The Compatibility of Bank Bailouts with EU Competition Law (No 1)

The Commission came under enormous pressure to approve structural aid more speedily, in some cases within 24 hours of notification, and to widen the scope of permissible State aid. In response, the Commission formed new guidance on recapitalisation, credit guarantee and toxic asset schemes to rescue the European banking sector.[vi] On 13 October 2008 the Commission responded to these developments with its Communication, the application of State aid rules to measures taken in relation to financial institutions in the context of the current global financial crisis (the 'Banking Communication'), which provides a framework for Commission approvals of State aid schemes and ad hoc rescue measures for banks.[vii] The unprecedented basis for approvals under the Banking Communication are Articles 107, 108 and 109 since December 2009 under the Treaty on the Functioning of the European Union (TFEU). This new and approved treaty can be compared with  Article 87 of the EC treaty with regards to State aid; 'to remedy a serious disturbance in the economy of a Member State'.[viii] This wording is construed narrowly to include only serious and systemic economic difficulties such as those experienced at present in the world economy. This Communication widens the scope of permissible State aid for banks by recognising the need for emergency structural interventions and rescue measures potentially lasting longer than six months.

Until relatively recently, state aid law was a field notable for its obscurity. Both the definition of a state aid, and the principles upon, which state aid could be approved were set out primarily in the  Commission's decisional practice under Articles 107, 108 and 109 of the TFEU[ix]. In addition, a number of horizontal and sector-specific rules were initiated in miscellany of guidelines, frameworks, communications and notices, without any consistency of approach across the different areas to which the State aid rules might be applied.[x] However, this picture dramatically changed within the last ten years. That period has seen a huge increase in the State aid cases which have been brought before the European Court, particularly in the Court of First Instance (CFI)[xi], with a peak of 227 State aid cases out of 872 pending cases at the end of 2002.[xii] That activity has been matched by legislative and policy initiatives, with a major overhaul of the Commission's practice and procedure.

The European Union has applied strict policies to ensure that the benefits of competition are not lost as a result of protectionism, “beggar thy neighbour” policies, or the creation of national champions.[xiii]

There are nevertheless restrictions on its scope. In view of the exceptional circumstances, there have been calls in recent months for the Commission to considerably 'relax' or even 'suspend' EU disciplines in the area of State aid or merger control, at least as long as the financial crisis lasts.[xiv] On the contrary, EU competition policy is not part of the problem but part of the solution,[xv] something which this paper aims to explore in depth. Abandoning EU competition discipline at this time of crisis would haver risked disintegration of the European single market for banking and financial services. Restrictions can only be invoked so long as the crisis lasts and member states must review and report to the Commission on any approved schemes.

Aid is reserved for 'illiquid but fundamentally sound' banks;[xvi] aid for those with inefficient and risky strategies are assessed under the usual Guidelines, which must also conform to the usual State aid principles of being well-targeted, proportionate and designed to minimise distortions of competition.

As the issue is current and on-going, this will help to improve commercial awareness and the future prospects of a hopefully positive outcome to the exit of a recession. The objective of my research is to understand and explore the depth of the bank bailouts and how they have been regulated with European Union Competition Law Rules. Primarily, I will be looking at the general principles and framework of the State Aids legislation and how it applies in the context of the financial crisis recognising the need for government intervention. I will explore the role of competition policy in the financial sector with regards to rescuing and restructuring, which will include, applying the legislation in the crisis. Continuing from this, I will be explaining the adaptation of competition law rules, processes and institutions to current issues. This begs the question as to whether the Commission's reaction to State Aid was adequate and what can be changed in limiting the application of competition rules if need be. Challenges will also be questioned as well as discussing in which circumstances can State Aid be given. Finally, my last theme will critically examine whether the provisions undertaken by the Commission were relevant in relation to Competition Law Rules and the exit strategies to address distortions to Competition. This will include, reference to experiences from previous crises. Should there be a need for State Aid Legislation? And what, if any, are the exit strategies to address distortions to competition instituted by crises responses?  Where assistance is granted to an undertaking from a financial or other institution over which the State has a certain degree of influence, it is necessary to determine whether the extent of the State's influence is sufficient to characterise the benefit as an aid granted by the Member State, through its resources and if it produces direct effects.[xvii] State Aid decisions have  had to prioritise saving financial institutions over distortions to competition. From an economic perspective, state support should be withdrawn gradually with a degree of international coordination, and, as market conditions improve, the value of a state protection ought to fall such that even if disengagement is partly asymmetric then the distortion to competition would remain limited. This disengagement process should naturally recognise that post-crisis saving banks is not the same as saving the financial system.

