Report from the Commission to the Council and the European Parliament concerning interest-rate subsidies
Date: 2001-02-15
Institutions: European Commission
Subjects: Community loan, Council of Europe fund, EU action, EU financial instrument, EU programme, State aid, Structural Funds, World Bank, capital transfer, interest rate subsidy

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 15.2.2001
COM(2001) 86 final

REPORT FROM THE COMMISSION TO THE COUNCIL
AND THE EUROPEAN PARLIAMENT

CONCERNING INTEREST-RATE SUBSIDIES

REPORT FROM THE COMMISSION TO THE COUNCIL
AND THE EUROPEAN PARLIAMENT

CONCERNING INTEREST-RATE SUBSIDIES

TABLE OF CONTENTS

INTEREST-RATE SUBSIDIES ............................................................................................ 5

1.

2.

2.1.

2.2.

2.3.

3.

INTRODUCTION: COUNCIL REQUEST TO THE COMMISSION ...................... 5

PART I: PROBLEMS ASSOCIATED WITH INTEREST-RATE SUBSIDIES;
POSITIVE AND NEGATIVE EFFECTS ................................................................. 5

Reasons for public intervention ................................................................................ 5

Interest-rate subsidies: positive effects...................................................................... 6

Interest-rate subsidies: negative effects..................................................................... 7

PART II: THE LESSONS OF EXPERIENCE.......................................................... 8

3.1.

Action at international level...................................................................................... 8

3.1.1.

Loans subsidised by the World Bank ........................................................................ 8

3.1.2.

Experience at the Council of Europe......................................................................... 9

3.2.

3.3.

Member States: measures involving interest-rate subsidies ..................................... 10

Community measures involving interest-rate subsidies ........................................... 11

3.3.1. A tentative classification......................................................................................... 11

3.3.2. Community programmes ........................................................................................ 13

4.

CONCLUSIONS AND RECOMMENDATIONS................................................... 15

ANNEXES: COMMISSION WORKING PAPER ON INTEREST-RATE SUBSIDIES ...... 20

5.

5.1.

5.2.

5.3.

5.4.

5.5.

5.6.

5.7.

ANNEX I: INTEREST- RATE SUBSIDIES: COMMUNITY PROGRAMMES .... 20

Summary table of programmes ............................................................................... 20

ECSC subsidised loans (Article 56: industrial conversion)...................................... 21

Trans-European Networks (TENs).......................................................................... 23

Interest-rate subsidies to help certain Member States to participate in the European
Monetary System.................................................................................................... 26

Edinburgh facility (SMEs)...................................................................................... 27

Subsidised loans in the ACP countries .................................................................... 29

Interest-rate subsidies linked to EIB loans in the Mediterranean ............................. 31

2

5.8.

5.9.

ERDF Programme .................................................................................................. 33

EAGGF Programme ............................................................................................... 34

5.10.

Interest-rate subsidies in the central and eastern European countries - Phare budget 36

5.11.

Exceptional aid for the regions of Italy devastated by the earthquake of 1980 ......... 38

5.12.

Exceptional aid to the regions of Greece devastated by the earthquake of 1981....... 40

5.13.

Exceptional aid for the reconstruction of Kalamata (Greece) .................................. 41

5.14.

Aid for the reconstruction of Madeira after the cyclone in 1993.............................. 42

5.15.

5.16.

The Special Support Programme for Peace and Reconciliation in Northern Ireland
and the Border Counties ......................................................................................... 43

Interest-rate subsidies under the Financial Mechanism of the European Economic
Area ....................................................................................................................... 44

5.17.

Interest-rate subsidies for projects in the western Balkans....................................... 46

6.

6.1.

6.2.

6.3.

ANNEX II: ANALYSIS OF OPERATIONAL ASPECTS...................................... 48

Management and control ........................................................................................ 48

Visibility ................................................................................................................ 48

Evaluation of Community programmes................................................................... 49

6.3.1. Reconstruction programmes ................................................................................... 49

6.3.2. Other programmes.................................................................................................. 50

6.4.

6.5.

7.

7.1.

7.2.

7.3.

7.4.

7.5.

7.6.

8.

8.1.

8.2.

Compliance with the competition rules ................................................................... 52

Final remarks.......................................................................................................... 53

ANNEX III: INTEREST-RATE SUBSIDIES: EXPERIENCE IN
MEMBER STATES ............................................................................................... 55

Italy........................................................................................................................ 55

France .................................................................................................................... 56

Germany................................................................................................................. 58

Spain ...................................................................................................................... 61

Sweden................................................................................................................... 64

United Kingdom..................................................................................................... 66

ANNEX IV: THE USE OF SUBSIDIES IN THE CONTEXT OF EU POLICIES
WITH SPECIAL REFERENCE TO SOFT LOANS: THEORETICAL
CONSIDERATIONS ............................................................................................. 69

Introduction............................................................................................................ 69

On the use of subsidies in general........................................................................... 69

3

8.3.

8.4.

8.5.

8.6.

9.

9.1.

9.2.

9.3.

On the equivalence of different forms of subsidy .................................................... 72

On the suitability of different instruments for one and the same objective............... 74

On the implementation of soft loans ....................................................................... 79

Conclusion ............................................................................................................. 82

ANNEX V: MACROECONOMIC EFFECTS OF AN INTEREST-RATE SUBSIDY
FOR FIRMS IN THE EU ....................................................................................... 86

Introduction............................................................................................................ 86

Assumptions........................................................................................................... 86

Simulation results ................................................................................................... 87

4

INTEREST-RATE SUBSIDIES

1.

INTRODUCTION: COUNCIL REQUEST TO THE COMMISSION

In response to the Court of Auditors' Special Report No 3/99 on the management and control
of interest-rate subsidies by the Commission (OJ No C 217 of 29 July 1999), the Council
"questioned more generally whether interest-rate subsidies are still justified [...] taking into
account in particular the cost of effective control measures and the availability of other [...]
financial instruments, such as loan guarantees" (doc. 6224/100 rev. 1). Accordingly, it asked
the Commission to present as soon as possible "a comprehensive report on the general
usefulness of interest-rate subsidies in terms of cost and economic efficiency, in the light of all
relevant factors".

This report, which has been drawn up following numerous contacts with the EIB, the national
authorities and the different Commission departments responsible for Community spheres of
activity where interest-rate subsidies are used,
(i) a Commission
communication, and (ii) a Commission working paper attached as an annex.

in two parts:

is

The communication examines the question in its entirety and sets out some general guidelines
for future use of interest-rate subsidies.

The Commission working paper is more empirical in nature, describing the operational
aspects of the instrument and experience of interest-rate subsidy programmes within the
European Union, making a tentative assessment of those programmes and, lastly, examining
which financial instrument is more adapted to the objective being pursued.

2.

PART I:
SUBSIDIES; POSITIVE AND NEGATIVE EFFECTS

ASSOCIATED WITH

PROBLEMS

INTEREST-RATE

2.1.

Reasons for public intervention

Interest-rate subsidies are above all transfers of resources to natural or legal persons. Like any
transfer, they are generally justified by the public interest, either as a sign of solidarity (e.g. in
support of housing policy) or as an instrument of industrial or sectoral policy (e.g. to promote
investment in infrastructure or R&D, to promote exports, etc.) or both (e.g. as support for
regional policy). It is to be noted that, where the beneficiaries are enterprises, interest-rate
subsidies fall within the definition of state aid, itself subject to Article 87(1) of the Treaty.

The point must be made that distortions caused by any form of public intervention may be
justified (positive distortions).

Subject
considered justified where:

to the rules on monitoring aid,

intervention by the public authorities may be

(a)

the market is failing to provide the requisite financing for non-profitable activities or
projects regarded by the public authorities as being necessary to the welfare of the
population at large, e.g. TENs, R&D, agriculture and the environment. Also included
here are measures to assist less-favoured regions and firms in difficulty.

5

(b)

certain external shocks have to be dealt with, e.g. by way of measures to assist
countries/regions affected by natural disasters, etc. or negative externalities.

While these principles justify intervention by the public authorities, they are silent as to the
form such intervention should take: interest-rate subsidies, subsidies, guarantees, loans, equity
participations, or a combination of all of them? Now, these instruments differ not only in
nature and as regards their effects but also in terms of their costs, whether budgetary
management or control costs. In view of these particular characteristics,
the choice of
instrument or form of intervention by the authorities must be a function of the objectives
pursued and actual circumstances, even if recourse is had very often to two or more
instruments at the same time.

SPECIAL CHARACTERISTICS OF THE INSTRUMENTS FOR PROMOTING
INVESTMENT

* Direct grants:

Objective: public-interest projects in general

* Interest-rate subsidies:

Objective: to improve project profitability by reducing
financing costs
Example: infrastructures

* Loan guarantees:

Objective: access to credit for high-risk projects
Example: SMEs at the start-up or development stage

* Equity participations:

Objective: risk-sharing and flexibility of return on capital
Example: innovative SMEs

* Tax breaks:

Objective: to improve the profit outlook
Examples: craft sector, SMEs, regions lagging behind

In all cases of such intervention, it is essential that certain conditions regarding control,
transparency and effectiveness in relation to the objectives being pursued should be met. This
imposes a range of obligations on the public authorities entailing additional administrative
costs that must be taken into consideration when the decision to intervene is taken. It must be
borne in mind that the follow-up of such operations extends throughout the life of the loan.

2.2.

Interest-rate subsidies: positive effects

(cid:1)

Interest-rate subsidies have the direct effect of reducing financing costs; indirectly,
they have a beneficial effect on the demand for credit, investment and, ultimately,
employment. Given their specific characteristics, they are the ad hoc instrument for
action by the public authorities to reduce costs, to ease the financing burden and thus
to rectify any lack of profitability. They have only an indirect bearing on project risk,
for which there are other, more appropriate instruments such as guarantees or risk
capital.

6

(cid:1)

(cid:1)

(cid:1)

(cid:1)

(cid:1)

(cid:1)

(cid:1)

Since interest-rate subsidies are tied to loans, they have the advantage over other
forms of intervention of imposing the management stringency or discipline that any
bank loan requires. Viewed from this angle, there is, in principle, less risk of abuse or
misuse of public money than in the case of grants or other forms of aid.

Interest-rate subsidies have a significant financial leverage effect; for example, the
€
92.3 million of subsidies under the SME facility generated just under EUR 1 billion
of investment credits. From a budgetary angle,
they are therefore a relatively
economic tool not simply because limited financial involvement allows substantial
volumes of finance to be raised but also because the budgetary commitment can be
spread over a fairly long period.

One of the features of the instrument is that, from the outset, the body granting the
subsidies knows for certain what its intervention will cost, something which is not the
case with other instruments such as guarantees or equity participations.

Although interest-rate subsidies are an instrument of micro-economic policy very
different from macro-economic policy instruments such as the interest rate (monetary
policy), the effects work through in the same way in both cases: the reduction in the
cost of credit has a beneficial effect on economic activity, and in particular on
investment and then employment.

Using the Quest model, we have been able to estimate the impact on investment and
employment of an interest-rate subsidy policy covering all enterprises (we were
unable to use the model to carry out an econometric estimation for SMEs alone). The
result (see Annex V: Tentative econometric simulation) is clear: an interest-rate
subsidy of 0.5% in real terms reduces the cost of capital by 7% at the end of the period
and increases industrial investment by 5%.

These estimations are sufficiently robust to answer the criticism levelled in certain
quarters ("windfall") to the effect that the investor receives the subsidies but his
decision to invest is taken regardless of the measure in question.

The instrument of interest-rate subsidies is used for various purposes: environmental
projects, infrastructure projects, social policy projects, etc. We have not been able to
undertake any quantitative estimations of the effectiveness of such intervention but
few doubts remain as to the beneficial effect of interest-rate subsidies on such forms of
investment: witness the level of financial charges in the business plans for such
projects.

2.3.

Interest-rate subsidies: negative effects

The undesirable effects of this instrument are well known.

(cid:1)

(cid:1)

it may lead, macro-economically speaking,

Like any public instrument,
to an
inefficient allocation of resources, with financial efficiency being defined as an
allocation of resources to investment with the highest anticipated rate of return. This
may in turn result in less profitable projects being undertaken or give rise to activities
that the market would not have financed, etc.

Other, more specific distortions of competition may, however, occur: on the demand
side either because certain measures are not sufficiently publicised or because the
readily
complexity of

the conditions imposed means that

the scheme is not

7

understandable to those eligible; on the supply side either because certain financial
institutions reserve the instrument for their best clients or because the public
authorities entrust management of the instrument to a preferred intermediary and
exclude competitors.

From an operational viewpoint, the instrument also has a number of pitfalls that are
associated with similar instruments, in some cases to a greater degree:

(a)

(b)

the passing on in full of the interest rebate to the final beneficiary sometimes
lacks visibility and transparency and is not even always guaranteed;

"public" control of interest-rate subsidies, which is essential in the case of such
expenditure since it involves public monies, is not always easy. It is even
difficult sometimes to ensure that all the conditions for granting subsidies have
been met; abuses may occur;

(c) moreover, such controls and the management of

the programme add
significantly to the administrative costs. It
is estimated, for example, that
a posteriori documentary checks on the regularity of the operations of financial
intermediaries cannot process more than 25-30 projects a day. For some
programmes, the total management cost has been put at some 7-8% of the
appropriations earmarked for the subsidies.

interest-rate subsidies have become much less
It should be borne in mind that
attractive for promoters since interest rates in Europe have fallen. None the less, a
given percentage subsidy still represents a large proportion of the interest burden.

it must be added that these positive and negative effects of interest-rate
Lastly,
subsidies are not an exclusive feature of this instrument but are common to other
instruments too.

(cid:1)

(cid:1)

(cid:1)

3.

PART II: THE LESSONS OF EXPERIENCE

The interest-rate subsidy instrument is commonly used at international level (by multilateral
financial institutions), at national level (by the Member States) and at Community level (by
the European Union). For the purposes of this report, use at international and national level is
examined briefly and only by way of example.

3.1.

Action at international level

We will confine our analysis to two cases: the initiatives undertaken by the World Bank and
those undertaken by the Council of Europe.

3.1.1.

Loans subsidised by the World Bank

The bulk of World Bank loans to its member countries are provided by the IBRD
(International Bank for Reconstruction and Development) on market terms, i.e. without any
interest-rate subsidy. A second group of World Bank loans is designed for direct project
financing via the International Finance Corporation (IFC), which offers credit lines (without
five priority purposes:
for
intermediaries
to local
interest-rate subsidies)
infrastructure, SMEs, strengthening of financial structures,
information technologies and
social needs (education and health).

financial

8

Subsidised loans for
the IDA programme
the poorest countries are disbursed under
(International Development Association), which is administered by the IBRD. Finance is
provided in the form of outright grants from the richest countries in line with a programme
that is updated every three years. These resources and the redemption of earlier loans permit
the disbursement of loans to the most heavily indebted countries at a rate of 0% (plus 0.75%
loading) for a period of 30-40 years and with a grace period of ten years.1

Assessment

During the tax year 2000 (which ended on 30 June), the World Bank lent USD 15.3 billion, of
which USD 10.9 billion in the form of commercial loans and USD 4.4 billion (29% of the
total) in the form of subsidised loans. It had been much more active the previous year
(USD 29 billion in total) in the wake of the Asian crisis. The assessment made by the World
Bank of its assistance in the poorest countries is a function of how stringent financial
management in the beneficiary country has been. According to the World Bank, in those
countries that respect the fundamental equilibria and free trade, USD 1 in aid can be tripled
thanks to the confidence it imparts to private investors. On average, however, USD 1 in aid is
reckoned to generate USD 1.5 in investment. These estimates relate to aid as a whole (all
types taken together) granted by the institution, and not merely to interest-rate subsidies.

3.1.2.

Experience at the Council of Europe

Lending by the Council of Europe takes place through its Social Development Fund, which,
under its statute, intervenes in two clearly defined situations: (i) aid to migrant workers
(housing, healthcare, education, training, etc.) and (ii) reconstruction of areas affected by
natural disasters. In the latter case, the Fund has in the past launched initiatives similar to
those of the Commission in disaster areas in Greece and Italy. Its involvement is on a smaller
scale than that of the World Bank, with funding of
2 billion a year for between 30 and
40 projects.

€

Concessionary assistance from the Fund is intended for initiatives concentrated in very needy
areas (currently the CEECs) via financing obtained on the foreign exchange market and on the
best terms available at the time (triple A). This results in a substantial interest-rate differential
relative to the local market to which can be added an interest-rate subsidy of between 1.5%
and 3% according to circumstances.

Assessment

The effectiveness of such lending must be assessed in the light of the social mandate entrusted
to the Social Development Fund. The Charter's signatory states attach importance to such
lending; clear and easily verifiable objectives ensure that the loans enjoy political visibility
and are attractive. Intervention by the Fund signals support for the policy being implemented
by the recipient country, thereby facilitating the inflow of private capital from abroad.

1

At the time of the first oil shock in 1975, the World Bank inaugurated a Third Window to act as a
half-way house between the two previous facilities and financed by donations from the OECD and
OPEC countries. The intention was to grant subsidised loans to Member States experiencing difficulties
in the wake of the increase in interest rates. The experiment was short-lived (1976-77) because donors
were reluctant to provide top-up financing.

9

3.2.

Member States: measures involving interest-rate subsidies

(cid:1)

Many Member States grant interest-rate subsidies for a variety of objectives: general
aid schemes for productive investment by SMEs, the craft sector, etc. and specific
measures (export promotion, fostering of innovation, help for young entrepreneurs,
etc.) or social measures (housing policy).

These interest-rate subsidy schemes are sometimes part-financed by Community programmes
under the Structural Funds (ERDF, EAGGF) with a view to promoting economic and social
cohesion. The public authorities responsible for carrying out multiannual development
programmes in eligible regions administer themselves the interest-rate subsidies for final
beneficiaries or entrust their administration to financial institutions on a contractual basis.

Annex III reviews government measures in Italy, France,
the United Kingdom, Spain,
Germany and Sweden (for operational reasons, we have been obliged to limit the number of
cases studied). Recourse to interest-rate subsidies is fairly widespread in the other
Member States too (Finland, Portugal, etc.).

A number of examples will serve to illustrate the orders of magnitude involved in
Member States:

-

-

-

-

-

-

in Italy in the period 1995-99 subsidised loans totalled some
year;

€

0.7 billion a

in Germany in 1999 the Special ERP Fund, which centralises the management
of interest-rate subsidies on behalf of the State, granted loans amounting to
€

€

6 billion for investment projects by SMEs totalling

15 billion;

€

in France the interest-rate subsidy scheme administers loans amounting on
250 million in
average to
subsidies;

1.5 billion a year and costs the State some

€

in Spain interest-rate subsidies administered by the ICO under the ERDF
programmes for SMEs during the period 1994-99 totalled
194.6 million in
3.3 billion for investment projects costing some
respect of loans totalling
€

€

€

6.1 billion;

in the United Kingdom the Small Business Loan Scheme provided subsidies
for loans totalling

70 million;

€

in Sweden, where interest-rate subsidies are used largely for housing policy,
state assistance amounted to only
80 million in 1999, sharply down following
a reform undertaken in 1993 and the fall in interest rates.

€

(cid:1)

(a)

The main findings of our investigations, which were conducted primarily among
enterprises, are the following:

The objectives pursued by a policy on interest-rate subsidies are, generally speaking,
fairly well targeted (purchase of equipment, business start-ups, etc.). The reduction in
the cost of financing has fostered productive investment and thus strengthened
productive capacity and competitiveness, notably in the regions assisted. The
effectiveness of national measures and of Community measures administered by
Member States is generally deemed to be satisfactory.

10

The Member States have also set
in place an administrative and operational
framework designed to guarantee the transparency of the operation. Announcements
of these measures are made in the media in order to inform all potential beneficiaries.
A particular point to be noted is that the monopoly of administration and indeed of
allocation of interest-rate subsidies by preferred financial intermediaries is gradually
being replaced by a system of competitive tendering.

(b)

The policy of the Member States concerning interest-rate subsidies varies since they
are attempting to find the most economic way of achieving their policy goals. Some
are restructuring their interest-rate subsidy products to suit the changing enterprise
landscape (France), some apply packages of loan conditions (Sweden), some make
little, if any, use of interest-rate subsidies (United Kingdom), and some continue to
use them to pursue their policy aims (Germany, Finland, Spain, etc.).

3.3.

Community measures involving interest-rate subsidies

Annex I gives a concise description of EU measures and programmes providing interest-rate
subsidies and of the resources devoted to them.

Unlike Member States' measures part-financed by the ERDF and EAGGF programmes,
Community measures are implemented directly by the Commission, which in many cases
entrusts their management to the EIB on a contractual basis.

3.3.1.

A tentative classification

For the purposes of the analysis, these measures can be classified into two groups (see also
table below):

(a)

(i)

(ii)

(iii)

(b)

(i)

Measures designed to combat market failures, with the practical objective being:

macro-economic, such as the Edinburgh facility, designed to create jobs in SMEs
without distinction;

infrastructures

meso-economic: this includes measures to promote sectors such as the environment
(MEDA) or
(Trans-European Networks), where projects are
characterised by a clear public interest and poor profitability prospects. It also
includes measures to assist sectors undergoing conversion (ECSC) and regions
lagging behind, where there is a mix of social and development objectives. Subsidies
tied to soft loans for developing countries also fall into this subgroup;

micro-economic: this includes Community measures in support of innovative firms,
business start-ups, etc. where the entrepreneurial risk is considered by investors to be
unduly high.

Measures to deal with fairly unpredictable external shocks; this group includes:

measures with a social or solidarity objective, such as the operations to assist regions
devastated by natural disasters and the measures in favour of Madeira, Kalamata and
southern Italy that were authorised by the Council and amounted respectively to
€
1 billion in loans, together with a 3% interest
subsidy that was paid to the European Investment Bank or direct to the regional
authorities as in the case of Madeira;

100 million and

15.9 million,

€

€

11

(ii)

measures with a macro-economic objective, such as the former European Monetary
System facility for countries facing external difficulties threatening their continued
participation in the EMS as a result, for example, of a sharp increase in oil prices or
an attempt by foreign-exchange markets to destabilise the currency. This facility was
applied only once (for Italy and Ireland jointly) and has since been discontinued.

€

In aggregate, the EU's budgetary resources devoted to this instrument have been substantial,
approaching
3 billion. With a subsidy rate of around 3%, this figure gives some idea of the
volume of loans involved (leverage effect). Annex I provides a breakdown of the subsidies by
instrument. It should be borne in mind here that the bulk of the subsidies have been granted
and administered by the EIB, which also disbursed the corresponding loans.

Community programmes involving interest-rate subsidies

Programme

Objective

Amount of
€

subsidies, in
(period)

m

Volume of
corresponding
€
loans, in
m
(same period)

Market failures:

ECSC conversion (Art. 56)

Employment and access to
credit for SMEs

620 (1967-97)

6 655

Trans-European Networks (TENs)

Transport infrastructures

171 (1995-99)

Edinburgh facility (SMEs)

Employment and access to
credit

92.3 (1994-96)

n.a.

1 000

Development cooperation (ACP)

Economic development
and Slovenia)

(MEDA

Infrastructures and access to
credit for SMEs

Environment
transport
(Slovenia)

(MEDA) and
infrastructures

496 (1986-99)

2 066

190 (1995-1999)

700

Phare programme (CEECs)

For information: Economic and
social cohesion (ERDF, EAGGF)2

Access to credit and
privatisation

Access to credit for SMEs

n.a.

3

n.a.

2

3

These measures, part-financed by the Structural Funds, are given in this table for information only since
they are actually carried out by Member States.
6 820 million was planned in the form of
For the period 1994-99, part-financing totalling some
subsidies, loans and interest-rate subsidies (Report on Thematic Evaluation of Structural Fund Impacts
on SMEs - DG Regional Policy – 1999, p. 32). The definitive figures will be known only after
completion of the programmes.

