The ESM Treaty Reform

In December 2018, the European Council launched a project for the ESM reform. The ESM (European Stability Mechanism) reform aims to increase its functions. The ESM will have an important role in pursuing a greater economic convergence among Member States to increase their competitiveness. Moreover, it will be involved in the framework of the European banking union.
The debate between the governments of EU countries on the reform lasted for years, mainly because of Italy’s veto from December 2019. Finally, an agreement was found and the Italian parliament gave the green light to the reform on 9 December 2020.

A lot of misleading news has circulated about the ESM reform. Some said that it would allow German banks to recapitalise with money from other European countries, or that it would force Italy and other countries to restructure their debt.  None of these statements is true. Moreover, this reform does not change anything about the ESM pandemic crisis support for health care spending during the pandemic.

ESM memes
ESM memes

Actually, the ESM reform concerns:[1]

  • A new role for the ESM as lender of last resort (Backstop mechanism) to the European banking Single Resolution Fund (SRF) in case of a banking crisis. The SRF is still under construction, it should be completed within 2024 and should have an endowment of about 55 billion: 1% of credit institutions’ protected deposits in the banking union. The fund will be directly financed by the banking sector and will intervene in the resolution of failing banks, if there are still creditors left to pay, after all other options have been exhausted (bail-in). (See the article Banking Union: A Step For More Stability for more information)

In the future, if the Single Resolution Fund is called to intervene in a banking crisis and its capital endowment is not sufficient to cover the needs, the SRF will be able to borrow money from the ESM.

The ESM will have up to 68 billion euro available to finance the SRF and these loans to the SRF will have to be repaid at most within 5 years.

The interventions of EU institutions through the SRF and, when necessary, the ESM in a banking crisis seek to avoid that the failure of a bank endangers the entire European banking system. They represent a European risk management tool, created with the objective of protecting all the EU countries from financial crises. They do not favour one state at the expense of another.

  • Changes to the monitoring roles of the EU institutions in case of ESM intervention in support of a state. The European Commission will be mainly responsible for monitoring the consistency of the economic policy measures implemented by the State and for assessing the sustainability of the debt and the macroeconomic framework in general.

The ESM, on the other hand, will monitor the capacity of member countries to finance themselves on the market and potential risks. It will also assess, during the intervention period, the risk that the assisted country will not be able to repay the loans received.[2]

  • Simplification of the requirements to access the Precautionary Credit Lines (PCCL). A State applying for support from the ESM through the Precautionary Credit Lines and fulfilling all the requirements will no longer need to sign a Memorandum of Understanding with the EU Commission and the European Council. It will suffice a letter of intent from the state, expressing its commitment to maintain the economic conditions that allowed it to access the credit line without enhanced conditionality during the ESM intervention period and in the future.
  • Changes to the Collective Action Clauses (CACs). CACs are clauses that allow a decision on a debt restructuring to be approved by a qualified majority of creditors. The debt restructuring is a modification of the initial conditions of a loan (interest rate, maturity, principal, etc.) that softens the debtor’s condition, increasing the probability that the loan is at least partially reimbursed. The reform establishes single limb CACs, clauses with single majority approval. So, it will be possible to approve a decision on debt restructuring with a single resolution of debt holders for all series of a given security, without the need to vote for each individual series issued.

However, this does not mean that the ESM reform imposes debt restructuring on member states as a condition for financial assistance. Debt restructuring is a rare and extreme event, usually carried out by countries close to bankruptcy. A decision to restructure even a portion of a country’s public debt would have dramatic effects on all public debt issues of the country. It would greatly increase the riskiness of the debt and, thus, the interest charged by investors (cost of debt), causing the market value of the securities to plummet.

The ECB holds a large share of Italian government debt, a large share is also held by banks, insurance companies and other financial institutions. Dramatically devaluing these government bonds would generate a crisis for the entire European Union, exactly the opposite of the objective for which the ESM was established. [3]

This amendment was introduced to improve the decision-making process in the case of restructuring by reducing uncertainty about the modalities and timing, not to make it more likely. In case restructuring becomes unavoidable, the absence of a clear and defined procedure may further increase the costs for all parties involved.

Michele Corio


[2] especially section “What will be the ESM’s new tasks in future financial assistance programmes?”


