What's New in the EU: European Commission guides members looking to save their banks

The pervasive uncertainty about the credit risk of individual financial institutions has dried up the market of interbank lending.

By ARI SYRQUIN
eu flag 88 (photo credit: )
eu flag 88
(photo credit: )
The global financial crisis has has impacted heavily on the EU banking sector. Over and above specific problems related to the US mortgage market and mortgage-backed assets, or linked to losses stemming from excessively risky strategies of individual banks, there has been a general erosion of confidence in the past month within the banking sector. The pervasive uncertainty about the credit risk of individual financial institutions has dried up the market of interbank lending and has consequently made access to liquid funds progressively more difficult for financial institutions across the board. The current situation threatens the existence of individual financial institutions with problems that are a result of their particular business model, or business practices whose weaknesses are exposed and exacerbated by the crisis in the financial markets. If such institutions are to be returned to long-term viability rather than liquidated, a far-reaching restructuring of their operations will be required. Under the prevailing circumstances, the crisis equally affects financial institutions that are fundamentally sound and whose difficulties stem exclusively from the general market conditions which have severely restricted access to liquidity. Long-term viability of these institutions may require less substantial restructuring. In any case however, measures taken by EU member states to support institutions operating within their national financial market may favor these institutions to the detriment of others operating within that member state or in other member states. Consequently, the European Commission has published guidance on how member states can best support financial institutions in the current financial crisis while respecting EU state aid rules, and so avoiding excessive distortions of competition. The guidance is based in particular on EC Treaty rules allowing for aid to remedy a serious disturbance in the economy of a member state (Article 87.3.b of the EC Treaty). The guidance is hoped to help member states to put in place coordinated concrete measures to restore confidence in financial markets in accordance with the 12th October Eurogroup declaration. EU state aid rules require that measures taken do not give rise to disproportionate distortions of competition, for example by discriminating against financial institutions based in other member states or allowing beneficiary banks to unfairly attract new additional business solely as a result of the government support. Other requirements include that measures must be limited in time and foresee adequate contributions from the private sector. The ECOFIN Council on October 7 adopted conclusions committing to take all necessary measures to enhance the soundness and stability of the banking system in order to restore confidence and the proper functioning of the financial sector. The recapitalization of vulnerable systemically relevant financial institutions was recognized as one means, among others, of appropriately protecting the depositors' interests and the stability of the system. It was further agreed that public intervention has to be decided on at national level, but within a coordinated framework and on the basis of a number of EU common principles. On the same occasion the commission offered to shortly issue guidance as to the broad framework within which the state aid compatibility of recapitalization and guarantee schemes, and cases of application of such schemes, could be rapidly assessed. Given the scale of the crisis, which is now threatening even fundamentally sound banks, the high degree of integration and interdependence of European financial markets, and the drastic repercussions of the potential failure of a systematically relevant financial institution further exacerbating the crisis, the Commission recognizes that Member States may consider it necessary to adopt appropriate measures to safeguard the stability of the financial system. Due to the particular nature of the current problems in the financial sector, such measures may have to extend beyond the stabilization of individual financial institutions and include general schemes. The commission's guidance (in the form of a Communication) indicates how the commission intends to apply EC Treaty state aid rules to state support schemes and individual assistance for financial institutions in the current crisis. Support schemes such as guarantees or recapitalization schemes can be cleared by the commission very quickly if they fulfill conditions which guarantee that they are well-targeted and proportionate to the objective of stabilizing financial markets and contain certain safeguards against unnecessary negative effects on competition. The specific conditions include:
  • Non-discriminatory access, to protect the functioning of the Single Market by making sure that eligibility for a support scheme is not based on nationality;
  • State commitments to be limited in time in such a way that it is ensured that support can be provided as long as it is necessary to cope with the current turmoil in financial markets, but will be reviewed and adjusted or terminated as soon as improved market conditions so permit;
  • State support to be clearly defined and limited in scope to what is necessary to address the acute crisis in financial markets, while excluding unjustified benefits for shareholders of financial institutions at the taxpayer's expense
  • An appropriate contribution of the private sector by way of an adequate remuneration for the introduction of general support schemes (such as a guarantee scheme) and the coverage by the private sector of at least a significant part of the cost of assistance granted;
  • Sufficient behavioral rules for beneficiaries that prevent an abuse of state support - for example, expansion and aggressive market strategies on the back of a state guarantee;
  • An appropriate follow-up by structural adjustment measures for the financial sector as a whole and/or by restructuring individual financial institutions that had to rely on state intervention.
    • The observance of these principles, including in individual aid measures, will have to be ensured by member states and will be monitored by the commission. The Commission is available to advise member states, on the basis of this guidance, on how best to tailor national measures to comply with EU state aid rules in advance of finalization of a particular scheme. syrquin@013.net The author is the head of the GSCB law firm's international department.