Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.4.1.1:5.4.1.1 Solvency

Public funding of failing banks in the European Union (LBF vol. 19) 2020/5.4.1.1

5.4.1.1 Solvency

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In accordance with guidance from the ECB, ELA can only be granted to solvent banks. The rationale behind this is that by financing an insolvent bank, a national central bank would be assuming a government task in violation of the monetary financing prohibition set out in Article 123 TFEU. Article 123 TFEU provides that overdraft facilities or any other type of credit facility with the ECB or with the national central banks of the Member States in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States, will be prohibited, as will the purchase directly from them by the ECB or national central banks of debt instruments. The ECB has developed guidance on the basis of which it may decide whether a task conferred on a national central bank is to be considered a central banking task or a government task for the purposes of the monetary financing prohibition set out in Article 123 TFEU. The ECB considers that, while, for purposes of the monetary financing prohibition solvency support is a government task, liquidity-related tasks, the ultimate objective of which are to finance the economy, are central banking tasks.1

In the ELA Agreement it is set out that a bank is considered to be solvent, if:

1.

its CET 1, Tier 1 and Total Capital Ratio as reported under CRR on an individual (if applicable) and consolidated (if applicable) basis comply with the harmonised minimum regulatory capital levels (namely 4.5%, 6% or 8%, respectively); or

2.

there is a credible prospect of recapitalisation - in case condition 1. is not met, i.e. the CET 1, Tier 1 and Total Capital Ratio, on an individual and/or consolidated basis, do not comply with the harmonised minimum regulatory capital levels (namely 4.5%, 6% or 8%, respectively) - by which harmonised minimum regulatory capital levels would be restored within 24 weeks after the end of the reference quarter of the data that showed that the bank does not comply with harmonised regulatory minimum standards; in duly justified, exceptional cases the Governing Council of the ECB may decide to prolong the grace period of 24 weeks.2

As a result of this broad definition of solvency, also including the “credible prospect of recapitalisation”, ELA could potentially also be granted in resolution as long as the bank put in resolution has a credible prospect of recapitalisation. This is further discussed in section 5.4.5.

Mr Mersch, Member of the Executive Board of the ECB, has indicated that the ECB will probably change these indicators in the future in order to take account of forward-looking elements, in line with the evolution of supervisory practices, so as to have a more accurate picture about the solvency of the bank and the appropriateness of continuing to provide ELA, and in view of the fact that FOLTF means a handover to resolution authorities.3 See also section 5.5.2.2.

Article 123 TFEU does not prevent a State guarantee from being provided for ELA. The ECB has, however, set a number of criteria that must be met in that case:

1.

It must be ensured that the credit provided is as short term as possible;

2.

There must be systemic stability aspects at stake;

3.

There must be no doubt as to the legal validity and enforceability of the State guarantee under the applicable national law; and

4.

There must be no doubt as to the economic adequacy of the State guarantee, which should cover both principal and interest on the loans, thus fully preserving the central bank’s financial independence.4

If a State guarantee is provided, the ELA qualifies as State aid and can only be awarded after approval from the Commission under the State aid regime for the banking sector. See also section 3.3.1.3 and section 5.2.2.

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