The ESM Programmes

Nowadays, the European Stability Mechanism (ESM) can lend up to 410 billion[1] to the Eurozone countries in financial difficulty via different case-specific ESM programmes. These resources are borrowed, issuing debt on the market, using as a guarantee of the ESM solidity its own capital (704 billion). The ESM can support the countries in different manners:

  • ESM programmes with loans in support of macroeconomic adjustment:

The Euro Area countries that need support to finance their public spending , because they are in financial distress or they can’t finance themselves directly on the market, can request financial assistance to the ESM. As a condition for the intervention, the ESM requires the state to implement certain reforms, established considering its specific situation. For example, these may concern reducing the public spending, strengthening the banking sector, adopting measures that improve the competitiveness of the country, increase its economic solidity and allow the state to return to economic growth in the following years. The reforms are established jointly with the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF), if the latter is also involved in the support programme. All the measures are reported in the so-called Memorandum of Understanding (MoU). The main objective is to restore the financial situation of the state to allow it to repay the previous debts and to be able to finance autonomously on the markets again.

The contribution of external and supranational institutions to the economic planning of the country in difficulty is often perceived negatively  by the public opinion. It is seen as a commissioner or, even worse, as an expropriation by foreign countries. Moreover, these reforms have been frequently criticized, because austerity and reduction of public spending in phases of economic contraction could exacerbate the recession, instead of solving it. However, past interventions of ESM programmes had always a positive impact on the country that has requested assistance. Even though they required numerous sacrifices, the reforms established with the European institutions contributed to a reduction of the inefficiencies in the public spending, relaunching the competitiveness of the national economy and its growth and impacted positively also on the labour market.

graph of GDP per capita trend

Figure 1: GDP per capita time series of countries whose  economies have suffered more during the sovereign debt crisis. Spain, Cyprus and Portugal requested the ESM assistance and realized a programme of reforms agreed with the European institutions. After some years of recession, their economy has returned to sustained growth. Italy did not join ESM programmes, but its recovery from the recession was slow and weak. Greece suffered a dramatic economic crisis. The country joined several support programmes of the IMF and the EU. Greek GDP diminished by around 30 percent between 2008 and 2016. However, recently, positive signs have emerged. The economy has started to recover and the country has been able to finance autonomously on the market again after a long time.[2]

unemployment rate trend europe

Figure 2: Unemployment rate of Greece, Spain, Italy, Cyprus and  Portugal from 2010 and 2019.[3]

Participating in the reform planning, the ESM and the other European institutions assure the other Euro Area countries that the resources lent are actually used to solve the vulnerabilities. Furthermore, the presence of conditionalities guarantees also to the ESM creditors that the institution employs the capital safely and will not have problems, in the future, to pay back its debts. Thanks to this mechanism, the ESM can finance itself at very low rates and lend to the countries in difficulty for lower rates than any other investor would offer them in the markets.     


savings ESM

Figure 3: Savings generated accessing the ESM programmes instead of financing directly on the markets. Source:

In addition, the repayment period for the capital of the loans starts only after many years. For example, Cyprus will start to pay back the capital of the ESM loans received in 2012 only in 2025. So far the country paid only a yearly amount of interest.[4]

The ESM can intervene providing loans to the States in crisis to finance their reforms and improve their economic situation, providing resources to recapitalize banks and other financial institutions or, even, purchasing government debt securities on the markets. Generally, the ESM loans have a higher seniority than the normal issuances of public debt. This means that the borrowing state will be responsible for repaying the ESM first and then the other creditors. This can contribute to increasing the cost for the state in difficulty to finance itself in the market. Indeed, the other investors will be more exposed to the risk of not receiving back the money lent, especially if the ESM loans are very large. However, countries that require substantial resources from ESM programmes have probably already lost the possibility to finance themselves on the market, because they are no longer able to find investors willing to purchase such risky debt or because the state is unable to pay the price these investors require to bear that risk. The negative impact of seniority may be softened by the fact that ESM loans have very long maturities.

For countries that can still finance themselves on the market, it is important to remember that the European Central Bank (ECB) can purchase debt securities of a Eurozone country, but only up to a maximum amount.[5] ECB purchases contribute to reduce the cost of debt for the recipient country. Moreover, in situation of extreme financial instability, a state that has requested assistance from the ESM through a macroeconomic adjustment program or a precautionary credit line with reinforced conditionality (see below), and has already signed the Memorandum of Understanding, can benefit from the Outright monetary transactions of the ECB (better known as OMT). [6]OMT allows the ECB to buy short term government bonds (1-3 years) of the state in the secondary market to prevent an excessive rise in yield rates, due to market tensions. By intervening with the OMT, the ECB has no constraints on the amount of securities that can be purchased. The ECB will also waive its right to a higher seniority than other creditors in order to avoid the negative consequences explained above.

Financing part of the needs with ESM programmes can really help a State in difficulty, because it can issue a smaller quantity of debt on the market, benefiting from the low rates and long maturities of the ESM and also from the effect on the cost of debt given by the intervention of the ECB, for the portion issued on the markets.[7]

Polandball comic on the news that the German Constitutional Court will rule on whether the European Stability Mechanism breaches the German constitution (2012)
  • Precautionary credit lines:[8]

Among other ESM programmes, there is the precautionary financial assistance.

