Top

Published in:

2016 | OriginalPaper | Chapter

14. State Aid and Guarantees in Europe

Authors : Reint Gropp, Lena Tonzer

Published in: The Palgrave Handbook of European Banking

Publisher: Palgrave Macmillan UK

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

During the recent financial crisis, governments massively intervened in the banking sector by providing liquidity assistance and capital support to banks in distress. This helped stabilize the financial system in the short run. However, public bailouts also bear the risk of longer-term distortions, for example, by affecting bailout expectations of banks. In this chapter, the authors first provide an overview of state aid interventions during the recent crisis episode. The third section then analyzes the effects of state aid on financial stability from a theoretical view. This is followed by the description of results obtained from empirical studies. The link between the provision of state aid and politics is discussed in the section “Institutional Design and Policy Implications”. Finally, in the section “The European Banking Union” the authors describe the elements of the European Banking Union meant to resolve and restructure banks in distress and to lower the need for public intervention. Based on the preceding analysis, conclusions are drawn regarding the new design.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

previous chapter Complexity in Regulation

next chapter The Bank Lending Channel of Monetary Policy: A Review of the Literature and an Agenda for Future Research

In 1984, the term “too-big-to-fail” (although already existing) gained prominence in the context of the rescue of Continental Illinois Bank due to the congressman Stewart B. McKinney who said: “We have a new kind of bank. It is called too big to fail. TBTF, and it is a wonderful bank” (Farber 2012). The term “too-interconnected-to-fail”, in contrast, became prominent during the recent crisis following the failure of Lehman Brothers or the collapse of Bear Stearns and the resulting spillovers (Taylor 2014).

Data come from the State Aid Scoreboard of the European Commission: http://ec.europa.eu/competition/state_aid/scoreboard/financial_economic_crisis_aid:en.html.

We define the country groups as follows: GIIPS comprises Greece, Ireland, Italy, Portugal and Spain; Eastern Euro comprises Latvia, Lithuania, Estonia, Slovakia and Slovenia; Remaining Euro comprises Belgium, Germany, France, Cyprus, Luxembourg, Malta, the Netherlands, Austria and Finland; Non-Euro comprises Bulgaria, Czech Republic, Denmark, Croatia, Hungary, Poland, Romania, Sweden and the UK. To calculate the total amount used, we take the sum of (1) recapitalization measures and asset relief measures over the period 2008–13, and (2) outstanding guarantees and other liquidity support measures in the EU-28 peak year 2009.

Looking at either asset relief measures or recapitalization measures separately reveals that the share of asset relief (recapitalization) measures of GIIPS countries amounted to 21% (40%) compared to 58% (34%) for the remaining Eurozone countries.

Detailed information on TARP can be found at: http://www.treasury.gov/initiatives/financial-stability/about-tarp/Pages/default.aspx, with the distribution of the granted money across the five programmes described here: http://www.treasury.gov/initiatives/financial-stability/about-tarp/Pages/where-did-the-money-go.aspx

See, for example, http://www.theguardian.com/business/blog/2008/oct/15/banking.

The Bank Investment Programs are explained at: http://www.treasury.gov/initiatives/financial-stability/TARP-Programs/bank-investment-programs/Pages/default.aspx

See http://ec.europa.eu/competition/state_aid/scoreboard/financial_economic_crisis_aid:en.html.

See also the section “Vulnerability to Runs” in Chap. 12.

Allen et al. (2015a) provide an excellent discussion of these assumptions and resulting limitations.

For example, there are papers which study panic- and fundamentals-based runs (see, for example, Gorton 1988; Jacklin and Bhattacharya 1988; Allen et al. 2015b; see also Chap. 12 of this book). The effect of limited commitment is studied in Cooper and Kempf (2016). Competition for deposits under deposit insurance or the pricing of deposit insurance is analysed by Matutes and Vives (1996) and Freixas and Rochet (1998). A more detailed overview of the literature is provided by Allen et al. (2011).

Further factors behind moral hazard and bank risk-taking are discussed in the section “Moral Hazard and Excessive Risk-Taking” in Chap. 12.

