Transcript Economic Analysis of State Aid Recent Developments

Bank Restructuring Aid
Economic and Policy Analysis
Dr. Lorenzo Coppi
Presentation to the Dutch
Association of Competition Lawyers
Amsterdam, 7 October 2009
Outline
• The financial crisis and the European Commission’s response: the
Restructuring Communication
• The inadequacy of the standard Rescue and Restructuring
framework for assessing Art 87(3)(b) aid
• An alternative framework: the Balancing Test
– Rationale and benefit of the aid
– Proportionality principle and distinction between structurally sound and
unsound banks
– Distortions of competitions
• The implications for compensatory measures
• Conclusions
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The financial crisis
European TED Spread
350
TARP voted
dow n in US
Senate
300
Bear Sterns
collapses
Northern Rock
nationalised
AIG, WaMu,
Fortis, Glitnir
collapse
Guarantees,
Recapitalisations,
Impaired asset
schemes
Lehm an
Bros
collapses
200
Record w ritedow ns
em erge
150
Fannie Mae
and
Freddie Mac
nationalised
ECB injects liquidity
in m oney m arkets
100
50
3
Jul 09
May 09
Mar 09
Jan 09
Nov 08
Sep 08
Jul 08
May 08
Mar 08
Jan 08
Nov 07
Sep 07
Jul 07
May 07
Mar 07
Jan 07
Nov 06
Sep 06
Jul 06
May 06
Mar 06
0
Jan 06
Basis Points
250
State
Interventions:
The Commission’s response to the financial crisis
• Initial Commission’s response within the standard framework of Rescue and
Restructuring Aid
– Northern Rock (UK), Bradford & Bingley (UK)
– Sachsen LB (DE), IKB (DE), WestLB (DE), Bayern LB (DE), Roskilde (DK)
• After late September 2008 aid approved under the hardly ever used framework of a
serious disturbance to the economy under Art. 87(3)(b)
– Emergency measure, fairly flexible approach
– Various types of aid allowed: loan guarantees, recapitalization, purchase of distressed assets
• Guidance by the Commission
– October 2008: the Banking Communication set out the main principles
– December 2008: the Recapitalisation Communication better specified the rules
– February 2009: the Impaired Assets Communication listed a series of requirements for the
Member States’ asset purchase schemes
– July 2009: the Restructuring Communication discusses restructuring of “structurally unsound”
banks
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The Restructuring Communication
• The Restructuring Communication lays out the Commission’s approach to
evaluating aid given during the financial crisis
• It distinguishes between “structurally sound” and “unsound” banks and it
requires a Restructuring Plan for structurally unsound banks
– banks deemed “unsound” if state guarantees triggered, or
– if they received aid for more than 2% of their capital
• As part of the Restructuring Plan, the Commission requires substantial
compensatory measures, often including significant asset sales
• Key question: how should the Restructuring Communication be applied in
practice?
– To maintain consistency with the general State aid framework enunciated in the
Commission’s Common Principles paper
– To achieve the goal of the aid and remedy a serious disturbance in the economy …
– … While minimising distortions of competition and helping prevent a similar crisis in the
future
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The inadequacy of the R&R aid framework
• Aid given under Art. 87(3)(b) is inherently different from the standard R&R
aid under Art. 87(3)(c), and should be analysed differently
– R&R aid helps keep in business firms that have been unable to survive under normal
market circumstances
– Aid given to remedy a “significant disturbance in the economy” is primarily seeking to
return a market affected by a series of market failures to its efficient state
– The problem is systemic, not specific to any individual firm (though some may be
faring worse than others)
• Aid under Art. 87(3)(b) should be evaluated using the Balancing Test
– Weigh the costs of the aid in terms of market distortions against the benefits in terms
of financial stability
– Three-step test identified in the Commission’s Common Principle paper
- Is the aid aimed at well-defined objective of common interest?
- Is the aid well designed to deliver the objective of common interest?
- Are distortions of competition and trade limited?
