The Global Crisis: a European Perspective Vitor Gaspar, Director General of BEPA (Bureau of European Policy Advisers) The views expressed are my own and

The Global Crisis: a The Global Crisis: a European PerspectiveEuropean Perspective

Vitor Gaspar, Director General of BEPA (Bureau of Vitor Gaspar, Director General of BEPA (Bureau of European Policy Advisers)European Policy Advisers)

The views expressed are my own and do not necessarily reflect those of the European Commission.

RTD Debate – 17 March 2009

BOTTOM LINEBOTTOM LINE

1. The crisis has spread globally through strong economic 1. The crisis has spread globally through strong economic and financial linkages. The crisis is global in character.and financial linkages. The crisis is global in character.

2. Experience of Great Depression shows unilateral 2. Experience of Great Depression shows unilateral national approaches lead to negative spillovers and national approaches lead to negative spillovers and retaliation deepening and prolonging the crisis. It is retaliation deepening and prolonging the crisis. It is necessary to engage multilaterally to preserve open necessary to engage multilaterally to preserve open trade.trade.

3. Europe is the largest economic entity in the world and 3. Europe is the largest economic entity in the world and the most integrated. Nowhere else is coordinated action the most integrated. Nowhere else is coordinated action so justified to explore synergies and to avoid negative so justified to explore synergies and to avoid negative spillovers. spillovers.

BOTTOM LINEBOTTOM LINE

The European Economic Recovery Plan is based on the The European Economic Recovery Plan is based on the judgment according to which the current financial and judgment according to which the current financial and economic crisis is a economic crisis is a unique, unprecedented, historical unique, unprecedented, historical eventevent that justifies exceptional responses. that justifies exceptional responses.

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1.1. Factors contributing to the current global Factors contributing to the current global crisis.crisis.

2.2. Events in economic and financial Events in economic and financial markets after October 2008.markets after October 2008.

3.3. Policy responses to the global crisis.Policy responses to the global crisis.

4.4. The European Economic Recovery Plan.The European Economic Recovery Plan.

5.5. Conclusion.Conclusion.

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1. Factors contributing to the 1. Factors contributing to the current global crisiscurrent global crisis

There have been several elements that led to the There have been several elements that led to the financial turmoil that started in August 2007:financial turmoil that started in August 2007:

Macroeconomic factorsMacroeconomic factors - The great moderation : low - The great moderation : low volatility of macroeconomic aggregates, low inflation, volatility of macroeconomic aggregates, low inflation, housing market bubbles, widening and unsustainable housing market bubbles, widening and unsustainable international imbalancesinternational imbalances

Microeconomic factorsMicroeconomic factors - Financial innovation: new - Financial innovation: new financial instruments of unprecedented complexity, financial instruments of unprecedented complexity, development of the “originate and distribute” development of the “originate and distribute” complementing the “originate and hold” model of bank complementing the “originate and hold” model of bank operations, excessive risk taking not always by those operations, excessive risk taking not always by those who could best bear risk, poor risk management, who could best bear risk, poor risk management, inadequate regulatory and supervisory surveillanceinadequate regulatory and supervisory surveillance..

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2. Events in economic and financial 2. Events in economic and financial markets after October 2008markets after October 2008

The economic outlook deteriorated sharply as the global The economic outlook deteriorated sharply as the global crisis intensified last autumn crisis intensified last autumn ::

The The Commission interim forecasts 2009-2010Commission interim forecasts 2009-2010 published on January 19 and published on January 19 and updating the autumn 2008 updating the autumn 2008 forecastforecast project project world GDPworld GDP growth to slow down to 0.5% growth to slow down to 0.5% in 2009 from 3.3% in 2008. in 2009 from 3.3% in 2008.

For the For the EUEU, , GDP is forecast to contract by 1.8% in 2009 GDP is forecast to contract by 1.8% in 2009 before recovering to 0.5% in 2010. before recovering to 0.5% in 2010.

In the In the euro areaeuro area, the respective estimates are -1.9% and , the respective estimates are -1.9% and 0.4%. 0.4%.

The Commission forecasts are in line with the IMF's The Commission forecasts are in line with the IMF's January 2009 January 2009 ad-hoc update of the November 2008 ad-hoc update of the November 2008 World Economic OutlookWorld Economic Outlook. .


