Banks, Business in Europe, Crisis, Economics, EU – Baltic States, Financial Services, Legislation

The Commission has been pushing for deeper economic integration as one of the remedies to the current crisis. This new step in European integration would complement the existing economic and monetary union. The new Commission’s idea is putting forward the concept of a banking union.

The European banking union is not a new legal instrument yet. It is a political vision for more EU integration, which will build on recent major steps to strengthen the regulation of the banking sector and go further.

See: Memo 12 /478, Press Release, 22 June 2012.   

Idea’s development

The Commission put forward the concept of a banking union (delivered by its President Barroso) at the informal European Council (23 May 2012). It attracted a lot of attention in the political debate since and ranks high on the agenda for the next European summit at the end of June.

The idea of the banking union is to stimulate further progressive development and deepening of the existing economic and monetary union. According to the Commission, the EMU’s benefits could be seen in creating the banking and by the development of the fiscal union.

The President of the European Council (it’s the last summit in the Danish 6-months’ rotating Presidency in the Council) will present at the next official summit (28-29 June) a report in close collaboration with the President of the European Commission, the Chair of the Eurogroup and the President of the European Central Bank. The main building blocks towards a deeper economic and monetary integration including the banking union and the fiscal union will be extensively discussed at the summit.

As soon as the political decision is reached, the Commission will propose the necessary measures for implementation at the end of 2012. The Commission also wants the Council and EP to accelerate the decision-making process on key legislation on financial sector’s activity. 

Main features in the banking regulations

Since the beginning of the crisis, the European Commission has tabled around 30 proposals to improve regulation of the financial system and benefit the real economy. This represents a solid basis to go further for creating a banking union. The Commission has also contributed to strengthening financial stability in the banking sector through its state aid control policy and the different stability and adjustment programs.

The Commission took the following actions:

1. More integrated banking supervision:

Three European supervisory authorities (ESAs) were established since 1 January 2011 to introduce a supervisory architecture, which included:  

• the European Banking Authority (EBA), which deals with bank supervision, including the supervision of the recapitalisation of banks,
• the European Securities and Markets Authority (ESMA), which deals with the supervision of capital markets, and  
• the European Insurance and Occupational Pensions Authority (EIOPA), which deals with insurance supervision.

The EU- 27 national supervisors are represented in all three supervising authorities. Their role is to contribute to the development of a single rulebook for financial regulation in Europe, solve cross-border problems, prevent the build-up of risks, and help restore confidence. Individual ESAs have specific roles: for example ESMA is the EU supervisor of credit rating agencies, while EBA and EIOPA carry out "stress tests" of their respective sectors. EBA has also overseen the current recapitalisation exercise of EU Banks. ESMA can ban products that threaten the stability of the overall financial system in emergency situations.

In addition, the European Systemic Risk Board (ESRB) has been tasked with the macro-prudential oversight of the financial system within the Union.

This new financial supervision framework has been in place since November 2010.

EBA has done a good job and established quickly its credibility as a new institution. Its merits have to be judged within the constraints of the rules agreed by Council and European Parliament. Most of the banking supervisory powers today remain in the hands of national supervisors, with EBA in a coordinating role. For the future, it is clear that there is a need to create direct supervisory powers at EU level.

For more information on financial supervision, see MEMO/10/434.

2. Strengthening the banking system and securing better capitalisation

Banking institutions entered the crisis with capital that was insufficient both in quantity and in quality, leading to unprecedented support from national authorities. With its proposal on bank capitalisation ("CRD IV") made in July 2011 (see IP/11/915 and MEMO/11/527), the Commission launched the process of implementing for the European Union the new global standards on bank capital agreed at the G20 level (most commonly known as the Basel III agreement). The Commission proposals are currently being discussed by Council and European Parliament and the Commission.  

Europe is playing a leading role on this matter, applying these rules to more than 8,000 banks, representing 53% of global assets.

