The genesis of the EU bank resolution framework was based on the fundamental principle that failing financial institutions could not receive external financial support, be it industry financing or state aid unless they had first internalized their losses by placing the burden at least upon shareholders and junior creditors. However, the General Court’s ruling in the Tercas case in March 2019 seems to strike a heavy blow against these fundamentals by considering that Tercas bank’s recapitalization by a private banking consortium did not constitute state aid, even though the consortium was operating as a mandatory deposit guarantee scheme (DGS) and was obliged to reimburse deposits in case of liquidation, pursuant to the DGS Directive. In this context, this blog-post embarks on a brief analysis of the European risk management framework, and sails on to discuss the Tercas judgment and its implications for the future, especially if upheld in the pending appeal case before the Court of Justice of the EU (CJEU).
Mapping the European risk management framework
To begin with, the EU bank resolution framework, as set out in the Bank Recovery and Resolution Directive (‘BRRD’), establishes two points of possible regulatory intervention: (i) the recovery and (ii) the resolution phase. In recovery, bank supervisors intervene whilst the bank remains solvent and can, among others, appoint a temporary administrator to its management (Article 29 BRRD). No specialized fund is designed for recovery purposes and state aid, if used, would trigger resolution. The resolution phase allows for full regulatory intervention since the institution has been deemed ‘failing or likely to fail’ (FOLTF) by the supervisor – a concept similar but not identical to national insolvency. In fact, resolution applies instead of national insolvency only when justified on public interest grounds to preserve financial stability (Article 32 BRRD). Thus, resolution authorities can impose losses upon shareholders, junior and senior unsecured creditors (‘bail-in’), and sell the bank partly or entirely to a competitor, while sending into liquidation any remaining impaired assets. Following bail-in, financing can be provided either through collective industry funds – the Single Resolution Fund (SRF) or the DGSs – or the state, if compliant with the Treaties. At any given point the rescue of an ailing bank can be funded through voluntary industry funds, separate from the SRF and DGSs.
There is one exceptional case of state aid use outside resolution built into the BRRD, the so-called precautionary recapitalization. Precautionary recapitalization allows the provision of state aid to solvent banks in order to cover capital shortfalls that have been identified during the bank supervisor’s stress tests.
As indicated above, the EU bank resolution framework operates in parallel to the conditions attached to the provision of state aid to the financial sector. In particular, the Commission’s 2013 Banking Communication – specifying the use of Article 107(3)(b) TFEU – requires, among others, that state aid is limited to the minimum required to preserve financial stability and presupposes that shareholders and junior unsecured creditors have contributed to the losses of the institution (‘burden-sharing’). Comparing ‘burden-sharing’ to ‘bail-in’, it is clear that burden-sharing under state aid rules is more lenient towards creditors since senior unsecured creditors are exempt, whilst they are included in bail-in under bank resolution rules.
All different financing scenarios can be summarized in the figure below.
The Tercas judgment
Tercas was a relatively small Italian bank put under special administration by the Italian Ministry of Finance on 30 April 2012, as a pre-insolvency procedure similar to the ‘recovery phase’ mentioned above. The special administrator started discussions with Banca Popolare di Bari (BPB) for a potential acquisition deal, otherwise if no buyer was found Tercas would end up in administrative liquidation pursuant to national insolvency law. In such case, the competent Italian DGS, the Interbank Deposit Protection Fund (FITD), which constitutes a private banking consortium, would need to reimburse covered depositors pursuant to the DGSD. However, BPB agreed to buy Tercas but only under the condition that the FITD would cover Tercas’ losses. Losses would thus be imposed only upon shareholders, not creditors. Following a request by the special administrator, the FITD voluntarily agreed to intervene and soon after, on July 7, 2014, the Bank of Italy authorized the intervention plan.
However, on December 23, 2015, the Commission decided that the FITD’s intervention plan constituted unlawful state aid. The Commission argued that the intervention was made through the use of State resources and was imputable to the State and could not be cleared on the basis of the 2013 Banking Communication. The Italian Republic, Banca Popolare di Bari and the FITD, with the intervention of the Bank of Italy, challenged this decision before the General Court.
