Virtually all OECD countries apply national cl to the banking sector
without exception or exemption. In most countries, the competition law is enforced by the
competition authority, although in a few, by the banking regulator.
major structural changes in the banking sector (i.e., ma) fall under the jurisdiction of both the banking regulators and the competition authority
most countries are currently experiencing a large number of mergers in the
financial sector which are likely to be, in part, a response to recent deregulation and trade
liberalisation trends.
competition concerns raised recently regarding bank distribution of insurance products. Where a bank has a dominant position in a local area, an exclusive dealing arrangement with a particular insurer may foreclose entry by other insurers and therefore may give rise to competition concerns. In a few countries the deposit insurance is not applied in a competitively-neutral manner. In these countries the deposit insurance premium varies between banks in a manner that is unrelated to the risk of the bank.
A partial list of the reasons for entering into co-operative agreements include:
– the interconnection of networks (such as networks of Automatic Teller Machines, EFTPOS networks);
– the operation of international credit card systems or national debit transfer systems;
– the operation of payments clearing systems;
– the establishment of a system for the joint maintenance of a database of the credit history of consumers;
– joint development and promotion of new products (e.g., Banksys / Belgacom smart card);
Bank regulation, like other forms of regulation, is justified as necessary to correct a “market failure”. In banks, market failure arises from the difficulty to demonstrate their level of risk to depositors and other lenders. It is argued that, as a result, in
the absence of regulatory intervention, banks would take on more risk than is prudent, bank failures would be common and the financial system would be unstable
If banks could credibly communicate their risk profile to depositors, riskier banks would (in the absence of deposit insurance) expect to pay a premium to attract funds. The desire to minimise borrowing costs would provide an incentive to maintain risk-management procedures.
Many countries seek to facilitate monitoring by depositors through regulatory disclosure
requirements.
[….i can research such reg. disclosures etc, to identify a bank recklessly failing to credibly communicate their risk profile to depositors, to prevent:
-paying such premium
-maintaining strict risk management procedures.,
-compensating depositors for increasing their risk
-being excluded from the payment systems]
bank managers greed to maximise their personal profits/bonuses, pushes them to increase returns which translates into an increase in bank risk.
Furthermore the financial system is unstable, as depositors may at any time lose confidence and withdraw their funds. This would lead to the domino effect failure of a large number of banks and the real economy. Since such a run on the banking
system as a whole could be triggered by the failure of any one bank, the risk-taking by banks has an “external” effect in that it threatens all the other banks.
Under payments systems, banks can build up large exposures to one another during a
trading day, which are settled at the end of the day. The failure of one bank to settle could, have significant “knock-on” consequences for other banks, even other healthy banks. As
a consequence, it is argued that access to payments systems should be restricted to carefully regulated institutions. Many countries are currently implementing so-called “real-time” payments systems which eliminate the build-up of exposures through the day.
The British Government owns no commercial banks. However, a large number of overseas
banks with presences in the UK are owned, directly or ultimately, by overseas governments. Middle Eastern, South East Asian, and African banks are often mainly or wholly owned by their governments. <> i can find coi , in those foreign banks in uk owned by foreign governments, who may be failing to separate role as shs, and role as supervisory authority… thus over subsidising them, and distorting the competition between banks in the uk…. you may also find other PI (sustainability of economy) policy grounds…. eg arising from the combination of banks’ liabilities and assets, and the lack of transparency over a typical bank’s risk profile.
Ignoring CL in banking, generates a vicious circle of insufficient restructuring, repetition of aid and therefore excessive aid and insufficient compensation to competitors. The confusion of roles of the State becomes apparent. … where the State is the main shareholder of the bank in crisis, its role as shareholder must be separated from its role as the supervisory authority. otherwise, the State may support the bank above what is necessary to restore the bank’s viability. no different treatment should be allowed between private and public banks.
The direct or indirect use of public funds to support failing banks (such as those which are too big to fail) is a form of public subsidy which may also distort competition. Such subsidies, in the case of the EC, may violate the Treaty of Rome. The EC notes:
“State aid for rescuing or restructuring firms in difficulty, in particular, tend to distort competition and affect trade between Member States. This is because they affect the allocation of economic resources, providing subsidies to firms which in a normal market situation would disappear or have to carry out thorough restructuring measures. Aid may, therefore, impede or slow down the structural adjustment…”. The lifting of certain regulatory restrictions for a bank in difficulty is another form of subsidy which may distort competition… deposit insurance is a much better option, as it allows a bank to fail in a competitive manner’.
In most countries risk-taking by banks is controlled through controls on the capital or “own funds” of banks, following the Core Principles by the Basle Committee.
but more recently, banks regulatory capital requirements are determined
by more sophisticated “in-house” models of banks’ risks.
the payment mechanism with (credit or debit) cards:
the shop has a point of sale (POS) in which data of the transaction to be carried out are introduced. This information is transmitted by phone to the network of which the shop’s bank, called “purchasing bank”, is a member. The network computer is connected to the computer of the card holder’s bank, called “issuing bank”, to check if there are sufficient funds available (for debit cards) or a sufficient credit line (for credit cards) in the holder’s account to authorise the transaction. When the issuing bank authorises the transaction, it is charged to the card holder’s account or it is recorded in his credit line.
Finally, the shop’s account is credited the amount of the sale less a fee (discount rate) which varies according to the sale.
In these transactions, the issuing bank assumes the risks (card holder default, fraud, operating risks) and most of the costs (technical infrastructure, cost of current assets, network payments, fees for using the card’s trademark, promotion, etc.), since it guarantees the payments it has authorised and maintains the technical infrastructure. The purchasing bank does not incur risks but it also bears a series of costs (technical infrastructure), as it is responsible for implementing the transactions.
The card holder pays the issuing bank an amount for maintaining and managing his account and a rate for issuing the card but he does not pay any amount in proportion to the purchase made. The shop pays his bank, the purchasing bank, a “discount rate” on the amount of the sales paid by card. As the shop is not directly related to the issuing bank, it is the purchasing bank that must pay for the services. This amount is a rate agreed at the
national level by the networks and implies a base on which the discount rates are determined according to the cost and the business policy of the purchasing bank.
discount rates have been decreasing in recent years in most countries, due to increasing competition.
UK
Banks in UK are regulated by the Bank of England
Why regulate banks?
1. to protect against the risk that failure of one institution might lead to the failure of other sound institutions, creating a wider financial instability
2. due to the asymmetry of information between depositor and bank. The retail depositor is not in a good position to assess the risk of a bank….However, it is important that the protection against loss is limited, because is not good to remove the likelihood of full loss to the depositor, this way depositors seek the most competitive bank (risk:reward)
3. to protect society from activities such as money laundering
4. to save banks from low incentive to innovation, which would happen if there was no regulation.
The smaller banking institutions (not clearing banks) incorporated in the UK are not publicly quoted. Approximately two-thirds of them are subsidiaries of a parent involved in the financial markets.
In the UK, banking regulators exercise no restrictions on pricing. also, there are no specific restrictions on lines of business that a bank may undertake. However, managers’ duty to conduct the bank’s business with integrity and skill, and the general “prudent conduct’ criterion mean that the regulator (FSA) expects a bank to discuss with it any
plans before embarking on any significant new line of business.
insurance business by banks must be carried out in a separate company (subsidiary)
There are no explicit restrictions on assets which banks may hold.
There are No specific restrictions on ownership linkages among financial institutions, but it must be shown that the shareholder controllers of a bank are fit and proper.
There are no explicit restrictions on the types of assets which banks may hold (on their portfolio). However, must prepare a liquidity policy, and maintain adequate liquidity, which for some retail banks involves holding a stock of high quality liquid assets. Banks are required to make adequate provisions against impaired assets.