The Commission also wants to set up a governance framework giving national supervisors new powers to monitor banks more closely and take action through possible sanctions when they spot risks, for example to reduce credit when it looks like it is growing into a bubble. European supervisors would intervene in some cases, for example when national supervisors disagree in cross-border situations.

For more information on EU measures on bank capitalisation, see IP/11/915.

3. Facilitating banking sector restructuration

Extensive financial sector conditionality has been included among the policy requirements addressed to Member States that have received international financial assistance.

With respect to the banking sector, the required policy measures consist, on the one hand, of the orderly winding-down of non-viable institutions and, on the other hand, of the restructuring of the viable banks. Higher capital requirements, recapitalisations of banks, stress tests, deleveraging targets as well as enhancing the regulatory and supervisory frameworks have also been part of the policy initiatives. While not specific to program countries, these stabilisation measures are most easily implemented in the context of international financial assistance.

The European Financial Stability Facility (EFSF) can provide loans to a “non-program” euro area member states for the specific purpose of recapitalising financial institutions, with the appropriate conditionality, institution-specific as well as horizontal including structural reform of the domestic financial sector. Specific bank restructuring under the program goes hand in hand with the conditionality of EU state aid rules.

Concrete examples

In the framework of the macro-economic adjustment programs or balance of payments assistance programs the following examples can be shown:

• In Greece, €50 billion have been allocated to the Hellenic Stability Financial Fund for the purpose of bank recapitalization.
• In Portugal, the €12 billion of the Bank Solvency Support Facility have been earmarked on a dedicated account at the central bank.
• With respect to the non-euro area countries which have received balance-of- payments assistance, the Latvian program also included a banking support envelope of €600 million.  

While these financial resources are an integral part of the international financial assistance packages, the latter's key contribution to the stabilisation of the financial sectors derives from the program-driven restructuring of banks.

For more information on the programs see:

http://ec.europa.eu/economy_finance/eu_borrower/greek_loan_facility/index_en.htm

http://ec.europa.eu/economy_finance/eu_borrower/portugal/index_en.htm

http://ec.europa.eu/economy_finance/eu_borrower/balance_of_payments/latvia/latvia_en.htm

Offering more protection to bank deposits

Thanks to EU legislation, bank deposits in any member state are already guaranteed up to €100,000 per depositor if a bank fails. From a financial stability perspective, this guarantee prevents depositors from making panic withdrawals from their bank, thereby preventing severe economic consequences.

In July 2010, the Commission proposed to go further, with a harmonisation and simplification of protected deposits, faster pay-outs and improved financing of schemes, notably through ex-ante funding of deposit guarantee schemes and a mandatory mutual borrowing facility. The idea behind this is that if a national deposit guarantee scheme finds itself depleted, it can borrow from another national fund. This would be the first step towards a pan-EU deposit guarantee scheme. This proposal is still being discussed by the Council and Parliament in the second reading. The Commission calls upon the legislators to speed up the process of co-decision on this proposal, retaining the mutual borrowing facility.

In managing a number of bank crises over recent years, national authorities have often created a new structure out of the failing bank and transferred some critical functions of the bank to this structure, such as safeguarding deposits. This resolution mechanisms make sure that depositors never lose access to their savings (for example in the case of Northern Rock, the bank was split up in a good bank, which contained the deposits and good mortgage loans, and a bad bank winding-down the impaired loans).

For more information on the Commission's proposal for a European system of deposit guarantees, see IP/10/918.

Controlled state aid to banks during the crisis

When financial markets were on the brink of collapse, the natural instinct of some policy-makers was to put our common rules aside and act unilaterally. Without some form of EU-wide coordination, we could have seen a subsidy race, massive transfers of capital from one country to another, and probably the end of the internal market as we know it.