EU Euro area EU Euro area EU Euro areaFebruary 2008 interim 2,0 1,8 - - - -Spring 2008 2,0 1,7 1,8 1,5 - -September 2008 interim 1,4 1,3 - - - -Autumn 2008 1,4 1,2 0,2 0,1 1,1 0,9January 2009 interim 1,0 0,9 -1,8 -1,9 0,5 0,4

Spring 2008 1,8 1,4 1,7 1,2 - -July 2008 update - 1,7 - 1,2 - -October 2008 1,7 1,3 0,6 0,2 - -November 2008 update 1,5 1,2 -0,2 -0,5 - -January 2009 1,3 1,0 -1,8 -2,0 0,5 0,2

June 2008 - 1,7 - 1,4 - -September 2008 update - 1,7 - 1,3 - -November 2008 update - 1,0 - -0,6 - 1,2Source: Commission, IMF and OECD forecasts, various issues as indicated

Commission

IMF

OECD - euro area

Table 1: Real GDP growth forecasts, EU-27 and euro area (annual average % change)2008 2009 2010


Financial systemic-risk pressures have abated Financial systemic-risk pressures have abated since September-October 2008 as the result of since September-October 2008 as the result of unprecedented and continuing government unprecedented and continuing government financial support. financial support.

Nevertheless, markets have not yet returned to Nevertheless, markets have not yet returned to normalcy and risk-perceptions—as reflected in normalcy and risk-perceptions—as reflected in interest-rate spreads—are still well above early-interest-rate spreads—are still well above early-crisis and especially pre-crisis levels.crisis and especially pre-crisis levels.


Figure 1. Average Libor interest rate in Euro Area, UK, US - as of Mar 4, 2009Figure 1. Average Libor interest rate in Euro Area, UK, US - as of Mar 4, 2009


Figure 2. 3-month Libor spreads to Overnight Index Swaps – as of Mar 4, 2009


Figure 3. 3-mo US TED Spread: T-bill vs. Libor - as of Mar 3, 2009


However, pressures are still strongly present in the credit markets that directly financeHowever, pressures are still strongly present in the credit markets that directly finance the real economy. the real economy.

Figure 4. Commercial MBS spreads as of Mar 3, 2009


Figure 5. Spreads in consumer finance sectors as of Jan 12, 2009


Figure 6. CDS spreads for US and European corporates as of Mar 3, 2009

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3. 3. Policy responses to the global Policy responses to the global crisiscrisis

In today’s conditions of financial turmoil the In today’s conditions of financial turmoil the transmission mechanism cannot be relied to operate transmission mechanism cannot be relied to operate as in normal circumstances; hence the responsibility as in normal circumstances; hence the responsibility for stabilization shifts towards budgetary policy. Fiscal for stabilization shifts towards budgetary policy. Fiscal policy initiatives are needed to complement monetary policy initiatives are needed to complement monetary policy action.policy action.

The spillovers across nations can be very significant The spillovers across nations can be very significant in the present circumstances – hence the steps to in the present circumstances – hence the steps to strengthen international policy coordination.strengthen international policy coordination.

Inter-linkages and interdependence are particularly Inter-linkages and interdependence are particularly strong in the EU and, in particular, in the euro area.strong in the EU and, in particular, in the euro area.


Member States are faced with a common disturbance, Member States are faced with a common disturbance, experience strong spillovers in their policy actions and experience strong spillovers in their policy actions and share central common interests:share central common interests:

• The Single Market and the Single Currency.The Single Market and the Single Currency.• Structural Adjustment and Sustainable Growth.Structural Adjustment and Sustainable Growth.• Financial Stability and overall Macroeconomic Financial Stability and overall Macroeconomic

Stability.Stability.• Multilateral governance for the global economy.Multilateral governance for the global economy.


•Central bank’s liquidity provision and Central bank’s liquidity provision and aggressive lowering of interest rates;aggressive lowering of interest rates;•Extension of guarantees on banks’ liabilities.Extension of guarantees on banks’ liabilities.•Capital injections and (in some cases) state-Capital injections and (in some cases) state-controlcontrol•Treatment of impaired assets.Treatment of impaired assets.•Discretionary fiscal stimulus.Discretionary fiscal stimulus.•A review of the regulatory and supervisory A review of the regulatory and supervisory framework in Europeframework in Europe


Monetary easing in a concerted joint policy Monetary easing in a concerted joint policy action on October 8, 2008. action on October 8, 2008.

