Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.3.2.2:5.3.2.2 Access criteria

Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.3.2.2

5.3.2.2 Access criteria

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Precautionary guarantees and precautionary recapitalisation can only take place without triggering the FOLTF determination, provided certain criteria are met. The remainder of this dissertation refers to these criteria as ‘access criteria’, because fulfilment of these criteria leads to the situation that a bank has access to precautionary guarantees or precautionary recapitalisation. In case of precautionary guarantees or precautionary recapitalisation, access is available outside resolution only.

Access criteria should be distinguished from ‘assessment criteria’. These are the criteria that the Commission applies in its assessment of compatibility of State aid with the internal market under the State aid regime for the banking sector. The assessment by the Commission under the State aid regime for the banking sector is further discussed in Chapter 6.

The following access criteria apply to the instruments of precautionary guarantees and precautionary recapitalisation.

Access criterion 1: Precautionary and temporary nature

First, the instruments must be of a precautionary and temporary nature. The BRRD and the SRMR do not contain a definition of ‘precautionary nature’. The term ‘precautionary’ suggests that the aid will result in the creation of prudential buffers in the bank.1 In a fact sheet published on 25 June 2017, the Commission explains precaution as “to prepare for possible capital needs of a bank that would materialise if economic conditions were to worsen significantly”.2 In the same fact sheet, the Commission explains that the relevant Member State should be able to recover the aid in the short to medium term.

In case of precautionary guarantees, the precautionary nature is established by the Commission based on the condition that the guarantees only cover newly issued liabilities.3 In the case of CCB, the Commission assessed that recapitalisation by the national resolution fund was not of a precautionary nature, as it aimed at covering a capital shortfall which stemmed from additional loan loss provisioning.4

The temporary nature of precautionary guarantees is established on the basis of the maturity of the guarantees.5 In case of a precautionary recapitalisation, the temporary nature can be realized by making use of a hybrid instrument with a predetermined maturity date or by taking a binding commitment that the shares will be sold at a certain point in time.6

Access criterion 2: Solvency

Precautionary guarantees and precautionary recapitalisation must be confined to solvent banks. The BRRD and the SRMR do not contain a definition of ‘solvency’.

In the Single Rulebook Q&A published on the EBA website, it is stated that within the context of Article 32(4)(d) BRRD, the notion of solvent institution should be interpreted as referring to a bank which does not fall within Article 32(4)(a), (b), (c) BRRD. As regards Article 32(4)(a), the concept of solvency does not refer to meeting conditions for authorisation that would relate to non-financial resources, such as systems and controls.7

This interpretation has been prepared by the Directorate General Financial Stability, Financial Services and Capital Markets Union (DG FISMA) of the Commission and is an unofficial opinion of that Directorate General, which the EBA has published on its behalf. The interpretation is not binding on the Commission as an institution, and it may change.

In addition to the EBA, the ECB had published on its website that the ECB, as the competent authority, is informed and asked to confirm in the case of a precautionary recapitalisation, that the bank is solvent i.e. it fulfils the minimum capital requirements (i.e. Pillar 1 requirements).8 This interpretation of solvency has, however, been deleted in an update of the publication on 2 May 2018, without any further explanation. The reason could be that this explanation differed from the interpretation given by the DG FISMA.

The Commission (DG COMP) applied the interpretation of the DG FISMA in the case of the precautionary recapitalisation of LCCU, further to the assessment that regulatory capital requirements were met. 9 In the case of MPS, the Commission, however, seemed to interpret ‘solvent’ as fulfilling the CET 1 and Total Capital Ratio requirement established in Article 92 CRR,10 while in the case of BES, it considered that, as long as the baseline scenario was not breached, the bridge bank to which the precautionary guarantees were granted was considered solvent.11 The Commission therefore still seems to be searching for the correct interpretation of the solvency condition. In its review of the resolution framework, it mentions the issue that there is no definition of solvency, and that it is not specified which authority should confirm that the bank is solvent.12

In relation to precautionary recapitalisation the following additional requirements should be met:13

a)

the indicators that a bank is FOLTF - as set out in Article 32(4) sub (a) to (c) BRRD – are not met (this means that the bank is solvent, according to the definition of solvency as published by the EBA);14

b)

the circumstances under which resolution authorities should exercise the PONV conversion power are not fulfilled (that is, the conditions for resolution are not met, the bank or its group is still viable and no EPFS is required, other than precautionary recapitalisation).

The condition mentioned under (b), i.e. that no EPFS is required, includes precautionary guarantees. It seems however that the use of precautionary guarantees is not considered to be a hurdle for a precautionary recapitalisation. For example, in the case of MPS, precautionary guarantees preceded the precautionary recapitalisation of MPS.

Access criterion 3: No capital shortfall under the baseline scenario

Precautionary guarantees and precautionary recapitalisation may not be used to offset losses that a bank has incurred or is likely to incur in the near future.15 In practice this means that losses stemming from an asset quality review or from the baseline scenario of a stress test must be covered by private funds.16 The bank may hence not have a capital shortfall under the baseline scenario.17

A precautionary recapitalisation should, in addition, be necessary to address a capital shortfall established under the adverse scenario in national, EU or SSM-wide stress tests, asset quality reviews or equivalent exercises conducted by the ECB, EBA or national authorities, where applicable, confirmed by the competent authority.18 The capital injection is hence capped at the capital shortfall under the adverse scenario. No similar requirement applies for precautionary guarantees.

