Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.7.1.2:3.7.1.2 The capital raising plan

Public funding of failing banks in the European Union (LBF vol. 19) 2020/3.7.1.2

3.7.1.2 The capital raising plan

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Pursuant to the 2013 Banking Communication, a capital raising plan, before or as part of the submission of a restructuring plan, has to be submitted in case of restructuring aid. A capital raising plan, in conjunction with a thorough asset quality review of the bank and a forward looking capital adequacy assessment, should enable the Member State, jointly with the Commission and the competent authority, to determine precisely the (residual) capital shortfall of a bank that needs to be covered with State aid.

The capital raising plan should a) list the capital raising measures, b) list the (potential) burden-sharing measures for shareholders and subordinated creditors, and c) contain safeguards preventing the outflows of funds from the bank. If after the implementation of these measures a capital shortfall remains, it can in principle be covered by public recapitalisation, asset relief measures or a combination of the two.1 Any such residual capital shortfall which needs to be covered by State aid requires the submission of a restructuring plan.2

The capital raising plan is in practice used as a way to enter into pre-notification contact with the Commission in order to ensure that the capital shortfall that needs to be covered by State aid will be limited to the minimum. According to Laprévote and Coupé, a key question is whether preventative measures that result from this pre-notification contact can credibly be imposed under the sole remit of State aid rules. The Commission’s powers under Article 107 and 108 TFEU are limited to assessing (and authorising) State aid granted by States and not to prevent this aid being granted in the first place.3 See further section 7.2.1.3.

Ad a: Capital raising measures

Capital raising measures aim to increase the regulatory capital, improve the funding structure or shorten the balance sheet of a bank in order to reduce the need for State aid to a minimum. Capital raising measures could consist of rights issues, voluntary conversion of subordinated debt instruments into equity on the basis of a risk-related incentive, liability management exercises, capital-generating sales of assets and portfolios, securitisation of portfolios in order to generate capital from non-core activities, earnings retention or other measures reducing capital needs.4

Liability management exercises are in practice commercially negotiated consensual bail-in arrangements. For example, a consensual bail-in led to the recapitalisation of the UK Co-op Bank.5

Ad b: Burden-sharing measures

Adequate burden-sharing normally entails that losses are first absorbed by equity, after which contributions are made by hybrid capital holders and subordinated debt holders (the burden-sharing principle). Hybrid capital and subordinated debt holders must contribute to reducing the capital shortfall to the maximum extent. This can take the form of either a conversion into CET 1 instruments or a write-down of the principal of the instruments. The Commission does not require a contribution from senior debt holders (in particular from insured deposits, uninsured deposits, bonds and all other senior debt) as a mandatory component of burden-sharing whether by conversion into capital or by write-down of the instruments. State aid must not be granted before equity, hybrid capital and subordinated debt have fully contributed to offset any losses.6

Where the capital ratio of the bank that has the identified capital shortfall remains above the EU regulatory minimum, the bank should normally be able to restore the capital position on its own, in particular through capital raising measures as set out above. If there are no other possibilities, including any other supervisory action, such as early intervention measures or other remedial actions to overcome the shortfall as confirmed by the competent or resolution authority, then burden-sharing measures must be taken.

In cases where the bank no longer meets the minimum regulatory capital requirements, subordinated debt must always be converted or written down, in principle before State aid is granted.

An exception to the burden-sharing principle can be made where implementing burden-sharing measures would endanger financial stability or lead to disproportionate results. This exception could cover cases where the aid amount to be received is small in comparison to the bank's risk weighted assets and the capital shortfall has been reduced significantly in particular through capital raising measures. Disproportionate results or a risk to financial stability could also be addressed by reconsidering the sequencing of measures to address the capital shortfall.7

The Commission has decided in several cases that no remuneration had to be paid by the bank for State aid measures in the form of rescue aid, because the financial stability in a Member State could be endangered without the State intervention.8 In the case of Banca Tercas, it was argued by the parties involved that not requesting the conversion or write-down of subordinated creditors was in line with this exception in this case.9 The Commission however assessed that burden-sharing by subordinated creditors was also applied to a large proportion of the banking sector in Slovenia and Spain and the third-largest bank of Portugal without putting in danger the financial stability or leading to disproportionate results. Therefore the Commission could not accept this risk to be present in view of the small scale of Banca Tercas.10

The exception on the basis of disproportionate results has been applied several times. Examples are the State aid decisions in relation to the Greek banks Eurobank11 and Alpha Bank12 and the Spanish bank CEISS-Unicaja.13

Ad c: Safeguards preventing the outfl ow of funds

Outflows of funds from the bank could, for example, occur by the bank acquiring stakes in other undertakings or paying dividends or coupon. From the time capital needs are known or should have been known to the bank, the Commission considers that the bank should take all measures necessary to retain its funds. In particular, from that moment on, banks which have identified or should have identified capital needs, must not:

a)

pay dividends on shares or coupons on hybrid capital instruments (or any other instruments for which the coupon payment is discretionary);

b)

repurchase any of their own shares or call hybrid capital instruments for the duration of the restructuring period without prior approval by the Commission;

c)

buy back hybrid capital instruments, unless such a measure, possibly in combination with others, allows the bank to fully absorb its capital shortfall, and occurs sufficiently close to current market levels and at not more than 10% above the market price. Any buy back is subject to prior approval by the Commission;

d)

perform any capital management transaction without prior approval by the Commission;

e)

engage in aggressive commercial practices;

f)

acquire a stake in any undertaking, be it an asset or share transfer. That requirement does not cover: (i) acquisitions that take place in the ordinary course of the banking business in the management of existing claims towards ailing firms; and (ii) the acquisition of stakes in undertakings provided that the purchase price paid is less than 0.01% of the last available balance sheet size of the bank at that moment and that the cumulative purchase prices paid for all acquisitions from that moment until the end of the restructuring period is less than 0.025 % of its last available balance sheet size at that moment; (iii) the acquisition of a business, after obtaining the Commission’s approval, if it is, in exceptional circumstances, necessary to restore financial stability or to ensure effective competition; and

g)

advertise referring to State support and from employing any aggressive commercial strategies which would not take place without the support of the Member State.14

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