In the light of Article 107 of the European treaty and previous decisions by the Commission, it is possible that this support will be interpreted as state aid.
The support of a public shareholder constitutes state aid
Article 107, paragraph 1 of the Treaty on the Functioning of the European Union (TFEU)[5] stipulates that “save as otherwise provided in the Treaties, any aid granted by a Member State or through State resources in any form whatsoever which distorts or threatens to distort 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 internal market.”
In the past, any recapitalisation proposals submitted by shareholders of Landesbanken have been treated as state aid, as they used state resources. German regional banks are, de facto, state-owned banks. They belong to the states (Länder) and the savings banks (Sparkassen), whose supervisory authorities (Träger) are public bodies held by municipalities or counties. Supporting a credit institution with public resources, even in the role of shareholder, represents, in principle, state aid under the TFEU.
Although this support would have provided the Landesbanken with capital to which they would not have had access via the market, the European Commission approved them on the basis of Article 107, paragraph 3, point b) of the TFEU. This allows state aid destined “to remedy a serious disturbance in the economy of a Member State” to be considered as compatible with the internal market. The Commission believes that “persisting stress in financial markets” and the risk of “major negative spill-over effects for the rest of the banking system which could flow from the failure of a credit institution” justify the prolongation of the conditions of application of the state aid rules in the context of the financial crisis (initially defined in October 2008 and updated on six occasions since then[6]). To be considered as compatible with the internal market, such aid must be limited to the minimum necessary (notably through a burden-sharing) and come with safeguards against undue distortions of competition.
By way of example, in 2012 the Commission came to the conclusion that the EUR 3.3 bn restructuring package granted to NordLB, whilst it constituted state aid, was compatible with European rules[7]. The Commission took the view that the restructuring plan presented guaranteed the viability of the bank over the long term, ensured adequate remuneration of the capital provided and had satisfactory burden-sharing (suspension of dividend payments and payment of hybrid coupons during the restructuring period). The reduction of NordLB’s balance sheet (restriction on certain commercial activities, sale of non-essential subsidiaries) and various commitments made by the bank were also likely to mitigate the distortions of competition as a result of the aid. The Commission also stressed that the recapitalisation was the result of the European Banking Authority’s capital requirements following a resistance test conducted in 2011 and the Capital Exercise of 2012 rather than an intrinsic problem. Lastly, the Commission judged that the failure of a bank such as NordLB, considered by a Member State as being of systemic importance, could have had damaging effects on the German financial markets and economy.
The unusual nature of this plan
The regional authorities have indicated that they are once again obliged to present a plan that does not contravene European state aid rules. The Länder and the DSGV both hope to avoid the privatisation of NordLB[8] or the triggering of a resolution process, which requires an internal recapitalisation equivalent to at least 8% of liabilities. Given that the bank no longer meets minimal regulatory requirements in terms of capital, in order to be considered compatible with the internal market[9] the bank’s restructuring plan must include a partial recapitalisation[10] by requiring a conversion to equity or a reduction in value of subordinated debt instruments[11]. At the end of 2018, NordLB’s additional Tier 1 and Tier 2 capital stood at EUR 2.7 bn.
The conditions for a rescue of NordLB would nevertheless be unique.
In contrast to the support packages previously put in place for Landesbanken, the aid provided will not come solely from NordLB’s shareholders but also from the mutual cooperation and support network, the S-Group, of which it is a member. Individual contributions from the members of the S-Group have not been fully communicated. The three biggest Landesbanken (LBBW, BayernLB and Helaba) are due to contribute to the recapitalisation of NordLB for a total of EUR 260 million. The association of the savings banks of the state of Lower Saxony, which is both a shareholder in NordLB and a member of S-Group, will inject EUR 320 million alongside the savings banks of Bavaria (EUR 68 million) and Hesse and Thuringia (EUR 37.7 million).
Mutual support structures, the cornerstone of IPS
European legislation recognises the S-Group, to which all German Landesbanken and Sparkassen belong, as an Institutional Protection Scheme (IPS)[12]. The European regulation of June 2013[13] defines an IPS as “a contractual or statutory liability arrangement which protects those institutions and in particular ensures their liquidity and solvency to avoid bankruptcy where necessary” (article 113, paragraph 7 CRR). According to the ECB’s guide to the approach for recognition of IPS for prudential purposes of July 2016[14], where there is a risk of failure at a member of an IPS and preventative measures are not sufficient, “the IPS needs to decide on material or financial support.”
