Italy has finally gotten around to sorting out its banks. But the way it is going about it looks horribly familiar. Never mind the EU’s high-minded ideas about bailing in creditors. In Italy, they like to do things the traditional way. Bailouts are back.
The background to this is the disastrous liquidation of four small popolari banks in December 2015. Imposing losses on retail bondholders proved politically toxic after one man committed suicide. Unsurprisingly, the wobbly Italian government, facing populist challenge from the left-wing nationalist Five Star Movement, was anxious to avoid putting any more bullets in its sensitive political feet. Bailouts might be unpopular, but at least they don’t wipe out people’s savings.
So, in December 2016, the Italian government approved a 20bn euro bailout fund. Italy would have to borrow this money, of course. But no matter, Italy has borrowed so much already that a bit more won’t make much difference. And anyway, the ECB has its back. Italian government bonds are included in the ECB’s QE program, which effectively caps their yields. A Greek-style bond crisis would be all but impossible.
True, as the additional borrowing will temporarily increase Italy’s deficit to GDP, it might fall foul of the Stability and Growth Pact. But the Italian government doesn’t care. Italy’s banks have been weighing down its economy for a long time. If fixing the banks enabled Italy to return to vibrant growth, that would more than offset any fiscal austerity measures the EU might impose to reduce the deficit.
The first candidate for bailout was Monte Dei Paschi Di Siena (MPS), the 14th-century monolith that desperately needs more capital to prevent it falling over. In December 2016, a precautionary recapitalization of the creaking giant was provisionally agreed, subject to EU approval. According to Reuters, the Bank of Italy’s Deputy Governor says EU approval for MPS’s precautionary recapitalization is now a 'done deal'.
This is, of course, recapitalization by means of an injection of state aid – hence the need for EU approval. MPS’s recapitalization will cost Italian taxpayers 6.6bn euros, of which 2bn euros will go towards compensating ordinary Italians who were sold MPS’s subordinate debt as a safe investment for their retirement savings. In the UK we call this mis-selling, and we expect the banks to pay – well, unless it is the Co-Op Bank, of course. But in Italy, as I said, they do things differently. Bailing these people out is better than wiping their savings. At least there will be no suicides this time.
Now two more banks are being bailed out. But these are not leaning towers that could bring down the European banking system if they fall. No, they are small local banks. Two more popolari, in fact. Banca Popolare di Vicenza and Veneto Banca, which together are known as the 'Veneto Banks' because they serve the area around Venice.
On June 23rd, 2017, the ECB declared the two banks 'failing or likely to fail' because they 'repeatedly breached supervisory capital requirements'. It said that the two had been given time to produce plans for raising more capital, but had been unable to do so. In short, they are insolvent.
In the Eurozone, the Single Resolution Board (SRB) ultimately decides what should be done with insolvent banks. If they threaten the stability of the European banking system, then the SRB takes responsibility for resolving them in accordance with the Bank Resolution and Recovery Directive (BRRD). The BRRD requires burden sharing by creditors: at least 8% of total liabilities must be met from shareholders' funds and haircuts on subordinated and, if necessary, senior debt, and even uninsured deposits, before taxpayer funds can be used. If the SRB decided the banks were systemically important, therefore, senior creditors might have to take losses. For the Italian government, this would be extremely bad news.
Fortunately, the SRB concluded that these banks do not pose a systemic risk to the European banking system, and washed its hands of them:
Following today’s decision taken by the European Central Bank to declare Banca Popolare di Vicenza S.p.A. and Veneto Banca S.p.A. as ‘failing or likely to fail’, the Single Resolution Board has decided that resolution action by the SRB is not warranted for these banks. As a consequence, the winding up of the banks will take place under national proceedings launched by the Italian authorities.
Now, you would think that this would mean the banks would be wound up by the Italian courts and losses imposed on creditors according to rank, as in a normal bankruptcy, wouldn’t you?
