April 2009 European Competition Journal 1

The Current Financial Crisis and State Aid in the EU

THE CURRENT FINANCIAL CRISIS AND STATE AID IN THE EU

ABEL M MATEUS*

A. I NTRODUCTION

We are in the middle of the worst financial and economic crisis since the Great
Depression. We argue that an aggressive and timely state aid and intervention is
required. The European Commission has acted on the measures notified by the
Member States in a fast and adequate manner, and has issued a generally
appropriate guidance, according to a cost–benefit analysis. But this was the
response to the first wave of the crisis. We argue that bank guarantees and
recapitalisation may not be enough to re-launch economic activity and some
economies may require the “cleaning-up” of bad debts, which needs a revision
of the guidelines.
All the major developed economies are expected to have a negative GDP
growth rate in 2009, with a slow recovery in the second half of 2010. The US
has already been in recession since the end of 2007, and unemployment rates
may well reach close to 10% in the US and 12% in the euro area before the crisis
is over. Equity prices have already registered the largest drop since the Great
Depression, falling by 50% between the peak last year and current levels. The
crisis, triggered by the burst of the real estate bubble in mid-2007,1 reached a
serious stage in September 2008, when the financial systems of the US and
Europe seemed on the brink of collapse. After this first wave, the decrease in
housing and stock prices and the accumulation of losses in the financial sector
led to a sharp fall in lending and a decrease in investment and consumer
demand. The deterioration of the real economy will further deteriorate the
balance sheets of banks and continue to feed into a vicious circle that will have to
be reversed by appropriate monetary, fiscal and structural policies.

* Visiting Professor at University College of London and British Institute of International and
Competition Law.
1 There have been similar financial crisis in the last 50 years, namely the S&L crisis of the 1980s,
the Nordic crisis of the early 1990s and the Japanese crisis of the 1990s. In all of them real estate
bubbles played a major role. For a compilation of crisis and their characteristics see C Reinhart
and K Rogoff. “This Time is Different: a Panoramic View of Eight Centuries of Financial Crisis”,
mimeo, Harvard University (April 2008), available at http://www.economics.harvard.edu/
faculty/rogoff/Recent_Papers_Rogoff (accessed December 2008). See also C Reihart and
K Rogoff, “The Aftermath of Financial Crisis” (December 2008), at the same website.
2 The Current Financial Crisis and State Aid in the EU ECJ VOL. 5 NO. 1

In this paper I will address, within the context of the EU, the need for state
aid to the financial sector and the rest of the economy. I will look at the rationale
for state intervention and state aid, and the way that the European Commission
has responded to the measures taken by Member States. Overall, the
Commission has responded quickly and with the right approach. Then I will
analyse the menu of measures currently being used using an economics-based
approach. The ranking of the measures shows that most of the governments in
the EU have responded with the right measures. However, with the experience
of past crisis, I consider that the menu has to be expanded, and the second wave
and further cycles of the crisis may warrant the expansion of the measures used
so far. The last section takes this issue further and considers whether more bold
and unorthodox measures may be required if the crisis continues to deepen in
order to jump-start the economy. This requires a revision and expansion of the
guidelines issued by the Commission2 and a more coordinated approach with
other institutions, mainly the ECB and regulatory bodies.3

B. W HY S TATE A ID ? T HE C OMMISSION I NTERVENTION

State intervention and aid to the financial sector in a crisis situation are essential
to avoid the collapse of the system. First, there are externalities and systemic risk
involved: the failure of a large bank may create a systemic risk of generalised
bank failures due to cross-balance-sheet relationships that are not internalised in
the failure of the particular bank. Also, the failure of an important deposit
institution may create bank runs, which will lead to liquidity squeezes and
precipitate bank failures. Secondly, there are externalities between the financial
and real sectors: the increasing risk of failure of banks leads them to curtail
lending to firms and households, precipitating a downturn in the economy; and
the loss of deposits and other household and firm assets leads to a decrease in the
money supply and cuts aggregate demand (the spectre of deflation). The second
broad type of market failure occurs due to information asymmetries and
collapsing markets: (i) banks may not have good information about the liquidity
and solvency of their household or firms clients. Besides, in a mark-to-market
world the values of all assets may decrease in synchronization, and it may be
difficult to distinguish between a relative price and overall adjustment; and (ii)