€

12

External shocks:

Natural disasters
Kalamata, Madeira)

(Italy, Greece,

Reconstruction and
restoration of productive
capacity

Madeira: 4.2

Madeira: 15.85

Greece: 27

Greece: 180

Italy: 211

(1982-92)

Italy: 1 000

European Monetary System

Infrastructures

1 000 (1979-83)

5 000

Peace and reconciliation in Ireland

Reduction in disparities (EEA)

Reconstruction in the Balkans
(FYROM and Bosnia)

Access to credit for SMEs
and infrastructures

Access to credit for SMEs
and infrastructures

Restoration of productive
activity and transport
infrastructure

34.7 (1995–97)

240

134.2 (1994-99)

1 500

39 (1998-2000)

FYROM: 150
Bosnia: 100

3.3.2. Community programmes

in the various programmes
The task of assessing the effectiveness of this instrument
mentioned above (described in Annex I) is not easy;
the
difficulty of calculating accurately management and control costs, the lack in some cases of
quantifiable objectives, the induced effects of the measures, etc. make any quantitative
assessment of effectiveness unreliable.

the small amounts involved,

Generally speaking, however,
interest-rate subsidies are an appropriate intervention instrument particularly as:

the analytical criteria described in Part I suggest

that

-

-

-

they are designed primarily to make up for poor project profitability and not to offset
risk;

they are properly targeted, thereby reducing the negative effects described above,
with a resulting increase in effectiveness;

ex post control and evaluation of the programmes are possible and reasonably
guaranteed, as is transparency (the subsidies are passed on in full to the final
beneficiaries).

By following this line of reasoning, the following observations can be made:

(a)
As regards the Community measures described at point 3.3.1 ("solidarity measures"),
interest-rate subsidies appear appropriate since, on the one hand, these measures are closely
targeted and involve investments - notably in infrastructures - with low profitability and, on
(discrimination, distortion of competition, etc.) are
the other,

the negative effects

13

insignificant.4 In some cases, however, there is still a problem of control because of the
increase in the number of bodies intervening and the large number of recipients.

The same can be said of concessionary loans to public and private operators in the ACP
countries, especially where tangible investment projects are being financed. Concessionality
here often takes the form either of a separate financial allocation earmarked for specific
technical assistance linked to the investment in question or of a reduction in the rate with a
view to facilitating debt servicing. It is thus more than a simple matter of an automatic
reduction in the rate and contributes to attainment of the development objectives.

(b)
Interest-rate subsidies for transport infrastructures (excluding the telecommunications
sector and certain energy sectors) and for environmental projects are especially appropriate,
notably in the case of projects where the Community interest is in addition to the national
interest (missing links). These are tangible investment projects that have poor profitability but
are of considerable public utility, and the control of the public monies involved is relatively
easy. What is more, not only are the negative effects of any distortion of competition very
limited but, when completed, these major works are quite often an important factor enabling
economic operators to participate fully in the internal market.

In the case of competing enterprises, the way in which interest-rate subsidies are
(c)
administered differs according to whether or not
they are located in regions receiving
assistance from the Structural Funds. Subsidies granted to enterprises in such regions are
included in point 3.2. under subsidies administered by Member States.

In the other regions, a distinction must be made between newly established SMEs and SMEs
requiring new investment in order to expand. In the former case, and notably where the
enterprises are located in growth sectors, the problem is less one of poor profitability and
more one of the high risk of failure associated with early-stage development; in many cases
they do not have access to credit, irrespective of the interest rate they are prepared to pay.5 By
contrast, the rates of return of those enterprises which move beyond early-stage development
and are located in growth sectors are often very high. Under the circumstances, therefore, it is
evident that subsidised loans are not the appropriate tool here since, in addition to the rigid
nature of loan redemption, it is highly probable that the subsidies will be redundant. In the
event, other instruments such as guarantees or risk capital as well as horizontal measures such
as tax reform and simplification of administrative procedures may possibly be more
appropriate (although each instrument has its own limitations).

(d)
The granting of interest-rate subsidies to SMEs generally, e.g. under the Edinburgh
facility, poses certain questions. Leaving aside the fact that the programme objective (job
creation) was achieved at a very low budgetary cost,6 the first remark concerns the size of the
programme. Since they have a very limited budget, these measures benefit only a small
number of enterprises, and the macro-economic objective (reduction in unemployment)
cannot be achieved using the instrument. There is, therefore, something of a mismatch
between the objective and the instrument.

4

5

6

It should though be pointed out that, since they are geared to enhancing solidarity, these Community
measures must be evaluated by applying more than a simple economic calculation.
Newly established SMEs have to invest heavily in production, distribution and marketing and do not
make profits during the first few years. The breakeven point could be in five years, or even later. Banks
are reluctant to extend financing under such circumstances.
€
The average subsidy for each new job was only
money (Commission report COM(2000) 376).

1 716 and represented extremely good value for

14

From an operational viewpoint, since the financial circuit through which the public aid is
channelled is, of necessity, very long, transparency is not fully ensured, but this is a feature
common to other programmes too.

4.

CONCLUSIONS AND RECOMMENDATIONS

(cid:1)

(cid:1)

Interest-rate subsidies are an instrument used widely in Community programmes in
pursuit of various objectives:

– political objectives: natural disasters in the countries of the Union as a symbol of
solidarity; subsidised loans in the CEECs (preparation for enlargement);
the
Balkan countries (regional stability) or the ACP countries (EU presence), etc.;

– economic objectives: structural problems, regional disparities, market failure,
support for SMEs, launch of infrastructure projects, anti-cyclical instruments:
unemployment, etc.

The main conclusion of this report is that it is not possible to state definitively that
interest-rate subsidies are an effective instrument; this depends not only on the nature
of the objectives of a particular measure and the manner in which the subsidies are
administered or utilised7 but also on the scope for exercising strict control and, lastly,
on the distribution chain for the subsidies and the quality of intermediaries.

The analysis made in this report has nevertheless brought to light a number of
underlying trends regarding the merits or limitations of the instrument. With all the
reservations that any attempt at simplification entails,
the situation can be
summarised as follows:

Strong points:

– Low budgetary cost;8

– Leverage effect (multiplier);

– Additionality;

– Linkage to a well-known form of general support (bank loan);

– Symbol of Community solidarity.

7

8

Interest-rate subsidy schemes differ greatly, e.g. between TENs and MEDA or other RELEX
programmes; subsidies are paid and administered in the former case by the Commission according to its
own control criteria and in the latter by the EIB according to a different arrangement.
However, where the choice of financial instrument for certain Community programmes (e.g. EAGGF)
is left to the Member States, experience has shown that the choice made is not neutral from a financial
viewpoint and in particular that it is unlikely to minimise the budgetary costs to the Community.

15

Weak points:

– Risk of inefficient allocation of resources;

– Cumbersome administration;

– Not-inconsiderable administration costs;

– Control and transparency not always ensured;

– Risk of discrimination;

– Low visibility.

Management and control are of major importance. Since interest-rate subsidies are tied
in most cases, entrusted to the EIB under an
to loans, overall management
agreement signed with the Commission. Given the number and type of beneficiaries
(SMEs, etc.), other national financial institutions intervene in the distribution chain,
and this necessarily complicates programme monitoring and control. It would seem
that this constraint is, however, difficult to avoid.

is,

(cid:1)

The issue of administration costs should also be commented on. These are,
is true,
significant in the case of interest-rate subsidy programmes or any other programmes that
cover thousands and even tens of thousands of small beneficiaries. That said, the commercial
nature of the intermediaries and competition between banking institutions help to keep down
costs. Moreover, in some cases, the amount received by intermediaries has to be considered
inadequate in relation to the costs incurred, especially in the case of intermediaries who set up
procedures to handle small subsidies.9

it

Lastly, the constraint imposed by administrative costs must be set against the advantage of
having access to a vast banking network allowing Community initiatives to be implemented
within a reasonable time frame.

(cid:1)

(cid:1)

The question as to which financial instrument is better adapted to the objective is
discussed in detail in the report.10 To sum up, this analysis suggests that interest-rate
subsidies are appropriate for remedying serious deficiencies in the financial sector and
for supporting projects with low profitability in special areas requiring assistance
(developing countries, assisted regions, etc.). They are also appropriate when the
project generates indirect positive effects (externalities) that cannot be reflected in the
user price of the service (environment, transport links, etc.) as well as for dealing with
external shocks (natural disasters, etc.).

The comparison between instruments does not permit any general clear-cut
conclusions either.

Interest-rate subsidies and direct donations (lump-sum) are virtually identical.11 Donations
(discounted subsidy paid as a single amount anticipated at the time of the loan) also aim to
reduce the cost of borrowed capital. But, unlike a donation, the beneficiary of a subsidy is still

9

10

11

in the implementation of the SME facility,

For instance,
the national agents and the
intermediaries shouldered a not inconsiderable administrative burden. In many cases, the intermediaries
created new internal procedures to accommodate the scheme and produced publicity material at their
own expense. The intermediaries were remunerated and received fees amounting to 1% of subsidies
disbursed (SME Facility Fifth Report).
See Commission working paper, Annex IV "Theoretical considerations".
However, the implications for the beneficiary's cash flow differ.

the EIB,

16

subject to the monitoring conditions imposed by banks throughout the loan redemption
period. Such monitoring comes on top of that exercised by the public body granting the
subsidy and thus complements it. However, donations are simpler to administer and more
transparent12 but they have a more adverse impact on the Community budget (concentrated in
the first year).

Recourse to guarantee-type instruments seems more justified than recourse to interest-rate
subsidies in cases where the financial system is reluctant to intervene because of the high risk
of the project (risk aversion), where information is asymmetrical or where the small scale of
the project does not justify the risk-assessment costs. In these cases, the guarantee allows
SMEs access to credit by diversifying the risk among a large number of lenders. In some
cases, however, guarantees may be prejudicial to the principles of sound administration (so
much so that this possibility can be minimised by close project monitoring and control).

Risk capital is a more flexible instrument than bank loans (interest payments are not rigidly
fixed) and very appropriate when it comes to risk sharing, notably in the earlier phases
(start-up, early-stage, etc.) of firms with high growth potential. The clear advantages of the
instrument are offset by the very small number of potential users and by the fact that the
institutional investor (venture capitalist) does not have a guaranteed exit (small, fragmented
stock market and regulatory barriers13).

It goes without saying that some of the advantages and disadvantages of interest-rate
subsidies are also common to other financial instruments.

(cid:1)

A number of conditions have to be met
effective:

if interest-rate subsidies are to remain

– Strict compliance with state aid legislation in order to limit any undesirable side

effects.

– Genuine competitive bidding between financial intermediaries can help to reduce
the lack of any real competition between
administrative costs. Moreover,
intermediaries can create distortions on financial markets and jeopardise the
transfer of the subsidy to the final beneficiary. In such cases,
interest-rate
subsidies must be avoided.

– Improved targeting of objectives/beneficiaries must be accorded priority (the
allocation of interest-rate subsidies to enterprises in general can be criticised
except in the case of specific regions, sectors or tangible investment projects).
Such assistance must be for a limited period.

– The programmes should have a budget that will trigger a visible impact and

amortise implementation costs.

– Public controls must be a requirement that is explicitly spelt out in contracts but
any duplication should be avoided. The cost of controls must not outweigh their
benefits. In the case of financial intermediaries, there is no manageable way to
ensure to what extent an interest-rate subsidy is actually transferred to the

12

13

TENs financing is one example even though this project category also contains exceptions for
interest-rate subsidies (see point 5.3 in Annex I).
See Risk Capital Action Plan (COM (2000) 658 final).

17

intended final beneficiary and to what extent it benefits the intermediary. This is
not a question of abuse that could be resolved by stepping up control operations; it
is inherent to the nature of interest-rate subsidies and is due to the fact that the
conditions for individual loans cannot be regulated by the Commission.

– Interest-rate subsidies must be accompanied by simple and clear

rules.

Complicated implementation and quantification conditions must be avoided.

– Programme implementation must generate value added for national measures

(subsidiarity).

– The monitoring and assessment aspects must be reinforced. Any programme must
to an ex ante evaluation, a mid-term evaluation and an ex post

be subject
evaluation.

in interest

rates14 and the availability of other
The fall
financial engineering
instruments have now reduced the relative importance of interest-rate subsidies.15
Encouragement should, therefore, be given to the use of complementary or alternative
instruments. What is more, a combination of two or more instruments may prove more
beneficial than reliance on a single and exclusive financial instrument. Partnership
(co-financing, etc.) between the public and the private sector should also be stepped
up. It should, however, be pointed out that interest-rate subsidies are tied to bank
loans, which were, and are still,
the main source of financing for productive
investments (it is a well-known fact that most SMEs are undercapitalised and depend
to a large extent on bank finance).

For a full appraisal of the instrument, account also needs to be taken of the views of all
those involved, particularly national intermediaries and final beneficiaries.

(cid:1)

(cid:1)

Financial intermediaries, which play the key role in the distribution chain, mostly
take a positive view of interest-rate subsidies for the following reasons:

• The direct effect and simplicity of the instrument: banks provide interest-rate
subsidies to firms to which they have granted credit. This is a more effective and
more direct mechanism than a guarantee line, which requires a more complex and
more uncertain procedure.

• The temporary and revocable delegation of responsibilities, with a posteriori
control, allows banking networks to assume part of the distribution cost under
optimum conditions. Value added stems from the dilution and transformation of
the cost within an overall financial and commercial relationship.

14

15

However, a fall in nominal rates does not necessarily mean a corresponding fall in real rates.
It is important to recognise that interest-rate subsidies are becoming a less important part of overall loan
conditions. For entrepreneurs and start-ups, it is much more relevant to obtain long-term finance (up to
twenty years) and a grace period, which cuts capital costs in the early phase (up to three years). For
the built-in
commercial banks channelling promotional
risk-sharing elements of such loan schemes are a relevant factor reducing their exposure. Currently,
access to long-term finance at reasonable cost, and not merely the interest-rate subsidy, makes schemes
attractive for entrepreneurs and start-ups in all sectors of the economy.

loans and quasi-equity to entrepreneurs,

18

Where financial beneficiaries are concerned, it is well known that bank loans (and
hence interest-rate subsidies) are preferred to equity participations by outside
shareholders on account of the partial loss of management control entailed by risk
capital. However, for some enterprises representing a very small proportion of the
forms of financial
total number of enterprises in the European Union, other
engineering have their attractions. Since enterprises learn as they go along, SMEs
could abandon loan financing in favour of more sophisticated options.

(cid:1)

For the reasons given above, interest-rate subsidies have played an important role in
the past. Generally speaking, given the historical context, their positive aspects can be
regarded as having outweighed the constraints they impose. The question of
abandoning them must not, therefore, be based on results (overall, the objectives have
been achieved) but rather must be viewed in the context of the emergence of a new
financial environment.

Under the circumstances, it would seem expedient for innovative firms facing high risks to
opt, among the financial instruments available, for guarantee or risk capital arrangements
when having to contend with market failure, notably in the start-up phase.

Elsewhere, the question of abandoning interest-rate subsidies in favour of other instruments
should be examined closely.16 This observation applies above all to programmes for areas
where financial markets are not yet highly developed (developing countries, CEECs), for
certain less-favoured regions in the European Union or for certain project categories
(environment, TENs, etc.) that give rise to externalities.

16

For example, risk capital schemes cover a very small number of enterprises. In 1999 only 3000 start-ups
were financed by risk capital in the EU whereas some 1. 5 million SMEs had recourse to bank lending.

19

ANNEXES: COMMISSION WORKING PAPER ON INTEREST-RATE SUBSIDIES

5.

ANNEX I:

INTEREST- RATE SUBSIDIES: COMMUNITY PROGRAMMES

5.1.

Summary table of programmes

Programme

Market failures:

ECSC conversion (Art. 56)

Trans-European Networks (TENs)
Edinburgh facility (SMEs)

Development cooperation (ACP)

Economic development
(MEDA and Slovenia)
Economic and social cohesion
(ERDF, EAGGF)
Phare programme (CEECs)

External shocks:

Natural disasters
(Italy, Greece, Kalamata, Madeira)

European Monetary System
Peace and reconciliation in Ireland

Reduction in disparities (EEA)

Reconstruction in the Balkans
(FYROM and Bosnia)

Objective

Employment and access to
credit for SMEs
Transport infrastructure
Employment and access to
credit
Infrastructures and access to
credit for SMEs
Environment and transport
infrastructure
Access to credit for SMEs

Access to credit and
privatisation

Reconstruction and
restoration of productive
capacity
Infrastructures
Access to credit for SMEs
and infrastructures
Access to credit for SMEs
and infrastructure
Restoration of productive
activity

5.2.

ECSC subsidised loans (Article 56: industrial conversion)

A.

Description

The purpose of subsidised conversion loans (Article 56 of the ECSC Treaty) is to assist in the
economic conversion of regions affected by the decline of the coal and steel industries, by
making a financial contribution to job-creating investment. The first loans were disbursed in
1961.

20

Amount of subsidies

Initial subsidies granted between 1993 and 1997

€
€
€
€
€

1993
1994
1995
1996
1997

Total :

37 693 920 for 20 911 jobs created
26 275 492 for 13 213 jobs created
21 614 248 for 11 138 jobs created
13 732 288 for 7 249 jobs created
22 948 045 for 11 482 jobs created
€

122 263 993 for

63 993 jobs created

Since the ECSC Treaty will expire in July 2002, the last loan instalments were disbursed in
May 1997, so that they can be repaid in May 2002, before the expiry of the Treaty.

Beneficiary industries/firms

Any firms located in an ECSC area, but particularly SMEs.

All industries are eligible, except those on a negative list, such as:

– the retail trade where the vendor does not process goods;

– hospitals;

– educational establishments;

– the steel industry, etc.

Criteria for granting interest-rate subsidies

– Investment

The amount invested must be at least twice the ECSC loan.

– Jobs

Jobs must be created not later than three years after disbursement of the loan (assessment
date).

They must be maintained for at least the following two years.

B.

Operational aspects

Management

The initial amount of the interest-rate subsidy is calculated on the basis of the number of jobs
to be created and the loan amount requested.

The subsidy is paid in three equal instalments, on the following due dates:

1. First instalment: one year after disbursement of the loan.

2. Second instalment: three years and six months after disbursement of the loan, following
verification of the business report demonstrating that the objectives of carrying through the
investment and creating jobs (social clause) have been achieved.

3. Third instalment: five years after disbursement of the loan, following verification of the
business report demonstrating that the jobs created have been maintained.

21

Control and procedures

Project control is decided on as part of the annual missions schedule laid down by DG
ECFIN's Financial Operations Unit 01 (Budget and Financial Aspects).

Depending on the case, the unit member is accompanied by members of other units or
institutions, such as:

– the European Court of Auditors;

– the European Commission's Financial Control Directorate-General (DG Audit);

– DG ECFIN's Evaluation and Internal Audit Unit;

– DG ECFIN's Project Management Unit.

Visits are made in the presence of an agent of the financial intermediary concerned by the
projects to be checked.

Control is carried out on the basis of official documents or declarations, such as:

– monthly returns of social security contributions;

– wages book;

– annual balance sheets confirmed by the auditors' report, etc.

C.

Evaluation

A report exists for the period 1981-90, and a new study is planned for the period 1991-2000.
In answer to questions put to it on several occasions by the Court of Auditors and the
European Parliament, the Commission has provided general replies on the effectiveness of the
actions carried out.

The real impact on job creation of interest-rate subsidies paid by the Commission under
Article 56 of the ECSC Treaty can be measured quantitatively as follows:

– the ECSC disbursed 15 000 loans and sub-loans in the period between 1982 and 1997,

most of which were granted to small and medium-sized enterprises;

– these loans helped to create about 285 000 new jobs at a budgetary cost of

ECU 490 million.

The ECSC has never claimed that
these loans and interest-rate subsidies alone were
responsible for creating these 285 000 new jobs; rather, they formed part of a package of
measures at European, national and local level which stimulated job-creating investments.

According to information received from banks acting as the Commission's financial
intermediaries and from beneficiary enterprises, the loans and interest-rate subsidies received
under Article 56 of the ECSC Treaty for job creation have, in fact, played an important role in
the investment decisions of the enterprises concerned.

22

5.3.

Trans-European Networks (TENs)

A.

Description

From 1995-99,
legal basis: Council Regulation (EC) No 2236/95 of 18 September 1995
laying down general rules for the granting of Community financial aid in the field of
trans-European networks.

From 2000, legal basis: European Parliament and Council Regulation (EC) No 1655/1999 of
19 July 1999 amending Regulation (EC) No 2236/95 laying down general rules for the
granting of Community financial aid in the field of trans-European networks.

Amount of interest-rate subsidies committed in the last five budget years (

€

m, approximate):

1995: 25
1996: 18
1997: 37
1998: 20
1999: 71.
(cid:1)

Objectives

Interest-rate subsidies are intended to assist in the launch of transport infrastructure projects,
mainly by reducing the financial burden on implementing authorities in the pre-operational
phase. They reduce the interest costs, or financing costs in general, of a loan. Some large TEN
projects have been funded primarily by loans from public financing bodies (e.g. EIB, National
Debt Offices, etc.) or from the international banking system.

(cid:1)

Criteria for granting interest-rate subsidies

To ensure agreement on the administrative procedures to be followed in the use of
interest-rate subsidies, criteria were laid down by the Commission departments responsible
for transport, subjected to inter-departmental consultation and agreed by the TEN Financial
Assistance Committee in 1997.

Regulation (EC) No 2236/95 stipulated in Article 4(1)(b) that Community aid for projects
may take the form of subsidies of the interest on loans granted by the European Investment
Bank or other public or private financial bodies. In addition, a declaration attached to the
minutes of the Council meeting at which this Regulation was adopted gave some further
indication of the proposed use of this form of support; the Commission declared that the
amount of interest-rate subsidy from the Community budget allocated to a project in a given
year should always represent a fraction of the volume of interest payments actually borne by
that project during the year in question.

The rules for interest-rate support for TENs proposed by the Commission in 1997 made a
distinction between different
in particular, between single-purpose
authorities, on the one hand, and multi-purpose authorities, on the other.

types of promoter;

Single-purpose authorities:

In the case of single-purpose authorities, all expenditure is effectively aimed at meeting the
objectives of the project which the Commission seeks to support. It
therefore seemed
unnecessary and unjustifiable to demand that each individual loan taken out by the authority
should be assigned to a physical objective. In such cases, loans are generally raised to meet

23

overall liquidity needs and not to pay for individual actions at any event. Loans are swapped
in some cases according to the conditions on international currency markets.

In such cases, the following rules apply:

– interest-rate subsidies not to exceed five years, this being the general rule laid down in
Article 4(1)(b) of Regulation (EC) No 2236/95 (although loan repayment itself may need
to be monitored over a longer period, depending on circumstances), and to be below actual
accumulated interest expenditure in each eligible period;

– interest-rate subsidies only for amounts of over ECU 1 million per year

(for

cost-effectiveness reasons);

– support can be granted to either newly negotiated or existing loans;

– interest-rate subsidies would be paid after receipt of invoices showing that interest had
been paid, and progress reports showing the achievement of physical milestones, and
related payments, as set out in the relevant Commission decision and application form;

– interest-rate subsidies will be paid direct to the beneficiary, where possible;

– overall support under the Regulation will be below 10% of the total expenditure on the
project during the entire period of support (i.e. within the spirit of the TENs Financial
Regulation limits on the financing of construction). (This may give the Commission the
flexibility to pay interest-rate subsidies of over 10% of expenditure for specific years, e.g.
during the launch period, when financial costs may be especially high. This form of
“accelerated” payment will in a way mirror the normal advance payment of 40% for direct
grants.)

Multi-purpose authorities:

In the case of multi-purpose authorities, the above individual points still apply but it cannot be
said in these cases that any loan is eligible for interest-rate support. Clearly, the loan or loans
supported by the Commission must be earmarked for the specific projects (i.e. track sections,
equipment installations, etc.) which it wishes to support. In practice, this specific link is more
likely to exist when the loan has been taken out from an institution like the EIB, which itself
demands regular reports on the achievement of physical objectives.

B.

Operational aspects

(cid:1)

Control

Essentially, the two key principles of control are the same as those applying for traditional
direct grant projects, i.e. (i) measuring physical progress and (ii) checking the eligibility of
expenditure and verifying the correctness of accounts.

For both types of project authority (see above), the Commission needs to ensure as a
condition of payment that proof of loan agreements and obligations, and the actual repayment
of financial costs, is accompanied by satisfactory physical and expenditure progress on
launching or continuing the project (according to the stage in its evolution). Payment of initial
tranches of interest-rate support and of the final tranche is contingent on progress towards and
achievement of the objectives respectively. Payments to contractors should be verified and
audited.

24

Lack of physical progress, or failure to launch, will mean that interest-rate subsidy payments
should be withheld by the Commission, as would be the case with payment tranches in a
direct grant scenario.

