Any direct public support of financial institutions affected by covid-19 has to comply with both State aid rules and the rules of the banking union.
Introduction
The Temporary Framework for State aid to combat covid-19 excludes financial institutions. But it does not mean that banks do not benefit indirectly from State aid granted to other sectors of the economy. This is indeed recognised by the Temporary Framework.
According to section 1 of the Framework[1], “(6) aid granted by Member States under Article 107(3)(b) TFEU under this Communication to undertakings, which is channelled through banks as financial intermediaries, benefits those undertakings directly. Such aid does not have the objective to preserve or restore the viability, liquidity or solvency of banks. Similarly, aid granted by Member States to banks under Article 107(2)(b) TFEU to compensate for direct damage suffered as a result of the COVID-19 outbreak does not have the objective to preserve or restore the viability, liquidity or solvency of an institution or entity. As a result, such aid would not be qualified as extraordinary public financial support under the Directive 2014/59/EU of the European Parliament and of the Council (the BRRD) nor under the Regulation 806/2014 of the European Parliament and of the Council (the SRM Regulation), and would also not be assessed under the State aid rules applicable to the banking sector.” [The BRRD is the bank recovery and resolution directive, while the SRMR is the single resolution mechanism regulation.]
The Temporary Framework goes on to explain that “(7) if due to the COVID-19 outbreak, banks would need extraordinary public financial support (see Article 2(1)(28) BRRD and Article 3(1)(29) SRMR) in the form of liquidity, recapitalisation or impaired asset measure, it will have to be assessed whether the measure meets the conditions of Article 32(4)(d) (i), (ii) or (iii) of the BRRD and Article 18(4)(d)(i), (ii) or (iii) of the SRMR. Where the latter conditions are fulfilled, the bank receiving such extraordinary public financial support would not be deemed to be failing-or-likely-to-fail. To the extent such measures address problems linked to the COVID-19 outbreak, they would be deemed to fall under point 45 of the 2013 Banking Communication, which sets out an exception to the requirement of burden-sharing by shareholders and subordinated creditors.”
Burden-sharing has been one of the corner stones of the State aid framework for banks. Its purpose is to mitigate the risk of moral hazard; i.e. shareholders take extra risk in the expectation that a failing bank will be rescued by the state. For this reason, State aid rules require that before a bank receives State aid, its shareholders and creditors must first suffer losses.
But according to paragraph 7 of the Temporary Framework, it appears that burden-sharing would not be required in case liquidity is provided to a bank to deal with covid-19 related problems.
The burden-sharing or “bail-in” obligation is laid down in points 43 and 44 of the Commission’s 2013 Banking Communication. Point 43 stipulates that “where the capital ratio of the bank … remains above the EU regulatory minimum, … subordinated debt must be converted into equity, in principle before State aid is granted”, while according to point 44 “in cases where the bank no longer meets the minimum regulatory capital requirements, subordinated debt must be converted or written down, in principle before State aid is granted. State aid must not be granted before equity, hybrid capital and subordinated debt have fully contributed to offset any losses.”
Point 45 of the Banking Communication provides that “an exception to the requirements in points 43 and 44 can be made where implementing such measures would endanger financial stability or lead to disproportionate results. This exception could cover cases where the aid amount to be received is small in comparison to the bank’s risk weighted assets and the capital shortfall has been reduced significantly in particular through capital raising measures as set out in point 35 [which identifies various possibilities for raising fresh capital].”
Of the hundreds of cases of State aid to financial institutions during the past decade there has never been a case where the Commission considered that burden-sharing would “endanger financial stability” and only two cases where the Commission accepted that burden-sharing would lead to disproportionate results.
But now, in the context of covid-19, it appears that for the exception in point 45 of the Banking Communication to apply, the liquidity needed to address covid-19 related problems must be “small in comparison to the bank’s risk weighted assets” and any capital shortfall is already “reduced significantly” with capital from private sources.
We will see, however, that in decision SA.57515 approving an Italian measure for liquidity support of banks, the Commission examined the compatibility of the measure with the provisions of the BRRD and the SRMR, but did not explain how the exception in paragraph 45 of the 2013 Communication applied to the Italian measure and why or whether burden-sharing was not necessary.[2] So we are still in the dark on this important issue.
Support for Italian banks during the pandemic
According to the Commission decision “(4) the liquidity support scheme authorizes Italy’s Ministry of Economy and Finance to grant a State guarantee on liabilities of banks having their registered office in Italy and on loans granted discretionarily by the Bank of Italy to Italian banks. The scheme is needed to avoid possible liquidity tensions experienced by Italian banks due to the COVID-19 outbreak.”
The Ministry would grant state guarantees, up to a total amount of EUR 19 billion, covering
- new senior liabilities; and
- emergency liquidity assistance [ELA] provided by the Bank of Italy.