There are no requirements in the UK for banks to direct credit to favoured sectors
Application of UK CL
banks and building societies, are subject to CL in exactly the same way as other
industries.
Under the Fair Trading Act 1973 and the Competition Act 1980, the Director General/cma, may make inquiries where the 25 per cent market share test is met buy a single company – a “scale monopoly”. He may also make enquiries into “complex monopolies” [= two or more businesses enjoy an aggregated share of a market of 25 per cent or more, and they are conducting their affairs (intentionally or not) in a way which adversely affects competition…
…..all other remedial action is reserved to the Secretary of State for Trade and
Industry; and can be taken only in the light of a cma finding that an abuse is
adversely affecting the public interest.
The Restrictive Trade Practices Act 1976 (RTPA)
requires the cma to maintain a publicly accessible register of agreements between businesses (undertakings) in the UK under which two or more of the parties accept restrictions on their commercial freedom. parties must lodge them, within the specified time limits, for scrutiny and assessment of their likely effects on competition. Agreements falling within the RTPA but not lodged with the Office within the appropriate time are void and legally unenforceable. The effect of that is to allow anyone adversely affected by such a void agreement to sue the participants in the civil courts for damages.
<> i can read that register, to identify parts of the agreement that cannot be allowed..(partly void).. and also to identify agreements that were never lodged and should have been, and are therefore void… and identify victims… approach them with NDA to retain my services.
the cma has also a duty to refer all agreements which fall within the RTPA to the Restrictive Practices Court.(RPC) He has no power himself to require restrictions which significantly damage competition to be removed or abandoned; that power is
reserved to the court. however, if the cma considers that none of the competition restrictions in an agreement are significant, [<> i can challenge this and insist the agreement must be referred to the RPC] he may seek to be discharged from his duty to refer that particular agreement to the RPC, by the Secretary of State for Trade and Industry. In practice, the overwhelming majority of agreements considered under the RTPA have been cleared under this procedure, many of them following negotiations between the Office and the parties, successfully amending or removing restrictions which would otherwise have led to a reference to the court.
Agreements between banks,[except exempted: agreements for financial
regulation by the Bank of England or the Treasury] are subject to this legislation. The principal of these agreements is the one that underpins the operation of the clearing system by the Association for Payment Clearing Services (APACS). Further agreements of significance are that under which the Switch electronic debit card system operates; agreements relating to the development, testing and the ultimate operation of the Mondex electronic purse system; an agreement underpinning the clearing system in Scotland, operated by the Committee of Scottish Clearing Bankers; and an agreement involving the British Bankers’ Association and its members, under which the Association has made recommendations on the conduct of its members.
-RTPA: members of any trade association, or equivalent, are considered to agree to their recommendations. Thus, the relationships between trade associations and their members are agreements falling within the RTPA.
All the agreements listed [are in more detail in Annex 4 ] (except the
agreement relating to the actual operation of the Mondex scheme, which is still under consideration) have been cleared under the discharge procedure, without reference to the Restrictive Practices Court.
Other arrangements described in the Annex do not fall within the RTPA.
The regulation of the banking trades by the Bank of England, and the rules, recommendations, and regulations, do not fall to be considered by the Office under the RTPA, and are not subject to potential action by the Restrictive Practices Court.
Mergers
The merger provisions of the Fair Trading Act 1973 apply equally to banking enterprises and other financial services providers as they do to other business sectors. For a merger to qualify for investigation it must satisfy the following criteria:
a two or more enterprises must cease to be distinct;
b at least one of the enterprises must be carried out in the UK or under the control of a body incorporated in the UK;
c either:
i the enterprises which cease to be distinct must supply or acquire goods or services of a
similar kind and must together supply or acquire at least 25 per cent of all those goods or services in the UK or a substantial part of it; or
ii the gross value of the worldwide assets to be acquired must be more than £70 million.
In the case of qualifying mergers, the Director General of Fair Trading advises the SOSTI whether or not they should be referred to the Monopolies and Mergers
Commission (MMC) for further investigation. If so, he can also advise the Secretary of State whether undertakings in lieu of an MMC reference may be appropriate to address the competition concerns arising from the merger. Unlike EC merger control provisions, there is no statutory requirement on the parties to mergers to submit particulars to the Office, but the possibility of reference remains a powerful tool for the
competition authorities.
In recent years, the UK banking industry has seen a number of significant changes, including the deregulation and demutualization of building societies, the introduction of competition in banking services from other sources such as the major supermarkets, and the introduction of telephone banking.
During this period, the Office has considered a number of mergers involving banks, based both in the UK and abroad, and other organizations in the financial services sector, such as building societies and insurance companies. However, to date, the majority of these cases has not raised competition issues serious enough to warrant a more detailed examination by the MMC. In the last decade, for example, there has been only one reference to the MMC of a banking merger. This was the proposed merger between Lloyds Bank plc and Midland Bank plc in 1992 which, the Director General considered, raised competition concerns in three particular markets – factoring, merchant acquiring, and small business
lending.
However, the MMC’s investigation into the proposed merger did not run its full course, and was set aside when a competing bid from the Hong Kong and Shanghai Bank Corporation (HSBC) was successful. The competing bid, which was dealt with under the EC Merger Regulation, did not raise competition concerns. More recently, the Office examined the proposed merger between Lloyds Bank plc and TSB Bank plc. On the advice of the Director General, this merger was cleared by the Secretary of State in December 1995.
In examining the competition implications of mergers in the banking sector, the Office has in the main defined the relevant economic markets as the various product lines offered by banks in both personal and business services, such as loans, mortgages, current and deposit accounts, merchant acquiring, and factoring, among others. In geographical terms, the scope of these markets has tended to be defined as UK-wide, in view of the competition faced from the national chains and, increasingly, from companies
offering telephone banking, and from other companies offering banking services. To date, the role of the Internet has not been considered in detail in our examination of merger cases. Because so few cases have so far given rise to significant competition concerns, it has not been necessary to examine in depth the scope for “trade offs” between the protection of competition and the stability of the banking sector.
Proposed changes in competition law
The Competition Bill was introduced into the UK Parliament in October 1997. It is expected to
complete its constitutional processes by the late Summer/early Autumn of this year. The Act, however, is not expected to come fully into force until about a year after that.
The Act will introduce into the UK a competition régime very similar to that which applies
under EC competition law. There will be a general prohibition of anti-competitive agreements; and a similar prohibition of the abuse of a dominant position. There will be a system of block exemptions for common categories of agreement, such as exclusive distribution agreements, or franchising contracts. The OFT will have wider powers of investigation, including the right to carry out “dawn raids” similar to that already enjoyed by the EC competition authorities. Moreover, the Director General will be able to fine businesses up to 10 per cent of their turnover for breaches of the prohibitions.
The Act will repeal the RTPA, and the Resale Prices Act 1976. Much of the Competition Act
1980 will also go. The existing mergers provisions of the Fair Trading Act will remain, as will the complex monopoly provisions of that Act, which allow the Director General to investigate practices widespread in an industry, which may adversely affect competition, but which do not amount to the adp by a single company. The Act will replace the MMC with a Competition
Commission.
In addition to taking on the role of the MMC, the Commission will act as a Tribunal to hear and decide on appeals against decisions by the Director General.
The situation in respect of banking specifically will not change. As noted above, the Bank of
England’s supervisory function is to be transferred shortly to the Financial Services Authority. The treatment of the FSA’s regulatory actions under competition law is still to be determined. Banks will be subject to the prohibitions of anti-competitive agreements, and of abuse of a dominant position. Although no one bank is likely to be in a dominant position, the banking trade collectively will still remain subject to the complex monopoly provisions of the Fair Trading Act. Banks will also remain subject to the mergers provisions of that Act.