2. The role of competition policy in financial sector rescue and restructuring

The global financial crisis has impacted heavily on the banking system in many EU countries. Recent months have shown a general erosion of confidence within the banking system. The pervasive uncertainty about the credit risk of individual financial institutions has dried up interbank lending and has consequently made access to liquidity progressively more difficult for financial institutions across the board.

2:1       State Aid Legislation s107-109 TFEU Treaty

The Lisbon Treaty, an international agreement which sees significant re-working of the mechanisms of the EU makes the changes necessary of 27 member states to work more effectively on competition law.[xviii] According to Article 3(1)(b) of the Treaty on the Functioning of the European Union (TFEU), the EU has exclusive competence in the establishing of the competition rules necessary for the functioning of the internal market.[xix] The rules on state aid former Articles 87 to 89 of the Treaty establishing the European Community (TEC) are now located in Articles 107 to 109 TFEU[xx]. The substantive treaty provision is constructed as a blanket ban on state aid affecting  the internal market, but with mandatory and discretionary derogations from the prohibition.

       2.1.1    General Principles

State interventions are aimed primarily at ensuring financial stability and ensuring the availability of adequate levels of lending to the real economy.[xxi] Such interventions contribute to the achievement of objectives of common interest. However, they are also likely to create distortions of competition, which need to be minimised through the instrument of State aid control.[xxii] First, distortions can appear between States where banks are given an undue competitive advantage over banks in other Member States.[xxiii] Access to funding or capital or other forms of support at considerably lower rates that in other Member States may have a substantial impact on the competitive position of a bank in the single European market.[xxiv] Excessive aid in one state could also prompt a subsidy race among States and create difficulties for the economies of States that have not introduced similar support schemes. Secondly, distressed or less performing banks may receive an undue advantage compared to banks which are better performing in the measures are available to all the banks within a State without an appropriate degree of differentiation between beneficiary banks according to their risk profiles. This will distort competition on the market, distort incentives, increase moral hazard and weaken the overall competitiveness of banks. Thirdly, public schemes which crowd out market based operations would frustrate the return to normal market functioning. Thus public recapitalisation, in particular its remuneration should not have the effect of putting banks that do not have recourse to public funding but seek additional capital on the market, in a significantly less competitive position.[xxv]

Experience from recent State interventions to recapitalise banks or to provide guarantees has illustrated possible anti-competitive effects at each of these three levels.[xxvi] Nevertheless, the EU in its communications and case assessment has shown that it is possible to strike a balance between these competition concerns and the objectives of restoring financial stability and ensuring adequate levels of lending to the real economy. This will be discussed in more detail in chapter three.

2.2        Applying legislation in context of financial crisis

The application of Articles 107-109 of TFEU has ensured, and continues to ensure that State support is granted on conditions that are sufficiently favourable to provide beneficiaries with effective access to capital, whilst preserving a level playing field and paving the way for a return to normal market conditions in the longer term. State interventions have accordingly been designed in a way that is proportionate and temporary in the sense that they provide incentives for banks to exit from reliance on State support as soon as market circumstances permit, in order for a competitive and efficient European banking sector to emerge from the crisis.[xxvii] This is what this paper deems to challenge. Finally, emergence rescue for banks has hitherto  has the effect of protecting the providers of funds (owners and creditors) and managers of banks from the consequences of the past excessive risk taking and led to a problem of moral hazard. Measures aimed at financial stability should thus also be designed so as to mitigate problems of moral hazard.[xxviii] Measures aimed at financial stability should thus also be designed to mitigate problems of moral hazard.[xxix] Restructuring of ailing banks has an important role to play in this respect, to ensure that incumbent owners, creditors and managers are not subsidised i.e. given their institutional responsibility for the decisions leading to distress.

