SUPERVISION OF MONTE PASCHI DI SIENA BY BANK OF ITALY: SUMMARY

(The following is an English translation of a document
prepared by Italian Finance Minister Vittorio Grilli for his
testimony in the Italian Parliament on Jan. 29 on Banca Monte
dei Paschi di Siena. The release was not confirmed by the
sender.) 
The supervisory activities conducted by the Banca d’Italia in
recent years with regard to Monte dei Paschi di Siena (MPS)
have been continuous and of growing intensity, with a focus on
the main areas important for its management: capital adequacy,
the prudent management of the liquidity position, financial
risks and, in particular, interest rate risk, the dynamics of
the large holdings of mainly long-term Italian government
bonds, credit quality, the verification of internal models for
measuring credit and operational risk, and the adequacy of
management and of the system of internal checks. The following
pages provide a brief description of the main supervisory
actions with regard to MPS, in chronological order: 
In January 2008 MPS submitted to the Banca d’Italia its
application to acquire ABN AMRO’s Antonveneta group
(BAV). The cost of the operation was around 9 billion (6
billion of which was for goodwill). A liquidity
commitment - of an estimated amount of around 9.5 billion
- was foreseen for MPS, for the purpose of repaying
(within 12 months of the conclusion of the contract) the
credit lines previously committed by AMRO to BAV. In line
with the applicable legislation, the cost was evaluated
in relation to the capital adequacy and on the basis of
its financial sustainability for MPS. 
The application contained a plan for a capital increase,
which was required in order to remain compliant with
capital ratios. A capital increase of 6 billion was
foreseen, 5 billion of which was earmarked for
shareholders and 1 billion for JP Morgan for the issuance
of convertible bonds in Monte shares (known as “FRESH”);
a further 2 billion was obtained via bond issuance. 
In March 2008 the Banca d’Italia informed MPS that the
conclusion of the operation was dependent on the
achievement of the above-mentioned capital strengthening
measures. With reference to the capital increase
earmarked for JP Morgan and the planned issuance of FRESH
bonds, the supervisor asked MPS to ensure that the
relevant contractual arrangements were consistent with
the tier one rating assigned to the instrument and to
guarantee the complete transfer of enterprise risk to
third parties. 
In May 2008 MPS reported that it had completed its plan
to increase its capital, as requested by the Banca
d’Italia. On the basis of the documentation provided, the
Banca d’Italia began an in-depth analysis of the draft
contract for the FRESH operation in order to verify the
compliance of the asset in question with supervisory
requirements. 
Technical discussions with MPS continued until September
2008, when the Banca d’Italia formally informed MPS of
the elements preventing the full inclusion in the bank’s
tier one capital of the shares used for FRESH. 
MPS provided the Banca d’Italia with new contractual
arrangements for the FRESH operation, in line with the
provisions of the Banca d’Italia. The Banca d’Italia took
note of this in October 2008. Further details were
subsequently to emerge in this regard (see below). 
In the second half of 2009 the supervisor intensified its
close examination of the liquidity conditions of the MPS
group. At the beginning of 2010 the bank was summoned by
the supervisor on three occasions in quick succession, on
5 March, 30 March and 21 April 2010. From 3 to 7 May the
supervisor visited the bank for a series of informative
meetings. It emerged that there was a high incidence of
repo operations backed by long-term Italian government
bonds, resulting in the absorption of high liquidity
margins (owing to growing demands for margin-setting) in
the context of worsening market conditions. The situation
of the bank was considered to be unclear and potentially
critical. 
Banca d’Italia’s supervisory rules are strict as regards
the necessary safeguards for complex financial
activities. The rules, laid down in 2004, state that
banks dealing in credit derivatives - as with the
transactions carried out by MPS - must be able to
evaluate on a daily basis developments in the prices of
individual products and in the overall risk profile of
their portfolios. More generally, the rules state that
banks unable to correctly measure and manage risks
associated with complex financial instruments must
abstain from trading in such instruments. 
In order to gain further necessary information in situ, a
supervisory inspection was launched immediately, looking
at the MPS group’s liquidity management and its financial
risk division. 
The supervisory inspection was carried out between 11 May
and 6 August and highlighted tensions in the liquidity
situation and a high level of exposure - not measured
precisely - to rate risk. The inspection also highlighted
the extent of investment in government bonds, the value
of which was quite conspicuous (around 25 billion). In
particular, the liquidity position, characterised by high
balance sheet volatility, had been mainly affected by two
structured repurchase agreements relating to government
securities carried out with Deutsche Bank and Nomura
respectively, with a total nominal value of around 5
billion euro, with risk profiles that were not adequately
monitored or measured by MPS, nor fully reported to the
administrative body. 