Conclusions
Although there is a comparatively high level of concentration in the UK banking market (in the
sense that a small number of very large banks enjoys a very substantial share of it), there appear to be adequate levels of competition in the provision of a variety of services for consumers. The markets are open to both UK and non-UK banks; are shared in many respects with building societies; and have recently been entered by large supermarket chains. Apart from the consideration, required by statute, of a comparatively small number of mergers and agreements, the competition powers of the Director General of Fair Trading have been invoked on only two occasions. Both cases involved the credit card market, and in both cases anti-competitive behaviour was found and remedied.
Considering the all pervasive nature of banking, and the number of different sub-markets into which it can be divided and in which anticompetitive behaviour or abuse of market power might have manifested themselves, that is a record on which the UK banking trades might reasonably congratulate themselves.
BANKING ACT – SCHEDULE 3 CRITERIA
Schedule 3 of the Banking Act 1987 sets out the minimum criteria for authorisation. These establish the requirements for entry to the banking sector, for example requiring that management be fit and proper and that an institution has a minimum amount of capital before it can be authorised. The criteria set out in the Act are expressed in general terms. Detailed guidance on the Bank’s interpretation of these criteria is given in the Statement of Principles, the Notices to Institutions as well as guidance for completion of statistical returns. The individual Schedule 3 criteria are described briefly below, together with the specific policies stemming from them:
(i) Requirement to conduct business in a prudent manner As well as an overarching requirement that the business be conducted in a prudent manner a number of separate aspects to this requirement are specified:
• Adequacy of capital – UK banks are required to maintain a level of capital which exceeds its individually set trigger risk asset ratio. The calculation of the risk asset ratio reflects the
implementation of the Solvency Ratio Directive and the Capital Adequacy Directive.
Capital adequacy of a banking group is also considered on a consolidated basis. Trigger
ratios are set for individual institutions based upon the assessment of a number of factors
such as adequacy of systems and controls, diversification of assets etc. No trigger ratio is
less than 8 per cent. The supervisor has discretion to raise or lower the trigger risk asset
ratio.
• Adequate liquidity – banks are required to prepare a liquidity policy statement and follow
individual liquidity mismatch guidelines, and in some cases maintain a stock of high quality liquid assets.
• Adequate provisions – banks are required to make adequate provisions against bad and
doubtful debts.
• Adequate accounting and other records and adequate systems and controls – the supervisor makes its own review of systems and controls and also relies on the reports of Reporting Accountants (external auditors) on systems and controls of banks.
(ii) Minimum net assets Own funds of all UK banks must exceed 5m ECU.
(iii) “Four eyes’ criterion;
(iv) composition of the board of directors. There is a requirement that the business is conducted by at least two suitably qualified individuals; and that the board of directors is appropriately constituted, including where appropriate non-executive directors.
(v) Fit and proper criterion;
(vi) requirement that the business be carried out with integrity and
skill Directors, controllers and managers are required to show that they are fit and proper to occupy their position with the bank. There is also a general requirement that the business must be carried out with integrity and skill.
MMC INVESTIGATIONS INTO THE CREDIT CARD MARKET
The credit card market has been investigated twice. In its first report, into Credit Card Franchise Services, and published in September 1980, the MMC found that the restriction placed on merchants by the credit card companies, requiring them to charge the same prices to customers paying by credit card as to customers paying by other means, commonly known as the no discrimination rule, was contrary to the public interest. It found that the rule had the effect of preventing merchants from competing with each other by offering different prices to credit card users and other customers, depriving customers of an important choice in purchasing goods or services, and, in some cases, possibly raising prices generally to
all the customers of that merchant. It recommended that the rule should be prohibited.
However, the Government of the day decided not to implement that recommendation, mainly because it considered that consumers were likely to be inconvenienced or confused, and that the display of the information necessary properly to inform consumers of any surcharges would impose undue burdens on merchants, and be difficult to enforce.
A second recommendation was that discussions between the Joint Credit Card Company Ltd and Barclays Bank Ltd (for practical purposes the only two credit card companies and merchant acquirers in the UK at that time), which might materially affect competition between them, should be abandoned. These discussions had covered such matters as floor limits for merchants, rates of interest to cardholders, the possibility of annual charges to cardholders, the enforcement of the no discrimination rule, and merchant service charges. The two companies subsequently gave assurances to the Director General that those
discussions would cease.
Further concerns expressed by the MMC, principally about the profits of, and the charges by, the credit card companies, prompted a suggestion, falling short of a formal recommendation, that the Director General should keep all aspects of the market under review, and should consider seeking a further investigation if he judged that the public interest might be prejudiced by developments. In the light of that process of monitoring and review, the Director General made a further reference to the MMC in 1987. The report of that inquiry was published in August 1989. The MMC again found the no discrimination contrary to the public interest, and again recommended that it should be prohibited. This time, the Government accepted the recommendation. It prohibited the rule by means of a Statutory Instrument – the Credit Cards (Price Discrimination) Order 1990 – which came into force at the end of February 1991. That order was accompanied by regulations – the Price Indications (Method of Payment)
Regulations 1991 – which came into force on the same date.
Those regulations prescribe the information which merchants must give to consumers in those circumstances where they charge different prices for goods or services according to the method of payment used. The regulations also prescribe the manner in which the information may be given. A further recommendation concerned a prohibition of restrictions on entry to the merchant acquisition market. It was the practice for the international payment organisations (Visa and MasterCard) to insist that those card issuing members who wished to become merchant acquirers should not be permitted to do so until they had actually issued a specified number of cards. The MMC found this contrary to the public interest as presenting an unnecessary and undesirable barrier to entry to the acquisition market. It recommended that card issuing members should be permitted to acquire merchants immediately (that is,
whether or not they had actually issued any cards) provided that the member and the payment organisation had agreed a business plan for the issue of cards in the future. This recommendation was also accepted by the Government of the day. It was implemented by means of a further Statutory Instrument – the Credit Cards (Merchant Acquisition) Order 1990 – which came into force at the end of February 1991.
ORGANIZATIONS AND CO-OPERATIVE ARRANGEMENTS IN THE BANKING TRADE
APACS
The Association for Payment Clearing Services (APACS) is the association of those banks and building societies at the heart of the UK payments industry. APACS has three affiliated clearing companies:
CHAPS (the high-value interbank funds transfer system), BACS (the automated clearing house), and the Cheque and Credit Clearing Co (for the paper clearings). It sets the criteria for membership of these. All APACS members (currently 21) must belong to one or other of the Clearing Companies. Membership is open to any appropriately supervised credit institution which can demonstrate its ability to meet fair, explicit, and objective criteria.
Within APACS there are also several “common interest groups”, eg the Card Payments Group which considers issues such as measures to reduce the level of plastic card fraud, progress towards the introduction of chip-based credit, debit and ATM cards, and ATM reciprocity.
The Bank of England is a member of APACS, and as such seeks to influence the behaviour and decisions of the membership in line with its broad, public policy objective to maintain the integrity of the financial system, including payment and settlement arrangements. The Bank has a separate role in relation to membership of the clearings, as all direct participants must successfully apply for a settlement account at the Bank. The Bank is also involved through its provision of the Real Time Gross Settlement facility for CHAPS (ie the actual settlement mechanism for the clearing).
BACS, CHAPS, the Cheque and Credit Clearings
BACS Ltd is an automated clearing house, which provides electronic bulk clearing for low to medium value payments, specifically direct debits, standing orders, and non-urgent automated credit transfers. It has 17 members.