EU leaders agreed on EU leaders agreed on the principles for an the principles for an unprecedented concerted action in the EU.unprecedented concerted action in the EU.

The European Economic Recovery Plan (EERP) The European Economic Recovery Plan (EERP) adopted on November 29 is the cornerstone of adopted on November 29 is the cornerstone of the policy response.the policy response.

The Commission has presented on January 28 The Commission has presented on January 28 proposals to invest €5 billion in key energy and proposals to invest €5 billion in key energy and internet broadband infrastructure projects in internet broadband infrastructure projects in 2009-2010. 2009-2010.

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4. The European Economic 4. The European Economic Recovery PlanRecovery Plan

EERP rests on two pillars:EERP rests on two pillars:

I.I. Discretionary fiscal stimulusDiscretionary fiscal stimulus

II.II. Priority areas for Lisbon strategyPriority areas for Lisbon strategy

Fiscal stimulus should be in line with the following criteria:Fiscal stimulus should be in line with the following criteria:

coordinated;coordinated;

timely;timely;

targeted;targeted;

temporary.temporary.

4. The European Economic 4. The European Economic Recovery PlanRecovery Plan

Policy action to respect the rules of the Single Market and Policy action to respect the rules of the Single Market and the Stability and Growth Pact.the Stability and Growth Pact.

Policy action should follow the priorities of the Lisbon Policy action should follow the priorities of the Lisbon Agenda and the urgency of structural reform.Agenda and the urgency of structural reform.

Crisis are moments of opportunity. Hard questions are posed Crisis are moments of opportunity. Hard questions are posed and traditional forms of operation are challenged.and traditional forms of operation are challenged.

The EERP leads us not only from crisis to recovery but from The EERP leads us not only from crisis to recovery but from crisis to long run sustainable prosperity.crisis to long run sustainable prosperity.

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5. Conclusion5. Conclusion Existing EU State-aid rules & ex-ante guidance of the EC Existing EU State-aid rules & ex-ante guidance of the EC

have played a major role in ensuring a minimum degree of have played a major role in ensuring a minimum degree of consistency between the measures taken by Member consistency between the measures taken by Member States and therefore contribute to stay close to a co-States and therefore contribute to stay close to a co-ordinated, co-operative outcome (Single Market). ordinated, co-operative outcome (Single Market).

Key characteristic of intervention: Reconciliation of short-Key characteristic of intervention: Reconciliation of short-term and longer-term perspectives of public intervention is term and longer-term perspectives of public intervention is crucial to reach a sustainable and competitive banking crucial to reach a sustainable and competitive banking sector and hence financial sector basis for the real sector and hence financial sector basis for the real economy.economy.

Reconcialiation between the short and long run Reconcialiation between the short and long run

perspectives is also present in fiscal policy. Discretionary perspectives is also present in fiscal policy. Discretionary expansion must be (co-ordinated) timely, targeted, and expansion must be (co-ordinated) timely, targeted, and temporary (SGP).temporary (SGP).

5. Conclusion5. Conclusion

Building the ground for sustainable recovery requires Building the ground for sustainable recovery requires (as a necessary, albeit not sufficient condition) the (as a necessary, albeit not sufficient condition) the restoration of financial stability.restoration of financial stability.

But to prevent and manage future crises, further But to prevent and manage future crises, further progress in the area of regulation, coordinated progress in the area of regulation, coordinated supervision and crisis management procedures (as supervision and crisis management procedures (as put forward in the put forward in the ESRCESRC & the & the ESFSESFS recommendations) is essential.recommendations) is essential.

The same applies in the global context (G20). The de The same applies in the global context (G20). The de LarosiLarosière Report is also a EU contribution to the G-20.ère Report is also a EU contribution to the G-20.

The Global Crisis: a The Global Crisis: a European PerspectiveEuropean Perspective

Vitor Gaspar, Director General of BEPA (Bureau of Vitor Gaspar, Director General of BEPA (Bureau of European Policy Advisers)European Policy Advisers)

The views expressed are my own and do not necessarily reflect those of the European Commission.