       2.2.1         Need for European coordination of national aid measures

State aid granted to promote the economic development of certain disadvantaged areas within the European Union may be considered to being compatible within the common market of the Commission. Article 107 of the TFEU[xxx] ensues that the European Commission determines the compatibility and incompatibility of a given national regional aid with the common market. Under the former Article 88 of the EC Treaty[xxxi], states that the Commission shall, in cooperation with the Member States, keep 'under constant review all systems of aid' existing in those States. The Member States notify the Commission of the proposed levels of regional aid and the latter either approves or amends them, often to lower levels. If the state concerned does not comply with this decision within the prescribed time, the Commission or any other interested State may refer the matter to the Court of Justice directly.[xxxii]

      2.2.2          Need for temporary State Aid measures

While State aid is no miracle cure to the current difficulties, well targeted public support for companies could be a helpful component in the overall effort both to ameliorate lending to companies and to encourage continued investment.[xxxiii] There are two clear objectives regarding the temporary measures needed. There is a need to encourage companies to continue investing in the future, in particular in a sustainable growth economy.[xxxiv] This could result in extreme consequences, if as a result of the current crisis, the significant progress that has been achieved in the environmental field were to halted or reversed. It is therefore, necessary to provide temporary support to companies in environmental projects, thereby combining urgent and necessary financial support with long-term benefits for Europe. In the light of the exceptional and transitory financing problems linked to the banking crisis, to unblock bank lending to companies and thereby guarantee continuity in their access to finance.[xxxv] As borne out by the recently adopted “Small Business Act” for Europe, SMEs[xxxvi] are particularly important for the whole economy in Europe and improving their financial situation[xxxvii] will also have positive effects for large companies, thereby supporting overall growth and modernisation in the longer term. The communication recalls the manifold opportunities for public support which are already at the disposal of Member States under existing State aid rules, before setting out additional State aid measures that Member States may grant temporarily in order to remedy the difficulties which some companies are currently encountering with access to finance and to promote investment pursuing environmental objectives.[xxxviii] 

       2.2.3         General Economic Policy Measures

In response to the current economic situation the Commission adopted its European Economic Recovery Plan on 26^th November 2008.[xxxix] In order to restore consumer and business confidence the European Union needed a coordinated approach given the scale of the crisis, which represents the first key pillar of the Plan.[xl] The Commission proposes that Member States and the EU agree to a budgetary impulse amounting to 200 billion euros. The second pillar directs action to smart investment, investing in the right skills to promoting efficiency and innovation.[xli] At the same time the Plan aids Member States to open up new finance for SMEs,[xlii] cut administrative burdens and kick-start investment to modernise infrastructure.[xliii] It is often asserted that fostering the development of SMEs has beneficial political and equity implications. It is posited that increasing participation of SMEs strengthens dominant values and enhances political stability, thereby promoting economic development.[xliv] This will help to protect jobs in the long-term and these opportunities will open up to accelerate change and the reforms will help to succeed in protecting the interests of European Citizens and businesses. SMEs also need to be protected from difficult operating environments, which is possible for the EU to do under the Lisbon Treaty. If an SME is facing a problem, the Commission should step in to protect them.[xlv] They need a Commission delegation to immediately go to the relevant government to help them overcome practical problems. That would require more resources for Commission embassies. Member States should use the major financial support provided to the banking sector to encourage a return to normal lending activities. The Commission should continue to monitor the economic and competition impacts of measures taken to support the banking sector.

       2.2.4         State Aid under existing instruments

The Commission has significantly modernised the State aid rules in order to encourage Member States to target public support better on sustainable investments, thus contributing to the Lisbon Strategy for growth, jobs and competitiveness. In this context, particular emphasis has been given to SMEs accompanied by more openings for granting State aid. The 'de minimis' Regulation adopted in December 2006, specifies that certain measures worth up to EUR 200 000 per company over any three-year period do not constitute State aid within the meaning of the Treaty.[xlvi] It also states that guarantees of up to EUR 1.5 million do not exceed the 'de minimis' threshold and therefore do not constitute state aid either.[xlvii] In addition, State aid rules have been simplified significantly and streamlined by the recently adopted General Block Exemption Regulation (GBER)[xlviii], adopted in August 2008, which now offers Member States a wide panoply of aid with minimum administrative burden. The GBER[xlix] is particularly important for SMEs as it provides for special rules on investment and employment aid. In addition, all 26 measures allows Member States to assist SMEs in areas ranging from access to finance to research and development and environmental measures at different stages in their development.[l] New Community Guidelines on State aid for environmental Protection[li] were adopted whereby Member States may grant State aid. In December 2006 the Commission adopted a new Community framework for State aid[lii] research and development innovation containing new provisions specially targeted at SMEs[liii] corresponding to better targeted of aid corresponding with the Lisbon Agenda. In 2008, a Notice on State aid on the form of guarantees[liv] specifies the conditions under which pubic guarantees for loans do not constitute State aid. New Community guidelines on State aid to promote risk capital[lv] were adopted by the Commission in July 2006 aimed at innovative and fast-growing SMEs a key focus of the Lisbon Strategy. It is evident that the Commission has already authorised a large number of schemes that Member States may use to respond to the current financial situation, showing commitment and determination in improving the economy.