The CHAPS Clearing Company Ltd is responsible for the UK same-day, high-value clearing system. CHAPS (Clearing House Automated Payment System) is a guaranteed irrevocable nation-wide electronic sterling interbank funds transfer system. With the advent of Real Time Gross Settlement (RTGS), CHAPS payments are settled in real time across Bank of England settlement accounts, thereby eliminating receiver risk between CHAPS member banks. The Bank provides intra day liquidity on demand to the CHAPS banks, in the form of same-day repos. Some assets held in CGO and CMO (see below) are among those accepted by the Bank to provide CHAPS settlement members with additional intra day liquidity for RTGS.
The Cheque and Credit Clearing Company is responsible for the bulk clearing of cheques and paper credits in England and Wales, and currently has 12 members. One membership criterion which applies to all of the clearings is the requirement that members have a settlement account at the Bank of England. The Bank of England needs to assess the banks who are permitted to hold accounts at the Bank of England, in order to control its own credit risk, particularly in the case of CHAPS banks.
The network of agreements underpinning these arrangements fell within the provisions of the RTPA, and was cleared without reference to the Restrictive Practices Court.
ECU Clearing The ECU Clearing is a cross-border payment system operated by the Euro Banking Association (EBA) for the payment/ settlement of obligations denominated in ECU. Of the current membership of 50 banks, 11 operate from the UK. There are no statutory regulations governing the involvement of UK entities in this clearing. However, the Bank of England has a potential involvement in that it has established emergency
liquidity facilities, offered to UK-based members of the Clearing, to help the end-of-day settlement process in the event of a problem. The Bank is also involved in the oversight of the system through the EMI.
CGO, CMO, RTGS
The Central Gilts Office Service (CGO) provides secure settlement for gilt-edged (and certain other) securities through a system of electronic book entry transfers in real time against assured payments. The Central Moneymarkets Office Service (CMO) provides a central depository for the immobilization of sterling money market paper and an electronic book entry transfer system for both physical and dematerialised money market instruments, which eliminates the handling of paper between members, and generates associated payment instructions.
These represent arrangements between existing settlement banks. Membership of CGO and CMO is conditional upon the appointment, by the applicant member, of a settlement bank approved by the Bank of England. Settlement bank status is granted by the Bank on the basis of objective criteria. Additionally, the granting of settlement bank status in CGO and CMO is conditional upon all other settlement banks having executed a Deed of Adherence, with the applicant bank, to the provisions of the relevant Service Payment Agreement (effectively giving existing settlement banks some control over the entry of new applicants). The Bank of England (RTGS) operates the daily settlement of the net payment obligations of the sterling settlement banks in CGO and CMO.
The distribution of banknotes:
The Bank of England distributes its new banknotes in a variety of ways. Most of the notes are distributed to the major banks (Lloyds, National Westminster, Barclays, Midland, Co-op, TSB, RBS) through APACS. Essentially, the Bank makes the notes available to APACS, which then oversees the distribution to the individual banks. The banks arrange between themselves who gets how many notes, and of which denomination.
Some of the smaller banks (eg Yorkshire, Abbey National, Halifax) and the Post Office have bilateral arrangements with the Bank so that the Bank supplies them with notes direct. The Bank also supplies notes direct to the Northern Irish banks, through an agency arrangement with the Bank of Ireland.
The ECU Clearing, the CGO, CMO and RTGS, and the arrangements for the distribution of banknotes, arising from the regulation of banking by the Bank of England, did not fall to be considered under the RTPA. Arrangements for the conduct of monetary policy by the Treasury and the Bank of England are excluded from the coverage of this Act.
Industry bodies
There are several industry bodies, eg the British Bankers’ Association (BBA), the London Investment Banking Association, and the Building Societies Association. In general, an important function of these bodies is to act as lobbying groups to represent the interests of their members, eg to attempt to influence new legislative or regulatory initiatives. Such organizations also provide straightforward mutual assistance for their members on non- competitive issues – eg co-ordinating work on the Year 2000 threat.
The BBA is the most influential of these trade bodies, representing over 300 banks, both UK and foreign, which have a presence in the UK. It has played a leading role in establishing industry standards. For instance, it worked with the Bank of England and various law enforcement bodies to produce best practice guidance for banks and building societies on the prevention of money laundering. While this guidance does not have statutory force, the Bank of England now assesses banks’ compliance with it as part of determining whether they have adequate systems and controls.
The BBA publishes daily LIBOR fixings, for all major currencies. These are based on quotes from a selection of banks, and provide an industry benchmark rather than a binding price. It has recently added benchmark option volatilities.
The BBA has also issued a number of SORPs (Statements of Recommended Practice), each providing detailed accounting standards for a particular aspect of banking. These supplement the standards issued by the Accounting Standards Board, which apply to companies generally. They are not mandatory, but are generally complied with, since they have been drawn up with wide industry consultation.
Another form of inter-bank agreement worth mentioning is the development of standardized legal documentation. For instance, in 1996 the BBA managed to achieve consensus on a Master Agreement on Deposit Netting. There is no legal requirement to use standard documentation of this sort, but it is widely used because most participants have an interest in using it. For straightforward transactions, it provides certainty and avoids wasteful duplication of effort. Other examples are IFEMA (the International Foreign Exchange Master Agreement) and ICOM (the International Currency Options Master Agreement).
The BBA’s rules and recommendations constitute an agreement falling within the provisions of the RTPA. The agreement was cleared without reference to the court.
THE BUILDING SOCIETIES COMMISSION
There are 71 building societies. They are among the nation’s most important savings and lending institutions accounting for around 17 per cent of personal sector liquid assets and about 24 per cent of the total UK mortgage market. They have total assets of about £140 billion with 19 million share investors and three million borrowers. Building societies are mutual organisations, jointly owned by their members.
They operate within the legal framework established by the provisions of the Building Societies Act 1986 as amended by the Building Societies Act 1997.
Until the Building Societies Act 1986 building societies were regulated by the Chief Registrar of Friendly Societies. The 1986 Act allowed a wider scope of commercial operation for societies, in recognition of the increasing competition they faced from other financial institutions in a fast changing financial market place. At the same time the 1986 Act provided a new framework for regulation and prudential supervision, and established a new body to carry it out – the Building Societies Commission.
The 1997 Act further liberalised the statutory regime for societies who will now, with a few exceptions, be able to conduct any type of business they wish in addition to their principal purpose of making loans which are secured on residential property and which are funded substantially by their members. The statutory principal purpose rule requires that at least 75 per cent of a building society’s business assets must be in the form of loans fully secured on residential property, which may be either owner-occupied or let, and at least half of its funding must come from members’ share accounts. Further background to the
history of societies and the legislative regime is in the Annex.
The Commission
The 1986 Act placed statutory responsibility for the regulation and supervision of building
societies on the Building Societies Commission, which was formed on 27 September 1986. It is a body corporate, acting on behalf of the Crown and answerable to Parliament. It must consist of between 4 and 10 members who are appointed by the Treasury.
There are currently eight members of the Commission. The Chairman and First Commissioner is the Departmental Head of the Registry of Friendly Societies and the Deputy Chairman and third Commissioner are also full-time senior officials of the Department. The other five part-time Commissioners have professional and business experience in the building society sector, the civil service, the law, banking and accountancy.
Functions of the Commission
The 1986 Act lays down the general functions of the Commission as:
− to promote the protection by each building society of the investments of its shareholders and depositors;
− to promote the financial stability of building societies generally;
− to secure that the principal purpose of building societies remains that of making loans which are secured on residential property and are funded substantially by their members;
− to administer the system of regulation of building societies provided for by the Act;
− to advise and make recommendations to the Treasury or other government departments on any matter relating to building societies.
