Government Measures in Support of the Financial Sector in the EU and the United States

In the latest issue of Intereconomics, the first article by current authors drew attention to the measures taken by central banks to support the financial sector in an effort to mitigate the effects of the financial crisis. This second article describes government measures to limit the impact of the financial crisis and discusses possible exit strategies. While the focus is on measures applied by euro area governments, the article also compares these measures with those of the United Kingdom and the United States.

The extraordinary corrective measures taken by central banks and governments since the end of 2008 have restored confidence in financial systems around the world and improved their resilience. These measures, together with important monetary and fiscal incentives, have begun a process of mutually strengthening the state of the financial system and of real economic performance. This increased confidence and weakened systemic risk. However, measures to support the financial system have increased the risk of distortion of competition, caused moral danger, and even increased the likelihood of excessive risk, while the dramatic increase in budgetary imbalances undermines the sustainability of public finances.

This article provides an overview of the corrective measures that governments have taken to support the financial system. First, it provides general details about support measures before proceeding with individual measures and options to withdraw such measures.

Ad hoc measures against national systems

Although the initial financial turmoil has revealed shortcomings in a wide range of large and complex financial institutions, the systemic risk is greatly mitigated. Governments initially responded to major ad hoc measures tailored to the individual needs of institutions that had suffered heavy losses. However, as the crisis deepened – with the collapse of Lehman Brothers in October 2008 – and became more systematic in nature, it became clear that interventions needed to be extended to a wider range of banks. This requires a more comprehensive approach to support system design. One of the first comprehensive schemes to be introduced was the US cloud asset support program, better known under the acronym TARP. For example, the Financial Market Stabilization Fund (SoFFin) was established in Germany on October 17, 2008. These schemes are characterized by the introduction of more transparent and predictable procedures to obtain financial support from banks. More specifically, transparency is enhanced by government announcements of global financial commitments that they are willing to support in support of their financial systems. The schemes usually also contain specific criteria for the adequacy, pricing, and duration of the support measures available under the schemes.

Measures taken

In general, support measures were normally available for financial institutions operating in a particular country and for foreign branches with significant local operations in the country. Support is usually provided at the request of a financial institution, although in some cases banks have also been instructed to accept government support (for example in the United States and France). The support measures were usually accompanied by restrictions on dividend distribution, requirements for regular reports on business development, restructuring requirements, government participation in banking management, and restrictions on remuneration for executives. In addition, government support in some cases has provided explicit credit growth targets to support lending to the economy (for example in France, Ireland, and the United Kingdom).

Deposit Insurance

Deposit insurance contracts were one of the first steps to mitigate the impact of the financial turmoil following the fall of Lehman Brothers. In Europe, pre-crisis EU law introduced minimum deposit insurance of € 20,000, with an optional insurance element of 10%, whereby deposits would bear 10% of the losses. As this deposit coverage was not sufficient to eliminate the issuance of deposits, the limit was increased to a minimum of € 50,000 in October 2008 and back to € 100,000 in December 2010.6 In addition, the EU countries agreed to accelerate guaranteed deposits in case of insolvency. in an effort to improve the effectiveness of deposit insurance.

Bank guarantees

In addition to the increase in deposit insurance, the provision of government guarantees for bank bonds was one of the first measures to support banks. These programs allowed banks to issue government-backed securities against bancassurance. Several countries have pledged large sums to guarantee the issuance of bank bonds. However, the use of state guarantees has been slow. Although several debt guarantee schemes were available in October 2008, issuance did not gain momentum until mid-November 2008. The Eurozone in particular and the United Kingdom, in particular, took the initiative to establish contact and report to the majority. of all governments still pending. Insured debt. The programs have been implemented in some countries (Italy, for example), but no bank has used them. In other countries, few banks registered and spending was low. In the United States, the guarantee is offered under the debt guarantee program, which is also part of the TLGP administered by the FDIC. Banks can choose not to participate in one or both of the programs offered by TLGP.

Capital injections

As the financial turmoil continues, the incidents resulting from the deterioration of credit quality are having a serious effect on banks’ capital. The deterioration in the economic environment has also resulted in banks losing losses in their loan portfolios and losing risk weight in asset exports, further straining banks’ capital positions. When it became clear that banks were facing not only liquidity problems but also potential risks to their solvency, several governments began to integrate liability guarantee systems and inject capital directly into banks. Capital injections mainly took place through the acquisition of preferred shares or other hybrid instruments that meet the Tier 1 capital requirements.

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