09 October 2013

VP Rehn: Letter to EU Finance Ministers on treatment of public capital injections under EDP rules in balance sheet assessment/stress tests

Cleaning up bank balance sheets is a pre-condition for sustainable growth and for revitalised financial integration in Europe through the creation of the Banking Union. To strengthen the gradual recovery that is now at its early stages, we need to make decisive progress on both of these fronts in the coming months.

The European Council of June 2013 concluded that the balance sheet assessment in the transition towards the Single Supervisory Mechanism (SSM) will consist of an asset quality review and a stress test. In case a balance sheet assessment indicates capital needs, the bank concerned will be required to recapitalise in the first place via private sources, relying on public funds only as a last resort. In this context, the European Council further concluded that Member States participating in the SSM will make appropriate arrangements, including the establishment of national backstops, ahead of the completion of the balance sheet assessment.

Pending the entry into force of the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) and when there is recourse to public money, the EU's burden-sharing framework is defined by the revised state-aid guidelines, which were presented in the recent Banking Communication and entered into force on 1 August, 2013. The revised state aid guidelines ensure a minimum level playing field in the application of burden-sharing within the European Union, with adequate safeguards for preserving financial stability. According to the revised guidelines, shareholders and junior bondholders would be required to fully contribute to building the capital base of a bank before public money could be injected.

Under the Stability and Growth Pact, public capital injections are, in general terms, regarded as one-off or temporary measures and as relevant factors for financial stability, which means that they do not count against the Member State in the context of the excessive deficit procedure.

In broad terms, the treatment of capital injections requiring recourse to public backstops can be summarised as follows (detail is given in the annex).

1. For a Member State in which the capital injection would lead to an apparent breach of the debt or deficit criterion of the Pact, financial stabilisation operations in the above context would be taken into account as a relevant factor in the Commission's assessment of compliance with the criteria, and thus an excessive deficit procedure (EDP) would normally not be opened. Member States with debt above 60 per cent of GDP however would be an exception and an excessive deficit procedure (EDP) would be opened, unless the amount of capital transfers is limited so that it allows them to keep the nominal deficit close to the 3% reference value. The EDP recommendation in such a case would consider that such operations are usually of a one-off nature.

2. For a Member State that is already in EDP, a capital injection would not lead to a stepping-up of the procedure, as one-off and temporary measures are netted out of the fiscal effort recommended to correct the excessive deficit by the deadline.

3. For the abrogation of the EDP, the deficit has to be brought below 3 per cent of GDP in a sustainable manner. While a capital injection could thus lead to a delay in abrogating the procedure, this would not result in a stepping-up of the procedure for the same reasons as given under (2), provided that the recommended fiscal effort (measured by the change in the structural balance) had been delivered.

The revised state-aid guidelines clarify that bank share-owners and junior creditors would need to contribute before taxpayers' money is spent to foot the bill in the case of possible bank bail-outs. At the same time, it is clear from the above that the EU fiscal rules provide no disincentive to effective public backstops.

Full letter with annex

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