The Commission fulfils its functions under the Act through a combination of supervision and
regulation. Supervision is based on close and continuing contact with individual societies coupled with the issuing of guidance in the form of Prudential Notes and other advisory material. Regulation under the 1986 Act operates in two ways – through the exercise of powers of control to ensure that societies adhere to statutory requirements and through the enactment of secondary legislation in the form of Statutory Instruments laying down detailed permissions or prohibitions on specific areas of activity by societies. As a consequence of the 1997 Act liberalisation, statutory regulation of the latter kind will be much reduced
in future.
The Commission meets about once a month. It considers a wide range of policy and
prudential matters and examines regular supervisory reports on each society. Commissioners also serve on Commission committees, for example dealing with prudential guidance and systems, and on panels considering building society mergers, conversions and takeovers and applications for access to the Register of Members of societies.
Organisation
The Commission has about 50 staff (who are part of the staff of the Registry of Friendly
Societies). These are organised into a number of groups including a secretariat, supervisory groups, a central policy unit and a financial monitoring group. In addition the Commission calls upon the support of the Registry’s central services staff, including legal and personnel.
The secretariat includes the Secretary to the Commission and provides support services for
Commission meetings. It also acts as a general enquiry point for interested organisations and members of the public.
There are three supervisory groups, responsible for providing the Commission with policy
advice on specific supervisory issues and for the day-to-day supervision of a number of building societies. Each consists of a Group Head, supervisors, analysts and support staff.
A central policy unit focuses on a range of wider policy issues including building societies
legislation, the impact of European financial services legislation and liaison with other regulators. It also manages the Building Society Investor Protection Scheme.
The financial monitoring group is responsible for processing monthly, quarterly and annual
monitoring returns completed by building societies and provides an economic and statistical service to the Commission.
The Registry’s Legal Division provides legal services to the Commission and the Head of Legal
Division is the Legal Adviser to the Commission.The Registry’s Resources Group Division provides IT, finance, accommodation and personnel services to the Commission.
Financing the Commission
The 1986 Act provides for a general charge to be levied on societies which, together with fees
for specific activities, “shall be such as to produce an annual revenue of the Commission sufficient to meet its expenses properly chargeable to revenue account, taking one year with another”. For 1997-98 the general charge will raise about £2.26 million. Each society pays a £2 250 lump sum plus 0.00081 per cent of total assets up to £30 000 million and 0.000405 per cent of assets over £30 000 million.
EC
Question 4 (interbank arrangements)
Yes, there are many interbank arrangements which require antitrust scrutiny. In the field of payment systems, these range from sector-wide arrangements involving dozens, hundreds or even thousands of banks (e.g. international credit card systems or national debit transfer systems) to forms of cooperation involving a more limited number of banks (e.g. cross border credit transfer systems set up by a “family” of banks, for instance postal banks). Some other interbanking arrangements may aim at the creation of a global cooperative alliance falling short of a genuine merger (e.g. BNP/Dresdner Bank) or at the supply of an innovative product (e.g. Banksys / Belgacom smart card).
Question 8 (exemptions)
Banks are not automatically “exempted” from the applicability of the EU competition rules. The antitrust as well as the state aid rules do in principle apply to them. The Court of Justice has firmly established this point many years ago. That is not to say that the EU Commission cannot take into account certain specificities of the sector when it applies the competition rules to banks. As a matter of fact, these rules leave the Commission with a certain margin of discretion to decide whether or not a particular agreement (or state subsidy) should be stopped. And this holds true for all sectors where there is economic activity and where thus competition rules apply. No treaty provision singles out the banking sector as one that
should receive a more lenient competition scrutiny.
Question 9 (competent authorities)
The EU Commission’s competition services are solely responsible to enforce the competition laws in the banking sector. They will, however, keep a close and constant liaison with other Commission services, in particular those in charge of banking regulation and of economic and monetary policy, and – as for any other sector – the Commissioner in charge of competition policy will have important decisions adopted by the full Commission (i.e. the college of 20 Commissioners). The liaison with other Commission services involves regular information and, occasionally, consultation. To this it could be added that formal draft Commission decisions are subject to a consultation procedure involving the national competition authorities and that in some Member States these also have prudential tasks (e.g. Banca d’Italia).
Question 10 (cases)
d) agreements relating to credit debit cards or to wholesale markets?
These arrangements indeed raise antitrust concerns.
Those relating to credit or debit cards raise first of all concerns about certain pricing matters (multilateral interbank fees, no discrimination rule or ban on dual pricing). Other concerns deal with the question of cross-border issuing or acquiring (and the obstacles erected against such cross-border activities).
As to wholesale markets, including the market for government debt, the Commission’s competition services do indeed occasionally have to look into allegedly anticompetitive practices. they are increasingly looking into financial markets, because they receive either notifications of agreements (e.g. among derivatives exchanges) or (usually) informal complaints about allegedly anticompetitive practices occurring on these markets.
e) abuse
Last year the Commission raised formal objections against Swift following a complaint from the French Post that it was not given direct access to Swift, and that the refusal was based on non-objective criteria and, in any event, on criteria which were applied in a discriminatory manner. Swift offered to change the access criteria. It finally subscribed to a detailed undertaking which was published in the EU Official Journal. The handling of the case has now been suspended.
STATE AID . EU
EC State aid regulation is an essential part of competition rules which are relevant for banks.
State aid rules, which in fact apply to all economic sectors, find their origin in the Treaty of Rome of 1957. The basic idea behind these rules can be found in the attempt to limit distortions of competition which may arise from Member States’ support to their own national companies competing in a unified internal market. Therefore, the Treaty gives the Commission the authority to prohibit or approve State aid, imposing if necessary conditions in order to limit distortions of competition which are caused by the State intervention.
Banks are not excluded from the application of State aid rules, nor is a special treatment reserved for them. Although the Commission acknowledges the peculiarities of the banking sector, it considers that these peculiarities do not justify an exemption from the State aid rules. It follows that many financial transactions such as State rescues of failing banks, State capital injections into State-owned banks, fiscal advantages and other financial advantages granted to credit institutions by public bodies are subject to the Commission’s scrutiny under the terms of Articles 92 and 93 and have to be notified ex ante.
The application of State aid rules in the financial sector is relatively new. Several factors can
explain the increase of the Commission’s activity in this specific field. Regulatory changes, such as the freedom to move capital across countries and the adoption of EC directives harmonising the rules governing the exercise of banking activity in Europe (mutual recognition, freedom to establish, home
country control), as well as technological improvements and “disintermediation” have increased the competitive pressures on banks and pushed for the restructuring of national systems and in particular of less efficient intermediaries. It is clear that in a market which becomes more and more competitive and where banks’ activities are gradually liberalised, banks can no longer count on a steady flow of profits nor on State interventions to support them when they get into difficulty. In this respect, the application of State aid rules to this sector means a radical change with respect to the traditional national public
authorities’ tendency to discretely solve the problems of their own failing banks.
Although the Treaty rules date from 1957, the Commission has only recently had to address
State aid cases in the banking sector. It was at the beginning of the 1990’s, with the single market and the mutual recognition of the rights of Member States’ banks that cross-border competition became more important. Since then, the Commission has examined a number of cases of possible State aid to banks, mainly banks in difficulty, such as Banesto, Crédit Lyonnais, Comptoir des Entrepreneurs, Crédit Foncier de France, Société Marseillaise de Crédit, CIC-GAN, Banco di Napoli, Westdeutsche Landesbank. In all these cases, the European Commission has played a major role as the authority responsible to ensure that
distortion of competition affecting trade resulting from State support was minimised.
In the following, the basic State rules are recalled (§ 2) before some specific problems are
addressed (§ 3).
It is important to note that we will not discuss the (serious) problem of the consequences for banks when they lend to a company benefiting from illegal State aid (e.g., State guarantees,) which have not been approved by the Commission.
