18 February 2008

MLex: Northern Rock nationalisation won't remove state aid imperative or its consequences

The nationalisation of Northern Rock won't change the UK government's obligations under Europe's state aid rules – the troubled mortgage lender still faces tough scrutiny and the prospect of a much reduced business outlook.

The European Union treaty is neutral on ownership – it doesn't matter whether the bank is owned by private shareholders or the state – and for the purposes of the investigation, the bank will be considered a business concern like any other. 

The UK government, now free of the constraints of outside investors, will be well placed to meet the 17 March deadline for notifying its restructuring package to commission regulators and, possibly, should be able to notify it much before that date. The sooner it is notified, the sooner the clock starts ticking, and if the government wants a speedy solution – a big if – then an early and complete notification would be appropriate.

The issues the regulators will need to address will depend on how the government has restructured the bank. While unlikely, the removal of unlimited deposit guarantees, an ending of the loan guarantees, and a repayment of existing loans at commercial rates would mean the bank would be in the clear. That would mean that the government could continue running and growing the bank's business in preparation for an eventual sale. 

If any or all of those aren't removed, then the long process of assessing the aid and what will be required to counterbalance it will begin. 

Competition for new business in the banking sector, particularly among mortgage lenders, is tough enough and for potential new entrants as well as existing lenders, being faced with a competitor with 100 percent deposit guarantees and government backed bonds will create an lopsided playing field for raising capital either from savers or through the markets. 

On the issue of the deposit guarantees, there are some useful precedents – even if the assessment of aid to a newly nationalised bank is somewhat virgin territory for the commission. 

In December 2005, the commission [approved plans] by France to create Banque Postale and found that the entity didn't enjoy any economic advantage from the remuneration it pays to La Poste under the so-called Service agreements. 

In its finding the commission ascertained that funds deposited in accounts and savings accounts transferred to Banque Postale would be covered by the state guarantee between 1 January and 31 December 2006. Under an agreement, Banque Postale will remunerate the State for this guarantee in respect of the fraction of deposits made after 1 January 2006 that exceeds 70 000 euros. The commission checked that the premium paid by Banque Postale for the grant of the state guarantee will be set in line with market conditions so that the state guarantee didn't confer an economic advantage. 

In the event, the approval of the state aid has been [challenged] by Credit Agricole in the Court of First Instance in Luxembourg. A date for a hearing has yet to be set in the case, indicating that a decision is still some months away. Similar legal challenges to whatever decision ultimately comes out of the Northern Rock process can be expected. 

And similar issues will need to be resolved in relation to any ongoing loan guarantees and on the question of repayment rates on existing loans. 

Again, looking at precedents – most relevantly the Bank Berliner decision – if the government is intent on Northern Rock continuing as a going concern and that some or all of the rescue aid is to remain in place post 17 March then it will have to be prepared to make asset divestments and reduce the scope of the bank's business. 

The commission, which has to date shown admirable caution and restraint during the Northern Rock crisis, has to balance the review of this situation in light of state aid reviews in the banking sector that may come in further down the line. A too-easy/too light precedent would send an unhelpful signal to other governments that may be hard to reverse and, in any event, would undermine the more subtle objective of a pan-European reorganisation of Europe's financial services sector. 

By Robert McLeod

© MLex