Stability and Competition in EU Banking During the Financial Crisis: The Role of State Aid Control

Gert-Jan Koopman, Dec 22, 2011

The available evidence suggests that the European Commission’s State Aid (“SA”) control of public assistance to the financial sector in the European Union during the period 2008-2010 has had a positive impact on both financial stability and competition in the EU’s internal banking market. The particular features of the crisis regime dedicated to assessing State Aid not only allowed the disbursement of unprecedented amounts of aid, often in record time, but also rendered the aid more effective by ensuring that aid recipients, where necessary, were restructured or liquidated. The conditions imposed on banks receiving large amounts of aid have generally led to highly significant restructuring and addressed fundamental weaknesses in business models, helping to avoid the creation of “zombie banks.” At the same time, where aid amounts were relatively small and banks were sound, these rules allowed financial institutions to be aided without requiring changes in their business model.

SA control has ensured that the large amounts of aid granted did not lead to major distortions in the Internal Market. Absent this control, these public interventions could have triggered a fragmentation of the Internal Market itself. While all substantial aid is likely to have a distortive effect, available indicators suggest that SA control has effectively mitigated these consequences. There is little evidence of retrenchment behind national borders and aided banks have generally not seen their market shares increase. Moreover, the crisis framework is likely to have had a strong signalling function to financial institutions with respect to moral hazard going forward.

In the absence of EU-wide rules for bank resolution, the SA crisis regime also presently acts as the de facto EU-wide resolution framework. However, it is an imperfect tool resolution compared to a full-fledged regulatory framework that helps avoid recourse to aid in the first instance and can provide clear ex ante guidance for all market players (which in itself is confidence-enhancing).

The re-emergence of serious tensions in the EU banking sector from the summer of 2011 onwards is largely linked to concerns about the sustainability of public finances in a number of EU Member States feeding through to concerns about assets on banks’ balance sheets. To remedy this, stability-oriented macroeconomic–especially fiscal–policies are required, and appropriate regulation of banking is needed. A key challenge for State Aid control in EU banking, therefore, is to ensure appropriate coordination with regulatory and macroeconomic policies as they are further developed.

Links to Full Content