Court Challenges EU on Bank Downsizings

WSJ: BRUSSELS—A decision from the European Union's highest court has called into question the tough downsizings imposed on many of the region's banks as the price of approval for the giant government bailouts they received during the financial crisis.

The ruling, issued last week by the European Union Court of Justice, said the EU misstepped and ultimately overreached in settlement talks with the Netherlands over the Dutch bank and insurance group ING Groep NV. The European Commission, the EU's executive arm, has dictated the terms of bank restructurings using its near unilateral power to regulate aid that private-sector companies receive from national governments.

Lawyers involved in other restructurings say the ruling shows that Europe's strategy of seeking huge reductions in the size of bailed-out banks—already criticized by some economists as inflicting heavy damage on the European economy—has been sloppily executed. Some settlements are likely to be revisited, lawyers say, and those banks still negotiating with the EU will have a stronger hand.

EU officials say the balance-sheet reductions are needed to ensure banks receiving aid get rid of unsustainable businesses, repay the aid and don't gain a competitive advantage because they received government support. They also estimate that just 2.5% of EU banking assets have been subject to selling requirements since the crisis hit.

The commission is considering whether to appeal the ING decision, said Antoine Colombani, spokesman for Joaquín Almunia, the chief EU competition regulator. "We will also adopt a new decision taking the judgment into account," he said, without saying what it would be.

Commission officials declined to comment on the overall handling of the downsizings.

The decisions have had a profound impact on the financial sector, affecting trillions of euros worth of assets held by dozens of banks. The settlements have often required deep cuts to bank balance sheets. For example, Royal Bank of Scotland PLC of the U.K. has been ordered to cut its balance sheet by 40% from precrisis levels over several years. The cuts were 45% for ING and 45% for Commerzbank AG of Germany. The agreements also forbid banks from making acquisitions for several years and set operating restrictions on their businesses.

In the ING case, the court annulled the bank's settlement with the commission, ruling that the commission miscalculated the amount of government aid the bank received. The court said the commission hadn't properly justified €2 billion ($2.62 billion) of the €17 billion it said ING had received.

The commission now will have to justify the €17 billion figure or relax the terms of the settlement, which included the requirement for ING to divest various businesses, including life-insurance subsidiaries that it has yet to sell.

Lawyers say the ruling is a significant defeat for Mr. Almunia's department. "The court basically says the commission hasn't done its homework properly," said Lode Van Den Hende, an attorney at Herbert Smith in Brussels. "Frankly, this is what the commission has done in many of these cases. In some of them, it didn't even quantify aid."

It is unclear exactly how the ruling will affect other restructurings, either those that have been completed or those still under negotiation with the commission, such as one for the Franco-Belgian bank Dexia SA. The commission, unless it appeals the decision, may have the obligation to go back and ensure that its previous settlements with banks conform to the ruling, lawyers say.

They say the ING decision highlights what some see as flaws in how the EU executive branch has negotiated settlements. For example, on Nov. 6, 2009, the commission sent the Dutch government and ING an email at 4:12 a.m. with a 23-page draft of part of the decision it intended to adopt. The commission asked ING to check details in the draft and respond by 10 a.m.

"A few hours to comment," the court said, is not "sufficient to allow such information to be produced." EU officials said the commission was under no obligation to show the draft to ING.

Andreas von Bonin, a lawyer at Freshfields Bruckhaus Deringer in Brussels who has worked on several bank restructurings, said the interactions between ING and the commission described in the ruling give "a flavor of the jumping to conclusions, lack of diligence, and—in the end—bad administration that we sometimes see in the commission's handling of these investigations."

The tough settlements have prompted quiet grumbling from national regulators that the EU is sacrificing banks' capacity to lend to the real economy for the sake of competition. Economists also note the combination of large-scale balance-sheet reductions and restrictions on asset purchases has put pressure on asset prices, undermining the solvency even of the few banks that didn't need government aid.

"You risk a downward spiral when many banks are trying to sell assets," said Thorsten Beck, chairman of the European Banking Center at Tilburg University in the Netherlands.

Mr. Beck said the EU should have taken a different tack. "Imposing haircuts on equity holders and possibly junior debt holders, yes. But trying to shrink bank balance sheets during a crisis is definitely not a good idea," he said.

Write to Matthew Dalton