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Compensating Competitors or Restoring Competition? EU Regulation of State Aid for Banks During the Financial Crisis

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Abstract

We contrast the theory underpinning state aid for failing banks with that for failing firms in the non-financial sector. We argue that there is little justification for measures to ‘compensate’ rivals when the bank has been saved for reasons of systemic stability. The Commission’s approach to bank restructuring aid takes insufficient notice of this. Furthermore, the use of punitive divestitures is not the best way of addressing moral hazard. Worse, such divestitures can impede competition by creating weak rivals. We provide four detailed case studies to illustrate the problems. We conclude that the Commission provided a useful constraint in the midst of a crisis of unprecedented scale and complexity, but its approach could have been improved by more systematic attention to effective competition relative to the appropriate counterfactual.

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Notes

  1. Fortis Bank, Fortis Bank Luxembourg and Fortis Bank Netherlands are counted as a single bank, as are Kaupthing Bank Finland and Kaupthing Bank Luxembourg. A further 18 banks notified specific aid during 2011, including an additional five Spanish cajas and the first two Greek banks. However, this trend must be treated with caution as the Commission effectively treated all banks that require additional state aid after the second half of 2010 as fundamentally distressed banks, instead of discriminating between distressed and fundamentally sound banks as it had done at the beginning of the crisis. This article does not include the Euro sovereign debt crisis which was adversely affecting an increasing number of banks at the time of writing in May 2012. It is likely that more European banks will need rescuing if there is further sovereign default.

  2. This figure refers to the maximum amount of aid approved by the European Commission including schemes and ad hoc interventions. The subsidy element was less than a tenth of this. See section 4.1.

  3. European Commission (2010) ‘State Aid Scoreboard’, Autumn update, COM(2010) 701.

  4. Article 107(1) of the Treaty on the Functioning of the European Union prohibits any aid that threatens to distort competition insofar as it could also affect trade between Member States. Article 107(2) provides very limited automatic exemptions for aid to individuals and for damage due to natural disasters. Article 107(3) sets out some further circumstances where aid may possibly be justified.

  5. As Collie (1998, 2002) points out, this may benefit consumers through lower prices, though it must be balanced by losses to tax payers.

  6. This provision was extended at the end of 2010 on the grounds that the ‘serious disturbance’ was continuing.

  7. These are the: Banking Communication (European Commission 2008); Recapitalisation Communication (European Commission 2009a); Impaired Assets Communication (European Commission 2009b); Restructuring Communication (European Commission 2009c). There was also a parallel communication providing a temporary Community framework for State aid measures to support access to finance for non-banks (European Commission 2009d).

  8. See Neven and de la Mano (2009).

  9. We use R#x to refer to paragraph x of EC (2004).

  10. We use F#x to refer to paragraph x of EC (2009c). See Bomhoff et al. (2009) for an insider view of the Communication.

  11. This had been established in the Banking Communication (EC 2008).

  12. An explicit counterfactual is recommended in Lyons et al. (2008).

  13. Although, the negative externality of exit may be felt by banks that are not necessarily rivals in a particular market, the systemic benefits matter more than bilateral effects.

  14. For an introduction to the philosophy of legal punishment, see Duff (2008).

  15. Autumn 2010 update: COM(2010) 701, 01.12.2010.

  16. In the case of a state guarantee, according to the Banking Communication, this price should be as close to the market price as possible and be based on the risk profile of the banks. In the case of recapitalisation, the Commission considers the Eurosystem recommendations of 20 Nov 2008 as an adequate method to determine the price of recapitalisation for fundamentally sound banks. This method involves the calculation of a price corridor on the basis of different components which should also reflect the specific features of individual institutions and of member states. The commission accepts a minimum remuneration based on the above methodology for fundamentally sound banks. The remuneration is then differentiated at the level of an individual bank on the basis of its risk profile and other relevant parameters. In the case of asset relief measures, as stated in the Impaired Assets Communication, assets should be valued on the basis of their current market value, whenever possible as a first stage. Then any transfer of assets covered by a scheme at a valuation in excess of the market price will constitute State aid. As a second stage, the Commission considers a transfer value reflecting the underlying long-term economic value of the assets as an acceptable benchmark indicating the compatibility of the aid amount as the minimum necessary. Adequate remuneration is then required to be secured by the state. If the transfer value of the assets exceeds the real economic value, the aid element contained in the measures is considered correspondingly larger. Furthermore, it must be accompanied by far-reaching restructuring.