Finally, the amount paid should be flexible, although linked to physical progress, and will not
exceed 95% of the amount of the interest-rate subsidy specified in the decision so as to allow
for an amount to be held back pending accounting controls and assessment of the achievement
of physical objectives set out in the decision.

(cid:1)

Visibility

The exact nature of this concept is hard to define. TEN projects supported by interest-rate
subsidies are essentially subject to the same general rules regarding physical progress as direct
grant projects and hence to associated requirements (e.g. for publicity to be given through
signboards, etc. showing the role of the European Union). Part of the purpose of control is to
ensure visible progress in this sense.

C.

Evaluation

As part of the mid-term evaluation of the TEN-T budget interventions, which the Commission
departments responsible for transport commissioned and which was delivered by outside
experts in 1999, the efficiency of interest-rate subsidies ("interest rebates") as a financial
instrument was discussed. An extract from the evaluator's report follows:

"The instrument of interest rebates is seen as the second best solution and generally of more
value with high and volatile interest rates. Nowadays nominal interest rates are lower and in
some Member States some transport operators (such as railways) can receive high grants from
their governments and interest-free loans making the instrument of interest rebates even less
attractive.

In addition the duration of the interest rate subsidy is not always compatible with the loans
and project duration. The present limit of five years is considered as a serious constraint for
the development of this instrument.

However Member States do not reject the possibility of applying for interest rate rebates in
the future in the light of PPP approaches. Therefore, the Commission should better explain
and spread more information on the reasons and advantages for project promoters to apply for
this instrument. More information on the existing TEN-T projects benefiting from interest
rebates should be provided to other Member States.

Three projects have applied for this instrument to date : the Øresund fixed link, the Belgian
HST, and Malpensa Airport. In these three cases, the choice of this form of intervention was
suggested by the Commission and the three projects received loans from the European
Investment Bank.

• Interest rebates function well for the Øresund connection but have otherwise not been
applied in Sweden. This type of support has been discussed as a possibility for the third
runway at Arlanda airport. The civil aviation administration did, however, not consider
them as a feasible solution as loans for the runway will have to be raised by the national
civil aviation administration proper, and not by the airport, which organisationally is only a
division within the administration.

25

• Interest rebates helped to complete the financial plan of the Belgian HST project and
launch the construction phase. As the Belgian Railways had to borrow the funds needed to
build the HST, the financial return of the project was highly influenced by the interest
charges. This instrument appeared to be the most adequate one in this particular case and at
that particular moment in time. It allowed Belgian Railways to be provided with EU aid
that was not directly linked to the stretches of routes for which the Belgian requests were
originally made.

• The Malpensa 2000 project is an example of a project for which this kind of support can be
well suited. It was the Commission itself who suggested this solution, believing that it was
the most appropriate one for this project.

Some Member States suggested that the interest rate form of aid should be allocated to the
promoter as a lump sum rather than be related to a specific loan. Railway companies do not
always borrow money for a specific project, but loans are arranged to finance their global
investment programmes. If the interest rate subsidy form of aid is granted provided that it is
linked to a specific and well-defined loan scheme,
then it can perturb its financial
management or impose increased auditing procedures."

There are also advantages to interest-rate subsidies for TENs : they are good for private or
semi-private project authorities which have to face high financial costs in the years before
their project starts to yield revenue from tolls, etc. (this was certainly the case for the Øresund
fixed-link project).

5.4.

Interest-rate subsidies to help certain Member States to participate in the
European Monetary System

A.

Description

At the end of December 1978 the Council adopted Regulation (EEC) No 3181/78 relating to
the European Monetary System (EMS). Previously, the Council had recognised the need to
support the less prosperous Member States in their efforts to participate in the EMS. Support
was to take the form of assistance in carrying out infrastructure programmes and projects
financed by the EIB and by the recently established NCI (Decision 78/870/EEC of October
1978).

The Regulation implementing this support was adopted in August 1979 (Regulation (EEC)
No 1736/79); it granted a 3% interest subsidy for loans relating to Commission-approved
programmes of up to one billion units of account a year for a period of five years. It was also
agreed that the discounted value of the subsidies to be entered in the general budget of the
Community should not exceed 200 million units of account a year for a period of five years.
At the same time, the Council designated Ireland and Italy as the Member States which were
eligible for these subsidies. The implicit subsidy for them was: 200 million units of account in
1979, 197 million in 1980, 193 million in 1981, 210 million in 1982 and 200 million in 1983.

In accordance with the above-mentioned Regulations, eligibility depends on the execution of
major infrastructure projects in Italy and Ireland that meet EIB and NCI operational criteria
and are capable of anchoring these countries' economies more firmly in the European
Monetary System. By financing individual projects of undisputed public utility, the aim was
therefore to pursue an overall (macroeconomic) objective in parallel with other instruments
with the same purpose. It will be remembered that at the time the oil crisis had destabilised
the industrialised countries' balances of payments and exchange rates and Community
solidarity had been mobilised on behalf of the weakest countries, i.e. Italy and Ireland, in the

26

form of Community borrowings (Article 108 of the Treaty). The interest-rate subsidies for
infrastructure projects thus reinforced measures to restore external equilibrium.

B.

Operational aspects

The subsidies were managed by the EIB, which both selected the projects and disbursed the
aid.

In view of the relatively large subsidy amounts decided by the Council, the EIB kept very
large-scale projects separate from those it usually managed so that they could be monitored
more easily. In some cases it selected tranches of programmes which had been started before
or were to be completed after the eligible period (1979-83) because of the scale of the projects
and the economic importance of the tranches in question.

The subsidies were paid to the project promoters only for the five-year period laid down by
the Council. Each half year, the EIB presented the Commission with a refund application
calculated on the basis of the subsidised amounts, updated at the beginning of each half year.
Italy thus received aid totalling ECU 669 million in respect of a loan volume of
ECU 3 336 million; the subsidies for Ireland totalled ECU 331 million in respect of a loan
volume of ECU 1 470 million. Control was exercised by the EIB and the Commission, in
cooperation with the central banks of the two countries concerned.

C.

Evaluation

During its investigations, the Court of Auditors noted delays in the execution of the projects
and increases in costs as compared with the original estimates. These overspends were
covered by other sources of finance such as the ERDF and state aid.

These criticisms, relatively minor by comparison with the objectives, did not prevent the
Court from acknowledging that the objectives had been attained. It stated that these projects
had contributed to the development of the water supply and drainage infrastructure in Ireland
in the context of the expansion of industrial, agricultural, tourist and urban activity. The
Court's assessment of the extension of an aqueduct in Italy was more qualified because of the
delays caused by the 1980 earthquake but it did not call into question the key importance of
the work for the economy of the Mezzogiorno.

5.5.

Edinburgh facility (SMEs)

Council Decision 94/217/EC of 19 April 1994

A.

Description

(cid:1)

Description

The purpose of this programme was to help enterprises, in particular SMEs, to create jobs. It
was decided on in the early 1990s, a period of severe recession, fairly high unemployment and
interest rates, and deep pessimism on the part of various economic actors.

The programme is managed by the EIB on behalf of the Commission. In each Member State
the EIB dealt with a national agent that coordinated the network of financial intermediaries
which selected the individual projects.

27

The interest subsidy related to interest on a five-year loan financing a job-creating investment
project. The financial intermediaries carried out the financial analysis of the credit provided
by the EIB. The subsidy was based on the number of jobs created.

The SME facility is a temporary “one shot” facility which, at the request of the Council, had
to be introduced very rapidly. The operational part, which began in 1995, was completed in
1997.
(cid:1)

Amount of subsidies

– Total amount of interest subsidies granted by the Council: ECU 100 million

The subsidy was tied to EIB loans of ECU 1 000 million to SMEs in the Community. On
8 June 1998 the amount distributed in interest subsidies totalled ECU 92 321 473.

At the end of 1997 subsidies paid totalled ECU 92.3 million. This amount corresponds to a
2% per year interest-rate reduction for a maximum of five years, which is equivalent overall
to 10% of the loan amount, or an average of ECU 3 000 per job created.

(cid:1)

Beneficiaries

– SMEs, in particular those with no more than 250 employees and a turnover not exceeding

ECU 20 million or assets not exceeding ECU 10 million;

– virtually all sectors of activity (some countries introduced exceptions);

– all Member States;

– The loans could not be combined with other subsidised loans granted by the EIB under

other agreements or with ECSC-subsidised loans.
(cid:1)

Criteria for granting interest-rate subsidies

In its application for subsidies, the SME had to state the amount of financing required from
the EIB, the capital cost of the investment and the number of jobs it planned to create; only
jobs created after 28 April 1994 were eligible.

In order to qualify for a definite subsidy payment, the beneficiary had to submit a sworn
statement concerning the actual net increase in the number of jobs and declaring that the
additional jobs had been in existence for more than six consecutive months prior to the date of
the declaration. If the number of jobs actually created was smaller, the proposed subsidies
were reduced accordingly.

B.

Operational aspects

(cid:1)

Management

The EIB shared out the facility among the national agents and its network of intermediary
banks.

– The interest subsidy is generally paid in a single instalment (lump sum). In Germany it was

used to reduce the last repayment of the borrowing.

28

– In its report the Court of Auditors criticised the fact that the rules were less clear in some

countries than in others.
(cid:1)

Control

The national agents verified each beneficiary's entitlement to its respective subsidy on the
basis of the declarations made by the intermediaries and beneficiaries. As well as the usual
monitoring of its global loans, the EIB also made spot checks on the documentary evidence
presented in support of the requests for subsidy payments. In 1996, 1997 and 1998 the EIB
monitored the procedures applied by agents in eleven countries

In its Report No 6/2000 the Court of Auditors criticised the fact that the Commission did not
monitor this facility in detail, despite the cooperation agreement.

(cid:1)

Community visibility

– The financial intermediaries' documentation generally referred to Community aid, at least

that of the EIB; this aspect was criticised by the Court of Auditors in its report.
(cid:1)

Accounting

– The accounting and presentation of the accounts were criticised by the Court of Auditors

and the Commission has undertaken to improve them.

C.

Evaluation of the action

* Four reports have already been presented to the European Parliament, the last on 2
December 1997 (COM (1997) 645 final).

* The fifth report was being drafted at the same time as this report. It contains statistical tables
and is more complete than the previous ones.

5.6.

Subsidised loans in the ACP countries

A.

Description

Successive European Development Funds have supported the action of the EIB and of local
banks by granting general interest-rate subsidies in order to reduce the very high level of
interest rates and to provide access to credit for small commercial and craft firms in the
countries which are signatories to the Lomé Convention. Since the pressing need for finance
is, however, very extensive, subsidies have also been allocated for infrastructure and sewerage
works.

During the life of the most recent Conventions, the WTO expressed reservations about this
general practice and about the risk of distorting competition in relation to neighbouring
countries not eligible for EDF loans. It has so far been possible to circumvent this obstacle by
granting loans to public enterprises at market rates, with the State receiving the interest-rate
subsidy under a contract signed with the enterprise concerned.

Nevertheless, in the spirit of openness which will guide future international conventions, it
has appeared essential to review the system as a whole in order to boost direct aid while
reducing indirect aid tied to a loan spread over time. The new ACP-EC Partnership
Agreement signed at Cotonou on 23 June 2000, which will replace the Lomé Convention,

29

contains a new financial mechanism - the Investment Facility (IF) - that will make it possible
to finance essentially private-sector investment. Like the risk capital funds under the old
Convention, this Facility will be managed by the EIB. The main changes introduced by this
Facility as compared with the former risk capital funds can be summarised as follows: unlike
the risk capital funds, the Facility will function as a revolving fund, thus offering ACP
countries a degree of security as to the finance available for private-sector development in the
short, medium and long term. In addition, the operations financed by the Facility (essentially
in the form of risk capital and loans) will be financed on conditions based on those of the
local financial market. However, the agreement provides that interest-rate subsidies could be
granted for certain specific operations, namely for:

(1)

(2)

infrastructure projects in the least-advanced countries or in countries in a post-conflict
situation that are essential for private-sector development. In these cases, the interest
rate will be reduced by 3 percentage points, and

projects involving restructuring operations in connection with privatisation or projects
entailing substantial and clearly demonstrable social or environmental advantages. In
these cases, loans may carry interest-rate subsidies the amount and form of which will
be decided on the basis of the special features of the project and thus on a case-by-case
basis, in line with predefined criteria. For this type of operation, the interest-rate
reduction will not exceed 3 percentage points and will therefore be calculated on a
case-by-case basis in line with the criteria jointly laid down by the EIB,
the
Commission and the Member States.

In all cases, the final interest rate on the loan will be no less than 50% of the reference rate, in
order to avoid situations in which the final rate would be close to 0% or even negative.

The specific criteria for granting interest-rate subsidies will form part of the Facility's policy
guidelines to be laid down jointly by the EIB and the Commission and submitted to the
Investment Facility Committee, which will include representatives of the Member States.

The interest-rate subsidy will be financed by the EDF's long-term development resources. The
funds necessary will not exceed 5% of the total amount allocated to finance investment by the
Investment Facility and by the EIB out of its own resources, i.e. some

200 million.

€

B.

Operational aspects

€

The EIB is currently managing the equivalent of 20.7% of the budget allocations of the
1 658 million in own resources (11.34% of the resources of the
8th EDF, comprising
Convention) and
1 370 million in risk capital and interest-rate subsidies (19.36% of the
Fund). As regards operations, the EIB has so far signed over 660 operations in the ACP
countries, 190 out of its own resources and 470 out of EDF funds.

€

The activity of the new Investment Facility will be more targeted than in the past as far as
interest-rate subsidies are concerned, but without the automatic aspect which existed in the
past; it will still be possible for concessionary loans to be granted in some cases and on the
basis of predefined criteria (see above).

The financial allocation for the Facility will be
2.2 billion for the First Financial Protocol
(2000-05), which will be used to finance investment. To this will be added a further
€
200 million or so to finance interest-rate subsidies for projects financed both by the Facility

€

and by the EIB out of its own resources.

30

C.

Evaluation

It is fairly difficult to make a general evaluation of the impact of subsidies in the context of
operations with 72 different ACP countries. Nevertheless, the purpose of the major changes
concerning the Investment Facility is to correct the shortcomings of the past and to take into
account the more open direction of international trade (WTO rules).

• The new Facility will have to take care not to generate distortions on local capital markets
institutions. Instead, the financial resources provided

or to undermine local financial
should enable these institutions to mobilise other sources of finance.

• The Facility must not disrupt or conflict with national and regional financial and monetary

policies or with policies advocated by international institutions.

• Unlike the public sector in the heavily indebted ACP countries, the private sector does not
seem to consider the subsidy to be a determining factor in investment decisions, unlike
rapid
other criteria, viz. provision of medium- and long-term financial
disbursement, loans in local currency, etc.

resources,

• Concessionary loans may, however, be beneficial in the cases mentioned above since they
encourage economic development and support investors in situations where the political
and economic risks are particularly high.

5.7.

Interest-rate subsidies linked to EIB loans in the Mediterranean

A.

Description

(cid:1)

Protocols

From 1978 to 1992 EIB loans formed part of the cycle of five-year financial protocols that
constituted an overall legal framework for financial and technical cooperation between the
European Community and each Mediterranean country and territory; each protocol fixed a
financial allocation indicating the origin of credits and the nature of the finance.

The beneficiary countries were then able to use the budget funds to subsidise all EIB loans by
up to two percentage points, whatever the sector (infrastructure, water, industry, etc. ). The
total amount of budget commitments for these interest-rate subsidies was

214 million

€

(cid:1)

Environmental protection: from 1992

In 1992, under the Renewed Mediterranean Policy, the EIB was instructed to implement a
specific financing programme for projects to protect the environment; the corresponding
Financial Regulation (outside the protocol) provided for an interest subsidy of three
percentage points on these projects.

the Barcelona Declaration,

Subsequently,
the
Euro-Mediterranean Conference of Foreign Ministers, established the Euro-Mediterranean
partnership, a joint initiative of the 15 members of the EU and 12 Mediterranean partners. The
Council Regulation of 23 July 1996 laid down the financial and technical measures (MEDA)
to accompany the reform of economic and social structures of the Mediterranean partners. It
provides for a 3% interest-rate subsidy on EIB loans in the field of the environment.

adopted on 28 November 1995 at

31

In accordance with these provisions,
255 million were
granted from 1992 to 1999 to 11 Mediterranean countries and territories and mobilised for
37 different projects. These projects concerned the treatment of waste water in order to reduce
pollution in coastal rivers and in the Mediterranean, the reduction of industrial pollution and
the treatment of solid waste.

interest-rate subsidies totalling

€

(cid:1)

Financial and technical cooperation with the Palestinian territories

The July 1994 Regulation laying down the provisions for this cooperation was amended in
December 1998, by providing in particular for the possibility of subsidising the loans granted
by the EIB to these territories at the rate of three percentage points. Two subsidies totalling
€
8.6 million were decided in 1999. These subsidies are not restricted to the environment but

cover the priority economic and social areas specified in the 1994 Regulation.

B.

Operational aspects

(cid:1)

Area of intervention

The areas of intervention, which were extended under the protocol system, were restricted to
the environment from 1992; the environment has therefore become the main eligibility
criterion for the budget grant in the form of interest-rate subsidy, with the exception of the
EIB loans granted to the Palestinian territories.

(cid:1)

Management

The EIB selects and prepares projects, draws up the financing proposal and then seeks both
the opinion of the "Article 14 Committee" (MEDA), consisting of the representatives of the
Member States, and the Commission's opinion. On the basis of this consultation, the EIB asks
the Commission to take a decision to fund the granting of an interest-rate subsidy. Following
an internal consultation process, the Commission submits to the MED Committee a draft
decision authorising or, where appropriate, refusing the funding. The Commission decision is
forwarded to the EIB; if the decision is favourable, the EIB may grant the subsidised loan.

The EIB and the Commission jointly see to the financial management of interest-rate
subsidies on the basis of a management agreement signed between them.

No problem of repayment of EIB loans by the Mediterranean partners has been indicated.

In its Report 1/98 on the management of the protocols, the Court of Auditors referred to
dormant commitments or commitments in excess of the needs of the operations concerned;
the Commission replied that it had introduced a regular information system and that it had
reexamined the dormant commitments as part of a periodic review.

C.

Evaluation

(cid:1)

MEDA evaluations carried out in 1998 and 1999

In November 1998 the evaluation by external consultants of certain aspects of EU
development aid for the Mediterranean region showed that coordination between the EIB and
the Commission was working well and was the subject of regular consultations but that it
could be improved by incorporating the EIB activities linked to the granting of budget funds
into the national indicative programmes at an earlier stage.

32

In February 1999 the evaluation of the MEDA provisions carried out under Article 15(6) of
the MEDA Regulation recommended that the procedure for deciding interest-rate subsidies
should be simplified, alone the lines of the other operations managed by the Commission.

(cid:1)

Proposal for amending the MEDA Regulation

to amend the MEDA Regulation (COM (1999) 494 final),

In its recent proposal
the
Commission stressed the need to streamline coordination with the EIB, i.e. in the preparation
of strategies and at the programming stage; as far as interest-rate subsidies specifically are
concerned, the Commission has followed the recommendation made in the evaluation and has
proposed lightening the decision-making procedure by providing that, as interest-rate
subsidies would be covered by approved national financing plans, they would not need to be
submitted separately to the MED Committee; the "Article 14 Committee" approval procedure
would require no modification.

The subsidy rate applied to each payment would be equal to half the interest rate relating to
the payment in question, but in no case higher than the nominal rate of 3%.

The Commission proposal maintains the area in which interest-rate subsidies would apply, i.e.
the environment; given the scarcity of water resources, the growing degradation of natural
resources and the dense urbanisation of the region, the environment will become an even
more important issue for all the countries bordering on the Mediterranean. Interest-rate
subsidies constitute an incentive mechanism which has effectively enabled the Mediterranean
partners to embark on specific environmental action programmes; the exception for the
Palestinian territories is justified by the very special situation there in the context of the peace
process.
(cid:1)

Evaluation of EIB activities in connection with the financing of the Community
budget

An evaluation of the financial assistance to the Mediterranean countries managed by the EIB
on behalf of the EC was launched at the beginning of this year; it covers the interest-rate
subsidy and risk capital mechanisms. It will review the period 1979-99 and contain an
analysis of the performance and impact of interest-rate subsidies and of the mechanisms and
procedures; it will conclude by addressing recommendations to the Commission and the EIB.
The results of this evaluation are expected shortly.

5.8.

ERDF Programme

A.

Description

Interest-rate subsidies part-financed by the Structural Funds, essentially the European
Regional Development Fund, are managed not by the Commission but by the national and
regional authorities in Member States charged with implementing multiannual regional
development programmes within specific eligible areas.

B.

Operational aspects

– SMEs in the less-developed areas of the EU face particular problems in terms of the cost of
credit: although base interest rates charged by financial institutions are uniform and set
nationally, a margin of additional interest is charged by banks to reflect the risks of a
particular lending operation, these being higher for SMEs than for larger enterprises and
often higher still for SMEs located in the less-developed regions.

33

– Applications for loans are vetted and granted in the normal manner by lending institutions,
which agree the terms of the financing with the SME. The interest-rate subsidy is covered
by a separate agreement and is paid to the SME during the term of the loan by the lending
institution. The total financial cost to the SME is therefore the commercial interest rate
paid to the lending institution, minus the interest-rate subsidy received from the managing
authority under a regional development programme measure (such as a global grant)
part-financed by the Commission.

C.

Evaluation

In regional development terms, the interest cost of the finance required for an investment is
reduced, enabling SMEs to invest and thereby to increase their production capacity and
competitiveness. The subsidy is covered by a separate agreement from the loan agreement,
thus ensuring a swift decision by the lending institution and reducing the administrative
burden on the SME.

Interest-rate subsidies available under the Structural Funds are considered to be on an equal
footing in terms of effectiveness with the several other forms of grant applied by the Funds. A
number of lessons arising out of experience with interest-rate subsidies during the previous
programming period are now being put into practice in the Commission's guidelines for the
period 2000-06, in particular the need for an initial diagnosis of SME requirements, the need
for prior consultation with intermediaries on the design of such schemes so as to avoid an
unnecessary administrative burden on the banks and their information systems, and the fact
that the targeting of interest-rate subsidies on particular SME sectors has generally enhanced
their impact.

Article 29(4)17 of the new Council Regulation laying down general provisions on the
Structural Funds18 explicitly encourages managing authorities to use forms of finance other
than direct assistance, including interest-rate subsidies, by permitting an additional 10% for
the maximum rate of contribution, in accordance with Article 28(3).

5.9.

EAGGF Programme

A.

Description of the action

– Amount of subsidies (statistics for the last five years):

Since the Agriculture Directorate-General does not grant
interest-rate subsidies
directly but only refunds the subsidies granted by the Member States for agricultural
structures (see also the answers to point B below) and since Member States often
combine different forms of investment aid (capital grants, interest-rate subsidies,
guarantees for loans contracted, etc.) for the same aid scheme, the EAGGF Guidance
Section does not possess any analytical statistics relating to the form of aid which it
has helped to finance.

Nevertheless, by way of an example to indicate an order of magnitude, France
244 million in interest-rate subsidies incurred
declared for 1999 alone an amount of
in 1998, while each year the EAGGF Guidance Section refunds Member States'
expenditure at variable rates set by the rules (25% to 60%) on the basis of various

€

17

18

Article 29 (4) (a) and (b) (iii).
Council Regulation (EC) No 1260/1999 of 21 June 1999.

34

parameters such as the type of aid scheme, the status of the beneficiary or its
location.

– Objectives

Interest-rate subsidies have so far been granted mainly in connection with the
implementation of Objective 5a of the reform of the Structural Funds, namely the
granting of official aid for investments made in agricultural holdings, and setting-up
aid to young farmers (Articles 7, 10 and 11 of Regulation (EC) No 950/97).

The system of interest-rate subsidies has been extended for the new programming
period 2000-06 (see Article 28(3) of Regulation (EC) No 1260/99 or Article 8(2) of
Regulation (EC) No 1257/99).

– Criteria for granting subsidies

Numerous criteria and restrictive conditions have been laid down by Council
Regulation (EC) No 950/97 in connection, for instance, with the economic conditions
of the agricultural holding, the status of the farmer (practising farming as his main
occupation, occupational skill, etc.) or with the type of production (no aid for surplus
production).