Agency problems due to ownership status and effects on profitability, risk and lending are presented in more detail in Chap. 3.

Freixas et al. (2000) provide a model in which banks with a key position in interbank markets are subject to a “too-big-to-fail” policy and rescued by the central bank to ensure the functioning of payment flows.

Acharya and Yorulmazer (2008) propose that instead of directly bailing out banks, the government should grant liquidity to surviving banks such that they acquire failed banks. This lowers banks’ incentives to herd and the probability of banking crises. However, this support should be conditional on surviving banks’ liquidity holdings, otherwise they might have incentives to hold less liquid resources (Acharya et al. 2011).

For a general discussion on the relation between competition and banking stability see Chap. 7.

For example, Keeley (1990) shows for US banks that if competition increases, risk-taking increases under a deposit insurance scheme due to reduced interest margins. Wheelock (1992) or Wheelock and Wilson (1995) find a higher probability of failure for US banks in the 1920s and 1930s due to membership in the deposit insurance system. Ioannidou and Penas (2010) show that after the introduction of deposit insurance in Bolivia in 2001, banks grant riskier loans without asking for higher collateral.

In a related study, Koerner and Schnabel (2013) also document an increase in funding costs for German savings banks. They assign this to spillovers from German Landesbanken, which have also been affected by the removal of guarantees and transmitted increased costs within the network of interrelated savings banks.

Also, Sironi (2003) shows that subordinated debt holders price risk appropriately except for public banks suggesting that they benefit from public guarantees. However, De Nicoló and Loukoianova (2007) do not find that public banks behave in a more risky manner than private banks.

The funding cost advantage for “too-big-to-fail” banks has also been shown by Ueda and Weder di Mauro (2013). Boyd and Gertler (1994) find higher risk-taking among the largest banks in the USA.

For a sample of Italian banks, Sapienza (2004) shows that government-owned banks grant cheaper loans to larger firms, providing evidence for a misallocation of financial resources.

A more detailed discussion on resolution schemes can be found in Chap. 12.

Summary information on the structure of the Banking Union can be found at: http://bankinglibrary.com/e/fdz/IntBankLib/regulation/monitoring.asp; http://ec.europa.eu/finance/general-policy/banking-union/index_en.htm.

See http://www.consilium.europa.eu/en/policies/banking-union/single-resolution-mechanism/

See for example: http://www.federalreserve.gov/bankinforeg/resolution-plans.htm.

Acharya, V. V., and Yorulmazer, T. (2007). Too many to fail—An analysis of time-inconsistency in bank closure policies. Journal of Financial Intermediation, 16, 1–31.

Acharya, V. V., and Yorulmazer, T. (2008). Cash-in-the-market pricing and optimal resolution of bank failures. The Review of Financial Studies, 21(6), 2705–2742.

Acharya, V. V., Shin, H. S., and Yorulmazer, T. (2011). Crisis resolution and bank liquidity. The Review of Financial Studies, 24(6), 2166–2205.

Acharya, V. V., Drechsler, I., & Schnabl, P. (2014). A pyrrhic victory? Bank bailouts and sovereign credit risk. The Journal of Finance, 69(6), 2689–2739.CrossRef

Acharya, V.V., Anginer, D., and Warburton, A.J. (2015) The end of market discipline? Investor expectations of implicit government guarantees. Available at https://ssrn.com/abstract=1961656

Allen, F., Carletti, E., & Leonello, A. (2011). Deposit insurance and risk taking. Oxford Review of Economic Policy, 27(3), 464–478.CrossRef

Allen, F., Carletti, E., Goldstein, I., & Leonello, A. (2015a). Moral hazard and government guarantees in the banking industry. Journal of Financial Regulation, 1, 30–50.CrossRef

Allen, F., Carletti, E., Goldstein, I., and Leonello, A. (2015b). Government guarantees and financial stability (CEPR discussion papers No. 10560). London: Centre for Economic Policy Research.