  17. See the decision text of the European Commission State aid case no. C14/2008 for detailed information on the case.

  18. The Financial Service Compensation Scheme, is a UK national scheme funded by the banks which, at the time, compensated at least 90 % of a maximum £35,000 for retail deposit holders in case of the failure of a financial institution.

  19. For example, were the shareholders holding out for a better offer or did potential buyers require an even bigger State subsidy to take on NR?

  20. NR’s market share in the UK mortgage market decreased in 2008 and 2009.

  21. According to the BBC (http://news.bbc.co.uk/1/hi/business/8205443.stm), the Building Societies Association (i.e. rival mortgage lenders organised as mutuals) had lobbied the Commission for formal limits on new lending to prevent NR having an ‘unfair advantage’, but the report makes no mention of price controls. The importance of lobbying by rivals is confirmed in section 5.3 of Didziokaite and Gort (2010).

  22. As part of the sale conditions, the UK Treasury required NR’s 74 branch network to be retained and eventually expanded. There should also be no further compulsory redundancies. These commitments at least incentivise a minimum scale of activity. Virgin Money had only a handful of ‘money stores’.

  23. See the decision text of the European Commission State aid cases no.C43/2008, N531/2009 and N555/2009 on which this section is based. See also Carletti and Vives (2009) for an analysis of state aid to Landesbanken in the 1990s and early 2000s. They also review an important earlier bank state aid case on Credit Lyonnais, which had got into difficulty due to bad lending (including property and film-production studios).

  24. Certain public mission activities were also floated off as NRW Bank.

  25. State of North Rhine-Westphalia, NRW Bank, two regional savings banks associations and two municipal associations.

  26. It had to: close 5 of its 11 locations in Germany (by 2010) limiting the locations to Dusseldorf, Berlin, Frankfurt, Hamburg, Munich and Stuttgart; and reduce its locations outside Germany from over 30 to 7 (by 2010), limiting the locations to London, New York, Hong Kong, Moscow, Sydney, Istanbul and Sao Paulo.

  27. See point 39 and 68 in the decision text.

  28. See State Aid N249/10–Germany, published 22.06.2010.

  29. See the decision text of the Commission 22 December 2009, P3.

  30. See also the paper by Haken in this volume.

  31. See the decision text of European Commission State aid cases no.N574/2008, NN42-46-53A/2008,N255/2009 and N274/2009 for detailed information on the case.

  32. Fortis Bank was a subsidiary of SA Fortis Brussels, itself controlled by Fortis SA/NV and Fortis NV (‘the Fortis Group’), whose securities are listed inter alia on Euronext Brussels and Euronext Amsterdam.

  33. The square brackets are ranges which the Commission uses in public documents to protect business confidentiality.

  34. The figures are from the background information of Fortis Bank in the decision text of the case of Fortis Bank Netherlands (case no. NN2/2010). RBS acquired the ABN AMRO business units of Global Business and Markets, Global Transaction Services and the international network; Santander acquired the business units of Latin America and Antoveneta (Italy) and Fortis Bank acquired business units Netherlands and Private Banking. At the time of acquisition agreement, business units acquired by Fortis Bank were harboured into Fortis Bank Netherlands (FBN). On 3 Oct 2008, the Dutch State acquired FBN (including the ANB AMRO business units) from Fortis Bank.

  35. According to the annual report of ABN AMRO for the year 2009, ABN AMRO recorded a loss for the period of €4.4b. The loss for the period comprises a loss of €4.3b attributable to the RBS acquired businesses, a loss of €117m attributable to the Dutch State acquired businesses and a loss of € 214m attributable to Central Items (mainly reflecting the impact of ongoing ramp down activities). For the Dutch acquired business, the loss was mainly attributable to lower net interest income (€2.1b in the first 9 months of 2009 compared with €2.4b in the first 9 months of 2008) and an increase of loan loss provisions (€838 m in 2009 compared with €383m in 2008). Pisani-Ferry and Sapir (2010) point to exposure to Lehman Brothers and sub-prime debt.

