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Banking crisis, financial stability and State aid: The experience so far

Vice-President of European Commission, Joaquín Almunia, delivered this speech at Bruegel's event 'Banking crises, financial stability and state a

Publishing date
13 March 2013

Vice-President of European Commission, Joaquín Almunia, delivered these remarks at Bruegel's event 'Banking crises, financial stability and state aid: the experience so far' on 8 March 2013.

"Ladies and Gentlemen,

First of all, let me thank Bruegel and Jean-Claude Trichet for giving me the opportunity to talk about the experience the European Commission has gathered so far on the use of the State aid instrument to control the public support of banks in distress.

In October 2008, the Commission was asked to safeguard the level playing field in the EU banking sector in view of massive aid measures taken independently by different national governments. State aid rules were adapted to deliver on three objectives at the same time: maintain financial stability, safeguard the internal market, and protect the taxpayer.

It was quickly apparent that these rules performed the essential and otherwise missing function of coordinating the European response to the financial crisis. The decision to support banks remained national. Supervision was also national, as was the decision to sound the alarm, which in some countries came quickly and in others late. But our intervention meant that the terms of state support were the same for all beneficiaries and treasuries across Europe.

On the basis of these rules, the Commission has acted as a de facto crisis-management and resolution authority at EU level. The special State aid rules for banks have been the only instrument available to fulfil some of the functions that a resolution authority at EU level should have performed, had there been one.

The task entrusted to the Commission included an explicit competition and financial stability mandate. This means that the Commission has been able to decisively address the structural problems of some of the aid beneficiaries while allowing public support to provide the shield needed for this process to take an orderly form. Until now, we have restructured 59 banks in the EU, representing around 20-25% of the European banking sector, and 19 of these have been put into orderly liquidation.

In the process, we have acquired an enormous and quite unique experience. Today, I would like to share with you some thoughts on the lessons we can draw from it.

My first consideration is on banks' business models. Over the past five years, we have seen all business models fail: universal banks, savings banks, monoliners, public-finance banks, and even cooperative banks. We have learnt that what matters is funding and the way risk is managed. Without proper risk management and the adequate control of this function by supervisors, any bank can accumulate unsustainable losses regardless of its business model. For instance, overreliance on wholesale funding and lack of access to stable funding sources proved fatal to some very large banks in the EU – and costly to taxpayers in a few Member States.

As regards supervision, we have witnessed large differences in the application of the same rules. We have also seen that national supervisors do not challenge enough the banks they supervise. One example comes from our experience with impaired assets measures, where we have required national supervisors to validate the valuation of impaired assets to be covered by state guarantees or purchased by the state. We subsequently verified these valuations with the help of external experts. In the vast majority of cases, national supervisors had underestimated the losses on these assets. Paradoxically, this problem is being addressed first in programme countries where external experts carry out the stress test of the banking sector and lend their credibility to national authorities. This is one of the reasons why I am a strong supporter of a single supervisory mechanism to be hosted by the ECB.

As regards cross-border banks, we have witnessed agonising disagreements between Member States and delays in their decision-making processes. This has resulted in larger amounts of aid granted to the banks, higher exposure of public finances, and a larger final bill for taxpayers.

We have experienced delays in taking action by responsible Member States also in relation to purely national banks, where for complex domestic political reasons there was – or still is – no agreement on the final distribution of the costs of banks’ failures. Let me just say that we still have an unfinished case where the first state support was given in 2008, and where the bank in question accounts for less than 6% of the market share in one region. Such delays have led to higher costs and in some cases larger financial stability risks during the process.

Some of the lessons over the past five years also apply to the Commission. One important lesson is that we needed to combine a case-by-case approach and a sector-wide approach to bank restructuring. We need to take into account the macroeconomic implications of our work. This applies in particular to our action in programme countries, where our scrutiny in some cases covers as much as 90% of a country's banking sector.

We have learnt to factor in the aggregate effects of restructuring measures on the economy. We look at the pace of de-leveraging and at the feasibility of divestments in the light of market conditions. We modulate the scope and terms of restructuring depending on aid amounts and reasons. And we have proven beyond doubt that there is no alternative to decisive restructuring or orderly resolution in case of banks' failures. No economy can recover with zombie banks. Therefore restructuring or orderly winding down banks is a necessary step towards a healthier and safer banking sector capable of financing the real economy.  Finally, we have shown in actual practice that financial stability and competition mandates are compatible and have been effectively ensured by the Commission.

In light of this experience, we have a good idea of the features a single resolution mechanism will need to have if it is to be effective. The best source draws on the governance model of the Spanish programme. A simple rule agreed in the Memorandum of Understanding provided that no money could be paid from the ESM to Spain for recapitalising banks until the Commission takes a final decision under the State aid rules approving the restructuring or the orderly winding down of individual institutions. This governance model significantly changed the incentives of the participants in the restructuring and resolution negotiations, and allowed us to conclude them with unprecedented speed. Restructuring and/or resolution decisions for eight banks were taken in less than six months, with decisive restructuring of 20% of Spain’s banking sector. Moreover, additional powers in relation to burden sharing meant that the Commission could go further than what is normally required under the State aid rules and arrive at a significant contribution by junior debt holders with important savings in the order of €12,7 bn compared to programme funds that eventually amounted to a total of €41,3 bn.

These were some of the lessons learned from restructuring or resolving 59 European banks. As we speak, we have another 29 individual institutions under scrutiny, and I'm afraid that the counting is not over. In dealing with these cases and the future ones, the Commission’s State aid enforcement will function in a new regulatory and institutional landscape which will be shaped by the steps taken towards the creation of the Banking Union.

As regards resolution, the harmonised toolbox for the resolution of banks is currently being discussed in the Council and Parliament. Once adopted and implemented, it will result in the creation of national resolution authorities equipped with the same set of tools. The question is how to put order in the functioning of the instruments, institutions and tools that will be available. In Spring 2014 the single supervisory mechanism (SSM) will become operational. In 2015 we should see the new resolution toolbox available to national resolution authorities. As from 2018, this should be complemented by the bail-in instrument. And, of course, State aid control will continue to apply.

I think that the SSM will need a Single Resolution Mechanism as its counterpart when it starts its operations. Based on our experience, I would never recommend that the latter takes the form of a platform for the coordination of national supervisors. Moreover, we have to realise that over the next three to five years the bulk of banks' restructuring and resolution is likely to involve the use of taxpayers' money, either from national or European sources, for the following reasons:

·         It will take time to collect the funding needed in the resolution funds – and even then, these will remain subject to State aid control;

·         Bail-in provisions are planned to be implemented only as of 2018, though the legislator may decide to bring this date forward;

·         Even then, measures need to be taken to level out to acceptable levels the proportions of bail-inable instruments that bank hold in their balance sheets. Their implementation will inevitably take time.

·         And any use of taxpayers' money – be it national or from the ESM, through direct recapitalisations or loans to governments – will continue to be subject to State aid control.

Therefore, in parallel with the work on the creation of the Single Resolution Mechanism, we are preparing to update the State aid control rules for banks, in order to integrate the lessons we have learned and in particular the mechanisms that have delivered the best results. We need to reflect on how our tried and trusted instrument can best contribute to the future functioning of the Single Resolution Mechanism.

Over the next few years we will be facing a transition period, before a fully functioning Banking Union enters into force and reaches its operational and financial capacity. This transition period will be characterised by continued exposure of the taxpayers to the cost of banks' failures and by the need to maintain a level playing field in the internal market. For these reasons, the role of State aid control during this transition period will remain very important as a proven instrument to protect financial stability, the internal market, and taxpayers' interests."

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