RTD Debate – 17 March 2009

EU as a Framework for National EU as a Framework for National GovernmentsGovernments’ Intervention’ Intervention

Vitor GasparVitor Gaspar(with Joep Konings)(with Joep Konings)

Bureau of Economic Policy Advisers, Bureau of Economic Policy Advisers, European CommissionEuropean Commission

Workshop on The Future Face of Europe’s Financial System, Workshop on The Future Face of Europe’s Financial System, Bruegel, 23 – 24 March 2009Bruegel, 23 – 24 March 2009

DisclaimerDisclaimer

The views expressed are my own and The views expressed are my own and do not necessarily reflect those of the do not necessarily reflect those of the

European CommissionEuropean Commission

Introduction and MotivationIntroduction and Motivation

Global crisis and many policy responses:Global crisis and many policy responses: Central bank’s liquidity provision and Central bank’s liquidity provision and

aggressive lowering of interest rates;aggressive lowering of interest rates; Extension of guarantees on banks’ liabilities.Extension of guarantees on banks’ liabilities. Capital injections and (in some cases) state-Capital injections and (in some cases) state-

controlcontrol Treatment of impaired assets.Treatment of impaired assets. Discretionary fiscal stimulus.Discretionary fiscal stimulus. A review of the regulatory and supervisory A review of the regulatory and supervisory

framework in Europeframework in Europe

In this presentation I concentrate on:In this presentation I concentrate on:

Global crisis and many policy responses:Global crisis and many policy responses: Central bank’s liquidity provision and aggressive lowering of Central bank’s liquidity provision and aggressive lowering of

interest rates;interest rates;

Extension of guarantees on banks’ Extension of guarantees on banks’ liabilities.liabilities.

Capital injections and (in some cases) Capital injections and (in some cases) state-controlstate-control

Treatment of impaired assets.Treatment of impaired assets. Discretionary fiscal stimulus.Discretionary fiscal stimulus.

Regulatory & Supervisory Framework.Regulatory & Supervisory Framework.

OutlineOutline

A/ Common framework for public intervention: linking A/ Common framework for public intervention: linking gains of co-operation to spilloversgains of co-operation to spillovers

B/ Single Market: Functioning of competition and State B/ Single Market: Functioning of competition and State Aid RulesAid Rules Example: Using the banking crisis to illustrate the risk of Example: Using the banking crisis to illustrate the risk of

negative spillovers and the need for co-ordinated action in negative spillovers and the need for co-ordinated action in the the context of the internal marketcontext of the internal market

C/ A new EU framework for crisis prevention and crisis C/ A new EU framework for crisis prevention and crisis managementmanagement

A/ Common framework for public intervention: A/ Common framework for public intervention: linking gains of co-operation to spillovers linking gains of co-operation to spillovers

(Berrigan, Gaspar, Pearson, 2008)(Berrigan, Gaspar, Pearson, 2008)

Coase TheoremCoase Theorem as a benchmark to identify the gains from co- as a benchmark to identify the gains from co-operation: operation:

In an environment with perfect information, well-defined property In an environment with perfect information, well-defined property rights an costly bargaining:rights an costly bargaining:

- Private provision of public goods is not pareto efficient in case of Private provision of public goods is not pareto efficient in case of non-cooperative interactions (Nash).non-cooperative interactions (Nash).

- inefficient as individuals do not take into account the inefficient as individuals do not take into account the externalityexternality to other economic agentsto other economic agents

- Pareto-improved outcomes can be achieved through Pareto-improved outcomes can be achieved through collective collective actionaction (bargaining; co-ordination) (bargaining; co-ordination)

-Let the units of public good that individual i contibutes to the provision Let the units of public good that individual i contibutes to the provision of the public good be denoted by of the public good be denoted by - Individuals have preferences for the public good and one private good- Individuals have preferences for the public good and one private good

2,1, iq i

Relevance of this framework in the EU Relevance of this framework in the EU contextcontext

Across the border Across the border spilloversspillovers as a result of public intervention are as a result of public intervention are much clearer when they materialize in the areas in which the much clearer when they materialize in the areas in which the European Union has core competence, such as aspects related to European Union has core competence, such as aspects related to the working of the internal market, including regulation and the working of the internal market, including regulation and supervision.supervision.