The IPS should have a broad range of measures, “ranging from less intrusive measures, such as closer monitoring of the member institutions on the basis of relevant indicators and additional reporting requirements, to more substantial measures that are proportionate to the riskiness of the beneficiary IPS member institution and the severity of its financial constraints, including direct capital and liquidity support.” Measures to clean up the balance sheet, restructure or adjust the business model may be imposed on the institution in difficulty. In order to minimise the ex-ante risks of moral hazard and the ex-post risks of contagion, IPS must establish contributions from their members as a function of their risk profiles and must not generally allow for unconditional or unlimited support for their members. Thus, although there must be “a clear commitment [...] on the part of the IPS to provide support when – despite previous monitoring of risks and early intervention measures – an IPS member is or is likely to become insolvent or illiquid”, this remains conditional: an IPS is a system of mutual commitments and obligations. The opportunity to help a member financially must be evaluated in the light of its financial position and its past risk-taking, available funds and the capacity of other members to replenish funds afterwards. Conditions for the use of funds are even more tightly restricted when the IPS has the double function of a mutual protection system and a deposit guarantee system (as is the case for the S-Group). The need for prior approval of members of the decision-making committee (with a 75% qualified majority) before any activation of mutual support illustrates this conditionality. As far as we are aware, this system has never been used to help a Landesbank since the financial crisis of 2008.
The decision in the Banca Tercas case cannot be extrapolated
The Commission’s communication on state aid does not set out any particular regime for intervention by an IPS. It does however stipulate that “interventions by deposit guarantee funds to reimburse depositors in accordance with Member States' obligations under Directive 94/19/EC on deposit-guarantee schemes do not constitute State aid. However, the use of those or similar funds to assist in the restructuring of credit institutions may constitute State aid. Whilst the funds in question may derive from the private sector, they may constitute aid to the extent that they come within the control of the State and the decision as to the funds' application is imputable to the State.” On 19 March, the European Court of Justice overturned the Commission’s 2015 ruling that the support measures to the Italian savings bank Banca Tercas, by the Italian deposit guarantee fund (FITD), were state aid. The Court considered that the Commission was not able to demonstrate that this was state aid on behalf of the state and financed with state resources. The Commission did not provided sufficient evidence that the Italian public authorities exerted a substantial influence on the decision to set up support measures. Moreover, the funds used came from voluntary contributions (FITD’s mandate allows for protective measures in favour of its members) rather than mandatory contributions to FITD[15].
However, we do not believe that the Banca Tercas case can be applied to NordLB. Granted, the S-Group also has the role of a deposit guarantee fund. It could also claim that any decision to intervene to help NordLB would not be attributable to the state (IPS preventative measures, internal vote) and that the funds used would correspond to voluntary contributions (over and above the minimum required for deposit guarantees). The fact remains that the resources mobilised in favour of NordLB would be, in contrast to those used for Banca Tercas, state resources in the sense of Article 107(1) of the TFEU.
Ultimately, a private solution?
European legislation is more favourable to IPS in the texts setting out the prudential framework (CRR, BRRD). Thus the BRRD directive[16] treats support measures put in place by IPS in the same way as private support packages, reducing the risk that the institution being helped be put into resolution. To this extent, an IPS can meet the BRRD’s requirements for recovery plans, and its members exempted as a result[17].
The BRRD allows a bank to be put into resolution only under three conditions: 1. “the institution is failing or is likely to fail”; 2. “there is no reasonable prospect that any alternative private sector measures, including measures by an IPS, or supervisory action, including early intervention measures or the write down or conversion of relevant capital instruments [...] would prevent the failure of the institution within a reasonable timeframe”; and 3. “a resolution action is necessary in the public interest”. The mutual support structures of an IPS are in some ways a sort of private bailout: the bailout of a Landesbank could be taken on by counterparties external to the group in difficulty but that are members of the same IPS (Landesbanken or perhaps even Sparkassen of other German Länder or Landesbausparkassen) and this offers protection to creditors from outside this network (deposit-holders and other creditors who are not members of the IPS).
We believe that the conditions for the rescue of NordLB represent, at the very least, evidence of the existence of a ‘real’ mutual support structure within the S-Group. Without an intervention from the DSGV, the credibility of the solidarity undertakings between S-Group members would have been called into question[18].
In the end, as far as state aid is concerned, NordLB’s restructuring plan should be considered only in terms of the public resources committed by the two Länder. To interpret any support provided by the S-Group as qualifying under the terms of the 2013 communication (without taking account of the specific nature of this support) would deny the possibility of IPS being composed of public sector members. In other words, it would imply that any intervention by the S-Group would be incompatible with state aid rules.
