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 EU
Banking:
State
Aids in the EU Banking Industry
©
Anastasia Tsakatoura, 22 June 2002. All Rights Reserved.
Introduction
In the
preamble to the 1957 Treaty of Rome the signatories States pronounced
their determination to “lay the foundations of an ever closer union
among the peoples of Europe”; they resolved to “ensure the economic
and social progress of their countries by common action to eliminate the
barriers which divide Europe”. The means of achieving this is provided
by the creation of a common market characterised by the elimination of all
obstacles to intra-community trade.
Article 7(a) of the EC Treaty provides that “the internal market is to
comprise an area without internal frontiers in which the free movement of
goods, persons, services and capital is ensured in accordance with the
provisions of this Treaty”. Therefore, what was visualised by the
signatory states is to merge national markets into a single one and to
bring about conditions as close as possible to those of a genuine internal
market.
In order
to secure that such a single European market is feasible, the European
Community had to ensure that nothing would distort competition among the
Member States and therefore to prohibit devices, which can impede the
attainment of such a goal. Consequently, competition has always played an
imperative role in the European Community. Competition regulation,
however, is not, as many commonly believe, restricted to the control of
anti-competitive behaviour of private undertakings that distort market
forces in the world of industry and commerce. As Graig and De Bùrca
observed: “the discussion of
the substantive law of the Community would, however, be incomplete if it
did not take account of the way in which the actions of the State itself
might infringe the Treaty.” But, in what way can a State infringe
the Treaty and distort competition? In a competitive and ever-growing
market such as the one that the Community visualizes non-viable private or
public undertakings might be tempted to resort to the government of their
State for some sort of support mostly of a financial nature. Such
financial assistance, though, constitutes anti-competitive behaviour
because it consequences to a disadvantage for competitors, and creates a
protectionist behaviour emanating from the government of the Member State.
Europe is
a market consisted by mixed economic systems. Each of these systems
constitutes an entity with each own rules and traditions. In some of those
systems the State traditionally used to intervene more than in others, on
the economic policy by nationalizing undertakings or conferring them some
privileged monopoly or quasi-monopoly status. The underlying principles
for this interference and the legal form, by which it has been attained
differs from the one State to another. On the other hand, a more modern
approach, encourage a more restricted role for the State, as illustrated
by the privatization of nationalized industries and in the deregulation of
several sectors of the economy. Despite these changes, there continue to
be undertakings which either remain within public ownership or which
possess a certain privileged status in the market place.
This kind
of State intervention in the form of financial aid and subsidies however
is incompatible with the notion of a free market and, as we mentioned
before, constitutes anti-competitive behaviour from a Member State towards
other States in the Community. The Community in an attempt to eliminate
the possibilities of such a conduct by the national governments
established a monitoring devise for State Aids, which is contained in the
Treaty. The provisions relating to the achievement of a market with a
limited state intervention are included in Articles 86 to 89 (formerly
Art. 90 and 92 to 94).
The
purpose of this essay is to explore the rules on state aids and their
exceptions as included in the Treaty, and assess their application
particularly in the banking sector. We will attempt to do so, by looking
at the relevant case law and the way those cases have been resolved.
Furthermore, we shall refer to the new legislation adopted by the
Commission aimed to “make certain changes and clarifications prompted
by a number of factors”.
Main
Provisions
Article
87(1) (formerly 92(1)) provides:
“Save as
otherwise provided in this Treaty, any aid granted by a Member State
through State resources in any form whatsoever which distorts or threatens
competition by favouring certain undertakings or the production of certain
goods, shall in so far as it affects trade between Member States, be
incompatible with the common market.”
This
Article, in substance, lays down the basic foundations for state aids by
establishing that they are incompatible with the common market. Even
though, Art.87(1) is not considered to be a directly applicable
prohibition of an aid, the ECJ appears to regard this provision as an
implied prohibition.
The
question that arises is what is precisely the meaning of the term ‘state
aid’. The Treaty does not contain any definition on the meaning of the
term and, therefore, it remained open to the interpretation of the ECJ to
provide for a definition. The ECJ, however, adopted a broad view of what
constitutes aid and did not refine its boundaries. The Commission, on the
other hand, released a full list of what amounts to illegal or prohibited
state aid. Yet this list is rather illustrative than exhaustive and thus
other forms of aid can be added to it .
For example the list did not include subsidies or tax exemptions, which
have been later, found to constitute state aid. It has been argued that,
the absence of a clear-cut definition on the subject matter is justified
by the presumption that ‘the substance, and not the form, is relevant
when defining aid’.
