We believe the Italian government and European Commission are likely to agree soon on a viable plan (in compliance with EU state aid rules) that will protect small savers – most of the subordinated bond holders – who invested in Monte dei Paschi di Siena (MpS).
While at least for now MpS will not be sent to full resolution, a “soft” version of bail-in may be applied to non-retail sub-debt holders to satisfy the Commission before public money is injected or a form of public guarantee is issued.
The broader issue of Non-Performing Loans in the Italian banking sector is, however, unlikely to be addressed at this point, and almost certainly won’t be before the constitutional referendum in October-November.
July 12, 2016
On July 29, the European Banking Association will publish the results of its most recent stress tests on 51 European Union banks, covering 70% of the banking sector of the EU.
– To no one’s surprise, the stress tests will almost surely certify a major capital shortfall in Monte dei Paschi di Siena, formerly Italy’s third biggest bank, but now riddled with Non-Performing Loans, and in deep trouble for a while.
– Failing a stress test is one of the necessary pre-conditions for the Italian government to request that the bank be EXEMPTED from resolution, as stated in Article 32 of the EU “Banking Recovery and Resolution Directive” (or BRRD). The other condition, also likely to be fulfilled in this particular case, is that a resolution and subsequent bail-in of the failing bank could be a threat to financial stability in the country (see bottom of report for the relevant BRRD extract).
– But even if the above stated exception to the bail-in rules is applied, it does not mean a country can freely inject public money into a failing bank. If all the conditions for the special treatment are indeed met, an EU government still has to present a plan to the European Commission’s competition branch envisaging losses from private creditors (a bail-in) before public money is deployed. That process is explained in the European Commission’s July 10, 2013 Communication on state aid to banks, (also included at bottom of report).
– The Italian government is currently in advanced negotiations – which we believe will be successful – with the European Commission to obtain a slightly milder application of the above mentioned state aid Communication, a solution that would allow Renzi to minimize or eliminate losses for at least sixty thousand small savers who invested in a 2008 subordinated bond issued by MpS to acquire Banca Antonveneta, and who otherwise technically would have to be fully “bailed-in.”
– Negotiations have long been at a deadlock because the Commission has shown little appetite to put into question what it considers an already “generous” exception to the stricter BRRD regime. But since the Communication is a soft-law instrument, there is some wiggle room to agree on a plan that protects some of the “subordinated debt holders” — an outcome that would allow Italian Prime Minister Matteo Renzi to claim victory in the court of public opinion.
– And indeed there is precedent within the EU when politically necessary for carving exceptions or subsidizing retail holders when it comes to bail-ins, on the banking side in the case of Spain’s Bankia in November 2012, when the government was allowed precisely this — to compensate retail subordinated debt holders for their losses. Spanish banks were back then the object of a comprehensive plan (in the absence of specific EU legislation, as neither the BRRD nor the state aid communication were in place) that the government presented to the European commission to obtain the green light for an ESM-financed recapitalization.
– On that note, Renzi has also been arguing for a while now that in 2008, at the peak of the crisis, Germany and France were allowed to help their own banks by injecting public money, without having to ask for contributions from private creditors and depositors. But again, that situation was “exceptional,” and at the time neither the BRRD nor the Communication were yet in place.
– On the broader issue of tackling the entire stock of Italy’s Non-Performing Loans, the current political climate in the country makes it hard for Renzi to push for deeper state intervention at this point. Renzi has put his government on the line with the upcoming constitutional referendum on Senate reform, and is well aware his depleting political capital does not allow him to fight two tough battles at once. One exception would be exactly this type of broader intervention to protect small savers.
– Barring that, the Italian government has pursued two options, neither of them good: First is to request a temporary suspension of state aid rules by invoking a major threat to the EU’s financial stability – which would require member state unanimity and is highly unlikely at this point (though it can’t be ruled out if the crisis becomes really serious). The other, muddling through, option of bolstering the recently-created “Atlante” fund with additional contributions from the relatively more solid banks like Unicredit and Intesa (and with a slightly larger stake for the Cassa Depositi e Prestiti), while in the cards, lacks credibility due to the wobbly state of the rest of the Italian financial sector.
Excerpts from, BRRD directives:
Extract from Article 32, n. 4, BRRD:
For the purposes of point (a) of paragraph 1, an institution shall be deemed to be failing or likely to fail when (…) extraordinary public financial support is required except when, in order to remedy a serious disturbance in the economy of a Member State and preserve financial stability, the extraordinary public financial support takes any of the following forms:
(i)a State guarantee to back liquidity facilities provided by central banks according to the central banks’ conditions;
(ii)a State guarantee of newly issued liabilities; or
(iii)an injection of own funds or purchase of capital instruments at prices and on terms that do not confer an advantage upon the institution , where neither the circumstances referred to in point (a), (b) or (c) of this paragraph nor the circumstances referred to in Article 59(3) are present at the time the public support is granted.
Extract from the July 10, 2013 European Commission Communication.
40. State support can create moral hazard and undermine market discipline. To reduce moral hazard, aid should only be granted on terms which involve adequate burden-sharing by existing investors.
41. Adequate burden-sharing will normally entail, after losses are first absorbed by equity, contributions by hybrid capital holders and subordinated debt holders. Hybrid capital and subordinated debt holders must contribute to reducing the capital shortfall to the maximum extent . Such contributions can take the form of either a conversion into Common Equity Tier 1.
42. The Commission will not require contribution from senior debt holders (in particular from insured deposits, uninsured deposits, bonds and all other senior debt) as a mandatory component of burden-sharing under State aid rules whether by conversion into capital or by write-down of the instruments.