The EU tried to put into effect a crisis regime: thus in autumn 2008, the Commission swiftly published guidance explaining how member states could assist distressed banks or businesses in line with EU state-aid rules. This guidance was based on art. 107(3)(b) TFEU, which allows state aid to remedy a serious disturbance in the economy of a Member State.

In one of the first Communications adopted in October 2008, the Commission spelt out basic principles for support schemes, such as keeping support limited in time and scope, ensuring that eligibility for a support scheme was not based on nationality or avoiding that beneficiary banks unfairly attract new additional business solely as a result of the government support (see IP/08/1495).

A good illustration is the Irish support scheme for banks, which was amended so as to ensure a non-discriminatory coverage of banks with systemic relevance to the Irish economy, regardless of origin (see IP/08/1497).

This was followed by a Communication on the recapitalisation of banks in December 2008, tackling the need to recapitalise banks, address solvency issues and access to credit for the real economy (see IP/08/1901). In February 2009 came another Communication-"Impaired Assets Communication" providing a framework to deal with the problems of toxic assets (see IP/09/322).

Finally, in July 2009, the Commission adopted the "Restructuring Communication", providing clarity on how the Commission would examine the restructuring of banks so that they can return to long-term viability, share the weight of the cost of their rescue, and address any distortions of competition resulting from the large amounts of aid the banks received (see IP/09/1180). Since 1 January 2011, every bank requiring state support in the form of capital or impaired asset measures has had to submit a restructuring plan (and not only distressed banks, as in the past).

Cases illustrating how the restructuring of important banks was guided by these rules include KBC (see IP/09/1730) and Lloyds (see IP/09/1728).

Commission's previous practice

When controlling state aid to banks, the Commission has been acting as a de facto crisis-management and resolution authority at EU level, working to address the structural problems that had been affecting many banks before the crisis. Three main goals were behind these ides: safeguarding financial stability, preserving the integrity of the internal market, and ensuring that the beneficiaries of aid return to long-term viability.

The restructuring was based on three principles: that the bank returns to long term viability without the need for further state support, that the bank and its shareholders and hybrid capital holders contribute to the costs of its restructuring, and that the competition distortions caused by the aid are mitigated.

For instance, some banks were asked to move away from unsustainable business models based on excessive leverage and the over-reliance on short-term wholesale funding. In other cases, they were required a downsizing and simplification of banking structures. Finally, when it was clear that the viability of a bank could not be restored, its orderly resolution was put in place. In all cases, the banks were asked to pay back the aid received from their governments. This condition was vital, because it addresses the moral-hazard issue and limits the cost to the taxpayer.

Some examples: deep restructuring and the partial resolution of banks such as Hypo Real Estate (see IP/11/898), Kommunalkredit (see IP/11/389), and Northern Rock (see IP/09/1600). The unsustainable business model adopted by some German Landesbanken has resulted – in cases such as LBBW (see IP/09/1927) and HSH (see IP/11/1047) – in the re-focussing on their core business. In the case of WestLB – the viability of which could not be restored – the result was an orderly resolution (see IP/11/1576). In other occasions, governments have had to take over the burden of wrong business decisions adopted by systemically important banks. In these cases, the Commission requested a downsizing and significant simplification of banking structures, such as with ING and Commerzbank (see IP/09/711).

Crisis regime for state aid and financial sector: perspectives

State aid control in the crisis has had two goals: on one hand, the critical conditions should be eliminated; on the other, conditions for post-crisis development should be elaborated.

Since the beginning, the Commission has imposed restructuring conditions that were designed to bring more stability to the financial markets and to help banks return to financing the real economy. These conditions include that banks remunerate and eventually repay the public support and that shareholders and hybrid-capital holders bear a fair share of the burden to address the moral hazard issue.

Renewed tensions in the markets has extend the crisis regime into 2012, prolonging all four banking Communications, with some modifications. Member states decide to recapitalise their banks using instruments such as ordinary shares, for which the remuneration is not fixed in advance. A revised methodology was also agreed concerning the remuneration of guarantees for banks' funding needs – the bulk of the support to date – to ensure that the fees banks pay reflect their intrinsic risk, rather than the risk related to the member state concerned or the market as a whole (see IP/11/1488).