A definition, consequently, might limit the scope of the relevant articles
if other forms of illegal aid will be introduced in the future. Therefore,
in the case Steenkolenmijnen v. High Authority
the
ECJ after distinguishing the word subsidy from an aid gave a useful
definition to the term by stating that an aid: “places emphasis on
its purpose and seems especially devised for a particular objective which
cannot normally be made without outside help”.
Irrefutably
a state intervention targeted to compensate a firm in difficulties, in
order to be tantamount to a prohibited state aid caught by art. 87(1) has
to represent a possible distortion of competition, while, at the same
time, it must be shown that it affects inter-state trade.
Yet,
not all State Aids are regarded to be incompatible with the common market.
Exceptions to the rule existing in 87(1) can be found in Art. 87(2), which
contains three types of aids considered as compatible with the common
market. These exceptions include aids with a social character, aids to
rectify damages caused by natural disasters and, finally, special aids to
compensate for the economic disadvantage of Germany due to its division.
Additionally Art.87 (3) encompasses some further exceptions of a
discretionary nature. These aids are not consequentially tolerable,
however the Commission has the discretion, under certain circumstances to
consider them legal.
The
control and supervision of State Aids have been entrusted to the
Commission in Brussels. Accordingly Art. 88(3) asserts that the Member
States are required to notify the Commission and report any aid prior to
granting it. As in every other rule, there are certain exceptions to this
rule too. For example, when an existing aid arrangement already approved
by the Commission for a certain amount, increases without exceeding 20% of
the agreed subsidy, notification is not necessary. Another remarkable
exception is the so-called ‘de minimis’ doctrine. The
Commission, in 1996, adopted the “de minimis” rule by which it
exempted from the state aid prohibition minor financial aid of up to
100.000 Euros to be granted over a three-year period. De minimis
aid shall not necessarily be notified to the Commission pursuant to Art.
88(3). Nonetheless, Member States will have to “record and compile
all the information regarding the application of the group exemptions”
and submit an annual report to the Commission of all the minor aids the
public authorities have granted during the year. However, the Court, at
the beginning consistently rejected to allow de minimis aid
and questioned the Commission’s power of control for doing so. The
Council Regulation 994/98, though, conferred a legal basis to it and
clarified the situation further.
Aids
in the Banking Sector
After
having examined briefly the main provisions for State intervention as
contained in the Treaty’s relevant articles, we shall now turn to the
heart of our analysis concerning State financial aid to the banking
sector.
The
crucial role that banks play in the economy of a State by providing credit
and liquidity necessitates stability to the banking system while the
opposite might be threatening to the economic development and growth of a
society leading even to an institutional breakdown. Therefore, the State
authorities in an attempt to preserve the status of their banking system
and prevent a financial institution from insolvency used to act in the
past as a ‘lender of last resort’. Particularly, in fear that a crisis
might result to ‘systemic risk’, namely that default by one
institution can spread to undermine other institutions, public policy
might endeavor to put some confidence in the system as a whole and
regulate against any potential risk.
Nowadays
though, fortunately or unfortunately, the State while attempting to
maintain an efficient and healthy banking system, should take into account
the relevant EU legislation so as to safeguard that by doing so it will
not distort and violate the European single market regulations.
There
are various ways, provided by the European Union, to mitigate risk of
insolvency. The first stage to do so is what is called ‘prudential
supervision’, which is aimed to ensure that the financial institutions
are prudently run and have adequate capital and liquidity. The second
stage concerns aid by the State itself so as to avoid any possible
collapse. However, as we have already mentioned competition policy in EU
restricts financial aids to any public and private enterprises in
difficulty.
Despite
the fact that the Treaty does not include any particular provisions for
financial institutions, the Commission takes into account the special
nature of banks as compared to other undertakings and under certain
circumstances it has been lenient in the application of the rules by
permiting an intervention so as to ‘restore confidence in the banking
sector or to protect the proper functioning of the payment system’.
In
the Solvency Ratio Directive,
which provides the legal framework so as to preserve the stability of the
banking system while at the same time ensures equal competitive conditions
within the Community, is acknowledged that “ in a common banking
market, institutions are required to enter into competition with one
another and… the adoption of common solvency standards in the form of a
minimum ratio will prevent distortions of competition and strengthen the
Community banking system”. Therefore a minimum solvency ratio set by
the EU, does not only portray the starting point of the competition among
credit institutions in the Community, but also is a decisive factor for
the viability of a bank. A State in attempting to restore the viability of
a bank by providing financial aid and ensuring that the required
prudential supervision standards are met, might distort competition and
infringe Art.87 of the Treaty. Especially nowadays that the Economic and
Monetary Union is a reality for most of the Member States, with a single
currency materializing the dream of a single free market without internal
frontiers, a protectionist policy emanating directly by a Member State
will constitute a more severe distortion of competition than ever before.
