Palgrave Macmillan Studies in Banking and Financial Institutions

Palgrave Macmillan Studies in Banking and Financial Institutions Series Editor : Professor Philip Molyneux The Palgrave Macmillan Studies in Banking and Financial Institutions are international in orientation and include studies of banking within particular countries or regions, and studies of particular themes such as Corporate Banking, Risk Management, Mergers and Acquisition. The books focus is on research and practice, and they include up-todate and innovative studies on contemporary topics in banking that will have global impact and influence. Titles include : Giuseppe Boccuzzi THE EUROPEAN BANKING UNION Supervision and Resolution Vincenzo Formisano NON-KNOWLEDGE RISK AND BANK-COMPANY MANAGEMENT The Role of Intangibles in Rating Models Bernardino Quattrociocchi INTERNAL RATING SYSTEMS AND THE BANK-FIRM RELATIONSHIP Valuing Company Networks Miao Han CENTRAL BANK REGULATION AND THE FINANCIAL CRISIS A Comparative Analysis Pierluigi Ciocca STABILISING CAPITALISM A Greater Role for Central Banks Anabela Sérgio (editor) BANKING IN PORTUGAL Michele Modina CREDIT RATING AND BANK-FIRM RELATIONSHIPS New Models to Better Evaluate SMEs Jes Villa ETHICS IN BANKING The Role of Moral Values and Judgements in Finance Dimitrios D. Thomakos, Platon Monokroussos & Konstantinos I. Nikolopoulos (editors) A FINANCIAL CRISIS MANUAL Reflections and the Road Ahead Elena Beccalli and Federica Poli (editors) BANK RISK, GOVERNANCE AND REGULATION LENDING, INVESTMENTS AND THE FINANCIAL CRISIS Domenico Siclari (editor) ITALIAN BANKING AND FINANCIAL LAW Supervisory Authorities and Supervision

Intermediaries and Markets Crisis Management Procedures, Sanctions, Alternative Dispute Resolution Systems and Tax Rules Fayaz Ahmad Lone ISLAMIC FINANCE Its Objectives and Achievements Valerio Lemma THE SHADOW BANKING SYSTEM Creating Transparency in the Financial Markets Imad A. Moosa GOOD REGULATION, BAD REGULATION Elisa Menicucci FAIR VALUE ACCOUNTING Key Issues arising from the Financial Crisis Anna Omarini RETAIL BANKING Business Transformation and Competitive Strategies for the Future Palgrave Macmillan Studies in Banking and Financial Institutions Series Standing Order ISBN: 978 1 403 94872 4 ( outside North America only ) You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England

European Bank Restructuring During the Global Financial Crisis Małgorzata Iwanicz-Drozdowska Professor, Warsaw School of Economics, Poland Jakub Kerlin Ph.D. Candidate, Warsaw School of Economics, Poland Anna Kozłowska Ph.D. Candidate, Warsaw School of Economics, Poland Elżbieta Malinowska-Misiąg Assistant Professor, Warsaw School of Economics, Poland Agnieszka Nowak Assistant Professor, Warsaw School of Economics, Poland Paweł Smaga Assistant Professor, Warsaw School of Economics, Poland Piotr Wisniewski Assistant Professor, Warsaw School of Economics, Poland Bartosz Witkowski Associate Professor, Warsaw School of Economics, Poland

Warsaw School of Economics 2016 Softcover reprint of the hardcover 1st edition 2016 978-1-137-56023-0 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6 10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2016 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave and Macmillan are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN 978-1-349-56021-9 ISBN 978-1-137-56024-7 (ebook) DOI 10.1057/9781137560247 This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Iwanicz-Drozdowska, Malgorzata (ed.). European bank restructuring during the global financial crises / Malgorzata Iwanicz-Drozdowska [and 7 others]. pages cm. (Palgrave Macmillan studies in banking and financial institutions) Includes bibliographical references. 1. Banks and banking European Union countries. 2. Financial institutions European Union countries. 3. Global Financial Crisis, 2008 2009. 4. Financial crises European Union countries. I. Title. HG2974.I93 2015 332.1094 dc23 2015023899

