I. TREATY FRAMEWORK

1. Primary Law:

Art 127 TFEU - Price Stability Mandate:
ECB primary objective is price stability. Lender of Last Resort is not mentioned. Secondary objective to support general economic policies without prejudice to price stability. Any LOLR action must be justified as necessary for monetary policy transmission.

Art 219 TFEU - Open Market and Credit Operations:
Art 18 ESCB Statute allows ECB and National Central Banks to conduct credit operations with credit institutions based on adequate collateral. This is legal basis for normal monetary policy - MRO, LTRO, TLTRO.

Art 123 TFEU - Prohibition of Monetary Financing - The Hard Limit:
Prohibits overdraft facilities or any other type of credit facility in favour of Union institutions, central governments, regional, local or other public authorities. Prohibits direct purchase of public debt instruments.

Consequence: ECB cannot be lender of last resort to Spanish State or to Spanish public entities. Cannot finance Treasury directly. Can buy Spanish bonds on secondary market only under conditions.

Art 125 TFEU - No Bail-out Clause:
EU and Member States shall not be liable for or assume commitments of another Member State. Limits ESM support.

Art 122(2) TFEU - Emergency Financial Assistance:
Exception allowing financial assistance if Member State in difficulties caused by exceptional occurrences beyond control - legal basis for EFSM, used for Spain bank recapitalisation 2012.

Art 14.4 ESCB Statute - ELA - Emergency Liquidity Assistance:
National Central Banks may perform functions on own responsibility and liability which are not ESCB functions, unless Governing Council finds they interfere with monetary policy by 2/3 majority. Legal basis for Banco de España ELA, with ECB veto power.

2. Secondary Law:
ECB Guideline ECB/2014/31 on ELA, ECB Decision on ELA procedures 2017, and Agreement on ELA 2020.

II. THREE CHANNELS OF LOLR IN SPAIN AND THEIR LIMITS

Channel 1: Normal Monetary Policy Operations - ECB itself is LOLR to Banks

Instrument: MRO, LTRO, TLTRO, PELTRO, marginal lending facility. Collateral framework.

Legal Limits:

• Counterparty must be credit institution established in Eurozone, financially sound per Art 55 Guideline ECB/2014/60. Cannot lend to insolvent banks.
• Adequate collateral per Art 18 ESCB Statute - Spanish government bonds accepted but with haircuts. If Spanish collateral downgraded below investment grade, ECB can suspend.
• Proportionate to monetary policy objective. Must not circumvent Art 123.
• Spanish banks access via Banco de España as operational arm.

Channel 2: Emergency Liquidity Assistance - Banco de España is LOLR, ECB controls

This was critical in Spain crisis 2012.

Legal structure:

• ELA granted by Banco de España to solvent Spanish credit institutions facing temporary liquidity problems, which cannot obtain adequate collateral for normal ECB operations.
• On its own balance sheet and risk. ECB does not share risk.
• Amount, collateral, interest rate decided by BdE, but needs ECB Governing Council non-objection every week if > €500m. Governing Council can prohibit by 2/3 majority if it interferes with monetary policy.
• Collateral can be lower quality than ECB collateral - e.g., Spanish banks used own credit claims, non-marketable assets during Bankia crisis.

Legal Limits for Spain:

• Solvency: Recipient must be solvent. Art 123 interpretation by ECB: ELA to insolvent bank = monetary financing of government if government guarantees it, because bank will fail and State pays. After Banco Popular resolution 2017, ECB tightened.
• Prohibition of Monetary Financing: BdE cannot fund State recapitalisation via ELA. If BdE gives ELA to Spanish bank and Spanish State guarantees it without adequate collateral, ECB can deem it violates Art 123.
• Maximum Maturity: ELA must be short-term, typically 90 days, renewable.
• Transparency: Since 2017 ECB publishes aggregate ELA.

Spanish use: In June 2012, Spanish banks ELA reached €400bn via BdE + ECB, highest in Eurozone. For Bankia, CAM, Banco de Valencia, BdE provided ELA against collateral that ECB refused.

Channel 3: ECB as Lender of Last Resort to Sovereign - Secondary Market Purchases - The Constitutional Conflict

This is where Treaty limits are most litigated.

ECB cannot buy Spanish bonds directly at auction - Art 123. But can buy on secondary market under Art 18 ESCB and Art 127 to restore monetary transmission.

Programs:

• SMP 2010-2012: Bought Spanish bonds. Legality challenged.
• OMT 2012 - Outright Monetary Transactions: Announcement by Draghi "Whatever it takes". Unlimited purchase of 1-3 year Spanish/Italian bonds if country under ESM programme. Never used but litigated.
• PSPP 2015-2018: QE, monthly purchase of Spanish Bonos per capital key.
• PEPP 2020-2022: Pandemic emergency purchases, flexible allocation allowed overweight Spain.

Legal Limits under Treaty Law - Developed by CJEU:

III. CASE LAW - THE DEFINITIVE LIMITS

1. Pringle v Government of Ireland - C-370/12 - 27 Nov 2012 - ESM Legality

Irish MP challenged ESM Treaty as violating Art 125 no bail-out.

CJEU Held: Art 125 does not prohibit financial assistance by Member States to another Member State if:
a) indispensable to safeguard financial stability of euro area as whole,
b) subject to strict conditionality.
Art 122(2) not sole basis. Established that ESM can lend to Spain for bank recapitalisation (Spain received €41.3bn ESM loan Dec 2012 for FROB). This allowed Spanish bank rescue without violating Art 125.