Alter, A., & Schüler, Y. S. (2012). Credit spread interdependencies of European states and banks during the financial crisis. Journal of Banking & Finance, 36(12), 3444–3468.CrossRef

Anginer, D., Demirgüç-Kunt, A., & Zhu, M. (2014). How does deposit insurance affect bank risk? Evidence from the recent crisis. Journal of Banking & Finance, 48, 312–321.CrossRef

Behn, M., Haselmann, R., Kick, T., and Vig, V. (2015). The political economy of bank bailouts (Institute for Monetary and Financial Stability working paper No. 86). Frankfurt am Main: Goethe University.

Berger, A., & Roman, R. (2015). Did TARP banks get competitive advantages? Journal of Financial and Quantitative Analysis, 50(06), 1199–1236.CrossRef

Berger, A., and Roman, R. (2016). Did saving wall street really save main street? The real effects of TARP on local economic conditions. Journal of Financial and Quantitative Analysis, forthcoming. Available at SSRN: https://ssrn.com/abstract=2442070

Berger, A., Bouwman, C. H. S., Kick, T., & Schaeck, K. (2016). Bank liquidity creation following regulatory interventions and capital support. Journal of Financial Intermediation, 26, 115–141.CrossRef

Boyd, J. H., & Gertler, M. (1994). The role of large banks in the recent U.S. banking crisis. Federal Reserve Bank of Minneapolis, Quarterly Review, 18, 2–21.

Brown, C. O., & Dinç, I. S. (2005). The politics of bank failures: Evidence from emerging markets. The Quarterly Journal of Economics, 120, 1413–1444.CrossRef

Brown, C. O., & Dinç, I. S. (2009). Too many to fail? Evidence of rgulatory forbearance when the banking sector is weak. Review of Financial Studies, 24(4), 1378–1405.CrossRef

Brownlees, C., & Engle, R. (2016). SRISK: A conditional capital shortfall index for systemic risk measurement. Review of Financial Studies, doi:10.1093/rfs/hhw060

Buch, C. M., Koch, C. T., & Koetter, M. (2011). Crises, rescues, and policy transmission through international banks (Discussion paper series 1: Economic studies 2011, 15). Frankfurt am Main: Deutsche Bundesbank, Research Centre.

Buch, C. M., Hilberg, B., and Tonzer, L. (2016) Taxing banks: An evaluation of the German bank levy. Journal of Banking and Finance, 72, 52–66.

Buch, C. M., Krause, T., & Tonzer, L. (2015). Drivers of systemic risk: Do national and European perspectives differ? Halle (Saale): Mimeo.

Calderon, C., and Schaeck, K. (2016). The effects of government interventions in the financial sector on banking competition and the evolution of zombie banks, Journal of Financial and Quantitative Analysis, 51(4), 1391–1436.

Calomiris, C., & Khan, U. (2015). An assessment of TARP assistance to financial institutions. Journal of Economic Perspectives, 29, 53–80.CrossRef

Cooper, R., & Kempf, T. W. (2016). Deposit insurance and banks liquidation without commitment. Can we sleep well? Economic Theory, 61(2), 365–392.

Cooper, R., & Ross, T. W. (2002). Bank runs: Deposit insurance and capital requirements. International Economic Review, 43(1), 55–72.CrossRef

Cordella, T., & Yeyati, E. L. (2003). Bank bailouts: Moral hazard vs. value effect. Journal of Financial Intermediation, 12, 300–330.CrossRef

Dam, L., & Koetter, M. (2012). Bank bailouts and moral hazard: Empirical evidence from Germany. Review of Financial Studies, 25(8), 2343–2380.CrossRef

Damar, E., Gropp, R., & Mordel, A. (2014). The ex-ante versus ex-post effect of public guarantees. In D. Evanoff, C. Holthausen, G. Kaufman, & M. Kremer (Eds.), The role of central banks in financial stability: How has it changed? World Scientific studies in international economics (Vol. 30). Hackensack: World Scientific.

De Nicoló, G., & Loukoianova, E. (2007). Bank ownership, market structure and risk (International Monetary Fund working paper no. 07/215). Washington, DC: IMF.