A Eurozone state which has an overall sound economic situation, but finds itself temporarily in financial difficulty, or feels it must intervene preventively in order to be able to continue to finance itself on the markets, can apply for access to the precautionary credit lines of the ESM. Precautionary credit lines are shorter duration programmes which last at most two years. Their objective is to protect the States during a period of higher market tension, allowing them to finance their spending for low rates, without the need for deeper interventions. If the State that requested the ESM financing has a sustainable public debt – that is a deficit-GDP ratio below 3% in the last two years and a debt-GDP ratio below 60% (or it is already following a plan agreed with the EU institutions to restore its public finances)[9]– and its banking system does not have problems of solidity that could affect the Euro Area banking system stability then the country is entitled to access the Precautionary Conditional Credit Line (PCCL). The ESM will provide financial support and the state will undertake to plan the necessary measures together with the European institutions, signing a Memorandum of Understanding, to overcome the phase of difficulty.

On the other hand, if the global macroeconomic framework of the state is substantially good, but there are significant imbalances in at least one of the aspects being assessed (public debt, stability of the banking and credit system, etc.), then the country can only access the precautionary credit line with enhanced conditionalities (ECCL). In this scenario, the European Council, the Commission and the ECB, together with the country, establish a detailed corrective plan to overcome the critical points. In addition, the EU institutions initiate periodic surveillance to monitor the risks related to the country’s public debt and financial sector, considering also the possible impacts on other eurozone countries.

The ESM has often been criticised. Many people consider it as a symbol of poor European solidarity. Mainly because its aid programmes to countries in difficulty are loans subject to numerous conditionalities and not subsidies. Unfortunately, conditionalities are difficult to avoid in the absence of greater European integration and major steps forward in the unitary project. The intervention of EU institutions for national economic planning and reforms is seen as a loss of sovereignty, but in the past it has had a positive impact on the economies of the assisted countries. It should not be forgotten that the situations in which the ESM was activated were often particularly critical and could not be overcome by ordinary interventions. In order to have a stronger and more lasting union, it is essential to avoid mechanisms that incentivise some countries to get into debt and use resources that they could not afford in fruitless expenditure, only because they are convinced that, in the end, other European countries will settle the bill for them. Solidarity between EU member States is essential, especially in times of difficulty, but it must be remembered that other States also finance themselves on the markets or through taxes. It is not easy to determine to what extent it is fair to ask a citizen of another country to go into debt or pay more taxes to support another indebted country.

On 15 May 2020, after intense negotiations in the various European institutions, the ESM board of governors established a special temporary credit line to support the healthcare spending of Euro Area States during the covid-19 crisis.

  • ESM Pandemic crisis support:[10]

The pandemic crisis support is a credit line available for all the countries participating in the ESM. Each state can borrow up to 2% of its 2019 GDP for a cost lower than the ordinary precautionary credit lines.

resources for pandemic crisis ESM

Figure 4: Amount of resources that each country could borrow activating the ESM Pandemic crisis support.

These resources will be available until 2022, with the unique conditionality that the credit line must be used to finance the spending related to the sanitary crisis. The ESM disburses the health financing within 12 months of the request and the loan will have a maximum duration of 10 years. Moreover, this assistance is not only available in the form of a loan, the resources of the pandemic credit line can also simply be used as collateral to raise finance on the market at lower costs[11]. Once the ESM intervention has been requested, the state and the European Commission will have to draw up a pandemic response plan, setting out the measures and expenditure that will be financed with the allocated resources. The commission will also monitor the state’s intervention and its economic situation during the life of the loan. Due to the specific conditions of access, the pandemic credit line will only be beneficial for an applicant state if it has a strategic plan to address the weaknesses of its health system or to better address the health emergency. [12] This is especially true since the use and management of the funds is supervised by the European Commission. Convenience will also depend, as usual, on the cost for the state to finance itself on the market. If the market offers similar or lower rates, there will be little point in asking the help of ESM programmes to get resources.

ESM lending rate comparison

Figure 5: 10 years Euro Area government bond yields compared with the ESM lending rate.

Michele Corio

[1] The overall amount that the ESM can lend is equal to 500 billion considering also the resources already deployed. These resources are borrowed by the ESM on the markets to finance its programmes. As explained in the article “ESM for dummies” (link), the 410 billion (or 500) are not part of the capital contributed by the States (700 billion).




[5]  ECB can purchase government bonds of the Eurozone countries in proportion to each national central bank’s share of the ECB’s capital (Capital key). However, the Pandemic Emergency Purchase Programme (PEPP) allows the ECB to have more flexibility in the purchases concerning the capital key.

