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EU Banking:

State Aids in the EU Banking Industry
© Anastasia Tsakatoura, 22 June 2002. All Rights Reserved.


In the preamble to the 1957 Treaty of Rome the signatories States pronounced their determination to “lay the foundations of an ever closer union among the peoples of Europe”; they resolved to “ensure the economic and social progress of their countries by common action to eliminate the barriers which divide Europe”. The means of achieving this is provided by the creation of a common market characterised by the elimination of all obstacles to intra-community trade.[1] Article 7(a) of the EC Treaty provides that “the internal market is to comprise an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured in accordance with the provisions of this Treaty”. Therefore, what was visualised by the signatory states is to merge national markets into a single one and to bring about conditions as close as possible to those of a genuine internal market.

In order to secure that such a single European market is feasible, the European Community had to ensure that nothing would distort competition among the Member States and therefore to prohibit devices, which can impede the attainment of such a goal. Consequently, competition has always played an imperative role in the European Community. Competition regulation, however, is not, as many commonly believe, restricted to the control of anti-competitive behaviour of private undertakings that distort market forces in the world of industry and commerce. As Graig and De Bùrca observed[2]: “the discussion of the substantive law of the Community would, however, be incomplete if it did not take account of the way in which the actions of the State itself might infringe the Treaty.” But, in what way can a State infringe the Treaty and distort competition? In a competitive and ever-growing market such as the one that the Community visualizes non-viable private or public undertakings might be tempted to resort to the government of their State for some sort of support mostly of a financial nature. Such financial assistance, though, constitutes anti-competitive behaviour because it consequences to a disadvantage for competitors, and creates a protectionist behaviour emanating from the government of the Member State.

Europe is a market consisted by mixed economic systems. Each of these systems constitutes an entity with each own rules and traditions. In some of those systems the State traditionally used to intervene more than in others, on the economic policy by nationalizing undertakings or conferring them some privileged monopoly or quasi-monopoly status. The underlying principles for this interference and the legal form, by which it has been attained differs from the one State to another. On the other hand, a more modern approach, encourage a more restricted role for the State, as illustrated by the privatization of nationalized industries and in the deregulation of several sectors of the economy. Despite these changes, there continue to be undertakings which either remain within public ownership or which possess a certain privileged status in the market place[3].

This kind of State intervention in the form of financial aid and subsidies however is incompatible with the notion of a free market and, as we mentioned before, constitutes anti-competitive behaviour from a Member State towards other States in the Community. The Community in an attempt to eliminate the possibilities of such a conduct by the national governments established a monitoring devise for State Aids, which is contained in the Treaty. The provisions relating to the achievement of a market with a limited state intervention are included in Articles 86 to 89 (formerly Art. 90 and 92 to 94).

The purpose of this essay is to explore the rules on state aids and their exceptions as included in the Treaty, and assess their application particularly in the banking sector. We will attempt to do so, by looking at the relevant case law and the way those cases have been resolved. Furthermore, we shall refer to the new legislation adopted by the Commission aimed to “make certain changes and clarifications prompted by a number of factors[4].

Main Provisions

Article 87(1) (formerly 92(1)) provides:

“Save as otherwise provided in this Treaty, any aid granted by a Member State through State resources in any form whatsoever which distorts or threatens competition by favouring certain undertakings or the production of certain goods, shall in so far as it affects trade between Member States, be incompatible with the common market.”

This Article, in substance, lays down the basic foundations for state aids by establishing that they are incompatible with the common market. Even though, Art.87(1) is not considered to be a directly applicable prohibition of an aid, the ECJ appears to regard this provision as an implied prohibition[5].

The question that arises is what is precisely the meaning of the term ‘state aid’. The Treaty does not contain any definition on the meaning of the term and, therefore, it remained open to the interpretation of the ECJ to provide for a definition. The ECJ, however, adopted a broad view of what constitutes aid and did not refine its boundaries. The Commission, on the other hand, released a full list of what amounts to illegal or prohibited state aid. Yet this list is rather illustrative than exhaustive and thus other forms of aid can be added to it [6]. For example the list did not include subsidies or tax exemptions, which have been later, found to constitute state aid. It has been argued that, the absence of a clear-cut definition on the subject matter is justified by the presumption that ‘the substance, and not the form, is relevant when defining aid’[7]. A definition, consequently, might limit the scope of the relevant articles if other forms of illegal aid will be introduced in the future. Therefore, in the case Steenkolenmijnen v. High Authority [8]the ECJ after distinguishing the word subsidy from an aid gave a useful definition to the term by stating that an aid: “places emphasis on its purpose and seems especially devised for a particular objective which cannot normally be made without outside help”.