  36. See European Commission State aid cases no. C11/2009, N19/2010 and NN2/2010. The final decision text was not available at the time of writing. The Commission opened an in-depth investigation having expressed doubts about whether a loan facility accompanying nationalisation by the Dutch authorities was either the minimum necessary or at an appropriate interest rate.

  37. Case No. M5384 (decided 3rd December 2008).

  38. This was considered to be a growing market. A complaint had been received by the Commission on 4 Nov 2008 against the state aid granted by the time to Fortis Bank on the grounds that it allowed Fortis Bank to offer higher interest rates on deposits and on-line savings accounts. Presumably, this complaint was by a competitor.

  39. See case M4844, 3rd October 2007.

  40. See EC press release IP/11/406, dated 5th April 2011.

  41. Vickers (2008) argues that stability might have been achieved in a less anticompetitive way.

  42. The Act does allow for such a political decision on the grounds of public interest though this was intended to be interpreted narrowly, with national security as the only stated example plus a public interest provision to maintain media plurality (Whish 2001, p.898). A new public interest “to ensure the stability of the UK financial system” had to be created in a formal Order to be passed urgently by both Houses of Parliament. Note that national security and media plurality are appropriately long-term considerations for a merger, whereas this merger’s contribution to financial stability could only have been short-term at best.

  43. This appears to be around 5 % market share.

  44. See points 18 and 19: “A transparent, objective, unconditional and non-discriminatory competitive sale process should generally be ensured to offer equal opportunities to all potential bidders. Furthermore, without prejudice to the merger control system that may be applicable, and while recognising that the sale of an aided ailing bank to a competitor can both contribute to restoring long-term viability and result in increased consolidation of the financial sector, where this would result prima facie in a significant impediment of effective competition, it should not be allowed unless the distortions of competition are addressed by appropriate remedies accompanying the aid.”[emphasis added]

  45. The post-divestiture market share for SME banking will be 21 %.

  46. The Commission explicitly acknowledges that the merger eliminates a ‘challenger’ and draws on the financial regulator’s opinion: ‘The FSA has observed that smaller banks like HBOS tend to behave like challengers, in the sense that they try to increase their market shares by decreasing price. Conversely, the four biggest banks (Barclays, Royal Bank of Scotland, Lloyds TSB and HSBC) tend to behave like harvesters, in the sense that they focus on extracting value from their existing clients’ [see footnote 47 of the Lloyds decision letter, N428/2009].

  47. See FTC (1999), EC (2005) and Davies and Lyons (2007).

  48. The Basel Committee on Banking Regulation is currently working on a list of systemically important banks (see Financial Times 29/03/11, http://www.ft.com/cms/s/0/2069bd4a-5a41-11e0-86d3-00144feab49a.html#axzz1LHLB567z). Although no such list was available to the Commission at the critical time in 2007–10, it could have sought advice more systematically.

  49. This follows from EC (2008) which give a first priority to viability, but it does not mean that these guidelines are always appropriate. See White (2009) and ICB (2011) for discussions of the too-big-to-fail argument.

  50. See FTC (1999), European Commission (2005) and Davies and Lyons (2007).

  51. Banks complain that it has imposed conditions that have not been applied to banks receiving aid from outside the EU. CEPS (2010) presents the views of a task force of leading European and US banks, including two discussed in our case studies (BNP Paribas/Fortis and Lloyds/HBOS).

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Acknowledgements

The support of the Economic and Social Research Council is gratefully acknowledged.

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  1. School of Economics and ESRC Centre for Competition Policy, University of East Anglia, Norwich, NR4 7TJ, UK

    Bruce Lyons

  2. ESRC Centre for Competition Policy, University of East Anglia, Norwich, NR4 7TJ, UK

    Minyan Zhu

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  1. Bruce Lyons
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  2. Minyan Zhu
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Correspondence to Bruce Lyons.

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Lyons, B., Zhu, M. Compensating Competitors or Restoring Competition? EU Regulation of State Aid for Banks During the Financial Crisis. J Ind Compet Trade 13, 39–66 (2013). https://doi.org/10.1007/s10842-012-0145-6

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