State aid for banks can be granted without triggering resolution in cases of precautionary recapitalisation and liquidation.
A primary objective of the European response to the financial crisis was to sever the link between troubled banks and indebted sovereign. The principle now is that if a bank needs money to meet the capital adequacy ratio required by banking regulation, it should get it from private investors, otherwise it should be “resolved” or closed down.
The banking rules that were adopted in 2014 empower both EU and national regulators to force the “resolution” of banks. When a bank is resolved, shareholders and other creditors must contribute first and only if there is a need for more money, then the EU’s nascent Single Resolution Fund [SRF] or the national resolution funds can provide assistance. Support from the sovereign (i.e. the state) in the form of State aid can only be given if all the other options are exhausted. Therefore it should be an exception.
Moreover, the SRF and the national funds are gradually capitalised with payments made by the banks themselves. This capitalisation process will be completed in 2024. So far, the SRF has accumulated about EUR 18 billion that it can inject in systemic banks whose critical functions need to be maintained for the broader public interest.
These regulatory developments imply that the use of taxpayers money to bail out banks should be a thing of the past and State aid should be rather exceptional. However, three recent cases have shown that there are exceptions to the exceptional nature of State aid for banks.
The European Commission’s 2013 Banking Communication makes the approval of State aid to banks conditional on “burden-sharing”. Burden-sharing is another term for the “bailing-in” of shareholders and creditors. Burden-sharing serves three purposes. First, on an ex ante basis it seeks to prevent moral hazard by discouraging excessive risk-taking by investors. When investors believe that in case of trouble they will be bailed-out by the state, they reap the profits in good times but taxpayers bear the costs in bad times.
Second, on an ex post basis it aims to reduce the liabilities of banks. In practice the reduction of liabilities is achieved by writing-off capital or converting shares to a lower denomination or converting debt to equity.
Third, the requirement for burden-sharing also aims to harmonise the conditions for bank restructuring across Member States and prevent distortions to competition from the eagerness or financial ability of some national authorities to bail-out failing banks. If some Member States are more willing or able to rescue banks, then banks have an incentive to locate in jurisdictions which treat them more favourably.
Paragraph 19 of the Banking Communication states:
“Before granting any kind of restructuring aid, be it a recapitalisation or impaired asset measure, to a bank all capital generating measures including the conversion of junior debt should be exhausted, provided that fundamental rights are respected and financial stability is not put at risk. […] Therefore, before granting restructuring aid to a bank Member States will need to ensure that the bank’s shareholders and junior capital holders arrange for the required contribution or establish the necessary legal framework for obtaining such contributions.”
Paragraph 44 also explicitly states that:
“State aid must not be granted before equity, hybrid capital and subordinated debt have fully contributed to offset any losses.”
The only exception is laid down in paragraph 45 when burden-sharing “would endanger financial stability or lead to disproportionate results.” So far, the Commission has not approved any exception to burden-sharing on the grounds that it would harm financial stability or lead to disproportionate results. The Communication does not explain how results can be disproportionate and in relation to whom. However, given that the provision in paragraph 45 constitutes an exception to the principle of burden-sharing, it must refer to shareholders and junior creditors and must mean that the extent to which they are bailed-in can be reduced if the cost they bear is excessive in relation to other creditors.
Indeed, those who do not have to be bailed-in are the depositors, both “covered” [i.e. with deposits up to EUR 100,000] and “not covered” [i.e. with deposits exceeding EUR 100,000] and senior creditors. Paragraph 42 of the Banking Communication explicitly states that “the Commission will not require contribution from senior debt holders (in particular from insured deposits, uninsured deposits, bonds and all other senior debt) as a mandatory component of burden-sharing under State aid rules”.
Since the Communication currently excludes senior creditors from burden-sharing, perhaps at some point in the future, and as the principle that State aid is exceptional becomes well-established, the Commission may consider that senior creditors may also have to bear part of the burden, especially in view of the fact that, as will be shown below, EU banking rules provide for the bailing-in of senior creditors. I will return to this issue at the end of this article.
The Banking Communication has also defined the principle that no creditor becomes worse off in resolution than insolvency. This implies that by being bailed-in, creditors do not lose more money than if the bank is restructured or does not receive State aid. Therefore, the condition that state aid goes hand-in-hand with burden-sharing may in fact be to the benefit of creditors when the alternative is plain bankruptcy and larger losses.
Paragraph 41 defines the sequencing of burden-sharing: “Adequate burden-sharing will normally entail, after losses are first absorbed by equity, contributions by hybrid capital holders and subordinated debt holders.”