2 Communication from the Commission—Temporary Community Framework for State aid

measures to support access to finance in the current financial and economic crisis, (2009/C
19/01), [2009] OJ C16/1. See also Communication from the Commission—The application of
State aid rules to measures taken in relation to financial institutions in the context of the current
global financial crisis, (2008/C 270/02), [2008] OJ C270/8.
3 At the time of writing, Treasury Secretary Geithner has announced some of the measures that are
being here proposed, like planning to buy bad assets from banks. See “Geithner Proposes New
Bank Rescue Plan”, New York Times, 10 February 2009.
April 2009 European Competition Journal 3

capital markets suffer from the same asymmetries in information—it is difficult to

distinguish good and bad investments, accentuated by the large correlation in
risk.
There are also cross-border externalities: (i) bank failures in one country may
lead to bank failures in other countries, especially in a currency union or a
financially integrated area; and (ii) there are also externalities arising from the
interaction of the financial and real sectors across all countries in the EU.
In view of the severity of the crisis, the Ecofin Council of 7 October 2008
established the following principles for the Commission intervention:

1. intervention should be timely and the support should in principle be

temporary;
2. Member States should be watchful with regard to the interests of
taxpayers;
3. existing shareholders should bear the due consequences of the
intervention;
4. Member States should be in a position to bring about a change in
management;
5. the management should not retain undue benefits—governments should
have, inter alia, the power to intervene in remuneration;
6. legitimate interest of competitors must be protected, in particular through
the state aid rules; and
7. negative spill-over effects should be avoided.

The scale of the collapse of the financial system, with ominous consequences to
the real economy,4 required a timely and speedy intervention and approval
systems. However, there was no blanket solution, since markets and agents were
in different situations. There were economies with high and low leveraged
households; the leveraging levels by firms also diverged significantly; and the
quality of bank supervision was also quite diverse. Besides, each institution in
difficulty requires a tailor-made intervention, ranging from a minority stake
recapitalisation up to liquidation. Moreover, the menu of measures that can be
taken is quite large, so each country has to assess the best policy at the time with
regard to its impact in reducing the specific and systemic risk. Consequently, the
only way to orchestrate rescues in the financial system, which also requires the
maximum secrecy in order to avoid bank runs, is to elaborate an excellent set of
guidelines to give clear guidance to states and regulators on different alternatives
and best practices. Similarly to other areas of state aid, the system has to:
(i) establish de minimis criteria; (ii) define measures and conditions that “most likely

4 Policymakers need to avoid the mistakes of the Great Depression, where bank failures led to a
decrease in money supply of about one third. This, coupled with a contractionary fiscal policy, led
to unemployment rates of about 30%.
4 The Current Financial Crisis and State Aid in the EU ECJ VOL. 5 NO. 1