       2.2.5         Risk Capital Measures: SMEs (Small and Medium Sized Enterprises)

The Community guidelines on State aid to promote risk capital investments in SMEs set out the conditions under which State aid supporting risk capital investment may be considered compatible with the common market in accordance with Article 107 of the TFEU.[lvi] Based on the experience gained from applying the Communication on State aid to promote risk capital, the Commission considers that there is no general risk capital market failure in the Community.[lvii] It does however, accept that there are market gaps for some types of investment at certain stages of enterprises' development which are the results of imperfect matching of supply and demand for risk capital and can generally be described as an equity gap. The distribution of capital would be considerably more uneven were it not for the activities of publicly-backed funds. SMEs are also significantly more likely to make smaller investments than other providers of capital, thus addressing an investment stage gap.

       2.3            Competition policy in times of systemic financial crisis

The role of competition policy is to ensure that firms do not conspire to evade this harsh but socially productive competitive discipline by fixing prices, excluding efficient rivals, merging with significant competitors or receiving discriminatory state subsidies or protection.[lviii] The problem  most familiar to the European debate on State aid is that subsidies create international distortions to competition, which can result in retaliation and a mutually destructive subsidy war funded by taxpayers.[lix] Subsidies also undermine the market mechanism because the prospect of a bailout leads to reckless behaviour as so vividily demonstarted by the banks.[lx] More insidiously, there is also a negative effect on efficient firms and entrants who are incentivised to hold back on investment and aggressive marketing[lxi] because they know that inefficient rivals will hang on to segments of the market with inappropriate product offers and bloated capacity without fear of the consequences.

2.4       Nationalization and recapitalisation of financial institutions and Mergers (alternative measures to deal with the crisis)

While companies merge and can expand market bringing benefits to the economy, some combinations may reduce competition for example by creating or strengthening a dominant player. All proposed mergers notified to the Commission are examined to see if they would significantly impede effective competition in the EU. Proposed mergers may be prohibited, for example, if the merging parties are major competitors or if the merger would otherwise significantly weaken effective competition in the market. For many years the Commission has applied rules to assess State aid to firms in difficulty under Articles 107, 108 and 109 of the TFEU requiring that aid is well targeted and that distortions of competition are avoided or minismised as far as possible.[lxii] These rules are set out in the Community guidelines on State aid for rescuing and restructuring firms in difficulty (R & R) and are of general application including to financial institutions in difficulty.[lxiii] In the light of the seriousness of the current crisis in the financial markets[lxiv] and the specific characteristics of the financial sector, restructuring banks in difficulty will become necessary to avoid serious disturbances in the economy of the Member States. The Commission has in recent months adopted additional guidance in the form of Communications, setting out standards and safeguards for the application of State aid rules in the financial sector.[lxv] The Commission should be able to refer to a Member State notified concentrations with a Community dimension which threaten significantly to affect competition in a market within that Member State presenting all the characteristics of a distinct market.[lxvi]

Aside from measures to restore competitive and effective banking, there are two ways in which governments can respond to companies in distress; they can give them money directly through State aid, or grant them monopoly profit by allowing anti-competitive mergers.[lxvii] Either way the citizen would pay as a taxpayer and/or as a consumer through higher prices. In all cases, efficiency and competition are harmed often with long-term consequences.

The risks with State aid are clear: if the government lacks the expertise and knowledge to sort out efficient from inefficient players, then it may just end up rescuing inefficient firms.[lxviii] A policy that is open to arguments for State aids additionally creates incentives for wasteful rent-seeking activity.[lxix]   This occurs when companies seek to profit through lobbying or other activity to change the regulatory and legal environment than through trade and wealth creation.[lxx] They are businesses seeking profits through manipulation of the economic and/or legal environment rather than trade and wealth production. For these reasons, the EU competition framework uses State aid control to prevent harmful inventions, and independent merger control to prevent mergers that restrict competition.[lxxi] If it is, exceptionally necessary for the government to intervene with the banks,  State aid might be preferred to allowing an anti-competitive merger for several reasons. State aid may have an immediate effect, whereas monopoly profits may not flow immediately. It may be that  State aid can be limited in duration. However, State aid may be extremely difficult to remove because of rent-seeking behaviour by powerful vested interests, as subsidising agriculture in the EU and US demonstrate.[lxxii] State aid may be tied to specific policy objectives, such as restructuring, whereas an anti-competitive merger hands a licence to charge monopoly prices with no conditions attached. However, absent clear and measurable incentives, State aid could have the same negative effect on effiiciency as anti-competitive mergers.[lxxiii] On the other hand, State aid that is not applied on an equitable basis can futher distort competition by creating an uneven playing field. In contrast, an anti-competitive merger will likely benefit rivals because it lessens competition for all players in the market.

