Reforming the European Stability Mechanism

Abstract:

The European stability mechanism (ESM) is a permanent crisis resolution mechanism for euro area countries. We analysed the costs of the current ESM refinancing design and evaluated an alternative asset‐backed securities (ABS) structure under different scenarios.

Our simulation results indicate that switching to an ABS structure could substantially lower the ESM refinancing rate by up to 3.5 per cent. Moreover, the current structure severely limits the ESM's potential to stabilize financial markets. As an unintended consequence, the ESM is likely to act as a crisis accelerant rather than a stabilizer in the most likely case of requests for medium‐sized financial support from distressed ESM members at a time when other ESM countries might be unwilling or unable to provide new capital.