Basic State aid rules
The assessment of State intervention is made through two linked but distinct steps. First the
Commission assesses whether the State intervention qualifies as State aid. Then, it verifies whether the aid can be found compatible with the common market.
The first step is carried out on the basis of Article 92.1 of the EC Treaty, which states that:
Save otherwise provided in this Treaty, 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 common market.
When the State directly, or through State-controlled bodies, intervenes to help private banks
State aid is almost certainly involved. State interventions into State-owned banks can be less transparent.
In order to assess the aid content of an intervention by the State as a shareholder, the Commission applies the so-called “market-economy investor principle” (MEIP). This principle provides that aid is involved if a private investor operating in a market economy would not have in similar circumstances made the financial support available to the beneficiary of the aid. State aid for rescuing or restructuring firms in difficulty, in particular, tend to distort competition and affect trade between Member States. This is because it affects the allocation of economic resources, providing subsidies to firms which in a normal market situation would disappear or have to carry out thorough restructuring measures. Aid may, therefore, impede or slow down the structural adjustment induced by the increasingly competitive
conditions of the single market, which will be intensified upon introduction of the single currency. They would shift the burden of structural change on to other more efficient firms and encourage a bidding war over the size of subsidies. Moreover, aid may also favour certain undertakings in the field of acquisitions or attraction of customers, thereby falling within Article 92(1) and requiring prior notification to the Commission.
Articles 92(2) and (3) of the EC Treaty provide for the possibility of exemption of aid banned in
principle by Article 92(1). Apart from cases of aid to make good the damage caused by exceptional occurrences which are exempted by art. 92(2)(b), the only basis for exempting aid for rescuing or restructuring firms in difficulty is art. 92(3)(c). Under this provision, the Commission has the power to authorise “aid to facilitate the development of certain economic activities… where such aid does not adversely affect trading conditions to an extent contrary to the common interest”.
The compatibility of the aid measures must be assessed in the light of the specific rules on
restructuring aid. The Commission considers that aid for restructuring may contribute to the development of economic activities without affecting trade to an extent contrary to the common interest where the following conditions are met:
(a) a restructuring plan based on realistic assumptions is comprehensively implementated,
making it possible to restore within a reasonable timescale the requisite minimum return on capital invested and thus to ensure the long-term viability of the business;
(b) there exists an adequate quid pro quo to offset the distortive effect of the aid on competition and thus to make it possible to conclude that the aid is not contrary to the common interest;
(c) the aid is proportional to the objectives sought and limited in amount to the strict minimum necessary for the restructuring in order that the recovery effort might be borne as much as possible by the firm itself;
(d) the restructuring plan and any other obligations provided for in the final Commission
decision are carried-out in full;
(e) a system for monitoring compliance with the preceding conditions is set up.
In order to assess the extent to which the above conditions are met and Article 92(3)(c) is
complied with, the Commission takes account of the particular sensitivity of the financial sector to the difficulties of the failing institution.
The Commission can identify all measures it considers appropriate as compensation. Typically,
compensatory measures include sale of assets, closure of subsidiaries or branches, growth ceilings, minimum pay-out ratios, etc. The Commission cannot impose privatisation for compensatory reasons, as Article 222 of the Treaty states that the Treaty shall in no way prejudice the rules in Member States governing the system of property ownership. However, privatisation is sometimes necessary to ensure viability, as it provides for greater support and restoration of a sound corporate governance system.
Anyhow, it is clear that the Commission considers a Member State’s commitment to privatisation as a very important element of its assessment, as it minimises the risk of future State aid to the same undertaking (“one time last time” principle) and often improves the bank’s corporate governance system.
Some specific issues Below, we discuss four specific problems we think are of particular interest for the treatment of competition aspects in this sector. All of them deal with the management of bank failures. We will first address the issue of the importance of the type of State aid measures for the calculation of the aid; then, we will examine a problem linked to the qualification of interventions by the Central bank of a Member State; this will lead us to the third issue, that is the problem of State aid procedures and the urgency
generally attached to State interventions; eventually, we will touch upon the nature of some “public” interventions such as those of certain deposit guarantee schemes.
Type of aid and assessment of the financial benefit to the failing bank The management of bank difficulties involves a large set of possible measures that can be adopted to help their solution. One common measure (see for instance Crédit Lyonnais, Comptoir des
Entrepreneurs, GAN-CIC, Banco di Napoli) is the break up of the bank into two entities, a good bank and a bad bank, the latter charged with the liquidation of the bad assets of the failing bank. The losses of the bad bank and its debts are normally covered by a State guarantee. Given the uncertainty of the future losses and the need to de-consolidate the bad bank from the good one, the guarantee is often unlimited.
When faced with such a situation, the Commission has first to assess the amount of the aid.
Without a calculation of the aid, the Commission is not able to take a final decision. It is not able to assess the impact on competition and fix the compensatory measures which are necessary to reduce the distortions of competition caused by the aid. Now, the aid in this mechanism is clearly the value of the guarantee. However, it is particularly difficult to come ex-ante to a good estimate of the value of such a guarantee. The revisions of the estimates of the losses of the bad bank of Crédit Lyonnais are a clear example. The assets which were hived-off were so many and so complex that it took several years to come to a reasonable estimate.
What happens if the actual losses are much higher than foreseen at the moment of the
Commission decision?
The Commission cannot use the standard argument according to which the amount
of aid has to be evaluated at the moment of its adoption, because at that time a proper estimate was not available. Therefore, the Commission is obliged to put a ceiling on the aid that it approves and declare that if losses exceed the aid approved, they would have to be considered as a new aid to the old bank. It is evident that the good bank still bears a responsibility on the increase of the losses of the hived-off assets because their increase comes from a better assessment than was possible at the time of the Commission’s
decision. It follows that the Commission decision on compensatory measures cannot be considered as definitive, if the aid ceiling is breached. The new Crédit Lyonnais case is a good example of such an approach of the Commission.
A particular problem is however caused when the beneficiary of the aid is a State owned bank
which has been then sold to a new private investor. To what extent can the buyer be considered as responsible of the new losses of the old bank ? No answer has yet been given to this problem.
Central Banks’ interventions and State aid rules
Interventions by Central banks are of great relevance for the application of State aid rules as they certainly constitute State resources. The Commission has not made its position fully clear on the type of the central bank’s interventions that are subject to Article 92 of the Treaty. However some observations can be made.
The qualification of a State intervention as State resources does not immediately lead to their
qualification as State aid. Given its responsibility for monetary policy, the central bank’s intervention through open market operations to provide liquidity to the market does not constitute State aid.
Direct liquidity support to a bank in difficulty may be State aid if it is not granted under normal
market conditions. In this respect it is likely that the Commission would require, in order to declare that this is not a State aid, that the Central bank’s support is granted at a penalising interest rate and on the basis of an appropriate security given by the bank in difficulty.
The release of regulatory constraints is likely to constitute State aid. For instance, if the Central
bank decides to release the sum deposited by a bank as a mandatory reserve in order to help it to overcome its difficulties, this is clearly a State aid. This was the Commission assessment in the Banco di Napoli case, where it considered that the decision of the central bank to partially release the reserve requirement of the bank, had to be considered as a State aid. At the same time the Commission stated that the aid could be considered compatible with the common market, although it was not notified to the Commission.
This leads us to the following issue.
Procedural issues linked to the adoption of State aid in the framework of banking crises
As we previously indicated, State aid measures require a formal notification to the Commission
before they are adopted. This means that the “Commission shall be informed, in sufficient time to enable it to submit its comments, of any plans to grant or alter aid. If it considers that any such plan is not compatible with the common market having regard to Article 92, it shall without delay initiate the procedure provided for in paragraph 2” (article 93.3 of the Treaty). The latter states that the Commission has to give notice of the aid to interested parties in order for them to submit their comments.