With reference to the assets of the Santorini vehicle,
the inspection did not reveal any information to support
the launch of a sanctions procedure or an alerting of the
legal authorities. In addition to the significant effect
on liquidity, a problem came to light in relation to the
book-keeping procedures (cost evaluation) adopted by MPS
and approved by the auditing company. These procedures
gave rise to reservations on the part of the supervisor
as regards the operation’s representation on the balance
sheet, which did not show its fair value. Given that
Banca d’Italia does not have powers as regards balance
sheet auditing, considering the complexity of the
operation and the possible room for interpretation
created by the IAS accounting rules, the Banca d’Italia
decided in November 2011 to conduct a more in-depth
specific accounting review of this issue, in
collaboration with the other authorities in this field,
in part so that an explanation could be provided to the
entire banking system. Given the particularly complex
nature of the operations, a discussion was opened that
has not yet been concluded. 
In the second half of 2010, in part owing to the initial
findings of the supervisory inspection, it was clear that
the capital of the bank needed to be strengthened as
before. A formal request for this was made in late August
2010. In subsequent meetings held in the autumn of 2010,
the level of increase in capital was discussed. In
particular, the supervisor requested that the level of
increase initially envisaged by the bank be made higher
to take into account the exposure to sovereign risk and
the need to strengthen the bank’s reserves in light of
the stress tests to be carried out at European level. 
The supervisory report was presented to MPS during a
meeting of the Board of Directors in the presence of the
Statutory Board of Auditors on 29 October 2010. On that
occasion the supervisor among other things reaffirmed the
urgent need to ensure, as before, a consistent increase
in capital and to strengthen the internal monitoring
system. The increase in capital was then to effectively
take place between April and July 2011 with a total
increase in core tier 1 capital of 3.2 billion, 2 billion
of which was to be paid in cash by the shareholders. 
In the face of requests for intervention and formal
notices, the corporate bodies of the banks were required
to respond to the findings of the inspection by Banca
d’Italia and report to it on the measures already taken
in order to rectify the shortcomings identified by the
inspection and measures planned for the future. In this
context, MPS indicated: the adoption of a organisational
model for the finance division which is uniform for the
entire MPS group; new supervisory and control tasks for
the Finance Committee with regard to the investment
choices of various entities within the MPS Group
(overseas subsidiaries were asked to suspend all trading
activity); and changes to the risk-management strategy,
with the aim of improving the measurement of financial
risk and achieving more rigorous financial risk control.
MPS stated that structured repurchase agreements relating
to Government securities were economically rational in
support of carry trade strategies and the intention to
take on reduced risk-return profiles in the context of
the overall position of the bank. For those reasons, and
taking into account adherence to operational limits in
place, these measures were not submitted to the
administrative body, but approved by the Finance
Committee and the Director General. 
The supervisor further intensified its scrutiny of the
three main areas which emerged as particularly
problematic in the course of the 2010 inspection: 
Liquidity risks: the submission to the supervisor of a
daily report on liquid balances was imposed;
strengthened governing procedures and an internal
survey on liquidity risks were requested; and the
verification of funding plans with the involvement of
management, which was expected to be ongoing, began.
These exercises revealed dysfunction and shortcomings
which sometimes seriously compromised the reliability
of the data: on 22 September 2010, during a conference
call, the supervisor asked Mr Vigni, the Director
General of MPS, to personally sign all information on
the bank’s liquidity position to be sent to Banca
d’Italia in its supervisory capacity on a daily basis; 
Interest rate risks: the supervisor requested that a
report on risk management be sent to it periodically;
the bank was also asked to include its specific
interest-rate risk profile in its capital adequacy
rating; 
Sovereign risk:  the evolution of the Government
securities portfolio became subject to constant
monitoring. Continuous checks on the quality of data
revealed organisational and procedural shortcomings
which became the subject of a formal intervention in
March 2011; in the absence of tangible results, the
bank was again sent a formal letter of intervention in
May 2012; the unsatisfactory response on the part of
the bank necessitated the opening of a sanctions
procedure in respect of the former managers. 
The Banca d’Italia collaborated closely with the
authorities of the United Kingdom (FSA), the United
States (Federal Reserve) and Hong Kong (the Hong Kong
Monetary Authority) in the monitoring of the liquidity
positions of the MPS branches in London, New York and
Hong Kong.
Seven meetings with the bank were held in the period between
the end of the inspection and the beginning of the following
inspection to discuss the specific areas of focus of the
supervisory report. A formal intervention letter was sent to
the corporate bodies of the bank. 
As of summer 2011 the rapid deterioration in market
conditions (the sovereign debt crisis spread to Italy)
caused a further severe weakening of the liquidity
position of MPS, especially following the widening of the
safety margins of the two above-mentioned repo
agreements. The supervisor, through both formal and
informal interventions, called for those at the helm of
the bank to focus on the absolute urgent need to adopt
all the necessary measures to re-establish appropriate
liquidity margins. 
