Portugal and the European Commission agreed terms for recapitalising Caixa Geral de Depósitos (CGD) last week, with the troubled lender set to receive €2.7bn of state funds and €500m of shares from its subsidiary ParCaixa.
The plans include an agreement that €960m of CGD’s CoCo securities will be converted to equity. And CGD will also have to issue €1bn in subordinated to institutional investors — an extremely tricky step that, if the bank somehow manages to drum up interest, will likely be completed in additional tier one format across a multiple new issues.
Curiously though, the European Commission’s public statement did not focus on burden sharing as a justification for why the €2.7bn recapitalisation would not constitute state aid, as might have been expected, and neither did it centre on the deal taking place on market terms.
Joaquín Almunia, Commission vice-president in charge of competition policy, instead assured market participants that CGD — along with Banco BPI and Banco Comercial Português — were “on the right track to become viable in the long term.”
Perhaps more importantly, he also said he was satisfied that the use of taxpayer’s money would be limited, because “the banks will repay the state aid they have received, with an appropriate remuneration.”
There is some precedent for this in Portugal, as a number of banks have repaid state funding in recent years. Banco BPI, for example, has repurchased €580m of the €1.5bn it received in hybrid securities from the government in 2012.
But, whether or not authorities believe a bank will pay back state funds is not part of the criteria for whether or not those funds constitute "state aid" under European law. And under the Bank Resolution and Recovery Directive, a bank must write down 8% of total liabilities and own funds before receiving any state aid.
In addition, it is far from clear why the Commission has placed such confidence in CGD to repay funds injected by Portugal, or come good on its restructuring plans, given that the government already plugged the bank with €750m in shares and €900m of hybrid capital instrument in 2012.
There has been significant criticism of the Commission for not being flexible enough around the rules for recapitalising banks but, in the case of CGD, state aid rules appear to have so many caveats they have almost become meaningless.
This lack of clarity makes it difficult to gauge the likelihood that banks in other jurisdictions could receive state backing along similar lines, which increases uncertainty for bondholders and shareholders and banks alike.
Italian financial institutions will be paying particularly close attention, as many of them are grappling with similar problems — including low interest rates and rising levels of bad loans.
The motive for continuing to allow state aid for struggling lenders is clear; bank failures can have serious and lasting consequences for a country’s or a region’s economy.
But by and large the Commission’s position on when to allow state aid is baffling, and potentially self-defeating. Rather than allowing state aid early in the process, participants in a recap have to now dance through hoop after hoop to get the money they'll end up having either way. Only, as in the case of CGD, whether they'll actually be able to pull off some of the conditions for receiving state aid is anything but certain.
The Commission must do more to show clear and consistent criteria, lest it make a mockery of how these decisions are made, add to the costs to both taxpayers and the financial system, and, perhaps most importantly, destroy faith in its own rules.