8.6.2 Pricing of guarantees

The Commission has provided guidance in the form of pricing principles. Initially, these pricing principles were based on the Recommendations of 20 October 2008 of the Governing Council of the European Central Bank. The pricing principles were updated twice: by the DG Competition Staff Working Document (30 April 2010)1 and by the Second Prolongation Communication.

The ECB Recommendations of 20 October 2008 made a distinction between guarantees on bank debt with maturities exceeding 1 year, and guarantees on bank debt with maturities of less than or equal to 1 year. In the latter case, the pricing should be based on an overall flat fee of 50 basis points. The pricing formula of guarantees on bank debt with a maturity exceeding 1 year, was more complicated. It comprised two elements: the pricing should be based on i) the bank’s CDS spread2, and ii) an add-on fee (of 50 basis points).

A bank’s CDS spread is a good measure of the (credit-)risk profile of a bank.3 Sometimes, there are no CDS data (or no representative CDS data). However, if the bank has a credit rating, then the CDS spread can be derived from the CDS spreads of banks with the same credit rating.

In April 2010, the pricing principles were updated by the DG Competition Staff Working Document.4 Although the financial markets had not yet returned to entirely normal functioning, the Commission observed a “gradual stabilization of the market situation” which led to a reduction of the risk premium for unguaranteed bank debt.5 As a result, sound banks chose to attract funding on the financial market without using the government guarantee. The DG Competition Staff Working Document of 30 April 2010 therefore provided for an increase of the guarantee fee by 20-40 basis points.6

A second update of the pricing principles took place by the adoption of the Second Prolongation Communication in December 2011. Thus far, the guarantee fees were based on the banks’ CDS spreads, because those CDS spreads were thought to reflect the risk profile of the individual banks. However, the Commission noticed that the banks’ CDS spreads were not only influenced by bank-specific factors, but that those spreads were also affected by the growing tensions in sovereign debt markets.7 In addition, there was an overall increase in the perception of risk in the banking sector as a whole. The pricing formula was therefore updated “to isolate the intrinsic risk of individual banks from changes in CDS spreads of Member States and of the market as a whole”.8

Most guarantee schemes provided for a guarantee fee that was in line with the ECB recommendations of 20 October 2008. If the fee was in line with the ECB recommendations, the Commission considered the remuneration to be appropriate.9

In ‘duly justified cases’ a lower remuneration can be accepted. The case of Anglo Irish Bank and Irish Nationwide Building Society (INBS) is such a ‘duly justified case’. Anglo and INBS were merged. The merged entity essentially was a resolution vehicle which facilitated the orderly resolution of Anglo and INBS. The merged entity would not carry out any economic activities besides those necessary to work out the loan book. The Commission further noted that Anglo and INBS would both disappear from the Irish lending and deposit markets. These circumstances justified that the merged entity did not pay a fee for the guarantee.10

Banco Privado Portugues (BPP) had to pay a fee of 20 basis points for the guarantee. The Commission observed that this was well below the level of remuneration normally required for distressed banks. The Commission considered that the low level of remuneration was needed to keep BPP afloat. The Commission concluded the remuneration appropriate only for the rescue phase.11 Importantly, the remuneration was subject to the submission of a restructuring plan.12