Yesterday, the European Commission (EC) issued guidance on the "treatment of impaired assets in the EU banking sector," and a related list of frequently asked questions. The EC, in creating its guidance, took into consideration recommendations received from the European Central Bank and its Member States. Further, the guidance "compliments and refines" the previously issued Banking Communication that sets forth "the principles governing the application of State aid rules to any support measures for banks in the context of the global financial crisis."

Impaired assets under the EC’s guidance are "categories of assets on which banks are likely to incur losses." The EC decided to adopt a "common European approach" in dealing with the treatment of impaired assets in order "to make sure that foreseeable losses are disclosed and properly handled and banks can use their capital to resume their normal function of lending to the economy instead of fearing they would need this capital to cushion against possible losses." The framework of the guidance proposes various methods regarding the treatment of impaired assets and the budgetary and regulatory implications of adopting asset relief measures. The guidance also highlights "methodologies concerning the valuation of impaired assets" and "the necessary remuneration of the State for the asset relief." It also provides an outline of the criteria and analysis that will be used in determining the allocation of State aid to banks.

Competition Commissioner Neelie Kroes noted that the EC has "already taken important steps towards financial stability through bank rescues and recapitalisation. Now, we need transparency, disclosure and correct valuation of impaired assets in order to clean the balance sheets of banks and address the root cause of lack of confidence. But we also require that the banks contribute adequately to the costs." The Commissioner further indicated that banks "may have to be restructured in exchange for the State aid they receive."

The guidance sets forth some of the following key principles:

  • greater transparency and disclosure of impairments (prior to government intervention);
  • a coordinated approach "to the identification of assets eligible for asset relief measures through development of eligible categories of assets" and to the "valuation of assets";
  • validation of the valuation of the assets by the EC and "coverage of losses incurred from the valuation of the assets at real-economic value by the banks benefiting from the scheme";
  • adequate allocation of the "costs related to impaired asset[s] between the shareholders, the creditors and the State" and appropriate remuneration for the State "at least equivalent to the remuneration of State capital"; and
  • appropriate measures relating to restructuring which includes "measures to remedy competition distortion, following a case by case assessment and taking into account the total aid received through recapitalisation, guarantees or asset relief, with a view to the long term viability and normal functioning of the European banking industry.

Each Member State is responsible for creating its scheme in line with the guidance. Under the guidance, the EC will approve the Member State’s asset relief measures for a period of six months, conditioned on the Member State’s commitment to provide information relating to the valuation of the impaired assets, viability assessments and restructuring plans of each of the beneficiary institutions within three months "from its accession to the asset relief program.