In times of crises In times of crises conditions of the Coase theorem are not metconditions of the Coase theorem are not met (e.g. (e.g. costless bargaining, symmetric information,…) and therefore there costless bargaining, symmetric information,…) and therefore there is increased pressure for decentralised and uncoordinated actions.is increased pressure for decentralised and uncoordinated actions.

Legal framework of the Legal framework of the internal marketinternal market is therefore a very powerful is therefore a very powerful tool: Member States have delegated authority to the European tool: Member States have delegated authority to the European Commission to have legally binding procedures governing the Commission to have legally binding procedures governing the working of the working of the internal marketinternal market..

These These legal and binding procedureslegal and binding procedures have fostered the working of have fostered the working of the internal market to the benefit of market integration, which in turn the internal market to the benefit of market integration, which in turn has forced further political integration. has forced further political integration.

B/ Single Market: Functioning of competition B/ Single Market: Functioning of competition and State Aid Rules – key featuresand State Aid Rules – key features

Internalising negative spilloversInternalising negative spilloversState aids rules are designed to prevent un-coordinated government State aids rules are designed to prevent un-coordinated government

interventions to interfere with the functioning of the Single Market and interventions to interfere with the functioning of the Single Market and also to improve the effectiveness of public intervention.also to improve the effectiveness of public intervention.

Proportionality,non-discriminatory and conditionality of the Proportionality,non-discriminatory and conditionality of the measuresmeasuresThe EU framework guarantees that measures taken by Member States The EU framework guarantees that measures taken by Member States

comply with the key principles in state aid rulescomply with the key principles in state aid rules

Reconciling short term imperatives with longer term Reconciling short term imperatives with longer term considerationsconsiderationsDesign of the intervention of the intervention should Design of the intervention of the intervention should reconcile short reconcile short

term imperativesterm imperatives (safeguarding financial stability, underpinning bank (safeguarding financial stability, underpinning bank lending) lending) with longer term considerationswith longer term considerations (avoiding fragmentation of (avoiding fragmentation of the Single Market, distortion of competition, emergence of a structurally the Single Market, distortion of competition, emergence of a structurally weak banking sector, unsustainable public finances)weak banking sector, unsustainable public finances)

Example: The Banking SectorExample: The Banking Sector

EC provided (ex-ante) EC provided (ex-ante) guidelinesguidelines on the application of State aid on the application of State aid rules to measures taken in relation to financial institutions in the rules to measures taken in relation to financial institutions in the context of the current global crisis. context of the current global crisis.

Guidelines on six classes of Guidelines on six classes of measuresmeasures since the start of the crisis since the start of the crisis (Com 2008/C 270/02):(Com 2008/C 270/02):

Guarantees covering the liabilities of financial institutionsGuarantees covering the liabilities of financial institutions Recapitalisation of financial institutionsRecapitalisation of financial institutions Controlled winding-up of financial institutionsControlled winding-up of financial institutions Provision of other forms of liquidity assistanceProvision of other forms of liquidity assistance Rapid treatment of state investigationsRapid treatment of state investigations Treatment of impaired assetsTreatment of impaired assets

Key features of guidelines common across Key features of guidelines common across measures (background)measures (background)

- Non discriminatory coverageNon discriminatory coverage ( (to avoid undue distortive effects on to avoid undue distortive effects on neighbouring markets and the internal market as a whole)neighbouring markets and the internal market as a whole)

- Minimum private sector contributionMinimum private sector contribution ( (fees charged for the fees charged for the provision of the scheme should come as close as possilbe to that provision of the scheme should come as close as possilbe to that could be considered a market price)could be considered a market price)

- Temporal scopeTemporal scope

- Behavioural commitmentsBehavioural commitments to avoid distortions of competition to avoid distortions of competition (including compulsory restructuring plans(including compulsory restructuring plans))

BackgroundBackground: : Communication (Communication (2008/C 270/02)2008/C 270/02) ::The application of State aid rules to measures taken in The application of State aid rules to measures taken in

relation to financial institutions in the context of the current relation to financial institutions in the context of the current global crisisglobal crisis

Article 87(3)(b) of the Treaty the Commission may allow State aid Article 87(3)(b) of the Treaty the Commission may allow State aid "to remedy a serious disturbance in the economy of a Member "to remedy a serious disturbance in the economy of a Member State". In the present circumstances: legal basis for aid measures State". In the present circumstances: legal basis for aid measures undertaken to address this systemic crisis. undertaken to address this systemic crisis.

