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Opinion

European banking: EU bares its teeth

Uncertainty is growing over the scope and scale of restructuring plans to be imposed by the EU Competition Commission on European banks that have been kept alive by state aid.

On October 29, Lloyds Banking Group announced to its shareholders that, based on its advanced discussion with the Commission, the final terms of its restructuring plan, including any required divestments of assets, will not have a material impact on the Group. Its shares rallied sharply on this news.

Over the following weekend, UK chancellor Alistair Darling revealed that Lloyds would indeed be expected to divest some large parts of its business in return for the government support it has already received. These could include big parts of its retail network, such as Cheltenham & Gloucester, TSB Scotland, and online bank Intelligent Finance.

It makes you wonder what Lloyds’ management considers ‘material’.

Then again, such news should really have come as no surprise. In June, when the EU approved a plan to restructure Commerzbank following its recapitalization by the German state, it required a roughly 20% cut in the balance sheet and the divestment of the majority of Eurohypo by 2014.

It was never clear what had changed at Lloyds, in which the UK government has a 43% stake, since European competition commissioner Neelie Kroes addressed the British Bankers’ Association on June 30 and analyzed the consequences of the UK government keeping the country’s financial sector alive with £1.26 trillion ($2.1 trillion) of government support. Kroes was chiefly concerned by distorted competition for the precious deposits smaller banks desperately need now that the thin-capital-wholesale-funded balance sheet model is broken. Kroes said back in June that the likelihood of requiring significant divestments by RBS and Lloyds was "strong".

In the immediate aftermath of the state rescues, it became clear that banks thought they had resolved their problems by seeking rescue from their own national governments. They didn’t seem to appreciate that the European authorities might not share their home governments’ interest in preserving the status quo nor did they recognize the powers of the Commission or its lack of concern for keeping national banking champions alive in their rescued form.

Before the summer of this year, there had been 70 cases of state aid to European banks with at least 27 cases of rescue or recapitalization aid. In adjudicating on these, the EU Competition Commission will play a bigger role than any other policy institution in reshaping the European banking industry.

The Commission’s determination to enforce radical change seems to be growing, not diminishing. Just three days before the Lloyds announcement, ING unveiled a final restructuring plan filed with the European authorities to repay state aid and reduce leverage that amounts to a 45% shrinkage in its balance sheet. This is much harsher than the market had expected. RBS will undergo radical restructuring for one. It is likely to have to sell parts of its UK retail network and its insurance division. It may even have a fight on its hands to keep its core US franchise, Citizens. Many other banks should be nervous.

European governments have been prepared to spend 16.5% of their GDP on bank bailouts. An emergency rights issue to escape the clutches of the UK’s asset protection scheme, as Lloyds had planned, could surely never have enabled Lloyds to carry on regardless without sanctions from the EU regulators.

It’s tough to read through to the likely future of European banking yet. One thing is clear though. If these state-supported forced sellers simply divest large portions of their businesses to the evident winners in European banking – BNP Paribas, BBVA, Credit Suisse, Deutsche Bank, HSBC, Société Générale – then competition will be diminished, not enhanced. New entrants should be encouraged, as long as they are credible owners of banks.

Meanwhile, Lloyds shareholders being asked to stump up £21 billion of new equity ought to be demanding the head of the group’s chief executive Eric Daniels. He was at the helm when a healthy banking group rushed through its takeover of the critically wounded HBOS. He and then chairman Victor Blank trumpeted the deal as a once in a lifetime opportunity to beat competition concerns and build unheard of critical mass in the UK market. How hollow those boasts seem now.

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