Why Italy’s €17bn bank rescue deal is making waves across Europe https://www.ft.com/content/03a1c7d0-5a61-11e7-b553-e2df1b0c3...

Italian banks

Why Italy’s €17bn bank rescue deal is making waves across Europe
Critics say use of state funds to deal with failing Veneto banks undermines EU rules

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JUNE 26, 2017 by FT Reporters

The rules seemed clear. After anger at how EU taxpayers had to meet the cost of bank
rescues during the financial crisis, any more failing lenders would have to be dealt with, as
far as possible, by their own shareholders and creditors.

But the €17bn of Italian government money committed at the weekend to deal with two
failing regional banks seems to flout that idea.

We examine why the rescue of Veneto Banca and Banca Popolare di Vicenza is
reverberating in Rome, Brussels and beyond.

What is the difference between liquidation and resolution?

Under the new EU rules, stricken banks are put into “resolution”, a legal process that
hands sweeping powers to regulators to decide how to safely wind them down. The law,
known as the Bank Recovery and Resolution Directive (BRRD), aims to protect taxpayers
from having to bail out banks by making creditors, including senior bondholders, liable
for losses.

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In the case of the Italian banks, the Single Resolution Board — the eurozone agency
responsible for dealing with bank crises — decided resolution was “not warranted in the
public interest” because their failure was not expected to have “significant adverse impact
on financial stability”. This opened the door for the banks to be dealt with under national
insolvency procedures instead.

What was the level of risk to the financial system?

The banks’ total balance sheets were €55bn — 2 per cent of the Italian banking system,
leading EU regulators to conclude that the banks’ failure would have a limited systemic
effect.

But Italy was able to argue there was regional economic risk from the failure of two
important regional lenders.

And some bankers and officials in Italy believe the Veneto banks did pose a risk to Italy’s
banks. A resolution under EU rules would have required them to find €12bn for the
country’s deposit guarantee fund. UniCredit, Monte dei Paschi di Siena and UBI Banca,
which have all recently been, or are going, to the market for extra capital, would have had
to make further capital calls and may have been deserted by investors, bankers argue.

In addition, all existing loans from the two banks would have been called in with
immediate effect.

Italian officials and bankers feared the result would have been a disorderly administration
and a domino effect, with bank runs on other Italian financial institutions.

Why were senior bondholders not hit?

Italy wanted to shield creditors, including senior bondholders, because a significant
amount of the Veneto banks’ debt had been sold to retail investors as part of an alleged
mis-selling scandal, European officials say.

To do this, the decision to allow Italy to liquidate the two banks under national insolvency
laws was key, since the recovery and resolution directive does impose losses on senior
creditors to fund restructuring.

Italian officials worked through the weekend to structure a government decree that would
allow the banks to be restructured under Italian law. This involved Intesa Sanpaolo, Italy’s

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best capitalised large bank, cherry-picking the good assets, supported by a government
subsidy of €5.2bn.

Defending Italy’s move on Monday, Fabio Panetta, deputy governor at the Bank of Italy,
said: “I think resolution would have been very costly not just in monetary terms but also
in terms of confidence.”

Another complication for Brussels and Rome was that €10bn of bonds issued by the two
banks were guaranteed by the Italian state, with the agreement of the commission.

The bonds did not give Italy much of a choice. It could either provide state aid to smooth
the winding down of the banks — and protect some bondholders — or face the bonds
being wiped out and the guarantees being called upon. In either case, the government
ended up paying.

Why were the guarantees authorised?

According to people briefed on the matter, the decision rested on an assessment by the
European Central Bank in January that the two banks were solvent. The ECB made the
call despite longstanding concerns about their health and poor performance in regulatory
stress tests.

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Sources close to the ECB’s bank supervision arm point out that the decision that the banks
were “failing or likely to fail” only came at the end of a process during which the two
lenders had tried and failed to raise sufficient private capital. That process had to be
exhausted before they could be declared insolvent.

FT View: EU banking union still has far to go

Comment: European banking union falls short
Lex: Italian bailout — too small to fail

Why does Intesa get a taxpayer guarantee?

Both Intesa Sanpaolo and Banco Santander in Spain have acquired stricken rivals for only
€1 in the past month. In each case, shareholders and junior bondholders of the smaller
banks were wiped out while senior debt and deposits were protected. But that is where the
similarities end.

Intesa insisted it would only take over the two lenders if they were cleansed of bad loans
by a bailout that also covered the costs of branch closures, lay-offs and legal risks.

Santander, in contrast, had to launch a €7bn share sale to fund the takeover of Banco
Popular. Madrid refused to provide any taxpayer money to rescue Popular.

However, Popular was a bigger bank and in better shape than the two Veneto banks,
which have a much higher ratio of toxic loans on their balance sheets. Popular also had a
strong small business lending operation that Santander had long coveted.

Is this end of Italy’s banking problems?

Rome certainly hopes so. “This could be a turning point, not just for these two banks but
also for the perception and the image of the Italian financial system,” Mr Panetta said on
Monday. The market reaction seemed to support his confidence, with banking shares
rising across the board.

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But Italian banks are not necessarily out of the woods. There is still a risk that the Veneto
deal could fall apart if lawmakers fail to approve the weekend’s decree.

And while MPS, the biggest sore point in the Italian banking system, has been dealt with,
there are other causes of concern, beginning with Carige, a Genoa-based bank. And if the
Italian economic recovery does not gather pace, it could still be difficult for other banks to
lower their stock of non-performing loans and open the credit spigots.

How much damage has been done to EU’s regime for failing banks?
When the EU introduced the BRRD it was supposed to stop failing banks being bailed out
by taxpayers. But the Veneto deal blows a big hole in that concept, according to some
investors.

“Any country willing to protect senior bondholders (preferred or not) now has a legal
route to do so: indeed, the Italian authorities have unearthed a formidable loophole in the
BRRD,” said David Benamou, managing partner of Axiom Alternative Investments, a
Paris-based investor in bank debt.

But another investor said the deal was positive: it showed the system could bend rather
than break when challenged. In this case, Italy faced a politically sensitive issue because a
high proportion of the bank’s senior bonds are held by retail investors.

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However, there is a growing view among many politicians and officials in Brussels that the
system has been damaged as a result, with MEPs warning that the credibility of the
eurozone banking union is under threat.

Reporting by Jim Brunsden in Brussels, Martin Arnold in London, Rachel Sanderson in

Milan and James Politi in Rome

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