In September 2011, the supervisor launched an urgent
second inspection of the bank, in order to carefully
assess the suitability of the measures adopted by MPS.
The assessment, which began at the end of September, also
provides - in tense market conditions - for a direct
check of the MPS group’s liquidity management, essential
to monitoring the situation in close connection with the
Banca d’Italia’s central supervisory offices. 
The supervisory inspection indicated, in the initial
phases, that the issues previously highlighted by the
Banca d’Italia in its supervisory capacity had not, in
fact, been overcome and confirmed that the MPS group
continued to have significant organisational problems and
an inadequate managerial structure. 
The bank’s liquidity position became increasingly
fragile.  In autumn 2011, the Banca d’Italia was obliged
to conduct securities lending operations in order to
enable the bank to increase its recourse to refinancing
from the European Central Bank. 
Given the difficult situation uncovered as a result of
the latest inspection, on 15 November 2011 the Director
of the Banca d’Italia summoned the senior management of
MPS and of the MPS Foundation to Rome in order to make
them face up to their responsibilities and ask MPS to
quickly and definitively turn around the way it conducts
its business. 
MPS later terminated the contract of its Director
General, Dr Vigni. On 12 January 2012, Dr Viola was
appointed as Director General. Upon termination of his
contract, Dr Vigni received a payoff of approximately €4
million. In July 2012, the Banca d’Italia, deeming the
payoff was not justifiable given the circumstances,
delved further into specific aspects of the matter which
then led to a formal intervention letter being  written
and sanctions being imposed on the administrative and
control bodies in office at the time, who were
responsible for the decision. 
On 19 January 2012, the Governor of the Banca d’Italia
sent a letter to MPS setting out the remarks from the
Board of Directors at MPS, made during the meeting on 15
November. In the light of the revealed shortcomings and
tensions, MPS was asked for an emergency intervention
plan. 
The inspection of MPS was completed on 9 March 2012,
after the MPS group’s liquidity position was normalised,
following, among other things, MPS’ participation in the
two three-year refinancing operations conducted by the
ECB. The inspection report was highly critical, citing
the bank’s serious shortcomings in its liquidity
management. Sanctions were imposed on the administrators,
the former Director General, the auditors and the members
of the Board of Directors for shortcomings in
organisation, internal checks and breach of the
regulations on containing financial risk. These
proceedings are in their final stages. 
In the inspection report, the structured repo agreements
mentioned previously were reexamined. MPS is criticised
for not critically reviewing these operations in terms of
their cost and advisability, even following the findings
of the Banca d’Italia on the occasion of the previous
inspection.  The bank was also questioned as to the
repeated irregularities which led to the exposure
deriving from these repos being underestimated. Relevant
information, providing further details on the transaction
with Nomura, highlighting the Alexandria restructuring
operation carried out with Nomura, and on the way the
accounts were handled in the transaction with MPS, was
submitted to the CONSOB (Commissione Nazionale per le
Società e la Borsa, the public authority responsible for
regulating the Italian securities market).  At the same
time, the supervisory report was communicated to the
legal authorities. 
At a meeting on 27 April 2012 the majority of the members
of the Board of Directors and the Board of Statutory
Auditors were replaced. Mr Mussari did not renew his
candidature for the role of President. 
In June 2012 the new corporate bodies approved the new
business plan, which contained the extraordinary
initiatives requested by the Banca d’Italia on 19
January. 
The plan, among other matters, confirmed the commitment
to achieve by 30/06/2012 the capital target (9% of core
tier 1 plus an exceptional temporary buffer for the
holding of state securities) set by the EBA in the
recommendation of December 2011, aimed at increasing
market confidence in the capacity of the banking system
to withstand adverse shocks. Although its capital was
well above the amount provided for in the prevailing
regulations, Banca Monte dei Paschi di Siena recorded a
shortfall of €3.3 billion as at 30/09/2011 compared with
the target set in the EBA recommendation. The shortfall
was entirely attributable to the valuation at market
prices of Italian State securities held in its portfolio
(about €25 billion); leaving aside the sovereign risk
buffer required by the EBA (€3.5 billion), the bank’s
core tier 1 ratio as at 30/09/2011 was equal to 9.2%. The
plan put in place by MPS to strengthen its capital did
not enable it to make up the shortfall entirely. The
Banca d’Italia therefore asked the Ministry of Economy to
adopt a public backstop measure, as provided for in the
decision of the European Council of Heads of State or
Government of 26October 2011. In November 2012 MPS put
the amount of the intervention at the maximum amount
provided for under the law, equal to €2 billion; the
Banca d’Italia gave a favourable opinion. 
In the ensuing months many senior managers with key roles
were replaced. 
