State Aids to the Banking Sector: Rescuing Some Harms Others'
Documentos de Economía "la Caixa", No. 13, April 2009
27 Pages Posted: 11 Jun 2009
Date Written: April 1, 2009
Abstract
Given the extreme uncertainty surrounding financial markets, there are strong efficiency reasons to justify the use public funds for guarantee schemes and precautionary recapitalisations of fundamentally sound financial institutions. The former tackle the severe asymmetric information problems between financial institutions and their creditors. The latter allow these institutions to restore their desired level of buffer capital without neither constraining their lending capacity, which could prevent the execution of profitable projects, nor triggering a fire-sale of assets that could have systemic consequences. However, these precautionary recapitalisations pose serious competition problems that the European Commission has not been able to address. On the one hand, this kind of state aid distorts the relative risk between recipient and non-recipient institutions, raising the costs of long-term funding for the latter. On the other hand, it better equips the recipient institutions with funds to implement aggressive strategies that are profitable only in the long run and thus, it distorts competition in the retail and corporate banking markets.
Keywords: state aids, banking competition, financial crisis
JEL Classification: H20, L50, G21, G28
Suggested Citation: Suggested Citation