1. Why does the use of funds from the Italian mandatory deposit guarantee scheme to support Banca Tercas amount to incompatible state aid?
Deposit guarantee schemes are required under EU law to ensure that covered depositors are paid out when a bank is liquidated and exits the market – this does not raise any state aid issues. However, if a mandatory deposit guarantee scheme intervenes beyond this pay-out function to depositors to support ailing banks themselves, EU state aid rules may apply.
This is because funds from private sources are state aid,if they come under public control before they are granted to a specific company, and the decision to do so can be attributed to the State. This is an established principle under EU case law. There is also a simple underlying logic – EU state aid control and the safeguards it provides for taxpayers and fair competition could otherwise be easily circumvented.
Importantly, if funds are state aid they can still be used to support an ailing bank, provided that the measures comply with the conditions of EU state aid rules and the BRRD. The Commission previously approved interventions by mandatory deposit guarantee schemes in a number of cases in Italy, Spain and Poland.
In the case of Banca Tercas, following an in-depth probe, the Commission concluded that the intervention of the Fondo Interbancario di Tutela dei Depositi (FITD) involves state aid to Banca Tercas, giving it an advantage its competitors did not have, because:
- The State has control over the funds – FITD is financed by levies from private banks, which are obliged under national law to contribute. Membership in FITD and contribution to its intervention is mandatory for Italian commercial banks.
- The decision to support Banca Tercas can be attributed to the State – FITD has apublic policy mandate and through its governance framework is controlled by the State. The decision to grant the aid was explicitly approved by the Bank of Italy.
Based on the facts and the circumstances at hand, the aid measures for Banca Tercas could not be found compatible with EU state aid rules, because Italy did not present any restructuring plan, burden-sharing principles were not respected and distortions of competition resulting from the aid were not sufficiently limited.
2. How can a failing bank be supported?
More stringent capital and liquidity requirements for banks and other credit institutions under the Capital requirement regulation and directive are meant to reduce the risk that banks get into difficulties in the first place.
However, in the event they do:
- If other banks themselves decide to intervene in a fully private mechanism, this falls outside the scope of EU state aid control.
- EU rules also provide for different tools for Member States to address bank failures and maintain financial stability. It is for the national resolution authority to decide which tools to use (for the Euro area as of 1 January 2016, the Single Resolution Board). The Commission’s role in this context is to make sure that any measures taken by national authorities are in line with EU rules.
a) State aid free – "private solution"
If banks themselves choose to set up a fully private mechanism, meaning that funds are used, which were contributed voluntarily by the private sector and without any interference from the State, there are no state aid issues. This solution falls outside the scope of EU state aid control.
For example, in the case of Banca Tercas, it appears that the FITD has now asked its members whether they would step in by supporting Banca Tercas on a voluntary basis and without involvement by the Italian authorities. In such circumstances, such funds would not be considered state aid to Banca Tercas.
b) State aid compliant solution
If state support is necessary, the responsible resolution authority has to decide whether to liquidate a failing bank under applicable insolvency procedures or whether it is in the public interest to resolve the bank.
Any state aid granted has to be in line with EU state aid rules and the BRRD, regardless of whether the funds come from the national resolution fund, the deposit guarantee scheme or by direct intervention of the State.
3. What does it mean to put a bank into resolution?
To put a bank into 'resolution' means that a resolution authority will restructure a bank, using resolution tools under the BRRD. The purpose is to ensure that its critical functions continue, financial stability is preserved and the viability of all or part of the bank is restored, while the remaining parts are put into normal insolvency proceedings. The objective of resolution is to minimise the extent to which the cost of a bank failure is borne by the State and its taxpayers.
Resolution does not generally require the entire bank to be put into liquidation; it simply separates the viable part from the part that should be wound-down. The viable part is restructured and either continues its operations as a core bank (for example in the recent case of MKB in Hungary) or is sold to a healthy bank (for example in the recent case of Banif in Portugal). Only if this is not possible, the entire bank is wound-down and exits the market in an orderly fashion. (More information in the Factsheet on the BRRD)
4. What is the reasoning behind burden-sharing / bail-in principles?
Repeated bailouts of banks have increased public debt and imposed a very heavy burden on taxpayers and public finances, contributing to the sovereign crisis. The approved state aid measures in the form of recapitalisations and asset relief measures between October 2008 and December 2012 amount to €591.9 billion or 4.6% of EU 2012 GDP.
Burden-sharing and bail-in further protect the taxpayers and public budgets, contributing to breaking the negative loop between the sovereign and the banks, addressing moral hazard and maintaining the level playing field in internal market. It makes sure that those who also stood to benefit from their investments, i.e. the bank's owners and creditors, bear the losses if they materialise – public support comes as a last resort. Customer deposits under €100 000 remain fully protected at all times.
5. What if investors did not know they were investing in financial instruments that were subject to bail-in?
All investors, and especially retail investors, should be adequately informed about potential risks when they decide to invest in a financial instrument. The EU Markets in Financial Instruments Directive (MiFID 1) requires investment firms to provide clients with information about financial instruments including appropriate guidance on and warnings of the risks so that they are able to understand the nature and risks of the investment service and of the specific type of financial instrument. All information, addressed by the investment firm to clients should be fair, clear and not misleading. The MiFID Implementing Directive sets out in greater detail the information required for 'retail clients', or consumers, so they can enjoy a higher level of protection. The EU rules were implemented into national law in all 28 EU countries, and have to be followed by the banks and their managers under the control of the responsible supervisory and market authorities.