State aid is also allowed when a bank is liquidated or placed in an insolvency procedure. However, in this case too, State aid may be granted only after shareholders and junior creditors have been bailed-in [paragraph 66 of the Banking Communication]. In addition, when assets of a failing bank are sold to another bank, the claims of shareholders and subordinated debt holders may not be transferred to the new owner [paragraph 77]. In order to prevent any aid from going to buyers of assets of failing banks, the Banking Communication requires that asset sales are carried out through competitive procedures [paragraph 77]. Otherwise, buyers are presumed to receive aid whose compatibility with the internal market has to be assessed separately.
Since the beginning of 2016, when the Commission assesses State aid to banks, it also examines whether the aid conforms with the provisions of the regulation that established the “single resolution mechanism” [SRM] [Regulation 806/2014] and the directive on banking recovery and resolution [BRRD] [Directive 2014/54].
Under the SRMR/BRRD, a failing bank should in principle be liquidated under normal insolvency procedures, except in cases where the SRB considers that it is in the public interest to resolve or restructure the bank because liquidation could jeopardise financial stability.
Resolution is the restructuring, break-up or orderly winding down of a bank for the purpose of safeguarding public interest in two ways: preventing disruption to the financial system and minimising the cost to taxpayers. In fact, the bail-in requirements of the SRM and of the BRRD are more demanding than those of the 2013 Banking Communication. In theory, they restrict more than the Communication of the possible amount of State aid.
The SRM regulation created a single resolution fund [SRF] for Member States in the Eurozone, while the BRR Directive obliges all Member States to create national resolution funds. All such funds are gradually capitalised by contributions by banks themselves in proportion to their size. As mentioned earlier, the SRF has accumulated close to EUR 18 billion so far.
The SRM makes State aid “exceptional”
The independent Single Resolution Board is responsible for the management of the SRF and the implementation of resolution plans. After the regulatory arm of the European Central Banking declares a bank to be “failing” or “likely to fail”, the SRB decides whether resolution is in the public interest [Article 18 of the SRMR]. Resolution is in the public interest if it is necessary to ensure continuity of a bank’s “critical functions” so as to preserve financial stability by, for example, preventing the collapse of a bank from causing losses on other banks [Article 14 of the SRMR].
If a failing bank is not likely to harm financial stability, then it is placed in insolvency for the purpose of closing it down. That is, resolution is the exception to insolvency. Since there are no European insolvency rules, the liquidation or closure of a bank is carried out according to the respective national rules.
In contrast to the 2013 Banking Communication, Article 27 of the SRMR exempts from burden-sharing only covered depositors and secured bond holders. In other words, the SRMR can bail-in uncovered depositors and senior bondholders. The same Article requires that creditors absorb at least 8% of liabilities before any aid is granted by the SRF. Moreover, the SRMR also imposes a limit of 5% of liabilities on the contribution by the SRF. Only after the contribution of the SRF may State aid be granted.
In the terminology of the SRMR State aid is called “extraordinary public financial support”. Indeed, according to Article 14, an objective of the resolution is to minimise “extraordinary public financial support” and the use of taxpayers’ money.
The Annex shows the decision-making procedure for precautionary recapitalisation, normal resolution and liquidation of banks.
Both the SRMR and the BRRD require the SRB and the national resolution authorities to obtain the consent of the Commission with respect to any resolution decision. At the same time, the Commission also retains its exclusive prerogative of assessing and authorising State aid, including any assistance from the SRF, regardless of the fact that the granting authority, i.e. the SRB, is a European institution. If a bank under resolution is sold to another bank and their combined turnover exceeds the thresholds of the EU’s merger regulation [the threshold of which is combined turnover over EUR 5 billion], then the Commission will also have to assess the acquisition under the provisions of that regulation [but it would be very unlikely that the Commission would consider that the acquiring bank would increase its market power by buying a failing bank]. Hence, the Commission looks at the same bank wearing different hats and from different perspectives, but always wielding considerable power.
It follows that the combination of wider burden-sharing under the SRMR/BRRD and the possibility of assistance from the SRF/national resolution funds make the granting of State aid highly unlikely or “extraordinary”.
Nevertheless, in June 2017, the recapitalisation of the Italian Monte dei Paschi di Siena and the liquidation of the also Italian Veneto Banca and Banca Popolare di Vicenza showed that there are exceptions to the exceptional nature of State aid.
Exceptions to the exceptional nature of State aid
Monte dei Paschi di Siena was in principle solvent [i.e. not “failing or likely to fail”] and therefore it was not placed in resolution. Its recapitalisation was a precautionary measure allowed by the SRMR. Although Monte dei Paschi di Siena had sufficient capital, it could fall below the minimum statutory ratio in the case of an adverse scenario; i.e. when one or more exceptional events would occur. Under the SRMR, a bank can be recapitalised as a precautionary move without having to be resolved or receive assistance from the SRF. Recital 57 of the SRMR states that “the provision of extraordinary public financial support should not trigger resolution where, as a precautionary measure, a Member State takes an equity stake in an entity.” However, compliance with State aid rules and, consequently, burden-sharing, are still necessary. An injection of EUR 5.4 billion by the Italian state was found by the Commission to be State aid in the meaning of Article 107(1) TFEU. The Commission concluded that the aid was compatible with the internal market [SA.47677].
