State aid: recapitalisation of Spanish banks – the Commission’s role under EU State aid control

Brussels, 29-11-2012 — /europawire.eu/ — Since the start of the financial crisis in October 2008, EU Member States have taken hundreds of measures in favour of financial institutions in order to preserve financial stability. Most of this support constitutes state aid in the meaning of the EU rules (Article 107 (1) of the Treaty on the Functioning of the European Union – TFEU). This means that it cannot be implemented before it has been approved by the Commission.

The Commission has responded to this unprecedented support to the financial sector by streamlining Member States’ initiatives into a coordinated European response to the crisis via the application of EU state aid rules. It has been firm on principles and flexible on procedure, making EU State aid rules the main EU level crisis management and resolution tool for the financial sector.

The Commission issued a first set of guidelines on how it would assess aid granted to banks in financial crisis already in October 2008, just days after the collapse of Lehman Brothers. Further guidance followed, specifying how the Commission would assess recapitalisation measures, impaired asset measures and bank restructuring plans. This crisis regime for state aid to the financial sector is still in place.

Today’s decisions approving restructuring aid for four Spanish banks are fully in line with this framework. The Commission has applied this framework consistently since the beginning of the crisis. The Commission already took more than 50 decisions on bank restructuring and resolution on the basis of these rules – not only in countries under a financial assistance programme (Greece, Ireland and Portugal) but also concerning banks based in other Member States, for example the United Kingdom, Germany and the Netherlands.

1. Why are the Spanish banks recapitalised? Why now?

After financial conditions for the Spanish banking sector deteriorated, a financial assistance programme was agreed by the Eurogroup in July 2012 and a Memorandum of Understanding (MoU) was signed with Spain.

The financing is to be channelled to the financial institutions in need state aid through the Spanish fund for the orderly restructuring of banks (FROB), acting as agent of the Spanish government. The package has been provided by the European Financial Stability Fund (EFSF) and is being transferred to the European Stability Mechanism (ESM) that is taking over the functions of the EFSF.

The MoU entailed an ambitious timetable, according to which state aid can be granted to individual banks with a capital deficit based on recapitalisation and restructuring plans to be assessed and approved by the Commission. The aid will be disbursed only after Commission approval of their restructuring plans. This has further strengthened the use of the EU State Aid rule as the crisis resolution mechanism for the financial sector.

The capital needs of the banks were determined through a bottom-up stress test and asset quality review conducted by independent consultants.

2. What are the different groups of banks in the framework of the MoU?

On the basis of the stress test results and the plans to address potentially identified capital shortfalls, the banks are categorised in four groups.

Group 0: banks for which no capital shortfall is identified and no further public action is required. Group 0 comprises Unicaja, Sabadell, Bankinter,Caixabank, Kutxabank, Santander and BBVA.

Group 1: banks already owned by the FROB. These are: BFA-Bankia, CatalunyaCaixa, NCG Banco and Banco de Valencia.

Group 2: banks identified by the bottom-up stress test as unable to meet their existing capital shortfalls without having recourse to state aid. This group includes Banco Mare Nostrum, Banco Caja 3, Liberbank and Ceiss.

Group 3: banks identified by the stress test as able to meet existing capital shortfalls from private sources without recourse to state aid until end December 2012 and having credible recapitalisation plans. Banks in Group 3 are Ibercaja and Banco Popular. These banks will not need State Aid.

3. Under what conditions can the Commission approve state aid for a bank in the current crisis?

A Member State granting state aid to a financial institution has to submit a restructuring plan. Only if this plan is in line with the EU state aid rules can the aid be allowed. The main requirements are:

• First, viability: The restructuring plan has to demonstrate that the bank is able to restore its long-term viability over time. To this effect, the bank has to review its business models with the aim of regaining the ability to lend and compete without state support following the restructuring period. This ensures that the bank can lend to the real economy on a solid basis. Depending on the facts of each case, such a review may require a refocus on the banks’ core business and the closing-down of risky and/or loss-making activities.
• Second, burden-sharing: To protect the interests of taxpayers and avoid that aided banks enjoy an undue advantage in the form of cheap or free capital, the received state aid needs to be repaid as quickly as possible and remunerated according to market rates. To ensure that state aid is kept to the minimum necessary, banks should first try to cover the restructuring cost through internal measures, like divestments or other burden sharing measures making capital holders (such as equity holders, or hybrid capital holders) contribute to an adequate level, so that state aid only covers the remaining gap.
• Third, compensatory measures: the distortion of competition created by the aid needs to be compensated. Measures to that effect should be proportionate to the size of the aid and the characteristics of the market on which the bank operates. In practical terms this is addressed for example by requirements for the bank to divest certain subsidiaries or cease its business activities in certain fields, and by behavioural measures such as acquisition bans.

