3 Issuing costs of state guaranteed bonds - Financial Risk and ...

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1 Introduction 1 Introduction 1.1 Background When wholesale financial markets dried up in autumn 2008 and banks faced severe problems in re-financing their debt, state guarantees were one of the first tools used by Member States to support banks. The motivation of the provision of state guarantees was to help solvent but illiquid banks issue debt securities in the maturity spectrum of 1-5 years after the Lehman Brothers collapse, thereby complementing central bank support that focused on the provision of short-term liquidity. By shifting the risk from the private to the public sector, the provision of state guarantees targeted the reduction of the counterparty risk, which hampered the proper functioning of wholesale financial markets, and the containment of systemic risk. From autumn 2008 onwards, 19 EU Member States offered guarantees on banks' liabilities either through generalised schemes or through ad hoc interventions. The approved amount through generalised schemes totals almost €2,500bn, which represents 20% of GDP. Of this amount, €712bn, i.e. 5.8 % of GDP was actually taken up by banks. In particular, in the first half of 2009, banks made extensive use of the issuance of state-guaranteed bonds. Since then, the number of issuances and the amount issued through state guaranteed bonds has ebbed. The December 2009 European Council concluded that "the phasing-out of support should start with government guarantees." At the beginning of 2010, France, Italy and the United Kingdom discontinued their guarantee schemes and the Netherlands introduced a price increase for its guarantees. However, in light of the fragility of the economic recovery and financial conditions, other Member States prolonged their schemes. Since the state guarantees constitute state aid, which is inconsistent with Internal Market rules except under specific conditions (Article 107 TFEU), the Member States' guarantee schemes as well as ad hoc guarantees to individual banks had to be notified to and approved by the European Commission. In its assessment of Member States guarantee schemes, the Commission considered their potential to distort competition among banks that could use state guarantees and those that could not as well as between Member States with different designs of the guarantee schemes or none at all. In order to minimise distortions to competition, the Commission established criteria of eligibility, remuneration and conditionality that Member States had to observe when they provided state guarantees to banks. Although the Commission was aware that these criteria could reduce but not exclude market distortions arising from the use of state guarantees, the risk was considered as being counterbalanced by the contribution of guarantees to restoring financial stability. In the first months after the Lehman Brothers collapse, observers expressed concerns that the criteria set by the Commission were too tight and discouraged the use of guarantees. As the risks to financial stability receded over time, competition concerns gained in importance. Numerous banks were able to raise capital through the issuance of securities without a guarantee and many of those that continued to rely on the use of state guarantees were under restructuring obligation due to their additional use of other forms of state aid. 10
1.2 Study scope 1 Introduction This study focuses on the EU27 Member States' guarantee schemes and ad hoc guarantees to banks 1 in the period 25 October 2008 2 – 31 December 2010. State guarantees to wholesale deposits and short- and medium-term debt instruments that were not adequately protected by investor arrangements or other means are considered in this study. State guarantees to retail deposits and debt held by retail clients that were also issued in the period are outside of the scope of the study. 1.3 Study objectives The overarching objectives of this study are to: Investigate the effectiveness of state guarantees to the proper functioning of the banking system. In particular, to inform the use and design of state guarantees in the future. Determine how state guarantees affect the functioning of wholesale capital markets. Specifically, to determine whether characteristics of state guarantees used "to remedy a serious disturbance in the economy of a Member State" 3 caused distortions to competition. The specific objectives of this study are to analyse the impact and effectiveness of state guarantees with respect to: Financial stability by analysing supported banks' issuance activity on medium-term debt security markets and the development of capital costs. Distortions to competition between institutions using the schemes and those not using them and across EU Member States. Financial market integration or fragmentation due to the organisation of guarantee schemes along national lines and differences in the design of schemes across EU Member States. 1 Banks are defined in a non-legal sense in this study as financial services firms that were able to avail themselves of a state guarantee. 2 Member States' guarantees to banks had to follow a number of common EU principles when the 'Communication from the Commission: The application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis' (European Commission, 2008) was issued on 25 October 2008. This date therefore serves as a suitable point at which to begin evaluating guarantee schemes' collective impact. 3 See Article 87(3)(b) in European Commission (2004). 11
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5 Key empirical findings and polic
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References Acharya V.V. and Sundara
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Lando, D. (1997). 'Modeling Bonds a
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Annex 1 Eligibility criteria for st
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Annex 2 Comparison of SG and non-SG
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Annex 2 Comparison of SG and non-SG
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Annex 3 Analysis of missing issuing
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Annex 5 -over model Annex 5 Results
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Annex 5 -over model Figure 25: Anal
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Annex 6 Availability of bank data A
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Annex 6 Availability of bank data T
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Annex 7 Linking Bloomberg and Banks
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Annex 8 Investigation of estimation
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