Dell’Ariccia, G., & Marquez, R. (2006). Competition among regulators and credit market integration. Journal of Financial Economics, 79(2), 401–430.CrossRef

Demirgüç-Kunt, A., & Detragiache, E. (2002). Does deposit insurance increase banking system stability? An empirical investigation. Journal of Monetary Economics, 49, 1373–1406.CrossRef

Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance and liquidity. Journal of Political Economy, 91(3), 401–419.CrossRef

Duchin, R., & Sosyura, D. (2014). Safer ratios, riskier portfolios: Banks’ response to government aid. Journal of Financial Economics, 113, 1–28.CrossRef

European Commission. (2014). Banking Union: Restoring financial stability in the Eurozone, MEMO/14/294.

Farber, A. (2012). Historical echoes: “Too big to fail” is one big phrase. Liberty Street Economics. http://libertystreeteconomics.newyorkfed.org/2012/10/historical-echoes-too-big-to-fail-is-one-big-phrase.html#.VfGDhpfbzsY

Farhi, E., & Tirole, J. (2012). Collective moral hazard, maturity mismatch, and systemic bailouts. American Economic Review, 102(1), 60–93.CrossRef

Fischer, M., Hainz, C., Rocholl, J., & Steffen, S. (2014). Government guarantees and bank risk taking incentives (CESifo working paper series 4706). Munich: CESifo Group.

Flannery, M. J., & Sorescu, S. M. (1996). Evidence of bank market discipline in subordinated debenture yields: 1983–1991. Journal of Finance, 51(4), 1347–1377.

Freixas, X., & Rochet, J. C. (1998). Fair pricing of deposit insurance. Is it possible? Yes. Is it desirable? No. Research in Economics, 52, 217–232.CrossRef

Freixas, X., Parigi, B. M., & Rochet, J.-C. (2000). Systemic risk, interbank relations, and liquidity provision by the Central Bank. Journal of Money, Credit and Banking, 32(3), 611–638.CrossRef

Gennaioli, N., Martin, A., & Rossi, S. (2014). Sovereign default, domestic banks, and financial institutions. Journal of Finance, 69(2), 819–866.CrossRef

Gimber, A. (2015). Bank resolution, bailouts and the time inconsistency problem. Available at http://apps.eui.eu/Personal/Researchers/Gimber

Gorton, G. (1988). Banking panics and business cycles. Oxford Economic Papers, 40(4), 751–781.

Gropp, R., & Vesala, J. (2004). Deposit insurance, moral hazard and market monitoring. Review of Finance, 8, 571–602.CrossRef

Gropp, R., Hakenes, H., & Schnabel, I. (2011). Competition, risk-shifting, and public bailout policies. Review of Financial Studies, 24, 2084–2120.CrossRef

Gropp, R., Gruendl, C., & Guettler, A. (2014). The impact of public guarantees on bank risk-taking: Evidence from a natural experiment. Review of Finance, 18(2), 457–488.

Gropp, R., Gruendl, C., and Saadi, V. (2015). Public bank guarantees and allocative efficiency (IWH discussion paper No. 7–15). Available at: https://ideas.repec.org/p/iwh/dispap/7-15.html

Gropp, R., Vesala, J., & Vulpes, G. (2006). Equity and bond market signals as leading indicators of bank fragility. Journal of Money, Credit and Banking, 38, 399–428.CrossRef

Hakenes, H., & Schnabel, I. (2010). Banks without parachutes: Competitive effects of government bail-out policies. Journal of Financial Stability, 6, 156–168.CrossRef

Houston, J. F., Lin, C., & Ma, Y. (2012). Regulatory arbitrage and international bank flows. Journal of Finance, 67(5), 1845–1895.CrossRef

Hovakimian, A., Kane, E. J., & Laeven, L. (2003). How country and safety-net characteristics affect bank risk-shifting. Journal of Financial Services, 23(3), 177–204.CrossRef

Hryckiewicz, A. (2014). What do we know about the impact of government interventions in the banking sector? An assessment of various bailout programs on bank behavior. Journal of Banking & Finance, 46, 246–265.CrossRef

Ioannidou, V. P., & Penas, M. F. (2010). Deposit insurance and bank risk-taking: Evidence from internal loan ratings. Journal of Financial Intermediation, 19, 95–115.CrossRef

Jacklin, C., & Bhattacharya, S. (1988). Distinguishing panics and information-based bank runs: Welfare and policy implications. Journal of Political Economy, 96(3), 568–592.CrossRef

Keeley, M. C. (1990). Deposit insurance, risk, and market power in banking. American Economic Review, 80, 1183–1200.