Guarantees must comply with the requirements of Article 32(4)(d) of Directive 2014/59 [the BRRD] and Article 18(4)(d) of Regulation 806/2014 [the SRMR]. In particular, they must
- be limited to solvent institutions;
- be conditional on final approval by the Commission;
- be proportionate to remedy the consequences of the serious disturbance;
- not be used to offset losses incurred by banks.
Beneficiary banks have to pay a guarantee fee calculated in accordance with the Commission’s 2011 Communication on State aid measures to support banks in the context of the financial crisis.
For guarantees with a maturity of less than 12 months, the fee has to be at minimum the sum of a basic fee of 50 bps and a risk-based fee of 20-40 bps, depending on the rating of banks. For guarantees with a maturity exceeding one year, the fee has to be at minimum the sum of a basic fee of 40 bps and a risk-based fee of 40 bps.
Italy made the following commitments [listed in paragraph 16 of the Commission decision]:
- The guarantees will be offered to banks with no capital shortfall.
- The guarantees will be issued only for new senior debt.
- The guarantees will cover only debt instruments with maturities up to five years.
- The minimum level of remuneration will be in line with the formula set out in the 2011 Communication.
- Restructuring plans will be submitted for banks that are granted guarantees on new liabilities or ELA exceeding both a ratio of 5% of total liabilities and the total amount of EUR 500 million;
- Restructuring or wind-down plans will be submitted if a guarantee is called.
- Advertising referring to state support will be banned.
Compatibility with the internal market
The Commission assessed the compatibility of the measure on the basis of Article 107(3)(b) TFEU and under the 2013 Banking Communication.
“(23) For aid to be compatible under Article 107(3)(b) TFEU, it must comply with the general principles of compatibility under Article 107(3) TFEU, viewed in the light of the general objectives of the Treaty. Therefore, according to the Commission’s case practice any aid or scheme must comply with the following conditions: (i) appropriateness, (ii) necessity and (iii) proportionality.”
Appropriateness
“(25) The Scheme should be appropriate to remedy a serious disturbance in the Italian economy. The objective of the Scheme is to temporarily establish a backstop for the financial system in a timely and efficient manner, where banks could face difficulties in obtaining sufficient funding. The Commission observes that the measures to contain the COVID-19 outbreak have significantly affected the creditworthiness of borrowers and that this at some stage might in turn erode the confidence in the banking sector, which may result in difficulties in obtaining necessary funding on the financial markets. Hence, the measure is a precautionary State-supported backstop mechanism for possible sudden liquidity needs subsequent to the deterioration of the creditworthiness of banks’ borrowers and to the lack of trust in the financial sector. It therefore is an appropriate means to avoid problems at the level of the banks as well as to maintain market confidence.”
“(26) Points 23 and 60(a) of the 2013 Banking Communication explain that guarantee schemes will continue to be available in order to provide liquidity to banks but that such schemes should be limited to banks without a capital shortfall.”
“(28) The Commission notes that Italy has committed to grant guarantees only for new issues of banks’ senior debt, as prescribed in point 59(a) of the 2013 Banking Communication.”
Necessity
“(29) With regard to the scope of the measure, the Commission notes positively that Italy has limited the size of the Scheme by setting its maximum budget at EUR 19 billion and that the Scheme applies only until 20 May 2021. While according to point 57 of the 2013 Banking Communication the Commission normally approves guarantee schemes for a maximum period of six months, the additional duration of the Scheme, on top of the six-month period from 20 November 2020 until 20 May 2021, is limited to the short period between the adoption date of the present decision and 20 November 2020. Such additional period of less than two weeks is minimal and therefore justified especially in view of the exceptional market turbulences in the Italian economy during the COVID-19 outbreak.”
“(30) The Commission notes that Italy has committed to grant guarantees only on debt instruments with maturities from three months to five years (seven years in case of covered bonds) and limit guarantees with a maturity of more than three years to one third of the outstanding guarantees granted to the individual bank, which complies with the requirements in points 59(b) and 60(b) of the 2013 Banking Communication.”
“(31) Regarding the remuneration, the Commission observes that Italy, in line with point 59(c) of the 2013 Banking Communication, has committed to follow the pricing and other conditions for State guarantees laid down in the 2011 Prolongation Communication, which requires, in particular, the application of a pricing method based largely on market data. The Commission further observes that the same pricing method will also be used in case of a State guarantee on ELA. As such, given that the additional remuneration requested for the guarantee makes the liquidity provided by the central bank more expensive, the bank has a sufficient incentive to avoid relying on that source of funding for developing its lending activities. Therefore, the measure does not encourage the bank to obtain excess liquidity, which could be used to finance lending activities, thus distorting competition.”