Irrefutably a state intervention targeted to compensate a firm in difficulties, in order to be tantamount to a prohibited state aid caught by art. 87(1) has to represent a possible distortion of competition, while, at the same time, it must be shown that it affects inter-state trade.[9]

Yet, not all State Aids are regarded to be incompatible with the common market. Exceptions to the rule existing in 87(1) can be found in Art. 87(2), which contains three types of aids considered as compatible with the common market. These exceptions include aids with a social character, aids to rectify damages caused by natural disasters and, finally, special aids to compensate for the economic disadvantage of Germany due to its division. Additionally Art.87 (3) encompasses some further exceptions of a discretionary nature. These aids are not consequentially tolerable, however the Commission has the discretion, under certain circumstances to consider them legal.

The control and supervision of State Aids have been entrusted to the Commission in Brussels. Accordingly Art. 88(3) asserts that the Member States are required to notify the Commission and report any aid prior to granting it. As in every other rule, there are certain exceptions to this rule too. For example, when an existing aid arrangement already approved by the Commission for a certain amount, increases without exceeding 20% of the agreed subsidy, notification is not necessary. Another remarkable exception is the so-called ‘de minimis’ doctrine. The Commission, in 1996, adopted the “de minimis” rule by which it exempted from the state aid prohibition minor financial aid of up to 100.000 Euros to be granted over a three-year period. De minimis aid shall not necessarily be notified to the Commission pursuant to Art. 88(3). Nonetheless, Member States will have to “record and compile all the information regarding the application of the group exemptions” and submit an annual report to the Commission of all the minor aids the public authorities have granted during the year. However, the Court, at the beginning consistently rejected to allow de minimis aid[10] and questioned the Commission’s power of control for doing so. The Council Regulation 994/98, though, conferred a legal basis to it and clarified the situation further.

Aids in the Banking Sector

After having examined briefly the main provisions for State intervention as contained in the Treaty’s relevant articles, we shall now turn to the heart of our analysis concerning State financial aid to the banking sector.

The crucial role that banks play in the economy of a State by providing credit and liquidity necessitates stability to the banking system while the opposite might be threatening to the economic development and growth of a society leading even to an institutional breakdown. Therefore, the State authorities in an attempt to preserve the status of their banking system and prevent a financial institution from insolvency used to act in the past as a ‘lender of last resort’. Particularly, in fear that a crisis might result to ‘systemic risk’, namely that default by one institution can spread to undermine other institutions, public policy might endeavor to put some confidence in the system as a whole and regulate against any potential risk.

Nowadays though, fortunately or unfortunately, the State while attempting to maintain an efficient and healthy banking system, should take into account the relevant EU legislation so as to safeguard that by doing so it will not distort and violate the European single market regulations.

There are various ways, provided by the European Union, to mitigate risk of insolvency. The first stage to do so is what is called ‘prudential supervision’, which is aimed to ensure that the financial institutions are prudently run and have adequate capital and liquidity. The second stage concerns aid by the State itself so as to avoid any possible collapse. However, as we have already mentioned competition policy in EU restricts financial aids to any public and private enterprises in difficulty.

Despite the fact that the Treaty does not include any particular provisions for financial institutions, the Commission takes into account the special nature of banks as compared to other undertakings and under certain circumstances it has been lenient in the application of the rules by permiting an intervention so as to ‘restore confidence in the banking sector or to protect the proper functioning of the payment system’[11].

In the Solvency Ratio Directive[12], which provides the legal framework so as to preserve the stability of the banking system while at the same time ensures equal competitive conditions within the Community, is acknowledged that “ in a common banking market, institutions are required to enter into competition with one another and… the adoption of common solvency standards in the form of a minimum ratio will prevent distortions of competition and strengthen the Community banking system”. Therefore a minimum solvency ratio set by the EU, does not only portray the starting point of the competition among credit institutions in the Community, but also is a decisive factor for the viability of a bank. A State in attempting to restore the viability of a bank by providing financial aid and ensuring that the required prudential supervision standards are met, might distort competition and infringe Art.87 of the Treaty. Especially nowadays that the Economic and Monetary Union is a reality for most of the Member States, with a single currency materializing the dream of a single free market without internal frontiers, a protectionist policy emanating directly by a Member State will constitute a more severe distortion of competition than ever before.