general support measures have to be:general support measures have to be:

- - well-targetedwell-targeted in order to be able to achieve effectively the objective in order to be able to achieve effectively the objective of remedying a serious disturbance in the economy,of remedying a serious disturbance in the economy,

- - proportionate to the challenge facedproportionate to the challenge faced, not going beyond what is , not going beyond what is required to attain this effect, andrequired to attain this effect, and

- designed in such a way as to - designed in such a way as to minimize negative spill-overminimize negative spill-over effects effects on competitors, other sectors and other Member States.on competitors, other sectors and other Member States.

Background:Background: Communication (Communication (2008/C 270/02), contd.2008/C 270/02), contd. Guarantees covering the liabilities of financial Guarantees covering the liabilities of financial

institutionsinstitutions eligibility:eligibility: non-discriminatory so as to avoid undue distortive effects on non-discriminatory so as to avoid undue distortive effects on

neighbouring markets and the internal market as a whole neighbouring markets and the internal market as a whole types of liabilities coveredtypes of liabilities covered: mainly depositors’ guarantees to avoid : mainly depositors’ guarantees to avoid

bank runs and contaminationbank runs and contamination Temporal scopeTemporal scope of guarantee scheme of guarantee scheme Aid limited to Aid limited to minimum-private sector contributionminimum-private sector contribution: fees charged for : fees charged for

the provision of the scheme should come as close as possilbe to that the provision of the scheme should come as close as possilbe to that could be considered a market price.could be considered a market price.

Avoidance of distortionsAvoidance of distortions of competition: negative effects on non- of competition: negative effects on non-beneficiary banks must be avoided by:beneficiary banks must be avoided by:- behavioural constraints- behavioural constraints- restrictions on commercial conduct (e.g. advertising using guarantee - restrictions on commercial conduct (e.g. advertising using guarantee status)status)- prohibitions of conduct incompatable with the purpose of the - prohibitions of conduct incompatable with the purpose of the guarantee scheme (e.g. new stock options for management)guarantee scheme (e.g. new stock options for management)

Background:Background: Communication (Communication (2008/C 270/02), contd.2008/C 270/02), contd.Recapitalisation of Financial InstitutionsRecapitalisation of Financial Institutions

Used to support financial institutions that are fundamentally sound Used to support financial institutions that are fundamentally sound but may experience distress because of extreme conditions in but may experience distress because of extreme conditions in financial markets financial markets strengthen capital base to avoid negative strengthen capital base to avoid negative systemic spillovers.systemic spillovers.

considerations in relation to general guarantee schemes apply, considerations in relation to general guarantee schemes apply, mutatis mutandis, also to recapitalisation schemes. mutatis mutandis, also to recapitalisation schemes.

The particular nature of a recapitalisation measure gives rise to the The particular nature of a recapitalisation measure gives rise to the following considerations:following considerations:- objective criteria, to avoid unjustified discriminatory treatment- objective criteria, to avoid unjustified discriminatory treatment- minimal capital injection and must include private participation- minimal capital injection and must include private participation- - Member State concerned should, in principle, receive rights, the Member State concerned should, in principle, receive rights, the value of which corresponds to their contribution to the value of which corresponds to their contribution to the recapitalisation + consider claw back mechanisms or better fortunes recapitalisation + consider claw back mechanisms or better fortunes clausesclauses

Background:Background: Communication (Communication (2008/C 270/02), contd.2008/C 270/02), contd.Controlled winding up of financial institutionsControlled winding up of financial institutions

considerations in relation to general guarantee schemes apply, considerations in relation to general guarantee schemes apply, mutatis mutandismutatis mutandis

Other considerations:Other considerations:- Minimise moral hazard, notably by excluding shareholders and Minimise moral hazard, notably by excluding shareholders and

possibly certain types of creditors from receiving the benefit of any possibly certain types of creditors from receiving the benefit of any aidaid

- Liquidation phase should be limited to the period strictly necessary Liquidation phase should be limited to the period strictly necessary for the orderly winding-up to avoid competitive distortionsfor the orderly winding-up to avoid competitive distortions

- Sales process should be open and non-discriminatorySales process should be open and non-discriminatory- Sale should take place on market termsSale should take place on market terms- Maximise sales price for the assets and liabilities involvedMaximise sales price for the assets and liabilities involved

