A bailout is defined as a procedure in which a country or company formally requests, and subsequently receives, money or funds from an institution (IMF, World bank, ECB, FED, etc.) or government (the european union or a company’s home government) to obtain the financing it needs to avoid bankruptcy. It’s similar to a very big and controlled loan.

One of the main reasons this may occur for a country is because investors who are buying sovereign debt (bonds, etc.) demand a yield (see risk premium) so high that a country will be unable to repay the debt (see borrowing cost) at the interest rate that’s contracted. The figure of the “troika”, or group of institutions and central banks, usually is the one that controls the bailout process and sets the conditions. A special “mechanism” is also sometimes created to help control the process. The bailout money comes from the amount that different government provide for the IMF, for example, depending on the size and strength of their economy. These bailout funds are always subject to conditions of repayment and issuance in function of how the country adopts and responds to the different terms that are agreed upon. These terms and conditions usually include: raising taxes, downsizing public employment, cutting salaries, cutbacks in social programmes and controlled bond issuances. When a country from the European Union requests a bailout, the government in question makes the formal petition to the president of the euro group. Next, an independent evaluation is made by the European Commission and the European central bank.
Two bailout mechanisms were created in the European Union:

  • The European Financial Stability Facility (EFSF) created in 2010 and programmed to last until mid-2013.
  • The European Financial Stability Mechanism, which set up the bailout for Ireland and Portugal.

These mechanisms were joined and replaced by the European Stability Mechanism (ESM) which was ratified by 26 of the 27 EU-27 countries (the Czech Republic is the only country not to sign the treaty) and has a maximum lending capacity of 500 billion euros.