Proportionality
“(32) As regards proportionality, the Commission notes, first, that Italy, in line with point 59(d) of the 2013 Banking Communication, has committed to submit a restructuring plan within two months for any bank granted guarantees on new liabilities or on renewed liabilities or on ELA for which, at the time of the granting of the new guarantee, the total outstanding state -guaranteed liabilities (including guarantees accorded before the date of the decision) exceed both a ratio of 5% of the bank’s total liabilities and a total amount of EUR 500 million. That commitment ensures that the use of the Scheme will not enable banks with structural weaknesses in their business models to postpone or avoid the necessary adjustments.”
(33) Furthermore, as described in recital (15), the Commission notes positively that Article 3(1) of the 2016 Decree Law, which also applies to the present Scheme, limits the amount of the guarantee granted to what is necessary to restore beneficiary banks’ capacity to fund themselves in the medium to long term. Moreover, Italy has declared that the amount of liquidity support should be sufficient to maintain/restore liquidity position of the bank with reference to the counterbalancing capacity expected under the different stress scenarios.”
“(34) Secondly, the Commission notes that Italy has committed, in line with point 59(f) of the 2013 Banking Communication, to impose on beneficiary banks a number of behavioural safeguards such as a ban on advertisements referring to the State support and a ban on any aggressive commercial strategies which would not take place without the State support.”
“(35) Thirdly, the Commission welcomes that Italy undertakes to submit individual restructuring or wind-down plans, within two months, for banks, which cause the guarantee to be called upon, in line with point 59(e) of the 2013 Banking Communication.”
On the basis of the above, the Commission found the measure compatible with the internal market.
Compliance with the intrinsically linked provisions of Directive 2014/59 [BRRD] and of Regulation 806/2014 [SRMR]
In addition, the Commission examined whether the measure violated indissolubly linked provisions of the BRRD.
“(40) That obligation is in line with the jurisprudence of the Union Courts, which have consistently held ‘that those aspects of aid which contravene specific provisions TFEU other than [Articles 107 and 108 TFEU] may be so indissolubly linked to the object of the aid that it is impossible to evaluate them separately so that their effect on the compatibility or incompatibility of the aid viewed as a whole must therefore of necessity be determined in the light of the procedure prescribed in [Article 108]’” [At this point the Commission cited case C-74/76, Ianelli v Meroni, para 14].
“(41) Without prejudice to the possible application of the BRRD and of Regulation (EU) 806/2014 on the Single Resolution Mechanism (“SRMR”), in the event that the institution benefiting from liquidity support meets the condition for the application of that Directive or of that Regulation, the Commission notes that the measure does not violate intrinsically linked provisions of the BRRD and of the SRMR, namely Articles 32(4)(d)(i) and (ii) BRRD, and 18(4)(d)(i) and (ii) SRMR, respectively.”
“(42) The first subparagraph of Article 32(4)(d) BRRD and of Article 18(4) SRMR establish that an institution shall be deemed to be failing or likely to fail where, inter alia, extraordinary public financial support is required, except when, in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability, the extraordinary public financial support takes the form, inter alia, of a State guarantee of newly issued liabilities or a State guarantee to back liquidity facilities provided by central banks according to central banks conditions.”
“(43) The second subparagraph of Article 32(4) BRRD and of Article 18(4) SRMR provides that in order not to trigger resolution such State guarantees on newly issued liabilities or liquidity facilities must be confined to solvent institutions and must be conditional on final approval under the Union State aid framework. Those measures must be of a precautionary and temporary nature and must be proportionate to remedy the consequences of the serious disturbance and must not be used to offset losses that the institution has incurred or is likely to incur in the near future.”
“(44) The Commission notes that the Scheme is limited to solvent institutions (see recital (8)). Moreover, the guarantees granted under the Scheme are of a temporary nature since the window of their issuance is limited and their maturity is limited to three years (see recital (7)) and are of a precautionary nature since they only cover newly issued liabilities (see recital (7)). The guarantees granted are also proportionate to remedy the consequences of the serious disturbance in the Italian economy as explained in recitals (32) to (35).”
“(45) Therefore, at the present stage, the Commission concludes that the aid measures do not seem to violate neither the intrinsically linked provisions of the BRRD nor of the SRMR. The scheme is in compliance with the requirements of Article 32(4) BRRD and of Article 18(4) SRMR, and they are apt to remedy the consequences of the serious disturbance in the Italian economy.”
The overall conclusion was that the aid was compatible with the internal market on the basis of Article 107(3)(b) TFEU.
[1] The consolidated version of the Temporary Framework, after its 5th amendment on 28 January 2021, can be accessed at:
[2] The full text of the Commission decision can be accessed at:
https://ec.europa.eu/competition/state_aid/cases1/202051/287680_2223630_98_2.pdf
Photo by on Pixabay
