The legality of government support for Northern Rock may not be determined for months or even years after the European Commission announced yesterday it is to hold an in-depth investigation into the move.
The inquiry will consider only whether the ongoing restructuring of the nationalised bank complies with competition rules. Earlier government support was rubber-stamped by the commission as it complied with provisions authorising temporary state for six months.
The bank was eventually taken into state ownership in February. It had been supported with £25bn of government loans since September after the mortgage securitisation market virtually closed, cutting off its major source of finance.
Northern Rock's turnaround plans were submitted to the commission on March 17. It provided for a vast reduction in the Newcastle institution's lending operations and a repayment of loans made by the Bank of England as well as a phasing out of government guarantees on its deposits.
But Competition Commissioner Neelie Kroes said: "The commission needs to open a formal investigation into UK measures to restructure Northern Rock to ensure legal certainty, notably in view of the large scale of the aid measures, the background of current conditions in financial markets and the risks of distortion of competition."
The commission indicated that it had not received full details of the restructuring plan and that it has requested further information from the UK authorities.
It has also called for submissions from "interested parties" on whether the government has put in place significant measures to avoid distorting the market.
This could give Northern Rock's numerous rivals the chance to voice the discontent many have expressed about the difficulty of competing against a bank with state backing.
The prospect that the bank may eventually have to compensate the government for some of the aid it has received and dramatically alter its restructuring plans could hang over it for some time.
Colin Miller, partner at Glasgow corporate law firm Biggart Baillie said: "These state aid investigations can go on for years particularly something like this because it is so big."
He added: "The commission will ask the building societies and the banks to put in their tuppence worth."
Separately, the commission is also looking at the state bail-outs of German banks IKB and Sachsen.
The commission has in the past stopped UK government authorities distorting the market but the cases were on a far smaller scale.
One notable case was its intervention in 2004 to force Scottish Enterprise to re-tender a contract to put high-speed internet links into business parks in the Central Belt after it responded to a complaint from Glasgow telecoms firm Thus by ruling the private sector should be given a greater role.
In 1990, it ordered the government to recover £43m of aid it had paid out to help British Aerospace buy former state-owned car manufacturer Rover.
Northern Rock said earlier this week that it expected to remain "significantly loss making" in 2008 and break even by 2011.
The government is facing another legal challenge, in the form of a judicial review, from small shareholders and hedge fund SRM Global over the system in place to calculate the compensation owed to the bank's former investors.
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