Background:Background: Communication (Communication (2008/C 270/02), contd.2008/C 270/02), contd.Provision of other forms of liquidity assistanceProvision of other forms of liquidity assistance

Provision of central banks’ funds to finanicial institutions are not Provision of central banks’ funds to finanicial institutions are not considered as aid when:considered as aid when:

- The financial institutions is solvent at the moment of the liquidity The financial institutions is solvent at the moment of the liquidity provisionprovision

- Fully secured by collateralFully secured by collateral- Central bank charges a penal interest rate to the beneficiaryCentral bank charges a penal interest rate to the beneficiary- Measure is taken by the central bank’s own initiativeMeasure is taken by the central bank’s own initiative

Most member states appealed to the revised guidelines on Most member states appealed to the revised guidelines on timely and coordinated state aid in the financial sector since timely and coordinated state aid in the financial sector since

last Septemberlast September

Total number of cases of state aid for the financial sector, by country

AS

BEDK

FI

F

DE

HU IRIT LV NL

PT

SI ESSW

UK

0123456789

10

Total per country

The Irish banking crisis triggered the awareness among the member The Irish banking crisis triggered the awareness among the member states to have a states to have a co-ordinated response across Europeco-ordinated response across Europe, given the , given the potentially large negative spillovers undermining the working of the potentially large negative spillovers undermining the working of the internal marketinternal market

Total number of cases of state aid for the financial sector

02468

10121416

month that the Commission adopted the decision

Economic Rational for Co-ordinated Economic Rational for Co-ordinated Intervention: Intervention: Internalising negative spilloversInternalising negative spillovers

1.1. Guarantees covering the liabilities of financial institutions:Guarantees covering the liabilities of financial institutions:

In volatile markets, need to reassure depositors that they will not In volatile markets, need to reassure depositors that they will not suffer losses and therefore to avoid bank runs.suffer losses and therefore to avoid bank runs.

Potential Potential negative spilloversnegative spillovers::

- Bank run can cause contamination of healthy banks- Bank run can cause contamination of healthy banks

- If decentralised and uncoordinated national measures - If decentralised and uncoordinated national measures are are taken, increased risk of a disturbing impact on deposit taken, increased risk of a disturbing impact on deposit shifting shifting from non- beneficiary banks to beneficiary banks (from non- beneficiary banks to beneficiary banks (e.g. e.g. Irish Irish casecase). ). Deposit shiftingDeposit shifting has the effect of contaminating has the effect of contaminating healthy healthy banks in neigbouring countriesbanks in neigbouring countries

2.2. Recapitalisation of Financial InstitutionsRecapitalisation of Financial Institutions

Financial sound institutions may experience distress because of Financial sound institutions may experience distress because of extreme conditions in financial markets (falling asset prices, extreme conditions in financial markets (falling asset prices, deposit runs, etc.)deposit runs, etc.)

Potential Potential negative spilloversnegative spillovers::

- When the compensation scheme does not reflect - When the compensation scheme does not reflect market market prices, prices, banks in other member countries not benefiting banks in other member countries not benefiting from from the capital injection are put at a disadvantage.the capital injection are put at a disadvantage.

- Irreversible nature of capital injections can trigger in a - Irreversible nature of capital injections can trigger in a later later stage expansion of the beneficiary bank at the expense of stage expansion of the beneficiary bank at the expense of non-non- beneficiary banks in the same or other countriesbeneficiary banks in the same or other countries

3.3. Treatment of impaired assetsTreatment of impaired assets

Reducing uncertainty about exposure of banks to financial losses Reducing uncertainty about exposure of banks to financial losses is key to restoring investor confidence (resolving the information is key to restoring investor confidence (resolving the information problem!)problem!)