Contents List of Figures List of Tables Preface About the Authors vii viii ix xii 1 Banking Crises and Restructuring Tools 1 Małgorzata Iwanicz-Drozdowska 1.1 Short history and the scope of the analysis 1 1.2 Causes of banking crises literature review 4 1.3 Types of financial support historical perspective 11 2 Pre-Crisis Landscape 18 Paweł Smaga 2.1 Economic environment 18 2.1.1 Macroeconomic conditions 18 2.1.2 Fiscal policy 21 2.1.3 Monetary policy 22 2.2 Pre-crisis financial standing of the EU banking sector 24 2.3 Pre-crisis legal and institutional arrangements for rescue operations in the EU 26 3 State Aid and Fiscal Costs 31 Małgorzata Iwanicz-Drozdowska, Elżbieta Malinowska-Misiąg and Bartosz Witkowski 3.1 State aid for financial institutions during the crisis 31 3.1.1 General rules for granting state aid 31 3.1.2 Guidelines for granting state aid to financial institutions 32 3.1.3 Guarantees for liabilities of financial institutions 33 3.1.4 Recapitalization of financial institutions 34 3.1.5 Assistance related to impaired assets 36 3.1.6 Assistance for liquidation 36 3.2 European Stability Mechanism and assistance to EU countries 37 3.2.1 European Stability Mechanism 37 3.2.2 Assistance to countries 38 v

vi Contents 3.3 The impact of restructuring costs on public finance 44 3.3.1 Burden on public finance 44 3.3.2 Econometric model 50 4 Restructuring Tools and Their Costs 56 Małgorzata Iwanicz-Drozdowska, Paweł Smaga and Bartosz Witkowski 4.1 General assumptions 56 4.2 Comparative analysis 57 4.3 Econometric model 66 4.4 Cluster analysis 71 5 Landscape after the Lessons of the Crisis 74 Małgorzata Iwanicz-Drozdowska, Jakub Kerlin and Paweł Smaga 5.1 Economic situation and changes in EU banking sector after the outbreak of the crisis 74 5.2 Changes in prudential regulations and the financial safety net 77 5.2.1 Changes in prudential regulations 77 5.2.2 Changes in financial safety net 81 5.3 Banks restructuring and resolution 84 5.3.1 The genesis of the restructuring and resolution regulations 84 5.3.2 Objectives and rules of the resolution process 86 5.3.3 Resolution authorities 89 5.3.4 Sequence of actions 91 5.3.5 Resolution tools 93 5.3.6 Funding the resolution procedure 96 5.3.7 Evaluation of solutions 97 5.4 Banking union 98 5.4.1 Construction of the banking union 98 5.4.2 Evaluation of the banking union 104 Summary 113 Małgorzata Iwanicz-Drozdowska Appendix 115 Bibliography 334 Index 341

List of Figures 1.1 Restructuring tools applied before 2007 vs. tools used during the crisis in 2007 2009 14 2.1 Residential real estate prices in selected EU countries 20 2.2 Banking sector assets to GDP in EU countries before the crisis 24 3.1 Recapitalization by country in 2008 2013 46 3.2 Recapitalization of EU banks in 2008 2013 47 3.3 Recapitalization of EU banks in 2008 2013 49 4.1 Total net aid (in EUR million) and bank s share in banking sector assets 58 4.2 Total financial aid (net) to GDP (2009) vs. average size of rescued banks to GDP (2009) 59 5.1 Financial safety net on country level and cooperation in the EU for countries outside eurozone 84 5.2 Competence scopes in SSM 99 vii

List of Tables 1.1 The list of banking crises in EU countries from 2007 to 2013 3 1.2 Variables for the analysis of the banking crises 7 2.1 GDP annual growth rate in 1999 2008 19 2.2 Public debt to GDP in 1999 2008 22 3.1 Financial support provided to banks in the EU in 2008 2013 45 3.2 Recapitalization of EU banks in 2008 2014 48 3.3 Determinants of scale of financial assistance (net) for banking sector 50 3.4 Descriptive statistics of potential determinants of scale of government support for banking sector 51 3.5 Results of estimation equation of scale of support for banking sector 52 4.1 Total financial assistance (net) vs. financial capacity of deposit guarantee scheme 60 4.2 Restructuring methods and their cost in EU countries 61 4.3 Restructuring methods depending on bank s size 66 4.4 Variables used in the model of financial assistance (net) to deposits ratio 67 4.5 Descriptive statistics of variables used in model of ratio of net financial aid to customer deposits 68 4.6 Results of ordered logit model estimation ASS_D level 69 4.7 Clusters of banks 71 5.1 Implementation of resolution in selected countries and responsible authorities 85 5.2 Stages of new resolution procedures for financial institutions 91 5.3 Resolution procedures in selected countries 95 5.4 Total amount of deposits and target amount of resolution funds in EU countries at 2012 year-end 97 5.5 Results of ECB S comprehensive assessment for restructured banks with capital shortages 102 viii

