EU Extends Crisis Rules For Banks' State Aid
Monday, December 05, 2011

The European Commission (EC) has updated and extended the set of temporary state aid control rules, which have been in place since 2008 to assess public support to financial institutions during the financial crisis.

In 2008, the EC adopted special state aid rules to allow member states to support the banking system during the financial crisis for the sake of financial stability without undue distortions of competition in the European Union's single market.

It was said that the crisis rules have proven their value in ensuring that banks restructure when changes to their business models are required to ensure their long-term viability, for example, if they are heavily reliant on risky activities. By also ensuring that shareholders and hybrid capital holders bear a fair share of the burden, the EC claims to have ultimately reduced the amount of taxpayers' money used to support the banks.

The new Communication adopted by the EC applies, from January 1, 2012, to state aid rules to support measures in favour of banks in the context of the crisis; and keeps in place the four previous Communications that set out the conditions for the compatibility with the European rules on state aid of support in the form of funding guarantees, recapitalization and asset relief, as well as the requirements for a restructuring or viability plan.

It is emphasized that the EC will continue to grant swift temporary approval whenever required to preserve financial stability, provided the terms of the intervention comply with the guidance provided.

The main new provisions of the rules consist in an explanation of how to ensure that member states are adequately remunerated if – as looks increasingly likely in the future – they decide to recapitalize their banks using instruments, such as ordinary shares, for which the remuneration is not fixed in advance.

Shares should be subscribed by a member state at an appropriate discount to the latest share price, depending, among other things, on the size of the capital injection compared to the bank's existing capital and whether or not the shares carry voting rights. As to hybrid capital instruments, to cater for circumstances in which banks may be unable to pay the agreed remuneration in the short-term, such instruments should include an "alternative coupon satisfaction mechanism", allowing coupons that cannot be paid in cash to be paid in shares instead.

A revised methodology has also been agreed concerning the remuneration of guarantees for banks' funding needs – the bulk of the support to date – to ensure that the fees that banks pay reflect their intrinsic risk, rather than the risk related to the member state concerned or the market as a whole.

The revised methodology establishes the minimum fees that should apply where the guarantees are granted on a national basis. The new rules apply for guarantees covering debt with a maturity between one and five years (or seven in case of covered bonds). The rules for shorter maturities remain the same.

The rules will apply as long as required by market conditions.

"The exacerbation of tensions in sovereign debt markets has put banks in the EU under renewed pressure, justifying the extension of the crisis rules," said the EC’s Vice-President in charge of competition policy, Joaquín Almunia. "We will continue to insist on the restructuring and cleaning up of balance sheets where it is necessary, to help break the vicious circle between the sovereign debt crisis and a weak financial sector. In its application of the rules, the EC will take full account of elements that indicate that banks can be viable in the long-term without the need for significant restructuring."

The EC will continue to require member states to submit a restructuring plan (or an update of a previously approved plan) for all banks which receive public support in the form of recapitalization or impaired asset measures, be it from national or EU sources, regardless of the size or the reason for support.

The EC will determine the need for restructuring through a proportionate assessment of the long-term viability of banks, taking full account of all relevant elements: whether the capital shortage is essentially linked to a confidence crisis on sovereign debt; the public capital injection is limited to the amount necessary to offset losses stemming from marking European sovereign bonds to market in banks which are otherwise viable; and the analysis shows that the bank in question did not take excessive risk in acquiring sovereign debt.

Banks which have not received public support in the form of recapitalization or impaired asset measures, but do benefit from member state guaranteed funding, do not have to present restructuring plans. Only "heavy users" of state guarantees on their liabilities will continue to be obliged to submit viability reviews to the EC.