These arguements are compelling in the framework of State aid in the EU, which specifically requires that aid be specific and constrained, transparent in application, time-bound, and with a clear rationale.[lxxiv] The EU framework pays close attention to the distortionary effect on the market and thereby supports open markets and a level playing field.[lxxv] Some may argue for allowing an anti-competitive merger over State aid because it would give rise to synergies[lxxvi]: this argument should be treated with the caution normally given to claims about efficiencies made by merging parties especiallhy in the light of evidence that market power leads to less, not more efficiency inside firms.  Overall subsidies harm competition and the consumer and unless very carefully structured and time-limited, may do as much harm as anti-competitive mergers.[lxxvii] The need for intervention to prevent systemic collapse in banking in exceptional circumstances should not cause us to set aside the competitive framework which, in preventing both distortionary State aid and anti-competitive mergers, provides an essential part of the foundation or long-term productivity growth.

It is widely accepted that that open and competitive markets deliver benefits. The existence of competition law and policy recognises public intervention is necessary to support strong competition and resist the market failure that arises from monopoly, cartels and other restrictions. The legal framework within the UK is relatively new, but is based heavily on the EU.[lxxviii] It has demonstrated the ability to balance the flexibility to deal with changing economic conditions alongside the need for a stable and consistent approach to foster long-term investment. The priority for competition agencies should be to continue to demonstrate the benfits of the framework, and to do so consistently internationally so that our economies are poised to grow  on the back of strong competition and open markets.

While intervention to help SMEs can be justified on the basis of issues such as employment, large scale interventions and the allowing of merges into large firms should be avoided because of the long-term negative impact on competition based on both economic theory and law. Competition policy should therefore be reconsidered by being aware of the causes of the current crises and its competitive effects.

3. Going forward: Adaptation of competition rules, processes and institutions to current financial sector issues

Looking beyond emergency actions to stabilise financial markets, the current crisis has stressed the importance of reconsidering the role of competition policy and competition agencies in these markets in the medium and long term.[lxxix] Effective enforcement of merger and antitrust rules after consolidations and nationalisations in the banking sector may require improvements in rules and institutions.[lxxx] The question is whether there will be a change in the view on the trade-off between competition and stability and, if so, whether competition will again be limited in the financial sector going forward or changes will be introduced in the design of competition policy to improve resolution of crisis situations. This requires awareness of the causes of the current crisis and its competitive effects in the medium and long run

3.1       Responding to the crisis

A recession can facilitate strong growth in long term productivity.[lxxxi] Unlike a boom, when inefficient players may survive and even grow, an economic downturn will tend to drive out the less efficient market players. This process of creative destruction leaves a stronger and more efficient supply base, thus driving innovation and productivity growth in the next period of expansion. This is why competition agencies should apply a rigorous  failing-firm defence, especially in a downturn. And it is a reason why governments should be very careful about supporting ailing firms with State Aid or other means. The banking sector may not follow this. The fact that banks are fundamentally different from other businesses may exceptionally justify intervention.[lxxxii] Bank failure risks contagion effects. The failure of one bank may lead to a run on others, as opposed to other sectors where the removal of one player would normally be in a competitors' interests.[lxxxiii] The collapse of confidence in turn caused liquidity to disappear, and thus removed an essential lubricant for the banking system to function and brought us close to systemic collapse.[lxxxiv] In this sense, the credit crunch resulted from an exceptional implosion of supply, and not simply a cost increase or a contraction demand. The state of the financial sector points to a further rationale for intervention. If the credit market has ceased to function effectively, then firms that struggle could be those whose re-financing is due earlier or which lack a broader conglomerate base and not those who are at least efficient.[lxxxv] Therefore, for the standard position that while industries should not receive state aid, the structural position of banks in determining the credit worthy from the non as well as their interrelatedness makes them more worthy of intervention. Put another way, banks or other providers of finance normally play a crucial role in sorting out the efficient from the inefficient players: with rationed credit, they may cease to perform this vital function. In this case efficiency and productivity growth could suffer further. Government intervention to get banks lending to business on a vigorously competitive commercial basis would enable banks to resume their critical function for the economy as a whole. This would be far better than directing government State aid to failing firms of their non-customers.

