Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.5.4.2:3.5.4.2 Rescue recapitalisations

Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.5.4.2

3.5.4.2 Rescue recapitalisations

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The Recapitalisation Communication, in combination with the 2013 Banking Communication, sets out the following specific assessment criteria for rescue recapitalisations as defined in section 3.4.3.2.

If the recapitalisation takes place in the form of restructuring aid, the criteria for restructuring aid set out in section 3.5.6.1 must be met.1

Criterion 1: Financial stability exception

Recapitalisation can only be authorised by the Commission to be granted by a Member State on a temporary basis as rescue aid before a restructuring plan is approved, if this measure is required to preserve financial stability.2

If a Member State invokes the financial stability clause in order to grant rescue aid in the form of recapitalisation, the Commission will request an ex ante analysis from the competent authority confirming that a current (not prospective) capital shortfall exists, which would force the supervisor to withdraw the institution’s banking license immediately if no such measures were taken. Moreover, any such analysis will have to demonstrate that the exceptional risk to financial stability cannot be averted with private capital within a sufficiently short period of time or by any other less distorting temporary measure, such as a State guarantee.3 An example of a case in which this financial stability clause was invoked is the case of Abanka.4 This Slovenian bank was in financial trouble due to insufficient subscription to capital issues and a constant growth of its non-performing loans. The Slovenian State therefore decided to recapitalise Abanka. The Bank of Slovenia informed the Commission about its findings that the situation of Abanka threatened financial stability and that, given the systemic importance of the bank and potential disruptions in the market in case of initiation of bankruptcy proceedings, an urgent State aid intervention was necessary to ensure financial stability in Slovenia. It also confirmed that it would have to withdraw Abanka’s banking license in absence of the recapitalisation. The Commission took into account the findings of the Bank of Slovenia and also noted that the calculation of the capital shortfall had been based on the asset quality review/stress test, a credible exercise carried out by several external experts. Lastly, it assessed that the recapitalisation would enable Abanka to maintain its access to funding from the ECB, in the absence whereof the bank ruptcy of Abanka would be triggered. Against that background, the Commission deemed that the recapitalisation was appropriate because it maintained financial stability – besides achieving the objective of remedying a serious disturbance in the economy.5

Criterion 2: Remuneration

The remuneration for rescue recapitalisations should lead to a certain rate of return for the Member State involved in the recapitalisation. This remuneration can be fixed or variable (e.g. when a Member State subscribes to shares in the capital of the beneficiary bank). The starting point is that closeness of pricing to market prices is the best guarantee to limit competition distortions. The exact level of remuneration in relation to the recapitalisation of an individual bank is set taking into account different paraments, such as the type of capital chosen, the appropriate benchmark risk-free interest rate, and the individual risk profile of the beneficiary and, at national level, that of all eligible banks. Additionally, Member States may choose a pricing formula that includes step-up or payback clauses.6 The remuneration should in principle reflect the risk profile of the beneficiary.7

Criterion 3: Incentives for exit

Rescue recapitalisations must contain appropriate incentives for banks to exit from State support as quickly as possible. In relation to shares with variable remuneration, exit incentives could, for example, be designed in a way that limits the upside potential for the Member State, for example by issuing warrants to the incumbent shareholders to allow them to buy back the newly issued shares from the State.8 In addition, pricing conditions should provide an incentive for the bank to redeem the State as soon as the crisis is over. The simplest way to provide an incentive for banks to look for alternative capital is for Member States to require an adequately high remuneration for the State recapitalisation. Member States may also consider using a restrictive dividend policy to ensure the temporary character of State intervention. In general, the higher the size of the recapitalisation and the higher the risk profile of the beneficiary bank, the more necessary it becomes to set out a clear exit mechanism.

For example, in the case of ING, the Dutch State provided a capital injection of EUR 10 billion. ING repaid the principal amount and an amount of EUR 3.5 billion in interest and premiums, six months ahead of the agreed repayment schedule. In addition, the Dutch State took over the risk on 80% of a portfolio of high-risk mortgages of EUR 27.7 billion and made a profit of EUR 1.4 billion when it sold this portfolio in February 2014. The total return for the Dutch State on the State aid that it had provided to ING was therefore EUR 4.9 billion.9 Another example is the repayment of State aid, including a penalty of 50%, by KBC to the Belgian State. KBC had received capital injections for a sum of EUR 7 billion, as well as a guarantee to cover its exposure to collateralized debt obligations. In exchange for this aid, KBC paid the Belgian State a total of EUR 13.09 billion at the end of 2015, 5 years ahead of the scheduled repayment date.10 One could wonder whether the incentives for exiting from State support were set at the right level in these cases, or whether they provided for economic coercion against the cost of further development of the bank involved. Both ING and KBC paid a high fee for their State aid, in addition to burdensome behavioural and divestiture measures.

Criterion 4: Compliance with burden-sharing principle for restructuring aid

Rescue aid in the form of recapitalisation must not prevent compliance with the burden-sharing principle set out for restructuring aid in the 2013 Banking Communication. These requirements are discussed in more detail in section 3.5.6.1. Consequently, either the required burden-sharing measures must be implemented as part of the rescue aid, or the recapitalisation must be arranged in a manner that allows for the implementation of the burden-sharing measures ex post. This may be achieved by, for example, equity recapitalisation in a form that is senior to existing capital and subordinated debt instruments, whilst being compliant with the applicable regulatory and supervisory framework.11

Criterion 5: Behavioural safeguards

Until redemption of the State aid, behavioural safeguards for banks subject to recapitalisation should, in principle, include a restrictive policy on dividends, including a ban on dividends at least during the restructuring period, limitation of executive remuneration, or the distribution of bonuses, an obligation to restore and maintain an increased level of the solvency ratio compatible with the objective of financial stability, and a timetable for redemption of State participation.12 In addition, banks subject to recapitalisation should avoid advertising this for commercial purposes or engaging in aggressive commercial strategies.13

The extent of behavioural safeguards will be based on a proportionality assessment, taking into account all relevant factors and, in particular, the risk profile of the beneficiary bank. While banks with a very low risk profile may only require limited behavioural safeguards, the need for these increases with a higher risk profile, according to the Commission. The proportionality assessment is further influenced by the relative size of the capital injection by the State and the level of capital endowment reached.14

Criterion 6: Restructuring plan

Following the authorisation of rescue aid in the form of recapitalisation, the Member State must submit a restructuring plan in line with the Restructuring Communication within two months of the date of the decision temporarily approving the aid.15

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