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Step 1 of the Balancing Test
The goal of the aid: remedying a serious disturbance
• Avoid a collapse of the financial system
– Banks are particularly vulnerable as they face several types of risk (solvency risk;
liquidity risk; contagion risk)
– The failure of one bank at the centre of the payments system can bring about a
domino effect on others
– Bank crises are extremely costly for the economy
• Return a market affected by a series of market failures to its efficient state
– Various market failures at the root of the crisis (mispricing of risk, unrealistic
expectations, asset price bubbles, and moral hazard followed by panic)
– “Lemons problem” caused by asymmetric information
– Resulted in the seizure of various securities and interbank markets and in market
prices not reflecting the fair economic value of assets
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Step 2 of the Balancing Test
Applying the proportionality principle
• Instead of distinguishing between “good banks” and “bad banks”, the
Commission should distinguish between “good aid” and “bad aid”
• Separate the State funding into
– Non-aid (using the Market Economy Investor Principle)
– Aid proportionate to remedying the market failures that led to the financial crisis
– Additional aid necessary to avoid a systemic crisis
• Aid proportionate to remedying market failures is “good aid”
– Banks that received only proportionate aid should be considered “structurally sound”
• Additional aid may result in distortions of competition and needs to be
assessed more rigorously
– This covers losses which would have materialised even in the absence of market
failures
– Banks that received also additional aid are not “structurally sound”
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Separating proportionate aid from additional aid
A structurally sound bank
Before the crisis
Assets
€100
Liabilities
€17 capital
€83 other liabilities
A.
‘Fair economic value’ (FEV) losses
(€10)
B.
‘Market failure’ losses
(€20)
C.
Change in minimum capital due to crisis of confidence
€5
(from €5 to €10)
• Aid Granted = €30
• Proportional Aid = B + C = €25
• Additional Aid = Aid Granted – Proportional Aid = €30 – €25 = €5
Bank has €17 in capital, it can repay the Additional Aid
Structurally Sound
Surplus capital (€17 - €5) > FEV losses (€10)
Structurally Sound
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Separating proportionate aid from additional aid
A structurally unsound bank
Before the crisis
Assets
€100
Liabilities
€10 capital
€90 other liabilities
A.
‘Fair economic value’ (FEV) losses
(€10)
B.
‘Market failure’ losses
(€20)
C.
Change in minimum capital due to crisis of confidence
€5
(from €5 to €10)
• Aid Granted = €30
• Proportional Aid = B + C = €25
• Additional Aid = Aid Granted – Proportional Aid = €30 – €25 = €5
Bank has €10 in capital, it cannot repay the Additional Aid
Structurally Unsound
Surplus capital (€10 - €5) < FEV losses (€10)
Structurally Unsound
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Step 3 of the Balancing Test
Distortions of competition are limited
• “Moral hazard” is the most significant potential distortion
– Overly risky behaviour would be fostered if banks expected that they will always be
saved without being punished
– Proportionate aid does not result in moral hazard, as it only applies to widespread
market failures
– Additional aid may result in moral hazard if no burden sharing and no behavioural
measures are taken
• Proportionate Aid returns the market to an efficient economic situation:
distortions of competition in the product markets are not possible
• Additional Aid may result in some distortions of competition in the
product markets, but those are likely to be limited
– Most large banks received aid, so level playing field largely maintained
– Aid does not necessarily confer an advantage
– In financial markets, the loss of a competitor may cause more harm than good
– The way banking markets work does not allow competitors to win significant share
quickly
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Implications for compensatory measures
• No compensatory measures should be considered for Proportionate Aid
– Proportionate aid does not result in appreciable moral hazard or distortions of
competition in the relevant product markets
• Compensatory measures should be considered only for the Additional
Aid
– Need to be commensurate to the level of Additional Aid not to Total Aid
– Need to consider the degree of “fault” of the financial institutions
• Even for Additional Aid, compensatory measures need to be considered
carefully
– Moral hazard best tackled by behavioural remedies (and some burden-sharing)
– Only distortions of competition in the product markets may justify asset sales
– Distortions of competition in the relevant product markets are unlikely to be significant
– Significant asset sales run the risk of endangering financial stability and slowing the
return to fully-functional financial market
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Conclusions
• The Commission’s communications note the exceptional nature of the
financial crisis and associated market failures
• But the Commission at times appears to slip back to the familiar, yet
inadequate, R&R approach
• Rather than distinguishing between “good banks” and “bad banks” the
Commission should distinguish between “good aid” and “bad aid”
• No compensatory measures are required for Proportionate (“good”) Aid
• The Commission should impose behavioural remedies commensurate to
the level of Additional (“bad”) Aid
• Asset sales are largely unnecessary, relatively ineffective, and potentially
dangerous
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Dr. Lorenzo Coppi
CRA International
99 Bishopsgate
London EC2M 3XD
Tel: 020 7959 1429
[email protected]
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