would be rejected” (red lines); and (iii) define a clear and efficient system for
monitoring evolution after the aid.
As of 3 December 2008, the Commission was notified by all major EU
countries on measures involving state aid of the following types: deposit
guarantees (DG), guarantees for bank lending (BG), bank recapitalisation
schemes (BR), set-up companies to dispose of bad assets (CD) and funds to buy
bad assets from banks (BA). The following countries have introduced general
measures to shore-up the financial sector: Austria (BG), Denmark (DG, BG, CD),
Finland (BG, BR), France (BG, BR), Germany (DG, BG, BR), Greece (BG, BR),
Hungary (BG, BR), Ireland (DG, BG), Italy (BG, BR), Latvia (BG), Netherlands
(BG), Poland (BG), Portugal (DG, BG, BR), Slovenia (DG, BG), Spain (BR, CD),
Sweden (BG) and United Kingdom (DG, BG, BR). There were also 22 bank
rescues notified,5 and one bank liquidation by Denmark. The majority of the
interventions have been on issuing state guarantees to bank liabilities and to set
up funds for recapitalisation. Only Denmark and Spain have set up a separate
company and fund, respectively, to buy and dispose of bad bank assets. But, so
far, the Commission appears to be reluctant to accept this type of intervention.6
There are some common benchmarks developed by this new case law:
1. eligibility and non-discrimination: subsidiaries of foreign banks, systemic
branches;
2. 6 months as the normal duration of schemes with review clauses, though
this term seems too short in view of the normal 2- to 3-year duration of
financial crises;
3. limitations on the issuance windows for guarantees, limitations in the
maturity of the debts (3 years); and
4. minimum remuneration of capital injected by the state.
In 6 months the Commission will review the measures already approved and
Member States will have to notify the Commission of their restructuring plans
for beneficiary entities. There will also be an assessment of the adequacy of the
measures and of their distortive effects.
Comparing two of the recent financial crisis—the Swedish crisis of the early
1990s,7 which was dealt with quickly and with a relatively small fiscal and
economic cost, and the Japanese crisis of the 1990s,8 which led to a decade of
5 Belgium, Germany and Netherlands, with four cases each, Luxembourg, UK and Sweden, with
two cases each; and France, Finland, Portugal and Latvia, all with one case.
6 Similar measures were taken by the US during the Great Depression and the S&L crisis. The
Reconstruction Finance Corporation was created to recapitalise banks, manage the portfolio of
shares and supervise the banks that had undergone state intervention from a commercial
shareholder perspective. The Resolution Trust Corporation was set up to buy bad assets.
7 For a comprehensive view of the crisis and policies adopted see P Englund, “The Swedish Banking
Crisis: Roots and Consequences” (1999) 15(3) Oxford Review of Economic Policy 80.
8 See, eg, T Hoshi and A Kashyap, “The Japanese Banking Crisis: Where Did It Come From and
Where It Will End?”, NBER Working Paper 7250 (July 1999).
April 2009 European Competition Journal 5

low growth and a financial cost ten times larger—we can learn a number of
lessons. The most important one is that banks need to be transparent and
evaluate their situation realistically, with the regulators doing their proper job.
Denying the problem and waiting for the economy to improve leads to a
prolonged crisis. Secondly, debt restructuring is absolutely necessary to prevent a
vicious cycle: debt relief and rehabilitation of viable but debt-ridden firms and
the liquidation of nonviable firms are crucially important to wipe out the
payment uncertainty from the economy and restore market confidence. The
Japanese case shows that if zombie firms stick around in the market, uncertainty
and business shrinkage will linger on. Capital injections into banks are just a
beginning. Thirdly, stringent asset evaluation and sufficient write-offs of the toxic
assets should be the premise behind bank-capital injections and debt restruc-
turing, with close supervision by the regulators. Fourthly, purchase of bad assets
by public asset management companies will unwind the leveraging: if bad assets
are disposed of by distress selling in the market, stringent asset evaluation will
result in a vicious cycle of debt deflation. To stop the vicious cycle of debt
deflation, the governments should establish asset management companies—
public entities that purchase and hold the bad assets. The public entities should
then restructure the bad assets and sell them off gradually after the market
stabilises. Finally, suspension of mark-to-market accounting has a long-term side
effect: if bankers hide bad assets, zombie firms will persist and the payment
uncertainty will remain, setting the stage for very low long-term economic
growth, so it should not be pursued after the phase of acute crisis.

C. A N E CONOMIC-BASED A PPROACH TO THE M ENU OF M EASURES

I have demonstrated the need of financial aid to stop a market failure. In order to
study the most appropriate measures for state aid, their impact on reducing the
systemic risk and improving the solvability and liquidity of the financial system
needs to be established, with an ultimate view of reducing the losses of
(consumer) welfare in the economy. Next, how the incentive changes the behavior
of banks and agents, which in this case have real problems of moral hazard and
adverse selection, should be studied. Finally, distortions to competition and trade
should be reduced to a minimum.
For each specific case, a cost–benefit analysis could be undertaken with the
help of some simple financial models, based on the net present value of stream
of benefits and costs. Direct benefits arise from avoiding contraction of credit to
the economy (use can be made of the credit multiplier or financial accelerator
estimated by the European Central Bank). Indirect benefits arise from containing
systemic risk and the overall risk of recession, after computing the impact on
financial risk. On the costs side, there are obvious immediate and delayed costs
6 The Current Financial Crisis and State Aid in the EU ECJ VOL. 5 NO. 1