Preface This book, to the best of our knowledge, is the first extensive work on the restructuring of banks in EU countries during the recent global financial crisis and the consequences of restructuring on both the macro- and micro-economic levels. In studies that we conducted during the period 1999 2002, culminating in two publications in Polish (Iwanicz-Drozdowska, 2000; Iwanicz-Drozdowska ed., 2002), our analysis covered 22 countries, including several that were undergoing political and economic transformations. Readers may consider this book a continuation of that earlier work. However, a prerequisite for this book has been the serious breakdown in financial markets, which, compared to earlier crises, has affected highly developed countries much more than developing countries. Our analysis covers 95 banks from 17 EU member states and, in addition, five institutions created during the crisis to take charge, above all, of managing bad assets. The purpose of our study is to demonstrate the diversity of the restructuring instruments applied in EU countries and to offer a critical, institutionalized analysis of the financial support provided to banks. In particular, our interest has focused on estimating the cost of that support and evaluating its effects. We bring to these considerations an analysis of the pre-crisis situation and of the numerous changes implemented because of the crisis. Our aim is to present the reader with a full context for the recovery actions implemented in the banking sector. The book comprises five chapters and an Appendix. Chapter 1 presents a historical outline, discusses causes of crises and offers an overview of the restructuring instruments and their use for crisis management before 2007. We also sketch the scope of the analysis that we have conducted. The following four chapters focus on the situation in the EU before the crisis outbreak (Chapter 2), the crisis landscape, comprising a comprehensive description of the rescue actions (Chapters 3 and 4) and the landscape after the changes that were the consequences of the crisis events (Chapter 5). We avoid using the term post-crisis landscape because there are insufficient grounds for arguing that the crisis finally has ended. Chapter 2 analyses macroeconomic factors in EU economies before the start of the crisis. It describes major tendencies shaping the environments in which banks were operating, focusing on the condition of the economy and the nature of the economic policies, in particular monetary and budgetary policies. After defining the main tendencies, we evaluate the impact of the above-mentioned factors on the condition of the banking sector in the EU. ix

x Preface Chapter 3 presents actions undertaken during the global financial crisis. We start by characterizing the rules for granting state aid, which the European Commission approved on a large scale, and which were in many cases used to rescue banks undergoing financial difficulties. In addition to examining the forms and scale of the support, we present an analysis of determinants of costs of banks restructuring on the macroeconomic level. Chapter 4 analyses costs of individual forms of restructuring on the microeconomic level. The analyses in Chapters 3 and 4 derive from the rich empirical material we collected during our study. We present these data in detail in the Appendix. Chapter 5 details the most important changes in the financial safety net and regulations, and are presented after an assessment of the situation in the real economy and the EU banking sectors. We pay particular attention to the bank resolution regime and the banking union because of the hopes that these measures evoked. The introduction of systemic regulations, enabling the application of new tools for the liquidation of financial institutions, was an important response to the global financial crisis. The chapter indicates reasons for introducing the resolution regime into the EU financial safety net, discussing its key objectives and tasks. The creation of the banking union has begun relatively quickly, although it is not yet complete. As early as May 2012, the European Commission called for the creation of the banking union. A month later (Van Rompuy, 2012, and subsequent reports) a road map was drawn for strengthening the Economic and Monetary Union through closer integration in the financial sphere, involving, among other actions, integration of banking supervision (Single Supervisory Mechanism, or SSM), creation of a pan-european restructuring and bank resolution regime (Single Resolution Mechanism, or SRM) as well as a single Pan-European deposit guarantee scheme. This integration involves the transfer of competence in the indicated three spheres from the national to pan-european level. The authors have made every effort to collect data and information of the highest quality from a variety of sources, regarding the course of events, the standing of the banks undergoing financial distress and the amounts allocated to the various rescue actions. To the best of our knowledge, this is the first extensive work on the restructuring of banks in EU countries during the recent global financial crisis and its consequences on both the macro and microeconomic levels. It will be important to revisit the standing of the restructured banks in five to ten years, as well as the results of companies managing bad assets and other entities involved in the crisis management. Such a timeframe will allow for evaluation of whether, for example, the restructuring actions have increased moral hazard in the banking sector and whether they have led in a longer perspective to gains or losses for state budgets.