It is not necessary to enter into the details of the procedural rules. What is important, is to realise that State aid procedures are normally quite long. Unless the Commission immediately finds the aid is compatible, no final decision can be given within a short time. Even such a direct approval takes time (1 to two weeks) which may in the banking sector be too long. A bank’s difficulties may come up overnight and may require a rapid action to prevent further deterioration in the bank’s financial situation and sometimes to prevent a systemic crisis.
As we have previously indicated, the Commission considers that liquidity support by the central bank through open market operations does not constitute State aid. State aid in the meaning of Article 92 arises when the support is addressed through State resources to a specific bank who would not otherwise have been able to obtain the necessary funds on the open market.
Although we think that the necessary actions to prevent a systemic crisis should not normally
require State aid, this cannot be always excluded. In such circumstances it is very likely that the Member State would consider that it is obliged to grant aid to avoid the bank’s collapse which could cause major difficulties going beyond the limits of the bank in question and it would do it before the Commission has been able to take a final decision. Such a State decision to grant the aid in breach of the State aid rules, however, may have serious consequences.
First, the Member State’s decision is clearly illegal, as Article 93.3 also states that “the Member
State concerned shall not put its proposed measures into effect until this procedure has resulted in a final decision”.
It is true that the Commission, as stated by the Court of Justice, cannot declare the aid
incompatible because it is illegal, but must in any case carry out its assessment and eventually come to a final decision to approve or to reject the aid. And Member States may rely on that to put the measure into force and then convince the Commission of its compatibility. It is clear from a Member State’s perspective that once the aid is granted, it becomes much more difficult to come back to the original situation. Typically, if the Member State grants a rescue aid to keep the failing bank afloat before a new solution is found, the Commission will have no other option than approve such an aid, even if the form or the amount of aid were not the best choices from the perspective of State aid rules.
The Commission can certainly assess the compatibility of the aid foreseen in the package of
restructuring aid and possibly try to correct the “overshooting” of the rescue aid granted illegally. However, it is evident that if the aid was properly notified, the Commission could have immediately obliged the Member State to correct the aid form or amount to make it fully compatible, so minimising distortions of competition. The Commission can also adopt a provisional decision to suspend the payment of the aid and even oblige the Member State to recover the aid, if this is considered necessary. However, it will find it difficult to take such a decision for a rescue aid granted in breach of the procedural rules, because it would immediately provoke the bank’s collapse.
It is therefore clear that the Commission has a strong interest to ensure that procedural rules are complied with in order to ensure that the aid does not cause unnecessary distortions of competition and avoid that in the banking sector illegal aid becomes the norm.
Member States and the beneficiaries of the aid, if they are not short-sighted, should share the
Commission’s view, at least because an illegal aid is easily subject to attack from competitors. The Court of Justice takes the view that national courts, when hearing an action brought by interested parties, have a role to play in eliminating unlawful State aid. If they find that an aid measure has been put into effect before being notified to the Commission and before the latter has stated whether it is compatible with the common market, in breach of the Article 93(3) procedure, which clearly and unconditionally produces direct effects in relations between Member States and those undertakings under their jurisdictions, they
must, in accordance with the legal rule that Community law takes precedence over national law in the event of conflict, find the aid unlawful and order, where appropriate, the recovery of the financial assistance granted in disregard of the provision and draw all legal consequences, both public and commercial.
Furthermore, it had to be recalled that the recipient of the aid cannot rely on legitimate
expectations when procedural conditions of the Article 93 have not been observed. It has to verify itself that the aid is legal and compatible. In order to solve the problem of proper notification and permit the rapid approval of the adoption of rescue measures for banks when their failure would cause major disruption in the financial markets, the Commission services have drafted a proposal for a new fast accelerated procedure. Although the proposal
has not been adopted yet and has not reached its final version, it is possible, within the limits of the disclosure rules for draft proposals, to indicate the principles and problems that are on the agenda for the final adoption of this proposal.
The idea is that the Commission would give its green-light, in a very short period of time, normally 1 day, to a notified rescue aid if it fulfils some conditions fixed beforehand,
which would allow the Commission to take a decision under the delegation procedure. The conditions will concern the form and the time length of the aid measure and will require a certification from the Central bank of the Member State concerned testifying the urgency and the necessity of the proposed aid, in order to prevent major difficulties to the financial stability of the Member State, as well as an commitment from the Member State to submit a thorough restructuring plan to the Commission within a few months.
State aid rules and the intervention of a Deposit guarantee fund to rescue a bank
Since 1 July 1995, the date of entry into force of directive 94/19/EC of the European Parliament
and the European Council, each Member State had to ensure that within its territory one or more depositguarantee schemes (DGS) are introduced and officially recognised. Except in some specific circumstances, no credit institution authorised in that Member State may take deposits unless it is a member of such a scheme. The directive does not say which kind of scheme shall be adopted and how it should work. The DGS simply stipulates that the aggregate deposits of each depositor must be covered up to ECU 20 000 in the event of deposits’ being unavailable.
A DGS normally intervenes to repay depositors at least a part of their holdings in a bank that has been put into liquidation. This kind of intervention certainly falls outside of the scope of Article 92. In some Member States, however, DGS can choose other types of intervention, if they are less expensive than depositors’ reimbursement. Accordingly, a DGS may intervene before liquidation and grant financial support to the bank to allow it to recover and avoid the loss of the bank’s goodwill. It is also possible that the DGS intervenes during liquidation by assuming some of the losses of the bank’s bad assets, so as to clean the portfolio and make the economic activity of the failing bank more attractive for its sale.
In these cases, DGS interventions may be relevant from a State aid perspective. In order to
assess whether such interventions constitute aid within the meaning of Article 92, the character of the financial resources provided by the DGS has first to be examined. Because banks’ contributions are compulsory, the qualification of the DGS as a private scheme is not sufficient and the contributions may be considered as State resources. Compulsory contributions by private entities to a system which is used by the State or under State influence to help one or more enterprises clearly constitutes a State aid scheme
and has to be notified to the Commission to verify its compatibility.
The Commission has not yet published its approach towards DGS interventions, in particular
when they allow a failing bank to stay afloat. However, a few remarks can be made to clarify some of theproblems before us. Certainly, a distinction has to be drawn between compulsory contributions set and used by a public authority and other compulsory contributions whose amount and use are set by the members of the system. As long as member-banks are free to set the level and the rules governing the collection of the members’ contribution and their use, it could be argued that the DGS acts as a private investor, choosing the least costly solution. But, if the use of the funds is decided by a public body, then DGS interventions, when they allow an economic activity to continue where otherwise it would be entirely liquidated or greatly reduced, have to be examined by the Commission as they may very well
constitute State aid within the meaning of Article 92.
conclusions
From a competition perspective, the way Member States decide to intervene to solve a bank
crisis is of great importance. When it is decided to save the bank or its economic activity and discard the option of a full liquidation, major distortions of competition may arise, because the failing institution should normally exit the market. In a market subject to competitive pressures and technological changes, excess of capacity is likely if exit from the market is blocked. The Commission is aware that in the banking sector the full liquidation of a bank is sometimes blocked because of the negative consequences it may have on competitors and financial markets. We think that if it has been decided that the bank liquidation can pose a threat to the rest of the banking system, a private market solution is still possible,
namely through DGS interventions instead of other more distortive State interventions. In principle a DGS should be able to deal with it and State aid should not be necessary. The Spanish Banesto case represents a good example in this respect. This Spanish case allows us to make two further comments.
