Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.5.5:3.5.5 The assessment criteria for asset relief measures

Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.5.5

3.5.5 The assessment criteria for asset relief measures

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The Impaired Assets Communication sets out the following specific assessment criteria for impaired assets measures. If asset relief measures are granted in the form of restructuring aid, these criteria must be met in addition to the criteria for restructuring aid, set out in section 3.5.6.1. Impaired assets measures can also exceptionally be awarded in the form of rescue aid, under the additional conditions discussed in section 3.5.4.3.

Criterion 1: Eligible assets

When determining the range of eligible assets for relief, a balance needs to be found between meeting the objective of immediate financial stability and the need to ensure the return to normal market functioning over the medium turn.1 To ensure consistency in the identification of eligible assets across Member States, categories of assets ('baskets') reflecting the extent of existing impairment have been developed by the Commission. The Member States have to decide which category of assets could be covered and to what extent, subject to the Commission's review of the degree of impairment of the assets chosen.2

Assets commonly referred to as ‘toxic assets’ e.g. US mortgage-backed securities and associated hedges and derivatives which triggered the financial crisis and largely became illiquid or subject to severe downward value adjustments, are considered eligible for impaired asset measures. Member States may however extend eligibility to well-defined categories of assets corresponding to this systemic threat on due justification without quantitative restrictions.3

Criterion 2: Transparency and disclosure

Applications for asset relief aid should be subject to full ex ante transparency and disclosure of impairments by eligible banks on the assets to be covered by the relief measures, based on adequate valuation, certified by recognised independent experts, and validated by the relevant supervisory authority.4

Criterion 3: Valuation

A correct and consistent approach to valuation is deemed of key importance to prevent undue distortions of competition. The main aim of the valuation exercise is to establish the real economic value (REV) of the assets. The REV constitutes the benchmark level in so far as a transfer of impaired assets at that value indicates the compatibility of aid. In other words, transfer at REV creates a relief effect because it is in excess of the current market value (MV), but keeps the aid amount to the minimum necessary.

It was recognised by the Commission that the value attributed to impaired assets in the context of an asset relief program (the ‘transfer value’) will inevitably be above current market prices (which may effectively be as low as zero) in order to achieve the relief effect. To ensure consistency in the assessment of the compatibility of aid, the Commission considers a transfer value reflecting the underlying long-term economic value (the ‘real economic value’) of the assets, on the basis of underlying cash flows and broader time horizons, an acceptable benchmark indicating the compatibility of the aid amount as the minimum necessary.5

Where the valuation of assets appears particularly complex, alternative approaches could be considered, such as the creation of a ‘good bank’ whereby the State would purchase the good rather than the impaired assets. Public ownership of a bank (including nationalisation) could be an alternative option, with a view to carrying out the valuation over time in a restructuring or winding up in an orderly manner context, thus eliminating any uncertainty about the proper value of the assets concerned.6

An application for aid by an individual bank should be followed by a full review of that bank's activities and balance sheet, with a view to assessing the bank's capital adequacy and its prospects for future viability (viability review). This review must occur in parallel with the certification of the impaired assets covered by the asset relief programme but, given its scale, could be finalised after the bank enters into the asset relief programme. The results of the viability review must be notified to the Commission and will be taken into account in the assessment of necessary follow-up measures.7

Criterion 4: Management of assets subject to relief measures

It is for Member States to choose the most appropriate model for relieving banks from assets. Whatever the model, in order to facilitate the bank’s focus on the restoration of viability and to prevent possible conflicts of interest, it is necessary to ensure clear functional and organisational separation between the beneficiary bank and its impaired assets, notably regarding their management, staff, and clientele.8

Criterion 5: Remuneration (own contribution) and burden-sharing

As a general principle, banks ought to bear the losses associated with impaired assets to the maximum extent. This requires, firstly, full ex ante transparency and disclosure, followed by the correct valuation of assets prior to government intervention. The bank should bear the difference between the nominal value and the REV of the assets. As a general rule, an asset relief measure can only be declared compatible, if the transfer value is equal or below the REV. Where this is not possible, the bank should be requested to contribute to the loss or risk coverage at a later stage, for example in the form of claw-back clauses or far-reaching restructuring.

In addition, a correct remuneration of the State for the asset relief measure is required.

In any event, any pricing of asset relief must include remuneration for the State that adequately takes account of the risks of future losses exceeding those that are projected in the determination of the REV and any additional risk stemming from a transfer value above the REV. This remuneration may be provided by setting the transfer price of assets at below the REV to a sufficient extent so as to provide for adequate compensation for the risk in the form of a commensurate upside, or by adapting the guarantee fee accordingly.9

Criterion 6: Behavioural constraints (prevention of undue distortion of competition)

Access to asset relief should always be conditional on a number of appropriate behavioural constraints. In particular, beneficiary banks should be subject to safeguards which ensure that the capital effects of relief are used for providing credit to appropriately meet demand according to commercial criteria and without discrimination, and not for financing a growth strategy (in particular acquisitions of sound banks) to the detriment of competitors. Restrictions on dividend policy and caps on executive remuneration should also be considered. The specific design of behavioural constraints should be determined on the basis of a proportionality assessment taking account of the various factors that may imply the necessity of restructuring.10

An interesting case in which the scope of the behavioural constraints was highly debated, is the aid package granted to ING by the Netherlands. This aid package consisted of an increase in capital, a cash flow swap relating to the impaired assets of a portfolio of securities backed by residential mortgages granted in the United States, and guarantees given on ING liabilities amounting to USD 9 billion and to EUR 5 billion. The Commission first authorised the capital injection and impaired asset measure as rescue recapitalisation and asset relief measure for a period of six months. On 12 May 2009, the Netherlands sent the Commission a restructuring plan for ING covering the capital injection and the impaired asset measure. On 14 July 2009, a meeting was held between the Commission, the Netherlands, ING and the Dutch Central Bank to discuss the restructuring plan. In this meeting, the Commission called for additional compensatory measures, including a complete prohibition on acquisitions, a price leadership prohibition in the retail banking sector in the Netherlands, and significant divestments of assets in the Netherlands, Belgium and within ING. On 5 August 2009, a second meeting took place in which ING explained why the original restructuring plan proposed on 12 May 2009 should be accepted by the Commission. The Commission, however, reiterated that it considered the plan insufficient. On 13 August 2009, ING, through the Netherlands, submitted a new restructuring plan to the Commission based on the restructuring requirements laid down by the Commission. It was not until 18 November 2009 and several versions of the restructuring plan later, that the Commission authorised the capital injection and the impaired asset measure as restructuring aid.11

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