to taxpayers: over the short term, there are the interest costs of public debt and
the cost of guarantees; over the medium term, there are potential costs due to
asset valuations and bankruptcy of the institution. There are also administrative
costs related with the implementation of the measures that may be important in
some cases (consulting, management, etc). Finally, there may be also direct costs
to depositors and investors, mainly an option cost of inaction. Financial
specialists use similar models for evaluating mergers and acquisitions or buyouts
in 2 or 3 days; we hope that similar methodologies will be used by state aid
specialists.
This is the methodology for specific cases. We used a scoring method for
evaluating the menu of measures mostly used and proposed to attack different
aspects of the financial crisis. We can group the menu of measures the following
way:
. General
. Guarantees:
measures addressed to all banks:

.. Bank deposits (main share of bank liabilities)

. General
. Bank
Guarantees for other bank liabilities
measures, but with a specific bank incidence:
recapitalisation:
.
. Buying
It can take a minority or majority stake
“toxic assets” from banks
.
.. Direct bank intervention
Need to set-up a fund, company and system for buying the assets

.. Nationalisation
Liquidation

.. General intervention in the real sector

Households holding mortgages under foreclosure

. Small to medium enterprises (SMEs) with bad debts and may be bankrupt
Large firms holding bad debts and may be bankrupt

Fig 1 shows the scoring (from 1 = worst to 5 = best) on the following aspects:

1. benefit to the particular institution;

2. reduction in systemic risk and other systemic impacts on the financial
sector and real economy;
3. distortions on behavior of the agents;
4. competition distortions;
5. costs to taxpayers;
6. administrative costs and complexity of implementation; and
7. duration of the aid/intervention.

The measure with the highest score has the best cost–benefit ratio, the lowest the
worst. The best measures are the general deposit guarantee and minority stake,
April 2009 European Competition Journal 7

Fig 1 Scoring Policy Measures for Financial Crisis on Cost–Benefit Analysis.

Source: author’s estimates.

which coincides with a large number of the measures approved by the

Commission. However, next comes general aid to SMEs and to households in
distress, then guarantees to other liabilities issued by banks, where the benefits
are restricted to a liquidity effect, despite it being used by a large number of
countries. At almost the same level comes the buying of assets by the state. Last
come the most drastic solutions, like majority stakes and nationalization, and the
measure with the least cost–benefit ratio—liquidation of institutions.
However, there is still some significant variation in the scoring according to
the specifics of the measure. For example, a minority stake may cost taxpayers
substantially if there is no previous write-off of the capital and it covers the
marginal losses of the bank. There are a number of important aspects that
minority stakeholders should take into consideration when designing a
programme.
First, no other state aid should be given without a depositor guarantee, since
this the measure with the highest score of benefits relative to costs. All modern
financial systems have this type of insurance. However, a blank guarantee to all
deposits should be only temporary. Normally, it is subject to an upper limit per
depositor and per bank, to limit moral hazard, assuming that large depositors
should have enough information about the risk of the bank. The fund for this
8 The Current Financial Crisis and State Aid in the EU ECJ VOL. 5 NO. 1