Ratio for Spain: Legalizes ESM as lender of last resort to Spanish sovereign for bank recapitalisation.

2. Gauweiler and Others v Deutscher Bundestag - C-62/14 - 16 June 2015 - OMT Case - Most Important

German Constitutional Court referred OMT.

Facts: German plaintiffs said OMT violates Art 123 (monetary financing of Spain/Italy) and exceeds ECB mandate under Art 127.

CJEU Grand Chamber Held OMT is Legal if limits respected:

• Purpose Test: OMT must aim at preserving monetary transmission, not financing States. ECB objective is to remove redenomination risk premium for Spanish bonds.
• Proportionality: Purchases must not go beyond necessary to achieve objective.
• Art 123 Safeguards to avoid Monetary Financing of Spain:
  • No purchase on primary market
  • No prior announcement of amount to purchase Spanish bonds
  • Minimum period between issuance of Spanish bond and purchase on secondary market
  • Spanish State must not have certainty that ECB will buy its bonds - no guarantee
  • Holding to maturity allowed but must be able to sell
  • Purchases only if Spain under ESM conditionality

This defined legal limits of ECB as sovereign LOLR. OMT complies because conditional.

Dissenting opinion of German Constitutional Court later in 2016 said Gauweiler gave ECB too wide discretion.

3. Weiss and Others - C-493/17 - 11 Dec 2018 - PSPP/QE Case

German Court again challenged PSPP where ECB bought > €2.2tn including Spanish Bonos.

CJEU Held PSPP legal:

• Does not violate Art 123 if safeguards:
  • Purchase not disproportionate: 33% issuer limit per ISIN (ECB could not hold >33% of Spanish bond issue, to avoid blocking CAC restructuring)
  • Purchases per capital key, not to finance specific State like Spain selectively
  • ECB must make risk assessment and provide reasoning
• Proportionality test: ECB must balance monetary policy benefits vs economic policy side effects (saving behavior, bank profitability). Court grants ECB broad discretion, only manifest error of assessment reviewable.

After Weiss, German BVerfG judgment of 5 May 2020 declared ECB PSPP ultra vires for first time, saying CJEU did not properly assess proportionality, ordered Bundesbank to stop buying Spanish/others unless ECB provides proportionality assessment. ECB then provided assessment, crisis resolved. Shows limit - national constitutional courts can challenge.

4. Case T-251/19 - Spanish ELA challenge - Banco Popular
Several shareholders challenged ECB decision to declare Banco Popular failing or likely to fail, leading to resolution and loss of ELA. General Court held ELA decision is Banco de España competence, not ECB reviewable, except ECB veto. Confirmed solvency limit - Popular was illiquid but solvent until ECB liquidity assessment changed.

5. Banco de España ELA and Art 123 - The Spanish Doctrine

Tribunal Supremo Contencioso-Administrativo, STS 21 Dec 2020 - Bankia / BFA:

Spanish Supreme Court held that BdE ELA to BFA/Bankia in May 2012, guaranteed by Spanish State via aval, did not constitute prohibited monetary financing under Art 123 because:
a) Guarantee was temporary, market-priced,
b) Recipient was solvent at moment of ELA per BdE certification,
c) ECB Governing Council did not object under Art 14.4.

Establishes Spanish test for monetary financing vs LOLR.

6. ECB Liability - Case C-62/13 - Peter Gauweiler preliminary:
Advocate General Cruz Villalón (Spanish) Opinion - proposed distinction crucial for Spain: If ECB purchases Spanish bonds to ensure transmission, it is monetary policy; if to finance Spanish deficit, it is economic policy and violates Art 123. Test is objective, not subjective intention.

IV. SUMMARY OF LEGAL LIMITS FOR SPAIN

ECB/Banco de España can act as Lender of Last Resort in Spain only if:

1. Recipient: Only solvent credit institutions, not State. Spanish Treasury cannot receive ECB loan.
2. Collateral: Adequate collateral. For normal operations - ECB eligible collateral. For ELA - adequate but lower quality, at BdE risk.
3. Temporary: Liquidity, not solvency support. Must be short-term. Solvency problems go to ESM/FROB.
4. No Monetary Financing: Cannot buy Spanish bonds on primary market. Secondary market only with safeguards: no certainty for Spain, limited holding (33% issuer limit), conditionality if unlimited (OMT requires ESM programme), market price, proportionality assessment published.
5. Non-objection: ELA > €500m needs weekly ECB non-objection. ECB can veto by 2/3.
6. Conditionality: Sovereign LOLR via OMT/PSPP must be linked to fiscal discipline. Spain had to sign MoU 2012 to get OMT eligibility.
7. Proportionality: ECB must show measure does not go beyond necessary for price stability and weighs side effects - Weiss doctrine.

In practice during Spanish crisis 2012:

• Spain could not get direct ECB funding for Treasury - Art 123 block.
• Spanish banks got ECB funding + BdE ELA up to €400bn - Legal via Art 18 + 14.4.
• Spanish State got ESM loan €41.3bn via FROB to recapitalise banks - Legal via Pringle.
• Spanish bonds supported by OMT announcement - Legal via Gauweiler, conditional.