In the case of MPS, the ECB considered MPS solvent. In the 2016 stress test carried out by the EBA and ECB, MPS's capital ratios were deemed sufficiently high under the so-called ‘baseline scenario’, i.e. where the economy and financial situation would evolve as expected. However, the bank had a capital shortfall in the ‘adverse case scenario’, i.e. should economic conditions worsen. The ECB considered that under the adverse scenario, EUR 6.3 billion was needed to realign the CET1 ratio to the 8% threshold and an additional EUR 2.5 billion was needed to reach the total capital ratio (TCR) threshold of 11.5%. Of those EUR 8.8 billion, about EUR 4.2 billion would be covered by the burden-sharing on subordinated bonds, while EUR 4.6 billion would be funded by the State. As to the 8% threshold used by the ECB to determine the capital requirements, it is similar to the threshold used in Greece in 2015 in the aftermath of the capital controls, but differs from the threshold used in 2014 and 2015 for other Eurozone banks (5.5% under the adverse scenario).19

Access criterion 4: Remedy a serious disturbance in the economy of a Member State and preserve financial stability

Precautionary guarantees and precautionary recapitalisation can only be used, when this is required in order to remedy a serious disturbance in the economy of a Member State and to preserve financial stability, in particular in the case of a systemic liquidity shortage,20 and is proportionate to remedy the consequences of the serious disturbance.

It is the author’s understanding that this criterion ties into access criterion 7 (precautionary guarantees and precautionary recapitalisation are conditional on final approval by the Commission under the Union State aid framework21), taking into account that the current legal basis for the assessment of the Commission under the Union State aid framework is Article 107(3)(b) TFEU. The addition that the precautionary guarantees should be proportionate to that goal is already an inherent part of the assessment made by the Commission under the State aid regime for the banking sector.

The Commission’s decisions show that it considers this access criterion to be fulfilled when established in the compatibility assessment under Article 107(3)(b) TFEU.22 Imposing this access criterion may therefore have as a consequence that precautionary recapitalisation and precautionary guarantees are no longer available should the Commission decide that Article 107(3)(b) TFEU is no longer available as the legal basis for its assessment of State aid awards in the banking sector.23 Whether the Commission will ever take such a decision is still unclear at the time of writing this dissertation. It should be noted that the Commission has assessed in certain State aid decisions that aid can also be compatible with Article 107(3)(b) TFEU when it is necessary to avoid (instead of remedy) a serious disturbance in a Member State.24 It also made this assessment in relation to the precautionary recapitalisation of LCCU.25 Moreover, several language versions of the BRRD use the wording ‘to avoid a serious disturbance’ in the translation of Article 32(4)(d) BRRD.26 This interpretation may lead to Article 107(3)(b) TFEU being used as a more permanent basis for the compatibility assessment of State aid awards in the banking sector, as it can then also be applied if a serious disturbance may be caused, if no aid is granted. In other words, aid may be compatible with the internal market, not because it remedies an existing serious disturbance, but rather because it avoids a future serious disturbance. It also provides greater flexibility, as the public funding can be granted in a situation where the market is still able to share the burden, making the intervention less onerous for the State and possibly more effective for the preservation of financial stability.27

Access criterion 5: No advantage

From the BRRD and SRMR recitals can be derived that precautionary guarantees should be sufficiently remunerated by the bank.28 The BRRD and SRMR do not further explain what is meant by ‘sufficiently remunerated’. The State aid regime for the banking sector includes the requirement that funding guarantees should be adequately remunerated. This implies that the minimum remuneration level of funding guarantees must be in line with the formula set out in the 2011 Prolongation Communication.

It can be derived from the Commission’s decisions in cases that concern precautionary guarantees, that the Commission assesses compliance with the 2011 Prolongation Communication in order to assess compliance with this access criterion.29

In addition, the injection or purchase by the State within the framework of a precautionary recapitalisation should be at prices and on terms that do not confer an advantage on the bank. According to Véron, this condition is widely open to interpretation.30 The author argues that interpretation can take place on the basis of a similar condition included in the State aid regime for the assessment of a rescue recapitalisation. The starting point for rescue recapitalisations is that closeness of pricing to market prices is the best guarantee to limit competition distortions.

In the first decision from the Commission on the use of precautionary recapitalisation (the case of Alpha Bank), the wording used by the Commission refers to “undue advantage”, that is, “an advantage incompatible with the internal market under State aid rules”. In order to avoid that such an undue advantage is conferred on the bank, the level of remuneration and the depth of the restructuring should be in line with the State aid regime.31

Access criterion 6: Not be part of a larger aid package

From the BRRD recitals can be derived that precautionary guarantees should not be part of a larger aid package.32 This requirement is not restated in Article 32(4)(d) BRRD or Article 18(4)(d) SRMR. The requirement seems, however, to be implied in the legal construction that the award of precautionary guarantees forms an exemption to the premise that the award of EPFS triggers resolution, besides precautionary recapitalisation.

Access criterion 7: Final approval under the State aid regime

The instruments of precautionary guarantees and precautionary recapitalisation may only be used after receiving final approval under the Union State aid framework.33 By requiring final approval, it seems that precautionary guarantees cannot be temporarily approved by the Commission as rescue aid. The State aid regime for the banking sector, however, provides that guarantees are temporarily approved by the Commission as rescue aid under the commitment to submit a restructuring or a wind up plan within two months, unless the aid is reimbursed within those two months. Only after assessment of the restructuring or wind up plan, can the aid be authorized on a final basis. If it is not possible for the Commission to approve precautionary guarantees as rescue aid – and therefore on a temporary basis – the use thereof in practice is severely obstructed. It can be derived from the Commission’s decisions in relation to the precautionary guarantees that it temporarily approves such as rescue aid.34 This is the correct approach in the author’s view.

The State aid regime for the banking sector provides that precautionary recapitalisation can also take place in the form of rescue aid, i.e. a rescue recapitalisation. See section 3.5.4.2. At the time of writing this dissertation, there were no examples thereof.

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