1.1 The GFC and its revelations

The Great Financial Crisis (GFC) has taught us a few things about the institutional and regulatory framework that is required for a healthy banking sector in the European Union (EU). Although banks had been in trouble before,1 the onset of the GFC in 2008 was different. This time the financial stability of the Member States of the EU and the single financial market in the EU as a whole was at stake. The integration of the national markets for financial services had created broader and deeper systemic connections amongst banks across the EU. As a result, the likelihood that a disturbance in the banking sector of one Member State would spill over into another had increased.2 The European arrangements for safeguarding financial stability were, however, still based on the guiding principle that a decentralised institutional setting, mostly based on the exercise of national responsibilities, would be able to prevent and manage crises affecting the single financial market.3 It was against this background that all eyes were on the European Commission (the Commission) to regulate the access to the main instrument that was available to ensure financial stability at the onset of the GFC: State aid.

Member States granted large amounts of State aid to banks established in their territories, while the Commission loosened its assessment framework for the approval of these State aid awards.4 Many banks were nation alized, while other banks were heavily dependent on State aid in order to survive.5 Between 2008 and 2015, Member States granted circa EUR 759 billion in capital, impaired asset measures and repayable loans and circa EUR 1,188 billion in guarantees to financial institutions in distress.6

As a result of the large amounts of State aid that were granted, Member States were increasingly confronted with budgetary deficits that by far exceeded the maximum limits agreed on in the Treaty of Maastricht.9 The GFC was therefore not only a financial and economic crisis, but also a sovereign debt crisis.10 The average ratio of the government debt to the gross domestic product of the Member States increased from 57.6% in 2007 to 86.7% in 2014.11 In addition, the average ratio of the planned or actual government deficit to gross domestic product increased from -0.9% in 2007 to -3.0% in 2014 (with a top of -6.6% in 2009).12

This toxic relationship between banks and Member States was not the only concern. There were also insufficient consequences for risky behaviour for banks, as failure did not lead to quitting the market. Many banks that were awarded State aid during the GFC already suffered from endogenous problems, which became apparent because of the GFC. The GFC worked as a catalyst for these problems, such as shortcomings in credit risk management, insufficient internal controls, problems in credit monitoring procedures, weaknesses in the management of investments held, imprudent investment decisions, an aggressive approach to credit risk policies or a strategy of aggressive expansion. Despite these internal problems, banks were able to continue their activities because of the State aid that they received in order to protect the financial stability.14

Altogether, the GFC revealed that the institutional and regulatory framework for the banking sector in the EU was inadequate not only to safeguard the stability of the single financial market and to break the link between Member States and banks, but also to limit the risk of ‘moral hazard’.15 It became clear that certain changes had to be made to address the inadequacies revealed by the GFC.16