April 24 2009
The level of systemic risk to the banking system and the economy brought about by the international financial crisis cannot be properly mitigated through existing prudential responsibility and guarantee mechanisms. This crisis has been the stimulus for a series of exceptional recovery measures.
As soon as the Banking Commission notices adverse changes in the condition of a bank (ie, realized net liabilities or cash shortages), it intervenes quickly to implement a recovery plan before the situation becomes irremediably jeopardized.
There is a legal framework for the specific responsibility of banks' shareholders. It requires that the governor of the Banque de France invite significant shareholders (holding at least 10% of voting rights) or partners of the bank to provide the support that it needs. In so doing, the governor must seek the recommendation of the commission, except in urgent cases. Nevertheless, majority shareholders or those exercising real power are obliged to provide most or all of the financial support.
However, in 1994 the Paris Court of Appeal decided that this legal provision imposes no legally binding obligation on the shareholders concerned.
As a result, the Banque de France usually requires the capital provider to send a letter to its governor, acknowledging the legal provisions above.
Furthermore, the Comité des Etablissements de crédit et des Entreprises d'Investissement consistently grants approval or authorization upon submission of a letter of intent, in which the majority shareholder commits itself to:
If a crisis arises, the commission may either nominate an administrator (receiver) at the request of the directors or appoint a liquidator - in particular, when the institution is subject to a withdrawal of its banking authorization.
In either situation, having obtained the Deposit Insurance Fund's recommendation, the commission is entitled to bring the case before the Tribunal de Grande Instance where it considers that the depositors' interest requires this, so that the transfer of shares held by the directors can be ordered.
Fixed at up to €70,000 for cash and €70,000 for securities, deposit insurance is provided through an insurance fund designed to compensate depositors which, because of the financial institution's bankruptcy, are unable to have their assets (cash or securities) returned.
The securities deposit insurance covers all financial instruments (shares, debt instruments, shares or units of collective investment undertakings and derivatives), as well as cash deposits with a non-credit institution member, related to a custodial investment service or the netting of financial instruments, including those carried out as security for or coverage of positions taken on a market for financial instruments.
The cash deposit insurance covers any positive balance as a result of either funds kept in account or transitional situations stemming from regular banking operations, which must be repaid pursuant to legal and contractual conditions, in particular in terms of netting.
The commission may call upon the fund to intervene in a preventive manner if a situation is likely to result in the unavailability of deposits or other repayable funds. The fund intervenes in a remedial capacity as soon as it notices that an institution under its jurisdiction is no longer in a position to repay funds received from the public, either immediately or in the short term. The commission may call on the fund to request the implementation of the insurance mechanism. The fund's intervention to compensate clients leads to the withdrawal of the institution's banking licence. The commission takes such decisions when it judges that the shareholders cannot or will not take the necessary measures for recovery.
The national plan adopted by the government on October 13 2008 has two main parts: refinancing and recapitalization of banks by the State.
Refinancing banks within a €320 billion limit
In order to allow banks in France to lend again to companies and individuals, the Société de Financement de l'Economie Française (SFEF) has been charged with the refinancing of banks and shall lend institutions cash up to a limit of €320 billion.
The loans granted to banks have terms of up to five years. The interest rate charged includes a rate corresponding to the refunding rate of the SFEF and an additional margin to compensate the state guarantee of the refunding of the SFEF. The security is priced so that the refunding cost of each institution amounts to what it would cost to refund on the market under arm's-length conditions.
In exchange for these loans, the SFEF receives debt instruments of good quality issued by borrowers, in particular real estate loans secured with a first-ranking mortgage or another security of the same kind and loans to companies with a good rating.
Securities issued by deposit-taking institutions in the form of shares, debt or securities are covered by the state guarantee, provided that they are issued before December 31 2009 for a maximum of five years.
The state is authorized to provide its guarantee of the issues carried out by the SFEF, up to a limit of €360 billion.
Recapitalization of banks within a €40 billion limit
With the aim of increasing the capital base of banks so that they fully support credit development while maintaining a high level of credit standing, the first tranche of the recapitalization plan occurred on December 11 2008 with the issue of hybrid securities, and more specifically of super-subordinated debt, subscribed by the Société de Prise de Participations de l'Etat to an amount of €10.5 billion, by the following:
The second tranche of the plan was approved by the European Commission on January 28 2009. It can be subscribed until August 31 3009 up to an amount of €11 billion. Banks can issue super-subordinated debt, having the same characteristics as that issued in December 2008 or preferred shares without voting rights.
Banks' duties as beneficiaries
In return for the implementation of these mechanisms, the finance minister asked the banks to commit to increasing the outstanding credit available for financing adapted to the needs of individuals, professionals, companies and local bodies. The minister also reminded the banks of the need to adopt ethical rules and comply with EU interests (eg, directors' remuneration and the end of speculative business located in tax havens).
This article is an exerpt from Crisis Paper 2, published by JeantetAssociés in Autumn 2008.
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