King, R. G., & Levine, R. (1993). Finance and growth: Schumpeter might be right. The Quarterly Journal of Economics, 108(3), 717–737.CrossRef

Koerner, T., and Schnabel, I. (2013), Abolishing public guarantees in the absence of market discipline (Ruhr economic papers 437). Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Essen.

Koetter, M., and Noth, F. (2016). Did TARP distort competition among sound unsupported banks? Economic Inquiry, 54(2), 994–1020.

Laeven, L., & Valencia, F. (2013). Systemic banking crises database. IMF Economic Review, 61, 225–270.CrossRef

Leonello, A. (2014). Government guarantees and the two-way feedback between banking and Sovereign debt crises. Philadelphia: Mimeo.

Liu, W.-H., & Ngo, P. T. H. (2014). Elections, political competition and bank failure. Journal of Financial Economics, 112, 251–268.CrossRef

Marques, L.B., Correa, R., and Sapriza, H. (2013). International evidence on government support and risk taking in the banking sector (IMF working paper 13/94). Washington, DC: IMF.

Matutes, C., & Vives, X. (1996). Competition for deposits, fragility and insurance. Journal of Financial Intermediation, 5, 184–216.CrossRef

Merton, R. C. (1977). An analytic derivation of the cost of deposit insurance and loan guarantees: An application of modern option pricing theory. Journal of Banking and Finance, 1, 3–11.CrossRef

Mitchell, J. (2001). Too many to fail and regulatory response to banking crises, Working paper. Brussels: Facultes Universitaires Saint-Louis.

Niepmann, F., & Schmidt-Eisenlohr, T. (2013). Bank bailouts, international linkages, and cooperation. American Economic Journal: Economic Policy, 5(4), 270–305.

Nier, E., & Baumann, U. (2006). Market discipline, disclosure and moral hazard in banking. Journal of Financial Intermediation, 15, 332–361.CrossRef

Perotti, C. E., & Suarez, J. (2002). Last bank standing: What do I gain if you fail? European Economic Review, 46, 1599–1622.CrossRef

Reinhart, C. M., & Rogoff, K. S. (2009). The aftermath of financial crises. American Economic Review, 99(2), 466–472.CrossRef

Sapienza, P. (2004). The effects of government ownership on bank lending. Journal of Financial Economics, 72, 357–384.CrossRef

Sironi, A. (2003). Testing for market discipline in the European banking industry: Evidence from subordinated debt issues. Journal of Money, Credit and Banking, 35, 443–472.CrossRef

Taylor, M. W. (2014). Regulatory reform after the financial crisis: Twin Peaks revisited. In R. Huang & D. Schoenmaker (Eds.), Institutional structure of financial regulation: Theories and international experiences, Routledge research in finance and banking law. London: Routledge.

Ueda, K., & Werder di Mauro, B. (2013). Quantifying structural subsidy values for systematically important financial institutions. Journal of Banking & Finance, 37, 3830–3842.CrossRef

Wheelock, D. C. (1992). Deposit insurance and bank failures: New evidence from the 1920s. Economic Inquiry, 30(3), 530–543.CrossRef

Wheelock, D. C., & Wilson, P. W. (1995). Explaining bank failures: Deposit insurance, regulation, and efficiency. The Review of Economics and Statistics, 77(4), 689–700.CrossRef

Title: State Aid and Guarantees in Europe
Authors: Reint Gropp
Lena Tonzer
Publisher: Palgrave Macmillan UK
Book: The Palgrave Handbook of European Banking
Print ISBN: 978-1-137-52143-9

Electronic ISBN: 978-1-137-52144-6

Copyright Year: 2016
DOI: https://doi.org/10.1057/978-1-137-52144-6_14