On 17 July 2012 MPS provided its response to the
inspection findings . In general, having regard to the
entire contents of the inspection findings (weakness of
the financial balance, failings in organisation and
controls), MPS cited the objectives in the recently
approved corporate plan for 2012-2015, in which the
central components were the financial rebalancing of the
group and the initiatives specified in the plan to
strengthen the liquidity position and the organisational
and control structure. With regard to the Deutsche Bank
and Nomura operations, MPS stated that, in order to
reduce the absorption of liquidity by such financial
investments, it had tried to mitigate the collateral
obligations by negotiating with the counterparties
possible amendments to the relevant contractual clauses.
In view of some amendments to the contracts agreed with
Deutsche Bank, the negotiations with Nomura were
abandoned by MPS owing to the heavy impact it would have
had on the profit and loss account. 
In a letter of 15 October 2012, MPS notified the
supervisor that on 10 October MPS’s new directors renewed
a contract dated 31 July 2009 between Banca Monte dei
Paschi di Siena and Nomura, related to the restructuring
of the Alexandria security transaction. This is a
“framework” contract that provided evidence of the link
between the restructuring of the Alexandria security
transaction and the repo operations carried out with
Nomura, and gave details about the real purposes of the
operations. The contract had not been disclosed to the
Banca d’Italia’s inspectors who were responsible for
checks conducted on MPS’s finance division in 2010 and
2011. In the absence of these documents, the supervisor
was not previously able to identify with certainty the
full purpose of the various components of the operation.
The new information also contributed to strengthening
reservations previously expressed regarding the
background to the Santorini operations. 
In the light of the above, the Banca d’Italia requested
that MPS provide it with an analytical and timely
reconstruction of the real nature of the transaction
carried out on the basis of the contract provided. In
addition, the Banca d’Italia asked MPS for an assessment
of the current and future impact of the operation on the
economic and patrimonial situation of both the bank and
the group as a whole, as well as of the accounting
practices used for the said operations, covering also
whether the data was entered appropriately in the
accounts requested. 
In this case, too, the Banca d’Italia immediately
informed the Public Prosecutor’s Office that the contract
had been kept hidden from the supervisory authorities at
the time of the inspections carried out in both 2010 and
2011. 
In an e-mail dated 28 December, before it provided the
formal response to the request for information issued by
the Banca d’Italia, MPS sent to the supervisory
authorities a draft report addressed to the board of
directors containing the initial references to the
Nomura/Alexandria, Deutsche Bank/Santorini transactions.
Mention was also made of a low impact transaction
entitled “Nota Italia”, in relation to which mistakes
were made in the figures as far as the specification of
risk factors was concerned. 
The e-mail in question also included the transcription of
a conference call that took place in July 2009 between
representatives of MPS and Nomura concerning the
transaction with the latter counterparty. In short, it
was specified that the framework agreement for the
Alexandria transaction would not be sent to the auditors.
In various written communications (dated 28 November
2012, 17 January 2013, 22 January 2013 and 23 January
2013), the Banca d’Italia informed the market that it had
requested further information on the aforementioned
structured repo agreements that had taken place in the
preceding years. 
From the end of 2011 the Banca d’Italia was kept informed
by Siena’s Public Prosecutor’s Office about the ongoing
investigation and was in constant contact with the judges
dealing with the enquiry, who received every possible
assistance and had access to all documentation, in
collaboration with the CONSOB and the Guardia di Finanza.
The establishing of the true nature of the transactions
by MPS was therefore also based on developments in the
criminal inquiries, which had brought to light facts that
were otherwise impossible to ascertain. 
In this regard, both the Banca d’Italia and the competent
judicial authorities worked in close cooperation to also
determine whether the contractual structures used for the
FRESH operation were in line with the regulations of the
Banca d’Italia and the information communicated at that
time by MPS to the supervisory authority. In response, in
December 2012 the Banca d’Italia instigated disciplinary
proceedings. 
To conclude, MPS has been subject to detailed scrutiny,
which has made it possible to identify and put a stop to
high-risk abnormal activity, leading the bank to
strengthen its administrative and control procedures. Its
business will henceforth be followed strictly by the
supervisory authorities, in close cooperation with the
new management, which is currently implementing a
comprehensive restructuring with a view to boosting
efficiency and restoring adequate profit levels. 
Following the action taken to date, the liquidity
situation has improved. Capital levels are more than
adequate with respect to the current regulatory limits:
the supervisory measures have led to an increase in the
total capital ratio of the MPS group from 9.3% at the end
of 2008 to 15.4% in September 2012 (compared with a
minimum regulatory limit of 8%). The public action that
is now required relates to the pursuit of the highest
objectives set by the EBA in its Recommendation of
December 2011 and the implementation of the restructuring
plan. 
Jan. 29 2013 
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