First, from a State aid perspective, a DGS intervention to keep a bank alive instead of reimbursing depositors should be freely decided upon by the bank-members with a significant participation of private members. If the decision is subject, directly or indirectly, to the influence of a public authority, the DGS intervention becomes a State aid.
Second, it is important that the DGS owns a well endowed fund to intervene if necessary. Many
times, DGS refused the intervention because they did not own a fund sufficiently large but they had simply the right to call on the bank’s contributions when necessary. Because a bank’s crisis is often linked to a general weakness of the national banking system, other banks may be very reluctant to intervene and would push for a State intervention, claiming that the necessary contribution would be too costly. The weak endowment of the DGS should not be a way of transferring problems to the public authorities. A DGS based on a regular funding should become the normal way to treat a single bank crisis. The Spanish
DGS constitutes in this respect a good example. It is worth noticing that in the case of Banesto, in spite of the fact that the funds provided for the rescue were particularly large with respect to the fund’s endowment, the latter has been able to finance itself by issuing bonds on the market backed by the members’ future contributions to the Fund.
Sometimes, the refusal of the fund to intervene is also linked to the fact that the failing bank was State owned, leaving the State with the main responsibility as a shareholder of the bank. However, State interventions into State-owned banks have often been proved to fulfil more a public goal (maintenance of the entity for social or political reasons) than a private one (return on investment). The goal of defending the conditions for a levelling of the playing field has been too often set aside. This typically generates a vicious circle of insufficient restructuring, repetition of aid and therefore excessive aid and insufficient compensation to competitors. The confusion of roles of the State becomes apparent. As it was stated by the Commission in the first final decision for the State aid to Crédit Lyonnais, “where the State is the main
shareholder of the bank in crisis, its role as shareholder must be separated from its role as the supervisory authority required to safeguard confidence in the banking system. This latter task may lead the State to take measures in support of the bank that are additional to what is really necessary to restore the bank’s viability”.
If we want to assure a level playing field between private and public banks, no different
treatment should be allowed between private and public banks.
What Is The Market Failure in banking?
If we do not know what is the market failure, then we cannot know whether the
regulatory interventions that are being discussed are effective, or well-targeted, or whether they are necessary at all.
The primary public policy concerns in the banking sector relate to the consequences of bank
failures. Therefore it is necessary to determine what it is about bank failures, as opposed to failures in other sectors of the economy, which yield particular public policy concerns. There are three possible lines of argument:
(1) First, that the failure of a bank is more serious than the failure of a similarly sized nonbank firm.
(2) Second, that the failure of a bank can lead to runs on other banks leading to the failure of other banks including other solvent banks.
(3) Third, that the failure of an individual bank could lead to a loss of confidence in the banking sector as a whole leading to a loss of stability in the banking system with potentially serious macroeconomic consequences.
In regard to the first argument, that the failure of a bank is inherently more serious the failure of a non-bank, it was noted that bank services are relatively homogeneous from one bank to the next, therefore there are often different suppliers of relatively close substitute products — for consumer loans consumer credit business loans etc. Some customers make an investment in bank specific information andthese customers will lose, and incur costs in switching to alternative providers. Overall it does not appear that bank insolvencies are systematically worse for shareholders and creditors than non-bank insolvencies.
In regard to the second argument, that the possibility that a bank failure could trigger a run
leading to the failure of other, potentially solvent banks, the Secretariat noted that economic studies of this point find that runs, when they occur on insolvent banks, do not spread to other solvent banks. The economic evidence shows that bank runs do not threaten other solvent banks. Instead, running depositors can distinguish between solvent and insolvent banks.
The third argument was that there is a public policy concern relating to bank failures because
widespread bank failures could cause a significant contraction in the money supply which would have important macroeconomic consequences.
However, the Secretariat noted that depositors, if they can distinguish sound from unsound banks, when they withdraw their money from an unsound and insolvent bank, are likely to simply redeposit their money in another bank. The net effect on a money supply as a
whole is limited or zero, especially if the banks hold similar reserve ratios. So, in that circumstance, there is no effect on the overall money supply and therefore no overall macroeconomic consequences. There is the possibility that depositors could lose confidence in the banking system as a whole and withdraw their deposits and hold cash. In such circumstances there could be a role for the central bank to intervene to
offset the reduction in the money supply.
However, there is no necessary link between bank failures and macroeconomic effects, especially if the central bank can play a role. The UK suggested that there are two features of banks’ balance sheets which make them special. One is the extent of interbank exposure – unlike banks one corporation is not likely to be engaged in a significant amount of lending to a competitor. The presence of interbank lending means that regardless of runs, the failure of one institution can lead to failures at other institutions. The second special feature of
the banking industry is that banks engaged in maturity transformation. Their assets are illiquid and their liabilities are, to a large extent on call. So a bank run can turn a solvent institution into it insolvent institution if they cannot liquidate assets quickly enough.
The Secretariat (CLP) responded to these questions, starting with the question of large interbank exposures. If a bank lends to an individual, to a firm or to another bank, that is part of the normal credit risk that a bank manages as part of the ordinary course of its business. If a bank happens to lend to the residential housing sector and a large number of residential housing loans go bad and the bank fails as a result, that is not normally a public policy concern. For the same reason, if a bank lends to other banks, and the other banks fail and, as a result the first bank fail, that is not normally a public policy concern.
This argument puts to one side payment-system risk. The payment system may create particular problems. It is possible that, as a result of the payment system, large inter-bank exposures may build up, particularly during a single day (in many systems settlement does not occur until the end of the trading day), but with new developments in payments systems, such as real-time settlement these exposures are significantly reduced or eliminated, virtually eliminating payments system risk.
In regard to the question of the illiquidity of assets and the potential for runs to turn a solvent
bank into an insolvent bank, it was argued that it cannot be simply the illiquidity of the assets that is at stake. Non-financial firms also invest in what are clearly illiquid assets. In fact, it is quite hard to imagine a non-financial firm with entirely liquid assets. What is important is that, a large proportion of the liabilities of a bank can be withdrawn on demand. However, even the liquidity of liabilities does not clearly make banks different from other firms. It is quite common for loans to non-financial firms to have a term which says that the entire amount outstanding falls due upon the trigger of some event, such as the failure to make a payment.
As a result, runs can and do happen on non-financial firms. It is not uncommon
to have a situation where you have a large number of creditors swooping on an insolvent firm to claim its assets. The standard insolvency laws of the economy are designed to deal with such “runs”. It is not clear that the insolvency of financial firms (and banks in particular) is sufficiently different to justify special public policy treatment.
The United Kingdom responded by noting that there is a large body of literature on why banks
are special. The delegate noted that if one bank failure can, in theory, trigger a chain of bank failures and you are therefore facing the possibility of a large proportion of a nation’s banks becoming insolvent then this would be a public policy concern.
Moves Toward Reliance On Market Forces:
The Chairman noted that some of submissions contained statements that suggest a movement towards greater emphasis on market mechanisms and competition. For example, there is a statement in a Canadian report which reflects the views of the Canadian Bureau of Competition which says that: “the public policy objectives that underline the review can best be achieved by relying upon competition and market forces to the maximum extent possible rather than through continued or increased regulation. The Competition Bureau of Canada recognizes that stability of the financial system is generally a paramount
goal of financial market regulation and that stability may come at the expense of competition.
In the Bureau’s view however, there are regulatory changes that can increase regulatory flexibility and increase competition without compromising the stability and solvency of the financial system.” In response the Canadian delegate noted that the Bureau of Competition Policy does a great deal of advocacy work, including advocating greater reliance on market mechanisms in the financial sector. The Competition Bureau wants to signal to policymakers that they should not disregard reliance on the market mechanism. The delegate also noted that the process of reform is likely to be iterative and should be structured in a coherent manner so as to make a smooth transition from a regulated system to a market
system.