Impaired asset relief is required to get credit markets functioning Impaired asset relief is required to get credit markets functioning againagain

Potential Potential negative spillovernegative spillover::

Introducing asset relief measures by a first-mover Member State Introducing asset relief measures by a first-mover Member State results in pressure on other member states to follow suit, risking a results in pressure on other member states to follow suit, risking a subsidy race between Member Statessubsidy race between Member States

C/ Towards a new EU framework for crisis C/ Towards a new EU framework for crisis prevention and crisis managementprevention and crisis management

To have an efficient internal market in financial markets, there is a To have an efficient internal market in financial markets, there is a need for further procedural agreement between the Member Statesneed for further procedural agreement between the Member States

de Larosière group formulates recommendations towards (ide Larosière group formulates recommendations towards (i) a new ) a new regulatory agenda, (ii) stronger coordinated supervision and (iii) regulatory agenda, (ii) stronger coordinated supervision and (iii) effective crisis management procedureseffective crisis management procedures

In particular:In particular: European System of Financial Supervision (ESFS)European System of Financial Supervision (ESFS)

create a network of EU financial supervisors, based on the principle of create a network of EU financial supervisors, based on the principle of partnership, cooperation and strong coordination at the centre partnership, cooperation and strong coordination at the centre

European Systemic Risk Council (ESRC)European Systemic Risk Council (ESRC)decide on macro-prudential policy, provide early risk warnings to EU decide on macro-prudential policy, provide early risk warnings to EU supervisors, compare observations on macro-economic and prudential supervisors, compare observations on macro-economic and prudential developments and give direction on these issues. developments and give direction on these issues.

Important Role for the EU in achieving Important Role for the EU in achieving globalglobal solutions solutions

Solutions at the European level can only have full effect if they are Solutions at the European level can only have full effect if they are part of a global effort to improve stabilitypart of a global effort to improve stability

Benefits of openness, non-protectionism and the internal market Benefits of openness, non-protectionism and the internal market have been clear in the pasthave been clear in the past

Financial system is global, so the EU must work also with third Financial system is global, so the EU must work also with third countries to foster global co-ordination and to obtain the best countries to foster global co-ordination and to obtain the best regulatory framework.regulatory framework.

G20 initiative is essential to enhance regulatory and supervisory G20 initiative is essential to enhance regulatory and supervisory standardsstandards

It is therefore important that the Commission is a permanent It is therefore important that the Commission is a permanent member of the G20 & the Financial Stability Forum to properly member of the G20 & the Financial Stability Forum to properly represent EU interestsrepresent EU interests

Conclusions Conclusions

Coase theoremCoase theorem is a useful framework for analysing public is a useful framework for analysing public interventionintervention

Existing EU State-aid rules & ex-ante guidance of the EC have Existing EU State-aid rules & ex-ante guidance of the EC have played a major role in ensuring a minimum degree of consistency played a major role in ensuring a minimum degree of consistency between the measures taken by Member States and therefore to between the measures taken by Member States and therefore to minimise non-cooperative outcomes. minimise non-cooperative outcomes.

Key characteristic of intervention: Reconciliation of short-term and Key characteristic of intervention: Reconciliation of short-term and longer-term perspectives of public intervention is crucial to reach a longer-term perspectives of public intervention is crucial to reach a sustainable and competitive banking sector and hence financial sustainable and competitive banking sector and hence financial sector basis for the real economy.sector basis for the real economy.

But to prevent and manage future crises, further progress in the But to prevent and manage future crises, further progress in the area of regulation, coordinated supervision and crisis management area of regulation, coordinated supervision and crisis management procedures (as put forward in the procedures (as put forward in the ESRCESRC & the & the ESFSESFS recommendations) is essential, within a global context (G20)recommendations) is essential, within a global context (G20)

THANK YOU FOR YOUR THANK YOU FOR YOUR ATTENTION!ATTENTION!

You can find more details at: You can find more details at:

http://ec.europa.eu/competition/sectors/finhttp://ec.europa.eu/competition/sectors/financial_services/financial_crisis_news_en.ancial_services/financial_crisis_news_en.htmlhtml

EU as a Framework for National EU as a Framework for National GovernmentsGovernments’ Intervention’ Intervention

Vitor GasparVitor Gaspar(with Joep Konings)(with Joep Konings)

Bureau of Economic Policy Advisers, Bureau of Economic Policy Advisers, European CommissionEuropean Commission

Workshop on The Future Face of Europe’s Financial System, Workshop on The Future Face of Europe’s Financial System, Bruegel, 23 – 24 March 2009Bruegel, 23 – 24 March 2009

Documents

The Global Crisis: a European Perspective Vitor Gaspar, Director General of BEPA (Bureau of European Policy Advisers) The views expressed are my own and