3.2       Changes in competition policy

Looking beyond emergency actions to stabilise financial markets, the current crisis has stressed the importance of reconsidering the role of competition policy and competition agencies in the long term effect.[lxxxvi] Effective enforcement of merger and antitrust rules after consolidations and nationalisations in the banking sector may require improvements in rules and institutions. The question is whether there will be a change in the view of the trade-off between competition and stability and if so, whether competition will again be limited in the financial sector going forward and/or changes will be introduced in the design of competition policy to improve the resolution of crisis situations. There has been a substantial change across countries in that competition policy has been applied more effectively in the financial sector.[lxxxvii] Overall, the strengthening of competition control in the banking sector has been successful in contrasting anticompetitive behaviours and potential anticompetitive mergers.[lxxxviii] It seems to have generated important externalities in that it has contributed to limiting the discretion of supervisory policies by creating a sort of “check and balance” system for the operating of the sector regulators.[lxxxix] In this sense, the Commission has had an important role in contrasting national protectionism, in particular in the case of some cross-border mergers.[xc] Despite this trend, there are some exceptions in the design of competition rules for the financial sector and in the institutions in charge of enforcing them. For example, in Canada, The Netherlands, Switzerland and in the European framework the review of a bank merger by the competition authorities may be suspended or a negative decision may be reversed because of stability concerns. The “stability exception” is typically implemented by a political body such as a Minister or by the sector regulator itself.[xci] The question arises as to whether the objectives of competition and stability should be weighted case by case or rather whether the competition objective should always be subordinate to the stability objective once a contrast occurs. In principle one may expect that a political body is more likely to give weight to two objectives but this causes the argument to become complex as it depends on the reputation of institutions and the levels of accountability in the specific country. A further issue in the case of the European framework is whether the stability exception should be implemented by some kind of supranational authority rather than Member States given the level of integration of financial markets and the supranational effects of mergers examined by the Commission. This issue is related to the current debate of whether a European banking regulator is needed, also in the light of the attempt of some Member States to use the stability exception to put obstacles to financial integration.[xcii]

3.3       Future prospects: Evaluation of the Commissions reaction

Several other important issues arise from looking at these exceptions. First, assuming that some limitations in the application of competition rules to the financial sector are warranted, one wonders whether there should be a more systematic attempt in trying to prevent the occurrence of crisis rather than only having exceptions in instruments that are more typically used for crisis management like mergers and public support. This begs the question as to whether the Commissions reaction was adequate as well as the provisions which were relevant. It may be important to reconsider the trade-off between competition and stability, and if a trade-off exists in that competition enhances the risk of bank failures.[xciii] At least after it reaches a threshold it may be worth limiting excessive competition, for example, through appropriate legislation. The risk is, however, to go back to a situation of protectionism and tolerated market power and collusive agreements.[xciv] Second, concerning more generally the objectives of competition, especially in the financial sector, the issue is whether competition policy should focus exclusively on consumer welfare or should also pursue other objectives such as general economic and systemic stability. A possibility is to explicitly incorporate objectives other than consumer welfare in the institutional design of competition policy. This implies having the competition authorities internalize objectives other than competition concerns in their decision making process. An example of this system can be found in the existing institutional designs across countries. For instance, in Austria a concentration can be cleared if it is indispensable for international competitiveness of the undertakings concerned.[xcv] Addressing the involvement of third agencies, in the United Kingdom the Secretary of State retains the decision making power for mergers involving public interest with the Office of Fair Trading and the Competition Commission holding advisory power.[xcvi] On the one hand an enlargement of the objectives of competition authorities beyond consumer welfare has the benefit of keeping potential trade-off's between competition concerns. Furthermore, competition authorities may not be in the best position to judge a collusive agreement or policy initiative because of lack of complete information of competence.[xcvii] In this respect, some form of co-operation between competition authorities and sector regulators seems inevitable.

