Bailing Out the Banks: Reconciling Stability and Competition

Abstract

The financial crisis of 2008 has seen the fall of several of the mighty US investment banks, the collapse of renowned commercial banks on both sides of the Atlantic and the exhaustion of banks' capital all over the world. With it, standard views of banks, financial markets, their risks and their regulation had to be suspended, at a time when bank bailouts became unavoidable. This raises key policy questions on the way taxpayers' resources should be used: What type of capital should governments inject? How should banks' shareholders and creditors be treated? Does capital injection distort competition? Should the standard rules preventing anti-competitive behaviour be applied? How to contain future risk-taking by banks? This report assesses two related aspects of the policy response to the unprecedented financial crisis: competition policy and financial regulation. It addresses both the effectiveness of the response to the current crisis, and the lessons that can be drawn in order to reduce the likelihood of future crises. The links between competition policy and banking stability are central to assessing the crisis policy response, and in particular the effectiveness of state aid control. There have been two contrasting views of the relationship between competition and stability - one is that stability is such an urgent issue in the crisis context that it overrides competition concerns, while the alternative view is that intervention to restore financial stability will lead to massive distortions of competition in the banking sector, and so competition rules should be applied even more vigorously than usual. In contrast to these two views, this report concludes that competition policy is indeed more important than ever in times of crisis, but that the competition rules appropriate to the banking sector are different from those that apply in other sectors. This is because bailing out one bank in an episode of crisis helps its competitors, and state aid rules should reflect this characteristic. Additionally, while European competition authorities have tried, since the autumn of 2008, to strike the appropriate balance between the insistence on competition concerns and the need for urgent action to respond to the financial crisis, the time has now come for a thorough competitive assessment of the banking sector following the recent bailouts. The fact that aid to individual banks has sector-wide competition implications means that a competition assessment conducted on a case-by-case basis is not sufficient. The report also makes a series of recommendations about regulatory reform, with regard to both financial stability and competition implications. Critically, the report calls for a strengthening of competences at the European level, beyond coordination mechanisms.

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