The Community, in order both to ensure that the special nature of credit institutions will be safeguarded while at the same time State Aid rules will not be infringed, distinguishes between a ‘rescue aid’ and a ‘restructuring aid’. It is important, therefore, for the purposes of this essay, briefly to elaborate upon the meaning of those terms.

I. Rescue Aid

The basic principles about rescue and restructuring aid are incorporated in the recent “Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty” [13] published in October 1999, which confirmed and modified previous versions of it. There, ‘rescue aid’ is defined as, a by nature temporary assistance authorized for not more than six months, designed to “keep an ailing firm afloat for the time needed to work out a restructuring or liquidation plan and/or for the length of time the Commission needs to be able to reach a decision on that plan.” A mere injection of capital with the sole purpose to rescue a credit institution confronting insolvency, without any further plan for a structural change is usually not permissible by the Commission especially in such circumstances that the State acts as a ‘lender of last resort’. Rescue aid may only be allowed if it takes the form of loan guarantees, repayable loans at market rates of interest or granted to such institutions situated in regions experiencing economic difficulties[14]. Additionally, it has to be notified to the Commission ensuring that it will not have adverse effects on competition and strictly conforming to the required six months deadline.

II. Restructuring Aid

On the other hand, restructuring aid involves “a feasible, coherent and far-reaching plan to restore a firm’s long-term viability” involving the reorganization and rationalization of the firm’s activities on to a more efficient basis as well as, the withdrawal from loss-making activities. A restructuring aid does not only include financial restructuring but might imply also physical restructuring. Under certain circumstances, the Commission might approve restructuring aid, as far as it is considered to be a contribution to the development of the economic activities of the Member State rather than resulting to a serious distortion of competition.

A restructuring aid shall be limited to the smaller possible duration period and the Commission is entitled to a close monitoring of the whole procedure. Additionally, in order to avoid, as far as possible, the adverse effects that the aid might have on competitors ‘the amount and the intensity of the aid must be limited to the minimum needed to enable restructuring’ while aid beneficiaries are expected to contribute significantly by means of their own resources (elsewhere called the quid pro quo principle). Furthermore, in order to preclude firms and undertakings from being unfairly assisted the Commission has favoured the “one time, last time” condition, according to which, a firm can be only assisted once[15]. The guidelines also require that there must be a direct link between the grant of aid and the operations benefiting from it. The restructuring plan must be considered capable of putting the enterprise in a position of covering all its costs, and generating a minimum return on capital such that, after restructuring is complete, the firm will not require further aid and will continue to operate in a solvent manner[16]. In practice, however, failure of a restructuring scheme to restore a bank to its full operational solvency does not exclude further restructuring aid.[17]

As we have already mentioned, whilst the Guidelines are of general application to all sectors, the Commission takes into consideration the special nature of credit institutions and has a different approach in assessing the scope of such aid. This is evident also in the Commission Decision 95/547/EEC[18], whereby the Commission was giving a conditional approval to the aid granted by France to the bank Crèdit Lyonnais. Therein, one can find guidelines for the applicability of the State Aid rules to bank. This case is of seminal importance for state aids in the banking sector and it is necessary for the purposes of this paper to analyze it further. Before, doing so, however, we shall first introduce the ‘private investor test’, which is a test of crucial importance when answering the question of whether a grant to undertakings by the public sector is caught by Art. 87(1).

III. The Market Economy Investor Test

In order to make a distinction between a legitimate state investment in a credit institution and a capital injection, the Commission adopted the so-called ‘private investor test’. For this test to be satisfied it must be demonstrated that a private investor, whose purpose is to profit in the long run, would have acted in the same way the State did in its capacity as a shareholder. Furthermore, “a coherent and detailed restructuring plan must be presented which shows that it can reasonably be supposed that there will be a normal return on the State’s investment in the whole operation which would be acceptable to a private investor in a market economy. Otherwise, there is a State aid component.[19] In Re Tubemeuse: Belgium v. Commission [20]case the ECJ ruled that in order to determine whether measures to increase capital taken by the State so as to assist a firm facing financial difficulties are not in the nature of State aid, it has to be demonstrated that “the undertaking could have obtained the amounts in question on the capital market”.

In other words in order to maintain the necessary principle of neutrality, the aid must be measured as the difference between the terms on which the funds were made available by the State to the credit institution, and the terms which a private investor would find acceptable in providing funds to a comparable institution when he is functioning under normal market economy conditions.