The
Community, in order both to ensure that the special nature of credit
institutions will be safeguarded while at the same time State Aid rules
will not be infringed, distinguishes between a ‘rescue aid’ and a
‘restructuring aid’. It is important, therefore, for the purposes of
this essay, briefly to elaborate upon the meaning of those terms.
I.
Rescue Aid
The
basic principles about rescue and restructuring aid are incorporated in
the recent “Community Guidelines on State Aid for Rescuing and
Restructuring Firms in Difficulty” published in October 1999, which confirmed and
modified previous versions of it. There, ‘rescue aid’ is defined as, a
by nature temporary assistance authorized for not more than six months,
designed to “keep an ailing firm afloat for the time needed to work
out a restructuring or liquidation plan and/or for the length of time the
Commission needs to be able to reach a decision on that plan.” A
mere injection of capital with the sole purpose to rescue a credit
institution confronting insolvency, without any further plan for a
structural change is usually not permissible by the Commission especially
in such circumstances that the State acts as a ‘lender of last
resort’. Rescue aid may only be allowed if it takes the form of loan
guarantees, repayable loans at market rates of interest or granted to such
institutions situated in regions experiencing economic difficulties.
Additionally, it has to be notified to the Commission ensuring that it
will not have adverse effects on competition and strictly conforming to
the required six months deadline.
II.
Restructuring Aid
On
the other hand, restructuring aid involves “a feasible, coherent and
far-reaching plan to restore a firm’s long-term viability”
involving the reorganization and rationalization of the firm’s
activities on to a more efficient basis as well as, the withdrawal from
loss-making activities. A restructuring aid does not only include
financial restructuring but might imply also physical restructuring. Under
certain circumstances, the Commission might approve restructuring aid, as
far as it is considered to be a contribution to the development of the
economic activities of the Member State rather than resulting to a serious
distortion of competition.
A
restructuring aid shall be limited to the smaller possible duration period
and the Commission is entitled to a close monitoring of the whole
procedure. Additionally, in order to avoid, as far as possible, the
adverse effects that the aid might have on competitors ‘the amount and
the intensity of the aid must be limited to the minimum needed to enable
restructuring’ while aid beneficiaries are expected to contribute
significantly by means of their own resources (elsewhere called the quid
pro quo principle). Furthermore, in order to preclude firms and
undertakings from being unfairly assisted the Commission has favoured the
“one time, last time” condition, according to which, a firm can be
only assisted once.
The guidelines also require that there must be a direct link between the
grant of aid and the operations benefiting from it. The restructuring plan
must be considered capable of putting the enterprise in a position of
covering all its costs, and generating a minimum return on capital such
that, after restructuring is complete, the firm will not require further
aid and will continue to operate in a solvent manner.
In practice, however, failure of a restructuring scheme to restore a bank
to its full operational solvency does not exclude further restructuring
aid.
As
we have already mentioned, whilst the Guidelines are of general
application to all sectors, the Commission takes into consideration the
special nature of credit institutions and has a different approach in
assessing the scope of such aid. This is evident also in the Commission
Decision 95/547/EEC,
whereby the Commission was giving a conditional approval to the aid
granted by France to the bank Crèdit Lyonnais. Therein, one can find
guidelines for the applicability of the State Aid rules to bank. This case
is of seminal importance for state aids in the banking sector and it is
necessary for the purposes of this paper to analyze it further. Before,
doing so, however, we shall first introduce the ‘private investor
test’, which is a test of crucial importance when answering the question
of whether a grant to undertakings by the public sector is caught by Art.
87(1).
III.
The Market Economy Investor Test
In
order to make a distinction between a legitimate state investment in a
credit institution and a capital injection, the Commission adopted the
so-called ‘private investor test’. For this test to be satisfied it
must be demonstrated that a private investor, whose purpose is to profit
in the long run, would have acted in the same way the State did in its
capacity as a shareholder. Furthermore, “a coherent and detailed
restructuring plan must be presented which shows that it can reasonably be
supposed that there will be a normal return on the State’s investment in
the whole operation which would be acceptable to a private investor in a
market economy. Otherwise, there is a State aid component.”
In Re Tubemeuse: Belgium v. Commission case
the ECJ ruled that in order to determine whether measures to increase
capital taken by the State so as to assist a firm facing financial
difficulties are not in the nature of State aid, it has to be demonstrated
that “the undertaking could have obtained the amounts in question on
the capital market”.
In
other words in order to maintain the necessary principle of neutrality,
the aid must be measured as the difference between the terms on which the
funds were made available by the State to the credit institution, and the
terms which a private investor would find acceptable in providing funds to
a comparable institution when he is functioning under normal market
economy conditions.