guarantee should also have the contribution of all the banks that benefit from
the insurance, thus decreasing costs to taxpayers.
Secondly, in recapitalisations of banks the government should require that
shareholders do not profit directly or indirectly from the infusion of capital to
cover the bank losses.9 There should be previous write-offs of the capital and
reserves, including all the provisions. Payment of dividends should be limited or
even prohibited during state intervention and, as the guidance states, either there
should be remuneration of the state capital invested or there should be
claw-back clauses to lower risk to taxpayers. The same holds for bonuses to
management. A problem arises with minority shareholders, especially pension
funds, which in certain cases, such as in Sweden, had special treatment.
Thirdly, nationalisation of banks should be a measure taken only as last
resort. State officials are not necessarily good bank managers, and governments
may be tempted to use banks for purposes other than commercially oriented
operations (profit at minimum risk). Thus they should stop their involvement in
the management of the bank and privatise it as soon as possible.
The financial crisis is a case of massive regulatory failure, and the capability
of recovering taxpayers money, as well as economic recovery, depends crucially
on good regulation. Thus, a daring but necessary conditionality for all these state
aid measures would be the periodic review of capabilities of national bank
supervision, carried out by an independent body jointly with International
Monetary Fund (IMF) and Bank for International Settlements experts.10
The ultimate impact of all state aid depends on the established rules for
financial institutions regulations. The G-20 has already established a set of areas
that need further strengthening.
Finally, the effectiveness and cost to taxpayers of state aid to each individual
institution, certainly subject to moral hazard, depends on restructuring and
system recovery measures, so the Commission should follow its implementation
closely.

D. T HE W AY A HEAD AND C ONCLUSIONS

With regulatory systems that are national it makes little sense to have EU-wide
interventions in the financial system, like the recent German and French episode
showed.11 However, as the French presidency showed, EU-wide measures are

9 This is in fact mandated by the Ecofin statement, above.

10 It is worrisome that, despite the large systemic risk in the eurozone, a way to improve the quality
of bank supervisors has yet to materialise. Lacking an EU-wide regulator that is long overdue, the
minimum is to carry out peer reviews, like in other fields, as among competition authorities.
11 The French proposal was to set up a large fund to support banks in the eurozone. But who would
finance the fund? The German government reacted by saying that German taxpayers were not
willing to bail out banks from other countries, given the fact that German households have some
April 2009 European Competition Journal 9

very important due to their reinforcing and spillover effects. Besides this
leadership at the political level and fiscal and monetary coordination, there is
also an important role that the Commission can play on state aid.
There are three theoretically strong justifications for the Commission to take
a hard-line position on state aid. First, to avoid “subsidy races”. Secondly,
because national governments have a commitment problem: they are not able to
commit to clear rules and a fixed budget ex ante (this is the Kornai problem of
soft budget constraint). There is also the problem of economic agents asking
national states for a renegotiation of conditions and the difficulty in setting
conditions. At the same time, regulatory, administrative and political capture are
all recognised to be easier at national level. The third problem is the difficulty of
national governments to respect dynamic commitments which may create
intertemporal inefficiencies.
Notwithstanding, the Commission needs to promote a more aggressive and
transparent approach by Member States to solve the crisis and revise its
approach, as we now argue, taking the hard lessons of the Japanese case and the
tendency for complacency of some national regulators and the less transparency
in the European markets in relation to the US.12
The Commission Guidance has already established a number of solid
principles for state aid in the context of a financial crisis. As discussed above,
priority is given to guarantees to bank deposits. In case guarantees are extended
to other bank liabilities, like subordinated debt, restrictions have to be imposed
in order not to let shareholders take a free ride.13 The Guidance also establishes
that recapitalisation of banks is appropriate, but only for sound institutions,
which means institutions with no major solvability risk and that should be able to
recover when normal market circumstances prevail.14 It should be done at
market prices, and there are two modalities accepted: preferred stocks with
adequate remuneration, or with claw-back mechanisms or better fortune clauses.
This is right for shoring-up the bank. However, the Guidance stops short of
recognising the most important impact, which is to enable the bank to supply
further lending. If the recapitalisation is going to have any impact on the asset
side of the bank, in order to clean up the balance sheet it needs to be used to
compensate losses. Two conditions were established above: that there is proper
accounting and recognition of the debts, which requires collaboration of the

of the lowest leverage in the EU and the German economy does not have a negative external
assets position that is threatening some smaller countries. In fact, the Stability and Growth Pact
was built on the assumption that no big country would bail out small countries’ economies.
12 In fact, for quite a number of financial instruments that measure bank or corporate risk, the
markets in Europe are substantially underdeveloped.
13 The economic model of a bank is based on the idea that shareholders and managers are the
agents which act in the name of the principal, which are depositors. So, when a bank takes an
abnormal amount of risk those primarily responsible are the shareholders and managers.
14 Once more, this is an analysis that financial analysts are able to carry out.
10 The Current Financial Crisis and State Aid in the EU ECJ VOL. 5 NO. 1