B.

Operational aspects

– Management: procedures for payment of subsidies

Within the fields of intervention of the EAGGF Guidance Section, it is up to the
they deem appropriate
Member States to opt
(interest-rate subsidies, grants, etc. or a combination of these instruments) in order to
implement the aid scheme provided for in a multiannual programme of assistance
decided on by the Commission.

the financial

instrument

for

Official aid is co-financed by the EAGGF Guidance Section and the Member States.
The Community rules or the programme fix the rate of Community financial
intervention. Payment by the EAGGF Guidance Section is made on the basis of a
system of advances, followed by refund of the annual expenditure which each
Member State declares to the EAGGF and which it has already financed in advance
(system in force until 1999) or
in the form of down payments/intermediate
payments/payment of programme balance (system in force from 2000).

When Member States are responsible for choosing the financial instrument for
implementing certain Community programmes, experience has shown that
this
choice has not been neutral from a financial point of view and in particular that it has
been unlikely to minimise budget costs for the Community.

If there was genuine competitive bidding between financial bodies, the cost of
managing these aid schemes could be partially reduced, but it should be remembered
that the Commission disagrees with most of the Member States on the question of
applying the public procurement Directives to financial services.

35

– Control: who is responsible and what are the procedures?

Under Council Regulation (EC) No 1260/99 (for
instance, Article 38(1)),
Member States take responsibility in the first instance for the financial control of
programmes. The Commission, as part of its responsibility for the implementation of
the general budget of the European Communities, ensures that Member States have
smoothly functioning management and control systems so that Community funds are
efficiently and correctly used (Article 38(2)).

The staff of the EAGGF Guidance Section regularly carry out on-the-spot checks,
including sample checks, in the Member States.

– Visibility

As stated above, it is not up to the Commission to opt for any particular financial
instrument to implement its programmes within the spheres of intervention of the
EAGGF Guidance Section since this is a matter for the Member States (subsidiarity
principle). Consequently, the question of desirability of choosing the system of
interest-rate subsidies as such does not arise when it is a matter of implementing
rules laid down by the Council.

C.

Evaluation

– Do evaluation reports exist?

Evaluations are obligatory under the rules, but they chiefly cover the operational
content of the programmes. However, there is as yet no properly targeted evaluation
the system of interest-rate
in terms of the type of financial
subsidies).

instrument (e.g.

Nevertheless, this lack of evaluation does not mean that there is no visibility as
the
regards the system of interest-rate subsidies in this area. On the contrary,
on-the-spot checks we have carried out
in the Member States have sometimes
prompted hefty criticism of the economy of such a system for the Community
budget, and in particular its cost effectiveness. The risk is that the Member States, in
their subsidy statement, charge part of the cost of administering the scheme to the
EAGGF Guidance Section by taking advantage of the reference rates, which diverge
significantly from market interest rates.

5.10.

Interest-rate subsidies in the central and eastern European countries - Phare
budget

A.

Description

(cid:1)

(cid:1)

Historically, Community funds have provided two types of interest-rate subsidies for
the central and eastern European countries: Slovenia benefited from the continuation
of EIB subsidised loans to the former Yugoslavia, and the Phare programme has
provided interest-rate subsidies for loans to SMEs in the applicant countries.

From September 1993 to 1997 Slovenia benefited from a financial protocol with an
EIB allocation of
150 million accompanied by interest-rate subsidies from the
Community budget of

20 million for transport projects in the public interest.

€

€

36

An amount of
loans totalling

€
47 million was spent on repairing the main rail network in 1993; two
€
41 million were signed in 1994.

€

A loan of
project, with a further
project.

32 million was granted in 1995 in support of the existing motorway
30 million being released in 1996 for the continuation of the

€

Subsequently, Slovenia reverted to the ordinary law applicable to the applicant
countries, with pre-accession EIB loans which no longer included interest-rate
subsidies but some of which enjoyed the Community budget guarantee. To a very
large extent, these loans were made in the telecommunications sector.

B.

Management

(cid:1)

Under financing provided by the Phare programme, interest-rate subsidies have been
granted for loans to SMEs. These operations were carried out mainly in the early- or
mid-1990s. Since inflation was high at the time, the beneficiary countries co-financed
these operations (at very low rates) with banks which were to lend at the market rate.
Of the total amount of the loan, the final beneficiary thus received a loan at a very
advantageous rate. Once the operation had been carried out, it repaid both its bank and
the State which had obtained the Phare funds and thus had funds available for
allocation elsewhere.

Micro-loans were also granted at preferential rates to small firms under the Phare
programme. They were often distributed by non-bank institutions.

C.

Evaluation

According to various sources, these operations do not seem to have worked to the
total satisfaction of the various players involved. There were repayment defaults.
This can perhaps be explained in part by the difficulties that persisted while these
operations were being carried out. It was also often difficult to find partners to
disburse the loans. These operations were frequently organised in parallel with grants
of guarantees, e.g.
the least encouraging
experience was in Bulgaria.

in the Czech Republic and Poland;

The conclusions which can today be drawn from the provision of interest-rate
subsidies for loans to SMEs are the following:

(cid:1)

(cid:1)

(cid:1)

The banking environment, coupled with the level of inflation, the weak involvement
of the beneficiary States and the absence of specific policy objectives, adversely
affected policy implementation, with it being impossible to obtain convincing results
in several countries.

However, relatively satisfactory results were obtained in Hungary because of the
greater maturity of the banking system, the attitude of SMEs, and support of the
Finance Ministry (possibility of co-financing, existence of an agency for SMEs) and
of SME associations (which were members of the agency's board of management).

A satisfactory rate of disbursement through the banking system depends less on the
level of subsidy to the SME and more on other factors. The most important factors
would appear to be the margin that can be earned by the bank compared to alternatives

37

(e.g. using deposits), whether the risk is shared with or borne entirely by the bank, and
who is responsible for exchange-risk losses.19

(cid:1)

See point 5.16 above for the FYROM and for Bosnia and Herzegovina.

5.11.

Exceptional aid for the regions of Italy devastated by the earthquake of 1980

A.

Description (Council Decision 81/19 of 20 January 1981)

The purpose of this action was to finance investments for the reconstruction of the means of
production and the economic and social infrastructure in the areas affected by the earthquake
of November 1980 which hit the Italian regions of Campania and Basilicata.

The Commission was empowered to contract loans in order to provide finance under the New
Community Instrument (NCI). The amount of such loans could not exceed a principal
equivalent to ECU 1 billion, subject to deduction of any operations of the same nature carried
out by the EIB from its own resources.

Amount of the interest-rate subsidies

The budget of ECU 1 billion in loans authorised by the Council was covered up to an amount
of ECU 613 million by NCI loans and up to an amount of ECU 353 million out of EIB own
resources. In both cases, the loans carried an interest-rate subsidy of 3% per annum for a
maximum of twelve years. The total amount in subsidies charged to the Community budget in
respect of the NCI and EIB loans was ECU 240 million.

Objectives

To remedy the damage caused by the earthquake quickly and effectively by financing the
investments required for the reconstruction of the means of production and the economic and
social infrastructure.

Beneficiaries

Contractors of loans granted under the Council Decision on the basis of projects presented by
the Italian authorities.

B.

Operational aspects

Management

The Council had decided that the programme would be managed by the EIB on behalf of the
Commission. An agreement was signed between the Italian Treasury, the Commission and the
EIB on the procedures to be followed. Under this agreement, the loans were granted to state
bodies, regional authorities, credit institutions and other bodies designated by the Italian
Treasury.

19

Final synthesis report of
(February 2000; pp. 46-48)

the evaluation of Phare-financed programmes in support of SMEs

38

Control

The agreement between the Treasury Minister, the Commission and the EIB specified that
applications for subsidised loans were to be forwarded by the Italian Treasury with its
favourable opinion; the loans were to be used exclusively to finance investment projects in
accordance with the Council Decision.

The Court of Auditors pointed out that EIB checks were inadequate and that the Commission
carried out no checks at all. In its replies, the Commission stated that the projects were
eligible in accordance with the criteria laid down in the Decision and had been examined
individually by the Commission in accordance with the procedure under Article 21 of the
Bank's Statute.

C.

Evaluation

Usefulness

The Italian authorities reported the estimated cost of the damage to be ECU 13 596 million.
The Community contribution of ECU 1 billion accounted for just over 7% of that amount.

The breakdown of the loans per sector is as follows (in ECU million):

- Public services (electricity, telecommunications and water)
- Roads, railways
- Schools, universities
- Housing
- Public buildings and defence
- Industry
Total

NCI
81.8
136.2
69.2
156.0
104.3
65.7
613.2

EIB
168.2
66.6

117.7
352.5

Reconstruction of the damaged infrastructure and means of production was achieved by
projects presented by the Italian authorities and declared eligible by the Commission in
accordance with the Council Decision and the tripartite agreement.

However, in its reports, the Court of Auditors criticised:

– the time taken to complete the work, and

– the lower-than forecast number of jobs created.

Regarding the time taken to complete the work, there were various reasons for the delays:
changes to the original projects, difficulties linked to expropriations, legal and administrative
problems that arose in connection with the implementation of complex projects in difficult
circumstances. Regarding job creation, the Commission indicated in its replies that this
criterion was secondary to the main objective (reconstruction).

39

Cost-effectiveness analysis

No cost-effectiveness analysis was carried out. The reason for choosing interest-rate subsidies
is the leverage effect: at a modest cost to the budget, they help to generate a high level of
investment.

Did the beneficiaries gain from the financial advantages conferred by the interest-rate
subsidies?

Almost all the projects were public-sector projects (water, railways, roads, public buildings,
etc.). The effect of the subsidies was therefore to reduce the cost to the public authorities'
budget.

Evaluation reports

The Bank produced progress reports on the work and summary reports by project and by
group or economic sector (see above table). A general evaluation of the NCI was done
internally by the Commission and sent to the Court of Auditors in 1994. Representatives of
the Commission and the Bank were present at several on-site inspections by the Court of
Auditors.

5.12.

Exceptional aid to the regions of Greece devastated by the earthquake of 1981

A.

Description (Council Decision 81/1013 of 14 December 1981)

The interest-rate subsidies concerned were intended for the reconstruction of the means of
production and the economic and social infrastructure, including housing, in the affected
regions.

Under the New Community Instrument (NCI), the Commission was empowered to contract
borrowings of ECU 80 million on the capital market for financing loans in the affected
regions. The loans carried an interest-rate subsidy of 3% per annum for a maximum of
twelve years. The same subsidy was granted to recipients of EIB loans made for the same
purposes.

The subsidies were granted in respect of projects in the western parts of Athens and Piraeus,
in the towns of Corinth, Loutrakio, Megara, Thive, Kiato and Preveza and in 140 other
localities.

The projects were presented by the Greek authorities. The EIB participated in the selection
procedure.

B.

Operational aspects

Borrowings were contracted by the Commission (NCI) and the EIB. The latter managed the
loans according to the requirements of a cooperation agreement with the Commission and its
usual loan criteria.

C.

Evaluation

The subsidies, covering more than a third of the amount of the loans, considerably reduced the
financing costs for the State and/or the local authorities and final beneficiaries at a time when
budgetary circumstances were difficult.

40

Some ECU 27 million in subsidies helped the Greek authorities to finance the individual
projects concerned.

No cost-effectiveness analysis was carried out. The reason for choosing interest-rate subsidies
is the leverage effect: at a modest cost to the budget, they help to generate a high level of
investment.

The EIB is monitoring implementation of the projects; if there are delays in implementation
and/or technical changes to the projects, the EIB is informed and participates in checks.

5.13.

Exceptional aid for the reconstruction of Kalamata (Greece)

A.

Description (Council Decision of 7 November 1988 (OJ of 15 November 1988))

On a proposal from the Commission based on Article 235 of the Treaty, the Council decided
to grant exceptional aid to the population affected by the earthquake of September 1986 in the
Kalamata region of Greece.

The loans were granted by the EIB out of its own resources within the authorised limit,
equivalent to a capital value of ECU 100 million.

The rate of the subsidy was set at 3% per annum for a maximum of twelve years. The
objective was to finance the reconstruction of infrastructure, buildings and homes damaged by
the earthquake and to help re-create the economic conditions that prevailed in the region, of
which Kalamata is the main town, prior to the earthquake.

B.

Operational aspects

The ECU 100 million in EIB loans was divided into two instalments:

– ECU 80 million paid to the Ministry for National Economic Affairs (MEN), and

– ECU 20 million allocated to the Deposits and Loans Fund (DLF) for global loans to be

on-lent to the organisations directly responsible for carrying out the work.20

In the first case, the subsidies were paid direct by the Commission to the EIB, enabling it to
reduce its interest rate. In the second, the Commission paid the subsidy direct to the DLF,
which then passed it on to the final beneficiaries.

The practical arrangements were set out in the EIB-Commission agreement of 30 March 1990
and in the Commission-DLF agreement. A financing contract was also signed between the
EIB and the DLF on 24 October 1989 for an amount of ECU 7 250 000. The Commission
paid to the EIB on each interest payment date the amount in each currency equivalent to the
difference between the interest to be paid in that currency by the borrower and the interest
which should have been paid on that date if the normal interest rate being subsidised had been
increased by 3 percentage points a year.

The EIB monitored project implementation and administered the loans. Monitoring was
undertaken in accordance with its usual procedures.

20

Part of the ECU 20 million was transferred from the DLF tranche to the MEN tranche because of the
latter's higher absorption rate.

41

C.

Evaluation

Did the beneficiaries gain from the financial advantages conferred by the subsidies?

This was clearly the case as regards the MEN tranche since the State was the only final
beneficiary of the subsidy. A cost-effectiveness analysis was not carried out. The reason for
choosing an interest subsidy is the leverage effect: at a modest cost to the budget, it helps to
generate a high level of investment.

The EIB is monitoring project implementation. If there are delays in implementation and/or
technical changes to the projects, the EIB is informed and takes part in checks.

5.14.

Aid for the reconstruction of Madeira after the cyclone in 1993

A.

Description (Council Decision 95/250/EC of 29 June 1995)

Subsidies of three percentage points for a maximum period of twelve years were disbursed on
loans granted by the EIB out of its own resources up to a total capital value equivalent to
ECU 15.85 million. They total ECU 4 294 309 over the life of the loans.

Objectives: loans for the reconstruction of areas devastated by the cyclone which hit Madeira
in October 1993, in order to mitigate its impact on the economic and social well-being of the
population affected, etc.

Sectors: from 1993 onwards, road infrastructure, improvement and repair of riverbanks, water
distribution, hydroelectric plant and social housing.

Criteria for granting the subsidies: projects proposed by the Autonomous Region of Madeira.

B.

Operational aspects

The subsidies were paid on each interest due date.

For control purposes, the Autonomous Region of Madeira is required to present twice yearly,
before 30 April and 30 October, a report to the EIB on the progress of the projects until their
completion. The most recent report confirms that the regional authorities have met all their
contractual obligations. The authorities had to report
to the Commission on project
implementation before 31 December 1997 and 31 December 2000.

Visibility is guaranteed at project sites by means of signboards indicating clearly that
Community aid has been provided.

C.

Evaluation

Representatives of the Commission visited Madeira at the end of October 1998 and produced
an evaluation report (COM (1999) 286 final of 11 June 1999).

42

5.15.

The Special Support Programme for Peace and Reconciliation in Northern
Ireland and the Border Counties

A.

Description

This is part of sub-programme 5 "Productive investment and industrial development" under
the Special Support Programme for Peace and Reconciliation in Northern Ireland and the
Border Counties of the Republic of Ireland (Community Initiative 1995-99).

The interest-rate subsidies during the last five years totalled:

€

€

–

–

29 000 000 for Northern Ireland;

5 667 000 for the border counties of Ireland.

Objectives of the initiative: "to create a positive investment climate throughout the area by
making available an interest-rate subsidy for capital investment projects which will contribute
to economic development, growth and employment (especially in the most deprived areas)
and thereby foster reconciliation".

(cid:1)

Which are the sectors/firms/projects that benefit?

Project investment in industry and related services, in tourism, in large and small urban
centres and in rural areas.

The scheme prioritises smaller companies (particularly those with fewer than fifty employees)
and projects that help to create/safeguard employment, promote industrial competitiveness
and innovation, develop new markets, make a significant contribution to tourism
development, demonstrate a particular linkage to the peace environment, benefit deprived
areas (in Northern Ireland) or involve the development of non-displacing or innovative
indigenous start-ups in services related to industry (in the border counties).

(cid:1)

Criteria for granting interest-rate subsidies

The criteria for granting the subsidies are the same as conditions under the EIB global loan
scheme. The same exclusions/restrictions apply to specified sectors of industry.

Given the large number of applications, there has been a focus on manufacturing, processing
and accommodation-related tourism projects, with priority given to smaller companies (in
Northern Ireland).

Eligible project costs comprise new investment in fixed assets and stocks (maintenance
expenditure and normal vehicle replacement are specifically excluded). The cost range for
3 million in
projects is between
Northern Ireland and

€
40 000 and
€
1 million in the border counties.

12 million; qualifying loans are limited to

€

€

Loans were approved by intermediary banks up to 31 March 1997 in the form of term loans,
leasing agreements or hire-purchase agreements. The term must not be less than five years
and can be up to fifteen years, with repayment of principal in equal instalments commencing
not later than two years after the first disbursement.

43

B.

Operational aspects

Applications are submitted by intermediary banks to the scheme's appointed agents.
Recommendations are made to the EIB by the agents, with the consent of the lead
departments (DED in Northern Ireland; Department of Finance in the border counties).
Decisions by the EIB are communicated to the intermediary banks, which inform the
borrowers.

The subsidy available under the scheme is calculated at 4% per annum on qualifying loans
over a five-year period.

Two database-management systems were set up by the agents for monitoring purposes.

Regular progress reports are sent to the Programme Monitoring Committee.

C.

Evaluation

The review carried out by the EIB in 1997 concluded that "the general reaction to the scheme
in both Northern Ireland and the border counties has been very positive".

(cid:1)

Can the rate of achievement of the objectives be quantified?

There were no specified targets attached to the scheme.

(cid:1)

Cost-effectiveness analysis

Eligible capital investment projects for which applications were made to the scheme far
exceeded the amount of subsidies available, necessitating early closure of the scheme. The
intermediary banks have indicated that their lending to the eligible sectors in Northern Ireland
has increased by between 30% and 40% in relation to what was expected to be advanced
during 1995/96.

The estimated increase in employment attributable to the approved projects is over 7 700 new
jobs in Northern Ireland and 1 170 in the border counties.

(cid:1)

Are there any evaluation reports?

The EIB reviewed the scheme with Wilson Gillespie and Company.

The ECA audited the scheme in 1997.21

5.16.

Interest-rate subsidies under the Financial Mechanism of
Economic Area

the European

A.

Description

A Financial Mechanism to assist development projects in Greece, Ireland, Northern Ireland,
Portugal and certain regions of Spain (Objective 1 regions, as defined in 1988) was set up on
1 January 1994 (Articles 115 and 116 of the EEA Agreement, and Protocol 38).

21

European Court of Auditors, Special Report No 7/2000.

44

To start with, the Mechanism was financed only by the EFTA member countries. From
1 January 1995, when Austria, Finland and Sweden joined the EU, the contributions of these
three countries to the Financial Mechanism were paid out of the EU budget.

Up to 31 December 1998 the Financial Mechanism provided funds to the recipient regions
primarily in the form of interest-rate subsidies of 2% per annum on loans of a total volume of
ECU 1.5 billion granted by the EIB.

Since then, the EIB has continued to manage the project portfolios and will do so until the
loans are repaid.

(cid:1)

Annual subsidy amounts

1999: EUR 9 398 033
1998: ECU 30 260 769
1997: ECU 60 964 034
1996: ECU 23 226 896
1995: ECU 7 314 073
1994: ECU 3 005 709

(cid:1)

Objectives

To strengthen economic cohesion and promote the development of the regions of the
European Economic Area (EEA).

(cid:1)

Which sectors benefit?

Priority was given to projects that placed emphasis on the environment (including urban
development), transport (including infrastructure), education or training.

B.

Operational aspects

(cid:1)

Management

The subsidies are linked to loans or tranches of loans from the EIB, which administers the
entire mechanism. They are paid at the same time as the associated EIB loan or tranche.

(cid:1)

Control and procedures

The subsidy applications were evaluated by the EIB. These evaluations were sent to the
Commission for its opinion and to the Financial Mechanism Committee (appointed by the
EFTA member countries and the Commission) for a decision.

Under Article 8 of the Cooperation Agreement of 30 June 1992 concluded between the EFTA
member countries and the EIB, financial control of the operations is carried out in accordance
with the audit and discharge procedures set out in the Bank's Statute for all its operations.

The European Court of Auditors is preparing an audit of projects part-financed by the
Financial Mechanism.

45

(cid:1)

Visibility

Under the operational guidelines of 10 June 1997 approved by the Financial Mechanism
Committee and the EIB, promoters are asked to give appropriate publicity to projects
receiving loans subsidised by the Financial Mechanism in such a way as to make recipients
and the general public aware of its assistance with project implementation (commemorative
plaques in the case of infrastructure works).

C.

Evaluation

(cid:1)

Usefulness

In so far as the borrower benefits fully from the financial advantage conferred by the
interest-rate subsidies paid by it, the Mechanism acts as an incentive for promoters to carry
out projects in the sectors covered.

(cid:1)

Do beneficiaries gain fully from the financial advantages conferred by the subsidies?

– In the case of subsidies linked to a direct EIB loan, the only intermediary between the
Mechanism and the borrower is the EIB. The subsidies are paid direct by the EIB to the
borrower, after deduction of the margins laid down in the EFTA-EIB cooperation
agreement.

– In the case of subsidies linked to a global EIB loan, it is more difficult to verify the
financial advantage conferred on the beneficiaries. The matter is among those being
addressed as part of an audit currently being carried out by the Financial Mechanism
Committee.
(cid:1)

Can the rate of achievement of the objectives be quantified?

Every year the EIB produces a general progress report on the implementation of the projects
receiving assistance under the Mechanism.

(cid:1)

Cost-effectiveness analysis

The EIB carried out an overall ex ante evaluation of each project proposed prior to the
Financial Mechanism Committee's taking a decision.

(cid:1)

Are there any evaluation reports?

A Commission report on the implementation of operations financed by the Mechanism is sent
each year to the Council, Parliament, the Economic and Social Committee and the Committee
of the Regions.

5.17.

Interest-rate subsidies for projects in the western Balkans

A.

Description

For the countries of the western Balkans, interest-rate subsidies are granted for EIB loans in
respect of projects in two countries: FYROM, and Bosnia and Herzegovina.

To date, the Commission has granted subsidies amounting to
€
EIB loans to FYROM totalling

150 million.

€

20 million in respect of two

46

In the case of Bosnia and Herzegovina, the Commission has decided to grant a
7 million
interest-rate subsidy on a first EIB loan to the country. This represents a partial interest-rate
subsidy in respect of this first
60 million. A further subsidy of
€
5.27 million will be required to cover the entire amount. This will probably be granted in
40 million
2001. In addition, if the EIB grants further subsidised loans to the country of
(bringing the total of such loans to
100 million), the Commission will be required to grant a
further interest-rate subsidy. On past experience this will require a subsidy of the order of
€

loan, which totals

€

€

€

8 million that will need to be disbursed in 2001.

€

The legal bases for subsidies for projects in FYROM are the cooperation agreement and the
transport agreement, which mentions infrastructure projects of mutual
interest as being
eligible for Community funding. For Bosnia and Herzegovina, the legal basis is the Council
decision granting the Community guarantee to the EIB for loans to that country.

B.

Management

The interest-rate subsidy is disbursed after the decision by the Board of Directors to grant the
loan.

It is committed when the loan is signed. It is paid as a lump sum at the time of payment of
each instalment of the loan, on the basis of a calculation of its present value. The visibility of
the Community contribution is very poor. It is difficult to ensure consistency between the
project cycle, managed by the EIB, and the requirements of managing the Community budget.

C.

Evaluation

The instrument's usefulness is relative in that the capacity of the countries concerned to
borrow on commercial terms is very limited. This limitation aside, the interest-rate subsidies
on EIB loans for transport
infrastructure projects in the Balkans, and especially in the
republics set up following the break-up of Yugoslavia, have proved very useful to the
development of projects of mutual interest to the Community and the beneficiary countries.

