State Aid in the Financial Services Sector and the Implications of the Recent Financial Crisis

Abstract: Financial services sector is fundamental to economic growth and development in all advanced economies. Financial services such as banking, savings and investment, insurance, and debt and equity financing constitute a nation’s economic engine by fulfilling three core functions in the economy. Firstly, these services provide financial intermediation functions between savers/investors that are looking for security and growth and consumers/businesses who are looking for access to credit and capital. This intermediation is vital for allocating capital to the most profitable investments, providing a mechanism for saving, raising productivity, and consequently, increasing competitiveness of the nation in the global economy. Secondly, in addition to pooling investment risks, financial services sector provides a mechanism to manage other risks effectively and efficiently by way of insurance and increasingly sophisticated derivatives. These tools help private citizens and businesses cope with diverse global risks and uncertainties. Finally, financial services sector provides the practical mechanisms for money to be managed, transferred and received quickly and reliably. This is an essential requirement for commercial activities to take place and for participation in international trade and investment. Therefore, the financial services sector is specific and can easily be distinguished from other sectors. A serious downturn encountered in this specific sector might have disastrous impacts on the real economy of a nation. The current economic crisis in the United States and Europe, marked by the ongoing weaknesses of major banks and the resulting credit and capital crunch, highlights the critical importance of the financial services sector in national and global economies. Considering the importance of this sector, it is very hard for States to be unresponsive to the calls for assistance from ailing financial institutions. In such a situation, the States ask for a well-targeted and organized public measures in order to safeguard financial stability and restore economic viability. The State aid measures are perceived as part of the solution and thus, they are generally implemented to rescue failing firms in the financial services sector. However, Member States in the EU should follow certain State aid rules while intervening to this specific sector. Unfortunately, the specific nature of this sector is not recognized in the EU until the recent banking crisis. Member States are required to follow the same State aid rules as in other sectors. To realize this fact, the Commission had to wait until the end of 2008 when the financial crisis spilled into the real economy. Later then, the Commission adopted some flexible measures for this sector but their sufficiency is also highly doubtful. The purpose of this thesis is to provide an overview of the State aid rules applied in financial services sector. In the first part, two common types of State aid measures granted in the financial services sector, rescue and restructuring aid and State guarantees, are discussed in detail. After a review of applicable rules in the form of guidelines and notice for these two forms of aid measures, implications of the recent financial crisis are discussed in the final chapter.