A related issue concerns the need for competition authorities to adapt to the evolution of financial markets. Financial innovation and changes in the structure of markets may not have always been taken into account in previous decisions and interventions by the Commission. For instance, merger control is still very much focused on the effects of consolidation on retail banking and on deposits and lending to small and medium sized enterprises.[xcviii] Whereas this is certainly warranted due to the presence of switching costs and relationship lending, it is also important to recognise the growing importance of electronic and online banking as well as other forms which may change the structure of retail banking.[xcix] Considering this, it may also be possible competition policy to try and influence the structure of financial systems.[c]

A final issue is whether the Commission, especially in the light of the current crisis, should pay more attention to the risks taken by the financial institutions.[ci] Given the characteristics of financial services prices may not be fully indicative of the competition situation in financial markets if taken in isolation. A financial institution offering higher deposit rates, low lending rates or easy access to credit may be taking important risks on the asset side which may hinder rather than promote competition in the long term.[cii]

3.4       Competition policy and Consumer welfare

In a more consolidated financial system, competition may be weaker, lending to higher costs of credit and other financial services to consumers and businesses.[ciii] Countervailing policies will be needed to restore or improve competitive conditions.[civ] Restructuring may integrate within a single institution potentially independent operations, such as consumer banking, SME lending and investment banking leading to questions about the resulting efficiencies and competition risks.[cv] Another question to be addressed is whether deposit insurance increases the risk of moral hazard in portfolio decisions and reduces competition between banks.

Competition policy considerations should play an important role not only in the financial sector bailouts and restructuring but also in the subsequent recovery. In the wake of the financial crisis, governments have been under pressure to support national industries through subsidies and protection.[cvi] Furthermore, in co-ordination with financial regulators, they have taken emergency and ad hoc measures to shore up financial institutions, in response to severe liquidity shortages and breakdown in lending markets and trusts.[cvii] These measures have included investments and guarantees, asset purchases and time-sensitive mergers.

Competition authorities may in turn be under pressure to loosen enforcement standards in order to favour economic recovery.[cviii] In responding to these pressures, competition policy makers must show that competition is part of the solution for benefiting consumers and fostering innovation, competitiveness and productivity. The usual tools of competition analysis and enforcement assume stable market conditions.[cix] In a context of crisis, authorities must consider how to safeguard competition principles without hampering policy measures to avoid a slump or the erosion of trust in the financial sector in accordance with Article 107 of the TFEU under the Lisbon Treaty.[cx]

In the crisis, businesses, and SMEs in particular, are vulnerable due to their heavy independence on bank credit and limited recourse to financial markets.[cxi] It is thus necessary to assess the differentiated  impact on sectors and firms and improve the effectiveness of new, innovative and alternative mechanisms to financial development.

3.5       Competition authorities adapting to the evolution of the financial markets

While it is plausible to assume a more lenient approach toward market power in banking, it remains unclear whether the presumption that stability considerations should override competition concerns is warranted. The question is rather to what extent stability considerations should influence the design as well as the application of competition policy. An even more important aspect given the current crisis situation is that the application of competition policy presupposes stable market conditions.[cxii] At the current stage, competition policy is meant to address the potential anti-competitive effects stemming from individual cases rather than from a generalised situation.[cxiii] Competition laws and policies are meant to address concerns that include preventing enterprises from entering into agreements which do not have beneficial features and which will restrict competition, either amongst themselves or between them and third parties; controlling attempts by monopolists of dominant firms from abusing their market position and preventing new firms from entering into the market; ensuring that workable competition is maintained in oligopolistic industries and monitoring merges between independent enterprises, where the effect of the merger my result in market concentration and reduction in competition.[cxiv] Competition authorities are now faced with a massive intervention of the public sector in the banking system both by sector regulators and governments, as well as central banks. Myriad measures have been taken in the last months to aid the financial markets, including sharp reductions in policy rates, changes in the liquidity injections in terms of the widening of collateral requirements, maturity and counter parties, and more direct asset purchases, capital injections and guarantee schemes covering the liabilities of financial institutions and interbank market transactions.[cxv] Moreover, regulators around the world have been directly involved in time-sensitive rescues such as those of Bear Sterns,  Morgan Stanley, Northern Rock, Fortis, ING, IKB, West LB and Hypo Real Estate. All of these measures seem to have been driven by the fear of contagion deriving from the failure of one institution and the risk of systemic crisis stemming from a widespread loss of confidence in the financial system.[cxvi]