Not a bit of it. The Italian government decided that although these banks might not be systemically important to the EU, they most certainly are to Italy. Claiming that allowing them to fail would cause disruption to the local economy in Venice, it bailed them out.
The bailout is dressed up as a rescue by a larger bank along the same lines as Santander’s recent acquisition for a nominal 1 euro of the insolvent Spanish lender Banco Popular. Like Santander, Intesa Sanpaolo, Italy’s second-biggest lender, will buy the two banks for 1 euro. But there the similarity ends. Santander took on full responsibility for recapitalizing Banco Popular, for which it announced a 7bn euro rights issue. But Intesa isn’t taking financial responsibility for anything. The Italian government is paying Intesa about 5bn euros in cash to take over the two banks, and is additionally providing guarantees worth 12bn euros for the two banks’ bad assets. The total bailout amount is thus around 17bn euros, though according to the European Commission, the net cost will be much lower:
Both guarantees and cash injections are backed up by the Italian State's senior claims on the assets in the liquidation mass. Correspondingly, the net costs to the Italian State will be much lower than the nominal amounts of the measures provided.
The bailout imposes losses on the two banks’ shareholders and subordinated debtholders. But the all-important seniors have been spared, and small subordinated debtholders will be compensated by Intesa from the funds provided by the Italian government. The BRRD has effectively been sidestepped.
Did the EU oppose this sleight of hand? No. In this statement, the European Commission approved the use of taxpayers’ funds to bail out these banks:
The Commission found these measures to be in line with EU State aid rules, in particular the 2013 Banking Communication. Existing shareholders and subordinated debt holders have fully contributed to the costs, reducing the cost of the intervention for the Italian State. Both aid recipients, BPVI and Banca Veneto, will be wound up in an orderly fashion and exit the market, while the transferred activities will be restructured and significantly downsized by Intesa, which in combination will limit distortions of competition arising from the aid.
Remarkable. Winding up two banks in the Venetian area would cause massive economic disruption. So the solution is to create an effective banking monopoly in that area. And this doesn’t distort competition, apparently. I detect a distinct odor of Eurofudge.
Italy's decision, supported by the European Commission, tramples the BRRD to death. Senior creditors need never again fear losses due to a failing bank. If it is systemically important, it will be given a precautionary recapitalization at taxpayers’ expense. If it is not, an excuse will be found to bail it out at taxpayers’ expense. Either way, seniors and unsecured depositors are safe.
That is, they are as safe as politicians want them to be. Italy is able to bail out these banks – and will no doubt in due course bail out others too – because it is a big country which can easily borrow the funds needed. It has decided to do so principally because its politicians fear for their jobs if the Venetian economy tanks and small bondholders lose their savings. And the European Commission has supported its decision principally because Italy is much too big to bully. The long-running standoff between the EU and Italy over bank resolution has ended with the EU caving in.
Predictably, this ignominious climb-down is being celebrated as a pragmatic compromise. But it is nothing of the kind. The EU’s brief flirtation with market discipline for banks is over. Senior creditors and unsecured depositors of banks in big Eurozone countries with wobbly governments now know they are safe from bail-in.
But that is not true in smaller countries, especially if they have big debts. If a government can’t afford to bail out its banks, senior creditors and unsecured depositors are still on the hook. And as Greece knows all too well, the European Commission finds it much easier to enforce rules when the country is not systemically important. Portugal is no doubt furious, since not long ago it imposed a highly contentious haircut on senior creditors to recapitalize the BES 'good bank' Novo Banco. But I doubt if it would have gotten away with state recapitalization. It just isn’t big or important enough.
We now have a two-speed Eurozone, made up of big countries that can do what they like, and small ones that must obey the rules set by the big ones. Not that there is anything new about this. We are simply back to where we were in the good old days, when Germany and France could break Eurozone rules with impunity but woe betide a smaller country that tried to do so. Italy, too, is part of the “too big to bully” club. Bankers, you know what to do.