The Community's particular interest derives from the international transit role these countries
have and its importance for the smooth functioning of the single market and for connecting
the Community to the applicant countries of southern and eastern Europe. The transport
agreements in force with Slovenia and FYROM form a specific legal basis for Community
financial assistance, including in the form of interest-rate subsidies.

the pattern of cooperation followed in Albania,

financing of
However,
(infrastructure) subprogrammes, produces the same financial result without the drawbacks
mentioned above.

i.e. parallel

The granting of an interest-rate subsidy or direct co-financing may, however, be envisaged on
a case-by-case basis where the EIB has a comparative advantage as implementing agent. In
such a case, it is important, notably in order to ensure satisfactory visibility of Community
assistance, that the two institutions cooperate closely in vetting projects, which should also
correspond to Community priorities.

Evaluation is carried out by the EIB in its regular activity reports.

47

6.

ANNEX II: ANALYSIS OF OPERATIONAL ASPECTS

For each of the programmes examined, specific attention has been paid to the operational
aspects of interest-rate subsidies. A number of general observations now follow.

6.1.

Management and control

Interest-rate subsidies have always been linked to mechanisms introduced in very specific
circumstances, such as the deep recession in the early 1990s to support job creation, structural
adjustment and the launch of transport projects. In most cases, the facilities have been
administered by the EIB on behalf of the Commission, while the subsidy mechanisms have
been laid down in a cooperation agreement between the Commission and the EIB.

For smaller loans, and SME loans in particular, financial intermediaries have carried out the
project appraisal on the basis of criteria previously agreed upon with the EIB, which has
subsequently given its approval.

The agents have ensured that approved subsidy applications are registered and processed on a
"first come, first serve" basis. They have also been responsible for processing and checking
the evidence which beneficiaries have been asked to submit in relation to the criteria set out in
the Council decisions. They have therefore played an important role in ensuring that potential
beneficiaries are treated in a uniform manner and that all administrative procedures linked to
verification of applications and payment of the subsidies have been handled in a consistent
fashion.

In most cases, in order to qualify for a subsidy, the beneficiary has had to declare in a sworn
statement that the conditions laid down in the decision (job creation, etc.) have been met.

Where the nature of the programme so permits, projects are selected from approved national
programmes so as to reinforce the monitoring and control obligations of
financial
intermediaries and local authorities. Member States, the EIB or financial intermediaries are
responsible first and foremost for the proper functioning of the management and control
systems.

levels of intervention complicates monitoring and control. The
Adding to the different
reconstruction aid programmes for earthquake damage (where even the regional and local
authorities are involved) are one example of a complex monitoring and control instrument.

In most programmes, given the number and nature of beneficiaries (SMEs, etc.) and the low
level of subsidy, it is difficult to image a system other than that based primarily on the
delegation of powers to, and the responsibility of, the EIB, the agents and the intermediaries.
The Council has indicated that further control by other Community institutions would be
superfluous.

6.2.

Visibility

loans are subject, in general, to the rules regarding technical
Projects financed by soft
progress and thus to associated requirements (e.g. signboard publicity) highlighting the role of
the European Union.

As for the documentary aspects, the Community origin of interest-rate subsidies is clearly
spelt out in the financing contracts signed between financial intermediaries and beneficiaries.
However, in a number of programmes (e.g. SME facility), the origin of the subsidies may be

48

lost sight of because of the degree of dispersion among the banking networks concerned and
the proliferation of national and regional aid managed by certain financial intermediaries.

Visibility can also be tested, to the extent that the borrower benefits fully from the financial
advantage conferred by interest-rate subsidies. Subsidies linked to a direct EIB loan are paid
direct by the EIB to the borrower. In the case of subsidies linked to a global loan or forming
part of an overall grant, it is more difficult to verify that the financial advantage has been
passed on. Nevertheless, competition between banks should ensure that this advantage is
passed on in full to final beneficiaries.

6.3.

Evaluation of Community programmes

6.3.1.

Reconstruction programmes

In the case of exceptional aid granted in the wake of natural disasters, the prime objective of
restoring the means of production and permitting a return to normal living conditions has been
achieved within satisfactory periods and on satisfactory terms, bearing in mind the difficulties
caused by the earthquakes (Italy and Greece) and by the cyclone that devastated Madeira.

Mention should be made of cases where fewer jobs than expected have been created, where
additional costs have been incurred and where there have been delays in carrying out the work
(e.g. reconstruction following the earthquake in Italy). Assessing the impact on employment
calls for very detailed analyses that take account of how jobs created and/or safeguarded are
measured and of the effects of technological change.

NCI/EIB financing operations were not the only ones to encounter additional costs and
delays, and the lack of additional resources and delays in resolving administrative or legal
problems are, in a way, attributable to the national, regional or local authorities (in some
cases, the national legislation governing public works contracts laid down special conditions
that differed from those contained in EIB loan contracts). It is evident that adding to the
different tiers of decision-making gives rise to delays and to monitoring, management and
control difficulties.

Below are a number of observations regarding the effectiveness of programmes:

– As regards budgetary costs, none of the guarantees entered in the budget have as yet been
therefore, been confined to the amount of the

called. The budgetary impact has,
interest-rate subsidies themselves.

– The basic rate charged by the EIB was invariably below the rates applied by commercial
banks in the regions affected. The life of EIB loans was also longer and the repayment
conditions more favourable (grace period). These advantageous terms relative to the
conditions generally imposed by commercial banks for similar operations helped in the
long term to diversify the resources generally available to the region (and to develop
capital markets).

– Community assistance for public infrastructures has had a positive effect on the volume of
production in the private sector (the GDP multiplier is particularly high in assisted regions)
as a result of the overall demand triggered by the projects and the increase in productivity
resulting from lower costs (e.g. the installation of more modern equipment than that which
had been destroyed).

49

– Although difficult to quantify, the impact of the reconstruction work following natural
disasters has, in all cases, been a factor in the recovery of the devastated regions (roads,
communications, energy, water supplies, environment, etc.). The work has also led to job
creation (direct and indirect).

– Alongside infrastructures, the loans have also served to finance housing reconstruction
(e.g. Kalamata and Madeira), also necessary in order to restore normal living conditions. It
must be mentioned here that, in the normal course of events, the EIB does not finance
the Council decisions made express
housing construction. In these cases, however,
reference to the reconstruction of housing exclusively for those whose homes had been
seriously damaged.

– Together with the favourable conditions for loans granted by the EIB,

interest-rate
subsidies have helped speed up the reconstruction work without imposing an excessive
burden on national budgets.

6.3.2. Other programmes

Irrespective of the aid schemes introduced by Member States, greater recourse has been had to
these programmes in structural action areas and this has boosted job creation. Below are a
number of points for consideration:

– Subsidised-loan programmes have exploited the synergies between bank loans and
budgetary resources. They have in some cases led to, and in others reinforced, close
cooperation between the EIB and the banks or financial
imparting a
significant multiplier effect to Community assistance.

intermediaries,

– For the most part, SMEs (and hence productive investment) have benefited from these
programmes. It goes without saying that SMEs account for the bulk of jobs created in the
European Union.

– In all cases, the amounts available have been used up quite quickly. Since the budgetary
funds earmarked for the programmes are not renewable (understandably so since the
measures had a limited objective), it has not been possible to improve cost effectiveness.
Therefore, an insufficient rate of return was obtained as regards efforts to implement an
administrative management package (as well as the learning curve of intermediaries and
clients).

– Most

interest-rate subsidies are tied to EIB loans, which were subject

to a ceiling
equivalent to 70% or 75% of the amount of investment. Taking all programmes into
account, the share financed by the EIB was lower on average. Since the remainder was
financed by intermediary banks or other financial
the
Community contribution had an additionality effect.

this shows that

institutions,

50

Impact of interest-rate subsidies within Community and national programmes: examples (in

€

m)

Edinburgh
facility

Madeira (Portugal)
Reconstruction
Of devastated areas

EEA
mechanism
Spain

Germany
ERP programme
Environment and
energy saving

1. Amount of subsidies (1)

92.3

2. Amount of subsidised
loans (2)

923.0

4.3

15.8

17.6

162.4

37.3

1699.6

3. Investment (3)

3 800

45.0

330.7

3853.2

4. Leverage effect

a) investment/loan ratio
(3)/(2)

b) investment/subsidy ratio
(3)/(1)

4.1

2.8

2.0

2.3

41.1

10.4

18.8

103.3

To sum up, the economic advantages of these programmes have been:

1. For the beneficiary:

Direct effects

– Reduction in the interest-rate burden: It is evident that the most immediate and visible
effect has been a fall in the price of money, this being the benchmark (other things being
equal) for the different alternatives. A lower price makes the entrepreneur's decision easier:

– reducing uncertainties and bringing forward the project's payback period;

– making it possible to increase available cash flow.

Indirect effects

Since interest-rate subsidies are tied to longer-term projects and are conditional on a
prior examination of project eligibility and monitoring, they have made it possible:

– to improve the financial structure of liabilities and to transform short-term debts

into longer-term debts;

– to create a new banking relationship culture (particularly in the less-developed

regions).

Such monitoring obliges the enterprise to improve the programming and follow-up of
the more demanding projects, all to the advantage of the project itself.

2. For the intermediary:

– Since these loans cost less, intermediaries are able to expand operations and gain

access to new clients.

51

– If the subsidy applies to the reduction in the principal, this allows banks to reduce

their risks but also the need for own funds (Cooke ratio).

– The projects are better studied and programmed by the entrepreneur;

this

generally results in a much lower failure rate.

Most intermediary banks take a positive view of interest-rate subsidies. Below is a summary
of the arguments:

• Competition between the banking networks involved, lending know-how and capacity,
prudential solvency and responsibility on the part of the financial institutions ensure that
the system functions properly.

• Direct effect and simplicity

The intermediary allocates the interest-rate subsidy direct to its client, passing on the
credit and cash-flow risk. This is more effective and more direct than a guarantee,
which does not entail credit and requires a more complicated and more unreliable
procedure.

• Delegation with a posteriori control creates value added

It is the temporary and revocable delegation of responsibility that allows competing
banking networks to assume part of the cost of allocating interest-rate subsidies
under optimum conditions by incorporating it into existing, tried-and-tested systems
and into the overall service provided to the enterprise. The value added stems from
the dilution and transformation of
financial and
commercial relationship.

the cost within an overall

6.4.

Compliance with the competition rules

Like measures taking other forms, interest-rate subsidies caught by Article 87(1) are, in
principle, incompatible with the common market. This provision states that, save as otherwise
provided for in the Treaty, any aid granted by a Member State or through state resources in
any form whatsoever which distorts or threatens to distort competition by favouring certain
undertakings or the production of certain goods is, in so far as it affects trade between
Member States,
the principle of
incompatible with the common market. However,
incompatibility does not amount to a full-scale prohibition. Articles 87(2) and 87(3) of the
Treaty specify a number of cases in which state aid could be considered acceptable
("exemptions").

The existence of these exemptions also justifies the vetting of planned state aid measures by
the Commission, as provided for in Article 88 of the Treaty. This article stipulates that
Member States must notify to the Commission any plan to grant state aid before putting such
plan into effect. It also gives the Commission discretionary power to decide whether the
proposed aid measure qualifies for exemption or whether the "State concerned shall abolish or
alter such aid".

The most important exemption clauses are those of Article 87(3)(a) and (c):

– Article 87(3)(a) covers "aid to promote the economic development of areas where the

standard of living is abnormally low or where there is serious underemployment";

52

– Article 87(3)(c) refers to "aid to facilitate the development of certain economic activities or
trading conditions

certain economic areas, where such aid does not adversely affect
contrary to the common interest".

In exercising its discretionary powers, the Commission has developed specific approaches
depending on the size of the firm, its location, the industry concerned, the purpose of the aid,
etc.

As its power is discretionary, the Commission has sought to publicise its approach in order to
ensure that its discretion is exercised with proper openness and that authorities and businesses
are clear about their legal position. To do so, it has published the criteria it applies when
deciding whether aid measures notified to it qualify for exemption. These publications have
taken the form of regulations, communications, notices, frameworks, guidelines and letters to
Member States. In many cases they define "eligible costs" (i.e. types of expenditure which can
attract aid) and "permissible intensities" (i.e. the proportion of these costs which can be met
by aid).

It is a principle of, for example, Structural Fund operations that the use of Community
resources must also be consistent with Community competition rules.

In general, though with some exceptions, the state aid rules do not specify the form of an aid
measure. Different forms of aid (grant, interest-rate subsidy, guarantee) are analysed for their
"net grant equivalent" for the application of the state aid rules. Considerations of state aid
policy are therefore not a critical factor in the comparison of interest-rate subsidies with other
forms of aid.

As a rule, the Commission considers only the borrower to be the beneficiary of state aid in the
form of an interest-rate subsidy, provided that mechanisms are in place to ensure that the
subsidy is fully passed on in reduced interest payments. This is the case even though (as
shown in Section 6.3 above) there may also be advantages for the lender.

6.5.

Final remarks

– Interest-rate subsidies are not a determining factor in investors' decisions. However, they
do provide an incentive in that they reduce enterprises' financial charges and thus promote
access to credit.

– Interest-rate subsidies are an effective mechanism for mobilising additional

funds
(additionality). At a modest cost to the budget, they have helped to generate a high volume
of investments (leverage effect). They are tied to, and accompany, long-term financing,
thereby fostering investments which create stable jobs. In some cases, there are synergies
with national programmes and/or other financial engineering instruments.

– A European framework can provide significant efficiency gains as compared with a
national approach. The participation of private banks in programmes involving interest-rate
subsidies is one way of publicising Community initiatives.

– When interest rates are channelled via financial

intermediaries which operate in a
competitive market, problems of market distortion could arise if full and free access by
these intermediaries to management of the instrument cannot be guaranteed. In cases
where financial intermediaries operate in a non-market environment, fully transparent
terms and conditions (e.g. interest rate to be paid by the final beneficiary) help to ensure
that the interest subsidy is transferred to the final beneficiary.

53

– An alternative to interest subsidies would be direct grants (with the grant being equal to the
net present value of an interest subsidy). The advantage of using a direct grant lies in
increased transparency and administrative simplicity. However, there is less risk of abuse
when interest-rate subsidies are tied to bank loans.

– There are shortcomings in programme implementation, particularly as regards control.

Nevertheless, the burden of control must not outweigh its benefits.

– Interest-rate subsidies must be accompanied by simple, clear provisions regarding
implementing conditions and procedures. Complicated conditions regarding outturn and
quantification should be avoided.

54

7.

ANNEX
MEMBER STATES

III:

INTEREST-RATE

SUBSIDIES:

EXPERIENCE

IN

7.1.

Italy

A.

Description

In Italy there are currently over 80 laws designed to support business investment (capital
grants and interest-rate subsidies, often combined), only half of which were activated in 1999.
Of these, only half a dozen may be considered to be significant because of their widespread
application.

The system is based on highly targeted programmes with the following main objectives:

– Law No 1329 of 1965, better known as the Sabatini Law, aimed at encouraging SMEs to
acquire productive plant and machinery with no sectoral bias (industry, distributive trades,
services, agriculture, craft industry). At first, the purchase of machinery was encouraged by
a financing scheme based on bills of exchange. This scheme, advantageous for all parties,
was later improved by the granting of an interest-rate subsidy at the time the debt was paid
off, calculated on the basis of a reference rate fixed by the government (slightly below the
market rate), together with a reduction ranging from 50% in non-assisted regions to 100%
in Objective 1 regions, with all the arrangements being published periodically in the press
to ensure complete transparency.

– Law No 598/94, aimed at encouraging investment by innovative SMEs or

in the
environment. In December 1999 the reduction in the reference rate fixed by the
government (6.15%) ranged from 1.40 percentage points for medium-sized firms to 4.9
percentage points for small firms located in Objective 1 areas.

– Law No 317/81, aimed at encouraging the formation of producer groupings in industry, the
distributive trades and the craft sector. The reduction in the reference rate ranges from 40%
in non-assisted regions to 70% in Objective 1 and Objective 2 areas.

– Law No 46/82, aimed at supporting applied research and technological innovation, both in

SMEs and in large firms, with a sliding scale of reductions.

– Law No 341/95, aimed at consolidating the debt of SMEs in Objective 1 regions and
covering all sectors. The medium-term loan granted in this connection, with the support of
a guarantee fund, is eligible for a maximum reduction of 4.5 percentage points, provided
that the equivalent discounted grant equivalent does not exceed 40% of the loan.

– Law No 227/77, aimed at promoting export credit for industrial and commercial firms. The

rate applicable in the country of exportation is reduced by 4.75 percentage points.

B.

Operational aspects

The management of the credit lines relating to these facilities is usually entrusted to a lead
bank (Mediocredito Centrale for SMEs, IMI for large firms, etc.) which allocates them among
the other banks on an ongoing basis, ensuring as far as possible distribution in eligible areas
of the country. The final recipient bank assumes all the risks of the operation, including the
follow-up and recovery of any unpaid debts.

55

Generally speaking, checks are carried out at three levels: (i) by the local bank, according to
its own procedures; (ii) by the lead bank on a more general basis in order to demonstrate to
the authorities that the system is functioning properly and that the economic objectives are
being met; (iii) by the competent Ministry (e.g. Industry, Treasury, Agriculture), on the basis
of documents and on-the-spot surveys. Naturally, such checks, which are necessary
throughout the period in which the loan is being paid off (around ten years), impose a heavy
administrative burden, especially on the Industry Ministry, which is responsible for a larger
number of smaller-scale (SMEs) and riskier operations.

The visibility of the instruments, conditions and objectives is strictly ensured, both in the
wording of loan contracts and in the promotion of specific instruments, with the implementing
arrangements being published regularly in the press. This allows each firm to calculate
accurately the financial advantage it can expect; in the event of a dispute, the financial
intermediary risks criminal proceedings

C.

Evaluation

The usefulness of the instrument is evaluated at regular intervals on the basis of surveys and
questionnaires sent to beneficiaries.

The surveys conducted by Mediocredito Centrale over the period 1992-94 among a sample of
SMEs comprising firms which did and firms which did not benefit from the scheme described
in point A produced the following results:

– 95% of firms eligible actually carried out new investment during the relevant period, while
80% of firms not eligible did so; the propensity to invest was therefore definitely boosted,
albeit to a modest degree, by interest-rate subsidies.

– Comparison of the economic and financial situation of the two groups of firms shows a
in the beneficiary companies as regards turnover, labour

more marked improvement
productivity, labour costs, net result and return on investments.

– In terms of job creation, it would appear that 87% of the SMEs which availed themselves
of the scheme have created new jobs, compared with 77% of those which have not.
Particularly as regards the Sabatini Law (purchase of productive plant and machinery) and
Law No 317/81 (producer groupings) it was observed that over the three-year period the
former led to an increase in recruitment of 0.8% (despite being "capital-intensive" in
scope) and the latter to an increase of 5.5%.

– With regard to the medium-term consolidation of SME debt (Law No 341/95),

the
SanPaolo-IMI Institute found that, of ITL 3 000 billion of loans with a subsidy and a
guarantee of 60% from the guarantee fund, only 1% were not repaid, resulting in an
improvement in the quality of debt.

7.2.

France

A.

Description

Since 1946 interest-rate subsidies in France have been used almost exclusively in two sectors:
craft industries and agriculture. In both cases, they pursue several objectives: for example,
setting up in business of young farmers, development/modernisation of
farms, and
compliance by farms with environmental standards. In recent years, for strictly limited

56

amounts and for a strictly limited period, the government has occasionally had recourse to
interest-rate subsidies in order to restore forests destroyed by the winter storms in 1999.

(subsidy) of

Public assistance, which was available on a generous scale at first, has tended to decline over
time, with the result that the craft sector was recently excluded. By 1999 the FRF 15 billion to
20 billion of subsidised loans granted each year in the 1970s had declined to between only
FRF 10 billion and FRF 12 billion, and this exclusively for the agricultural sector, together
with a public grant
including
FRF 700 million from the EAGGF. This trend is attributable to the fall in interest rates, but
also to the narrower targeting of farms. The criteria for granting an interest-rate subsidy are
laid down in great detail by law, by the Rural Code and by ministerial decrees (age of the
farmer, size of the enterprise, type of production, quantities produced, etc.) For most loans,
investment programme approved by the
the beneficiary must carry out a multiannual
administration; the applicant must, therefore, be assisted by a management consultant or by
the administration in drawing up and implementing the programme.

the order of FRF 2 billion per year,

B.

Operational aspects

The system of interest-rate subsidies in France developed in three main phases. From 1946 to
1978 (credit controls), the State provided both the capital and the subsidy. In practice, it made
available to financing bodies specialised in specific sectors (i.e. Crédit Agricole for the
agricultural sector, the "banques populaires" and Crédit Coopératif for the other sectors) credit
raised on the market (at an interest rate of 10% at the time). These bodies were charged with
vetting the projects and financing them with an interest-rate subsidy of around 4-6% . With
growing demands on the budget, the State decided in the 1980s to redirect its efforts towards
the loan categories with the highest
in particular establishment and
modernisation. In the early 1990s these two categories accounted for around 75 % of annual
subsidised loans disbursed. However, the arrangements for granting subsidies remained more
or less unchanged compared with the previous period.

rate of subsidy,

Since 1983 the budget allocation for the agricultural subsidy has fallen sharply, in part
because of the increase in EAGGF refunds with respect to establishment and modernisation
aid, but mostly because of the increase in the cost of bank financing since 1986. In 1990 the
distribution of subsidised loans in the agricultural sector, previously entrusted to Crédit
Agricole, was opened up to various banking networks, once accredited by the State. Since
1995 successive improvements aimed at opening up access (for farms run as joint-stock
companies, for example) were made to the system of subsidised loans at the same time as the
subsidy rates were lowered. As for the financial management arrangements, subsidies are, in
general, paid out quarterly by the Ministry of Agriculture and Fisheries to a public body
(CNASEA) which each month reimburses the financial
intermediaries for expenditure
calculated on the basis of loan repayment requirements. Once the files have been vetted by
decentralised departments, each bank is responsible for financial accounting on the basis of a
central computer system which filters files vetted by the various bank branches throughout the
country, according to the contractual conditions laid down.

Monitoring and checks are carried out at three levels: by the public authorities (Ministry of
Finance or Agriculture) on a representative sample selected each year and via ex post and
on-the-spot documentary checks, by the bank's head office on supporting documents and by
subsidiaries. Visibility of the measure and provision of information to potential beneficiaries
are ensured by administrative departments, by bank branch officials and by trade associations
that advise applicants, help them present their projects and filter or redirect applications to the
most appropriate source of financing.

57

C.

Evaluation

During the period of credit controls, when there was therefore a shortage of fresh capital, the
scheme had a major impact on investment by small agricultural and craft enterprises and,
conversely, imposed a very heavy burden on the state budget, given the very advantageous
conditions offered.

During the phase of liberalisation and simultaneous tightening of the allocation criteria, the
scheme remained highly effective, especially in the agricultural sector, when it came to
increasing the capitalisation of small farms and boosting their productivity. Its success was
due in part to the back-up and information provided by the trade organisations to their
members, which made it possible to optimise the scheme's impact. The scheme is judged to
have been very effective in the sector in promoting unprecedented modernisation and giving
an important boost to the establishment of young farmers.

According to some financial intermediaries, the tightening of the allocation criteria, on the
one hand, and the fall in interest rates, the cost of the computer changeover to the year 2000
and the introduction of the euro, on the other, have seriously complicated the management of
interest-rate subsidies and made the authorisation procedures a less attractive proposition for
lead banks.

In the craft sector, the State is moving towards abolishing the system of subsidies to
craftworkers and replacing it with a system of public guarantees. This trend is dictated by the
constraints imposed by the EU on Member States' budgetary discipline. By means of the
guarantee, the Treasury therefore aims to reduce the rationing of credit
to small craft
businesses and thus allow an increase in more risky financing that would not have been
possible on market conditions. Given the present cost of money, the reduction in the cost of
credit brought about by the subsidy no longer appears to be a priority objective in this sector.

Official opinions appear to diverge considerably. Some point to the bureaucracy of the
system, in particular as regards checks, the outdated nature of the instrument given the current
level of interest rates, and the need to improve computer tools in order to reduce management
costs. Others, however, stress the proven effectiveness of interest-rate subsidies as regards
agricultural investment, with subsidies being considered to be an instrument well suited to the
i.e. around
capitalisation levels in the sector
EUR 150 000), and the rate of success of projects, which is regarded as satisfactory.