auditors and regulators, and that there are previous write-offs of the capital. The
Japanese case is extremely telling on this point.
The Commission Guidance also recognises that liquidation should be taken
as a second alternative if the guarantee does not work. I would go further and
say that liquidation should be used pure and simply as a last resort. There were
enormous costs to the bankruptcy of Lehman in the US, and despite the moral
hazard that all these measures generate, I still think that liquidation of a major
bank should be an in extremis situation due to the systemic risk that it ultimately
creates.
The Guidance also specifies that liquidity provision by a central bank is not
considered state aid if open to all institutions and, when provided as aid to an
individual institution, is not state aid if the bank is sound and normal penalty
charges are applied.
Most of these measures, and especially the way they are moulded, are for
liquidity support. However, according to most of the market news, European
banks now have plenty of liquidity, still mainly provided by the central bank,
whilst the economic situation continues to deteriorate rapidly. Households are
cutting consumption and increasing savings, due to large losses in wealth and an
expected drop in income, whilst unemployment rises at an alarming rate. And
corporations are cutting investment and production. So we have a vicious circle
of dropping demand for loans and banks cutting lending. Figs 2 and 3 show the
fall in actual corporate lending in the US and the deceleration in the eurozone,
and the rapidly deteriorating expectations.
Not all economies have the same level of household and firms leverage, but
the second phase of the financial crisis is about to hit in full force, affecting
mainly the highly indebted countries. And, as referred to above, this requires a
change in the approach to the problem.
Certainly, that fiscal stimulus is an important policy in this situation, and some
fiscal measures can also help resolve the financial crisis when they help the real
sector to stimulate demand.15 Structural measures to increase productivity are
also of tremendous importance at the time of the economic crisis.
Direct intervention at the household level may be required in a prolonged
recession, to decrease the rate of foreclosure, although generalised schemes are
difficult to administer. These measures are very important for equity purposes,
since they usually help the poorest taxpayers, or taxpayers who have suffered a
sudden loss of income.16 For example, in the UK the government introduced a

15 Governments should also think hard about the large implicit subsidy that they are giving
homeowners who some economists have argued are also at the root of the crisis in mortgage
lending.
16 There are economists that have advocated these types of measures because they have an
immediate impact on the real economy, they help the most illiquid of the households and thus
have a larger multiplier effect.
April 2009 European Competition Journal 11

Fig 2 US Corporate Loan Growth (in %).

Source: Citi, EcoWin, Federal Reserve Senior Loan Officers’ survey.

Fig 3 Eurozone Corporate Loan Growth (in %).

Source: IMF WEO, October 2008, 130.
12 The Current Financial Crisis and State Aid in the EU ECJ VOL. 5 NO. 1

measure for the state to pay interest in arrears, for up to 2 years, for households
in which the main breadwinner has became unemployed or has suffered a large
drop in income. In Portugal, the government is proposing to set up a state fund
in conjunction with major banks to allow homeowners who are to be foreclosed
to stay in their property as tenants.
Direct intervention to help SMEs, through fiscal measures, debt rescheduling,
reduction in interest costs or guarantees, is also very important, since they are the
backbone of the European economy—especially in a prolonged recession. They
also have a significant impact on employment support.
These direct measures to the economic agents are seen as an important
counterweight, in equity and political terms, to the other measures for saving the
bankers. A less costly alternative is to establish funds for guarantees to loans or
setting up risk clubs.
The most important measure that needs to be introduced in the high
leveraged economies is the cleaning and restructuring of bank balance sheets. To
jump-start the economy, central banks17 and state institutions, using specially
created vehicles, may need to start buying toxic assets (as the Spanish proposal
envisaged). These schemes should use reverse repo auctions so as to be
transparent and competition friendly. Government may need to set up a
collection agency (bad bank)18 for holding and freezing these toxic assets while
the markets remain depressed and then quickly unwind the portfolio. The
Swedish government followed this path with the Securum Bank, a “bad bank”
created to resolve the problem of toxic assets.
I conclude by reiterating that we need to use all our expertise and lessons
from past crises, and all the instruments—fiscal, monetary, state aid and
regulatory policies—in a coordinated and harmonic way in order to fight the
once-in-a-generation crisis that has now reached global proportions.