[6] The OMT is an extraordinary instrument that gives the ECB the right to intervene to preserve the financial and economic stability of a country – and the whole Euro Area –  purchasing its debt securities on the secondary market without any limitation on the amount. This tool was introduced after the famous speech of Mario Draghi (“whatever it takes”) in London in July 2012. Luckily, so far it has never been necessary to use the OMT.



[9] These rules have been suspended during the pandemic and they might be modified after the sanitary crisis.




what is the ESM?

The European Stability Mechanism (ESM) is a financial institution founded by the Euro area countries in 2012, during the sovereign debts crisis. Its objective is to support the member States, ensuring them financial assistance in hardships, when they can’t finance themselves on the markets or the cost of issuing debt is unsustainable[1]. Nowadays, 19 countries contribute to the ESM.

To provide assistance to the Eurozone States in case of need, the ESM does not draw financial resources from the taxpayers. It raises funds directly from the markets, issuing debt securities. Its creditworthiness is proven by its own capital endowment, which is jointly guaranteed by the 19 States. Establishing the ESM, the member States have decided to commit a capital of 704 billion for it, a share of approximately 80 billion euro was paid directly and the remaining of 624 billion was subscribed by each State and it is callable by the ESM, if needed[2]. Normally, the callable part of the capital serves only as an additional guarantee for the lenders and testifies both the solidity of the ESM and the commitment of the countries. The actual contribution of these resources could be requested only in extremely serious situations. At this point, it is crucial to have clear in mind that the ESM finances the countries with resources borrowed from the markets and not using the capital contributed by the States.

graph contribution mes per country

Every country contributes to a share of the capital, determined considering its population and its GDP. Figure 1 shows the percentage of the capital provided by each country. The fact that its capital is financed and guaranteed by all the Eurozone countries makes it extremely safe to lend money to the ESM. For this reason, it currently issues securities with a triple A rating, the highest in the rating scale (for more information see the article What Is The Role Of Credit Rating Agencies In The Economy?).

 Moreover, its financial strength allows the ESM to borrow at a lower price than any State in financial difficulties. [3]The cost of debt does not depend only on the borrower’s creditworthiness, but it is linked also to the duration of the loan. A three-year fixed-rate loan costs less than a 10-year loan with the same counterparties and conditions. Indeed, in a longer period of time, one or more fundamental variables of the financing, such as the market conditions or the stability of the debtor, are more likely to change and this could negatively affect the lender. Therefore, the lender requires a higher remuneration to bear the additional amount of risk given by the higher uncertainty.

To minimize the cost of funding, the ESM finances with short term loans, exploiting its large liquidity. This facilitates cheap lending to the Euro area countries in hardship. In addition, to make sure that the supported State has the time to recover, the loans distributed by the ESM have longer maturities than any other financing that the State could obtain directly on the markets[4].

The decisions on conceding financial support and on eventual additional contribution to the capital are taken by the Council of Governor of the ESM. The Council is a decision-making body composed of the ministers of finance of every member state. The individual ministers do not have the same voting power. The weight of every vote depends on the share of the capital owned by each state. This system allows the States that bear more risk to have a bigger impact on decisions too.[5]


The European Union is incomplete. Its member States have a large exchange of resources, goods and capitals, and they share a part of their economic and financial risks too. Some of them have a deeper cooperation and use the same currency, however it does not exist any sort of fiscal union yet. Decisions on the taxation systems, economic policies of any individual country  and other economic interventions are taken at national level. Even if there is coordination at European level on these issues and a set of common rules, there is nothing like a European Ministry of Finance. This absence is even more significant in times of crisis, when rapid and joint reactions can avoid major problems. Thus, the ESM was created as a defensive instrument to increase the power of intervention of the EU. However, this instrument is still far from being perfect. Long and hard negotiations have been necessary before reaching an agreement on its foundation. The main concern was preventing some countries from increasing their debt more than they could actually sustain only with their own public finances, just because they felt safe relying on the financial commitment of the other European partners. To avoid this misbehaviour, the ESM adopted precautionary and strict rules of intervention. The rules of intervention and the conditionalities attached to ESM programmes varies according to the type of support needed by the State in every specific case. We will deepen the analysis on the conditionalities directly analyzing the programmes of intervention of the ESM in a specific article (The ESM Programmes).

Therefore, the ESM has been created for sure to support the Euro Area countries during a financial crisis, but its role is also to defend the other Member States that are not directly affected  from a possible contagion effect.
Hopefully the severe rules and conditionalities will be reduced in the future, increasing the solidarity among the States. However, this will be possible only proceeding on the path of European integration, because the unique way to reduce conditionalities is increasing the trust among Eurozone countries and to achieve it a major coordination is needed.




[4] Maturity transformation.

[5] (Chapter 2 article 4)


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