Burden sharing and measures to limit competition distortions address moral hazard, thus ensuring that banks and their owners do not learn the wrong lessons from the crisis, i.e. that gains are private and losses are socialised at the expense of the taxpayer.

A Member State granting aid to a financial institution has to submit a plan for the orderly resolution of the entity if its long term viability cannot be restored and if this option is less costly for the taxpayer than restructuring. An orderly resolution allows the entity to exit the market in an orderly manner, i.e. while preserving financial stability.

4. Is the approval of aid a mere formality under the crisis rules?

Since the beginning of the crisis, the Commission has been able to grant temporary approval quickly (sometimes in less 48 hours) to state aid granted to financial institutions, provided the Member State complied with the conditions and provided the necessary information. This has helped to preserve financial stability at the height of the crisis and provided legal certainty to the market.

However, final approval by the Commission is always conditional on the submission of a restructuring plan within 6 months. Typically, the Commission services work together with the Member State and the bank to ensure that the restructuring plan is in line with the three pillars mentioned above (viability, burden sharing, competition). This often entails complex negotiations and significant changes to the initial plans.

Contrary to other financial assistance programmes (Greece, Ireland, Portugal), the MoU signed with Spain foresees that the aid cannot be granted before approval by the Commission of the restructuring plans of the banks receiving aid. In the case of Spain, Commission approval will therefore allow the aid from the European Stability Mechanism (ESM) to be disbursed, via the Spanish Fund for the Orderly Restructuring of Banks (FROB). The restructuring plans also take into account the state aid that banks may have already received before Spain’s programme for financial assistance was set up.

5. Which banks have to present restructuring plans?

All banks which receive state aid – other than liquidity guarantees – in the European Union have to present restructuring plans that comply with EU state aid rules. For Spain, these are all banks in so-called “Group 1” and “Group 2” (see above), receiving recapitalisation and transferring assets to the Asset Management Company.

Today, the Commission has approved restructuring plans for the four Group 1 banks, i.e. the banks which had already been nationalised and had already received state aid, in line with the timetable of the MoU.

6. Who decides how much state aid banks get? Was this based on the stress test alone?

The MoU foresees that banks can only receive capital after having conducted an asset screening and stress test exercise (stress diagnostics) for the main asset groups held by the major Spanish banking groups. The objective of the stress diagnostics was to determine the overall capital needs of individual Spanish banks. The screening work was performed by auditors and an external consultant, Oliver Wyman. The methodology of this valuation had been endorsed by a group composed of the Bank of Spain, the Commission and the European Central Bank (ECB), with the International Monetary Fund (IMF) as observer.

However, the stress test is only the starting point. In order to determine the final capital needs of a bank, further elements come into play. First, banks will transfer their risky assets related to real estate and their real estate development assets to an Asset Management Company (AMC), the “Sareb”, and thus remove them from their balance sheet. This will relieve the banks from further losses deriving from this risky portfolio and decreases the overall riskiness of the bank’s balance sheet. Transferring troubled assets to the AMC will in itself be considered as state aid.¹

Second, the capital and subordinated debt holders of the banks need to participate in the recapitalisation effort via burden sharing measures aimed at reducing the overall capital needs. This also serves to limit the cost of bank restructuring for taxpayers, in line with the MoU.

Spain has agreed that existing equity holders will lose their claims depending of the economic valuation of each bank when state capital is injected in the form of equity. For holders of preference shares and perpetual subordinated debt, burden sharing will be implemented firstly by applying a haircut to the nominal amount of the instrument and subsequently through conversion of these securities into equity or equity equivalent instruments. As regards the holders of dated subordinated debt they will be given the choice between conversion into equity or into a senior debt instrument after taking an appropriate haircut.

As a result, there will be no cash outflow from banks to the holders of these securities with the sole exception of the holders of dated subordinated debt instruments deciding to convert into new debt securities with a maturity matching that of the subordinated debt being exchanged.

Spain has introduced legislation to ensure the effectiveness of the burden sharing measures, including when necessary by mandatory means.

In addition, each bank may carry out other divestments generating capital.

The final capital needs of the banks to be met through state aid are determined only after having considered all these elements. This ensures that the contribution of taxpayers is limited to the amount necessary.

7. How does the transfer of problematic assets to the asset management company (“Sareb”) work?

Real estate related foreclosed assets and real estate development assets are to be removed from the banks receiving state aid. The value of those assets has been provided by an external consultant under the methodology described in point 6 above.