(average investment of FRF 1 million,

More generally, interest-rate subsidies are considered a highly appropriate instrument for
carrying out investments which have low profitability but are necessary to meet statutory
standards. This is the case, for example, when SMEs have to meet pollution standards or
when an unforeseeable event, such as a natural disaster, disrupts normal economic activity or
when, even in normal circumstances, the return on investment in forestry is satisfactory but
very long-term.

7.3.

Germany

A.

Description

In Germany the measures taken by the federal administration to encourage economic
development (in the case of SMEs) traditionally take the form of loans managed primarily
through the special European Recovery Programme Fund (ERP). However, subsidised loans
are also granted by the Länder.

58

In 1999 the special ERP Fund helped to strengthen SMEs through loans totalling some
DEM 11.5 billion to investment projects with a total value of DEM 30 billion. In the main,
this assistance has been in the form of repayable loans, with facilities such as:

*

*

*

*

an extended repayment period (up to twenty years);

a grace period (up to five years);

a preferential rate;

possibility of early repayment at any time (without penalty).

The loans are granted mainly through the enterprise's own bank, with the result that all credit
institutions are involved in these operations. As they are responsible for repaying the loans to
the Fund, the borrower must provide the usual guarantees required for any bank loan (e.g.
claim on property, collateral or surety).

The ERP equity loan scheme ("Eigenkapitalhilfe" or EKH) is an exception. A subsidy under
this scheme does not consist in granting a lower fixed rate valid for the life of the loan, but in
fixing a progressive rate from the first to the sixth year, followed by a stable rate up to the
tenth year. In addition, in the case of a twenty-year loan, the grace period is ten years. For this
type of assistance, a traditional bank guarantee is not required, which means that the credit is
granted in the form of a personal loan. Here too, however, the profitability of investment
projects is monitored by the credit institutions participating in the overall financing.

German credit institutions are involved in the overall financing of SME investment projects
via all the forms of credit available under the ERP because, on the one hand, subsidiarity is
verified (self-financing capacity) and, on the other, investment projects can be financed only
in part by this type of credit. Thus, from the outset, they are directly or indirectly associated
with the financing of businesses. It is then easier for them to grant "growth" financing
directly.

Interest-rate subsidies are not calculated in the form of a fixed spread relative to the market
rate in Germany. The rates granted under the programmes vary in line with market
developments. Thus, the normal rate for a ten-year ERP loan with a two-year grace period is
currently 5.88% in western Germany. Since the reference rate (fixed by the Commission) for
calculating the amount of subsidy is currently 5.70%, the subsidy in this case is nil. By
comparison, in the eastern Länder an ERP loan with the same terms is currently granted at an
effective rate of 5.36%.

The beneficiaries of the ERP programmes are mainly young entrepreneurs running SMEs;
there are no regional limits or sectoral preferences (only sensitive sectors in the EU are
excluded).

Financing under the special ERP Fund may therefore be granted without discrimination to a
wide range of firms. Under the circumstances, promotion of economic development involves
support for:

– business start-ups via equity assistance and launch funding;

– the expansion and modernisation of existing firms in assisted regions;

– R&D in respect of new products and processes up to the marketing stage;

59

– the creation of more apprenticeship places;

– investments linked to environmental protection (waste water treatment, recycling of waste,

air quality protection, energy saving and use of renewable sources of energy).

B.

Operational aspects

The procedures are quite straightforward. The special ERP Fund sets the criteria for allocating
funds for the various programmes and makes repayable funds available to its two institutions,
the Kreditanstalt
für Wiederaufbau (KfW) and the Deutsche Ausgleichsbank (DtA).
Applications for subsidised loans under the various support programmes are submitted by
firms to their own bank, which examines them and forwards them to the two institutions.

These ensure that the funds are transferred and used for the stated objectives. To do this, they
rely on the usual criteria and principles of sound banking management. The special ERP Fund
is also subject to the general budgetary rules in Germany, which means that the overall use of
resources is regularly monitored by the Federal Court of Auditors.

The special ERP Fund promotes economic development under transparent conditions, its
procedures being published for
the businesses concerned. Credit
the information of
informed by the two institutions via bank circulars and regular
institutions are kept
conferences reviewing practical matters and planned changes in procedure.

C.

Evaluation

The granting in Germany of loans subsidised to a greater or lesser extent has proved its worth
in recent years. This form of financing has witnessed a revival of a sort since unification in
1990. At the time, the main aim was to create in the new Länder a hitherto virtually
non-existent network of small and medium-sized businesses. Thanks to the ERP programmes,
the authorities have managed to provide these new small businesses that had little equity and a
limited self-financing capacity but also offered viable projects with the means to finance those
projects.

The granting of subsidised but repayable loans is an "economic" way for the State to promote
small businesses, enabling them to overcome the difficulties of gaining access to capital
markets and at the same time allowing them to help themselves.

The interest-rate subsidies granted by the special ERP Fund are of direct benefit to businesses.
The rate offered to the final borrower by his own bank is imposed by the Fund, and the bank
receives the corresponding funds for on-lending.

The special ERP Find and the two institutions associated with its programmes carry out
regular (internal) cost-effectiveness analyses. External expert reports are also commissioned
at less regular intervals. For instance, a check on the effectiveness of state measures to
stimulate the economy via the ERP programmes was carried out in 1995. At the moment, an
independent economic research institute is also conducting a detailed evaluation of the ERP
programmes aimed at stimulating the economy.

60

7.4.

Spain

A.

Description

Interest-rate subsidies and repayable advances without interest (i.e. fully subsidised) are
economic policy instruments for promoting productive investment that are widely used in
Spain by the State and its agencies, both financial (Instituto de Credito Oficial - ICO) and
technological (CDTI), and by the Comunidades Autonomas (the regions have complete
budgetary autonomy and some fiscal autonomy) at regional level.

There is no general law governing the use and allocation of subsidies. However, subsidies are
granted under specific schemes or programmes for a limited period.

*

Programmes implemented by the State

There is a wide variety of programmes, and we will therefore refer only to a few by way of
is the programme for expanding technological research and
example. The most recent
innovation (PROFIT). Assistance is in the form of :

– repayable aid of up to 75% of the cost of the project, with zero interest for projects with a
low technological risk; repayment periods vary according to the characteristics of the
projects but do not exceed fifteen years.

– subsidies for projects with a high technological risk; the rate of aid varies between 25%

and 60% of the cost of the project, depending on its characteristics.

SMEs and projects in assisted regions qualify for the most advantageous rates of aid.

Under no circumstances can assistance exceed the limits laid down by the Community rules
on the cumulation of aid (state aid).

Aid may be distributed through partner institutions (e.g. the Centro de Desarrollo Tecnológico
Industrial), which undertake (i) to check that the beneficiaries comply with the conditions laid
down, (ii) to transfer the funds, (iii) to monitor the projects and (iv) to check that the funds are
used for the stated objectives.

*

Programmes implemented by the "Comunidades Autonomas"

the "Comunidades Autonomas" have set up programmes to support small and

All
medium-sized enterprises.

For example, the "Comunidad de Andalucía", through the Instituto de Fomento, grants
subsidies for long-term loans22 signed by private banks or by the EIB under a cooperation
agreement. The subsidies come out of their own budget but also partly out of the ERDF
budget. The terms of the loans (interest rate, repayment period) applied by the banks are those
applied to their best customers. The rate of subsidy is 3.5% (on average). The beneficiaries
are small and medium-sized businesses. An additional subsidy of 2% is granted to loans
guaranteed by a mutual guarantee company.

22

Loans are for seven years with a two-year grace period. Interest may be at a fixed or variable rate.

61

*

Programmes implemented by other public institutions.

Instituto de Crédito Oficial (ICO)

The ICO is a financial institution whose assets are held by the State. It is therefore a publicly
owned bank and a financial agent of the State.

The ICO has implemented interest-rate subsidy programmes using subsidies from Spanish
State funds and Community funds. The programmes are specific in nature and of limited
duration. These are some examples:

– "PYME 2000": Interest-rate subsidies on loans to finance investment by SMEs.
The loans may cover up to 70% of the project, and the repayment period is seven
years. The subsidy is provided by the ERDF and by the ICO.

– "Creación de empleo"(Copenhagen facility): With funding from the EIB,

subsidies per job created come out of the Community budget.

– "Internacionalización de la empresa española": This programme aims to promote

projects abroad. The subsidies come out of the State budget.

– EEA Financial Mechanism:

Interest-rate subsidies

in the
environmental and renewable energy sectors in particular. The ICO receives a
global loan from the EIB and uses this to grant subsidised loans. The ICO funds
may also be added to the EIB loans (in this case,
the ICO loans are not
subsidised).

investment

for

*

Centro para el Desarrollo Tecnológico Industrial (CDTI)

The CDTI is a public institution responsible for promoting investment and technological
development and innovation. It finances projects either from its own resources or jointly with
other bodies (e.g. ICO, ERDF) at low or zero interest rates. In some cases, it also shares the
risk of the operation (i.e. it does not ask for guarantees); 45% of projects financed are SMEs
with fewer than fifty employees. The CDTI is the Spanish representative for European Union
programmes (e.g. Eureka). Its most important activities are:

– Financing of R&D projects: Five-year loans from own resources and from the

ICO; interest-rate subsidies of 1.25%

– Eureka projects

• 60% of CDTI financing over eight years at zero interest

• 25% of subsidies financed by the State budget or the "Comunidades Autonomas"

– Projects abroad: CDTI loans over eight years at zero interest

62

B.

Operational aspects

Comunidad de Andalucía

The application procedures are straightforward (form and a brief file on the firm).

Where the funds are not used for the stated objectives, the firm must repay the loan and the
proportional share of the subsidy plus statutory interest.

For operations of a certain size, on-the-spot inspections are carried out. For the rest, spot
checks are made. In all cases, SMEs must submit documents justifying the investment.

As regards the rules on aid cumulation, the application form states that potential beneficiaries
must declare any existing or future aid.

In all cases, loans are limited to 70% of the investment. The rate of subsidy varies between
2.15 and 3 percentage points. All economic sectors are eligible (except agriculture, fisheries
and the wholesale trade).

ICO

The ICO ensures that the conditions laid down by the EU (de minimis rules) are met.

Payment procedures differ from one programme to another. In some cases, the subsidy serves
to reduce the loan principal. In others, it is paid to the beneficiary, who must then pay the full
interest rate without deduction.

The intermediary banks monitor compliance with eligibility conditions (almost all sectors are
eligible). The beneficiary submits a sworn statement on the use of the financing, which is
verified by documents or by spot checks carried out by the intermediary bank. Given the large
number of operations and the small size of the loans (around EUR 70 000), stricter controls
inspections for
would be difficult
operations amounting to more than EUR 600 000. For the EEA Financial Mechanism,
controls are also carried out by the EEA Committee.

to implement. In any case,

the ICO has carried out

Subsidised loans are allocated on a "first come, first served" basis. All available funds have
been used.

Visibility is ensured as the origin of the funds is stated in the loan contract.

CDTI

Financing applications are examined and a decision taken within two or three months.
Payments are made as the project progresses. There is therefore a prior check on the proper
use of the funds.

C.

Evaluation

ICO

The aim of most of the programmes (PYME 2000, etc.) was to lower interest rates in order to
encourage investment. Clearly, this has been achieved. The ICO has made certain that the
intermediary banks do not levy commission or extra charges on the final beneficiaries, who

63

have therefore received the full amount of the subsidy. Payment to these banks for their
services was, in fact, clearly established separately. Job creation, which is the criterion for
eligibility, has also been ascertained.

The theoretical maximum ceiling for loans (70% of the investment) has not been used in most
cases, which suggests that the subsidised loans have had a multiplier effect as they have
attracted additional funds.

According to the ICO, the failure rate for subsidised loan operations is much lower than the
average for other operations. This may be due to better preparation and follow-up.

CDTI

According to the CDTI, the programmes are considered to be very successful in terms of cost
effectiveness. Long-term financing and subsidies reduce the uncertainty attaching to
innovative and technological projects and can improve the structure of the firm's liabilities
(long-term financing). Moreover, project monitoring by the CDTI necessitates better planning
by the entrepreneur, and this is beneficial for the project.

7.5.

Sweden

A.

Description

In Sweden interest-rate subsidies are currently used as a policy instrument within the SME
and housing sectors.23 In terms of budget expenditure, housing subsidies are by far the most
important policy instrument and this chapter will therefore deal only with the subsidy
programmes for that sector.

By the budget year 1992/93, the annual cost of interest-rate subsidies had escalated to more
than SEK 30 billion (around ECU 3.5 billion). The increased cost of the programme, due in
part to a large increase in interest rates, and the resulting strain on the overall budget led to a
reform of the programme in 1993. The reform meant that the subsidy element was reduced
significantly during a transitional period. Previous generous programmes which targeted both
single- and multiple-family dwellings and which included unlimited interest subsidies above a
set interest rate were replaced by a programme targeting multiple-family housing only and
with a reduced subsidy.

The reduction of government expenditure on the reformed subsidy programme can be seen
from the table below. It should be noted that declining interest rates in the late 1990s also
contributed to the sharp reduction in government expenditure on the programme.

Government expenditure - interest-rate subsidies for housing

Year

1992-96
(average)

1997

1998

1999

2000

2001

2002

Subsidy (in
SEK billion)

31.1

20.8

11.1

7.4

4.124

2.210

1.910

Source: Ministry of Finance.

23

24

Interest-rate subsidies for export credits have effectively been phased out as the consensus rates agreed
within the OECD for export credits now equal market rates.
Forecast.

64

The current programme offers a government contribution of 30% towards the "estimated"
interest-rate costs for the construction or conversion and modernisation of multiple-family
housing. The recipient of the subsidy is the registered owner of the property and may be a
private individual, a company, a housing association or some other legal entity.

Subsidy payments according to the above formula are made in perpetuity and regardless of
how the project has been financed.25

B.

Operational aspects

The Swedish Board of Housing, Building and Planning (Boverket), a central government
agency, has overall responsibility for implementing the programme, which is administered
mainly by the regional authorities (länsstyrelserna). Boverket issues regulations concerning
the implementation of the programme, provides information and offers training on how to
implement the programme to the regional authorities.26 It also serves as the highest instance
for appeals.

the programme according to the relevant

In its supervisory role, Boverket ensures on an ongoing basis that the regional authorities
implement
legislation and according to its
instructions. For internal control purposes, both Boverket and the regional authorities conduct
their own internal audit units and, as government bodies, they are also subject to regular
audits of their activities by the National Audit Office. Boverket’s internal auditors also
regularly visit
to conduct detailed checks on the
administration of the programme.

the regional authorities in order

Prime responsibility for ensuring that
the rules are being applied falls to the regional
authorities, which vet and approve applications and authorise subsidy payments. The risks of
irregularities in connection with the programme are limited thanks to a few basic controls
built into the programme:

– The basis on which subsidies are calculated is determined by reference to standardised

construction costs specified in the regulations governing the programme.27

– Subsidy applications have to include a construction plan and a building permit. This
is given only to projects that comply with the rules of the

ensures that approval
programme.

– A check by independent inspectors approved and authorised by the regional authorities that
the building work has been carried out according to plan is undertaken before the subsidy
is paid out.

An indication of the cost of administering the programme is given in a study of policies in the
housing sector28 undertaken in 1996. During 1994/95 Boverket’s administration of the
interest-rate subsidies cost some SEK 56 million, of which SEK 30 million concerned EDP
systems and postage. At regional level it was estimated that the regional authorities spent a
further SEK 58 million. During 1994/95 the number of subsidy recipients totalled 273 000

25

26

27

28

Certain exceptions to this rule exist for housing associations.
With the exception of payment execution, which is handled by Boverket.
In the case of conversions/modernisations, where the subsidies are calculated on the basis of actual
costs, the beneficiary has to select the lowest of three independent estimates. This is also verified by the
regional authorities' experts.
SOU 1996:156.

65

and the number of payments exceeded 1 000 000. Together,
amounted to around 0.35% of total subsidies paid in 1994/95.

the administrative costs

C.

Evaluation

There is no mechanism in place for evaluating the programme. As part of its ongoing review
of overall policies in the housing sector, the government may, of course, initiate an evaluation
or study of the programme as it sees fit.

The National Board of Auditors, which is the highest audit body in Sweden, may, in addition
to its annual audits of government activities, undertake "specific performance audits". To
date, no such audit has been undertaken with regard to the interest-rate subsidy programme in
the housing sector.

7.6.

United Kingdom

A.

Description

No interest-rate subsidy programmes are currently being operated by the UK government. The
last such programme was the Small Business Loan Scheme (SBLS) in Scotland. It was
launched in November 1994 as a two-year pilot project but was subsequently extended for a
third year.

The programme was developed by Scottish Enterprise (a non-departmental government
agency responsible for economic development
in Scotland), Highlands and Islands
Enterprises (which subsequently withdrew) and four Scottish clearing banks with a view to
providing a source of stable, long-term finance for new and expanding businesses. The
scheme was approved by the Board of Scottish Enterprise and the Treasury.

Under the scheme SMEs could obtain loans with a capped interest rate through the
participating banks. The interest-rate cap was set in relation to the Bank of England base rate
plus one percentage point at the time the loan was made. Each bank would add its own credit
margin as normal,
in order to maintain competitiveness between banks in lending to
customers. SMEs would therefore have access to medium- and long-term loans and interest
rates could rise by only one percentage point above the rate applicable at the outset. Should
interest rates rise any further, Scottish Enterprise rather than the SMEs themselves would
cover the additional loan interest payable to the banks. The scheme was therefore intended to
give companies an element of certainty in terms of knowing the maximum payment required,
while at the same time allowing them to benefit from any reductions in interest rates over the
loan period.

The programme applied only to SMEs and for loans of between UKL 20,000 and UKL
500,000000 with terms of up to seven years. Certain eligibility restrictions with regard to the
sector in which the applicant SME operated and to the use of loan proceeds were built into the
programme. In volume terms, the SBLS was a relatively small programme. Towards the end
of the programme29 264 loans had been taken out. The total value of those loans was around
UKL 44 million, with the cost of the caps purchased (i.e. the subsidy element) totalling some
UKL 2.4 million.

29

That is to say, November 1997, when a report "Evaluation of the Small Business Loan Scheme" was
compiled by DTZ Pieda Consultants.

66

B.

Operational aspects

While the overall management of the SBLS was undertaken centrally by Scottish Enterprise,
its network of local enterprise companies and the participating banks played an important role
in the operation and delivery of the scheme. All three parties were involved in vetting
applications. Scottish Enterprise and the local enterprise companies focused on assessing
eligibility, while the banks assessed the viability of proposals.

In general terms, companies entered the SBLS "system" through contact with their own
banks. The banks appraised the project on a standard commercial basis. If SBLS seemed an
appropriate funding route, then the bank would begin to process the company’s application.
The application would then be passed to the relevant
local enterprise company for an
assessment of eligibility. Once the application was "accredited" by Scottish Enterprise, the
loan finance agreement was finalised and the company joined the programme.

Scottish Enterprise had access rights to the firms which joined the programme in order to
collect information and access accounts and business plans relating to the SBLS loan. The
banks monitored the ongoing progress of the loans, reporting as required to Scottish
Enterprise, which undertook its own monitoring and analysis of the scheme.

C.

Evaluation

In November 1997 an evaluation of the SBLS was undertaken by an outside consultancy.30
With regard to management and delivery, the consultants reported that they were impressed
with the day-to-day management and administration of the scheme by Scottish Enterprise.
The scheme was said to be very tightly controlled and an excellent database monitoring cap
activity had been developed as well as good communication channels and arrangements with
the banks. However, some of the banks considered the level of administration required for cap
"repayments" burdensome. Control aspects of the SBLS were not assessed in the study.

The study’s overall conclusions concerning the scheme were as follows:
• The SBLS had attempted to address a genuine problem of medium/long-term finance for
SMEs. However the main issues of market failure did not lay with the banks but were
related to the perceptions, attitudes and knowledge of small firms.

• The SBLS was too blunt an instrument

to tackle that problem effectively. A high
proportion of assisted cases were not additional and there was a need to minimise
deadweight assistance through improved targeting, marketing and screening. In addition,
there may have been room for closer integration with the business development activities
of the local enterprise companies – it was a question not just of selling the scheme but also
of working with companies to improve their financial and business performance.

30

"Evaluation of the Small Business Loan Scheme", a report by DTZ Pieda Consulting, November 1997.

67

• It is sensible and practical that efforts to encourage small firms to make more effective use
of finance should operate through the commercial lenders. However, it is essential that
future initiatives are targeted effectively on small firms with little experience of finance.
Some form of incentive to use loan finance may be necessary and the cap may be an
effective instrument in this regard. However, this is essentially a matter of expediency and
there is no specific market failure which calls for the subsidisation of capped loans per se.

The Small Business Loan Scheme in Scotland was not extended after 1997 and no other
scheme is currently planned to replace it.

68

8.

ANNEX IV: THE USE OF SUBSIDIES IN THE CONTEXT OF EU POLICIES
WITH SPECIAL REFERENCE TO SOFT LOANS: THEORETICAL
CONSIDERATIONS

8.1.

Introduction

At first sight, the issue of recourse to soft loans instead of other forms of subsidy gives rise to
two contradictory interpretations. The first maintains that different forms of subsidy are
essentially equivalent in their effect as regards a similar objective, while the second maintains
that each instrument should have a single objective because an instrument’s characteristics,
and hence its suitability for a given objective, vary. This annex attempts to demonstrate that
this contradiction is apparent rather than real.

When examining the suitability of recourse to soft loans compared with other types of
subsidy, three different levels of analysis need to be borne in mind. At the most general level,
the issue of recourse to subsidies as an instrument of economic policy has to be addressed. In
particular, the different types of justification for providing subsidies may have an impact on
the choice of instrument. At an intermediate level, the appropriateness of a given instrument
can be evaluated only in the context of the specific individual project. In turn, this requires
that the type of expenditure eligible for subsidy and the different possibilities for financing
such expenditure by the recipient be known. Finally, each instrument will have its own
advantages and drawbacks at the implementation stage when viewed from the point of view
of the public authorities, any intermediary responsible for administering the scheme and the
recipient.

The conclusion reached is that it is not possible on theoretical grounds either to condone or to
reject the use of soft loans as an instrument for subsidising economic activity. In particular
there is no single instrument that can replace soft loans in all circumstances. If certain
developments point to less use of this instrument in the future, this should not be taken to
mean that it would ever be inappropriate to have recourse to soft loans.

8.2.

On the use of subsidies in general

Soft loans (more properly, interest-rate subsidies) are a form of subsidy and must be treated as
such. It follows that they are subject to the same general considerations as other subsidies.
The subsidy element on the loan is the difference in price that the borrower would pay to a
commercial lender in the absence of subsidy and the price actually paid. This will usually be
expressed as a reduction in the rate of interest paid.

From a macro-economic point of view, public subsidies to enterprises should be treated as
transfers. Accounting for over 2% of GDP in the EU as whole, they are far from negligible
although they represent only a tenth of public transfers to households. Certain characteristics
of subsidies make them particularly harmful from the point of view of economic efficiency.
The most harmful effects concern their impact on resource allocation and on competition
between enterprises.

At the highest level of abstraction, it can be argued that all taxes are levied directly or
indirectly on the market economy in the terminology of European national income accounts.
The market economy is composed essentially of enterprises, public or private, whether for
profit or not for profit (such as producer cooperatives and mutuals). Since enterprises are both
the source of the means to provide subsidies and the recipients of subsidies themselves,

69

transfers to enterprises should properly be seen therefore as transfers between enterprises via
the potential for
the tax system. Because this exercise is essentially non-transparent,
misallocation of resources and unforeseen side effects is rather high. Little information on the
whole cycle of taxation and subsidisation is available but it can be conjectured that the
direction of transfer is most likely to be from small and medium-sized enterprises to large
ones by virtue of
to
decision-makers enjoyed by large enterprises.

the superior organisational possibilities and greater access

A number of other objections to recourse to subsidies may be mentioned. They raise public
expenditure and therefore either the level of taxation or public deficits, both of which can
have a negative effect on growth. They distort market signals particularly in periods of high
inflation, when restrictive monetary policies are often required in order
to achieve
they may undermine the effectiveness of general
macro-economic stability. As such,
instruments of economic policy.

