The Ethical Dilemma - 4 Conflicts

1. Solvency vs Liquidity: Bagehot's rule - lend freely to solvent but illiquid banks against good collateral at penalty rate. In Spain 2008-2012, real estate cajas were insolvent, not just illiquid. Lending to them was fiscal bailout disguised as liquidity.

2. Constructive Ambiguity: Banco de España and ECB never publish ex-ante ELA conditions. The procedural rules are in ECB Agreement of 7 Sept 2024 - a soft law instrument. The ethics: you avoid moral hazard but you create market panic because nobody knows if bank will be saved.

3. Monetary Financing Prohibition: Article 123 TFEU prohibits ECB/Banco de España financing governments. But when Banco de España gives ELA to a bank that holds Spanish government bonds, and government guarantees that ELA [as in CCM case], is that indirect monetary financing? This was core of Gauweiler and Weiss cases.

4. Taxpayer vs Creditor: Who pays? Spanish solution: FROB [Fondo de Reestructuración Ordenada Bancaria] - created by Royal Decree-Law 9/2009. FROB gave loans, then converted to shares, nationalizing. Later under EU Bank Recovery and Resolution Directive 2014/59/EU - bail-in, not bail-out.

Spanish History of LOLR - Case by Case

Case 1: Caja Castilla-La Mancha [CCM] - March 2009 - First Spanish ELA
First caja to fail. Real estate exposure. When CCM exhausted ECB-eligible collateral, it turned to Banco de España for ELA.

• BoS advanced EUR 900 million in Feb 2009, then second line up to EUR 9 billion on March 31, 2009.
• Government guaranteed up to EUR 3 billion under newly enacted Royal Decree-Law 4/2009 enabling guarantee up to EUR 9bn of ELA.
  Ethical issue: Government guarantee of central bank ELA = fiscalization of monetary support. European Commission approved as state aid.

Case 2: Banco de Valencia, CAM, Novacaixa - 2011-2012
From July 2011 to Feb 2012, Banco de España disbursed EUR 9.6 bn for mergers of savings banks; EUR 4.75 bn allocated by FROB to recapitalization. FROB credit lines EUR 3bn to Banco Valencia. The pattern: Banco de España as LOLR provided liquidity, FROB provided solvency support. This is the classic two-tier model.

Case 3: BFA-Bankia - The Systemic Test - May 2012
Seven troubled cajas merged to form Banco Financiero y de Ahorros [BFA], commercial subsidiary Bankia.

• FROB initially loaned EUR 4.465 bn convertible securities to BFA in 2010-11.
• In May 2012, BFA-Bankia announced EUR 4.3 bn shortfall, later audit found EUR 21bn losses for 2012, EUR 59bn stressed.
• Bankia unable to repay FROB loan. FROB converted debt into 45% shares, nationalized BFA, injected another EUR 19bn.
• Spain requested ESM bailout: Eurozone approved max EUR 100bn, ultimately used EUR 41.4bn for banking recapitalization. SAREB bad bank created Dec 1, 2012 to buy up to EUR 90bn toxic assets.

Throughout, Banco de España discharged duties as lender of last resort in Spain, including provision of liquidity support to solvent Spanish banks facing liquidity crises. But FROB actions were fiscal.

Ethical ruling: Tribunal Supremo Bankia IPO Case - Bankia prospectus misled investors. Criminal acquittal but civil liability to return investments. Bank cannot use LOLR to hide insolvency from investors.

Case 4: Banco Popular - 2017 - The End of ELA Ethics
Most important LOLR case in Spain.

• June 2 and 5, 2017, Banco Popular suffered depositor run - EUR 300bn foreign capital had fled Spain from 2011-2012, but this was idiosyncratic run.
• Popular requested ELA from Banco de España. ECB approved second request for ELA ceiling, but Banco de España rejected second request because collateral insufficient.
• ELA proved insufficient.
• On June 6, 2017, ECB declared Popular "failing or likely to fail".
• Single Resolution Board adopted sale of business: Popular sold to Santander for EUR 1, provided Santander raise capital.

Case Law:

a) Aeris Invest Sàrl v ECB - T-628/17 - General Court, Monthly Case-Law Digest Oct 2021
Aeris, shareholder of Popular, requested access to ECB documents on ELA ceiling. ECB refused. General Court held ECB failed to provide sufficient reasons for second contested decision refusing access to information relating to ceiling for emergency liquidity assistance. Establishes limited transparency duty even for ELA.

b) ICSID Arbitration - Banco Popular investors v Spain - Case 1:18-mc-00085-ER
Investors sued Spain under UNCITRAL rules. Spain defended that throughout crisis, Banco de España acted consistent with internationally accepted role of NCBs as lender of last resort. Tribunal had to distinguish liquidity support vs supervisory failure.

c) SRB Resolution Cases - T-478/17 and others
CJEU upheld that resolution with zero compensation to shareholders was proportionate to protect financial stability.

EU Constitutional Case Law Governing Spanish LOLR

Case 5: Gauweiler C-62/14 - OMT Program - 2015
German plaintiffs challenged ECB Outright Monetary Transactions [promise to buy unlimited sovereign bonds of Spain/Italy]. CJEU granted broad discretion to ECB in definition of monetary policy and conditionality. Held OMT is monetary policy, not economic policy, even if it saves Spanish state. This legally allowed ECB to act as sovereign lender of last resort.

Case 6: Weiss C-493/17 - PSPP - Dec 11, 2018
Challenge to ECB Public Sector Purchase Programme. CJEU again upheld proportionality. German Constitutional Court in Weiss tried to challenge but ultimately accepted. For Spain, this meant ECB could buy Spanish bonds under PSPP to keep sovereign yields down, indirectly supporting banks holding those bonds.[2020]

Case 7: Pringle C-370/12
Held ESM bailout fund is not monetary financing. This allowed Spain to receive ESM loan for banks without violating Article 123.

Current Framework - Post-Crisis Ethics

IMF Financial Sector Assessment Program for Spain, Technical Note July 12, 2024:

The BdE should publish a policy framework that clarifies its role as a lender of last resort, including for liquidity to entities recapitalized through resolution which are viable, and ensure its ELA and liquidity in resolution lending capabilities are fully operational, including by establishing a testing arrangement.

In other words, 12 years after crisis, Banco de España still has no public ELA framework - ethical ambiguity remains policy.

Summary Ethical Rule in Spain:

Since 2015 Law 11/2015 transposing BRRD, LOLR in Spain works as:

1. ECB liquidity first[collateralized]
2. Banco de España ELA second [own risk, government may guarantee]
3. FROB solvency third [bail-in 8% of liabilities first, then Single Resolution Fund]
4. Taxpayer last

The ethics has shifted from bail-out [CCM] to bail-in. Popular shareholders wiped out to protect depositors and taxpayers - that is the current ethical definition of Banking Sovereignty in Spain.[Bankia][Popular]