On the subject matter, the Commission suggested that, even where national rules provide for compulsory recapitalization of a bank in difficulty, such recapitalization would constitute aid if it were not granted under normal conditions that were acceptable to a private investor in terms of return. Additionally, in comparing the actions of the State and those of a market-economy investor, the evaluation of the amount of aid must be based on a comparison between the cost of the operation and its correctly discounted value.[21]

IV. The Credit Lyonnais Case

We shall now turn and briefly discuss the leading case of Crèdit Lyonnais, which is yardstick for the purposes of this essay. On the facts of the case, Credit Lyonnais (thereinafter CL) at the end of 1993 was a leading European banking group. Its majority shareholder was the French State, holding 55% of the capital and 76% of the voting rights. After a period of rapid growth CL recorded very heavy losses in proportion to its own funds and solvency ratio and in 1995 it was clear that CL would record further losses threatening its solvency and viability. The French Government in an attempt to assist the bank put together a rescue package involving the setting-up of a specific hived-off[22] vehicle to take over FF 135 billion of assets, including CL’s non-performing or poorly performing assets. The setting-up of this vehicle limited the accounting loss for 1994 to FF 12,1 billion. Nevertheless this was not the only time that the French government financially assisted CL. We shall not further analyze the facts of the case due to the limited size of the essay as well as to the complexities they involve.

As we have already mentioned, whilst the Commission had been assessing the aid granted by the French government considered the special nature of banks and applied the guidelines of rescue and restructuring with specific reference to the banking sector.

It is noteworthy that during the assessment of the aid it had been demonstrated that given the circumstances and since CL’s solvency ratio fell below the minimum, a private investor would have not undertaken an investment in the bank, mostly because a private investor could have never mobilized such amounts as to rescue CL.

Also, the aid has been found to distort competition and effect inter-state trade because more than half the activities of CL were taking place outside the local area of France, while the activities located in France, although spread throughout the country, were concentrated in medium-sized and large urban areas. Additionally, the aid was not designed to remedy a serious disturbance in the economy because it was concerned only to remedy the difficulties of a single recipient, rather than those of all enterprises in the sector.

However, it was decided that the financial aid could be compatible with the common market and therefore not to fall under Art. 92(2) and (3) [now 87(2) & (3)], if certain conditions were satisfied. Those conditions were that:

1.      the aid must restore the viability of the firm within a reasonable timescale;

2.      must be in proportion to the restructuring coasts and benefits and must not exceed what is strictly necessary;

3.      aid measures must have the least distorting effect on competition possible and the firm must make a significant financial contribution to the restructuring costs; and

4.      measures must be taken to compensate competitors as far as possible for the adverse effects of aid.

The decision in the CL case has been followed by many subsequent cases such as the Credit Foncier de France [23] case. There, again the French government was assisting a credit institution not to be wounded-up. The Commission after examining the nature of the aid, considered it compatible under certain circumstances.

To my understanding, even if in both cases, the financial subsidies granted were deemed to distort competition and inter-State trade and also both cases failed to satisfy the ‘private investor test’, a very significant role to the Commission’s ruling played the so-called ‘quid pro quo’ principle. Accordingly, if major distortion of competition is unavoidable, substantial compensatory measures must be required that benefit other operators in the sector in order to mitigate the harmful effects of the aid.


After having briefly examined the main principles upon which State intervention, in the form of financial aid, is being monitored by the Community and especially by the Commission, there are surely questions that still remain unanswered. The wording of the Articles of the Treaty is far from explicit and there is a lot of room for different interpretation. Obviously, even if in theory there is not any particular provision for the banking sector, in practice there are some allowances made by the Commission due to the special nature of the credit institutions. Statistically, State Aid to the financial sector has increased from an annual average of 1.1 Euro in 1993-1995 to 2.7 billion in 1995-1997, while it is estimated that there has been a further increase especially after the ruling in the CL case.

However, the increasing demands of a free and unified European market cannot leave the banking sector in the margin. While realizing that the stability of banking is of a prominent significance to the national economy of a Member State, competition policy compels that institutions which are not capable to survive must fail and that there is not such a principle as that: it is “too big to fail”. A Member State is required to restrict the capital injection or any other financial aid to the minimum especially to undertakings that are not restrained to the local area of the State but their activities expands to the whole of the Community. Surely, State aid rules are more lenient as far as banks are concerned, however, the Commission keeps stressing the importance of prudential supervision in order to avoid State intervention.

back to Lex e-Scripta© Anastasia Tsakatoura, 22 June 2002. All Rights Reserved.

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