From the point of view of EU integration, the principal concern with regard to the harmful
effect of subsidies for enterprises has always been a concern with competition, particularly
with regard to their effect on trade between Member States. For this reason, such subsidies are
in principle prohibited where they are likely to affect intra-EU trade. Since the state aid
provisions of the Treaty apply to subsidies provided by Member States, it may be objected
that the subsidies provided by the EU, which are the subject of this report, are not affected by
competition considerations. However, this would ignore the need for coherence between the
actions undertaken by the EU and those undertaken by Member States.

A number of texts indeed make this point, e.g. the Commission communication to the
Member States on the links between regional and competition policy “Reinforcing
concentration and mutual consistency”.31 The linkage between EU and national subsidies is
explicitly made in other areas, such as the Community framework for state aid for research
and development (point 1.3).32 The guidelines on aid for SMEs go further; see point 4.2.1,
where they state that “The aid ceiling will apply regardless of whether the aid is provided
entirely from domestic sources or is part-financed by the Community from the Structural
Funds, and more especially the European Regional Development Fund (ERDF)".33 Indirectly,
this places a limit on the aid intensity also of EU subsidies. The basic Structural Funds
Regulation 1260/1999 requires that “operations financed by the Funds or receiving assistance
from the EIB or from another financial instrument shall be in conformity with the provisions
of the Treaty, with instruments adopted under it and with Community policies and actions,
including the rules on competition, on the award of public contracts, on environmental
protection and improvement and on the elimination of inequalities and the promotion of
equality between men and women.”

In practice, the corpus of legislation, decisions and practice of EU policy with regard to state
aid provides a sound basis also for evaluating the pertinence of recourse to subsidies at EU
level.34 Indeed,
to ignore this aspect by applying different criteria or giving differing
justifications for similar types of subsidy at EU level to those applied by EU competition

31

32

33

34

OJ C 90, 26.3.1998, p. 3.
OJ C 45, 17.2.1996, p. 5.
OJ C 213, 25.7.1996, p. 4.
For the purposes of this annex, the terms “state aid” and “subsidies” will be used interchangeably, even
though certain subsidies which do not affect intra-EU trade, such as subsidies for local services, are not
considered as state aid under the EU’s competition policy.

70

policy at national level might justifiably be criticised on the grounds of consistency and
equality of treatment between the actions undertaken by differing levels of authority.

As a general rule, subsidies find their justification as a means of compensating for an
externality that market forces are unable to integrate into the final end-user price for a product
in the normal operation of competition or for resolving another market failure. Such general
considerations must be applied on a category-specific basis if they are to be operational. For
the purposes of this annex, a number of the EU provisions governing state aid are relevant,
research and development,
particularly the horizontal
environmental protection, small and medium-sized enterprises, employment and training as
well as the notice applying to state aid in the form of guarantees, the guidelines on national
regional aid and the multisectoral framework on regional aid for large investment projects.35
They illustrate why, although in principle not an efficient instrument of economic policy,
subsidies to enterprises may be justified in particular instances.

frameworks or guidelines

for

A second, more practical consideration with regard to subsidies relates to the distinction
between subsidies and public investment, which is not always easy to make. This concerns
certain forms of investment in infrastructure (which may be financed, built or operated on
either a public or a private basis) but more particularly intangible investment. Here, certain
expenditures may be denominated as public investment or even consumption, but an
equivalent result may be obtained through providing subsidies to enterprises. A typical
example concerns training where vocational training may take place in publicly financed and
operated establishments or in enterprises with public financing. In the first case,
the
expenditure would not normally be considered as a subsidy, but in the second it would fall
within the remit of the appropriate Commission framework on state aids for training. In such
cases, the decision by public authorities to provide a service directly or through subsidies to
enterprises may be based essentially on criteria of efficiency of supply

Of course, the fact that Member States are authorised under certain conditions to provide
subsidies to enterprises does not oblige the EU to follow them. Indeed, in view of the
persistently high level of such subsidies and the desire to reduce them, it would be preferable
for the Commission to set an example by having only sparing recourse to subsidies in its own
policies. Many areas remain outside the EU's remit or fall within it only to a limited extent. In
such cases, it would be quite normal for the Commission to refrain from proposing subsidies
even though Member States are providing them. It would also be legitimate for the EU to
refrain from subsidisation where the necessary results were already being achieved by action
by or within Member States.

Nevertheless, there are certain cases in which the Commission could be led to provide
subsidies, even where Member States either do not or cannot provide them. One of these cases
concerns infrastructure where the major beneficiary or beneficiaries were situated mainly or
partly in other Member States. The Member State in whose territory the infrastructure was
located might decide that the use made of the infrastructure by its own citizens or enterprises
did not warrant the public expenditure involved. In this case, an EU subsidy could be justified
in order for the wider benefit to be felt. It represents in a sense a particular form of externality
based on the fact that users and administrative territories do not coincide. Article 87(3)(b)
EEC (previously Article 92) implicitly provides for this case where it permits aid for
promoting the implementation of an important project of European interest. If subsidies

35

The guidelines on state aid for environmental protection are particularly useful for the analysis of
externalities, and the framework on training aid for the analysis of other market failures.

71

provided by Member States for such a project are admissible, it should follow a fortiori that
EU subsidies for such projects also represent a valid case for intervention. Trans-European
networks constitute a typical application.36

The Treaties have also placed on the EU specific responsibilities in certain areas, such as
economic and social cohesion, which may require recourse to subsidies. These may
complement the efforts of Member States or may, in certain circumstances, be required
independently of them, particularly where the application of the additionality principle would
place an undue burden on the public finances of a Member State. Similar considerations apply
to extra-EU interventions, e.g.
in the field of development policy with the European
Development Fund or for specific interventions linked to foreign and security policy, as in the
Balkans. To the extent that it is more efficient for the EU to act with one voice and to avoid
dispersal of resources ("saupoudrage"), recourse to subsidies at EU level without recourse to
complementary sources from Member States may well be justified in certain cases.

Even where the major responsibility in a policy area lies with Member States, there can be
aspects which either are not covered by national schemes or are better dealt with by EU
subsidies. For instance, aid for the internationalisation of small enterprises, particularly
through industrial cooperation, is better organised at EU level because, by definition, the
matching of partners requires the participation of more than one country. Using a multilateral
framework in this context provides significant efficiency gains over a bilateral approach
between pairs of Member States, although there is still a question about the efficiency of any
aid for such activities.

Just as there are cases for which subsidies to enterprises are justified and permissible under
EU state aid rules, so there are cases where the EU needs to have recourse to such subsidies.
The same theoretical considerations that are applied to state aids can by and large also be
applied to the EU’s own measures.

8.3.

On the equivalence of different forms of subsidy

Probably the most common confusion that arises with regard to soft loans concerns their
particular usefulness, or
form of subsidies.
Sometimes soft loans are endowed with almost mystical capacities in the financial field, while
at other times they are reviled. In practice, soft loans are a form of subsidy with similar effects
to other forms.

lack of usefulness, compared with other

The essential equivalence of soft loans and direct grants is the easiest to demonstrate. Loan
guarantees and tax incentives are more difficult to compare directly, but it is always possible
to reduce a subsidy system to a single figure by replying to the question “what is it worth to
the recipient?".37

Take a simple example, that of a fixed investment in plant and equipment. An enterprise may
finance this from its own resources as reinvested earnings, may take a loan or may raise new

36

37

Another example of trans-national externalities is provided for by the guidelines on environmental
protection, which state in point 3.7 that “Aid to promote the execution of important projects of common
European interest which are an environmental priority and will often have beneficial effects beyond the
frontiers of the Member State or States concerned can be authorized under the exemption provided for
in Article 92 (3)(b) of the EC Treaty.”
In any substantial company this is the question that the finance director will pose before deciding
whether to take up the possibility offered. In a smaller company it will be the CEO, or more often the
company’s accountant, that will reply to the question.

72

equity either on external markets or in the form of private equity. Since it is relatively rare to
raise new equity for the purpose of financing fixed investment, the main choice will be
between taking a loan or financing from own resources. Where a subsidy is provided in the
form of a direct grant, the need for external finance is diminished by an equivalent amount.
Any loan taken out will bear a full rate of interest on a diminished principal. In the case of a
soft loan, the full principal is charged, but the interest repayments are reduced. Any difference
between the forms of subsidy therefore concerns the timing of the cash flows associated with
the repayment of the loan. Since the value of money diminishes over time, a subsidy in the
form of interest paid in the future will be less valuable than a cash sum allotted at the outset.
In order to calculate the worth of the two possibilities, a finance director will discount any
interest-rate subsidies to find their net present value. Any soft loan can therefore be compared
to a direct grant. It also follows that, for any specified loan, there will be some interest-rate
subsidy that is equivalent to a given direct grant.

It will be immediately apparent that the rationale and steps indicated above are those applied
over many years by the Commission in the context of its evaluation of state aid. Any given
state aid is reduced through appropriate calculations to either a gross (before tax) or net (after
tax) grant equivalent. Similar levels of subsidy are deemed to have similar effects on
competition and therefore to be equivalent for the purposes of competition policy.38 Certain
countries, in particular the UK, have traditionally used direct grants as the main form of
subsidy, while others have relied mainly on soft loans. However, Member States typically use
a combination of different instruments, albeit in different proportions.

In passing, it may be mentioned that, as with any net present value calculation, one of the
most difficult choices to be made is that of the discount rate. Choice of discount rate is
particularly important because it significantly affects the outcome of the calculation. The
Commission usually, but not always, sets discount rates to be applied in state aid cases as the
five-year interbank swap rate in the relevant currency plus a premium (which may vary
between Member States). The use of a single rate has advantages in terms of transparency and
ease of administration. Since projects and enterprises have different risk characteristics, it is
not evident that a single rate can adequately capture the true net present value of a soft loan
compared with a direct grant. It merely indicates that, although equivalence between the effect
of different instruments may be true in theory, there are problems in applying the principle in
practice. These problems have not prevented policies on state aid from developing and being
applied on a daily basis.

Since the Council, in its report to Coreper on the special report of the Court of Auditors on
interest-rate subsidies, specifically draws attention to the availability of “other, possibly more
efficient, financial instruments, such as loan guarantees”, Commission treatment of such
guarantees under competition policy is also of interest. In particular, it can help elucidate
major differences between instruments. The Commission notice on the application of Articles
87 and 88 of the EC Treaty to state aid in the form of guarantees sets out the procedure to be
followed.

Not all guarantees constitute state aid. A number of conditions must be met for guarantees not
to be considered as aid. A key provision requires that the market price for a guarantee be paid.
In the case of guarantee schemes, the premiums must cover both the normal risks associated

38

The steps taken by the Commission to calculate net grant equivalents for a capital grant or a subsidised
loan are set out in Annex 1: Net grant equivalent of investment aid to the “Guidelines on national
regional aid”.

73

with granting the guarantee and the administrative costs of the scheme, including a return on
any initial capital provided. Two main methods are used to calculate the amount of subsidy
attached to a guarantee. The first covers the difference between the market rate on a loan and
the rate obtained thanks to the guarantee after any premiums have been deducted. The
guarantee can then be likened to a soft loan. The second covers the difference between the
risk-adjusted sum guaranteed and the appropriate premium for such a sum. The second of the
two methods already indicates that risk constitutes the problem that guarantees are intended to
address. Although risk constitutes an element in any financing decision, soft loans and direct
grants are more directed towards solving problems of cost or availability than risk. It suggests
that for different types of problem there can be different instruments, even when the net grant
equivalent of the subsidy is the same.

8.4.

On the suitability of different instruments for one and the same objective

The doctrine according to which each financial instrument has its own characteristics and
each objective to be met will have an optimum financial instrument is well anchored in
Commission thinking. At an abstract level, it is necessary to define clearly the public policy
objective to be met, especially whether an externality or market failure is the cause of the
problem, the characteristics of the action to be undertaken and the type of recipient of the
instruments that are close
subsidy. For any given profile of problem-action-recipient,
substitutes will usually give a range of acceptable outcomes. The decision to use one or other
of them will then depend on other characteristics of the instruments such as their ease of
deployment or the degree to which they can be adequately monitored for abuse. To the extent
that instruments are not close substitutes, it can be expected that one or other instrument will
be appropriate and the others inappropriate to the task in hand, unless several are required
jointly in order to meet the policy objective.

In the case of a large infrastructure project, e.g. a transport
link with pan-European
implications, there can be several possible outcomes. Certain projects require very large
outlays of capital for returns far in the future and of a very uncertain nature. In this case the
problem to be addressed is risk which cannot be adequately evaluated by the market, either by
the enterprise wishing to execute the project or by the financial intermediaries wishing to
invest in it.39 The Channel Tunnel was an example of how difficult it is to assess and price
risk adequately in such cases. The difficulties it encountered and the losses borne by
shareholders may make it difficult for similar projects in future to find financing on a purely
commercial basis. Faced with this situation, the public authorities could either decide to build
and finance the link themselves, thereby assuming all of the risk and the necessary finance, or
provide a guarantee such that the risk became manageable for commercial operators and
markets. In such a case, soft loans or direct grants would not be an appropriate instrument
because the problem concerns incalculable risks rather than weak profitability.

The case of a transport link that relieves congestion and/or reduces pollution constitutes an
entirely different type of problem. Here, we are faced with one or more externalities rather
than a market failure. In the case of congestion, the cost appears in terms of time taken to
travel to destination, more accidents and higher pollution. This cost is not or only partially
borne by the owners and operators of the current infrastructure. In the case of commercial

39

It is necessary to distinguish unpredictability from duration. Not all infrastructure projects, even those
with very long pay-off periods, encounter problems of financing. Typically, power stations display very
stable returns over a long period and do not encounter any problems of financing when operated on a
commercial basis. However, the uncertainty surrounding decommissioning costs of nuclear power
stations may inject a sufficient degree of unpredictability to jeopardise their commercial viability.

74

exploitation (e.g. of a motorway or rail link), only part of the benefit to society can be
recuperated by the end user. In this case, infrastructure provision may be suboptimal for
society.

As with any externality, the provision of a subsidy may be justified when for any reason it is
not possible to reflect adequately the value of the externality in the end-user price (e.g. by
levying taxes on emissions). However, the level of subsidy should be calculated according to
the value of the externality rather than in order to ensure that any particular project becomes
commercially viable. In principle, the projects with the highest return in terms of increasing a
positive externality or reducing a negative one should be subsidised. An infrastructure project
to which externalities are attached should be undertaken if the commercial value of the project
plus the subsidy equivalent to the value of the externality is sufficient to ensure commercial
viability. The value of the subsidy should not be calculated as the difference between the total
cost of a project and that which a commercial promoter would be willing to pay. In such a
case, the cost in subsidy might well outweigh the value of the externality.

In terms of the financial instrument to be used to meet the problem of an externality, it is clear
that it is the cost of the project rather than its risk characteristics which is being addressed.
Both soft loans and direct grants reduce the cost to the promoter and, since both are close
substitutes, either could be used. It would be unlikely for a loan guarantee to be an appropriate
instrument in this case.

Aid to small and medium-sized enterprises (SMEs) represents a second typical case for which
subsidies are often provided. Under point 1.2 of the Community guidelines:

“SMEs suffer from a number of handicaps that can slow down their development.
One of the main handicaps is the difficulty in obtaining capital and credit, the chief
causes of which are imperfect information, the risky nature of financial markets and
the limited guarantees that SMEs are in a position to offer; SMEs' limited resources
also restrict their access to information, notably regarding new technology and
potential markets. The introduction of new regulatory arrangements often entails
higher costs for SMEs. The imperfections in the market which limit the socially
desirable development of SMEs justify the favourable consideration which the
Commission has traditionally been prepared to give to state aid to SMEs, provided
trade to a disproportionate extent relative to the
that such aid does not affect
contribution it makes to the achievement of Community objectives allowed by
Article 92(3). The Community has in fact
itself been implementing an action
programme for SMEs.”

The objective identified here is to remedy a market
failures leading to
insufficiencies in a number of areas, each of which could be the subject of one or more
actions. When a decision is taken on the choice of financial instrument for the provision of
subsidies, risk and limited resources will be key considerations. The recipients obviously are
small and medium-sized enterprises and the Community dimension of the problem is
acknowledged.

failure or

When it is the intention to provide subsidies to remedy a market failure with regard to the
provision of financing for SMEs, it is necessary to establish properly the specific financing
needs that are currently either not being provided or being provided only inadequately. This
implies a good knowledge of SMEs' specific financial structures and needs. Since corporate
finance texts and business school classes deal mainly with the financing of large firms, there
is a dearth of easily accessible information on this. A study for DG ECFIN which makes a

75

comparison between the financial structure of SMEs versus large enterprise using the BACH
databank helps to fill a gap.40 As is well known, SMEs have little access to external markets
either for equity or for loans (corporate bonds). In spite of this, debt/equity ratios and the
degree of leverage for SMEs are quite similar to those of large enterprises. Since the report
does not distinguish between different sources of equity, the amount of self-financing through
reinvested earnings compared with outside sources of equity is not available. However, as
mentioned above, this distinction is not significant for most investment decisions. By placing
SMEs in a more dependent relationship with banks, the lack of access to bond financing could
be of greater significance in terms of the market failure to be remedied.

One of the most important findings of the report concerns the much lower capital intensity of
SMEs and their much higher share of working capital in total capital. SMEs rely on flexibility
to respond to market signals quickly. Most subsidy schemes relate either to investment in
fixed assets – whether tangible or intangible in the form of patent rights, licences, know-how
or unpatented technical knowledge - or to specific aids for meeting a shortfall in specific areas
such as recourse to consultancy schemes. Since working capital does not give rise to a fixed
asset, no provision is made for it by the Community guidelines and operating aid is
specifically excluded. In practice, a significant area for SME financing for which loans are the
overall source, and hence the possibility of providing soft loans appear to fall outside the
scope of existing Member State and indeed EU schemes.41

Concerning recourse to loan guarantees or soft loans for those categories of SME investment
that are eligible for subsidy, the appropriateness of one or other instrument depends again on
the specific market failure to be addressed. Assessing the degree of riskiness of a loan for an
SME may be difficult even for an established financial intermediary such as a bank. High
turnover among SMEs may mean that there is an insufficiently long period of operation to
judge the financial health of an enterprise. The large number of firms in very specific market
niches, particularly in service industries, means that specialist knowledge of the conditions for
success on these markets will often be lacking within commercial lenders. Success in the
market may, in any case, depend more on the individual capacities of the SME manager than
on any objectively verifiable criteria on which, for instance, a credit rating can be made. The
attendant difficulty of accurately pricing a loan can lead a bank to withhold credit, especially
when the collateral offered is insufficient. In this instance, guarantee schemes which diversify
risk among a large number of SMEs appear the most appropriate financial instrument. They
address the failure to obtain credit at any (or almost any price) rather than the high cost of
credit. In a sense, they can be seen as a response to a particular form of credit rationing.42

There are a wide range of loan guarantee schemes for SMEs currently in operation within
Member States. For instance, the "banques populaires" in France operate a scheme whereby
potential borrowers in the craft sector are interviewed by other craftsmen to determine
whether their professional capacities make them a good or bad credit risk (peer review). Once
their professional capacities have been assessed, the borrower has access to a guarantee
scheme for which a premium must be paid. Such a system acts to solve the risk evaluation
problem both by injecting specialist knowledge into the loan application system and by
diversifying risk. In principle, the subsidy element is absent, so there is no market failure.
However, since the French Government provides soft loans to the "banque populaires" for

40

41

42

I.D.H.E. Final Report by Dorothée Rivaud-Danset et al, June 1998.
There is an exception in the case of agriculture.
There are other forms of credit rationing, e.g. those stemming from inadequate balance-sheet resources,
by lending institutions that cannot be dealt with through guarantee schemes.

76

craftsmen and since the lender obliges the recipients of these loans to participate in the
guarantee scheme, it can be said that there is an indirect subsidy element. The scheme also
illustrates how soft loans and guarantee schemes can be complementary.

Other Member States, such as Germany, Italy and Spain, operate guarantee schemes where, in
principle, the premiums cover the full cost of operation but where there is a public guarantee
in the case of particularly distressed conditions either because of a crisis in an individual
sector or because of a particularly severe business downturn which could generate large
numbers of bankruptcies if borrowers were forced to default. Such schemes inevitably imply a
subsidy element of imprecise nature. Nevertheless, they may be very efficient at remedying
the market failure outlined above.

Soft loans to SMEs, whether or not in conjunction with loan guarantee schemes, can be
valuable where the cost rather than the availability of capital is an issue. This applies where
economically or socially desirable investment is forgone because of the incapacity of SMEs to
obtain finance on sufficiently favourable terms. Weak bargaining power with regard to banks,
the lack of a competitive alternative to banks in the form of the bond market and a higher risk
of default means that loans to SMEs are generally more expensive than those for large
enterprises, sometimes substantially so. Since SMEs are less capital-intensive and more
labour-intensive than large enterprises, subsidies for their investment needs may be justified
in periods of severe employment shortfall.

The value of subsidising investment changes over time along with the situation of financial
markets. During a period of low interest rates and low inflation, the need for public subsidies
for investment may decline, particularly if profits are growing steadily and the self-financing
capacity of enterprises is improving. However, low nominal interest rates do not necessarily
lead to low real interest rates. On the grounds that real interest rates should determine
investment behaviour,
there may still be some justification for maintaining investment
subsidies such as soft loans even when nominal interest rates are low. Figs. 1, 2 and 3
illustrate movements in nominal long-term interest rates on government bonds and real
interest rates (nominal rates adjusted ex post for inflation) for a sample of countries over the
past decade.43 The first impression is, to say the least, hazy. For instance, in Japan the
relationship between nominal and real interest rates appears to be downwards sloping while in
the UK it is upwards and then downwards sloping; in the US there is no discernible pattern in
the relationship. On closer inspection, it would appear that in Europe there is some sort of
pattern to the relationship but that this pattern varies in timing from one country to another.
Generally speaking, at the beginning of the disinflationary cycle real interest rates fall but
then rise as inflation falls faster than interest rates. They then resume their downward path
until reaching a minimum around which there is some stability. In certain cases, such as Italy,
real interest rates rose at the beginning rather than towards the middle of the disinflationary
cycle.

Certainly, it would be difficult to adjust public subsidy schemes in line with changes in real
interest rates, particularly since such adjustments would have to be based on inflationary
expectations rather than realised outcomes. The best that could be hoped for would be that
schemes are able to move in line with a relatively steady-state situation. If, as now appears to
be the case, there is some stability in low real interest rates, then it becomes possible to adjust

43

It is not suggested that this provides an adequate proxy for the actual financing conditions of SMEs. It is
intended only as an indication of the overall relationship in an economy between nominal and real
interest rates.

77

aid schemes and intensities in line with changed economic situations. An era of abundant and
cheap capital clearly does not call for the same level of subsidies as one of scarce and
expensive capital. Therefore, investment subsidies for enterprises in the form of soft loans
may have become a less appropriate instrument than previously. In specific instances, either
where capital remains expensive or where there is a need for particularly significant
incentives (usually associated with an important externality), soft
loans may still be
appropriate. Identical considerations apply to close substitutes for interest-rate subsidies, such
as direct investment grants. They clearly apply only to the EU and cannot be extended, e.g. to
developing countries and the European Development Fund.

Developments in the “new economy” and the greatly enhanced importance of intangibles also
presage a change in the financial needs of enterprises and thus in the suitability of soft loans
as an instrument of economic policy. Much of the expenditure on intangibles takes place on a
regular rather than discrete basis and is treated as an operating cost rather than a balance-sheet
asset. As such, traditional forms of subsidy as a percentage of a fixed investment may become
less relevant in the future. Instruments such as soft loans either will have to be adjusted to
take this development into consideration or are likely to decline in importance.

For the limited number of firms with high growth potential, often but not exclusively in
high-technology industries, a lack of seed and start-up capital has been identified as a major
problem. The Commission has already proposed action at both EU and Member State level to
address this matter. The general approach is to improve the functioning of financial markets
rather than subsidisation. To the extent that recourse to public subsidies might be justified, it
would probably be required in the form of equity injections rather than loans. However, once
such firms enter into the high-growth phase (so-called gazelles), the need for all kinds of
finance grows very rapidly. Cash-flow problems are often encountered in this phase because
revenues are growing more slowly than investment. In order to ease cash-flow constraints,
soft loans concentrated in the early phase of the repayment period may have a role to play.