The General Court annulled the Commission’s decision by concluding that the Commission incorrectly decided that the measures granted to Tercas entailed the use of State resources and were imputable to the State. Therefore, the Court did not proceed to the analysis of other grounds for annulment, as was the compatibility of the aid with the internal market, but focused entirely on the fulfilment of the criterion of state origin which comprises the elements of ‘imputability to the State’ and the use of ‘State resources’.
The Court, aligned with the Commission’s argumentation, noted that what was crucial to this case was not the direct origin of the resources but rather the degree of intervention of public authorities in the design and execution methods of the said intervention plan. According to the Commission, the crucial elements were:
- The DGS’ public mandate since it was obliged to reimburse covered depositors up to the amount of EUR 100,000 in case of liquidation. The private nature of the consortium was not relevant according to the Commission.
- The influence that public authorities exerted upon the DGS during all stages of design and implementation of the intervention plan. The Commission argued that the – appointed by the Ministry – special administrator, seating also as an observer in the FITD’s board meetings, was coordinating the intervention, whilst the requirement for authorisation by the Bank of Italy indicated the existence of state influence.
- The state control over the DGS funds since participating banks were obliged to be members of a DGS in order to be licensed while exiting the scheme was practically impossible.
As established in the Stardust Marine case (C-482/99), and cited by the Court, imputability can be inferred from a number of indicators, none of which may be decisive on its own. In this context, the Court went on to discuss the three aforementioned elements. However, as illustrated below, the Court seems to have raised the standard of proof for the claimed intervention by requiring the Commission to provide decisive proof and not merely a series of indicators about it.
- As regards the DGS’s public mandate, the Court acknowledged that the DGS’ obligation to reimburse all covered depositors upon liquidation serves the public objective of preserving financial stability. However, voluntary interventions prior to liquidation such as the one under consideration fall outside the scope of this public mandate; as long as these ‘voluntary interventions’ cost less than reimbursing depositors they serve purely the best private interests of the DGS members and only incidentally public interest. However, it is important to clarify the DGS’ alternative options. Once no buyer would be found, national authorities would be forced to liquidate Tercas. Such a development would automatically generate a statutory obligation for the DGS to reimburse all depositors up to EUR 100,000. Instead, the DGS could intervene at an earlier stage in order to facilitate the sale of Tercas by agreeing to cover its losses. The latter option was ultimately chosen as the least costly only because the law requires the DGS to contribute in any event to liquidation. If reimbursement of depositors in liquidation was not required, it is questionable whether the DGS would voluntarily pay for the rescue of Tercas. Therefore, in my view, the Court wrongly focused on the form of intervention and not on the need for intervention in any event, ultimately in liquidation. The fact that this ‘voluntary intervention’ cost less than full reimbursement justifies the form of intervention, not the intervention itself.
- As regards the state influence to the DGS, the Court argued that there was no evidence that the special administrator influenced the actions of the DGS, while the BoI’s authorisation requirement concerned only the impact of the intervention on the banking system and financial stability; it by no means made the intervention mandatory. Whilst the Court’s argument is accurate, this element becomes irrelevant when considering that the DGS had a legal obligation to act in any event and regardless of any state influence.
- As regards the state control over the DGS funds, the Court argued that the decision to intervene was taken by a common decision of all DGS members to allow such voluntary interventions and which was included in the articles of association of the DGS, as well as by a second common decision to intervene in this particular case. Thus, the Court concluded that the intervention was not attributable to its legal obligation to reimburse depositors. However, based on the views under point (1) the Court’s argument here seems unsubstantiated.
The Commission has appealed against the General Court’s judgment. In case the CJEU upholds Tercas, two direct implications will emerge.
- In the context of state aid, it would mean that the CJEU departs from the landmark Stardust Marine as regards the imputability of state aid deriving from private resources, and requires from now on decisive proof for imputability, not mere indications.
- In the context of bank resolution, it challenges the credibility of the entire resolution framework. It means that DGS funds could be used either in recovery or resolution as a voluntary means of intervention to rescue banks without requiring creditors to carry any losses. Such an exception would generate moral hazard and thus threaten financial stability, the very objectives that the recently established bank resolution framework aims to achieve.