Kroes hits right note on EU bank aid

July 22, 2009

Neelie Kroes, the EU Competition Commissioner, is right to be taking a hard line on state aid to banks, which will distort competition if not repaid. However, she will have to fight member states like Britain and Germany, which are desperately encouraging banks to lend locally, nursing large losses on their capital injections or trying to avoid massive upheaval in their banking industries.

The reasons for her tough stance — laid out in guidelines she will unveil on Thursday, obtained by Reuters — are sensible. At their heart is the desire to maintain the imperfect European market in financial services that the Commission has done so much to foster. State aid risks distorting this market because of members’ differing ability and willingness to underwrite their banking sectors.

Kroes is also concerned about moral hazard: unless banks that have received state aid are put through a restructuring boot-camp, others will learn that it pays to take wild risks. Many private-sector banks are already muttering that their state-backed rivals are rampaging through the market.

The British government had to rein in Northern Rock, a nationalised mortgage lender, after rivals groused that it was topping the “best buy” league tables. In the City, investment bankers bitch that Royal Bank of Scotland  is showing as much aggression as in the heyday of Sir Fred Goodwin.

A further admirable aim is to avoid damaging subsidy races. The Irish government earned opprobrium when it extended a blanket guarantee to depositors and creditors of its domestic banks last September. Other governments resented what they saw as a “beggar thy neighbour” policy that forced them to raise and make explicit their own deposit protection schemes.

Finally, when banks that are state-aided are not indulging in cut-throat competition for market share, they are often bilking their customers instead. Investment banks have made record profits during the first half as they widened their bid-offer spreads in busy, volatile markets, especially in fixed
interest, currency and commodity markets. Consumers looking for a mortgage will find the rates on offer can be up to ten times that at which lenders borrow from central banks. In contrast, at the height of the credit boom the spreads above central bank rates virtually disappeared due to
competitive wholesale market funding.

However self-evidently sensible Kroes’s position is, she will face a fierce rearguard action from national governments. Britain’s Gordon Brown has signalled that “stability” is as important as competition in the banking sector and Germany has balked at seriously restructuring its zombie banks, which could lead to some being wound up or bought by foreigners. Brown is eager to see continued lending, especially in the absence of the Irish and Icelandic banks, even though one
state-backed British bank, Lloyds, now has a third of the market thanks to its takeover of HBOS. 
In the event of a change of government next year, the opposition Conservatives will also want to ensure the taxpayer turns a profit on its stakes in both Lloyds and RBS. A restructuring is unlikely to enhance either bank’s value.

Kroes has thrown the member states a bone by agreeing to allow them five years, rather than the usual two or three, to restructure. That should avoid “fire sales”, she says. Member states will still fear getting singed.
(additional reporting by Margaret Doyle)

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