When reviewing the future of an instrument such as soft loans, possible developments in the
financial environment and institutions for potential recipients must be acknowledged. SMEs
face a number of potentially contradictory developments as regards their access to finance. On
the one hand, they are becoming a much more significant part of the customer base for banks.
Major companies are now able to raise finance more cheaply on bond markets than they can
borrow from banks and in many cases more cheaply than banks themselves can borrow on the
market. As a result, the borrowing and lending activity of banks has been heavily curtailed,
leaving them with rather unprofitable business such as effecting transfers. At the same time,
consumers are no longer willing to leave large sums unremunerated in their bank accounts. In
order to attract such savings, banks are increasingly required to pay market rates of interest.
SMEs represent the last major source of potentially profitable business from conventional
lending activities. Banks themselves are also facing much greater competition, both from
other banks and from non-banks. All these developments point to a lowering in the cost of
finance for SMEs.

On the other hand, the cost of capital to banks is rising because of capital adequacy provisions
and the desire of retail customers for remuneration for their savings. Very heavy investment in
information technology and the infrastructure for processing financial flows must be repaid. If
SMEs remain the principal source of profitable business for banks, a larger element of the
cost base must fall on them. This points to higher financing costs for SMEs.

78

8.5.

On the implementation of soft loans

A major part of the criticism of the Court of Auditors echoed by the Council concerns the
implementation of soft loans by the Commission or by agents appointed by the Commission
to manage them, such as the European Investment Bank. In its report to Coreper, the General
Secretariat of the Council even goes so far as to state that:

“…several delegations questioned more generally whether interest-rate subsidies are
still justified in the light of experience taking into account in particular the cost of
effective control measures…”

Several types of criticism are levelled against soft loans including the cost of administration,
the uncertainty as to whether the borrower receives the subsidy or whether the financial
intermediary pockets all or part of it, a lack of transparency in the choice of intermediary and
the possibility of distortion of competition between financial institutions and the assertion that
the investment financed by a soft loan would have taken place even without the subsidy.
Some of these criticisms are justified but apply to subsidy schemes in general, others are
inherent in the soft loan instrument but are offset, wholly or partly, by other advantages while
still others appear to have little merit or to be based on a misconception.

Soft loan schemes typically target a very wide audience, with many recipients for relatively
small amounts. Such schemes are expensive to administer. The same is true of direct grants
and other instruments with a comparable impact. Because soft loans are, as a general rule,
administered by commercial firms, these require their costs to be covered in some form or
other (either through a fee for administration or in the form of the difference between the
interest subsidy received and that provided to the borrower). The cost of administration is
reduced by the incentive that any commercial firm has to reduce costs in order to maximise
profits and by the fact that the infrastructure for providing loans is already place and does not
have to be remunerated by the soft loan scheme or at least not remunerated in full. In the case
of an alternative to soft loans administered by the public authorities themselves such as direct
grant schemes, the cost of administration is not transparent and rarely, if ever, calculated.
Experience with the privatisation of public enterprises and the outsourcing of public services
demonstrates that cost savings in the field of administration are huge. It defies belief that the
cost of administering soft loan schemes is higher than, for instance, that associated with direct
grants.

It is true that under soft loan schemes it is difficult to ensure that the borrower and ultimate
recipient receives the full benefit of the subsidy. This is in part because of the administrative
costs mentioned but mainly because of the oligopolistic structure of the banking industry and
asymmetric information on the part of the borrower and the lender. This represents a very
serious drawback because the high price of borrowing constitutes one of the essential reasons
why public authorities provide soft loans. The only solution to the problem is to create a more
competitive environment for lenders. Progress in implementing the single market and the
developments in the banking industry outlined in the previous section should make banks
more eager to compete for SME business. Under competitive conditions,
it would be
counterproductive for a lender to fail to pass on to the borrower the maximum benefit of a soft
loan since the borrower would then have an incentive to go elsewhere. In some cases of state
aid schemes in the form of soft loans, the Commission has insisted that the benefit be
available through all lenders for precisely this reason.

A key advantage from the point of view of public authorities that stems from recourse to soft
loans as compared with other forms of subsidy resides precisely in the expertise of banks in

79

assessing the commercial viability of borrowers and their projects. As indicated in a previous
section, this expertise may be imperfect and there are occasions where it is impossible or
difficult to evaluate risk precisely. However, commercial operators whose success depends on
this ability are more likely to make a thorough and proper evaluation of a request for a loan
than public administrations are in the case of a grant. Where all risk is taken away from the
lender, a problem of moral hazard arises. For this reason, it is legitimate to limit subsidies to a
certain percentage of the total, even where there is no legal requirement to do so. In the case
of loan guarantees for example, Member States usually limit
the amount guaranteed to
between 50% and 70% of the principal.

It has been the practice of the Commission, either directly or through the European
Investment Bank, to restrict access to soft loans to a limited number of institutions. This can
only diminish the amount of competition between such institutions. However, the practice can
be justified on a number of grounds. The choice of institutions is usually made by virtue of
their specific expertise in the field to be covered by the scheme (e.g. banks specialised in
lending to SMEs). Enhanced efficiency in implementing the scheme and lower administration
costs for the Commission or its agents should be treated as valid bases for restricting the
number of eligible institutions.

A large number of intermediaries make administrative control of the execution of a scheme
more difficult. However, faced with a general problem of large numbers of final beneficiaries,
recourse to intermediaries may be the only cost-effective way of supplying a service.
Particularly when speed of execution is called for, administrative control may have to be
sacrificed in order for the initial objective to be met. Taking the Edinburgh facility for SMEs
as an example, the European Council entrusted the Commission with the task of rapidly
executing a scheme to promote investment by SMEs in order to help relaunch growth in the
EU. Inevitably, only projects already in the pipeline could be financed and a considerable
degree of delegation to intermediaries was required. Any aid scheme implies a trade-off
between efficiency of execution and efficiency of control. The optimal trade-off cannot be
established in abstract or without reference to the particular characteristics of the action
involved. In particular, speed and control are likely to be contradictory.

The most difficult and controversial aspect of soft loan schemes is their degree of efficiency
in meeting the results expected. Although soft loans may be provided for a variety of reasons
and to finance a range of activities, the most common case is that of a loan to finance a fixed
investment. The criticism levelled is that the investment would have been made even in the
absence of the aid provided. Contrary to the opinion expressed by the Council, this constitutes
a general problem with subsidy schemes and is by no means restricted to soft loans.

According to corporate finance literature, the returns on an investment project should be
compared with a firm’s cost of capital to ascertain whether or not an investment should be
undertaken. All projects with a profitability greater than or equal to the cost of capital should
be financed. In theory, therefore, it should be sufficient to establish whether or not the
projected return on an investment covers the cost of capital in order to determine whether the
aid provided has been decisive in the investment decision. In practice, things are not so
simple. The cost of capital varies not only from firm to firm but also from project to project.
A large investment financed by a loan will alter the degree of leverage, which may affect
negatively a company’s credit rating. The attendant increase in the cost of capital can then
make other investments no longer worthwhile. Even on a firm-wide basis, cost-of-capital
calculations are complicated to make, particularly if the most reliable method of evaluating
equity, the capital asset pricing model (CAPM), is employed. Non-quoted firms and firms in
countries with small or illiquid stock exchanges are precluded from applying CAPM at all. A

80

study undertaken for the European Commission by Coopers and Lybrand at the beginning of
the 1990s found that even large firms do not calculate their cost of capital for the purpose of
making investment decisions.

An alternative approach which appears more in line with corporate practice assumes that an
enterprise has a portfolio of possible investments at any moment in time. According to
prevailing conditions, the most profitable or the least expensive or some combination of these
two criteria will be applied and an investment carried out. The relevant variables are market
conditions, which determine the extent to which investment possibilities are present and their
profitability, the cost of finance, in particular the prevailing interest rate faced by a firm, and
internal financing possibilities. According to the pecking order theory of corporate finance,
external financial sources are a second best. In order to finance the growth of fixed assets,
managers give priority to retained earnings, then to borrowing and finally to issuing shares.
When retained earnings are high, many investments are made, even with low profitability and
conceivably even below a firm’s average cost of capital.

Under such circumstances, the question whether a specific project would have been financed
in the absence of aid becomes irrelevant. If a supplementary project were to be financed from
the portfolio of possible investments, the intention of the aid could be very well met. The
difficulty then is to establish whether all of the portfolio realised would have been undertaken
in the absence of the aid. Where there is a definable credit constraint either in total amounts
available to the firm or in a sharply rising cost curve for borrowing, it may be possible to
demonstrate that a subsidy has really led to additional investment. In many cases, this will not
be possible. Applying the pecking order theory, an investment that could be financed by
retained earnings would probably have been executed in any case, while an investment
requiring an equity injection would not have been undertaken. This leaves a considerable grey
area covered by investments for which a loan would in any case have been required.

Similar considerations apply to the lender. Although any individual loan may have been made
in the absence of a subsidy, aid which expands the total amount of loans for a given category
of investment that it is the intention of public authorities to assist can be deemed to meet the
objectives of the scheme. Where the number of potential recipients is small or market
conditions unfavourable, then the probability that the loan portfolio will have expanded is
reduced. Where the lending institution faces a limitation on the quantity of loans it can
provide, e.g. as a result of balance-sheet restrictions, or where the lender’s cost of funds is
high, then the probability that the loan portfolio has expanded as a result of the subsidy is
increased.

In the final analysis, the impact of a subsidy scheme for a given policy objective should be
seen as an empirical and not a theoretical question. It relates to the tools of evaluation that are
available and the capacity of the Commission to apply them. Systems involving public
loss or “effet d’aubaine”. Rigorous evaluation
subsidies are subject
procedures require that such losses be calculated in a formal way44. In the United States,
where evaluation methods are more developed, systematic recourse to control groups for
public aid schemes is encouraged and often mandated. Control groups are a useful tool for
evaluation, but aid recipients may not themselves be typical of firms in the economy as a
whole. It follows that differences in outcomes between recipients and the control group do not

to a deadweight

44

“Six steps to heaven: evaluating the impact of public policies to support small businesses in developed
economies”, David Storey, Warwick Business School Working Paper No 59, September 1998, sets out
the problems of evaluation in an area of significance for the Commission in a practical way.

81

necessarily stem from the programme of aid. Closer definition of control groups by matching
on the basis of defined objective criteria (size of firm, sector, location, age of entrepreneur,
etc.) can reduce but not eliminate this problem. Very rigorous selection procedures are
required in order to take into account various forms of bias in making comparisons between
recipients and non-recipients. In the end, it is the lack of a culture of evaluation in Europe that
leads to a situation in which the effect of subsidy schemes is unknown and therefore open to
criticism on efficiency grounds.

8.6.

Conclusion

Since capital in developed countries is no longer scarce and is increasingly cheap and because
of the growing importance of intangibles in the economy, it is likely that the use of soft loans
as an instrument of economic policy will decline both at EU and Member State level. The
same does not apply to developing countries or therefore to the Commission’s development
policy.

In certain specific cases, in particularly where there are externalities which cannot be dealt
with in other ways, soft loans may remain an appropriate instrument. Excluding any future
recourse to this instrument on theoretical grounds would not appear to be justified. Only on a
case-by-case evaluation of the advantages and disadvantages of soft loans compared with
other instruments will it be possible to judge whether such loans are appropriate for a given
objective. In any case, it will not be possible always to replace soft loans by loan guarantees
since they address different kinds of problem and in some cases are complementary.

82

Problem to be addressed
Very high or incalculable risk (rather than
weak profitability)

Typical example
Large-scale infrastructure

Financial instrument
Loan guarantees

FINANCIAL INSTRUMENTS: SOME EXAMPLES

Investment in the industrial sector or other
economic sectors with high leverage
Transport links
Environment

Interest-rate subsidies; grants

Interest-rate subsidies; grants

Comments
In such cases, soft loans or direct grants would not be an
appropriate instrument because the problem concerns
incalculable risk rather than real profitability.
To boost private investments in assisted areas. To overcome
recession.
The commercial value of the project plus the subsidy
equivalent to the value of the externality should ensure
commercial viability.

Economic recession
Unemployment
For whatever reason it is not possible to
adequately reflect the value of the
externality in the end-user price; when
users and administrative territories do not
coincide
Privatisation, move from « tax pays » to
« users pay»
High cost or low return of the project
(rather than risk) ; difficulty in obtaining
capital and credit (market failures) ; little
access to external markets
To reduce housing shortages or supply of
high standards at affordable prices
Damages due to natural disasters;
financing the reconstruction
When success depend more on the
individual capacities of the manager ;
difficulty in accurately pricing a loan (risk
evaluation problem)

High risks concentrated in the first years

High-growth companies

83

Infrastructure, public services
Environment
Small and medium-sized enterprises

Public-private partnership
(PPP)
Interest-rate subsidies; grants

Reduces debt and holds down taxation.
Leving of taxes on emissions.
To overcome the market failures or the handicaps that SMEs
suffer

Construction of new housing or upgrading
of existing stock
Infrastructure; housing

Start-up in new or high-growth sectors
(innovation, technology, etc.)
Very small enterprises

Interest-rate subsidies; grants

Political goals. Transfers to young couples, the poor, etc.

Interest-rate subsidies; grants

A symbol of solidarity

Loan guarantee scheme

Diversify risk among a large number of SMEs.
The premium must be equal for all the applicants and
represent the genuine cost of the guarantee otherwise there is
an indirect subsidy. The risks are externalised (insurance
technique).

Venture capital; business angels Share the risks (and the profits) with the venture capitalist.
An exit for the investment is needed (stock exchange) once
the project has matured.

Real Interest Rates

Long-Term Nominal and Real Interest Rates 1990-99 (%)

6

5

4

3

2

1

0

0

2

4

6

8

10

12

Nominal Interest Rates

JP

US

UK

Real Interest Rates

Long-Term Nominal and Real Interest Rates 1990-98 (%)

9

8

7

6

5

4

3

2

1

0

0

2

4

6

8

10

12

14

16

Nominal Interest Rates

DE

FR

IT

84

Real Interest Rates

Long-Term Nominal and Real Interest Rates 1990-99 (%)

9

8

7

6

5

4

3

2

1

0

0

2

4

6

8

10

12

14

16

Nominal Interest Rates

ES

NL

SW

85

9.

ANNEX V: MACROECONOMIC EFFECTS OF AN INTEREST-RATE
SUBSIDY FOR FIRMS IN THE EU

9.1.

Introduction

This annex presents results concerning the effects of an EU-wide interest-rate subsidy for the
corporate sector, using DG ECFIN’s macroeconomic model QUEST II. An interest-rate
subsidy is one way to promote private investment. The channel is via a reduction in capital
costs for firms. The analysis presented here looks at the macroeconomic impact of such a
policy, i. e. the implicit assumption is made that the policy is not targeted at specific forms of
investment, specific sectors or specific types of firm but applies to the corporate sector in
general. The simulations can therefore only give a broad picture and illustrate the various
channels through which policy affects the main macroeconomic aggregates. In contrast to a
purely microeconomic or sectoral analysis, a macroeconomic analysis will, however, consider
many possible feedback effects. In particular, this simulation analysis will shed some light on
the following issues:

• How responsive is investment to a change in interest rates?

• Are there offsetting effects, e.g. an increase in the interest rate when aggregate demand

increases?

• What are the exchange-rate effects?

• What are the budgetary implications?

• How much of a GDP and employment effect can be expected from an increase in

investment?

• What is the time horizon for the effects to materialise?

Though feedback mechanisms are important, the initial impact of interest rates on investment
is, of course, crucial for the aggregate impact. The QUEST model allows for such a direct
interest-rate effect since investment is specified using the standard neoclassical model of the
firm with adjustment costs, i.e. investment is a function of the present value of profits. This
model of investment is also known as Tobin’s q model. This hypothesis postulates that firms
equate the marginal product of capital to capital cost and marginal adjustment costs. The
interest rate enters the capital-cost term together with the depreciation rate, the corporate tax
rate and the purchase price of new investment goods. Policy has three instruments available to
promote investment; it can either lower corporate taxes/increase depreciation allowances,
subsidise investment or subsidise interest rates. The last of these policy alternatives is
considered in this annex.

9.2.

Assumptions

In the simulation presented below, a permanent EU-wide subsidy is assumed which reduces
the real interest rate of the corporate sector by half a percentage point. This amounts to a
reduction in capital costs of some 7%. Such a subsidy would represent a considerable fiscal

86

stimulus amounting to more than 2% of EU GDP.45 It is assumed that the government does
not offset this subsidy with either a reduction in expenditures or an increase in taxes but
instead runs a deficit/surplus. In this way one can see most clearly the budgetary implications
of the policy measure. A debt rule is invoked after ten years which adjusts government
transfers to households in order to restore the baseline debt-to-GDP ratio in the medium term.

9.3.

Simulation results

The results of this simulation for the EU economy are contained in Table 1. First, it is
interesting to look at the effects on GDP, private consumption, investment, employment and
wages. Starting with the direct impact on private investment, it will be seen that investment is
sensitive to changes in capital cost. Investment increases by about 5% on average in the first
ten years. The elasticity of investment with respect to the user cost is about 0.7. This is within
the range of recently reported estimates for OECD countries.46 But notice also that, despite a
strong investment response, the GDP effect is rather small. There exists both a supply-side
and a demand-side interpretation of this result. It takes time for investment to increase
significantly the capital stock of the economy. As can be seen from the table, the capital stock
increases only by 0.17% in the first year and it takes ten years for the capital stock to increase
by 2%. With an output elasticity of capital below 0.5, it is obvious that the GDP response will
be limited, even with such a boost to investment. An increase in employment would be
another factor which could increase GDP. However, the employment effect is limited. There
are two reasons for this: first, the policy lowers the relative price of capital and therefore
induces substitution effects and, second, since wages are partially linked to an increase in
labour productivity, the policy leads to an increase in real wages.

There is also a demand-side aspect which should not be neglected. The consumption response
is negative. This response is important for understanding the macroeconomic effect of the
policy. On a macroeconomic level a policy of promoting investment will, as a result, increase
the rate of savings, at least temporarily. Lowering interest costs for firms allows them to
borrow at higher rates and thereby stimulates savings.47 Higher interest rates also attract
capital inflows and lead to an appreciation of the euro. While this is necessary to increase

45

46

47

QUEST does not distinguish between different sources of financing and different forms of ownership.
In the simulation full debt financing of investment by firms is assumed, with the result that the
interest-rate subsidy is a subsidy to the total capital stock.
There is considerable scepticism in the macroeconomics profession as to whether capital costs are a
significant
investment determinant. This scepticism is based mostly on time-series estimates of
investment equations where generally a strong accelerator term is found, reflecting the stylised fact of a
strong positive correlation between investment and output over the business cycle. Moreover, real
interest rates themselves are partly endogenously determined and show a procyclical pattern. This
makes it difficult to estimate the effect of exogenous interest-rate shocks on investment with time-series
data. Recent empirical research into the effects of capital costs on investment has therefore moved away
from time-series analysis to individual-firm data sets, which make it possible to look more closely at the
investment response to “exogenous” changes in capital costs, e.g. by looking at the investment response
of firms after tax reforms. An influential paper by J. G. Cummins, K. A. Hassett and R. G. Hubbard
(1996), "Tax reforms and investment: A cross-country comparison” (Journal of Public Economics 62,
pp. 237-273), arrives at the conclusion that for a set of seven OECD countries the investment elasticity
with respect to the user cost of capital lies between 0.5 and 1.0. A recent study by R.S. Chirinko,
S. M. Fazzari and A. Meyer (1999), “How responsive is business capital formation to its user cost? An
exploration with micro data” (Journal of Public Economics 74, pp. 53-80), arrives at an estimate of
0.25.
As can be seen from the table, the increase in real interest rates partly offsets the initial interest-rate
subsidy.

87

investment, it obviously has demand repercussions which limit the expansion of the economy
as a whole. Nevertheless, the permanent rise in investment increases the capital stock and
therefore permanently raises potential output. The adjustment process is,
in fact, not
completed after ten years but it takes about 25 to 30 years before 90% of the total adjustment
is completed, with a permanent increase in the level of GDP of around 2.5%. The policy also
generates employment effects of some 0.4% in the long run.

Although this policy seems attractive from a macroeconomic point of view, there are also
considerable costs involved and the macroeconomic welfare effects do not seem to be
overwhelmingly positive. First notice that, as can be seen from the rise in the government
deficit, the interest-rate subsidy is far from self-financing. This becomes clear if one compares
the trend of income (GDP) with the trend of consumption, which shows that the losses in
VAT revenue outweigh the induced increase in income taxes. In order to stabilise the
debt-to-GDP ratio, it is assumed in the model that transfers to households will be reduced.
This is another reason why consumption is not picking up. Of course, this mode of financing
is relatively non-distortionary; if other financing alternatives were chosen such as an increase
in labour taxes, the GDP and employment effects would be likely to be smaller.

88

Table 1: Macroeconomic effects of an interest-rate subsidy (EU economy)

2000A
0.49
TOTAL.GDP_PCER
0.27
YQPOT_PCER
-0.73
PRIV.CONS_PCER
4.73
PRIV.INV_PCER
-0.00
EXPORTS_PCER
0.35
IMPORTS_PCER
0.21
EMPLOYMENT_PCER
0.07
REAL.WAGE.COSTS_PCER
0.30
PRICE.LEVEL_PCER
0.14
CONS.PRICE.LEVEL_PCER
IMPORT.PRICES_PCER
-0.10
EXCHANGE.RATE.USD_PCER -0.59
-0.40
REAL.EXCH.RATE_PCER
0.17
CAPITAL.STOCK_PCER
0.37
LAB.PROD_PCER

SHORT.RATE_ER
LONG.RATE_ER

REAL.SHORT.RATE_ER

INFLATION_ER
UNEMPL.RATE_ER
DEBT.TO.GDP_ER
DEFG.TO.GDP_ER
TRADE.BAL.TO.GDP_ER

0.26
0.09

0.37

0.14
-0.19
0.94
2.13
-0.10

PCER: % deviations from baseline

ER: % point deviations from baseline.

2001A
0.19
0.27
-1.86
5.93
-0.28
0.08
0.12
0.19
0.22
0.10
-0.05
-0.38
-0.27
0.53
0.10

0.14
0.09

0.14

-0.04
-0.11
3.36
2.28
-0.10

2002A
0.33
0.37
-1.66
5.71
-0.09
0.21
0.10
0.29
0.22
0.12
0.01
-0.24
-0.21
0.87
0.27

0.13
0.09

0.13

0.02
-0.09
5.44
2.33
-0.08

2003A
0.42
0.47
-1.50
5.41
0.05
0.29
0.10
0.37
0.22
0.15
0.08
-0.10
-0.14
1.18
0.38

0.14
0.09

0.13

0.03
-0.09
7.55
2.37
-0.07

2004A
0.52
0.57
-1.33
5.11
0.18
0.38
0.10
0.46
0.23
0.19
0.16
0.04
-0.07
1.44
0.48

0.15
0.09

0.14

0.03
-0.09
9.62
2.41
-0.06

2005A
0.59
0.66
-1.19
4.91
0.31
0.46
0.11
0.54
0.24
0.23
0.24
0.20
-0.00
1.68
0.56

0.17
0.09

0.16

0.04
-0.10
11.71
2.44
-0.04

2006A
0.68
0.74
-1.06
4.78
0.43
0.53
0.12
0.62
0.26
0.28
0.33
0.38
0.07
1.91
0.64

0.19
0.09

0.16

0.05
-0.11
13.84
2.49
-0.03

2007A
0.77
0.82
-0.94
4.67
0.57
0.62
0.12
0.71
0.29
0.34
0.44
0.58
0.15
2.12
0.74

0.22
0.08

0.17

0.07
-0.12
15.95
2.54
-0.01

2008A
0.88
0.90
-0.81
4.62
0.72
0.71
0.13
0.82
0.35
0.45
0.59
0.82
0.23
2.31
0.85

0.30
0.08

0.19

0.10
-0.13
18.04
2.61
0.00

2009A
1.04
0.98
-0.69
4.70
0.91
0.85
0.15
0.95
0.49
0.62
0.82
1.16
0.33
2.49
1.01

0.44
0.07

0.24

0.17
-0.14
20.07
2.70
0.02

89