Shareholders and subordinate bondholders were bailed-in. Equity was written down and bonds were converted to equity. In addition, private investors had committed to purchase the bank’s non-performing loan portfolio amounting to EUR 26 billion.
The other two Italian banks were considered by the SRB on 23 June 2017 not to be “systemically important”. Their failure would not cause financial instability. Consequently, they had no critical functions that had to be preserved in the public interest.
The two banks ceased to have any systemic significance because when their financial troubles began they shrunk in size as depositors took their money to other banks and companies sought loans from other banks too.
The SRB concluded that normal insolvency procedures would achieve the same results as resolution in protecting covered depositors and other customers. Therefore, no resolution was implemented by the SRB because it was neither in the public interest, nor the most effective instrument.
Although the two banks did not receive any assistance from the SRF, they did obtain a large amount of State aid – close to EUR 17 billion – in order to enable the transfer of performing assets, deposits and employees to another bank that was chosen via a competitive procedure.
The Commission approved the State aid [SA.45664] and its press release of 25 June 2017 explained that “Italy has determined that the winding up of these banks has a serious impact on the real economy in the regions where they are most active. Outside the European banking resolution framework, EU rules foresee a possibility for Italy to seek Commission approval for the use of national funds to facilitate the liquidation by mitigating such regional economic effects. As the aided banks exit the market there should be no distortion of competition in European banking markets.”
However, it is not clear how the Commission approved the aid, given that the legal basis for State aid to banks is Article 107(3)(b) which allows aid for the purpose of remedying a “serious disturbance in the economy of a Member State”. This has been interpreted in the case law to mean a disturbance that affects the whole economy, not just a region or sector.
Resolution without State aid
By contrast, on 7 June 2017, the SRB decided that the resolution of Banco Popular Español was in the public interest, after the ECB declared it to be failing. The resolution plan entailed the transfer of all shares and capital instruments of Banco Popular to Banco Santander which paid a mere EUR 1. This meant that Banco Popular continued to operate under normal business conditions as a solvent and liquid member of the Santander Group.
Although, shareholders were bailed-in through a write-down of capital, the Banco Popular received neither assistance from the SRF, nor State aid.
It should also be noted that, while on 7 June 2017, the Commission approved the resolution plan as provided by the SRMR, on 8 August 2017, it also approved the sale of Banco Popular to Banco Santander under the EU merger regulation [Regulation 139/2004].
Two conclusions should be drawn from these recent cases. First, the objective of severing the link between banks and the sovereign is pursued more vigorously in the case of normal resolution than in the case of liquidation.
Second, precautionary recapitalisation also allows for State aid without triggering assistance by the SRF or national resolution funds.
State aid for banks is not a thing of the past.
The SRB decisions concerning the Spanish Banco Popular and the Italian Veneto Banca and Banca Popolare di Vicenza were the first ever measures adopted by the SRB on the basis of the SRMR.
On 8 August 2017, the “Financial Times” published an interview with Elke König, the Chair of the SRB. In the interview she was reported to have said that “state aid guidelines adopted by the European Commission in 2013 were in effect out of date”. She was in favour of revision of the Banking Communication in order to close the “loopholes” that allowed aid for liquidation.
But there is a weakness in both the SRMR and the Banking Communication. On the one hand, the SRMR allows liquidation to be carried out under national rules. This the correct approach, given that the EU has no specific rules or procedures on insolvency. But if the liabilities which are bailed-in are not enough, then there seems to be no reason why the SRF should not make a contribution before State aid is granted. This would further de-link bank debt from sovereign debt. A revision of the SRMR may also be necessary.
On the other hand, the 2013 Banking Communication is more lenient towards creditors than the SRMR or the BRRD. The SRMR and the BRRD can bail-in senior bondholders and uncovered depositors. Perhaps the time has come for the Banking Communication to require senior bondholders to share the pain too before permitting Member States to tap into taxpayers’ money.
Decision-making procedure for resolution, precautionary recapitalisation or liquidation of banks
 The Commission’s Communication on State aid to banks of 30/7/2013 can be accessed at:
 The Commission press release on Monte dei Paschi di Siena can be accessed at:
 Summaries of the two SRB decisions can be accessed at:
 The Commission press release can be accessed at:
 See the landmark judgment in cases T-132/96 and T-143/96, Freistaat Sachsen and Volkswagen v Commission, par. 167.
 The SRB decision can be accessed at:
 See the Commission press release summarising the main points of its approval under the merger regulation:
 Financial Times, Tighter EU curbs urged on winding down banks, 8 August 2017. The article can be accessed at: https://www.ft.com/content/545c1790-7b7f-11e7-ab01-a13271d1ee9c#myft:saved-articles:page.