The estimated value of those assets was then further reduced. This has been done by applying various haircuts related to the specific conditions of the transfer to the asset management company (AMC). For instance, the fact that the AMC purchases a large quantity of assets would result in a lower transfer price. Another reason for a discount is that certain expenses previously borne by the bank must now be assumed by the AMC, such as asset management and administration costs.

The Commission has assessed the conditions of transfer of those assets with the help of external experts and concluded that they were in line with EU state aid rules.

8. How does the Commission ensure that Member States implement plans to restructure banks that have received state aid?

Member States give the Commission a legal commitment to abide by the restructuring plans which the Commission approves. The Commission has a monitoring system, including periodic reports and possibly a trustee in more complex cases, to ensure that the restructuring plans and commitments are duly implemented. There will be a trustee for BFA/Bankia, NGC Banco and Catalunya Banc.

9. Does the Commission look at state aid issues in other programme countries?

All state aid provided to banks everywhere within the EU has to be approved by the Commission under EU state aid rules. This is also the case in countries under a programme of financial assistance.

For further information on the Commission’s state aid action in programme countries, go to

http://ec.europa.eu/competition/recovery/programme_countries_en.html

10. Under which specific rules is state aid to banks assessed?

State aid to banks is assessed under the EU’s crisis rules for the rescue and restructuring of financial institutions.

A first Communication, adopted in October 2008, spelt out basic principles for support schemes, such as keeping support limited in time and scope, ensuring that eligibility for a support scheme was not based on nationality or avoiding that beneficiary banks unfairly attract new additional business solely as a result of the government support (see IP/08/1495). A good illustration is the Irish support scheme for banks, which was amended so as to ensure a non-discriminatory coverage of banks with systemic relevance to the Irish economy, regardless of origin (see IP/08/1497).

This was followed by a Communication on the recapitalisation of banks in December 2008, tackling the need to recapitalise banks, address solvency issues and access to credit for the real economy (see IP/08/1901) and in February 2009 by the “Impaired Assets Communication” providing a framework to deal with the problems of toxic assets (see IP/09/322).

Finally, in July 2009, the Commission adopted the “Restructuring Communication”, providing clarity on how the Commission would examine the restructuring of banks so that they can return to long-term viability, share the weight of the cost of their rescue, and address any distortions of competition resulting from the large amounts of aid the banks received (see IP/09/1180).

11. Why do we have EU state aid rules at all?

State aid control was already laid down in the founding treaties of the European Communities. Its objective is to ensure that public interventions do not distort competition and trade in the EU internal market. In this respect, State aid is defined as an advantage conferred on a selective basis to companies by a public authority.

Article 107 of the Treaty on the Functioning of the European Union submits State aid to notification and approval by the Commission. The TFEU leaves room for a number of policy objectives of common interest for which public support can be found compatible with the internal market. As State aid distorts competition, it is only allowed in cases where public intervention is justified and under certain conditions.

The Commission has complemented the fundamental rules with a series of legislative acts that provide for a number of exemptions, establishing a worldwide unique system of state aid control. The Commission has also adopted guidelines specifying the principles and conditions according to which it assesses State aid. State aid control is one of the pillars of the EU Single Market since it ensures that governments and local authorities of all Member States are submitted to the same rules in their interventions.

In particular, the Commission has adopted guidelines on the rescue and restructuring of companies. These guidelines specify the conditions under which restructuring aid can be allowed such as the need of a restructuring plan restoring viability, the need for an own contribution of the company to restructuring costs, and the need to compensate for competition distortions created by the aid.

The crisis rules for rescue and restructuring of financial institutions implemented by the Commission since 2008 have adapted these general principles to the specific features of the financial sector and the need to preserve financial stability during the crisis. They are based on Article 107(3)(b) of the TFEU, which allows state aid to remedy a serious disturbance in the economy of a Member State.

For more information on how the Commission is implementing state aid rules in the crisis, go to: http://ec.europa.eu/competition/state_aid/legislation/temporary.html

12. Why not simply suspend the State aid rules in times of crisis?

In bad economic times, individual countries may be tempted to favour their own companies even more than in times of prosperity, risking a breakdown of international trade and investment.

Since the start of the financial crisis in 2008, the crisis regime put in place for the real economy (the so-called “Temporary Framework”, now expired) and for the financial sector ensured that the EU had a common response to the challenges posed by the crisis. These common rules have preserved a Single Market for banking and financial services.

Sticking to these common rules today is more necessary than ever because keeping the EU Single Market together and ensuring it remains competitive and dynamic are key to restoring economic growth.

Finally, the conditions set out in state aid rules ensure the interests of taxpayers are preserved, i.e. that the aid is adequately remunerated and eventually repaid. This is essential as taxpayers have been asked to make a very high contribution to the rescue and restructuring of the financial system since the beginning of this crisis.