What is European Financial Stablisation Mechanism (EFSM)

The European Financial Stablisation Mechanism is a permanent fund created by the European Union (EU) to provide emergency assistance to member states within the union. The European Financial Stablisation Mechanism (EFSM) raises money through the financial markets, and is guaranteed by the European Commission. Funds raised through the markets use the budget of the European Union as collateral.

BREAKING DOWN European Financial Stablisation Mechanism (EFSM)

The European Financial Stablisation Mechanism is rated AAA by Fitch, Moody's and Standard & Poor's and is based in Luxembourg. European countries have several options outside of the open market to seek financial help. Other than the European Financial Stablisation Mechanism starting in 2013, The EFSM has been supported in the past by other organizations such as the European Financial Stability Facility (EFSF) and the International Monetary Fund (IMF).

Member states of the European Union may support the various funding mechanisms because, while they may potentially give rise to domestic political fallout, they may prevent a domino effect in which other stronger countries are dragged down as well.

Today, euro area countries in need of financial assistance turn to the European Stability Mechanism (ESM), a permanent intergovernmental institution. The ESM is set up by and for euro area countries. EU countries outside the euro area can turn to the EU directly for assistance. The EFSM, however, remains in place for specific tasks, such as the lengthening of maturities for loans to Ireland and Portugal and providing bridge loans.

The EFSM can lend directly to governments. It can also buy their debts (bonds) either directly when they are first issued or in the financial markets. In addition, the EFSM can support banks directly. This type of support usually amounts to "recapitalisation," by providing funds in return for a shareholding. 

The financial footing of the EFSM is capital provided by the Eurozone governments, which have committed in principle to a total of €700 billion, although they have actually paid in just €80 billion. The additional capital can be called in if it is ever required. 

The capital is NOT the money used for providing assistance. It absorbs any losses if countries receiving help fail to repay it. It provides a reassurance to investors in the financial markets that they can lend to the ESM (by buying its bonds) and be confident of being repaid. That confidence is vital for keeping the ESM's credit rating high and its borrowing costs low.

European Financial Stablisation Mechanism and the United Kingdom

As it is not a member of the Eurozone, the United Kingdom does not contribute directly to the European Financial Stablisation Mechanism. However, it does indirectly contribute to Eurozone bailouts, where the IMF has a role. It also made a bilateral contribution in the case of the Republic of Ireland. It also contributed to the bailout of Portugal.