State aid is dead. Long live state aid

The EU State aid regime

The European Union is the only jurisdiction in the world which effectively operates a binding State aid control system. It is fair to claim that the project of a European Single Market, enshrined in Article 3 TEU, would not have achieved the remarkable current grade of economic integration without the establishment of an efficient State aid regime. The State aid control scheme, which was identified as a priority in the well-known Spaak Report, has thus remained a cornerstone of the Single Market project as the articles dealing with this provision have survived largely untouched since the Treaty of Rome.

Article 107(1) of the Treaty on the Functioning of the European Union (TFEU) sets out a general prohibition against State aid. However, this prohibition is not absolute and there exist some exceptional circumstances, listed in Article 107(2) and (3) TFEU, which make State aid compatible with the internal market. Article 108 TFEU specifies that the body which has the exclusive competence to assess whether State aid can be considered compatible with the internal market is the European Commission.

The EU regime for the control of State aid is based on two separate mechanisms. First, the Commission will have no discretion in employing a set of objective criteria to determine the existence of any State aid under Article 107(1). Secondly, should the Commission find that a measure falls under the Article 107(1) definition, it enjoys a wide discretion when assessing the possibility of any compatibility under Article 107(2) or (3) of the State aid in question with the internal market.


The 2008 banking crisis

Although the TFEU sets out the fundamental legal basis for the control of State aid, the provisions are rather generic and imprecise. This has led the Court of Justice of the EU and especially the Commission to play an increasingly essential role in interpreting the Treaty articles and functionally adapting the State aid regime in times of economic turmoil. In particular, the 2008 banking crisis has provided the necessary spark for a significant reform process.

The 2008 banking crisis has represented an existential threat to the EU State aid control regime, as there was a concrete risk that Member States could disregard the rules in order to save their banking systems. According to a recent EU report, between 2007 and 2014, Member States granted approximately €700 billion in capital and repayable loans and €1300 billion in guarantees to financial institutions in trouble under State aid rules. Astonishingly, EU State aid rules were applied to the restructuring of around 25% of the entire EU banking sector.

The Commission first responded to this dramatic situation by invoking Article 107(3)(b), which permits State aid ‘to remedy a serious disturbance in the economy of a Member State’. The Commission also introduced a number of soft law measures, known as the ‘Crisis Communications’ and the ‘Temporary Framework’.

What has arisen from the 2008 banking crisis is a ‘constitutionally dubious practice’ by the Commission of indirectly transforming State aid law by adopting self-binding soft law measures. As the Advocate General Wahl noted, these soft law instruments cannot be considered, de jure or de facto, binding upon Member States. Nevertheless, they create an indirect binding effect, according to which Member States are not bound by the soft law introduced by the Commission, which in turn will base its decisions – which are legally binding instruments – on those same soft law measures.



In the banking sector, State aid can take the form of recapitalisations, asset protection schemes, resolutions or State guarantees. One of the perks of employing soft law instruments is that they can be used to momentarily fill in the regulatory gaps and allow the EU bodies to gain time during particularly troublesome economic situations, while laying the conceptual foundations for the development of hard law measures.

An example of this behaviour can be discerned by analysing the relationship between the “2013 Banking Communication” and the Bank Recovery and Resolution Directive (BRRD). The 2013 Banking Communication has originally introduced the notion of ‘burden-sharing’ by shareholders, which was deemed an essential feature to ‘ensure financial stability in the long term’, which was further developed by the BRRD. Together with the Single Resolution Mechanism (SRM), the BRRD constitutes one of the pillars of the new EU banking regime.

Developing on the concept of burden-sharing, the BRRD has conceived the so-called ‘bail-in tool’, which enables a resolution authority to write down or convert into equity the liabilities of an institution which is ‘failing or likely to fail’. In theory, any failing institution would thus be liquidated under the usual insolvency proceedings, avoiding expensive bail-outs with taxpayers’ public support. The objective of the EU legislators was to reduce the risk of allowing moral hazard, that in the words of Paul Krugman is a ‘situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly’. According to the original conception of bail-in, in principle, no bank would be ‘too big to fail’.


State aid is dead. Long live State aid

The 2013 Banking Communication had already provided an exception to the burden-sharing rule, which applied in case that implementing such measures would endanger financial stability or lead to disproportionate results (point 45). Likewise, Article 32(4)(d) of the BRRD allows for precautionary recapitalisations, although the following conditions must be fulfilled: 1) the institution concerned must be solvent and 2) the injection of funds or purchase of capital instruments must take place “at prices and on terms that do not confer an advantage upon the institution”. According to Article 32(4)(d), precautionary recapitalisations will not be permitted for banks that are insolvent or considered likely to fail in the near future under the “point of non-viability test”.

This exception will thus allow injections of capital by national governments into solvent banks when this is necessary to remedy a serious disturbance in the economy and preserve financial stability in the EU. What is ironic and significant is that the Commission has stated in its 2013 Banking Communication – which is still in force and has not yet been revised – that a “crisis situation persists” in the EU. It therefore appears that by affirming (or rather not negating) a perpetual state of banking crisis, the Commission is legitimising state aid for (big) solvent banks in distress.

On 21 December 2016, the Italian Parliament approved a 20 billion euro increase in the public sector borrowing limit to provide capital support to Italian banks, which amounts to 1.2% of the Italian GDP. This action was justified as “precautionary” and “extraordinary”, while also being “beyond the control of the State”. On 23 December 2016, the Italian government introduced the “Salva Risparmio” decree, which created a fund of up to 20 billion euro to support the banking sector, by providing capital and liquidity to financial institutions and protect retail savers. The first bank to access this fund will be Monte dei Paschi di Siena (MPS), which requires an €8.8 billion precautionary recapitalisation to bolster its troubled balance sheets. MPS, the Italian government and the Commission are still in the process of negotiating the details of the costly recapitalisation. Moreover, the Italian government is likely going to employ the emergency fund to rescue two additional banks: Veneto Banca and Banca Popolare di Vicenza.

The lesson to be taken from the Italian experience is that State aid is very much alive and the BRRD has not yet been able to achieve its objective of confining it. In the words of Philippe Lamberts, a EU lawmaker, MPS ‘has been on the verge of collapse for years’ and in the spirit of the BRRD ‘this is precisely a case for resolution’. This applies even more to the other two Italian banks.

However, the situation is more complicated than that. This is because whenever one deals with the banking sector and citizens’ savings, he inevitably enters into an extremely politically sensitive territory. EU institutions realise that by introducing rules that are too rigid, they would face the risk of Member States disregarding these same rules and save their banks anyways. On the other hand, a too-flexible system would allow the flourishing of moral hazard and reckless behaviour in the banking sector, which represents one of the very causes of the banking crisis in Europe. There are no certain answers to this dilemma. What is clear is that the balancing exercise which the Commission must perform is not an easy one and State aid will continue to play a significant role in EU economy and politics. State aid is alive, at least for now.

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