17 The Federal Bank is already using unorthodox measures by extending the securities used for
collaterising its operations and even conducting open-market operations and buying toxic assets
directly from banks. This is purely money creation that may help fight deflation.
18 This would allow a specialisation of managers and personnel, dividing those who are good at
lending and those who are good at collecting bad debts.
 Annex: Types of State Aid to Financial Institutions
April 2009

Type of aid Impact on Impact on Distortion on Distortion Cost taxpayers Administrative Duration
financial institution economy behavior agents competition costs and
complexity

General deposit High (insurance of High on securing Creates moral General measure: Medium to low. Low Long
guarantees large share of debt the banking system hazard on no distortion Equal to
in commercial commercial banksa probability of a
banks, but not bank failure times
others) the potential losses
of bankb
State guarantee to Medium: main May be important Creates moral General measure: Low. Low Duration of crisis
bonds or other impact is to resume bank hazard on banks no distortion Equal to and recovery of
credits issued by increasing liquidity lending to the because they can probability of each institution
banks economy take additional risk default on those
credits times
potential losses of
banks
European Competition Journal

autoState takes Avoids bank Depends on share Creates moral High, since it Small, since Low, esp. if Duration of crisis
minority stake in failure of bank assets on hazard by bank “saves the preferred shares government does and recovery in
bank capital total market assets management and offender” that took may be required to not intervene in institution
(problem of “too invites taking on excess risk earn a minimum administration
big to fail”) excess riskc return, and
probability loss
depends on
probability of bank
failure
13
 14

Annex continued

Type of aid Impact on Impact on Distortion on Distortion Cost taxpayers Administrative Duration
financial institution economy behavior agents competition costs and
complexity

State takes Avoids bank Depends on share Creates moral High, since it Medium, since Medium Duration of crisis
majority stake in failure of bank assets on hazard by bank “saves the preferred shares and recovery in
bank capital total market assets management and offender” that took may be required to institution
(problem of “too invites taking on excess risk earn a minimum
big to fail” excess riskc return. Probability
loss depends on
probability of bank
failure
Nationalisation Avoids bank Depends on share Creates moral It “saves the High, since state High. Duration of crisis
bank failure of bank assets on hazard by bank offender” that took has to cover all Government has and recovery in
total market assets management and excess risk. present bank to designate new institution
(problem of “too invites taking on Depends on terms losses. Only administration
big to fail”) excess risk of compensation recovered loans in
future will lower
that cost
Merging of banks Avoids bank Avoids bank runs. No major problem Potentially high No cost if simple Low Immediate
or assets failure Depends on bank merger. But State solution
acquisition share of total may have to
The Current Financial Crisis and State Aid in the EU

market sweeten the deal or

get part of bad
assets
ECJ VOL.
5 NO. 1
 Annex continued

Type of aid Impact on Impact on Distortion on Distortion Cost taxpayers Administrative Duration
April 2009

financial institution economy behavior agents competition costs and

complexity

Bank liquidation Allow an orderly Avoid bank runs No problem No major problem State may have to Low (liquidating Low to medium
unwind of and asset pay depositors and committee depending on time
operations deterioration. creditors for losses nominated) needed to liquidate
Can have a high
impact on risk of
other bank failure
Buying toxic assets Avoids bank High. Reduces bad Creates moral Potentially some Very high. Equals Very high. Long. Until credits
from banks thru failure if buying assets on bank hazard by bank distortion, rules of amount of assets Government has are recovered
“reverse auctions” price by assets and creates management and access should not times part not to administer
government above “room” for new invites taking on be recovered assets and recover
mark-to-market lending excess risk discriminatory loans
Direct aid to Limited at Limited at Reduced Low, since there is Very high. To Very difficult and Long
households beginning. beginning, and distortion, since no discrimination have an impact on complex to
(mortgage reform) Builds-up as larger increasing. only households in between financial system administer. Needs
European Competition Journal

share of bank Increases liquidity trouble are institutions has to be carried to target each
assets is “cleaned to households and “saved” out in large household in
from the books” gives an incentive amounts bankruptcy
to increase
demand
15
 16

