bank bailout deal, it will be unilaterally applied to all other Eurozone members who fulfil the criteria. While Europe establishes a bank regulator, Spain will simultaneously have to perform bank stress tests to the transparency and standard of Ireland’s 2011 stress tests, to firstly establish a credible level of impairments and only then can capital injection levels be decided.

Ireland will then benefit from banking steps already taken in 2011, along with its Troika programme compliance, to avail of a retrofitted bank deal which the Government will push to be in place by March 31st 2013.   Ireland’s bank bailout amounted to € 64 billion.  €43.4 billion is classified as part of the State’s debt and potentially can be reclassified.

The €43.4 billion is split between the former Anglo Irish promissory notes [€30.7 billion] and Government borrowings [€12.7 billion]. The balance of €20.7 billion represents an investment by the National Pension Reserve Fund.  Ideally, the Government would like to get all €43.4 billion in banking aid off the State’s balance sheet. This would decrease Ireland’s debt / GDP ratio to below 85% from the current 108% level.

While challenges still remain, such as ratification of the ESM and significant implementation risk, this is a significant game changer for Ireland, which has suffered more than any other country due to the link between bank debt and sovereign debt and therefore, potentially has most to gain from any new bank bailout deal.