bank restructuring aid economic and policy analysis dr. lorenzo coppi presentation to the dutch...
TRANSCRIPT
Bank Restructuring Aid
Economic and Policy Analysis
Dr. Lorenzo Coppi
Presentation to the Dutch Association of Competition Lawyers
Amsterdam, 7 October 2009
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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
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Bear Sterns collapses
Northern Rocknationalised
ECB injects liquidity in money markets
Record writedowns emerge
Fannie Mae and
Freddie Mac nationalised
Lehman Bros
collapses
TARP voted down in US
Senate
AIG, WaMu, Fortis, Glitnir
collapse
State Interventions:
Guarantees, Recapitalisations,
Impaired asset schemes
European TED Spread
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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 aidA structurally sound bank
Before the crisis Assets Liabilities
€100 €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 aidA structurally unsound bank
Before the crisis Assets Liabilities
€100 €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 International99 Bishopsgate
London EC2M 3XD
Tel: 020 7959 1429