On
the subject matter, the Commission suggested that, even where national
rules provide for compulsory recapitalization of a bank in difficulty,
such recapitalization would constitute aid if it were not granted under
normal conditions that were acceptable to a private investor in terms of
return. Additionally, in comparing the actions of the State and those of a
market-economy investor, the evaluation of the amount of aid must be based
on a comparison between the cost of the operation and its correctly
discounted value.
IV.
The Credit Lyonnais Case
We
shall now turn and briefly discuss the leading case of Crèdit Lyonnais,
which is yardstick for the purposes of this essay. On the facts of the
case, Credit Lyonnais (thereinafter CL) at the end of 1993 was a leading
European banking group. Its majority shareholder was the French State,
holding 55% of the capital and 76% of the voting rights. After a period of
rapid growth CL recorded very heavy losses in proportion to its own funds
and solvency ratio and in 1995 it was clear that CL would record further
losses threatening its solvency and viability. The French Government in an
attempt to assist the bank put together a rescue package involving the
setting-up of a specific hived-off
vehicle to take over FF 135 billion of assets, including CL’s
non-performing or poorly performing assets. The setting-up of this vehicle
limited the accounting loss for 1994 to FF 12,1 billion. Nevertheless this
was not the only time that the French government financially assisted CL.
We shall not further analyze the facts of the case due to the limited size
of the essay as well as to the complexities they involve.
As
we have already mentioned, whilst the Commission had been assessing the
aid granted by the French government considered the special nature of
banks and applied the guidelines of rescue and restructuring with specific
reference to the banking sector.
It
is noteworthy that during the assessment of the aid it had been
demonstrated that given the circumstances and since CL’s solvency ratio
fell below the minimum, a private investor would have not undertaken an
investment in the bank, mostly because a private investor could have never
mobilized such amounts as to rescue CL.
Also,
the aid has been found to distort competition and effect inter-state trade
because more than half the activities of CL were taking place outside the
local area of France, while the activities located in France, although
spread throughout the country, were concentrated in medium-sized and large
urban areas. Additionally, the aid was not designed to remedy a serious
disturbance in the economy because it was concerned only to remedy the
difficulties of a single recipient, rather than those of all enterprises
in the sector.
However,
it was decided that the financial aid could be compatible with the common
market and therefore not to fall under Art. 92(2) and (3) [now 87(2) &
(3)], if certain conditions were satisfied. Those conditions were that:
1.
the aid must restore the viability of the firm within a reasonable
timescale;
2.
must be in proportion to the restructuring coasts and benefits and
must not exceed what is strictly necessary;
3.
aid measures must have the least distorting effect on competition
possible and the firm must make a significant financial contribution to
the restructuring costs; and
4.
measures must be taken to compensate competitors as far as possible
for the adverse effects of aid.
The
decision in the CL case has been followed by many subsequent cases such as
the Credit Foncier de France
case. There, again the French government was assisting a credit
institution not to be wounded-up. The Commission after examining the
nature of the aid, considered it compatible under certain circumstances.
To
my understanding, even if in both cases, the financial subsidies granted
were deemed to distort competition and inter-State trade and also both
cases failed to satisfy the ‘private investor test’, a very
significant role to the Commission’s ruling played the so-called ‘quid
pro quo’ principle. Accordingly, if major distortion of
competition is unavoidable, substantial compensatory measures must be
required that benefit other operators in the sector in order to mitigate
the harmful effects of the aid.
Conclusion
After
having briefly examined the main principles upon which State intervention,
in the form of financial aid, is being monitored by the Community and
especially by the Commission, there are surely questions that still remain
unanswered. The wording of the Articles of the Treaty is far from explicit
and there is a lot of room for different interpretation. Obviously, even
if in theory there is not any particular provision for the banking sector,
in practice there are some allowances made by the Commission due to the
special nature of the credit institutions. Statistically, State Aid to the
financial sector has increased from an annual average of 1.1 Euro in
1993-1995 to 2.7 billion in 1995-1997, while it is estimated that there
has been a further increase especially after the ruling in the CL case.
However, the increasing demands of a free and
unified European market cannot leave the banking sector in the margin.
While realizing that the stability of banking is of a prominent
significance to the national economy of a Member State, competition policy
compels that institutions which are not capable to survive must fail and
that there is not such a principle as that: it is “too big to fail”. A
Member State is required to restrict the capital injection or any other
financial aid to the minimum especially to undertakings that are not
restrained to the local area of the State but their activities expands to
the whole of the Community. Surely, State aid rules are more lenient as
far as banks are concerned, however, the Commission keeps stressing the
importance of prudential supervision in order to avoid State intervention.
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 ©
Anastasia
Tsakatoura, 22 June 2002. All Rights Reserved.
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