These rules will apply as long as required by market conditions; and as soon as market circumstances allow, the Commission will adopt a permanent regime for state aid to the financial sector.

Measures to strengthen Europe's financial sector

In addition to reinforcing the supervision of the financial sector, increasing protection for bank depositors, strengthening capital requirements for financial firms, and improving crisis management in the banking sector, the Commission is also working on the following issues: examining reform of the structure of the banking sector though the work of the high-level expert group (see MEMO/12/129); regulating shadow banking (see IP/12/253); making credit ratings more reliable (see IP/11/1355); tightening rules on hedge funds (see IP/09/669), short selling (see IP/10/1126) and derivatives (see IP/10/1125); revising current rules on trade in financial instruments (see IP/11/1219), market abuse (see IP/11/1217) and investment funds (see IP/10/869); curbing banking pay practices that encourage recklessness (see IP/09/1120); reforming the sectors of audit (see IP/11/1480) and accounting (see IP/11/1238).

Proposal on resolution tools for banks in crisis

The Commission proposed recovery and resolution tools for banks in crisis (6 June 2012), in a series of measures to strengthen Europe's banking sector and avoid the spill-over effects of any future financial crisis, with negative effects on depositors and taxpayers.

To ensure that the private sector pays its fair share in any future bailouts, the EU has proposed a common framework of rules and powers to help EU countries intervene to manage banks in difficulty. Repeated bailouts of banks have fuelled a public perception of deep unfairness, increased public debt and imposed a heavier burden on taxpayers.

A common EU-wide framework of tools for bank recovery and resolution would offer instruments to prevent crises from emerging in the first place and address them early on if they do.

This will provide a set of tools allowing for the managed resolution of banks and financial institutions where necessary.

The European Stability Mechanism and the banking sector

The European Stability Mechanism (ESM) will have a lending capacity of €500 billion. For euro area states not subject to a program, the ESM will have the possibility of providing a loan for the specific purpose of re-capitalising financial institutions. The granting of such financial assistance is subject to decision of the Board of Governors of the ESM, i.e. the finance ministers of the euro area member states. The ESM Treaty does not currently foresee direct lending by the ESM to a financial institution.

a) medium-term measures. The Commission is ready to propose an introduction of more integrated and direct banking supervision at EU level, common deposit guarantee and resolution funds, based on the political orientation of the European Council. The basic principle in the frameworks shall be sharing of risk in guarantee scheme in an integrated, strong supervision of the banking sector that can ensure mutual trust between all EU countries.

b) integrated system for the supervision of cross-border banks. While the current role of the European supervisory authorities is mainly to oversee the functioning and convergence of national supervisory systems, the Commission intends to propose the creation of banking supervision at EU level. The present system is too fragmented to face current challenges, which is not conducive to the necessary trust between EU member states. This requires political agreement on more and independent EU supervision.

c) single deposit guarantee scheme (DGS). In the context of the DGS proposal in 2010, the Commission proposed the possibility of mutual borrowing, in case one of the schemes is depleted. The Commission is examining different options to build on that. In addition, the deposit guarantee scheme and the resolution fund will be created as part of the same framework, as successful resolution of a bank avoids having to call on deposit guarantees.

d) EU resolution fund. Commission’s proposal on recovery and resolution tools for banks in crisis is only a first step towards an EU resolution fund. The Commission proposes the setting up of funds at national level which would interact and have to lend to each other under certain conditions and when necessary in order to constitute a European system of resolution funds.

Furthermore, the closer integration of supervisory and resolution arrangements for cross-border institutions will have to be organized in advance. The proposal foresees the mechanisms to make sure that national authorities and EBA cooperate for cross-border bank that face problems.

See MEMO/12/416.