It is primarily the responsibility of each Member State to enforce the rules if they are broken. In specific cases, a Member State can decide to set up an arbitration mechanism to enable retail customers to claim compensation from the relevant banks for potential mis-selling of bonds in line with State aid rules.
6. What about Member State interventions in the form of asset management companies (so-called “bad banks”)?
Bad banks can be created with the use of state aid or without state aid. The choice of the type of intervention lies with the Member State.
Without state aid - If a Member State chooses to intervene in a bank as a private investor would do, then such an intervention would not constitute state aid. The measure is both state aid free, if the bad bank is set-up in a way that does not involve public funds, or, if the bad bank is supported by public funds, the loans have to be transferred at market prices (i.e. prices corresponding to what a private investor would ask for). The aim in both cases is to ensure that the State does not bear any more risk than a private investor would have taken and paid for.
With state aid - If, conversely, assets are transferred at above market prices to the bad bank, then they constitute state aid and can only be implemented if the bank is put into resolution, in compliance with State aid and relevant BRRD requirements. It is possible to set up "individual" bad banks to deal with non-performing loans of a single bank or a limited number of banks (for example recently in the cases MKB in Hungary and Banca Marche, Banca Etruria, Carife and Carichieti in Italy) or to set up systemic bad banks (for example in Spain, SAREB, or in Ireland, NAMA).
7. Why do we need state aid control for the financial sector?
State aid to banks, as to any other company, can seriously distort competition. In the context of the financial crisis the European Commission adopted specific rules for the financial sector on the basis that aid should be exceptionally allowed to prevent a collapse of the banking sector and remedy serious disturbances in the economy of a Member State.
EU state aid rules therefore strike a balance – they enable Member States to intervene to support a bank in difficulty but make sure that (1) the amount of public money used is limited, (2) that it is put to good use to avoid a need for further state aid, and (3) that competition distortions are limited. In particular, state aid can only be allowed if:
- The use of taxpayer money is limited through appropriate burden-sharing measures – this requires the bank, its owners and creditors contribute to the cost of the bank failure before the taxpayer can be exposed;
- Banks undergo the necessary in-depth restructuring to return to long-term viability without further need for state support on the basis of a restructuring plan, or - if this is not possible – are wound down and exit the market in an orderly fashion;
- Distortions of competition are limited through proportionate remedies - Giving state aid to a particular bank distorts competition, as it gives the bank an advantage over its competitors, which needs to be balanced out by ordering the bank to close or sell parts of their businesses or ensuring that they do not use the aid to undercut their competitors.
8. Which state aid rules apply to the Commission's assessment?
This depends on when the measure was notified to the Commission by the Member State. EU state aid rules were updated a number of times, in consultation with all EU Member States, to adapt to the evolution of the financial crisis and reflect lessons learnt.
Between 13 October 2008 and 31 July 2013 – In 2008-2009, the Commission adopted a comprehensive framework for state aid to the financial sector during the crisis. These comprise the 2008 Banking Communication, the Recapitalisation Communication, the Impaired Assets Communication, the Restructuring Communication, as well as the Prolongation Communication of 2010 and of 2011. Given the need to act quickly and the great uncertainty regarding the banks' problems in the initial stages of the crisis, the Commission allowed for "rescue aid", i.e. aid could be approved on a temporary basis while a restructuring plan had to be submitted within 6 months for subsequent, final approval by the Commission.
From 1 August 2013 - The Commission adopted a new Banking Communication (see also Memo, full text here), which came into effect on 1 August and continues to be in force. It replaces the 2008 Banking Communication and supplements the remaining crisis rules (in particular the Recapitalisation Communication, the Impaired Assets Communication and the Restructuring Communication). Most importantly, these rules introduced a more effective restructuring process for aided banks and strengthened burden-sharing requirements, asking shareholders and sub-ordinated debtholders to contribute before aid could be granted (see further Question 3). Aid can no longer be approved on a temporary basis, as difficulties for banks should now be better anticipated by the relevant competent authorities, through strengthened supervision, including for example through asset quality reviews and stress tests.
From 1 January 2015 – The Bank Resolution and Recovery Directive (BRRD) entered into force, according to which the default option for failing banks is to go into normal insolvency proceedings. Only if the resolution authority decides that it is in the public interest to do so, they can be resolved in line with the provisions of the BRRD. State aid to failing banks notified to the Commission after 1 January 2015 can only be granted if the bank is put into resolution, in compliance with the provisions of the BRRD in addition to EU state aid rules. The only exception is a so-called "precautionary recapitalisation", allowing state aid outside of resolution in narrowly defined circumstances.
From 1 January 2016 - The bail-in requirements under the BRRD enter into force in all Member States (unless already in force in countries which implemented early). Any state aid notified to the Commission after this date that triggers resolution under the BRRD can only be approved subject to bail-in of at least 8% of the bank's total liabilities, which may require also converting senior debt and uncovered deposits.