Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.5.4.1:3.5.4.1 Funding guarantees and liquidity support

Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.5.4.1

3.5.4.1 Funding guarantees and liquidity support

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In order to be temporarily approved by the Commission, rescue aid in the form of funding guarantees and liquidity support must meet the following criteria:

Criterion 1: Eligible debt instruments

Funding guarantees may only be granted for new issues of banks' senior debt (subordinated debt is excluded) with maturities from three months to five years, or a maximum of seven years in the case of covered bonds. Guarantees with a maturity of more than three years must, except in duly justified cases, be limited to one-third of the outstanding guarantees granted to the individual bank.1

In exceptional cases, guarantees may also be approved covering exposures of the European Investment Bank (EIB) towards banks for the purpose of restoring lending to the real economy in countries with severely distressed borrowing conditions compared to the EU average. When assessing these measures, the Commission will examine in particular whether they do not confer an undue benefit that could, for example, serve to develop other business activities of those banks. The guarantees may cover a period of up to seven years. If approved by the Commission, they do not trigger an obligation for the bank to present a restructuring plan.2 An example of a guarantee scheme covering exposures of the EIB is the Portuguese Guarantee Scheme on EIB lending.3

Criterion 2: Remuneration

Liquidity support and funding guarantees should be adequately remunerated. The minimum remuneration level of funding guarantees must be in line with the formula set out in the 2011 Prolongation Communication. This pricing formula establishes the minimum guarantee fees that should apply where funding guarantees are granted on a national basis, without any pooling of guarantees among Member States. The guarantee fee is set as a sum of a basic fee of 40 basis points (or 50 for debt with a maturity of less than one year) and a risk-based fee which takes into account the CDS spreads of the beneficiary bank and the Member State granting the guarantee.4

The 2011 Prolongation Communication recognised that the creditworthiness of the Member State providing the funding guarantee should be reflected in the pricing of the funding guarantee.5 Until that time, in many instances ‘weak’ banks located in ‘strong’ Member States had access to cheaper funding than ‘strong’ banks located in ‘weak’ Member States.6

In relation to liquidity support, the 2013 Banking Communication does not specify what an adequate remuneration is. However, the Commission has, in the past, applied the rules applicable to funding guarantees by analogy when appraising liquidity facilities.7 In respect of subordinated loans, it has applied the recommendations of the ECB on the pricing of recapitalisations.8

Criterion 3: Behavioural safeguards

The recipients of guarantees and liquidity support must refrain from advertising referring to State support and from employing any aggressive commercial strategies which would not take place without the support of the Member State.9

Criterion 4: Restructuring or liquidation plan

Unlike recapitalisation or asset relief measures which in principle must be preceded by the notification of a restructuring plan by the Member State concerned and approval by the Commission before they can be granted, the Commission can accept that Member States notify funding guarantees and liquidity support to be granted after approval on a temporary basis as rescue aid before a restructuring or liquidation plan is approved.10

A restructuring or liquidation plan must, however, be submitted to the Commission within two months for any bank granted guarantees on new liabilities or on renewed liabilities for which, at the time of the granting of the new guarantee, the total outstanding guaranteed liabilities (including guarantees accorded before the date of that decision) exceed both a ratio of 5% of total liabilities and a total sum of EUR 500 million. In addition, for any bank which causes the guarantee to be called on, an individual restructuring or liquidation plan must be submitted within two months after the guarantee has been activated.11

In relation to liquidity support, the 2013 Banking Communication does not specify when and in which circumstances liquidity support requires the submission of a restructuring or liquidation plan. Taking into account that the Commission has, in the past, applied the rules applicable to funding guarantees by analogy when appraising liquidity support, it is likely that banks that receive liquidity support in excess of both a ratio of 5% of total liabilities and EUR 500 million or default on their payment obligations, must submit a restructuring or liquidation plan.12

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