The European Parliament ECON committee commissioned Copenhagen Economics to conduct a study on crisis rules for State aid to the financial sector and the real economy in the context of the recent financial crisis.
In the light of the crisis, State aid has been increased massively reaching 3.5 % of EU GDP in 2009 against 0.5-1 % of GDP per year in the previous decade. The financial sector has received the vast majority of these funds (roughly 80 % in 2008 and 2009). We find that action to stabilise the trust in and within the banking system has been to a large extent effective in stabilising the overall banking system, but at a considerable price.
While the European Commission deserves credit for launching four Communications on banking rather swiftly after the recognition of the crisis, there is no doubt that the EU as a whole was badly prepared to deal with a major banking crisis. First, the basic instrument to deal with all failing firms, the guidelines on “Rescue and restructuring” was developed to deal with manufacturing firms not banks. Second, the seriousness of the pre-crisis situation was recognised very late and there were limited established legal procedures in place to deal with failing banks in an orderly manner. Member States has therefore tended to jump directly and very quickly into the “restructuring” phase.
It is of large importance that the strengthened capital requirements in the context of Basel III are implemented rigorously at Member State level and followed up by regular stress tests that reveal potentially weak banks in due time before they fail. Public injection of capital should only be given as a last resort option after attempts to attract new private capital has failed and at the pre-condition that private investors, beyond narrowly defined smaller depositors, should accept very substantial losses.
We find little evidence that the temporary framework for State aid to the nonfinancial sector did not function properly. We also take note that most of the temporary rules have been prolonged until the end of 2011 which we find justified.
The study can be found on the website of the European Parliament here
The study was presented for the ECON committee at the European Parliament in Strasbourg on 5 July 2011. The presentation can be found here
For further information please contact partner Helge Sigurd Næss-Schmidt