The European Investment Bank and national development banks provide a framework through which a European Recovery Fund could work quickly and effectively.
The European Union is at a pivotal moment. The debate over how solidarity should be organised to respond jointly to the coronavirus-induced economic crisis is in full swing—with the installation of the European unemployment scheme SURE, the use of the European Stability Mechanism, and a €25 billion credit guarantee to the European Investment Bank only the first steps. A European Recovery Fund, financed by EU budgetary means, is desperately needed.
To gain the greatest economic leverage from such a fund we suggest a path, based on existing institutions, which would allow for a quick and effective response. Our approach focuses on the European Investment Bank (there are related proposals by Brunnermeier and colleagues and by Counterbalance) and the network of national development banks (NDBs), with which the EIB has increasingly collaborated over the last ten years.
It involves a €500 billion convertible loan programme. This would be aimed by the EIB at the sectors most affected by Covid-19—services and in particular hospitality, among others—with the option of converting loans into equity, to be held by the European Recovery Fund.
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Among the primary challenges facing our economies are the financing and liquidity constraints of companies, compounded by rising corporate debt. This is one reason why EU member states—first and foremost Germany—have mobilised their development banks to provide loans to struggling companies, in particular small and medium enterprises. Other countries, such as Spain and Italy, have guaranteed much less credit as a percentage of gross domestic product, despite being hit hardest so far by the Covid-19 crisis, with the €200 billion credit guarantee of the EIB offering only partial compensation.
Beyond the immediate need for liquidity, however, many of these companies, such as hotels, although they may have a sound business model in normal times, will simply accumulate too much debt to survive the coronavirus-related reduction in their business activities. This suggests the need to transform liquidity assistance by development banks into equity, should the deterioration of business so necessitate.
Such conversion into equity needs to be backed by fresh public money, not financial alchemy. Billions of euro of EU budgetary means will be needed to absorb the credit risk and so convert the debt.
To provide struggling companies with this form of convertible debt, we propose a strategy that leverages NDBs’ balance sheets, expertise and existing relationships to engage in such actions with the European budget’s financial means. Concretely, we propose a four-step model.
Step 1: Just as after the great financial crisis in 2008, EU member states should double the subscribed capital to the EIB, from currently €243 billion to €500 billion. In return, the €50 billion accumulated by the bank in reserves should be transformed into shareholder equity. As the EIB is currently bound by a leverage rule of 1:3, this would expand its balance-sheet space from about €750 billion to €1.5 trillion. This would provide an expanded funding capacity both for the €500 billion programme and additional action for the EU climate plan endorsed before the crisis.
Step 2: Initiate a €500 billion convertible-loan programme financed by the EIB, based on a catalogue of criteria for company eligibility, including a reduced ecological footprint and conditions for conversion into equity. Allow NDBs to act as agents to extend these loans, selling them onward to the EIB. This mitigates the problem that the EIB has little physical presence in member states. Banks such as the CDP in Italy, ICO in Spain and Bpifrance in France, but also smaller banks with a developmental mandate, could quickly roll out such a programme, providing a first contact point for companies in need.
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Step 3: Install the European Recovery Fund within the European Investment Fund—the optimal institutional place, since the EIF is already 30 per cent owned by the European Commission. Allocate €100 billion of EU budgetary means to the ERF. Were this sum to be larger, as ideally it should be, this would allow more attention to be devoted to the ecological transformation.
Step 4: Where loans cannot be repaid to the EIB due to coronavirus-related hardships, transform these loans into equity in the company. The ownership of this equity would lie with the ERF, which would pay the EIB for it, absorbing part of the losses on the loans by the bank through the budgetary means allotted to it. The other portion would need to be absorbed by the owners of the relevant company through equity dilution, the final amount subject to negotiation. These steps could be accompanied by tax forgiveness for these companies by member states, thereby further sharing the costs and increasing the firepower of the programme.
Strategy of solidarity
Such a strategy could turn the EIB and EIF into a prime element of a European strategy of solidarity to face the crisis together, pooling member states’ risk and reducing individual member-state cost. On the one hand, it involves the issuance of joint EU debt, guaranteed by member states, to provide liquidity to firms. It also leverages EU budgetary means to transform these loans into equity, should the need arise, thereby avoiding the addition of more debt to an existing mountain.
By providing this large-scale financial backing in the least bureaucratic way possible, the EU could quickly organise support for its economies ravaged by Covid-19, particularly in the south. By combining the issuance of debt by the entity already issuing bonds backed by all EU members with union budgetary means, it could display the European solidarity necessary to cushion the devastating impact of this crisis.