Annex continued

Type of aid Impact on Impact on Distortion on Distortion Cost taxpayers Administrative Duration
financial institution economy behavior agents competition costs and
complexity

Direct aid to Limited at Limited at Reduced Low, since there is High to medium. Difficult and Long
SMEs (direct beginning. beginning, and distortion, since no discrimination It is equal to complex to
loans) Builds-up as larger increasing. only small firms in between probability of administer. Needs
share of bank Increases liquidity trouble are institutions SMEs failing times to define clear
assets is “cleaned to firms and gives “saved” average loss criteria for access
from the books” an incentive to
resume production
Direct aid to Limited at Limited at Reduced Low, since there is Medium. It is Difficult and Long
SMEs (loan beginning. beginning, and distortion, since no discrimination equal to complex to
guarantees) Builds-up as larger increasing. only firms in between probability of administer. Needs
share of bank Increases liquidity trouble are institutions SMEs failing times to define clear
assets is “cleaned to firms and gives “saved” average loss criteria for access
from the books” an incentive to
resume production
Direct aid to Limited at Limited at Reduced Low, if there is no Medium. It is Difficult and Long
SMEs (reducing beginning. beginning, and distortion, since discrimination equal to complex to
loan charges) Builds-up as larger increasing. only households in between firms probability of administer. Needs
share of bank trouble are SMEs failing times to define clear
The Current Financial Crisis and State Aid in the EU

Increases liquidity
assets is “cleaned to firms and gives “saved” average loss criteria for access
from the books” an incentive to
resume production
ECJ VOL.
5 NO. 1
 Annex continued

Type of aid Impact on Impact on Distortion on Distortion Cost taxpayers Administrative Duration
April 2009

financial institution economy behavior agents competition costs and

complexity

Direct aid to large Limited at Limited at Creates moral Highly Very high. It is Very difficult and Long
firms (direct loans) beginning. beginning, and hazard by distortionary equal to complex to
Builds-up as larger increasing. management of probability of administer. Needs
share of bank Increases liquidity firms, that may be bankrupcy times to define criteria
assets is “cleaned to firms and gives complacent to average loss for access. Needs
from the books” an incentive to restructuring to analyse and
resume production needed monitor
restructuring plan
Direct aid to large Limited at Limited at Creates moral Highly Medium. It is Very difficult and Long
firms (loan beginning. beginning, and hazard by distortionary equal to complex to
guarantees) Builds-up as larger increasing. management of probability of administer. Needs
share of bank Increases liquidity firms, that may be bankrupcy times to define criteria
assets is “cleaned to firms and gives complacent to average loss for access. Needs
from the books” an incentive to restructuring to analyse and
European Competition Journal

resume production needed monitor

restructuring plan
Direct aid to large Limited at Limited at Creates moral Highly Medium. It is Very difficult and Long
firms (reducing beginning. beginning, and hazard by distortionary equal to complex to
loan charges) Builds-up as larger increasing. management of probability of administer. Needs
share of bank Increases liquidity firms, that may be bankrupcy times to define criteria
assets is “cleaned to firms and gives complacent to average loss for access. Needs
from the books” an incentive to restructuring to analyse and
resume production needed monitor
restructuring plan
17
 18

Annex footnotes
aThis is the reason why guarantee is usually limited to a certain maximum. Assumes large depositors have enough information on risk
of the bank.
bThe fund to back-up guarantee may be financed by contribution from banks, which decreases cost to taxpayers.
cGovernment has to require that shareholders do not profit from the recapitalisation, by preconditioning write-down of capital, and
avoiding payment of dividends and large bonus to management while bank benefits from aid
The Current Financial Crisis and State Aid in the EU
ECJ VOL.
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