Preface xi A team of researchers and doctoral candidates conducted the research at the College of Management and Finance, Warsaw School of Economics (funding no. KZIF/S/14/14). I would like to thank all the members of the team most warmly for their research and organizational efforts.

About the Authors Małgorzata Iwanicz-Drozdowska is Full Professor of Finance at Warsaw School of Economics, Poland and Head of the Financial System Unit in the Institute of Finance. She is a member of the supervisory boards for Alior Bank, the Insurance Guarantee Fund and the European Medical Fund. She cooperates with the Gdansk Institute for Market Economics and Warsaw Institute of Banking. She was a visiting researcher at New York University, Stern School of Business, and a visiting professor as part of the Erasmus program. She is the author of more than 130 publications on banking and financial services and a participant in numerous research projects. Her specializations include financial stability, management of financial institutions and financial education. Jakub Kerlin is a doctoral candidate at the College of Management and Finance, Warsaw School of Economics, Poland. He holds a Master s in Finance and Accounting from Warsaw School of Economics. He is a Bank Guarantee Fund employee and is training as a legal articled clerk. His research interests include deposit insurance, bank recovery and resolution, financial safety net architecture and financial stability. Anna Kozłowska is a doctoral candidate at the College of Management and Finance, Warsaw School of Economics, Poland. She has held professional positions within the Risk Management Division of ING Bank Śląski since 2010. Her research interests include financial stability, market risk and banking regulations. Elżbieta Malinowska-Misiąg is an assistant professor at the Institute of Finance, Warsaw School of Economics, Poland. Graduating from the Faculty of Economic Sciences, University of Warsaw in 1997, from 1998 to 2012, she worked as a research assistant at the Gdansk Institute for Market Economics. Between November 2006 and June 2007, she was an advisor to the Ministry of Finance on the preparation of new laws on public finance. Her main area of interest is public finance, with particular emphasis on organizational and regulatory issues. She is the author and co-author of some 40 publications, including nearly 20 books. She has also provided reports and consultancy for inter alia, the Polish Parliament, the Ministry of Finance and the Ministry of Regional Development, and she has published articles in newspapers and specialist journals. xii

About the Authors xiii Agnieszka K. Nowak is an assistant professor at the Institute of Finance, Warsaw School of Economics, Poland. An author of publications on bank controlling, banking risk, bank management, and financial education, she also has practical experience in banking, having worked for financial institutions and been employed as a member of the supervisory board of a brokerage firm. Paweł Smaga is an assistant professor at the Institute of Finance, Warsaw School of Economics, Poland. He is a senior economist at the National Bank of Poland, where he analyses financial stability issues, macroprudential supervision and the EU financial system regulations, which also are his research interests. For his Ph.D. thesis in 2014, he received the first Award of the President of the Bank Guarantee Fund and recognition from the Governor of the NBP (National Bank of Poland). Piotr Wiśniewski is an assistant professor at the Institute of Finance, Warsaw School of Economics, Poland. He is also a visiting professor at various universities. He has held managerial positions at Crédit Lyonnais (now Crédit Agricole Group) in London and at Erste Securities, Wood & Company. His areas of interest include corporate finance, global capital markets and success factors of international financial institutions (including the context of intellectual capital). Bartosz Witkowski is an associate professor at the Institute of Econometrics, Warsaw School of Economics, Poland. He graduated from Warsaw School of Economics in 2001. His research specialization includes panel data analysis and its application in economics and finance. He cooperated as lecturer and researcher with the Polish Academy of Science, the National Bank of Poland, the World Bank and the Bank Guarantee Fund. He is a participant in numerous research projects financed by the National Science Center and the National Bank of Poland, and is author and co-author of various research papers.